Economic Foundations for Entertainment and Media

1. Economic Foundations for Entertainment and Media Pricing and Value for Experience Goods

2. Demand and Value Demand and Demand Curves Prices • Reservation price • “Value” • “Bargain” Pricing • Pricing strategies • Price discrimination • Pricing innovations

3. An Important Aspect of Prices for Experience Goods: The Implicit Price Lady Gaga and Tony Bennett, The Axis, Las Vegas, 4/10/15

4. An Important Aspect of Prices for Experience Goods: The Implicit Price • Nominal price: $675+ • Implicit price: $ far more than $675 • Transportation (+ Parking + Any ancillary costs) • Time – at least 5 hours in total. • This divergence is characteristic of experience goods. They take time to consume. The time used up having the experience is part of the price. Choosing to see this concert means not using the time for some other purpose. • TIME IS THE REAL CONSTRAINT

5. “Value” • What is it? • From the consumer’s viewpoint • From the seller’s viewpoint • Creating Value • Capturing Value • Meaning • Sources of value

6. Pricing and Value from the Consumer’s ViewpointReservation price reveals “willingness to pay.”

7. Reservation Price:Price Strategy Under Uncertainty Your reservation price is $2,500. Auction to take place in 5 days. What would you do now?

8. Price and Value What are the reservation prices in this discussion? Consumer surplus? Is it ethical to buy something at a yard sale or a flea market at the seller’s asking price if you know the value of the item to be significantly higher than what is being asked? Let’s say, for example, someone is selling an old comic book worth thousands of dollars but asks for only a quarter because he or she does not know the true value. Is it incumbent on the seller to do his or her research? If the seller does not, is it fair game? The operative word in your question is “true” directly placed before the word “value.” You suggest the “true value” of a specific comic book is a few thousand dollars — but all that means is someone might be willing to pay that much for it, based on extrinsic qualities (rarity, for example). To the person running the flea market, the “true value” of the comic book is virtually nothing. There is no “true value” for any object: it’s always a construct, provisionally defined by a capricious market and the locality of the transaction. Things cost what they are being sold for, and they’re worth whatever the seller can get. … Look at it like this: Let’s say the person at the flea market was selling that same rare comic for $2,000. You, however, would be willing to pay far more than that; because of its sentimental value and the status it will bring among your comic-book-collecting peers, you’d gladly fork over $5,000. Would you feel the need to inform the seller, “You know, I’d actually pay you $3,000 more than what you’re asking”? I don’t think you would, and no one would expect you to.

9. Consumers Valuation of Products Surplus Value: Consumers must perceive “value” over price. By Attributes: Hedonic Pricing $3000+ The high price was one of the reasons for market failure. Consumers did not get enough surplus value.

10. The profits that can be obtained in a market come from consumer surplus • Final demand for a good or service reveals the surplus. • Stages in the delivery to the consumer may accumulate the surplus. • Total appropriable “rent” in a market is generated at the final sale. Different buyers have different reservation prices. These are “willingness to pay.” Therefore, demand curves slope downward. This is the total consumer surplus that can be extracted from all stages of this market. Price Pm Qm Quantity

11. Event Consumer Surplus Price=15 9,000 people are willing to pay 70 20,000 people willing to pay 60 (including the 9,000) 40,000 people willing to pay 30 (including the 20,000) 56,000 people willing to pay 20 (including the 40,000) 64,000 people willing to pay 15 (including the 56,000) Price Per Ticket 90 80 70 60 50 40 30 20 10 0 = 9,000(55) = 495,000 = 11,000(45) = 495,000 = 20,000(15) = 300,000 = 16,000(5) = 80,000 = 1,370,000 15 Tickets (1000s) 0 8 16 24 32 40 48 56 64 If all 64,000 tickets are sold at $15, revenue = $960,000. Is it possible to do better? How can promoters capture the consumer surplus in markets like this?

12. Scalpers andSellouts Promoters could sell out the concert at $2,000/ticket, but they don’t. Mork buys ticket to Star Wars Bar Scene concert for $500. Values ticket at $1,000 If Mork can sell the ticket for > 1,000, he will do so If Mork can only sell the ticket for $500 - $1,000 he will just go to the concert. Mindy values the concert at $1,600, offers Mork $1,100. Mork sells the ticket. New surplus for Mork is $100 Mindy buys for $1,100 a ticket that she values for $1,600, $500 in new surplus. The transaction creates $100 + $500 = $600 in new surplus value. Price 2000 1600 1100 1000 500 Tickets No one loses. Trade makes both people better off. What could be wrong?

13. Scalping: Reallocates the Surplus Why does Ticketmaster care? Why is it “illegal?” Should Hanna Montana, Bruce Springsteen and the Spice Girls care?

14. A Merger Made in Heaven

15. Why We Worry About this Merger • Horizontal Issues: Will the large market share enable them to raise prices? • Vertical Issues: Will control of venues and artists enable anticompetitive practices? • Foreclosure from markets • Bundling

16. Why does Bruce Springsteen care?

17. Live Nation Also Owns Tickets Now • Ticketmaster and Live Nation were opposed by DOJ but did merge in 2010. • Tickets Now is LNE’s own scalper. • This is a vertical integration case. • We will revisit later in the vertical integration section.

18. Economic Foundations for Entertainment and Media Strategic Pricing for Experience Goods

19. Demand Concepts • Consumer “response” to changed circumstances = the extent to which quantity demanded changes when price or income or something else changes • “Elasticity” is the measure of “responsiveness” • Response to changes in price = price elastity • Changes in Income – Recreation is the Normal Good (Recall: “Why do we work?”)

20. Less elastic More elastic Elasticity Ticket Price Less elastic Change in Price More elastic Quantity of tickets Change in Quantity

21. Demand Curves from the Seller’s Viewpoint • Elasticity of demand • %change Q / % change x • Income, price • Elasticity is a measure of seller’s market power • Consumer surplus measures consumers’ benefit from consumption • Sellers with market power can (only) obtain “profits” in a market by capturing consumer surplus • The less elastic is demand, the greater is the potential surplus

22. Applying Price Theory to Experience Goods • Different results from consumption: Humdrum goods vs. Experience goods • Implications for pricing and price strategies • The “price” • Monopoly pricing results

23. “Competitive Outcome” • Many sellers, many buyers • Any seller can sell as much as they wish at the “market” price • No seller can sell at a price above the market price • No buyer has (or would take) an opportunity to bid above the market price – there is no shortage so no incentive to do so.

24. Market Power over Price • Seller (Monopoly) = Control over price • Set any price they wish • Price strategically recognizing that quantity sold will depend on the price they set • Buyer (Monopsony) = control over purchase price • Typically labor markets • Ford modeling agency • Professional sports • Silicon Valley engineers conspiracy (HP, Apple,…)

25. Monopoly Pricing Monopolist will price where MR = MC. If MC > 0, this must be in the elastic region of the demand curve. For a performance, MC = 0. Price |Elasticity| > 1(Elastic) |Elasticity| < 1 (Inelastic) MC D Quantity MR If the |elasticity| is < 1, the price is too low. MR is < MC. Basic theory would not predict that a monopolist would price in the inelastic region of the demand curve.

26. Price Determination-Standard • In the presence of “market power” Market power is the ability to elevate price above the competitive norm. Short run profit is obtained by transferring consumer surplus from buyers to the seller. P* Marginal Cost Demand Qm Marginal Revenue

27. An Index of Market Power

28. Pricing Strategies • Exploit pockets of market power • Take advantage of market imperfections • Exploit unusual market configurations

29. New Broadway Math • 2001: Record price: $100  Producers $480 • 2006: Average price about $65 • 2006: “Premium Seats” (The Producers) • $200-$500 seats are now routine. • Theater owners had underestimated the number of inelastic buyers.

30. Concert Ticket Prices: Live Nation Effect Connolly, M. and Krueger, Al, “Rockonomics” http://www.irs.princeton.edu/pubs/pdfs/499.pdf

32. The Pricing Conundrum in Major League Baseball • Empirical Models of Demand Produce Price Elasticities between -1 and 0. • Team owners could raise revenue by increasing price • Are team owners pricing irrationality? • (I assume models that produce positive elasticities are misspecified)

33. “A current finding in estimates of the gate demand for sports events is pricing in the inelastic portion of demand.” This finding has puzzled analysts who study the demand for sporting events because it suggests that owners could raise ticket revenue by raising ticket prices. Estimated Long-run Elasticities of Attendance Elasticity Real Ticket Price ANA -0.88 ATL -0.57 BAL 0.72 BOS 0.57 CIN 1.95 CLE 2.74 DET 0.78 HOU -2.31 KCR -1.46 MIL -1.14 MIN -0.46 NYM 0.85 NYY 0.73

34. A theory that might explain pricing in the inelastic region • Monopoly Pricing Model for Tickets=Q(P,q,m), P=Price, q=quality, m=market conditions • Pricing is cognizant of a second good; Concessions C(R,P,q), R=concession price • Total profit from both Tickets+Concessions • Ticket Price might be low to draw people to the concessions. • (We will revisit this model later in the context of movie theaters.)

35. Research from Stanford GSB and the University of California, Santa Cruz suggests that there is a method to theaters' madness—and one that in fact benefits the viewing public. By charging high prices on concessions, exhibition houses are able to keep ticket prices lower, which allows more people to enjoy the silver-screen experience. Indeed, movie exhibition houses rely on concession sales to keep their businesses viable. Although concessions account for only about 20 percent of gross revenues, they represent some 40 percent of theaters' profits. That's because while ticket revenues must be shared with movie distributors, 100 percent of concessions go straight into an exhibitor's coffers.

36. Two Part Pricing Strategy: Movie Studios to Retailers – Videotapes Tapes: Marginal Cost = $3.00 • One time: $70.00 - $80.00 • Revenue Share: $8/tape + x% of rental • Unclear which was the better price strategy

37. The Disneyland Dilemma Two part tariff (price): Entry Fee Fixed Marginal Fee Per attraction Higher Fixed Fee (and lower Marginal Fee): Control the number of people who come to the park. Extract $$ from consumer surplus at the gate. Higher Marginal Fee (and lower Fixed Fee) More people come to the park and spend more on rides. Theoretical result: Charge a very high Entry Fee and zero Marginal Fee. Disney: Two part fees 1955-1982; One part 1982-now A Disneyland Dilemma: Two-Part Tariffs for a Mickey Mouse Monopoly Walter Y. Oi The Quarterly Journal of EconomicsVol. 85, No. 1 (Feb., 1971), pp. 77-96

38. Mixed Pricing Strategy: Adventureland, Farmingdale NY Allow customers to sort themselves into low and high elasticity groups. (High ride price elasticity buyers will choose the POP ticket.)

39. Rye Playland, Rye NY