Fixed costs +(Variable Cost Per Unit ´ Number of U nits Produced) Number of Units Produced

The simplest models of production assume that initially the average cost of production decreases as scale economies are realized. However, after some level of output, average costs of production begin to increase, typically because of some limited resource that makes other factors/inputs less productive. The scarce factor can be as clear-cut as the physically limited size of a key location site (e.g., a production studio) or as complex as the ability (or lack thereof) of a particular management team to efficiently man- age an increasingly large enterprise. If there is managerial limitation in terms of span of control or coordinating incompatible managers, then doubling all inputs may result in an increase in production that is less than dou- ble and so-called “diseconomies of scale.” 23 If a doubling of inputs results in more than a doubling of units of output, then generally economies of scale are still being realized. It is such synergy that motivates managers. How- ever, approximately 75% of all mergers are later considered unsuccessful. The hubris of managers rather than the consistent delivery of synergies is considered to provide the key explanation for the ongoing series of mergers and acquisitions in the face of such poor average outcomes.

For these reasons, the “theory of the firm” assumes that firms’ costs of producing units increase, as a result of having exhausted opportunities for economies of scale and encountering nonreplicable resources. Economists capture these inclinations in an upward sloping supply curve, as in Fig. 1.4. Because firms are operating at levels of output such that unit costs are increasing as volume increases, they can supply more to a market only at the higher prices necessary to meet their increasing unit cost of production.

1. AN INTRODUCTION TO MEDIA ECONOMICS THEORY AND PRACTICE

FIG. 1.4. Supply and demand relationships and market outcomes.

The competitive structure of media industries reflects different levels of efficiency, economies of scale, technology, and industrial organization. For example, the broadcast television industry has relatively few firms, reflect- ing both the technology of production (channel/license availability) and the scale of operations necessary to achieve most efficient cost relationships. By contrast, the book and magazine publishing industries have liter- ally thousands of firms, albeit dominated by a few major companies. The technology of print publishing is such that the fixed costs of physical production are typically not the major factor in the overall cost structure since much of the printing is outsourced to specialty print shops. Perhaps the critical factor in the profitable operation of smaller scale publishing houses is the availability of an efficient and effective distribution channel. Effective refers to getting the task accomplished, whereas efficiency refers to the cost competitiveness of doing so. As introductory business texts often note, “killing a housefly with a sledgehammer is effective, but not efficient.”

Markets

For a given good or service, the superimposition of demand and supply curves on the same diagram leads to an analysis as depicted in Fig. 1.4. The “theory of the consumer” sustains the downward sloping demand “curve,” which can take the shape of either a curve or a line, and the “theory of the firm” the upward sloping demand curve. What will be the outcome in the marketplace?

24 OWERS, CARVETH, ALEXANDER

At point P*, Q* in Fig. 1.4, the curves coincide. This indicates the “mar- keting clearing” price (P*), and corresponding quantity (Q*) transacted. If this intersection of supply and demand is resolved in this manner, the market is said to be in “equilibrium.” Buyers will want to demand Q* units, and firms will want to supply Q* units. As economists say, “there will be a coincidence of wants, not a want of coincidence.”

The depiction of “the Market” as in Fig. 1.4 is a powerful analytical framework. For example, if a regulatory authority sets a price PR less than the market clearing P*, then at that regulatory price quantity demanded will exceed the quantity firms choose to supply at that price, and there will “excess demand”—leading to nonprice allocation, such as “queuing” and “rationing coupons.”

The impact of additional suppliers in a market will move the supply curve “out/down,” generally with the impact of a decrease in price. The relevance of this to media markets is direct. For example, the much of the deregulatory process is motivated by leading to increased supply. The Tele- communications Act of 1996 is a widely cited example of this motivation.

Supply and demand curves are not easily measured for any given market. Firms often try to determine the “shape” of the demand curve they “face” (or supply) by such techniques as market surveys and experimenting with the impact of price changes. And of key relevance to the media industries is the fact that advertising is motivated by the potential to influence demand curves. Advertising attempts to “raise” the demand curves.

Conditions of Supply and Demand—Elasticity

As before, the familiar upward-sloping supply curve reflects combinations of price and quantity supplied. As price increases, producers make a higher profit and wish to place more product on the market. When one or more of the factors previously held constant changes, this shifts the supply curve outward (increase in supply) or inward (decrease in supply), depending on which factor changed and its positive or negative relationship to supply. The shape of the supply curve is known as its elasticity and reflects the relative responsiveness of quantity supplied to changes in prices. Elasticity de- pends primarily on the closeness of substitutes in production and the amount of time available for producers to respond.

If a supplier faces a “steep” (inelastic) demand curve, then a price increase imposed by the supplier (being a jump in the supply curve) will lead 24 to a large price increase, and a little decrease in market-clearing quantities. Conversely, if a supplier facing elastic demand curves increases prices that supplier will lose a large part of the demand, and the price increase will be only partly “passed on.” Again, numerous applications of these relationship can be observed in the media markets.

1. AN INTRODUCTION TO MEDIA ECONOMICS THEORY AND PRACTICE

These considerations are also of direct relevance to government policy. If

a tax is added to a good or service, the effect is equivalent to raising the supply curve. Who really “absorbs” the tax? In the formal terminology of tax theory, what is the “incidence” of the tax? It is determined by the relative elasticities of demand and supply. In the extreme case of a completely inelastic demand curve (i.e., a price has no impact on quantity demanded), all the burden (incidence) is borne by buyers. The price goes up by the full 25 amount of the tax per unit.

However, a discussion of elasticity highlights a feature of demand curves—they change over time. Although a demand curve may look very inelastic, the availability of substitutes will have an impact over time; so will the impact of technology. For example, the increase in automobile fuel efficiency significantly reduced the demand curve for gasoline, although the gas lines of 1974 and 1979 indicated clearly the short-run inelasticity of demand. Satellite TV has significantly increased the elasticity cable TV pro- viders are facing.

Market Imperfections

The ideal case depicted earlier is a reflection of the conditions economists call “perfect markets.” This assumes knowledgeable consumers, many competing suppliers, and an upward-sloping supply curve. There are many instances where such ideal conditions are not met, and many of these are encountered in the media industries.

For example, if there is only one supplier, there is the potential for monopolist behaviors. Duopolies are two-competitor markets, as are some- times the case in large-city newspapers. These are examples of market conditions that provide the potential for strategies and behaviors that are to the detriment of consumers. A “pure” monopolist can change very high prices, at least in the short run before substitutes get established. This ex- plains the regulations on cable-TV rates, in order to prevent a single supplier from “acting like a monopolist.”

Another market condition that can have related implications is where the per-unit cost continues to decrease as volume increases, which is different from the assumptions underlying the upward-sloping supply curve in the preceding analysis. An efficient large-scale producer will be able to drive out other competitors, or prevent them reaching profitability, and become a monopolist.

Thus the notion of an ideal competitive marketplace is closely tied to the wide dispersal of market power associated with the perfectly competitive market structure. When firms become large and command significant market control, the supply, demand, and price functions of the market are dis- rupted and consumer sovereignty is diminished. On a local market level,

26 OWERS, CARVETH, ALEXANDER

this is what has happened with the newspaper and cable industries, as most areas have only one local newspaper and one local cable system. Similarly, when the market fails to adequately provide public goods or take account of products with harmful byproducts (externalities), then the government may have to step in and play a role as well. Of course this conclusion is sub- ject to vociferous debate. The recent debates over violent and suggestive content in television shows are an excellent example of such issues.

Fixed costs +(Variable Cost Per Unit ´ Number of U nits Produced) Number of Units Produced