Firms’ Decisions—“Producers”

Firms purchase inputs (land, labor, and capital) in resource markets, and transform these inputs into outputs (products and services), employing the technological and industrial organizational choices considered to be the most efficient of those available. Marketing and distribution costs are in- curred in attaining the final sale of the output. Generally, the goal is the 22 maximizing of economic profits.

The “theory of the firm” is a large and complex body of knowledge that is important for a full examination of the coverage of supply of goods and services. Here we take an overview of decisions made by firms and leave the interested reader to seek further coverage in the referenced materials (cf. Picard, 1990).

Firms have varying degrees of influence in their input markets as far as affecting prices is concerned. For example, a small firm seeking to purchase less than 1% of the offering in a particular market will have little opportu- nity to influence the price by exercising its option (or threatening to do so) to not make a purchase at the going price. In contrast, a large firm will have considerable potential in this arena. In summary, some firms will be “price takers” in the inputs/factor-of-production markets, whereas others will be “price influencers.”

1. AN INTRODUCTION TO MEDIA ECONOMICS THEORY AND PRACTICE

Just how input prices relate to the cost of production will be significantly influenced by the production process and form of organization employed in the transformation of inputs into outputs. These issues are referred to by economists as the “production function.” Technology clearly plays a key role in determining potential production techniques and their relative efficiency. A prominent media example is the role of electronic typesetting in the newspaper industry. Although many workers were understandably re- sistant to this technology, fearing loss of jobs, the potential of electronic typesetting to make the newspaper industry more efficient is clear.

Another dimension of the production function is the set of choices and features that determine the partition of costs into fixed and variable. The “dot-com” firm had high fixed costs and relatively low variable costs, a structure that proved fatal when “eyeballs” could not be translated into revenue producing transactions or subscriptions.

For a given price and volume, maximizing profits requires minimum production cost. As noted above, total costs of production include both fixed costs and variable costs. Examples of fixed costs include depreciation on the plant and the wages of staff employees (as contrasted to production- line employees). Variable costs include the materials directly used in producing output and the wages of production line employees. The fixed–variable cost relationships are depicted in Fig. 1.3.

Some costs are neither purely fixed nor purely variable in nature. In particular, several costs have a step-function nature—they take discrete steps up, but do not vary in direct proportion to units of output. For example, a plant may have the capacity to produce 250,000 newspapers per day. When circulation demand requires that a second plant be built, the introduction of the second plant would significantly increase fixed costs at the 250,000 level of production in a step-like manner.

FIG. 1.3. Cost and revenue relationships.

22 OWERS, CARVETH, ALEXANDER

These cost structures will vary considerably from one type of media industry to another. Once a decision to make a film is taken, most costs be- come fixed. By contrast, for a publishing firm printing a book that does not have a large advance, a significant portion of its costs will be variable, deter- mined largely by the number of books produced. The cost relationships depicted in Fig. 1.3 are the simplest; in practice, complexities such as nonlinearities are encountered. Recent refinements in cost measurement systems such as Activity Based Costing (ABC) have provided critical addi- tional information to managers. Activity Based Costing provides an oppor- tunity for better understanding and measurement of costs. It has particular relevance for industries engaged in repetitive production processes, a fea- ture that is found in many media firms.

A key factor in determining the competitive structure of industries in terms of the number of competitors and relative efficiency is what happens to the average cost of production as volume increases. The average cost of a unit of production for a given level of production is:

Firms’ Decisions—“Producers”