Part 1: Foundational concepts

for media economics

Dr An Nguyen
Media Economics – MMAP02 (HCMC)
M.Sc. in Media & Communications Management
HO Chi Minh City, 19 January, 2010

Outline

1. Introduction to economics and economic analysis

2. Consumer behaviours
3. Firm behaviours
4. The market: demand, supply, price, and
structure

1. Introduction to economic analyses

 What is economics?

Scarcity: tension between unlimited wants/needs and
limited resources

For an individual: limited time, money, energy etc.

For a country: limited natural resources, capital, labour force
and technology etc.

So everybody must make decisions over how to

allocate resources most efficiently

Hence, the social science of economics

”the study of how people make choices to cope with
scarcity” (Parkin et al, 1997: 8)

“the study of the use of scarce resources, which have
alternative uses” (Sowell, 2003: 1)

Three key questions

What goods/services are to be produced and how
many of each?

To decide which resources to allocate to what

How are the goods/services to be produced?

Technology and organisation of production

For whom the limited goods/services are produced?

Branches of economics

Microeconomics

'the study of the allocation of resources and the
distribution of income as they are affected by the working
of the price system and by the policies of the central
authorities' (Lipsey & Chrystal, 1995: 890)

Three major subjects: consumers, firms and markets

Macroeconomics

'the study of the determination of economic aggregates
and averages, such as total output, total employment, the
general price level, and the rate of economic growth'
(Lipsey & Chrystal, 1995: 889)

Managerial economics
 Media economics

studying "how media operators meet the informational
and entertainment wants and needs of audiences,
advertisers and society with available resources"
(Picard, 1989: 7).

i.e. looking at the business operations and financial

activities of firms producing and selling output into the
various media industries.

In the context of given market conditions, technological
alternatives, the regulatory and legal environment, and their
anticipated financial implications

Basic assumption in economics

Individual economic units are rational

making economic decisions to maximise its goals within the
constraints of their resources and the economic and legal
environment

Consumers (individuals/households): maximising

their total utility from consuming a particular good
or service

Firms: maximising profits and value from producing

goods and services

Economic analysis

Most often a marginal analysis

examining the consequences of adding or subtracting one
unit to or from something already in place.

e.g. hiring an additional worker involves

a marginal benefit (the value of the additional product or
service that the new worker could produce)

a marginal cost (the additional wages paid to the new
worker)

an economic analysis of this must weigh the marginal cost
and marginal benefit to arrive at a decision
 Ceteris paribus assumption

Often many factors influence one outcome

E.g. demand affected by price, consumer income,
availability of similar goods and other factors

Pure effect of each factor difficult to separate from

others

Hence, a reliance on ceteris paribus (Latin for “all else held
constant”) assumption

A ceteris paribus analysis examines the effect of

only one of many variable factors, assuming that all
the others are unchanged

E.g. an analysis of the effect of the price of a good on its
market demand is a ceteris paribus analysis – i.e. it
assumes that other influential factors remain unchanged

The false-cause fallacy

The fact that two things that are correlated does not
necessarily mean that one thing causes the other.

E.g. Recent data show that car prices rise at the

same time as a rise in demand for cars. Does that
mean that increased car demands cause increase in
car prices?

Maybe but not always!

There are other factors that might affect this relationship –
e.g. a rise in consumer income, a rise in production cost,
inflation etc.

Fallacy of composition

If one individual or firm benefits from some action, it
does not necessarily mean that all individuals or all
firms will benefit if they take the same action at the
same time.

E.g. a price reduction by a firm might result in more

income for that firm (through gaining more
consumers); but what if firms of the type follow this
move and reduce their product price to a similar
level?

Each firm’s market share in unlikely to change but the
profits of all firms could fall (due to cheaper prices)
 2. Consumer behaviours: key
concepts

Scarcity and consumer choice

Consumers = all individuals, households or firms that
consume goods and services generated in the
economy

Scarcity: limited resources versus unlimited wants

I want a £10 music CD and a £20 action movie DVD but I
have only £20.

So a consumer has to make a choice between

desirable alternative goals and wants.

The CD or the DVD?

Sometimes also choice over whether or not to purchase any
of the desired goods at all (Why do I have to buy the CD or
the DVD while I need a text book more than them?)

Economic analysis of consumer choice

how consumers maximise their utility from consuming
a good/service within restrained resources

to work out how consumers allocate their resources

(e.g. money, time) to alternative goods/services. For
example:

whether I should spend the £20 budget on two £10 CDs or
one £20 DVD or whether it’s better for me to use that budget
for something else (e.g. going to the theatre)

whether to spend night time watching TV or going out with
friends or playing with children
Utility

Utility = the satisfaction or fulfillment a person
receives from consuming a good or service.

In practice: impossible to measure utility or to claim

that one individual's utility is higher than another's.

But in economic theories: useful concept to explain

consumer choice

Helps to explain how individuals aim to gain optimal
satisfaction in dealing with scarcity.

Often measured in an imaginary unit called “utils”

Total utility and marginal utility

Total utility = the sum of satisfaction that an
individual gains from consuming a given amount of
goods or services

Usually, more consumption = greater total number of utils.

Marginal utility = the additional satisfaction, or

additional amount of utility, an individual gains from
each extra unit of consumption

Follows “the law of diminishing marginal utility”

The law of diminishing marginal utility

Although people try to maximise the total utility of
consuming a good or service, there is a certain
threshold of satisfaction due to saturation.

Once that threshold is crossed, the consumer will no

longer receive the same satisfaction from consumption.

So, after saturation point, the marginal utility of each

additional unit of good/service will decrease.

i.e. total utility will increase at an increasingly slower pace.
Example: Utility from watching Co gai
xau xi
Episodes Total utility Marginal utility
watched (number of "utils") (number of "utils")
0 0 0
1 60 60
2 90 30
3 100 10
4 105 5

An individual consumer’s downward-

sloping demand curve

Because marginal utility
decreases as the quantity
of a consumed
good/service increases, a
consumer will buy
additional units only if the
price decreases.

In other words, the price

an individual is willing to
pay is negatively
correlated with the
quantity he/she demands.

3. Firm behaviours
 The firm

Firms = establishments where production takes place

i.e. where labour, land and capital are converted into goods
and services.

requiring a structured interrelationship between various
functions and subtasks to achieve the overall business goals

Theory of the firm: All of the firm's decisions are

taken in order to maximise its profits (in the short
run) and its value (in the long run)

For a given output, maximising profit requires minimising
production cost.

With a given cost, maximising profit = maximising output.

Short-run versus long-run production

In the short run: some factors of production are fixed

e.g. the size of the firm's factory, its machinery, its
administration system and other factors do not change and
can’t be adjusted to influence output

To maximise output, a firm can only adjust variable factors
such as amount of raw material, fuel, direct labour etc.

In the long run: all factors of production are variable

e.g. the firm can adjust the size of its factory and its use of
machinery and equipment

This course: focus on short-run production

Measures of output

Total product (TP) = total amount produced
during a certain period of time with a certain set of
production factors

Average product (AP) = TP divided by number of

units of the variable factor

Marginal product (MP) = the change in total

product as we increase or decrease one unit of the
variable factor
 Measures of costs

Total cost = fixed costs + variable costs

Average cost = total cost divided by quantity (also

called cost per unit)

Average variable cost = total variable cost/quantity

Average fixed cost = total fixed cost/quantity

Marginal cost = the increase in total variable cost

after raising output by one unit

E.g. Marginal cost of a 10th unit is the difference in total
cost when production output is increased from nine to
ten units per period.

The law of diminishing returns

“After a certain level of input of the variable factor,
each additional unit of the variable factor,
employed with a fixed quantity of another factor,
adds less to total product than the previous unit”
(Hoskins et al, 2004: p. 86).

Because the fixed factor can only work efficiently

with a certain level of variable factor

after that point, the fixed factor becomes less efficient
and thus marginal returns will decrease

Example: Marginal and total product

in producing music CDs
Labour input Capital (fixed) Total product Marginal product
(no of workers) input (no of CDs) (no of CDs)
0 1 0 0

1 1 20 20

2 1 60 40

3 1 90 30

4 1 110 20

5 1 120 10
Returns to scale

Returns to scale = the effect on total output when
all inputs are increased by an equal percentage

Constant returns to scale

An X% increase in all inputs creates an X% increase in
output – e.g. doubling all inputs exactly doubles output

Increasing returns to scale (economies of scale)

An X% increase in all inputs creates a more than X%
increase in output – e.g. doubling all inputs more than
doubles output

Decreasing returns to scale (diseconomies of scale)

An X% increase in all inputs creates a less than X%
increase in output – e.g., doubling all inputs less than
doubles output

Sources of economies of scale (1)

Technical economies

Some fixed capitals for production are not divisible

e.g. producing 100,000 copies of a newspaper requires the
same printing facilities as producing 200,000 copies

Managerial economies

Some managerial functions do not cost more to produce a
higher quantity of goods/services

e.g. personnel for R&D, sales, administration, distribution

Financial economies

E.g. larger firms with larger outputs can enjoy lower interest
loan rates

Sources of economies of scale (2)

Marketing economies

Large firms with large production can enjoy substantial
discounts in purchasing raw materials or in sales activities

Social economies

Benefits from building goodwill and loyalty among both
customers (to increase sales) and employees (to increase
internal efficiencies)

Specialisation of input

Greater specialisation of labour and machinery improves the
overall efficiency of production
Economies of scope

Takes place when the average total cost of
production decreases as a result of increasing the
number of different goods produced

Key reasons:

Joint use of factors of production (same labour, equipment
and infrastructure) to produce different products

Joint marketing and administration

Production of one good resulting another as a by-product

Examples

a movie shown in theatres, then broadcast to TV networks,
and then produced in DVD and VHS formats for sales/rentals

a company producing TV sets, VCRs, DVD players,
camcorders and other consumer electronic hardware

4. The market: demand, supply,

price, and structure

Introduction

Market = an area over which buyers and sellers
negotiate the exchange of some product or related
group of products

E.g. the film market, advertising market, newspaper
market, television market, online market etc.

An economy is a combination of thousands and thousands
of markets

Resource allocation in the market determined by

the relationship between demand and supply, which
is influenced by price and other factors
 Demand and supply

Demand = quantity of goods/services consumers
are willing to buy at a certain price

Not quantity actually purchased

Supply = quantity of goods/services producers are

willing to supply at a certain price

Not quantity actually sold

Both expressed per period of time – e.g. two

oranges/week; four movies/year

The law of demand

If other determinants of
demand are held
constant, an increase in
the price results in a
decrease in the total
quantity demanded.

Due to substitution effect

increase in the price of a
good makes it a less
attractive purchase when
compared with substitute
goods whose prices are
unchanged

Price elasticity of demand (1)

A measure representing the extent to which the
quantity demanded responds to price change

% change in quantity demanded

PED =
% change in price

E.g. If change in price is 20% and change in quantity

demanded is 10%, then PED = 10/20 = 0.5.
Price elasticity of demand (2)

If PED ≥ 1: elastic demand curve

A small increase in price causes a
large decrease in demand (ceteris
paribus)

Demand sensitive to price

If PED < 1: inelastic curve

A small increase in price causes a
small decrease in demand (ceteris
paribus)

Demand not too sensitive to price

Calculating percentage changes

E.g., What is the percentage change in the price of a
movie ticket from $4 to $6?

What about the percentage change from $6 to $4?

The mid-point method

Work out the mid-point between the changed quantities

Calculate the percentage change from A to B: the absolute
difference between A and B, divided by the midpoint
between A and B, multiplied by 100

In the example:

midpoint = (4+6)/2 = 5.

% change between $4 and $6 = [(6-4)/5]x100 = 40%

Shift in demand

Even if price is fixed, demand
for a good/service can
change if another demand-
related factor changes.

In the figure:

Demand for a movie with a box
office ticket of $2 increases
from Q1 to Q2 due to some
non-price factor (e.g. no better
movie to watch)

Demand curve for the movie
shifts to the right from D1 to
D2.
 Other determinants of demand

The prices of all other products

Income and income distribution among the
individual consumers in the product’s market

Consumer tastes

Consumer expectations

Market sizes

Special circumstances

Demographic factors (age, sex etc.)

Supply and price

If other determinants of
supply are held constant,
an increase in the price
results in an increase in
the quantity supplied.

Because selling a higher

quantity at a higher
price increases profits.

Price elasticity of supply (1)

A measure representing the extent to which the

quantity supplied responds to price change

% change in quantity supplied

PES =
% change in price

E.g. If change in price is 45% and change in quantity

supplied is 15%, then PES = 15/45 = 0.33
Price elasticity of supply (2)

If PES ≥ 1: elastic supply curve

A small change in price causes a
substantial change in supply
(ceteris paribus)

Supply sensitive to price

If PES < 1: inelastic curve

A large change in price causes a
substantial change in supply
(ceteris paribus)

Supply not very sensitive to price

Shift in supply

Even if price is fixed, supply
of a good/service can change
if a non-price factor changes.

In the figure:

Supply of a movie with a box
office ticket of $2 decreases
from Q1 to Q2 due to some
non-price factor.

Supply curve for the movie
shifts left from S1 to S2.

Other determinants of supply

The prices of inputs (factors of production)

Materials, labour, machines

The goals of producing firms

Not always just profit maximisation

The state of technology

Demand-supply relationship: the
equilibrium point

Equilibrium point: intersection
between demand and supply
curves at a given price

Quantity demanded = quantity
supplied

P* = equilibrium price

Q* = equilibrium quantity

Allocation of goods/services at
its most efficient point

Disequilibrium: excess demand

Price is set below the equilibrium
point

At price P1, demand (Q2) bigger
than supply (Q1)

B/c the price is so low, too many

consumers want the good
while producers are not making
enough of it.

Competition among consumers to

buy the good at this price will
push the price up

suppliers want to supply more and
bring the price up (closer to its
equilibrium)

Disequilibrium: excess supply

Price is set above the equilibrium
point

At price P1, demand (Q2) smaller
than supply (Q1)

The supplier is trying to produce

more goods, but due to it high
price, consumers find the product
less attractive and purchase less.

To compete with other firms, the

supplier must bring down the
price (closer to the equilibrium
price)
Market structure (1)

Market structure: a concept describing the state of
the market with respect to competition

Three key indicators

the number of sellers

differences in their products

entry barriers to the market

Four idealised market structures

perfect competition

monopolistic competition

oligopoly

monopoly

Market structure (2)

Perfect competition

There are many sellers of a homogenous product

No firm has a market power to set its own price

No barriers for new entrants

Very rare to find in the real world

Monopolistic competition

A good number of sellers

Differentiated products (products that are substitutable for
each other but each has some distinguishable attributes and
comes from only one firm)

Product differentiation leads to brand loyalty and thus gives
firms some control over their prices but this power is limited
(due to the availability of many close substitutes)

Market structure (3)

Oligopoly

Only a few large firms selling either differentiated or
homogenous products

Each firm has enough power to set market prices but faces
enough competition

Most common and increasingly popular thanks to the
globalisation process and inexpensive technologies

Monopoly

A single firm has absolute control over the market and its
product’s price

Insurmountable entry barriers