Economic Foundations for Entertainment, Media, and Technology
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Economic Foundations for Entertainment, Media, and Technology
Production and Cost in E&M IndustriesSpring 2001 (4)Professor W. Greene
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Production and Cost Production Functions Costs of Production Economies of Scale and Scope Technological Change Integration: Horizontal and Vertical Economic Profits
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The Production Function Output Inputs – The factors of production The “process”
Labor
Capital
Materials?
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About Production Functions Factors and Factor Intensity
Higher education Broadway Theater – Labor intensive Major League Baseball - ??? Casino – Capital intensive
Multiple stages of production Outputs as downstream inputs
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Multiple Stages in Production
Players
Capital
EquipmentF(x)
Capital
Equipment
Labor
F(x)
TV Sports
What’s better for this process, one firm or two?
The game
The TV broadcast
The viewer
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Production Functions Managing a multiplex Casino Making movies (indies vs. studios) Professional sports Delivery of professional sports Music Publishing
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The Costs of Production Fixed cost: Not a function of output. Capital Sunk cost: One time, nonrecoverable costs (very significant in the movie business) Variable cost: Variable with respect to output
Labor Materials
Marginal cost: Avoidable cost of one more (less) unit
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Economies of Scale Working definition: Declining average
cost Market based definition: Competitive
advantage of large size Sources
Supply based: Technical, Demand based: Networks Indivisibilities: Lumpiness
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Economies of Scale in EMT Cablevision Professional sports Publishing/Movies – Backlists of titles Casinos Movies Television Telecommunications Web based businesses
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Economies of Scope Cost effect
C(Q1,Q2) < C(Q1,0) + C(0,Q2) Not the effect behind vertical
integration Applications?
Cable TV, Internet (convergence?) Basketball, Hockey
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Technical Advance Cost Reduction Digital setup in newspapers
Product innovation: Adult orthodontics Rapid, disruptive product innovation Seagate disk drives
Satellite delivery of electronic content (Cablevision?)
Output
Average total cost
t1
t2
t3
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Digitizing Entertainment – Technical Advance in Delivery of Existing Forms
Music MP3 - affects distribution, not creation Pop music without musicians. (Britney Spears)
Literature: E-books?? (Maybe not yet) E-zines (Slate.com) Web based news services (NYTimes.com)
Movies: Creation – digital equipment Distribution – transmission without film Exhibition – digital projection (expensive)
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Multistage ProductionFinancial Services Professional Sports Publishing
Back office Team sports Author
Large scale Advertising andPublisher
content assembly
Retail banking Broadcast to homes Retail distribution
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New Football LeagueNFL XFL
Labor Pool
NFL Draft
LA CLE
NY CHI
ABC NBC CBS FOX
Homes
Other inputs
Labor Pool
WWF/NBC
Homes
Is it vertical integration?
Is it a cartel in the labor market?
Why are salaries so low compared to NFL?
What does WWF bring to the party?
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Integration of Firms
MarketsFinancial Services Professional Sports Traditional
Publishing
Final Consumers
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Theoretical Departure Pointon Firm Integration Perfectly Competitive Markets
All firms atomistic price takers All firms fully informed and efficient
Reasons for firm integration: None Reasons against integration: None Reasons we observe integration:
Reaction to market failure of some sort Creation of a market failure
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Conglomerate Mergers
MarketsFinancial Services Professional Sports Traditional
Publishing
Why do this? Why do we observe this?
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Economies of Scope?
MarketsFinancial Services Professional Sports Traditional
Publishing
Sports broadcasting and newspaper
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“Synergistic” Mergers Firms in related industries Not a conglomerate merger Exploitation of commonalities Are there economies of scope? Applications?
Hockey and basketball? Newspapers and book publishing? Others?
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Horizontal Integration
MarketsFinancial Services Professional Sports Traditional
Publishing
What objective?
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Horizontal Mergers Increases market share Extends market power forward
Monopolization Hirfindahl index = firms (market shares) (S1+S2) = S1 + S2 + 2 S1 S2
May extend market power backward What justifies horizontal integration?
Economies of scale “Synergies?” (What is this?) Capture market power
Application: The media mogul
22 2 2
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Vertical Integration
MarketsFinancial Services Professional Sports Traditional
Publishing
Final Consumers
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Benefits of Vertical Integration
All arise from some market failure Lower transaction costs: Firm organizational limitations
Transactions involving information Avoidance of government restrictions, taxes, or regulations. Extension of market power (forward or backward) Avoidance of upstream market power Assurance of steady or reliable input supply
Murdoch’s (alleged) attempt to influence staffing decision of a baseball field manager before a broadcast
Internalization of market failures Franchising reduces problems of free riding
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Costs of Vertical Integration Private costs
Loss of economies of scale Organizational complexity Assumption of risk
Social costs Creation or extension of market
power Possible cartelization
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Vertical Integration in EMT Analysis
Where is it observed? What are the benefits / motivation? What are the costs?
Applications Seagram and Vivendi Cablevision and home delivery of cable
generally End to end production Internet service providers and cable operators
The movie business (at several stages)
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AOL Time Warner AOL
Internet service providerInstant messaging
Time Warner
Time Warner Cable Time Inc. (Magazines)
HBO Turner Broadcasting The WB Network New Line Cinema Warner Music Time Warner Publishing Warner Brothers Studio
Horizontal vs. vertical integration What kind of merger is this?
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Cablevision
The Wiz
Clearview Cinemas
Radio City Enter.
Optimum Online
Rainbow Media
Madison Square Garden
Knicks
Rangers
Liberty
CSC Holdings and Optimum TV: The cable system
Lightpath
Homes
Businesses
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Rupert Murdoch
MarketsFinancial Services Professional Sports Traditional
Publishing
Mogul take all?
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Profits and Losses
Simple Cases: Electronic Commerce
Average Total Cost
Average Variable CostAverage Fixed Cost
Amazon
EToys
Amazon: P > AVC, P < ATC
EToys: P < AVC (RIP, April 6, 2001)
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Profits in Multistage and Multiple Output Processes Allocation of revenues to activities Multiple revenue sources (outputs) Allocation of costs to activities Fixed costs in multiple output firms Net vs. gross in Hollywood
A Miami Fish Story
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Economic Profits and Losses Opportunity cost of capital Valuing an investment?
t=years
Economic value of a business How to do this? (Offer the business for
sale.) When is a business “losing money?”
Profits in year t
(1 + r)t