Profits are maximised where marginal cost equals marginal revenue. And in a perfectly competitive market, where price equals marginal revenue, profits are maximised where marginal cost equals price. But what if marginal cost equals zero? Should the competitive profit-maximising firm give the product away? Or is there simply no opportunity for making a profit when there is a high degree of competition?
This is the dilemma considered in the articles linked below. According to Jeremy Rifkin, what we are seeing is the development of technologies that have indeed pushed marginal cost to zero, or close to it, in a large number of sectors of the economy. For example, information can be distributed over the Internet at little or no cost, other than the time of the distributor who is often willing to do this freely in a spirit of sharing. What many people are becoming, says Rifkin, are ‘prosumers’: producing, sharing and consuming.
Over the past decade millions of consumers have become prosumers, producing and sharing music, videos, news, and knowledge at near-zero marginal cost and nearly for free, shrinking revenues in the music, newspaper and book-publishing industries.
What was once confined to a limited number of industries – music, photography, news, publishing and entertainment – is now spreading.
A new economic paradigm – the collaborative commons – has leaped onto the world stage as a powerful challenger to the capitalist market.
A growing legion of prosumers is producing and sharing information, not only knowledge, news and entertainment, but also renewable energy, 3D printed products and online college courses at near-zero marginal cost on the collaborative commons. They are even sharing cars, homes, clothes and tools, entirely bypassing the conventional capitalist market.
So is a collaborative commons a new paradigm that can replace capitalism in a large number of sectors? Are we gradually becoming sharers? And elsewhere, are we becoming swappers?
Articles
Capitalism is making way for the age of free The Guardian, Jeremy Rifkin (31/3/14)
The End of the Capitalist Era, and What Comes Next Huffington Post, Jeremy Rifkin (1/4/14)
Has the Post-Capitalist Economy Finally Arrived? Working Knowledge, James Heskett (2/4/14)
Questions
- In what aspects of your life are you a prosumer? Is this type of behaviour typical of what has always gone on in families and society?
- If marginal cost is zero, why may average cost be well above zero? Illustrate with a diagram.
- Could a monopolist make a profit if marginal cost was zero? Again, illustrate with a diagram.
- Is it desirable for there to be temporary monopoly profits for inventors of new products and services?
- What is meant by a ‘collaborative commons’? Do you participate in such a commons and, if so, how and why?
- Should tweets and Facebook posts be regarded as output?
- What is meant by an internet-of-things infrastructure?
- What are the incentives for authors to contribute to Wikipedia?
- Could marginal cost ever be zero for new physical products?
- Think about the things you buy in the supermarket. Could any of these be produced at zero marginal cost?
- How can capitalists make profits as ‘aggregators of network services and solutions’?
- Provide a critique of Rifkin’s arguments.
How important are emotions when you go shopping? Many people go shopping when they ‘need’ to buy something, whether it be a new outfit, food/drink, a new DVD release, a gift, etc. Others, of course, simply go window shopping, often with no intention of buying. However, everyone at some point has made a so-called ‘impulse’ purchase.
There is only one article below, which is from the BBC and draws on data released from the National Employment Savings Trust’s survey. This report suggests that British people spend over £1 billion every year on impulse buys – purchases that are not needed, were not intended and are often regretted once the ‘high’ has worn off. Often, it is the way in which a product is advertised or positioned that leads to a spontaneous purchase – seeing chocolate bars/sweets at the tills; a product offered at a huge discount advertised in the window of a shop; 2 for 1 purchases; points for loyalty etc. All of these and more are simple techniques used by retailers to encourage the impulse buy. As consumer psychologist, Dr. James Intriligator says:
Retailers have clever ways of manipulating customers to spend more but if you stick to your plans you can avoid being affected by their tactics.
In other cases, it’s simply the frame of mind of the consumer that can lead to such purchases, such as being hungry when you’re food shopping or having an event to attend the next day and deciding to go window shopping, despite already having something to wear! Dr. Intriligator continues, saying:
Your ability to resist and make rational choices is diminished when your glucose levels are down … When you get irrational, you fall back on trusted brands, which often leads you to spend more money … Later in the shop, you’re more tired and less likely to resist [impulse buys]
But are such purchases irrational? One of the key assumptions made by economists (at least in traditional economics) is that consumers are rational. This implies that consumers weigh up marginal costs and benefits when making a decision, such as deciding whether or not to purchase a product. But, do impulse buys move away from this rational consumer approach? Is buying something because it makes you happy in the short term a rational decision? Behavioural economics is a relatively new ‘branch’ of economics that takes a closer look at the decisions of consumers and what’s behind their behaviour. The following article from the BBC considers the impulse buy and leaves you to consider the question of irrational consumers.
Article
How to stop buying on impulse BBC Consumer (30/5/13)
Questions
- If the marginal benefit of purchasing a television outweighs the marginal cost, what is the rational response?
- Using the concept of marginal cost and benefit, illustrate them on a diagram and explain how equilibrium should be reached.
- What is behavioural economics?
- What are the key factors that can be used to explain impulse buys?
- How can framing help to explain irrational purchases?
- If a product is advertised at a significant discount, what figure for elasticity is it likely to have to encourage further purchases in-store?
- Is bulk-buying always a bad thing?
A key economic principle is that rational decision making requires thinking at the margin. This involves a comparison of the additional (or marginal) benefits and costs of an activity.
An example of such rational behaviour would be deciding to drink one more beer or spending one more hour studying only if the additional benefits were greater than the additional costs. The optimum is where marginal benefit equals marginal cost.
And this applies to firms too. A firm maximises its profits by producing the output at which marginal revenue is equal to marginal cost.
However, a recent book by the American business guru Clayton Christensen argues that thinking in this way can be a problem. A recent article in the Guardian describes a story he tells of the time he refused to play for his university basketball team in a national final which took place on a Sunday and therefore conflicted with his religious beliefs. His decision involved sticking to his principles rather than thinking at the margin. For him, whilst the marginal cost of sacrificing these principles just once may well have been small compared to the resulting benefits, the eventual cost would be much higher.
Christensen also suggests that similar arguments can apply to firm decision making. The above article provides an example he uses of decisions made by executives at the Blockbuster video chain. When smaller rivals started offering movies by mail, Blockbuster instead continued to invest in its existing video store business model. This eventually proved disastrous for the company. The explanation given for this is that building on previous investments made more sense than setting up a mail-order arm which would cannibalise their existing business. On the other hand, an alternative explanation may be that executives at Blockbuster were irrationally allowing sunk costs to affect their decision making.
Articles
Clayton Christensen’s “How Will You Measure Your Life?” Harvard Business School, Clayton Christensen (9/5/12)
Clay Christensen’s life lessons BloombergBusinessweek, Bradford Wieners (3/5/12)
Bust Blockbuster goes on the block Guardian, Ben Child (4/4/11)
Questions
- Can you think of a situation where you have decided to stick to your principles rather than think at the margin?
- Why does a firm maximise profit by producing the output at which marginal revenue is equal to marginal cost?
- What do you think are the main costs of setting up a mail-order business?
- Are these costs mainly fixed or variable costs?
- Why is it irrational to take sunk costs into account when making a decision?
- Can you think of a situation where you have been influenced by sunk costs?
Ahead of Lord Davies’s report on Boardroom equality, he will be somewhat alarmed by the survey results carried out by the Institute of Leadership and Management, which found that 73% of women felt that they still face barriers to top-level promotion. Quotas are a suggestion to break down this barrier. As Sheelagh Whittaker, a non-executive directive of Standard Life said:
‘I am a big supporter of quotas. I believe that we will only have true equality when we have as many incompetent women in positions of power as incompetent men.’
However, others say that quotas are not the answer, as they don’t actually change the fundamentals. Forcing compliance for equality in the workplace is not the same as equality in the workplace. There are a number of other reasons behind fewer women in top level positions, including less confidence and ambition, a more risk-averse attitude to promotion, as well as more women than men aspiring to run their own company, rather than seek promotion within a firm. So does discrimination still remain in the workplace or are there other explanations for the fact that only 12% of FTSE 100 directors are women?
Women still face a glass ceiling Guardian, Graham Dnowdwon (21/2/11)
Female managers say classing ceiling intact – survey BBC News (21/2/11)
The ‘glass ceiling’ is all in the mind: women lack confidence and ambition at work says new survey Daily Mail, Steve Doughty (21/2/11)
Women hit glass ceiling while report rejects boardroom quotas Independent, David Prosser (21/2/11)
Poll: Glass ceiling still a barrier The Press Association (21/2/11)
Men not to blame for the glass ceiling The Australian, Jack Grimston (21/2/11)
Questions
- How are equilibrium wages determined in perfect and imperfect markets?
- Is it efficient for a firm to pay men more than women or to hire/promote more men than women?
- Illustrate the concept of discrimination against women in the labour market. Think about the effect on the MRP curve and hence on equilibrium quantity and wage. How does this affect the MRP curve for men?
- What are the other causes of less women being FTSE 100 directors besides ‘the glass ceiling’?
- To what extent would a quota be effective in achieving gender equality in the workplace?
- Are there any other policies that could be used to tackle discrimination of any kind? What are the pros and cons of each?
The ‘tragedy of the commons’ refers to the overuse of common land. If people can freely graze their animals on such land and have no responsibility for maintaining it, then the land will be overused and everyone will suffer. The problem is that the benefit of using the land occurs to the individual whereas the cost is collectively incurred.
There are many modern examples of the tragedy of the commons and the articles below look at some of them. Perhaps surprisingly, not all cases of the use of common resources end in tragedy; some common resources are used sustainably. A more thorough analysis must involve deeper questions of human motivation and behaviour.
IT’s tragedy of the commons Datamation (IT Management) (8/4/09)
The Tragedy of the Commons TechFlash (7/4/09)
Encarta’s failure is no tragedy Guardian (7/4/09)
How Self-Interest Destroyed The Economy The Huffington Post (23/3/09)
What does The Pirate Bay ruling mean for the web? Telegraph (17/4/09)
Tragedy of the Commons The Manila Times (23/3/09)
Questions
- Explain how the tragedy of the commons arises and give some examples other than common grazing land.
- How and why does the tragedy of the commons occur in information technology? Consider the benefits and costs of the ‘fix’ to the problem advocated in the first linked article.
- Does the case of Wikipedia (see the third linked article) disprove the proposition that common resources will be overused?
- To what extent is free access to content (music, newspapers, videos, books, etc.) a tragedy of the commons? Is the only solution to devise an effective charging model that rewards content creators?
Profits are maximised where marginal cost equals marginal revenue. And in a perfectly competitive market, where price equals marginal revenue, profits are maximised where marginal cost equals price. But what if marginal cost equals zero? Should the competitive profit-maximising firm give the product away? Or is there simply no opportunity for making a profit when there is a high degree of competition?
