Lecture 7 The Creative Industries Professor Julia Lowell - - PowerPoint PPT Presentation

Lecture 7

The Creative Industries

Professor Julia Lowell lowell@econ.ucsb.edu Spring 2012

4/ 23/ 2012 1 Econ 191ac -- Lecture 7

Outline: Lecture 7

• Key points from Lecture 6: Firms,

costs and markets in the live performing arts

• Go over Homework 6
• Creative industries versus “standard”

industries

• Homework for Wednesday 4/ 25

4/ 23/ 2012 Econ 191ac -- Lecture 7 2

KEY POI NTS FROM LECTURE 5 : MI CROECONOMI CS OF THE PERFORMI NG ARTS FI RM

4/ 23/ 2012 Econ 191ac -- Lecture 7 3

Simple Case With Costless Production: Vertical Supply Curve, Price Predetermined

4/ 23/ 2012 Econ 191ac -- Lecture 7 4

P1 D S1 - determined by size of theater

Number of available seats is independent of price; since production is costless, maximize revenue by setting P1 to fill theater

ticket price Available seats per performance; quantity

• f seats demanded

QS1 a

Output and Pricing in the Performing Arts: A Closer Look, With Costs

Remember:

• Theater rental, promotion etc. are

measured per production

• Wages of actors & stage crew, electricity

for evening etc. are measured per performance

• Some small cost associated with selling

tickets, ushering measured per seat

4/ 23/ 2012 Econ 191ac -- Lecture 7 5

Marginal and Average Cost in the Performing Arts

• Marginal cost is the increment to total cost from

– Filling one more seat – Giving one more performance – Staging one more production

• Marginal costs are determined by variable costs --

which vary with output measure

– If variable costs associated with output measure (e.g., seats) are zero, marginal costs are zero

• Average cost is total cost (fixed plus variable) per
• utput measure

– If variable costs associated with output measure are zero, average costs will monotonically decline

4/ 23/ 2012 Econ 191ac -- Lecture 7 6

Output and Pricing in the Performing Arts: Filled Seats As Measure of Quantity (1)

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is fixed cost

associated with seating 1, 5, or 24 people?

• What is marginal cost
• f seating 1 person?
• What is variable cost
• f seating 1, 5, or 24

people?

4/ 23/ 2012 Econ 191ac -- Lecture 7 7

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is fixed cost

associated with seating 1, 5, or 24 people? $16+ $8 = $24

• What is marginal cost
• f seating 1 person?
• What is variable cost
• f seating 1, 5, or 24

people?

4/ 23/ 2012 Econ 191ac -- Lecture 7 8

Output and Pricing in the Performing Arts: Filled Seats As Measure of Quantity (2)

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is fixed cost

associated with seating 1, 5, or 24 people?

• What is marginal

cost of seating 1 person?

• What is variable cost
• f seating 1, 5, or 24

people?

4/ 23/ 2012 Econ 191ac -- Lecture 7 9

Output and Pricing in the Performing Arts: Filled Seats As Measure of Quantity (3)

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is fixed cost

associated with seating 1, 5, or 24 people?

• What is marginal

cost of seating 1 person? $1

• What is variable cost
• f seating 1, 5, or 24

people?

4/ 23/ 2012 Econ 191ac -- Lecture 7 10

Output and Pricing in the Performing Arts: Filled Seats As Measure of Quantity (4)

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is fixed cost

associated with seating 1, 5, or 24 people?

• What is marginal cost
• f seating 1 person?
• What is variable

cost of seating 1, 5, or 24 people?

4/ 23/ 2012 Econ 191ac -- Lecture 7 11

Output and Pricing in the Performing Arts: Filled Seats As Measure of Quantity (5)

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is fixed cost

associated with seating 1, 5, or 24 people?

• What is marginal cost
• f seating 1 person?
• What is variable

cost of seating 1, 5, or 24 people? $1* (1, 5, or 24) = $1, $5, or $24

4/ 23/ 2012 Econ 191ac -- Lecture 7 12

Output and Pricing in the Performing Arts: Filled Seats As Measure of Quantity (6)

The Math

• Total Cost (TC) = Fixed Costs (FC) + Variable Costs (VC)
• VC at Q = the sum of Marginal Costs from 1 to Q or Σ(1 to Q)MC

and

• Average Total Cost (ATC or AC) = (FC + VC)/ Q,

where Q = number of seats filled

So for Q = 12 seats in our example, FC = $24; VC = $12; and AC = ($36/ 12) = $3 Note that, because MC is constant in this example (unlike typical assumption where MC increases due to diminishing returns to labor), we have the interesting case that VC = Σ(1 to Q)MC = Q* MC, so that ATC = (FC + VC)/ Q = FC/ Q + Q* MC/ Q = FC/ Q + MC. As Q gets bigger, ATC will approach (but never quite reach) MC— always a teensy bit of fixed cost still to spread.

4/ 23/ 2012 Econ 191ac -- Lecture 7 13

Per Seat Theater Cost Example: What It Looks Like

4/ 23/ 2012 Econ 191ac -- Lecture 7 14

5 1 0 1 5 2 0 2 5 3 0 1 3 5 7 9 1 1 1 3 1 5 1 7 1 9 2 1 2 3

Cost per Seat Available Seats AC MC capacity constraint

What If the Quantity Measure Is the Number of Performances?

4/ 23/ 2012 Econ 191ac -- Lecture 7 15

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is the fixed

cost of 1 vs 5 performances?

• What is the marginal

cost of 1 more performance?

• What is the variable

cost of 1 vs 5 performances?

4/ 23/ 2012 Econ 191ac -- Lecture 7 16

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is the fixed

cost of 1 vs 5 performances? Output and Pricing in the Performing Arts: Performances As Measure of Quantity (1)

4/ 23/ 2012 Econ 191ac -- Lecture 7 17

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is the fixed

cost of 1 vs 5 performances?

Fixed cost is $16 regardless of number of performances

Output and Pricing in the Performing Arts: Performances As Measure of Quantity (2)

4/ 23/ 2012 Econ 191ac -- Lecture 7 18

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is the fixed cost of

1 vs 5 performances?

• What is the marginal

cost of 1 more performance? Output and Pricing in the Performing Arts: Performances As Measure of Quantity (3)

4/ 23/ 2012 Econ 191ac -- Lecture 7 19

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is the fixed cost of

1 vs 5 performances?

• What is the marginal

cost of 1 more performance?

$8 for wages etc., plus $24 (if theater is full), for a total of $32

(need to know how many seats are filled at each performance)

Output and Pricing in the Performing Arts: Performances As Measure of Quantity (4)

4/ 23/ 2012 Econ 191ac -- Lecture 7 20

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is the fixed cost of

1 vs 5 performances?

• What is the marginal

cost of 1 more performance?

• What is the variable

cost of 1 vs 5 performances? Output and Pricing in the Performing Arts: Performances As Measure of Quantity (5)

4/ 23/ 2012 Econ 191ac -- Lecture 7 21

• Let theater rental
• etc. be $16
• Let actors’ wages,
• etc. be $8
• Let cost of seating
• ne person be $1

Assume 24-seat theater

• What is the fixed cost of

1 vs 5 performances?

• What is the marginal cost
• f 1 more performance?
• What is the variable

cost of 1 vs 5 performances?

1 performance (with full house): $32 5 performances (with full house: $160

Output and Pricing in the Performing Arts: Performances As Measure of Quantity (6)

4/ 23/ 2012 Econ 191ac -- Lecture 7 22

1 0 2 0 3 0 4 0 5 0 6 0 1 2 3 4 5 6 7 8 9 1 0 1 1 1 2

Full- House Cost per Perform ance

Num ber of Perform ances

ATC MC

Per Performance Theater Cost Example: What It Looks Like

Regardless of the Output Measure You Choose…

Price and cost measures must be consistent with output measures

• Price per ticket goes with cost per seat
• Revenue from performance goes with cost

per performance (on revenue side, need to know how many seats are filled; on cost side not so important, since marginal costs of filling seats are very small)

4/ 23/ 2012 Econ 191ac -- Lecture 7 23

HOMEW ORK 6 REVI EW

4/ 23/ 2012 Econ 191ac -- Lecture 7 24

Homework 6 for Monday 4/ 23 (Output & Pricing in the Performing Arts )

4/ 23/ 2012 Econ 191ac -- Lecture 7 25

On a single graph, depict the demand, marginal revenue, marginal cost, and average cost curves for a theatre company that will make a positive profit if it produces at the profit-maximizing price and quantity. Assume that your company can put on the same production for as long as people are willing to pay to see it (no schedule constraints).

• 1. How will your costs change if you sell one more ticket to a performance that is

not sold out?

• 2. How will your costs change if you add one more performance to the

production run?

• 3. Label and identify the point corresponding to the profit-maximizing price and

quantity.

• 4. Suppose your theatre company is a nonprofit. Label and identify the point

corresponding to the price and quantity where you are likely to produce.

• 5. Is your nonprofit company covering its costs at this point? If not, what options

are available to you? Describe one of those options in words and graphically.

Economics of Live Performance With Costly Production, Open-Ended Run

4/ 23/ 2012 Econ 191ac -- Lecture 7 26

D MC AC MR

price and cost per seat Available seats over length of run, seats demanded

Case 1: Where Will the Commercial Theatre Produce?

4/ 23/ 2012 Econ 191ac -- Lecture 7 27

D MC AC MR P1 AC1 P2

price and cost per seat Available seats over length of run

Q2 Q1 E H G F

Case 1: Where Will the Nonprofit Theatre Produce?

4/ 23/ 2012 Econ 191ac -- Lecture 7 28

D MC AC MR P1 AC1 P2

price and cost per seat Available seats over length of run

Q2 Q1 E H G F

A Good Set of Answers – Thanks, Patrick!

• Costs will not change if one additional ticket is sold because one

additional person attending a performance does not change anything about the cost of the performance.

• Costs will be constant if an additional performance is added to the

schedule because there are no time constraints. Costs will be same as previous performances assuming no fixed or variable costs rise.

• The theatre company will set their price at P1 and quantity Q1

because this price and quantity will maximize profit.

• If the theatre company was a non-profit company they would set

their price at P2 and quantity Q2, because they will only need to cover their costs in order to be a successful operation.

• The non-profit theatre company will break even in this situation

because their costs will be equal to their revenue.

4/ 23/ 2012 Econ 191ac -- Lecture 7 29

4/ 23/ 2012 Econ 191ac -- Lecture 7 30

D MC AC MR P1 AC1

price and cost per seat Available seats over length of run

Q1 E H

Aside: Subsidies Allow Nonprofits to Produce When Cost Is High, Demand Low

AC’

In-Class Exercise: The Swiss Alphorn (???)

4/ 23/ 2012 Econ 191ac -- Lecture 7 31

In-Class Exercise (from Econ191 Midterm, Winter 2010)

You are the owner of a performance space that presents cutting-edge Swiss alphorn music. You are trying to decide whether to incorporate your business as a 501(c)(3) tax-exempt organization, or to remain a taxable sole proprietorship. Explain how and why the following factors might influence your

• decision. If it’s helpful, use a graph to illustrate your points.

– You’re a passionate fan of the Swiss alphorn, and want to expose as many people as possible to this marvelous art form. – You’re still paying off the money you borrowed to attend Harvard Business School, and your beachside condo is expensive to maintain. – The fixed costs of presenting alphorn are very high, and the audience is mostly poor Swiss exchange students. – A couple of very wealthy local cheesemakers have recently expressed an interest in alphorn music.

4/ 23/ 2012 Econ 191ac -- Lecture 7 32

Class Project Homework 6 for Monday 4/ 23

(1) Drop one of your U.S. cities/ metropolitan statistical areas

Tell me why you chose that one to drop.

(2) For each of the 4 remaining cities, report

• Number of art museums
• Number and tax status of cultural festivals (you define)
• Number of dance studios
• Number of book stores

This is not data you can get from the Economic Census! Suggested sources: American Association of Museums (“Find a Museum”), City websites (cultural calendars, e.g.), Guidestar.org (info on nonprofits), manta.com (info on local businesses), Google with keywords I will put more instructions up on the class webpage.

4/ 23/ 2012 Econ 191ac -- Lecture 7 33

Class Project Homework 6 for Monday 4/ 23

We will talk about this at more length on Wednesday 4/ 25

4/ 23/ 2012 Econ 191ac -- Lecture 7 34

THE ORGANI ZATI ON OF PRODUCTI ON: FI RMS AND MARKETS I N THE COMMERCI AL ARTS

4/ 23/ 2012 Econ 191ac -- Lecture 7 35

Caves’ Economic Properties

• f Creative Activities
• “Nobody knows”

– Demand for creative products is highly uncertain

• “Art for art’s sake”

– Creative workers care very much about artistic goals

• “Motley crew”

– Creative workers are highly diverse and non-substitutable

• “Infinite variety”

– Creative products are multi-dimensional and very substitutable

• “A list/ B list”

– There is a clear skill/ income hierarchy for creative workers

• “Time flies”

– Temporal coordination of creative products is complex

• “Ars longa”

– Creative products produce long-lasting income streams

4/ 23/ 2012 Econ 191ac -- Lecture 7 36

Features of Commercial Creative Industries That Differ from “Standard” Industries

• Integrated production

& long-term relationships

• Substitutable inputs

to production

• Fixed costs up-front
• Appeal to consumers

estimated upfront

• Regular contracts

4/ 23/ 2012 Econ 191ac -- Lecture 7 37

• Segregated

production & one- shot relationships

• Unique inputs to

production

• Costs sunk

progressively

• Appeal to consumers

revealed gradually

• Option contracts

Standard Industry Creative Industry

Integrated vs Contract Production

• In “standard” industries

– Many phases of production (design, parts manufacture, assembly, distribution, etc.) are internalized in a single firm – Note this does not mean that all phases of production are co-located (globalization rules!)

• In creative industries

– Independent firms or individuals, linked by contracts, perform each phase of production

4/ 23/ 2012 Econ 191ac -- Lecture 7 38

Substitutable vs. Unique Inputs to Production

• In “standard” industries

– Workers don’t have unique skills or knowledge – If one worker not available, can hire another

• In creative industries

– Workers are unique, often hired for their name recognition and personal artistic visions – If one worker not available, entire project may be jeopardized

4/ 23/ 2012 Econ 191ac -- Lecture 7 39

Consumer Appeal Estimated Up-Front vs Gradually

• In “standard” industries

– Firms conduct market research before deciding on product – Major decisions about design occur at beginning of production process

• In creative industries

– Producers identify creative works (book, novel, screenplay, play) that seems appealing – Throughout production process, other creative workers can make big changes to concept – By end of production process, product may be very different—and new consumer fad may have taken hold

4/ 23/ 2012 Econ 191ac -- Lecture 7 40

Fixed Costs Up Front Versus Sunk Costs Incurred Progressively

• In “standard” industries

– Firms pay rent, taxes, utility bills, etc. on factory, warehouse, headquarters building, etc, regardless of production quantity and often before production begins – These “sunk costs” are generated at beginning of production – Firms keep going if revenues are expected to cover remaining variable costs

• In creative industries

– Costs are sunk at beginning of each phase – Decisionmakers compare expected revenues to remaining variable costs at each phase

4/ 23/ 2012 Econ 191ac -- Lecture 7 41

Regular vs Option Contracts

4/ 23/ 2012 Econ 191ac -- Lecture 7 42

• In “standard” industries

– Common contract forms include price contracts, cost contracts, and incentive contracts – These contracts may have complicated provisions to handle contingencies – But in all cases, decision rights are retained by the principal producing firm

• In creative industries

– Important creative decisions are made at each phase of production – Option contracts give decision rights to those about to contribute new resources (ignore sunk costs) – Option contracts typically specify specific decision intervals

HOMEW ORK – YOU ARE OFF THE HOOK! NO HOMEW ORK FOR W EDS, 4 / 2 5

4/ 23/ 2012 Econ 191ac -- Lecture 7 43