Basic Market Structure and Perfect Competition

Discussion on “So What’s New? Is the “New Economy” really different from the old one?”  (Slate Magazine, Aug. 22, 2000)

Michael Kinsley starts out by comparing market forces to that of the cross. Following this comparison he provides definitions of both the demand curve as well as the equilibrium point but leaves out the definition for the supply curve.  He then goes into the main focus of the article by calling into question the common notion that the supply curve is always upward sloping. He argues that the problem lies within the concept of marginal cost because “marginal costs determine the supply curve” (Kinsley 1). Kinsley takes this argument further by pointing out the difficulty inherent within the two major assumptions that comprise marginal cost. He cites airplane seats, prescription drugs and software as products that have high initial costs with low marginal costs, which violate the assumptions of upward sloping supply curves. He ends his article by pointing out that this potential problem, due to marginal costs could result in a new economy.

This article is relevant to our classroom theory because it provides examples of instances where supply and demand curves may not behave in the manner we have discussed in class. This is important because if the issues Kinsley discusses are true then we are in a new economy that is driven by marginal costs that have high initial costs but cheap marginal cost.

Doctrine states that in a free market, competition will make price equal to marginal costs, because as production increases the marginal cost of producing another product increases. Thereby resulting in an upward sloping supply curve. In the instance of airline seats, prescription drugs, and software, the high initial costs cause the marginal cost function not to be upward sloping. This is because it is more expensive for the initial consumers because they have to absorb the high initial costs compared to later consumers who have low marginal cost. For example in the airplane situation some customers have to pay a higher price to cover the costs of the flight. However the marginal cost of an airplane that is flying regardless of capacity is practically nothing because the marginal cost of adding another passenger is just the cost of printing another ticket. In the prescription drug example marginal cost is downward sloping because the initial drugs are more expensive due to research and development costs but the cost of producing the pills later is very low. Likewise, in the software example there are high development cost but low disc production costs, which results in marginal cost not being upward sloping.

A real world application of this concept of downward sloping supply curves is clearly present in the film industry. In the film industry the initial costs to produce a film tend to be very expensive. However the actual marginal cost of distributing the film to more consumers in different theaters around the world is fairly cheap, given the advent of digital media. Therefore the film company will attempt to play their film in as many locations as possible because they will receive additional revenue in the form of tickets sales and the cost of reproducing the film in an additional theater is inexpensive.

Posted by Joe, John and Jim (Section 3)

Resources:

Kinsley, Michael. “So What’s New? Is the “New Economy” Really Different from the Old One?” Slate. 22 Aug. 2000. Web. 19 Mar. 2012. <http://www.slate.com/formatdynamics/CleanPrintProxy.aspx?1295416032412&gt;.

Collett-Schmitt, Kristen. FIN 30210: Managerial Economics. University of Notre Dame, 2011. Print.

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