Monday, November 06, 2006

TV Economics

There was a scene on the West Wing recently about protecting pharmaceutical patents. One guy says: "Those pills cost them 4 cents a unit to make." The other guy says: "That's not true. The second pill costs them four cents, the first pill costs them $400 million dollars."

When a firm faces a large fixed cost of production for research and development, and a low marginal cost of production that might be close to zero, e.g. computer software, CDs, DVDs, books, textbooks, pharmaceutical products, medicine, computer games, etc., the firm faces a "pure selling problem." Under those production conditions of high fixed cost and low marginal cost, the firm usually wants to maximize global sales to maximize profits.

Suppose a new economics textbook costs $50 million to develop to the point where it can start being printed, and it then costs about $10 for each additional, marginal copy of the book. The textbook publisher now wants to maximize global sales, and will now price the textbook according to the demand conditions in each country. In wealthy countries like the U.S., Japan and Western Europe, it will price the texbook at $150 because that is "what the market will bear" in those countries. In Central and South America, it might price the textbook at $75, and in China and India it might price the textbook at $50, based on "what the market will bear" in those economies. These editions are often called "International Editions" and might be in soft cover instead of hard cover, and are usually marked "Not for Sale in the U.S.," but are otherwise identical to the U.S. edition.

Pharmaceutical products, CDs, DVDs, etc. are priced globally the same way, and many CDs, DVDs and books in countries like India and China are labelled as only for sale in specific countires and maybe "Not for sale in the U.S."

There is nothing necessarily sinister, evil, unethical or illegal about this practice of what economists call "price discrimination," the pricing practice of adjusting the price based on "what the market will bear." Think about how common coupons are - that is simply a pricing practice of charging "what the market will bear" to two different consumer groups: a low price to price-sensitive consumers who use the coupon, and charging a high price to price-insenstive consumer who don't use the coupon.

If you think there is anything wrong with charging "what the market will bear," think about the last time you sold a house, or think about when you sell your current house. Did you, or are you going to, charge "what the real estate market will bear" at the time of sale, or would you be willing to accept some price less than that?


At 11/06/2006 10:29 AM, Blogger Jeff Ack said...
Here's a paper related to the subject of price discrimination of college textbooks.


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