2 Progress Report on Piracy

ECONONE K33 CALINGACION, Lia ILUSTRISIMO, Althea MACATANGAY, Dang March 31, 2011

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I.Problem (Recall)
Piracy is a common problem every year. In fact, it also gets worse as it progresses throughout the years. Technology has made almost everything easy for us. We can even buy movies, songs and games online. Even if technology reaches different options to make life easier, people tend to abuse it. Peer-to-peer networking software and websites make the abuse of technology possible to everyone. From these applications, anyone can download music, games, scholarly software and more importantly movies for free. Taking advantage of one thing for oneself always gives a disadvantage to the other. As people who abuse technology by downloading movies enjoy what they get for free, the people who made the film itself arent getting the money that they are supposed to receive from the rights they have on the film. They do not get their fair share of profits on what they have sacrificed so much for. As shown on the demand and supply schedule for original DVDs given, the equilibrium price of original DVDs is Php 700. Not everybody, not even the middle-class Filipino is willing to buy original DVDs at that price. If they can get the same movie for a cheaper price, even while sacrificing some quality, they would obviously settle for that, which are the pirated DVDs. Filipinos also think that it is not a reasonable price because they also base their willingness to pay on their income. An average Filipino has a lot of other priorities than buying a 700-peso DVD. It is almost like a weeks lunch for others. Piracy is such a very big and cheap business because it only has to get its item to reproduce from only one source and just duplicate the same things over and over again. It is also why producers of the pirated discs can sell their DVDs for a very low price. Therefore, there is always a higher supply of fake DVDs than of original DVDs. Since the pirated DVDs are always a whole lot cheaper, there is also a higher demand for it. Another possibility of the occurrence of piracy is that people have to pay quite a hefty price before being able to watch a 90-minute movie in a room with strangers. More importantly, the original DVDs themselves are already too expensive for a person having an average income, thus, resulting to the cheaper pirated DVDs. In addition to that, movies featured in some theaters only last for an estimated 2-4 weeks. Not everybody can watch on weekdays and because of that, movie theaters get crowded on weekends. 4 weeks is actually just a short span

of time. Since not everybody can travel to their nearest mall and watch movies in 4 weeks, the most convenient alternative solution is to watch movies from a DVD.

II. MARKET FAILURES

A. ORIGINAL DVDS AS A MONOPOLY MARKET
Table 1.1 Marginal costs, total costs, prices and marginal revenue for original DVDS

UNIT
(Q)

MARGINAL COST
(MC)

AVERAGE COST
(AC)

TOTAL COST
(TC)

PRICE
(P or AR)

MARGINAL REVENUE
(MR)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

400 350 300 250 200 280 310 360 410 450 500 550 600 650 700

400 375 350 325 300 297 299 306 318 331 346 363 381 401 421

400 750 1,050 1,300 1,500 1,780 2,090 2,450 2,860 3,310 3,810 4,360 4,960 5,610 6,310

1,000 950 900 850 800 750 700 650 600 550 500 450 400 350 300

950 850 750 650 550 450 350 250 150 50 -50 -150 -250 -350 -450

Table 1.1 shows the marginal cost, average cost, total cost, price and marginal revenue per unit. Marginal cost is the extra cost of producing an extra unit. The first unit yields 400 php as its MC and as each unit increases (until the 5th unit), its MC decreases from 400 php to 200 php. However, as for the 6th unit, its MC starts to increase from 200 php to 280 php. From the 7th until the 15th unit, their MCs have increased from the range of 310 php to 700 php. Average cost is equal to the total cost divided by the quantity of units. Computing for the mean of the AC, it is approximately about 348 php. The total cost is the sum of the fixed variable and the fixed cost. The TC for producing one to fifteen units ranges from 400 php to 6,310 php, respectively. For original DVDs that are sold for 1,000 php, there is only one unit demanded; 950 php, there are two units demanded, and so on and so forth. Selling original DVDs for 300 php each will yield an approximate of 15 units demanded by consumers. Lastly, the marginal revenue is the

change in total revenue divided by the change in sales. The amount of the MR is lesser than those of the price or also known as the average revenue (price range for one unit is 950 php and theres a present deficiency when selling fifteen units about a loss of 450 php).
Graph 1.1 Marginal costs, total costs, prices and marginal revenue for original DVDS

Looking at Graph 1.1, it already illustrates the top three market failures, namely: overcharging, when P>MC; generating abnormal profits, and; leaving consumers with social losses or deadweight losses. These market failures will prove at some point that transforming the business of selling original DVDs to a monopoly can be unhealthy for the entire market which includes both consumers and producers. The thorough discussions later will show that transforming this from a competitive market into a monopolist market will not solve the problem of piracy in the country as well. Firstly, the issue of overcharging happens when a monopolist tends to maximize their profits. In the perspective of the producers or the sellers, their goal is to earn profit by means of selling all their units. However, their topmost goal is to maximize their profits and this is only

possible if they charge prices higher than their marginal costs. They do not have to worry about setting prices of their goods since they are known to be the price setters. This is mainly because monopolists are the sole seller of a certain productand they have high market power. They also possess certaincapabilities to produce it. Observing the areas and lines in Graph 1.1, the monopolist market of original DVDs cannot charge prices lower than their marginal cost because of two reasons: (1) in the long run it can be seen from the line of the marginal revenue/MR that they will lead to losses or deficiencies, and; (2) it can produce abnormal profits. Thus, basing the areas affected in Graph 1.1, the original DVDs must be sold at an approximate price of at least 680 php per copy, or else the two situations that were cited earlier will happen. Going further, the number of DVDs that can be sold is at most 7 copies. This shows that only few people can own an original DVD having expensive price ranges. Secondly, in relation to the issue of overcharging, comes the generation of abnormal profits. Abnormal profits are the money that is left after the paying for all expenses incurred throughout the business operation. This happens when monopolists charge a price higher than their marginal cost or the lower part of the rectangle area of PM and QM. In Graph 1.1 the rectangle area of the abnormal profits is the horizontal line from 0 units to 7 units, and the vertical line from 300 php until 700 php. Computing for the abnormal profit in selling original DVDs (Average revenue average cost * QM) yields a total of 32,666.40 php. The graph shows that this monopoly will not end up with a normal profit reasonable rate of return after having to pay for expenses unlike in competitive markets. Lastly, the case of deadweight losses is always present. This is defined as a loss of economic efficiency in consumers. Causes for such situation include pricing, externalities, etc. Consumers get to pay for the product they want. However, these monopolists would earn their revenue, but a part of the consumers payment is a loss a foregone economic benefit. This is evident in Graph 1.1. The area that corresponds to the deadweight loss is the triangle near the marginal cost curve and the price curves equilibrium. For example, one customer wants to buy 9 copies of original DVDs for a price of 600 php each. Since the original DVDs seller wants to maximize his profit he decided to charge his prices higher and limited his copies up to 7 only. These 7 copies cost about 680 php each, basing it from the graph. The deadweight loss in the example is the 2 copies of DVDs the customer almost enjoyed. Not only that, but the customer paid for an extra amount which is a loss that did not go anywhere. Going further, analyzing it carefully, buying 9 copies for 600 php each is 5,400. But there are only 7 available copies with a price of 680 php (price above marginal cost). The total price of it is 4,670. The difference of the

prices is 640 php. The seller had actually received his profit in this case (excluding the extra amount).

B. CINEMAS AS A MONOPOLY MARKET

Table 1.2 Marginal costs, total costs, prices and marginal revenue for movie tickets

UNIT
(Q)

MARGINAL COST
(MC)

AVERAGE COST
(AC)

TOTAL COST
(TC)

PRICE
(P or AR)

MARGINAL REVENUE
(MR)

1 2 3 4 5 6 7 8 9 10 11 12

210 200 180 160 150 110 130 150 155 170 220 250

210 205 197 188 180 168 163 161 161 163 167 174

210 410 590 750 900 1010 1140 1290 1445 1615 1835 2085

350 330 310 290 270 250 230 210 190 170 150 130

330 290 250 210 170 130 90 50 10 -30 -70 -110

Table 1.2 shows the marginal cost, average cost, total cost, price and marginal revenue per unit of movie ticket when cinemas are monopolized. The marginal cost of the first unit of movie ticket that would be sold is 210 php. From the word itself, marginal means additional. Therefore; marginal cost represents the additional cost charged when an additional movie ticket would be sold. This price decreases up until the 6th unit. It then increases from the 7th unit up to the last unit. The average cost represents the total cost over the number of movie tickets being sold. The same pattern for marginal cost may also be observed in the data for average cost wherein the price decreases up to a certain point which is until the 9th unit and then increases from the 10th unit up to the last. The total cost of producing 12 units of movie tickets is 2085 php. The total cost includes all fixed and variable costs. As shown in the table, at 170 php, the price for a movie ticket is equivalent to its marginal cost. This represents the equilibrium price, or the price that would be charged for each movie ticket in a competitive market.Charging 130 php for a movie ticket would lead to 12 units of quantity demanded by consumers. And for 350 php that would be charged for movie tickets, only one unit would be demanded. The

marginal revenue shown in this table represents the additional revenue when an additional unit of movie ticket would be sold. Unlike in a competitive market, wherein the price is equal to the marginal revenue, the price charged for movie tickets is higher than the marginal revenue. This is because cinemas would charge at a lower price when they would want to sell more movie tickets. For example, for a price of 350 php, only one unit would be demanded or sold but for 330 php, 2 units may be sold. So to sell more tickets, the company has to charge 330php instead of its higher original price. Thus, those who are willing to pay for 350 php would only have to pay at a price lower than that. Thus, the additional revenue that cinemas earn decreases as the number of units of movie tickets demanded increases. Graph 1.2 Marginal costs, total costs, prices and marginal revenue for movie tickets (See Attachment) Graph 1.2 illustrates how it would look like if cinemas were monopolized. As a competitive market, cinemas would charge a price that is equal to its marginal cost in order to maximize its profits. As shown in the graph, cinemas would only sell each unit of movie ticket for 170php. 170 php is the point wherein marginal cost meets price. Cinemas as a monopoly market, however; would have to charge each movie ticket at a price higher than its equivalent in the competitive market. This is because, in order to maximize their profits, monopoly firms would have to charge a price wherein their marginal cost is equal to their marginal revenue. This leads to one of the reasons why monopolies are market failures, which is overcharging. Instead of charging prices equal to its marginal costs, monopolists are forced to charge a price much higher than that in order to earn profits. The graph also shows the amount of money that was lost when cinemas would charge movie tickets at a price higher than their marginal cost. This represents the value of the lost opportunity of consumers to purchase movie tickets at a lower price. Instead of buying a movie ticket at a price of 170 php, consumers would have to spend at least 240 to 230 php just to see a movie.This loss is known as a deadweight loss. Deadweight loss is a market problem since it reflects inefficiencies or the misallocation of resources. It serves as a social problem since, as mentioned earlier, monopolists are forced to charge prices in this way. This means that it is not entirely the monopolists fault nor is it in their full control. Another reason why monopolies are market failures would be about the issue of abnormal profits. There are two types of profts: normal proft and the abnormal profit. Normal porfits, also known as reasonable rate of return, shows what is left of the producers total

revenue after all marginal or variable costs have been paid. Abnormal profits or monopoly rents on the other hand, shows what is left of what producers earned after all variable and fixed costs have been paid. In the graph, the price line also serves as the average revenue or total revenue over quantity. The area below the average cost curve represents the total cost (fixed and variable) over quantiy. By subtracting the average cost from the average revenue and then multiplying it to the quantity (in a monopoly setting or Q m), the result would be abnormal profits. Abnormal profits shown in the graph is the area above the marginal cost and average cost, and the area below the price charged in a monopoly market (Pm) up to Q m.

III. CONCLUSION
There is definitely no better market. However, there is a market that can most likely solve a business problem based on how it can price things. Abolishing crime is to abolishing piracy itself in a city we can never clean it 100%. In reducing piracy, aside from the government spending money to tighten security and police force (piracy abatement), we believe that keeping cinemas as a competitive market would be fine as long as they can still lower their prices. Based on our first progress report, we still believe in the same solution because there really is more elasticity in changing the prices of movie tickets than there is in prices of original DVDs because of the rights and royalties we have to pay. And we are comfortable with the competitive market because we can risk more when we put it in a monopolistic market due to the possible market failures stated previously (deadweight loss, abnormal profit, overcharging). In addition to that, based on the peoples preferences, the fact that they want to see the latest movies always result to them watching whatever is showing in their nearest cinemas. Buying of DVDs happen either because they really liked the movie they just saw, or they want to have a different time for it.