Mankiw Principles of Microeconomics (4th ed)

IN THE NEWS

TV Networks as

Brand Names

BRAND NAMES CONVEY INFORMATION TO

consumers about the goods that firms are offering. Establishing a brand name—and ensuring that it conveys the right information—is an important strategy for many businesses, including TV networks.

A T V S e a s o n W h e n

I m a g e I s E v e r y t h i n g

BY STUART ELLIOTT

A marketing blitz to promote fall television programming, estimated at a record $400 million to $500 million, has been inundating America with a barrage of branding.

Branding is a shorthand term along Madison Avenue for attempts to create or burnish an identity or image, just as Coca-Cola seeks to distinguish itself from Pepsi-Cola. For the 1996–97 prime-time broadcast television season,

which officially began this week, viewers have been swamped by the torrent of teasing practically since the 1995–96 season ended in May.

At the center of those efforts is the most ambitious push ever by the broadcast networks to brand themselves and many of the blocks of programming they offer—a marked departure from the past, when they would promote only specific shows.

“The perception was that people watched shows, not networks,” said Bob Bibb, who with Lewis Goldstein jointly heads marketing for WB, a fledgling network owned by Time Warner, Inc., and based in Burbank, California.

“But that was when there were only three networks, three choices,” Mr. Bibb added, “and it was easy to find the shows you liked.”

WB has been presenting a sassy singing cartoon character named Michigan J. Frog as its “spokesphibian,” personifying the entire lineup of the “Dubba-dubba-WB”—as he insists upon calling the network.

“It’s not a frog, it’s an attitude,” Mr. Bibb said, “a consistency from show to show.”

In television, an intrinsic part of branding is selecting shows that seem related and might appeal to a certain audience segment. It means “developing

AN ATTITUDE, NOT JUST A FROG

an overall packaging of the network to build a relationship with viewers, so they will come to expect certain things from us,” said Alan Cohen, executive vice president for the ABC-TV unit of the Walt Disney Company in New York.

That, he said, means defining the network so that “when you’re watching ABC, you’ll know you’re watching ABC”—and to accomplish it in a way that appeals to the primary ABC audience of youngish urbanites and families with children.

SOURCE: The New York Times, September 20, 1996, p. D1.

A monopolistically competitive market is characterized by three attributes: many firms, differentiated products, and free entry.

The equilibrium in a monopolistically competitive market differs from that in a perfectly competitive market in two related ways. First, each firm has excess capacity. That is, it operates on the downward-sloping portion of the average-total-cost curve. Second, each firm charges a price above marginal cost.

Monopolistic competition does not have all the desirable properties of perfect competition. There is the standard deadweight loss of monopoly caused by the

markup of price over marginal cost. In addition, the number of firms (and thus the variety of products) can be too large or too small. In practice, the ability of policymakers to correct these inefficiencies is limited.

The product differentiation inherent in monopolistic competition leads to the use of advertising and brand names. Critics of advertising and brand names argue that firms use them to take advantage of consumer irrationality and to reduce competition. Defenders of advertising and brand names argue that firms use them to inform consumers and to compete more vigorously on price and product quality.

1.Describe the three attributes of monopolistic competition. How is monopolistic competition like monopoly? How is it like perfect competition?

2.Draw a diagram depicting a firm in a monopolistically competitive market that is making profits. Now show what happens to this firm as new firms enter the industry.

3.Draw a diagram of the long-run equilibrium in a monopolistically competitive market. How is price related to average total cost? How is price related to marginal cost?

4.Does a monopolistic competitor produce too much or too little output compared to the most efficient level? What practical considerations make it difficult for policymakers to solve this problem?

5.How might advertising reduce economic well-being? How might advertising increase economic well-being?

6.How might advertising with no apparent informational content in fact convey information to consumers?

7.Explain two benefits that might arise from the existence of brand names.

1.Classify the following markets as perfectly competitive, monopolistic, or monopolistically competitive, and explain your answers.

a.wooden #2 pencils

b.bottled water

c.copper

d.local telephone service

e.peanut butter

f.lipstick

2.What feature of the product being sold distinguishes a monopolistically competitive firm from a monopolistic firm?

3.The chapter states that monopolistically competitive firms could increase the quantity they produce and lower the average total cost of production. Why don’t they do so?

4.Sparkle is one firm of many in the market for toothpaste, which is in long-run equilibrium.

a.Draw a diagram showing Sparkle’s demand curve, marginal-revenue curve, average-total-cost curve, and marginal-cost curve. Label Sparkle’s profitmaximizing output and price.

b.What is Sparkle’s profit? Explain.

c.On your diagram, show the consumer surplus derived from the purchase of Sparkle toothpaste. Also show the deadweight loss relative to the efficient level of output.

d.If the government forced Sparkle to produce the efficient level of output, what would happen to the firm? What would happen to Sparkle’s customers?

5.Do monopolistically competitive markets typically have the optimal number of products? Explain.

6.Complete the table below by filling in YES, NO, or MAYBE for each type of market structure.

7.The chapter says that monopolistically competitive firms may send Christmas cards to their customers. What do they accomplish by this? Explain in words and with a diagram.

8.If you were thinking of entering the ice-cream business, would you try to make ice cream that is just like one of the existing brands? Explain your decision using the ideas of this chapter.

9.Describe three commercials that you have seen on TV. In what ways, if any, were each of these commercials socially useful? In what ways were they socially wasteful? Did the commercials affect the likelihood of your buying the product, and why?

10.For each of the following pairs of firms, explain which firm would be more likely to engage in advertising.

a.a family-owned farm or a family-owned restaurant

b.a manufacturer of forklifts or a manufacturer of cars

c.a company that invented a very reliable watch or a company that invented a less reliable watch that costs the same amount to make

11.Twenty years ago the market for chicken was perfectly competitive. Then Frank Perdue began marketing chicken under his name.

a.How do you suppose Perdue created a brand name for chicken? What did he gain from doing so?

b.What did society gain from having brand-name chicken? What did society lose?

12.The makers of Tylenol pain reliever do a lot of advertising and have very loyal customers. In contrast, the makers of generic acetaminophen do no advertising, and their customers shop only for the lowest price. Assume that the marginal costs of Tylenol and generic acetaminophen are the same and constant.

a.Draw a diagram showing Tylenol’s demand, marginal-revenue, and marginal-cost curves. Label Tylenol’s price and markup over marginal cost.

b.Repeat part (a) for a producer of generic acetaminophen. How do the diagrams differ? Which company has the bigger markup? Explain.

c.Which company has the bigger incentive for careful quality control? Why?

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T H E M A R K E T S F O R T H E

F A C T O R S O F P R O D U C T I O N

When you finish school, your income will be determined largely by what kind of job you take. If you become a computer programmer, you will earn more than if you become a gas station attendant. This fact is not surprising, but it is not obvious why it is true. No law requires that computer programmers be paid more than gas station attendants. No ethical principle says that programmers are more deserving. What then determines which job will pay you the higher wage?

Your income, of course, is a small piece of a larger economic picture. In 1999 the total income of all U.S. residents was about $8 trillion. People earned this income in various ways. Workers earned about three-fourths of it in the form of wages and fringe benefits. The rest went to landowners and to the owners of capi- tal—the economy’s stock of equipment and structures—in the form of rent, profit, and interest. What determines how much goes to workers? To landowners? To the owners of capital? Why do some workers earn higher wages than others, some

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IN THIS CHAPTER YOU WILL . . .

Analyze the labor demand of competitive, pr ofit - maximizing fir ms

Consider the household decisions that lie behind labor supply

Learn why equilibrium wages equal the value of the mar ginal

pr oduct of labor

Consider how the other factors of pr oduction — land and capital — ar e compensated

Examine how a change in the supply of one factor alters the earnings of all the factors

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Figure 18-2

THE PRODUCTION FUNCTION.

The production function is the relationship between the inputs into production (apple pickers) and the output from production (apples). As the quantity of the input increases, the production function gets flatter, reflecting the property of diminishing marginal product.

Notice that as the number of workers increases, the marginal product of labor declines. As you may recall from Chapter 13, this property is called diminishing marginal product. At first, when only a few workers are hired, they pick apples from the best trees in the orchard. As the number of workers increases, additional workers have to pick from the trees with fewer apples. Hence, as more and more workers are hired, each additional worker contributes less to the production of apples. For this reason, the production function in Figure 18-2 becomes flatter as the number of workers rises.

THE VALUE OF THE MARGINAL PRODUCT

AND THE DEMAND FOR LABOR

Our profit-maximizing firm is concerned more with money than with apples. As a result, when deciding how many workers to hire, the firm considers how much profit each worker would bring in. Because profit is total revenue minus total cost, the profit from an additional worker is the worker’s contribution to revenue minus the worker’s wage.

To find the worker’s contribution to revenue, we must convert the marginal product of labor (which is measured in bushels of apples) into the value of the marginal product (which is measured in dollars). We do this using the price of apples. To continue our example, if a bushel of apples sells for $10 and if an additional worker produces 80 bushels of apples, then the worker produces $800 of revenue.

The value of the marginal product of any input is the marginal product of that input multiplied by the market price of the output. The fourth column in Table 18-1 shows the value of the marginal product of labor in our example, assuming the price of apples is $10 per bushel. Because the market price is constant for a competitive firm, the value of the marginal product (like the marginal product itself) diminishes as the number of workers rises.

diminishing mar ginal product

the property whereby the marginal product of an input declines as the quantity of the input increases

value of the mar ginal product

the marginal product of an input times the price of the output