Marginal Cost

Robert Waldmann

Kevin Drum writes

Nicholas Tabarrok (brother of Alex) is a producer of small indie films. But he’s frustrated because there’s no way for him to increase his audience by lowering the price to see his pictures:

When I make, say, an $8M film it has to compete at the same price level as the studios’ $80M or $100M film. It costs the consumer the same $12 at the multiplex.

….A few years ago Edgar Bronfman Jr, during the time his family briefly owned the Universal film studio, suggested that theaters actually charge different admission prices for different pictures so those films that cost less to make had correspondingly lower ticket prices than the mega-budget studio pictures.

I think the next time the Tabarrok family gets together Alex might take Nicholas over for a quiet chat about the concept of “marginal cost.”

Oh notice the second link is to

Also this is the very first time I have ever had the impression that Kevin Drum might have gained something by studying economics more — until now his thoughts on economics have consistently dominated those of most trained economists

update: Various commenters explain at length that I don’t understand how movie distribution works at all. The distributor takes a share of ticket sales not a fixed rental, so the deal with the distributor certainly does affect marginal cost.

I should have guessed that this is how it works, since we have big distributors providing insurance to little theaters and we have big distributors making sure that theaters sell tickets for the price that maximizes the revenue to be shared between the big distributor and the theaters.

revised (probably still confused) thoughts after the jump.

Marginal cost is the cost of providing one more of the product. The cost of making the master copy (you know of making the movie) is a fixed cost. The profit maximizing price for a product is a function of marginal not average cost.

OK so the price of tickets is effectively set by the distributor not the movie theater owner. What is the distributor’s marginal cost ? Well it has nothing to do with the budget to make the film. That is a sunk cost when one gets around to distributing (as the cost of editing and typesetting a book is sunk and fixed, the marginal cost is ink, paper, labor operating the printing press, wear and tear of the printing press, binding etc).

The marginal cost is the distributor must give the theater owners something plus the cost of making and shipping a copy of the film (which is roughly zero). This is low. I am a bit chastened having shown my ignorance, but I would guess that most of the cost of distributing a film is the cost of advertising. Uh oh.

So there are two choices — ticket price and advertising budget. A condition for profit maximization is that one gets the same ticket sales X by cutting the price of a ticket by Y and cutting the advertising budget by XY. I don’t see the cost of making the film in that calculation.

However, I *know* that I don’t understand advertising. I am personally certain that no advertisement has ever had any effect on my consumption. Most people believe that. We are obviously wrong. But this time I know I don’t get it.
The key variable explaining the price of tickets is the overall elasticity of demand for that film.

Everything written below is based on total ignorance and not worth reading.

Now the marginal cost of selling a film viewing experience can be higher than the ushering and cleaning costs. If the film is sold out, no seats available in the theater, then the marginal cost is …. well huge (I guess you could show the film on another screen and send the people who wanted to see the scheduled film home saying it was sold out).

The sold out theater effect explains why matinee tickets are cheap. Yeah a super duper mega hit film might justify more expensive tickets because tickets are often sold out. But only for the first few days. I have never, ever, ever had the experience of going to a movie theater hoping to see a film and being told that it is sold out.

Notice that there is already an incentive to go to films that aren’t super popular. I go to arty art flick with subtitles and I can sit where I want with no strangers anywhere near me. I go to MegaColossal and I better get there early if I want to really see the screen.

Basically so long as there are empty seats in front of each screen, it makes no difference to the theater which film you watch. Therefore it is profit maximizing for the theater to charge the same price to see each film.