Ingo Böbel

Subject Related Problems and Discussion Questions

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NEW CLASS DATES IN OCTOBER! I HAVE UPDATED THE SYLLABUS - PLEASE CHECK IT OUT!

Problems, Discussion Questions and Additional Readings:

1. Introduction:

Subject: Scarcity

Article: "Art Appreciation"

Lead Story-Dateline: The Wall Street Journal, Friday January 23, 2004, pgs. W1 & W10 (source: http://myphlip.pearsoncmg.com/)

Summary:

Art, as an investment, is not always a sure thing. While the works of one artist, Albert Bierstadt, are up a staggering 1,871 percent over the last 15 years many other formerly highly sought after works have fallen in value. And picking winners and losers is far from an exact science.

Often the best bets are those works collected by celebrities. Others that have recently appreciated are works of artists that have been on tour. As with any somewhat illiquid market, visibility or additional exposure tends to increase the demand. But art collectors are also fickle and works of a particular artist can fall out of vogue in weeks. Many “new” hot artists appear to come out of nowhere.

However, if you have the ability to spot trends and have a taste for art, it can be a profitable investment with many artists outperforming the stock market during the past decade. Experts warn that investment should not be the primary motive for buying art. Buy what you love, because you may be stuck with it.

Questions:

1. How does the fundamental economic problem of scarcity relate to the topic of art and its value?

2. What factors impact the demand for art works?

3. How does the art market differ from a more organized market like the stock market?

4. What markets exhibit similarities to the art market?

Hint:

As with any collectible, the value depends not only on the scarcity of the item, but also on the potentially changing tastes of the individuals who demand the collectible. Remember one of the fundamental factors that can shift the demand curve is changing tastes and preferences. We all know that no more Warhol’s are being made, thus the supply is fixed, but still their values have fallen recently. Be cautious when using collectibles for an investment. There are a number of factors that can drastically impact value that are beyond your control.

Read this recent Harvard Business Online-post: How to Profit from Scarcity.doc

2. Ad. Demand and Supply

Exercise: Try to solve the following problem by yourself (self-practice):

In 1998, the value of worldwide sales of recorded music in the form of singles, music cassettes, and CDs was $38.7 billion. Americans bought 3.1 CDs and 0.6 music cassette per capita, while Mexicans bought 0.5 CD and 0.3 music cassette per capita.

a.Explain why per capita CD sales were relatively higher while per capita sales of music cassettes were relatively lower in the United States than in Mexico.

b.On a suitable diagram, draw the U.S. demand for music CDs. Explain how the following changes would affect the demand curve: (i) increase in the price of CDs; (ii) rise in the ownership of CD players; and (iii) fall in the price of music cassettes.

c.On another diagram, draw the demand for music CDs in Mexico. Explain how the following changes would affect the demand curve: (i) fall in advertising by music publishers such as Sony and Time Warner; (ii) reduction in the penalty for copyright infringement; and (iii) increase in the price of hamburgers.

Read: Bob McTeer, http://www.bobmcteer.com/articles/dismalscience.html

Another home-practice question:

Suppose that a car rental business faces a demand represented by the equation, D = 30 - p + 0.4Y, where D is the quantity demanded in rentals a month, p is the price in dollars per rental, and Y is the average consumer's income in thousands of dollars a year.

a. Suppose that income, Y = 100, and car rental business raises the price from p = 30 to p = 35. Calculate the own-price elasticity of demand.

b. Suppose that income, Y = 110, and car rental business raises the price from p = 30 to p = 35. Calculate the own-price elasticity of demand.

c. Suppose that the price, p = 30, and that income rises from Y = 100 to Y = 110. Calculate the income elasticity of demand.

d. Suppose that the price, p = 35, and that income rises from Y = 100 to Y = 110. Calculate the income elasticity of demand.

Increasing demand and the market for gasoline

Suppose that the price of gasoline is presently $2 per gallon and sales are 500 million gallons a week. How will a 3% increase in household income affect the price and sales of gasoline? The increase in household income will cause the demand for gasoline to shift to the right. The increase in household income, however, will not affect the supply of gasoline.

Accordingly, there will be a new market equilibrium with higher price and quantity.

To calculate the new equilibrium using the procedure just given, we need the relevant elasticities. Previous research provides the following estimates. The price elasticity of the demand for gasoline is 0.23, while the income elasticity is 0.39. Further, the price elasticity of the supply of gasoline is 0.62.

The first step is to calculate the percentage change in the quantity demanded. Let %p represent the percentage change in price. Then, the percentage change in the quantity demanded due to the change in price will be 0.23 x %p. The percentage change in the quantity demanded due to the increase in income will be 0.39 x 3 = 1.17. Hence, the percentage change in the quantity demanded due to the changes in price and income will be 0.23 x %p + 1.17.

The next step is to calculate the percentage change in the quantity supplied. The percentage change in the quantity supplied due to the change in price will be 0.62 x %p.

The third step is to equate the percentage changes in quantity demanded and quantity supplied. This implies that 0.23 x %p  1.17 = 0.62 x %p.

Solving this equation, we have 1.17 = (0.62  0.23) x %p, which implies that the percentage change in price, %p = 1.17/0.85  1.38, which is approximately 1.4%. Hence, the 3% increase in household income results in the market price rising by 1.4%. Since the original price is $2 per gallon, the new price will be 2 x (1.014) = $2.2028.

The fourth step is to use the percentage change in price to calculate the percentage change in quantity. In this case, the equilibrium quantity will increase by a proportion of 0.62 x 1.4 = 0.87, or approximately 0.9%. Since the original quantity is 500 million gallons a week, the new quantity will be 500 x 1.009 = 504.5 million gallons.

Sources: (a) Molly Espey, “Gasoline Demand Revisited: an International Meta-analysis of Elasticities,” Energy Economics 20, no. 3 (1998), pp. 273-95; (b) Timothy J. Considine, “A Short Run Model of Petroleum Product Supply,” Energy Journal 13, no. 2 (1992), pp. 61-91.

The first Group Homework is due Sept. 21, 2009

Ad. Costs (sunk cost etc.) read:

< Dan Seligman, http://www.mywire.com/pubs/Forbes/1998/08/24/1012413?extID=10037&oliID=229

and

< Thomas Friedman, http://www.nytimes.com/2005/04/03/magazine/03DOMINANCE.html?ei=5090&en=cc2a003cd936d374&ex=1270267200

Harvard Mgmt. Update Article (2002): "Don't Throw Good Money (or Time) After Bad" - Product Number: U0205D

(ask Ms. Susan Eklow, IUM Librarian, how to access HBS sources)

Article description: "Have you ever chased after the sunk cost of an investment that was no longer recoverable? Often, people's ability to answer yes or no to this question depends on whether the investment was one of time or money. Because people tend to be more accustomed to accounting for money, they are more likely to give prior monetary investments undue importance in deciding whether to kill a failing project. To ensure that you don't escalate your company's commitment to a product, person, or strategy beyond a reasonable point, read the tried-and-true tips in this article to help you identify a sunk-cost trap before you pour too much money or time down a rat hole."

Ad. Economic Profits (or EVA) read:

Marakon Associates, "Beyond Performance Measurement: The Use and Misuse of Economic Profit," August 1994

Ad. Profits and Social Responsibility read this famous - but highly controversial - article:

Milton Friedman, "The Social Responsibility of Business Is to Increase its Profits," New York Times Magazine, September 13, 1970

Ad. Market Power read:

Peter Huber, http://www.manhattan-institute.org/html/_wsj-antitrusts_real_legacy.htm

From The Economist: Economics focus Slackers or pace-setters Economist_com.htm

NEW! MONOPOLIES IN JAPAN:

An article in The Economist (Nov. 5, 2009) reports about a cluster of mid-sized Japanese manufacturers who continue to enjoy near pure-monopoly power in highly specific, high value-added businesses. Decades of industry expertise and reinvesting profit to fund high levels of research and innovation continue to give these companies a remarkable competitive strength in the market. The barriers to entry for rival manufacturers are very high and this helps to explain the limited contestability in the global marketplace.

For example: Shimano earns around $1.5 billion a year by supplying 60-70% of the world’s bicycle gears and brakes, YKK makes around half the world’s zip fasteners by value, 75% of motors for hard-disk drives in computers come from a firm called Nidec, 90% of the micro-motors used to adjust the rear-view mirror in every car are made by Mabuchi “Many technology products have become commodities, but certain components have not, since they require continual innovation. So entry barriers to the business of making them remain high, and although the margins on the final goods have deteriorated, the margins on specialised, high-end components are still juicy."

Read: http://www.economist.com/displaystory.cfm?story_id=14793432

Ad. Entrepreneurship and Innovation read:

the new HBS paper (May 2007) by S. Silverthorne on Joseph Schumpeter: http://hbswk.hbs.edu/pdf/item/5619.pdf

Interesting case on "How to stay on Top": http://www.bnet.com/2422-13721_23-165545.html?promo=713&tag=nl.e713

Nov. 21, 2008 - An excellent "must read" on in productivity the US from The Economist:

http://www.economist.com/business/displaystory.cfm?story_id=12637160

Ad. Business Strategy read:

a new paper on "What Strategy is Not": What Strategy is not.pdf