In an earlier posting, the discussion in the comments raised the econ-speak concepts of marginal revenue and marginal costs. Here is another intriguing application, using that backward-L shaped marginal cost curve.
A student asked the question in the subject line, "Why don't teams cut their ticket prices when the team isn't doing well and attendance has dropped?"
I trotted out the usual answers.
- Maybe the transaction costs are too high. It is easy to program a computer to change prices, but how would the team give refunds to people who had already purchased their tickets, if at all?
- Perhaps lowering the prices would have the effect of reducing demand in the future if people waited for lower prices before purchasing their tickets.
- They do. Sometimes teams effectively reduce ticket prices by staging promotions and give-aways that were not part of the pre-season marketing plan.
Here is another fun answer, though, which hinges on a set of heroic assumptions.
- Suppose the demand for tickets is linear [and hence so is the marginal revenue "curve"] .
- Suppose the marginal costs are backward-L shaped, with a horizontal portion in the relevant region, which is well-below capacity.
- Suppose the drop in demand just reduces the percentage of people willing to pay each possible price for tickets. E.g., whereas before the team went on the skids, perhaps 1000 fans would have been willing to pay $100 for a ticket, but now only 500 are willing to pay that much. In other words, suppose the drop in demand doesn't shift the demand curve in parallel fashion but instead rotates it clockwise around the vertical intercept.
- Suppose the team is a profit maximizer.
In this case, it can be shown that the profit-maximizing price is invariant with the slope of the demand curve, so long as the marginal revenue curve intersects the horizontal portion of the MC curve. The demand can drop way off (i.e. rotate inward one heck of a lot), and the profit-maximizing price is the same as it would be if demand were high (but not so high that the MR crosses the vertical portion of the MC curve).
I realize the assumptions are heroic, but they're not too extreme are they? This explanation probably helps us understand a bit more why prices for tickets to sporting events are fairly stable regardless of the team's performance.