Question

Hollywood screenwriters negotiate a new agreement with movie producers stipulating that they will receive \(10 \%\) of the revenue from every video rental of a movie they authored. They have no such agreement for movies shown on on-demand television. a. When the new writers' agreement comes into effect, what will happen in the market for video rentals - that is, will supply or demand shift, and how? As a result, how will consumer surplus in the market for video rentals change? Illustrate with a diagram. Do you think the writers' agreement will be popular with consumers who rent videos? b. Consumers consider video rentals and on-demand movies substitutable to some extent. When the new writers' agreement comes into effect, what will happen in the market for on-demand movies-that is, will supply or demand shift, and how? As a result, how will producer surplus in the market for on-demand movies change? Illustrate with a diagram. Do you think the writers' agreement will be popular with cable television companies that show on-demand movies?

Short answer

The supply in the video rental market will decrease, leading to higher prices and reduced consumer surplus, which will likely make the new writers' agreement unpopular with consumers who rent videos. In the on-demand movies market, demand will increase, improving producer surplus and potentially making the agreement popular with cable television companies.

Step-by-step solution

Analyzing the Video Rental Market

The introduction of the new agreement means that screenwriters will now receive a share of the revenue from video rentals. This effectively increases the cost for producers to distribute films for rental since they now have to share revenue with writers. The producers might try to pass on some or all of this cost to consumers. If they are successful, the supply curve will shift to the left, reflecting a decrease in supply at each price level. There won't be an immediate shift in demand as the agreement does not directly affect consumers' willingness to rent videos.

Impact on Consumer Surplus

When the supply curve shifts left, the price of video rentals is likely to increase, with fewer rentals being made. This increase in price and decrease in quantity will result in a decrease in consumer surplus, as the area between the demand curve and the market price will shrink. Consumer surplus is the difference between the highest price consumers are willing to pay and the market price. Therefore, the new writers' agreement will likely not be popular with consumers who rent videos because they will have to pay higher prices or face a reduced availability of video rentals.

Shift in Demand for On-Demand Movies

Since consumers consider video rentals and on-demand movies to be substitutes, the increase in the cost of video rentals will make on-demand movies relatively cheaper or more attractive. This could lead to an increase in demand for on-demand movies, shifting the demand curve to the right as consumers substitute away from the more expensive video rentals towards on-demand movies.

Change in Producer Surplus in the On-Demand Market

As demand for on-demand movies increases, the price that providers can charge may go up, leading to a higher quantity being supplied. The producer surplus, which is the difference between the market price and the minimum price producers are willing to accept, will likely increase. This is because the area above the supply curve and below the market price expands when the price increases.

Reactions from Cable Television Companies

Cable television companies, as providers of on-demand movies, are likely to experience an increase in demand and potentially higher profit margins due to the new writers' agreement affecting video rentals. Therefore, it's likely that the writers' agreement will be popular with cable television companies as it indirectly benefits their on-demand movie services.

Key concepts

Supply and Demand Shift

Understanding the shifts in supply and demand is critical when assessing market dynamics. In the case of the new revenue sharing agreement between Hollywood screenwriters and movie producers, such shifts are central to predicting market outcomes. After the agreement, the cost to movie producers for video rentals increases because they now share revenue with the writers. This rise in cost is likely to trigger a leftward shift in the supply curve, which indicates a lower quantity supplied at any given price. With producers trying to pass on costs to consumers, rental prices could increase, leading to a potential decrease in the quantity of rentals consumers are willing to purchase.

As for the demand side, it initially remains unchanged for video rentals, as the agreement doesn't influence the consumers' desire to rent. However, in the market for on-demand movies, demand is likely to increase as these become more appealing relative to the now more expensive video rentals. This results in a rightward shift of the demand curve for on-demand movies, illustrating increased willingness to purchase at every price level. A key takeaway is that market equilibrium is significantly affected by shifts in supply and demand, which are often triggered by changes in market conditions, policies, or agreements like the one discussed here.

Consumer Surplus

Consumer surplus is a measure of the economic benefit that consumers receive when they are able to purchase a product for less than the maximum price they're willing to pay. When supply for video rentals shifts leftward due to the new revenue sharing agreement, we anticipate an increase in rental prices. This increase translates into a reduction of consumer surplus, as individuals either pay more for the same number of rentals or experience a decrease in available rentals.

Illustrated in a demand and supply diagram, consumer surplus is the area below the demand curve and above the market price. As the equilibrium price rises due to the supply shift, the area representing consumer surplus diminishes, directly showing the loss in consumer benefit. This change often leads to consumer dissatisfaction with market changes, which in this instance, would likely make the new writers' agreement unpopular among video rental consumers.

Producer Surplus

Conversely, producer surplus is the economic measure of the benefit that producers receive when they sell a product for more than the minimum price they are willing to accept. In the context of on-demand movies, the increased demand as a result of the video rental market price change leads to a potential increase in the price of on-demand services. Assuming the supply of on-demand movies remains the same, the higher price results in an increased producer surplus.

The producer surplus is depicted as the area above the supply curve and below the price consumers actually pay. As the on-demand movie market experiences a higher equilibrium price due to the demand shift, the producer surplus area grows, reflecting the greater benefit producers are receiving. Cable television companies stand to benefit from this change, suggesting that the revenue sharing agreement would, in fact, be viewed favorably by these companies, as it indirectly boosts their market.

Substitute Goods

Substitute goods are products that can be used in place of each other; when the price of one increases, consumers may switch to the substitute. In our case, video rentals and on-demand movies are considered substitutes. Following the implementation of the revenue sharing agreement and the subsequent increase in the cost of video rentals, consumers may shift their consumption towards on-demand movies.

This substitution effect leads to an increase in demand for on-demand movies, rendering the cross-elasticity of demand between these products a key factor in market change. Understanding how substitute goods interact is pivotal for predicting consumer behavior and market responses to changes such as price adjustments or agreements like the one described, which ultimately influence the market demand for these substitutes.