Question

In February, \(2003,\) Germany's patent office proposed a solution to reimburse copyright holders for illegal digital file sharing: charging personal computer manufacturers a fee of \(\$ 13\) per computer that would go into a special fund to reimburse the copyright holders. Two computer makers-Fujitsu-Siemens and HewlettPackard-claimed that imposing the fee would do great injury to them because they would be unable to pass any of the fee onto consumers. Under what assumptions about the demand curve would the computer makers' claim be true? Is this assumption realistic?

Short answer

The computer makers' claim would be true under the assumption that the demand for computers is perfectly elastic, meaning any small increase in price leads to a drastic reduction in demand. However, this assumption is not realistic as consumer demand for computers is likely to be elastic but not perfectly so. It is unlikely that a $13 increase in price would cause computer sales to drop to zero.

Step-by-step solution

Understanding the Demand Curve

A demand curve is a graph illustrating how changes in price affect the quantity of the product a consumer is willing and able to purchase. If the demand for the product (in this case, computers) is perfectly elastic, any price increase would drastically reduce the quantity demanded to zero. A perfectly elastic demand curve is horizontal.

Identifying the Assumption

The computer makers' claim would be true if the demand for their products is perfectly elastic. This assumption means that consumers would buy significantly fewer computers or stop buying altogether if manufacturers increase the price by only a small amount, such as the $13 fee.

Evaluating the Realism of the Assumption

The assumption of perfectly elastic demand is generally unrealistic for most goods and services, including computers. It is unlikely that a small increase in price (like the $13 fee proposed) would cause consumers to stop purchasing computers completely. The demand for computers is likely to be elastic, but not perfectly so. This means that while sales might decline if prices increase, they are unlikely to drop to zero.

Key concepts

Perfectly Elastic Demand

Perfectly elastic demand is an interesting and somewhat extreme concept in economics. Imagine a situation where even the tiniest increase in price leads to a total collapse in demand. In such circumstances, the quantity demanded drops to zero if the price increases at all. That's what perfectly elastic demand is all about.

For example, if you're considering buying a product that many others can easily supply at the same price, your willingness to pay more diminishes completely. If anyone offers the product for even a fraction more, you simply won't buy it from them. From a graphical viewpoint, this scenario is represented by a horizontal demand curve. This means that the price remains constant regardless of the quantity demanded, and any change from this price results in no sales at all. While this is a theoretical situation, it helps to highlight how sensitive demand can be to price changes in certain competitive markets.

Pricing Strategy

Pricing strategy involves setting the right price for a product to achieve specific business goals, such as maximizing profits, gaining market share, or deterring competition. It's a critical part of a company’s marketing strategy. The choice of pricing strategy depends on the demand curve of the product.

In cases like perfectly elastic demand, companies do not have the luxury to increase their prices without risking a huge drop in sales. This situation necessitates a competitive pricing strategy where companies must match or undercut competitors' prices.

However, for goods with less elastic demand, a company might consider raising prices without greatly sacrificing sales. They might employ psychological pricing strategies, like setting prices at $9.99 instead of $10, to make consumers perceive the price as lower. In essence, the elasticity of demand heavily influences the pricing decisions a firm makes.

Consumer Behavior

Consumer behavior is the study of how individuals make decisions to spend their available resources, such as time and money, on consumption-related items. It involves understanding the various factors that influence purchasing choices. Several internal and external factors impact these decisions, including:

• Price Sensitivity: How sensitive a consumer is to changes in price affects their buying habits significantly, aligning closely with demand elasticity concepts.
• Substitute Availability: If many similar alternatives are available, consumers are less likely to feel committed to a specific brand or product when prices increase.
• Needs and Wants: Essential needs drive more inelastic demand, while wants usually have elastic demand behaviors.

Consumer behavior thus reflects the broader concepts of demand and pricing strategy, as people's responses to price changes guide businesses on their strategic decisions.

Microeconomics

Microeconomics is a branch of economics that examines how individual units, such as households and firms, make decisions to allocate limited resources. It focuses on the behaviors of consumers and businesses, the ensuring supply and demand in markets, and how prices are set. Key elements of microeconomics include:

• Supply and Demand: The core model for understanding how prices and quantities of goods are determined in markets.
• Market Structures: Different market types, such as perfect competition or monopoly, influence pricing and production strategies.
• Elasticity: Understanding how changes in price affect changes in quantity demanded or supplied provides critical insights to both producers and consumers.

Microeconomic principles help explain the rationales behind businesses’ pricing strategies and consumer purchasing decisions. It's a fundamental area of study that aids in understanding everyday economic interactions and the effects of government policies on consumer welfare and business profits.