Question

Down On Our Luck Studios has spent 100 million dollar n producing an awful film, \(A\) Depressing Story About a Miserable Person. If the studio releases the film, the most cost-effective marketing plan would cost an additional 5 million dollar, bringing the total amount spent to 105 million dollar. Box office sales under this plan are predicted to be 12 million dollar, which would be split evenly between the theaters and the studio. Additional studio revenue from video and DVD sales would be about 2 million dollar. Should the studio release the film? If no, briefly explain why not. If yes, explain how it could make sense to release a film that cost \(\$ 105\) million but earns only 12 million dollar

Short answer

The total cost is 105 million dollar and total revenue is 8 million dollar, resulting in a loss of 97 million dollar. From a financial perspective, it would not make sense to release the film.

Step-by-step solution

Calculate the total costs

First, add up all the costs involved in making, marketing, and releasing the film. This will include the production cost of 100 million dollar and the marketing cost of 5 million dollar, which comes to a total of 105 million dollar.

Calculate the total revenue

Next, sum up all the revenue that the studio will earn. This will include 50% of the box office sales (as the other 50% goes to the theaters) and the revenue from video and DVD sales. Hence, the total revenue will be \(0.5 * 12\) million dollar from box office sales and 2 million dollar from video and DVD sales.

Determine the profit or loss

Subtract the total cost from the total revenue to determine the profit or loss. If the result is positive, it means the studio made a profit whereas if it's negative, the studio made a loss.

Final analysis

Lastly, the decision to release the movie or not will depend on the calculated profit or loss. If there's a profit, then it would be recommended to release the movie. However, if there's a loss, then the studio will have to decide if it's worth it to release the movie. Potential factors may include salvaging what can be earned and reputation impact.

Key concepts

Cost-Benefit Analysis

Understanding cost-benefit analysis is crucial for making informed decisions in microeconomic contexts. It involves comparing the costs associated with a particular action to the benefits that would be received.

In the exercise, Down On Our Luck Studios evaluates whether to release a film by comparing the monetary costs (production and marketing) against the expected revenue (box office and video sales). While their total costs amount to 105 million dollars, the anticipated revenue is far less. They must analyze if the benefits of releasing the film, such as potential long-term gains from brand recognition or avoiding total loss of investment, outweigh the immediate financial loss.

This cost-benefit analysis doesn't only include tangible factors. Intangible benefits, such as industry experience for staff or maintaining a relationship with distributors, could influence the decision. The studio must weigh all of these potential costs and benefits, both tangible and intangible, to make an economically sound decision.

Profit and Loss Calculation

Profit and loss calculations are a straightforward yet fundamental aspect of microeconomic decision-making. To determine if a business venture is financially viable, one needs to subtract total costs from total revenues.

In our example, the studio's total costs are 105 million dollars - the sum of production and marketing expenses. The revenue is only part of the box office sales (6 million dollars after splitting with theaters) plus 2 million dollars from video and DVD sales, totaling 8 million dollars. By subtracting the costs from the revenue, the studio is facing a loss of 97 million dollars.

Beyond the immediate loss, the studio might consider other factors, like diminishing returns on additional marketing, the opportunity cost of alternative projects, or the sunk cost fallacy. Understanding that a sunk cost—money already spent—is not recoverable helps in avoiding further unwarranted investment based on past expenses, a common pitfall in economic decision-making.

Economic Reasoning

Economic reasoning is used to make decisions by evaluating the available information according to economic principles. It often involves considering opportunity costs, marginal benefits, and rational decision-making.

Applying economic reasoning to the studio's dilemma, we must consider factors such as the marginal utility of releasing the film versus the opportunity cost of not releasing it. Would the funds and efforts be better allocated to a different project offering higher returns? Could the release of the film damage the studio's brand image, leading to a loss of goodwill and potentially more significant financial losses in the future?

Moreover, the decision could be influenced by non-financial considerations. For instance, a commitment to artistic expression may lead the studio to release the film despite financial loss. Employing economic reasoning means contemplating all these variables and choosing a course of action that aligns with the overall objectives of the studio, financial or otherwise.