Category: Microeconomics

The Roman Emperor Vespasian Fell Prey to the Lump-of-Labor Fallacy

Bust of the Roman Emperor Vespasian. (Photo from en.wikipedia.org.)

Some people worry that advances in artificial intelligence (AI), particularly the development of chatbots will permanently reduce the number of jobs available in the United States. Technological change is often disruptive, eliminating jobs and sometimes whole industries, but it also creates new industries and new jobs. For example, the development of mass-produced, low-priced automobiles in the early 1900s wiped out many jobs dependent on horse-drawn transportation, including wagon building and blacksmithing. But automobiles created many new jobs not only on automobile assembly lines, but in related industries, including repair shops and gas stations.

Over the long run, total employment in the United States has increased steadily with population growth, indicating that technological change doesn’t decrease the total amount of jobs available. As we discuss in Microeconomics, Chapter 16 (also Economics, Chapter 16), fears that firms will permanently reduce their demand for labor as they increase their use of the capital that embodies technological breakthroughs, date back at least to the late 1700s in England, when textile workers known as Luddites—after their leader Ned Ludd—smashed machinery in an attempt to save their jobs. Since that time, the term Luddite has described people who oppose firms increasing their use of machinery and other capital because they fear the increases will result in permanent job losses.

Economists believe that these fears often stem from the lump-of-labor fallacy, which holds that there is only a fixed amount of work to be performed in the economy. So the more work that machines perform, the less work that will be available for people to perform. As we’ve noted, though, machines are substitutes for labor in some uses—such as when chatbot software replace employees who currently write technical manuals or computer code—they are also complements to labor in other jobs—such as advising firms on how best to use chatbots. 

The lump-of-labor fallacy has a long history, probably because it seems like common sense to many people who see the existing jobs that a new technology destroys, without always being aware of the new jobs that the technology creates. There are historical examples of the lump-of-labor fallacy that predate even the original Luddites.

For instance, in his new book Pax: War and Peace in Rome’s Golden Age, the British historian Tom Holland (not to be confused with the actor of the same name, best known for portraying Spider-Man!), discusses an account by the ancient historian Suetonius of an event during the reign of Vespasian who was Roman emperor from 79 A.D. to 89 A.D. (p. 201):

“An engineer, so it was claimed, had invented a device that would enable columns to be transported to the summit of the [Roman] Capitol at minimal cost; but Vespasian, although intrigued by the invention, refused to employ it. His explanation was a telling one. ‘I have a duty to keep the masses fed.’”

Vespasian had fallen prey to the lump-of-labor fallacy by assuming that eliminating some of the jobs hauling construction materials would reduce the total number of jobs available in Rome. As a result, it would be harder for Roman workers to earn the income required to feed themselves.

Note that, as we discuss in Macroeconomics, Chapters 10 and 11 (also Economics, Chapter 20 and 21), over the long-run, in any economy technological change is the main source of rising incomes. Technological change increases the productivity of workers and the only way for the average worker to consume more output is for the average worker to produce more output. In other words, most economists agree that the main reason that the wages—and, therefore, the standard of living—of the average worker today are much higher than they were in the past is that workers today are much more productive because they have more and better capital to work with.

Although the Roman Empire controlled most of Southern and Western Europe, the Near East, and North Africa for more than 400 years, the living standard of the average citizen of the Empire was no higher at the end of the Empire than it had been at the beginning. Efforts by emperors such as Vespasian to stifle technological progress may be part of the reason why. 

Who Is Wealthier, Iron Man or Batman?

Photo from Paramount Pictures via britannica.com.

Photo from Warner Brothers Pictures via insider.com.

Income and wealth are often confused. Media accounts of the “wealthy” typically switch back and forth between referring to people with high incomes and referring to people with substantial wealth. It’s possible to have a high income, but not much wealth, if you spend most of your income. It’s also possible, although less common, for someone to have substantial wealth while having a relatively low income.

As we discuss in the Don’t Let This Happen to You feature in Macroeconomics, Chapter 14 (also Economics, Chapter 24), Your income is equal to your earnings during the year, while your wealth is equal to the value of the assets you own minus the value of any debts you have. It’s also worth keeping in mind that income is a flow variable that is measured over a period of time—such as a year—while wealth is a stock variable that is measured at a particular point in time—such as the first or last day of the year.

Both income and wealth can be difficult to accurately measure. Although we typically think of a person’s income as being equal to the salary and wages the person earns, income, properly measured, also includes changes in the value of the assets the person owns. For example, suppose that at the start of the year you own shares of Apple stock worth $5,000. If at the end of the year, the price on the stock market of your Apple shares has risen to $5,500, the $500 increase is part of your income for the year. (Note that this capital gain on your stock is included in your taxable income only if you sell the stock. Whether you sell the stock or not, though, the capital gain is part of your income.)

It can be difficult to measure the wealth of someone who owns significant assets that, unlike shares of stock, aren’t regularly bought and sold in a market. For instance, if someone owns a restaurant, determining what the price the restaurant would sell for—and, therefore, how wealthy the person is—can be difficult. Although other restaurants in the area may have sold recently, every restaurant is different, which makes it possible to determine only approximately what the sales price of a particular restaurant would be. As we discuss in the Apply the Concept feature “Should the Federal Government Begin to Tax Wealth?” in Microeconomics, Chapter 17 (also Economics, Chapter 17), the difficulty of valuing some types of wealth is one complication the federal government would face in enacting a tax on wealth. 

If measuring the wealth of someone in the real world is difficult, measuring the wealth of a fictional character is even more daunting. Some years ago, undergraduate students, most of whom were economics majors at Lehigh University, estimated the wealth of Bruce Wayne, the alter ego of Batman. To narrow the focus, the students based their estimate on only the information available in the three Batman films directed by Christopher Nolan. On the basis of that information, they estimate that Bruce Wayne’s wealth is $11.6 billion. At the time the films were produced, that would have made Bruce Wayne the seventy-third wealthiest person in the world—if, of course, he had been a real person! You can read the details of their estimate here. 

Bruce Wayne is apparently very wealthy, but is he as wealthy as Tony Stark, the alter ego of Iron Man? Apparently not, according to an estimate appearing on the business web site forbes.com. Although he doesn’t seem to give the details of how he arrived at the estimate, the author of the post values Tony Stark’s wealth at $9.3 billion, making him about 20 percent less wealthy than Bruce Wayne.  Score one for the Caped Crusader!

California Deals with the Paradox of Tobacco Taxes

(Photo from Zuma Press via the Wall Street Journal.)

When state and local governments impose taxes on sales of liquor, on cigarettes and other tobacco products, or on soda and other sweetened beverages, they typically have two objectives: (1) Discourage consumption of the taxed goods, and (2) raise revenue to pay for government services.  As we discuss in Chapter 6 of Microeconomics (also Economics, Chapter 6), these objectives can be at odds with each other. The tax revenue a government receives depends on both the size of the tax and the number of units sold. Therefore, the more successful a tax is in significantly reducing, say, sales of cigarettes, the less tax revenue the government receives from the tax.

As we discuss in Chapter 6, a tax on a good shifts the supply curve for the good up by the amount of the tax. (We think it’s intuitively easier to think of a tax as shifting up a supply curve, but analytically the effect on equilibrium is the same if we illustrate the effect of the tax by shifting down the demand curve for the taxed good by the amount of the tax.)  A tax will raise the equilibrium price consumers pay and reduce the equilibrium quantity of the taxed good that they buy. For a supply curve of a given price elasticity in the relevant range of prices, how much a tax increases equilibrium  price relative to how much it decreases equilibrium quantity is determined by the price elasticity of demand. 

The following figure illustrates these points. If a city implements a tax of $0.75 per 2-liter bottle of soda, the supply curve shifts up from S1 to S2. If demand is price elastic, the equilibrium price increases from $1.75 to $2.00, while the equilibrium quantity falls from 90,000 bottles per day to 70,000. If demand is price inelastic, the equilibrium price rises by more, but the equilibrium quantity falls by less. Therefore, a more price elastic demand curve is good news for objective (1) above—soda consumption falls by more—but bad news for the amount of tax revenue the government collects. When the demand for soda is price inelastic, the government collects tax revenue of $0.75 per bottle multiplied by 80,000 bottles, or $60,000 per day. When the demand for soda is price elastic, the government collects tax revenue of $0.75 per bottle multiplied by 70,000 bottles, or only $52,500 per day.

One further point: We would expect the amount of revenue the government earns from the tax to decline over time, holding constant other variables that might affect the market for the taxed good, . This conclusion follows from the fact that demand typically becomes more price elastic over time. In other words, when a tax is first imposed (or an existing tax is increased), consumers are likely to reduce purchases of the taxed good less in the short run than in the long run. This result can a problem for governments that make a commitment to use the tax revenues for a particular purpose.

A recent article in the Los Angeles Times highlighted this last point. In 1999, California voters passed Proposition 10, which increased the tax on cigarettes by $0.50 per pack, with similar tax increases on other tobacco products. The tax revenues were dedicated to funding “First 5” state government agencies, which are focused on providing services to children 5 years old and younger.  The article notes, as the above analysis would lead us to expect, that the additional revenue the state received from the tax increase was largest in the first year and has gradually declined since as the quantity of cigarettes and other tobacco products sold has fallen. (Note that over such a long period of time, other factors in addition to the effects of the tax have contributed to the decline in smoking in California.) As a result, the state and county governments have had to scramble to find additional sources of funds for the First 5 agencies. The article quotes Deborah Daro, a researcher at the University of Chicago, as noting: “It seemed like a brilliant solution—tax the sinners who are smoking to help newborns and their parents …. But then people stopped smoking, which from a public health perspective is great, but from a funding perspective for First 5—they don’t have another funding stream.”

Claudia Goldin Wins the Nobel Prize in Economics

Claudia Goldin (Photo from Goldin’s web page at havard.edu.)

Claudia Goldin, the Henry Lee Professor of Economics at Harvard, has been awarded the 2023 Nobel Prize in Economic Sciences. Goldin’s research is wide-ranging, with a focus on the economic history of women and on gender disparities in wages and employment. She received her PhD from the University of Chicago in 1972 for a thesis that was published in 1976 as Urban Slavery in the American South, 1820 to 1860: A Quantitative History. Her thesis adviser, Robert Fogel, was awarded the Nobel Prize in 1993 for his work in economic history. He shared the prize that year with Douglas North of Washington University in St. Louis. Goldin’s work on economic history contributed to the cliometric revolution, which involves the application of theoretical models and econometric methods to the study of historical issues.  At the time of the award to Fogel and North, Goldin discussed their research and the cliometric revolution here.

Goldin’s pioneering and influential research on the economic history of women was the basis for her 1990 book Understanding the Gender Gap: An Economic History of American Women. The themes of that book were expanded on in 2021 in Career & Family: Women’s Century-Long Journey toward Equity, and in her forthcoming An Evolving Force: A History of Women in the Economy.

In research with Lawrence Katz, also a professor of economics at Harvard, Goldin has explored how technological change and educational attainment have affected income inequality, particularly the wage premium skilled workers receive. Goldin and Katz summarized their findings in 2008 in the influential book, The Race between Education and Technology.

The wide scope of Goldin’s research can be seen by reviewing her curriculum vitae, which can be found here. The announcement by the Nobel committee can be found here.

9/16/23 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss inflation, the current status of a soft-landing, and the green economy.

Join authors Glenn Hubbard & Tony O’Brien as they discuss the economic landscape of inflation, soft-landings, and the green economy. This conversation occurred on Saturday, 9/16/23, prior to the FOMC meeting on September 19th-20th.

A Reporter for NPR Encounters the Challenge of Network Externalities on an EV Road Trip

An electric vehicle (EV) charging station. (Photo from the Associated Press via the Wall Street Journal.)

Secretary of Energy Jennifer Granholm recently took a road trip in a caravan of electric vehicles (EVs). The road trip “was intended to draw attention to the billions of dollars the White House is pouring into green energy and clean cars.” A reporter for National Public Radio (NPR) went on the trip and wrote an article on her experience.

One conclusion the reporter drew was: “Riding along with Granholm, I came away with a major takeaway: EVs that aren’t Teslas have a road trip problem, and the White House knows it’s urgent to solve this issue.” The problem was that charging stations are less available and less likely to be functioning than would be needed for a road trip in an EV to be as smooth as a similar trip in a gasoline-powered car. The reporter noted that in her experience with her own EV: “I use multiple apps to find chargers, read reviews to make sure they work and plot out convenient locations for a 30-minute pit stop (a charger by a restaurant, for instance, instead of one located at a car dealership).”

EVs exhibit network externalities. As we discuss in Microeconomics and Economics, Chapter 10, 10.3 (Essentials of Economics, Chapter 7, Section 7.3), Network externalities are a situation in which the usefulness of a product increases with the number of consumers who use it. For example, the more iPhones people buy, the more profit firms and individuals can earn by creating apps for the iPhone. And the more apps that are available, the more useful an iPhone becomes to people who use it.

In this blog post, we discuss how Mark Zuckerberg’s Meta Platforms (which was originally named Facebook) has had difficulty selling Oculus augmented reality headsets. Many people have been reluctant to buy these headsets because they don’t believe there are enough software programs available to use the headsets with. Software designers don’t have much incentive to produce such programs because not many consumers own a headset necessary to use the programs.

The difficulty that Meta has experienced with augmented reality headsets can be overcome if the product is sufficiently useful that consumers are willing to buy it even if complementary products are not yet available. That was the case with the iPhone, which experienced strong sales even before Apple opened its app store. Or to take an historical example relevant to the current situation with EVs: When the Ford Motor Company introduced the Model T car in the early twentieth century, many people found that owning a car was such an advance over using a horse-drawn vehicle that they were willing to buy one despite there being realtively few gas stations and repair shops available. Because so many cars were being sold, entrepreneurs had an incentive to begin opening gas stations and repair shops, which increased the attractiveness of using a car, thereby further increasing demand.

As the NPR reporter’s experience shows, consumers choosing between buying an EV or a gasoline-powered car are in a situation similar to that faced by early twentieth century consumers in choosing between cars and horse-drawn vehicles. One difference between the two situations is that Congress and the Biden administration are attempting to ease the transition to EVs by subsidizing the construction of charging stations and by providing tax credits to people who buy EVs.

Solved Problem: The German Tobacco Tax and Price Elasticity

(Photo from Reuters via the Wall Street Journal)

Supports: Microeconomics, Chapter 6, Section 6.3, Economics, Chapter 6, Section 6.3, and Essentials of Economics, Chapter 7, Section 7.7.

In August 2023, an article in the Wall Street Journal discussed the effort of the German government to reduce tobacco use. As part of the effort, the government increased the tax on tobacco products, including cigars and cigarettes. The tax increase took effect on January 1, 2022. According to German government data, during 2022 the quantity of cigars and cigarettes sold declined by 8.3 percent. At the same time, the tax revenue the government collected from the tobacco tax declined from €14.7 billion to €14.2 billion.

  1. From this information, can you determine whether the tobacco tax raised the price of cigars and cigarettes by more or less than 8.3 percent? Can you determine whether the demand for cigars and cigarettes in Germany is price elastic or price inelastic? Briefly explain.
  2. According to the Wall Street Journal article, in addition to increasing the tax on tobacco products, the German government took other steps, including banning outdoor advertising of tobacco products, to discourage smoking. Does this additional information affect your answer to parts a.? Briefly explain. 

Solving the Problem

Step 1:  Review the chapter material. This problem is about the effect of price changes on revenue, so you may want to review Microeconomics, Chapter 6, Section 6.3, “The Relationship between Price Elasticity of Demand and Total Revenue,” or the corresponding sections in Economics, Chapter 6 or Essentials of Economics, Chapter 7.

Step 2: Answer part a. by explaining whether you can tell if the tobacco tax raised the price of cigars and cigarettes by more than 8.3 percent and whether the demand for cigars and cigarettes in Germany is price elastic or price inelastic. We have two pieces of information: (1) In 2022, the quantity of cigars and cigarettes sold in Germany fell by 8.3 percent, and (2) the revenue the German government collected from the tobacco tax fell. We know that if a company increases the price of its product and the total revenue it earns falls, then the demand for the product must be price elastic. We can apply that same reasoning to a government increasing a tax. If the tax increase leads to a fall in revenue we can conclude that the demand for the good being taxed (in this case cigars and cigarettes) is price elastic.  When the demand for a good is price elastic, the percentage change in the quantity demanded resulting from a price increase will be greater than the percentage change in the price.  Therefore, the percentage change in price resulting from the tax must be less than 8.3 percent. An important qualification to this conclusion is that it holds only if no variable, other than the increase in the tax, affected the demand for cigars and cigarettes during 2022.

Step 3: Answer part b. by explaining how the German government’s banning of outdoor advertising of tobacco products affects your answer to part a. Banning outdoor advertising of tobacco products may have reduced the demand for cigars and cigarettes. If the demand curve for cigars and cigarettes shifted to left, then some of the 8.3 percent decline in the quantity sold may have been the result of the shift in demand rather than the result of the increase in the tax. In other words, the German market for cigars and cigarettes in 2022 may have experienced both a decrease in demand—as the demand curve shifted to the left—and a decrease in the quantity demanded—as the tax increase raised the price of cigars and cigarettes. Given this new information, we can’t be sure that our conclusions in part a.—that the demand for cigars and cigarettes is price elastic and that the tax resulted in an increase in the price of less than 8.3 percent—are correct.  

Extra credit:  This discussion indicates that in practice economists have to use statistical methods when they estimate the price elasticity of demand for a good or service. The statistical methods make it possible to distinguish the effect of a movement along a demand curve as the price changes from a shift in the demand curve caused by changes in other economic variables.  

Sources:  Jimmy Vielkind, “Smoking Is a Dying Habit. Not in Germany,” Wall Street Journal, August 31, 2023; and Statistisches Bundesamt, “Taxation of Tobacco Products (Cigarettes, Cigars/Cigarillos, Fine-Cut Tobacco, Pipe Tobacco): Germany, Years, Tax Stamps,” September 10, 2023.

The Price Elasticity of Demand for Subway and Bus Rides

Supports: Microeconomics, Chapter 6, Section 6.3, Economics, Chapter 6, Section 6.3, and Essentials of Economics, Chapter 7, Section 7.7.

New York City subway. (Photo from the New York Times.)

An article on Crain’s New York Business noted that the Metropolitan Transit Authority (MTA), which runs New York City’s public transportation system was increasing the fare for a bus or subway ride from $2.75 to $2.90. The article noted that: “Revenue generated by the fare increase is expected to cover the [MTA’s] operating expenses and help keep up with inflation.”

a.  What is the MTA assuming about the price elasticity of demand for subway and bus rides in New York City? How plausible do you find this assumption? Briefly explain.

b. What is the largest percentage decline in subway and bus rides that the MTA can experience and still meet its revenue expectations?

Solving the Problem

Step 1:  Review the chapter material. This problem is about the relationship between a price increase on quantity demanded and revenue, so you may want to review the section “The Relationship between Price Elasticity of Demand and Total Revenue.”

Step 2:  Answer part (a) by explaining what the MTA is assuming about the price elasticity of demand for subway and bus rides, and comment on the plausibility of this assumption. If the MTA is expecting that an increase in the price of a subway and bus ride will increase the total revenue it earns from these rides, it must be assuming that the demand for subway and bus rides is price inelastic. If the demand were price elastic, the MTA would earn less revenue following the price increase.

 As we saw in Chapter 6, Section 6.2, the most important determinant of elasticity is the existence of substitutes. In a big city, the most important substitutes to taking public transportation are: (1) people walking, (2) people driving their own cars, or (3) people using a ride-hailing service, such as Uber and Lyft.  People who live close to their destination and who were indifferent between walking and taking public transportation before the price increase, are likely to switch to walking. Given the size of a city like New York, we might expect the number of these people to be relatively small. Driving your own car in a big city has the drawback that heavy traffic may mean it takes longer to drive than to take the bus or subway and paying for parking can be expensive. Using Uber or Lyft is also much more expensive than taking public transportation and may also be slow. It seems likely that current users of public transportation in New York City don’t see these alternatives as close substitutes for the bus or subway. So, it’s plausible for the MTA to assume that the demand for subway and bus rides is price inelastic. 

Step 3:  Answer part (b) by calculating the largest percentage decline in bus and subway rides that the MTA can experience and still meet its revenue expectations. The MTA is increasing the price of subway and bus rides from $2.75 to $2.90 per ride. That is a ($0.15/$2.75) × 100 = 5.5 percent increase. (Note that we would get a somewhat different result if we used the midpoint formula described in Section 6.1.) For the MTA’s revenue to increase as a result of the price increase, the percentage decrease in the quantity demanded of subway rides must be less than the percentage increase in the price. Therefore, the price increase can’t result in a decline of more than 5.5 percent. 

Source:  Caroline Spivak, “Subway and Bus Fares Will Increase Starting Sunday,” crainesnewyork.com, August 18, 2023.

The Fortune Magazine Global 500

Photo of a Walmart store from the Associated Press via the Wall Street Journal.

Many people are familiar with Fortune magazine’s list of the 500 largest U.S.-based firms, measured by their revenue in 2022. (Note: It’s easy to confuse the Fortune 500 with the S&P 500. Firms are included in the S&P 500 on the basis of their market capitalization—the value of all of their outstanding shares of stock—rather than on the basis of their revenue. The S&P 500 is used to compute the most widely followed stock market index. See Microeconomics and Economics, Chapter 8, Section 8.2, and Macroeconomics and Essentials of Economics, Chapter 6, Section 6.2.) 

Fortune also compiles a global 500 list, which includes firms based anywhere in the world. The table below shows the top 10 firms on this Fortune list. With more than $600 billion in revenue in 2022, Walmart tops the list. Five of the ten largest firms are in the oil industry. The three firms based in China are owned by the Chinese government. The Saudi government owns more than half of Saudi Aramco. 

FirmIndustryCountry
WalmartRetailingUnited States
Saudi AramcoOilSaudi Arabia
State GridPublic utilityChina
AmazonRetailingUnited States
China National PetroleumOilChina
Sinopec GroupOilChina
Exxon MobilOilUnited States
AppleConsumer electronicsUnited States
ShellOilUnited Kingdom
UnitedHealth GroupHealth insuranceUnited States

The following table shows how many firms among the top 100 are headquartered in the listed countries. All countries that have more than one firm located in them are included. Far more of these large firms are located in the United States and China than in any of the other countries. Germany, Japan, France, and South Korea are the only other countries that are the headquarters for more than two firms.

CountryNumber of firms
United States38
China30
Germany7
Japan5
France4
South Korea3
India2
United Kingdom2
Italy2

The Fortune article can be found here.

The Price Elasticity of Demand for Disney+

Supports: Microeconomics, Chapter 6, Section 6.3, Economics, Chapter 6, Section 6.3, and Essentials of Economics, Chapter 7, Section 7.7

The Walt Disney Studios in Burbank, California (Photo from reuters.com)

On August 9, Disney released its earnings for the third quarter of its fiscal year. In a conference call with investors, Disney CEO Bob Iger announced that the price for a subscription to the Disney+ streaming service would increase from $10.99 per month to $13.99. An article in the Wall Street Journal quoted Iger as saying that the company had been more uncertain about pricing Disney+ than rival Netflix was about pricing its streaming service “because we’re new at all this.” According to the article, Iger had also said that “there was room to raise prices further [for Disney+] without reducing demand.” A column in the New York Times made the following observation: “The strategy now is to extract more money from subscribers via hefty price increases for Disney+, and hoping that those efforts don’t drive them away.”

a.  What is Disney assuming about the price elasticity of demand for Disney+? Briefly explain.

b. Assuming that Disney is only concerned with the total revenue it earns from Disney+, what is the largest percentage of subscribers Disney can afford to “drive away” as a result of its price increase?

c.  Why would Iger point out that Disney was new at selling streaming services when discussing the large price increase they were implementing?

d.  According to the Wall Street Journal’s account of Iger’s remarks, did he use the phrase “reducing demand” as an economist would? Briefly explain. 

Solving the Problem

Step 1:  Review the chapter material. This problem is about the effect of a price change on a firm’s revenue, so you may want to review the section “The Relationship between Price Elasticity of Demand and Total Revenue.”

Step 2:  Answer part (a) by explaining what Disney is assuming about the price elasticity of demand for Disney+.Disney must be assuming that the demand for Disney+ is price inelastic because they expect that the price increase will increase the revenue they earn from the service. If the demand were price elastic, they would earn less revenue following the price increase. 

Step 3:  Answer part (b) by calculating the largest percentage of subscribers that Disney can drive away with the price increase. Disney is increasing the price of Disney+ by $3 per month, from $10.99 to $13.99. That is a ($3/$10.99) × 100 = 27.3 percent increase. (Note that we would get a somewhat different result if we used the midpoint formula described in Section 6.1.)  For the price increase to increase Disney’s revenue from Disney+, the percentage decrease in the quantity demanded must be less than the percentage increase in the price. Therefore, the price increase can’t drive away more than 27.3 percent of Disney+ subscribers. 

Step 4:  Answer part (c) by explaining why Iger mentioned that Disney was new to streaming when discussing the Disney+ price increase. Firms sometimes attempt to statistically estimate their demand curves to determine the price elasticity. But particularly when a firm has only recently started selling a product, it often searches for the profit maximizing price through a process of trial and error. Iger contrasted Disney’s relative lack of experience in selling streaming services with Netflix’s much longer experience. In that context, it’s plausible that Disney had been substantially overestimating the price elasticity of demand for Disney+ (that is, Disney had thought that in absolute value, the price elasticity was larger than it actually was). So, the profit maximizing price might be significantly higher than the company had initially thought.

Step 5:  Answer part (d) by explaining whether Iger used the phrase “reducing demand” as an economist would. Following a price increase, Disney will experience a reduction in the quantity demanded of Disney+ subscriptions—a movement along the demand curve for subscriptions. For Disney to experience reduced demand for Disney+ subscriptions—a shift of the demand curve—a change in some variable other than price would have to cause consumers to reduce their willingness to buy subscriptions at every price.

Sources:  Robbie Whelan, “Disney to Significantly Raise Prices of Disney+, Hulu Streaming Services,” Wall Street Journal, August 9, 2023; and Andrew Ross Sorkin, Ravi Mattu, Sarah Kessler, Michael J. de la Merced, and Ephrat Livni, “Bob Iger Tweaks Disney’s Strategy on Streaming,” New York Times, August 10, 2023.