Analytical assignment-3

Why is That Web Site You're Using Free?

Case Summary
The case "why is that website you're using free?" initially recalls the saying by
economist Milton Friedman that "there's no such thing as a free lunch." But web
companies by using digital technology and the principles of freekonomics make profits by
giving away free of charge. this model of business has been connected to be understood
by the concept of economies of scale. The case brings the concept of freemiums which
basically means a business model, especially on the Internet, whereby basic services are
provided free of charge while more advanced features must be paid for (example: Adobe
reader, search engine, etc.) where the premium's revenue covers the cost of both the
premium and the free activities.

Then the case provides some example of freeconomics such as King Gillette, free service
to deliver advertise in Tv, radios as well as the links that are sponsered in Google and
other websites as well which numbers of users use. Talking about the concept of
economies of scale comes three topics mainly Economies of scale, Constant return to
scale and Diseconomies of scale.

When the long run average cost curve decreases with the increase in output, it is
economies of scale. Similarly, the long run average cost curve remaining constant with
the increase in output shows the constant returns to scale. Finally, diseconomies of scale
is the situation of increasing long run average cost curve with the increasing level of
output.
Analze The Issue
Suppose a hugely successful Web company has used freeconomics, expanded its scale of
operations and spread its long run costs over larger and larger audiences. After years of
profits, the company's profits fell continuouslu. Using production costs theory, exolain
why this situation might be occuring.

Ans:
The highly successful Web company may have used freeconomis (a business model in
which product or service is offered free of charge and supported by sales of premium
version) for many reason such as it being designed not to earn money, those websites
covering their cost from premium users as well as revenue from sponsering a lot of links
and making those links reach to almost all the users using that particular website.

The web company initially expanding its scale of operation and spreading its long run
costs over lagere audiences make them earn profit for initial years due to economies of
scale as in a long run the company reduces its average cost and its revenue exceeds cost
which makes it earn profit. The more the company expands the result will be
diseconomies of scale i.e increasing cost with the increasing output which reduces the
profit. The reason of long run average cost curve to increase can be the increase in
number of workers, management costs, maintainances, etc. There will be complexity in
communication as a lack of direct communication which ultimately leads to the
diseconomies of scale. The further explaination for the company's falling profit can be
plotted in graph as follows.

Cost per unit of output

(dollars)
INDEX

Economies of scale

LRAC Constant returns to scale

Diseconomies of scale

O X
Quantity of output

Fig: Web company's long run average cost curve

The given graph also shows the long run average cost curve of the web company where
the economies of scale, constant return to scale and diseconomies of scale has occured.
As in the question, after years of profits, the company's profit has fallen continuously.
This situation might be occuring due to occurence of diseconomies of scale in the
company because the long run average cost is increasing as shown in the figure which
represent the increasing cost with the increase in quantity of output. The profit that the
company was gaining at the begininng will fall continuously as the cost compared to the
beginning will increase.

Thus, the situation of the company's profit which was falling continuously will occur in a
long run when disconomies of scale exists.