General Information How are prices determined?

Netflix

Microeconomics - Lecture 1

Christoph Kuzmics

Uni Graz, PR (8th edition) 7.1, 10.1, 10.2

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General Information How are prices determined? Netflix

General Information

Lecture Friday 10.00-11.30

Location: HS 11.01

plus your exercise class (attendance mandatory)

Materials: http://moodle.uni-graz.at/
Exams: 4 Quizzes (5 points each), midterm and final exam (40 points each)
suggestions: midterm 28.11.2023 final 30.1.2024
Grading: 50 - 59 = genügend (4), 60 - 72 = befriedigend (3), 73 - 85 = gut (2), 85 - 100 =
sehr gut (1)

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Textbooks

textbook: Pindyck Rubinfeld Microeconomics, any edition.

relevant chapters (8th edition): parts of 1 - 4, 6, 7.1, 8.3, 10, 11, 12.2 - 12.6, 17 (not in this
order).
textbook: Acemoglu, Laibson, List, Microeconomics.
There are many other microeconomics textbooks - many are ok.

I like Rakesh Vohra, Prices and Quantities: Fundamentals of Microeconomics.

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General Information How are prices determined? Netflix

How are prices determined?

Sky, Netflix, DAZN, Disney+, Spotify, farm products, Playstation, Xbox, Switch, ski lift tickets,
airline tickets, train and bus tickets, haircuts, Nescafe, supermarket products, notary and legal
services, highway construction, printer cartridge, McDonald’s burger, second-hand goods on
eBay or Willhaben, player cards on Fifa Ultimate Team, a Banksy artwork, crude oil, electricity
and gas, gym membership, car, computer chip, Kindle, Kindle book, real book, advertising ad,
Google listing place, ...
What are important factors for price determination?

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Netflix

How does Netflix determine its subscription price?

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Relevant costs in general

Relevant for economic decisions are the opportunity costs.

What would be the best alternative decision? This is the opportunity cost.
Example: you work for a few years and then consider getting an MBA, which takes 2 years and
costs $70,000 per year. After the MBA you expect an annual income of e150,000. Should you
do the MBA?
Not relevant are, for example, sunk costs.
Sunk costs are costs that have already been incurred and cannot be recovered.
Example: The Austrian Armed Forces assist in an emergency operation (e.g., flooding). A
deployment of 500 people plus a helicopter for 48 hours. Costs: Salary per person per day gross
e200; helicopter per hour (including pilot) e1000. Damage to public property prevented by
deployment: e220,000; human lives are not at risk. Should the Austrian Armed Forces do this?

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Netflix demand

Demand D(p) (D for demand, and p for price) is the number of Netflix subscriptions as a
function of the price that Netflix can sell at the given price.
Does Netflix know the demand function?
If not, then it should work with the subjective expected demand function - and do a risk
analysis on top of it.
What aspect of the demand function is relevant to price determination?

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Netflix’ pricing problem

You can think of Netflix’ pricing problem approximately like this:
Netflix chooses the price p to maximize revenue (profit),
since Netflix has virtually no (marginal) cost for providing a subscription.

max D(p)p
p

An optimal price (if positive) must satisfy the first order condition:

D 0 (p)p + D(p) = 0

two effects: D(p) is the additional profit if we increase the price by e1, and all (D(p)
subscribers) now pay e1 more;
and D 0 (p)p is the additional gain (loss) due to the change in demand when the price is
increased by e1.
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Concrete example

So optimally D 0 (p)p + D(p) = 0.

For, e.g., semi-log-linear demand D(p) = Ae −γp (for A, γ > 0) this yields p ∗ = γ1 :

D 0 (p) = −γAe −γp

D 0 (p)p + D(p) = −γAe −γp p + Ae −γp = Ae −γp (−γp + 1) = 0,
therefore p ∗ = γ1 .

In Austria, the Netflix subscription price is e8, so γ must be about 81 !

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