Exercise 10.1:
If everyone can save money by making an offer to Priceline.com doesn't that mean the sellers of these products are losing money? So why do they do it?

We've all seen the ads. William Shatner, spokesperson for Priceline.com (http://www.priceline.com/) has a 1950's beat poem extolling the advantages of making an offer on priceline.com. You only pay what you want for the product you want. This is a fascinating idea, called a reverse auction, which, as a sidebar, Priceline.com has patented. You, the consumer, simply log on to Priceline and make an offer to buy anything from airline tickets to groceries. Your offer is posted, merchants get it and decide whether to accept the offer and provide the product. You only pay what you offer to get the product (of course, if the offer is simply too low, no merchant will accept and you will have to increase it).

The implication is that the consumers always pay a lower than equilibrium price, implying that the producers lose revenue and profit. Why would producers enter into such an agreement? If the implication were accurate, they wouldn't.

This is an excellent example of price discrimination. Some people will, in fact, purchase things at lower prices than they otherwise could. However, it is not the case that everyone will do so. Consider the following diagram:

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If the market is allowed to operate without the reverse auction, the price of this product (say a hotel room for one night) would be $54, and the quantity sold would match both the sellers and buyers desires at that price. The implication of the Priceline ads is that everyone could offer a price as low as $28, and the firms would respond by providing rooms in the quantity buyers wished. Of course this is not so, the hostlers (people who operate hotels, inns, motels, etc.) would only provide an amount equal to the amount at the intersection of $28 and the supply curve, resulting in a shortage. As the price is bid up toward $54, the hostlers would offer more rooms and the bidders would gradually drop out. Sometimes this is the way it works. However, this is only one way of arriving at the equilibrium price. It is quite unlikely that any individual buyer is aware of the equilibrium price of a room. In many cases buyers offer a price above the equilibrium. From the May 19, 2000 Hey Wait a Minute column in Slate magazine (http://www.slate.com/), "In the première issue of eCompany Now, Time Warner's new business magazine, a reporter tells of bidding—and prepaying—$75 for a room in a South Dakota hotel where the most expensive regular rate is $54." It is clear that businesses are willing to participate in Priceline because it is profitable—however, markets are not a series of "if I win, you lose" arrangements and consumers also benefit from the arrangement.

Exercise 10.2:
Why are Cable TV Companies Advertising Even Though They Have a Local Monopoly?

Cable TV companies are often granted a local monopoly to provide cable TV service to an area. If consumers in a given area want access to cable TV, they must contract for that service with the company that holds the local monopoly. These local monopoly arrangement were created to allow for efficiency (it is less costly for one firm to provide the infrastructure for cable TV than to have many firms duplicating it).

Recently, many local cable TV providers have begun to advertise their service. Their advertisements tout the quality and dependability of cable TV service. But why would a company that has a local monopoly for providing cable TV need or want to advertise? Consumers who want cable service MUST get that service form the one company serving the local area.

The answer comes from the dynamic nature of the economy! Technological advances have created competition in a once monopolized industry. Satellite dishes and other services that provide access to television signals now compete with cable service. Remember that monopoly markets are markets in which a single firm sells a unique product with no close substitutes. When cable TV was the only way to gain access to the variety of available TV channels, the cable companies had a monopoly and no need to advertise. But now that technological change has provided alternative ways to gain access to TV channels, cable companies must compete for consumers' business. One way to compete is through advertising!