Sunday, 23 March 2014

Cornering the market for Christmas toys - an application of elasticities

This week in ECON100 (and next week in tutorials) the class is covering elasticities. So, I thought it might be timely to talk about this video. Now, I'm not a big fan of The Office, but that scene makes me laugh. Mainly because, I've thought about doing this exact thing many times. At least, I thought about it many times in the aftermath of the Great Christmas Bakugan Crisis of 2008 (my son, like many others, missed out on Bakugans, and had to wait all the way until his birthday - oh, the injustice!).

Here's how it works. Dwight does some market research, and identifies the Christmas season's hottest toy: the Princess Unicorn doll. He then whips around the local stores and buys up all of the available stock in town, before raising the price and turning a profit. What Dwight is relying on is a change in the price elasticity of demand of parents. When time horizons are long (long before Christmas), parents have time to shop around. This means that their price elasticity of demand is going to be lower (more elastic). They're not willing to pay a high premium for the Princess Unicorn. And, because people tend to procrastinate, that gives Dwight the opportunity to buy the stock.

But as Christmas approaches, time horizons for Christmas shopping get shorter. With less time available for shopping around, parents' price elasticity of demand increases (less elastic, more inelastic), and they become willing to pay a higher premium for the Princess Unicorn. Voila! Profits to be made for the entrepreneurial Dwight. But only if Dwight has market power - he needs to have some control over the price. Which is guaranteed if he is the only seller of Princess Unicorns in town.

Unless... If Princess Unicorn dolls are available online, then there is a perfect substitute available for Dwight's Princess Unicorn dolls (a Princess Unicorn bought online is the same as one purchased in a store). The availability of a perfect substitute reduces the parents' price elasticity of demand for Dwight's Princess Unicorns, and eliminates the premium they are willing to pay. This leaves Dwight penniless, sad, and with a large pile of dolls.

OK, maybe it's not all bad news, since delivery time means that the Princess Unicorn bought online is not a perfect substitute for one bought from Dwight, if buying online means it will arrive too late for Christmas morning. But clearly that reduces Dwight's window of opportunity (since he can only sell at a premium after the delivery window for Christmas has passed) and his profits (since there are substitutes available, albeit imperfect substitutes).

[HT: I was reminded of this scene on Dirk Mateer's excellent website last year]

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