Nova workboard

a blog from young economists at Nova SBE

Apple accused of forming a cartel

The prices of e-books were fixed through a wholesale model. This model states that the retailers are the owners of their e-books, and so they choose the price alone (retail price).

Amazon was the first company to offer a large variety of e-books, and with the launch of Kindle, the prices were about  $9,99 per e-book. Other retailers, in order to compete with Amazon, tried to match this price.

The benefits derived from this model were practically absorbed by the consumers, who were able to buy from every retailer the books they wanted at a reasonable price.

However, publishers feared the e-book market would affect their long-term profit, due to the fact that the demand for printed books would decrease or even cease to exist and due to the fear of being pushed by retailers to drop their prices even lower.

This forced the publishers to act together in order to ensure their own survival by forcing Amazon to raise their prices.

Despite the efforts, it was only with the entrance of Apple in the e-book market that they achieved the result intended.

The cartel formed by Apple and the publishers decided to change the wholesale model to an agency one. This differed from the previous one, in the sense that publishers were the ones fixating prices, and it was established that 30% of the value would revert to Apple.

Amazon tried to fight back, but with the launch of the Ipad, and the realization that all publishers were acting together, it had no choice but to give up and accept the agency model.

This resulted in higher prices in the e-book markets, causing consumers to loose the benefits they had before.

Let’s consider now a general equilibrium model, which is divided in two sectors: a sector with the e-books/books and another sector representing all the others.

In order for the economy to be efficient in consumption, and a Pareto Optimal, the choice bundle must lay in the contract curve, when both indifference curves are tangent and MRS of one agent is equal to the other. This means that the amount the consumers are willing to give up the same amount of good 2 in order to increase the quantity of the other by 1.

Efficiency in production occurs when the MRTS of both factors of production are the same.

Adding both conditions, it comes that equilibrium of production and consumption is given by MRS=MRT.

This is illustrated in the picture; the optimal choice is point A since MRS=MRT.

With the increase in the price of the e-book, the MRS of increase as well since MRS = pebook / pothersector.

ImageAs MRS=MRT, when MRS increases so does MRT, which means that the marginal cost of producing e-books/books will increase (MRT=MCebook/MCothersector).  

This is linked to the fact that the publishers practice such a high price for the books, which leads to a decrease in consumption. This decrease in consumption will, then create an incentive for writers to stop writing, since no one will buy their books.  

To sum up, this decision of Apple to form a cartel and increase the prices leads to negative effects: the welfare loss of consumers due to the more expensive e-books, and the reduction of writers due to the fact that the demand for their product decreases.

Maria Almeida

#637

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Author: studentnovasbe

Master student in Nova Sbe

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