I’ll be in Vancouver for a few days for the Western Economics Association International meetings, so I won’t be posting anything for until I get back mid-week. I get to see a beautiful city, check out what is supposed to be an amazing aquarium, have some nice meals, present my DVD paper, and reconnect with people from other schools I haven’t seen in a year or two, while the school picks up the tab for the flight and hotel.

This has been a chance to try to figure out how my iPhone is going to work in Canada. It’s $.79 to make a call to another US number while in Canada, a little less to send a text, same price to receive a text. I can buy an international calling plan for $5/month, but that only reduces the cost per call to $.59, probably not worth it. The cheapest international data plan is $25, which seems like too much for me. I’ve downloaded some wi-fi spot-seeking applications so I can still access the internet and e-mail that way instead of through the 3G network. I’ll be in a foreign city trying to meet up with friends and colleagues at several different hotels, all while trying not to use my phone because I’m so cheap. Should be interesting.

A New York Times reporter, David Rhode, was kidnapped by the Taliban in Afghanistan seven months ago, and somehow managed to escape recently.  People at the Times are saying that they will not release details of the situation other than to say that a) no ransom was paid, and b) no Taliban or other prisoners were released in exchange. It appears that the reporter found the right moment and took advantage of the situation and got away.

The Times never published anything about the kidnapping until now. The editor of the Times, Bill Keller, said he sends a lot of reporters to dangerous places, and the less that is known about situations like this, the better. To quote Keller: “The more you talk about who did what … the more you’re writing a playbook for the next kidnapping,” and “As other victims have told us, discussing your strategy just offers guidance for future kidnappers.”

I agree with him completely. Unfortunately, this seems to be the first time that Bill Keller has agreed that secrecy can be a good thing. Despite numerous objections from the Bush administration, Keller and the Times had no problem publishing a story about the United States government wire-tapping foreigners (even over the objection of Democrat Jane Harmon), or the SWIFT program (monitoring financial transactions of terror suspects). The Bush administration argued that making this type of information public would let terrorists in on our game plan and our strategies, so they could change their behavior to avoid being detected (exactly what Keller argued in relation to the kidnapping). This would make it harder for us to fight the war on terror overseas contingency operations, and might cost American lives. Keller published those stories anyway. But when it’s one of Bill Keller’s people on the line, he wants secrecy. When it’s his people, he understands that if you tell your enemy what you do and how you do it, you make it harder for you to accomplish your goals. The hypocrisy of the situation is so blatant that it would be laughable if the consequences weren’t so dire.

If other news organizations were like the New York Times, they would have printed the story months ago and it might have compromized the safety of David Rhode. Fortunately, other newpapers apparently have higher ethical standards than Bill Keller does. He was afforded a courtesy by his colleagues that he would not extend to President Bush. Let’s hope that Keller remembers this when President Obama asks him to hold off on publishing a story about government secrets to protect national security.

A few weeks ago, Apple announced a new pricing policy for the songs it sells on iTunes. Instead of every song being $.99, they now have three tiers. Popular songs have increased to $1.29. Older songs have been cut to $.69. The rest are still at $.99.

Apple defended the policy saying that the vast majority of its collection is experiencing a price cut. According to them, this is a way of getting consumers to explore their favorite artists’ older albums. If that works, it might be a win-win for Apple and consumers: our demand for those older songs is likely more elastic (more sensitive to a price change) than for newer songs, so the low price means we finally can afford the product.

Of course, the majority of the songs bought on iTunes are the popular new releases, whose prices are likely to go up. Our demand for these is more inelastic, less sensitive to a price change. (How else can you explain people paying $5 for ringtones?) The 30% price hike here might only dissuade a small percentage of customers from buying, but everyone who still buys pays 30% more, so Apple’s revenues go up. Consumers are worse off in this case, no question about it.

Looking at the 100 most popular downloads, about 75% of them are listed at the $1.29 price, while only 25% are at $.99. While the majority of songs in the catalog see a price decrease, the majority of songs people buy see a price increase.

I haven’t heard about much of a backlash as a result of this, but Apple is rightly concerned that people might think they are being treated unfairly. Consumers love it when firms lower prices for goods that turn out to be not as popular as they hoped. But we get really upset when firms raise prices for goods that are more popular than they expected.

The policy interests me because of my research in the motion picture industry. Movie theaters charge the same price for each movie. Obviously some movies are better than others, so why don’t they charge different prices? A few different studies have been done on this (my favorite is this one by Orbach and Einav).

First, movies are not like songs. With songs, you hear it first and know whether you like it or not, so you know what you’re getting when you buy it, and the point is that you want to listen to it over and over again. Most of us only see a movie in theaters once, so you’re buying a product of uncertain quality. If theaters charged higher prices for good movies and lower prices for bad ones, it might hurt both markets.  The low price is a signal that nobody else wants to see it, from which we infer that it must not be good, and that might be enough to drive people away from those movies altogether. And the higher price of good movies might drive a significant percentage of people away from those movies too — why pay more when you can buy it on DVD in 4.5 months anyway? (That’s the average “release window” between when a movie opens in theaters and when it is available on DVD.)

Second, it puts theaters in a difficult situation when dealing with movie studios. When I was working with a theater in St. Louis for my graduate thesis, it was at the time when Star Wars Episode I: The Phantom Menace was released. Everyone knew the movie was going to be huge, and the contract terms that 20th Century Fox got on the movie were insane — the studio got more of the profits (in percentage terms) than on any movie contract I’ve ever seen. As a result, movie theaters understandably considered increasing ticket prices. Expecting this astronomical demand and people waiting in line for days to see the movie, the theater chain increased the price on Phantom Menace tickets by $.25. Not much at all, right? Probably not, but it was enough to have news stations do live coverage outside theaters, talking to customers who were mad at being taken advantage of. All because of twenty-five cents.

The unexpected consequence? There was just as much backlash from other studios as there was from the public at large. The vice president of the theater chain told me that he got calls from other studio representatives asking: “Why aren’t our movies good enough to warrant higher prices?” (Remember: movie studios get a percentage of the revenues, so if theaters can increase prices and still sell tickets, that helps the studios too.) The other studios were jealous! So to avoid irritating everybody else involved, the theater stopped the practice after the first week or two.

As an economist, I love what Apple is doing. While we have statistical techniques we can use when we do not observe price variation, they rely on sometimes unrealistic assumptions. The best way to determine what the demand curve in a market looks like is for firms to change prices and see what happens to the quantity sold. One of the most frustrating things about working on motion pictures is that a) every movie is the same price at the theater, and b) theaters change their prices usually just once a year to adjust for inflation. If we observed more price variation, and saw how consumers responded to it, it would inform our analysis of consumer behavior so much more. But any time a theater has tried dropping prices, movie studios get upset because they think it might hurt their profits, so theaters don’t do it.

How will this pricing change affect you in the future? If Apple determines that there’s a huge response to the dropping of prices on less popular songs, that might end up transferring over into their movie or TV downloads too, benefitting consumers even more. The downside? If they see that the price increase boosts profits, expect more of that in other areas too…

This week Apple announced it was cutting the price of the entry-level iPhone 3G (8GB) in half, from $199 to $99. This comes as part of the announcement of a new and improved iPhone 3GS, which will go on sale next week with new features (video, better camera, voice controls, etc) and more memory. One report I saw said that they hope the move will boost sales of the old iPhone as an entry-level smartphone for those that just haven’t been convinced to switch over from their old-school cell phones yet because of the cost. That article said Apple thought sales of the old version might increase as much as 50% because of the price cut.

It remains unclear (from what I could find about the situation) whether Apple plans on continuing the 3G phone into the future or if they’re phasing it out rapidly in favor of the 3GS. The way I see it, they’ve gone from 2 levels of product quality (3G 8GB and 3G 16GB) to 3 levels (3G 8GB, 3GS 16GB, and 3GS 32GB). Dropping your price 50% and selling 50% more output is not a smart move — you make half as much on each phone and sell 1.5 times as many units as before, so total revenue drops. But broadening your potential customer base is a smart thing.

Keep in mind, this comes right when Palm is releasing their new Pre phone, which looks to me like it might even be better than the iPhone — and I LOVE my iPhone. Running multiple applications at once, synching contacts between Facebook and Outlook are two things I wish my iPhone could do, and the Pre can do them and more — with a slide keyboard to boot.

So Apple steps up and improves the iPhone to compete with the new Pre, and in the process makes their other product more available to the less tech-savvy among us. This is consistent with their multiple iPod strategy — they come out with new ones but seldom wipe out earlier versions; they just drop the price on them to try to get late-adopters to finally purchase.

For a while, Apple’s multiple iPod strategy didn’t make much sense to me. I kept wondering why they would come up with all these different models — wouldn’t they just cannibalize their existing sales? They’ve got the Shuffle, Nano, Classic, and Touch, with multiple memory options for each and just about every color you can think of. Why so many? What they’re doing is flooding the available market space with every possible product anyone might want, much like the three dominant cereal companies (General Mills, Post and Kellogg) come out with every kind of cereal imaginable (Strawberry-Banana Cheerios? REALLY?). That way, there is no room for competitors to find a niche and gain market share. This iPhone move is much the same, and even if total revenues from the 3G will fall, it may still be a smart move when you look at the strategic component of it. (Not to mention the increase in App Store revenues if a whole new slew of people get their hands on iPhones…)

In a good Time magazine piece on the Pre, Palm says they’re not trying to steal anybody away from Apple. They insist that with only around 10% of cell phones being smartphones, the market’s big enough for everybody. We’ll see. And if the market keeps expanding, expect Apple to come up with yet another version to fill yet another niche in the market.

(Part 2 will focus on the new iTunes pricing strategy, with 3 tiers of prices.)

My use of the word inferior here is in the economic context, not in terms of product quality. In economics, we define goods as either normal or inferior, depending on the way in which income affects demand.  A good is normal if the demand for it increases when income rises. A good is inferior if the demand for it decreases when income rises.

I’m currently working on two papers on motion picture revenues: one on box office revenue determinants and another on DVD revenue determinants. Previous research on VHS rentals showed those to be inferior and that made a lot of sense to me — when your income is lower, you rent more movies. The presumption made here (which I make as well) is that you substitute away from going to the theater or buying a DVD and instead just rent it. But it’s not so clear that’s what’s happening.

The data on DVD revenues suggests that new DVDs are also an inferior good. The data on box office revenue, looking at the last 16 years in theaters (and over 2,000 movies) suggests those are inferior also. Those conclusions didn’t make sense to me at first. I thought: if people are renting more DVDs when income goes down, aren’t they spending less money at theaters and on new DVDs?

Apparently not. The National Association of Theater Owners (NATO) project this year to be a pretty decent one for theaters. They cite the fact that in 5 of the last 7 recessions, box office revenue went up. It appears that people cut back on more expensive things like sporting events, vacations and amusement parks, and take the family to the movie theaters a little more. The effect is not large, but it’s there.

Take, for example, the big Memorial Day weekend at the box office. Last year, total box office for Memorial Day weekend (4 days) was $219 million. This year, it’s $221 million. Ticket prices may be a bit higher, but I think theaters have raised their prices less this year than the standard 4% of the last decade. If ticket prices are up 3% while revenues are only up 1%, that means quantity has fallen by 2%. But that fits the general pattern of the last decade of flat or so of flat if not declining attendance (about since the time DVD players started becoming more affordable). One might reasonably argue that any decrease in tickets sold this year vs. last year are not due to the recession, but rather due to a continuation of a trend toward more home viewing on DVD, Blu-ray, and VOD.

I’m not sure why this inferiority result surprised me, but it did. NATO’s explanation seems to make sense, but it runs counter to what I had thought before running the regressions. I guess that’s why we do the research…

UPDATE: My co-author and I have decided that “counter-cyclical” is a better term for the motion picture industry rather than the standard “inferior.” The word inferior, in an economics context, generally implies that when income increases, the demand for the good falls because consumers are substituting something better instead. McDonald’s sales have done well in the recession, as people substitute cheaper goods (McD’s) instead of more expensive meals out. But that’s not quite what we think is happening with movies. We think it’s more that when the economy goes bad, people have an increased desire to escape their troubles with movies. So when the economy goes bad, box office sales, rentals and even DVD sales go up. It’s not necessarily that when times are good they substitute to a higher quality of entertainment (perhaps they do, live sports maybe…), but they don’t need to escape their life quite so much.