I found this article interesting because it helped to show the consequences of not accounting for externalities. Universal Music Group, one of Big Fives recording firms, decided to change their minds about permanently lowering the price of CDs. UMG attempted to increase sales and discourage music piracy by lowering their prices, but found their actions did not have the desired effect. Their inability to obtain their desired outcome was a result of a few contributing factors:
1. When UMG lowered prices for Retailers, Retailers continued to sell their CDs as high prices. Therefore customers were not persuaded to purchase UMG CDs over others because they were marked at the same price. Retailers were pocketing the extra cash instead of passing on the savings to their customers. This can be compared to when taxes are levied on one party, and then passed on to another party. The person intended to receive the cost or benefit is not necessarily the one that receives it.
2. Many of the Retailers could not afford to lower the prices and suffer even lower profit margins. The CD business has become highly competitive with smaller firms barely scraping by whereas large corporations like Walmart could afford to mark down prices to basically nothing and making the small business owners suffer. If small stores lowered their prices, like Walmart, they would go out of business.
3. The amount of piracy going on was not being decreased by their lowering of prices. Perhaps piracy would have decreased if lower prices had been implemented for a longer period of time, and if people preferred UMG’s music to other companies, but since these factors were not met piracy did not decrease.
4. Other recording firms did not lower their prices with Universal, but instead decided to step up their advertising “which curried favor with retailers just as Universal was alienating them.” Universal was forced to lower advertising prices because of their shortage of cash from the decrease of revenue from sales. In fact, “Universal stopped paying promotional fees, which helped prop up the teetering chains.”
UMG did not account for the prospect that retailers might decide against lowering their prices on CDs even though they were receiving them at discounted prices. UMGs attempted to increase output by decreasing price, but their objective was not obtained.