ECON1008 Economics: Netflix Slugs Aussies with Price Rise GST

Read the article written by Adam Turner “Netflix slugs Aussies with price rise alongside GST tax hike” published in Sydney Morning Herald, 28 June 2017. Answer the three questions that follow the article using economic models where appropriate.

Task:

1.

This news article talks on the new 10% GST levied on Netflix services which has led to a rise in the price of Netflix plans. There has also been a hike in price of its plans by Netflix, to support the introduction of new content. The combined effect of tax hike due to GST and Netflix’s own price hike is an increase in the price of Netflix services. This rise ranges from $1 to $9.99 per month for the basic plan, while the four-user Ultra HD plan rises $3 to $17.99.

The rise in price can be seen through the prism of demand- supply analysis. A tax has the effect of adding to costs of the firm, so that supply decreases. This is shown as an upward shift of the supply curve from S1 to S2. We start with equilibrium at E1 where demand equals supply- D1 intersects S1 at this point.  As a tax is levied new equilibrium is found at E2, where S2 intersects D1. This leads to rise in price fromP1 to P2, while quantity falls from Q1 to Q2.

Along with this tax, we also have Netflix increasing its own price.  ‘Adding a price rise on top of Australia's digital tax is justified by Netflix's introduction of new content and features’.  This higher price can be seen with a movement along the supply curve as shown below. Netflix moves from E1 to B. the article does not mention how B and E2 are connected. Both events cause price to rise but it cannot be said how much rise is due to tax and how much has Netflix contributed to it.  

2:

There are many determinants of price elasticity of demand:

• Elasticity is higher when there are greater number of substitutes for the good.
• The nature of the good affects elasticity- luxury goods have an elastic demand, while a necessity good has an inelastic demand.
• Time plays a role here. In the long run, consumers  get time to adjust to changed situations, making elasticity more elastic.

Based on these factors it seems that Netflix enjoys inelastic demand. This is because it has increased prices on its own, on top of price rise due to new tax. The timing of the own price rise shows that it is not relay worried about falling demand. it is reasonably confident of getting the price rise through with consumers.  This also saves Netflix from transparently showing what share of the tax has been pushed to the consumer- the timing of price rise is chosen to push tax burden on consumer.   

b.

If we believe that demand is inelastic then it is clear that Netflix will get more revenues by raising prices. This is because in economic theory a rise in price causes revenues to rise when demand is inelastic. We can show this as follows:

Change in TR/ change in price = dTR/dP = d(PQ)/dP = Q + P(dQ/dP)

= Q + Q*(PdQ/dP*Q)

Q( 1 – lEl ) where E is the absolute value of demand elasticity E.

When E < 1 ( inelastic demand) then a rise in price will cause a similar rise in revenues for Netflix. 

3.

The incidence of any tax is shared between the seller and consumer.  This sharing depends on the relative strength of demand and supply elasticity. The share of tax burden falls more on the economic agent who has lower price elasticity. If the price elasticity of demand is higher than price elasticity of supply then the seller will bear a greater burden than the consumer.  If the price elasticity of supply is higher than price elasticity of demand then the consumer will bear the majority of the tax burden.  (Mankiw, n.d.; Sexton, n.d.)

In the diagram the tax = P3 – P1

 Consumer burden/ incidence = P2-P1

 Netflix burden/ incidence = P3-P2

Since Netflix has an inelastic demand we can expect consumers to bear a greater burden of the tax than Netflix burden.

We can also show that with a amore elastic demand , the burden would fall more on the Netflix. this is seen below with a blue demand curve which is more elastic- flatter than DD. It is seen that the price rise in much lower, as shown with blue vertical line.  This blue line is the consumer incidence, which is much lesser than the red line( with inelastic demand like for Netflix) 

Since Netflix has an inelastic demand we focus on the red vertical line only. The price rise causes welfare losses for consumers, as price is higher now. The loss of consumer surplus is shown as red shaded area.  as price is higher there is a gain for seller/producer. but as quantity is lower there is some gain as well. Both are shown as shaded areas in different colours. The total change in both surplus is negative, and is called the deadweight loss, shown in green . Whenever a tax is levied it leads to a deadweight loss- society is less efficient when a tax is levied. (Aure, 2012) 

References

Anon., n.d. Shifts in demand and supply. [Online] Available at: https://cnx.org/contents/[email protected]/Shifts-in-Demand-and-Supply-fo [Accessed 19 Sep 2017].

Aure, M.L., 2012. Deadweightloss and taxation. NTRC Tax reserach journal, XXIV(6), Available at: https://www.ntrc.gov.ph/images/journal/j20121112a.pdf.

Economics.utoronto.ca, n.d. Elasticity, TR and MR. [Online] Available at: https://www.economics.utoronto.ca/jfloyd/modules/eltr.html [Accessed 20 Sep 2017].

economicsonline.co.uk, n.d. Price elasticity of demand. [Online] Available at: https://www.economicsonline.co.uk/Competitive_markets/Price_elasticity_of_demand.html [Accessed 18 SEp 2017].

Mankiw, N.G., n.d. Principles of Economics. In markets and welfare. 6th ed. Cengagebrain.com. pp.160-62.

Setiyadi, D., n.d. Relationship between price elasticity and total revenue. [Online] Available at: https://www.academia.edu/7378448/The_Relationship_Between_Price_Elasticity_of_Demand_and_Total_Revenue [Accessed 18 Sep 2017].

Sexton, R.L., n.d. Marker Efficiency and Welfare. In Exploring Economics. 7th ed. Cengage. pp.197-99.