Netflix: A Lesson In the Law of Demand

For those of you who heard, there was recently a price increase in Netflix's services. It began offering its streaming and DVD services separately. Those who continued to use both services saw an effective price increase of 60%.

Lo and behold, Netflix came out today and announced that its profits would be only 72 cents to $1.07 a share, compared to analysts' projections of $1.11 a share. Sales are also projected to be only $828.5 million instead of the analysts' expectation of  $842.9 million.

So what went wrong? For one thing, Netflix forgot to take into effect one of the most fundamental pillars of economics: the law of demand. It evidently forgot that as prices increase, quantity demanded decreases. Considering the fact that a goods like online streaming and DVD rental, both markets with numerous competitors, can be expected to be relatively elastic in demand, it is somewhat surprising that Netflix's management managed to overlook this critical fact. The result? A vote of no confidence in Netflix's management.

Some Self-Deprecating Humor

Courtesy of Abstruse Goose

Common Knowledge

What is common knowledge? Economists tend to talk about "perfect information." It implies that certain information is common knowledge among participants within a certain market transaction. Game theory draws upon the concept of common knowledge in analyzing games with asymmetric information. For a functional, albeit mathematical definition of common knowledge, we turn to logic theory. The basic principle is perhaps confusing at first, but the concept is extremely important in both economics and logic theory.

Below is a comic (courtesy of Nedroid) that demonstrates the concept, though for something to be truly common logic, the process must continue ad infinitum.

Bank Stocks

I just bought shares of Citigroup.

Dan Pink and Some Interesting Ideas in Incentive Design

A Theory of Interstellar Trade

This paper is pretty old, but I just took the time to read it. Very interesting, and courtesy of Krugman.

The Wallet Paradox

Another classic game theory puzzle, this time with a different twist. Here's the basic setup:

Bill Gates meets Warren Buffett at a dinner party and the host tells them to play a game. Each person will place his wallet on the table. The person with less money in his wallet wins all the money. 

Is anyone favored to win this game? 

...Afterwards, it turns out both Bill Gates and Warren Buffett loved the game.
They add a twist as follows. They will play the game every day for a month. To manage the stakes, they agree to carry an average (mean) of $100. Is this game fair? What is the best possible strategy, given you know what your opponent is doing?

Think about this game for a while. The solution is here. 

Is the Economy Growing Too Fast?

For the past year or so, the Fed has been forecasting a timid recovery with little upward price pressures. Are things going better than expected? But more importantly, are the latest growth numbers going to signal to the fed that this period of extraordinary expansionary monetary policy is over? A good analysis is here.

Interactive Global Inflation Chart

The Wall Street Journal provides this graphic that shows inflation rates in nations around the world during the recession. You can really gain a good perspective about the risk of deflation in many countries through this period. This perhaps is more evidence for the strength and duration of the Fed's response to the recession. 

A Game Theory Puzzle

A game theory puzzle from an interesting new blog I found:

"On a game show, two people are assigned whole, positive numbers. Secretly each is told his number and that the two numbers are consecutive. The point of the game is to guess the other number.

Here are the rules of the game:

–The two sit in a room which has a clock that strikes every minute on the minute

–The players cannot communicate in any way

–The two wait in the room until someone knows the other person’s number. At that point, the person waits until the next strike of the clock and can announce the numbers

–The game continues indefinitely until someone makes a guess

–The contestants win $1 million if correct, and nothing if they are wrong

Can they win this game? If so, how?"

The solution is a very interesting application of game theory. The solution can be found here.