1. What are the four basic cost concepts? Write notes on each.

The four basic cost concepts of cost analysis are I> fixed costs, ii> variable costs, iii>marginal costs and iv> total costs.

Fixed costs are the costs associated with the fixed input used in the production process. These costs are incurred at the time there is a commitment to production, even at zero units of output, and do not vary with the level of output. Items of fixed costs that cannot be recovered upon liquidation of the business are also referred to as ūsunk costsū. Examples of fixed costs are rent, insurance, interest payments, contractual labor, depreciation, repair and maintenance, and storage.

Variable costs are zero at zero levels of production and increase directly with the level of output depending on the nature of the technology embedded in the production function. They are associated with variable types of inputs. Examples of variable type costs are the costs of raw materials, the costs of energy and water, and hourly labor.

Total costs are costs that include all fixed and variable type costs and are calculated by adding the totals of the two. Total costs are equal to fixed costs at zero levels of output and increase with output depending on the nature of the production function.

Marginal costs are associated with an incremental unit of production and can be defined as the change in total cost or total variable cost due to a unit change in output. Marginal costs comprise solely of variable type costs.

2. How many different cost types exist and how are they computed?

There are seven different cost types. These are i>the total fixed cost, ii> the total variable cost ,iii> the total cost iv> the average total cost, v> the average variable cost, vi> the average fixed cost, and vii> the marginal cost.

The total fixed cost (TFC) is computed by finding the sum of all fixed cost types.

The total variable cost (TVC) is computed by finding the sum of all costs associated with variable inputs used in the production process.

The total cost (TC) comprises of the sum of all TFC and TVC.

The average fixed cost (AFC) is computed by dividing the TFC by the quantity of goods produced or output Q.

The average variable cost (AVC) is computed by dividing the TVC by the number of goods produced or output Q.

The average total cost (ATC) is found by dividing the total cost by the number of goods produced or output Q.

The marginal cost (MC) is the quotient of the change in TC by the change in the number of goods produced or output Q. It is also equal to the quotient of the change in TVC by the change in the number of goods produced or output Q.

3. What are the characteristics of the markets in the performing arts?

Most markets in the performing arts are monopolistic types though a few markets existing in the smaller cities are of the oligopolistic type. The structural characteristics of monopolistic competition are I> many producers, ii> many consumers, iii> product is differentiated, iv> the firms use advertising as a key strategy to emphasis price and non- price related differences associated with quality, design, performance and service, v> each firm has some monopoly power to affect pricing of the goods, and vi> the key to successful product differentiation is building product loyalty.

If the entire live performing arts were to be considered a single industry, the opera company, the symphony orchestra, the dance groups and the resident theater companies in major cities are all competing with each other by offering competitive products that are unique but also substituteable as forms of artistic entertainment.

Advertising functions to raise the level of demand for the specific firm's product and to make the product demand less price sensitive or inelastic. It also helps in the cultivation of taste and artistic culture.

4. What is unique about the nature of costs in the performing arts?

One aspect of costs in the performing arts that is different from other forms of production is that is difficult to measure the output. Some suggestions by economists are to measure I> the number of performances (this method does not provide much information as there are differences in quality and costs), ii> the number of productions (this method can not help to determine the demand), iii> the number of seats filled (yet the experience is not captured), iv> seat utilization, which is equal to the number of performances x the capacity of the house x the capacity utilization in percent. Economists have generally adopted the seat utilization method of measuring output in the performing arts.

Another aspect of costs in the performing arts that is unique is the average variable costs are equal to the marginal costs, both of which remain constant. The price of production does not increase with the sale of one more ticket, nor do the variable costs rise with the additional sales of tickets.

5. How does this effect pricing if I>the firm is a for- profit organization, ii>the firm is a not-for-profit organization?

A for-profit organization wishes to maximize profits by maximizing the difference between total revenues and total costs. Pricing is set to maximize profits. Quality and quantity factors are important to a for-profit firm but so is economic efficiency. It is necessary for this type of firm to maximize profits by setting output where marginal revenue equals marginal cost.

A not-for-profit organization typically has quality and quantity goals. The quality goal may be a wish to excel according to it's own internal standards of excellence. The quantity goal may be to attract the largest possible audience for its performances. Spending on quality and quantity will diminish the marginal returns as costs for production are increased. The not-for-profit firms do not intend to recover more than their average costs since this has legal and tax implications on account of their incorporation as not-for-profit firms. Thus they intend, rather, to merely break even. This is the point on the diagram (Refer Fig 7.1 handout) where the average cost curve intersects the demand curve. The price of a ticket is set corresponding to this point on the demand curve and it ensures that the firm will at best break even.

Not-for-profit performing arts companies also receive donation and grants from foundations, private patrons and donors, the NEA, the federal, state and local governments and the art councils. These contributions may often make up 35- 38 percent of the operating revenues of the not-for-profit firms. Some contributions may have conditions attached such as for strict purchase of equipments or improving or enhancing the quality of the theater or augmenting its capacity or for renovation works. However if there are no conditions attached, then the firm has a choice to use the money to improve quality or to increase audience participation (viewership). If the firm chooses to do the latter, then the price will be set at a point below average cost and the losses made up by the amount of donations and grants received. Thus in effect the price of admission is being subsidized to encouage audience participation in the specific type of performing arts in which the firm specializes. (Refer figure 7.2 handout).
6. What are the sources of growth in physical output per work hour? Which one of them is effective for the live performing arts?

There are 5 possible sources of growth in physical output per worker. These are as follows:

1. Increased capital/worker (capital by economists is defined as the produced means of production. examples are machinery, equipment, factories, warehouse space etc). Having more machinery helps labor create more output. Thus output per work hour rises.

2. Improved Technology Technology can be defined as the state of knowledge about methods of production. Improvements in the state of knowledge bring about increased production efficiencies. For example, using bulldozers with frontloaders instead of pick axes and trucks in road building efforts.

3. Increased Labor Skills More skilled the worker, more output can be created per worker. Skills can be learned although the learning curve itself follows a sigmoidal pattern with an eventual levelling off. Investment in human resources such as education and job training are important to building labor skills.

4. Better Management If production is organized efficiently, then the output per worker will rise. The number of managers in performing art companies has been rising. Managerial skills can have payoffs in the performing arts.

5. Economies of Scale In some production processes output per unit of input rises when the scale of production rises.

As Baumol and Bowen point out the conditions of production themselves in the live performing arts preclude any substantial change in productivity because the work of the performer is an end in itself, not a means for the production of some good. Since the performer's labor is the output- eg. singer singing, dancer dancing, actor acting,- it is not possible to increase the output per hour.

Of the five sources of productivity discussed, economies of scale has some potential in the performing arts. Length of seasons as measured by number of performances or for symphony orchestras, the number of concerts can be an appropriate indicator of scale. Economies can be effected because orchestras can play more concerts without investing in additional rehearsal time for example by selling subscriptions in three series (Thursday evenings, Friday evenings and Sunday afternoons). Also administrative expenses of running the orchestra need not increase by increasing the number of concerts. This results in reduced overhead per concert as the season lengthens.

7. What are some of the offsets to the problem of productivity lags in the performing arts?

According to Baumol and Bowen costs in the performing arts increase relative to costs in the economy over time. This is because wages to artists must keep up with the rest of the economy even when productivity lags in the performing arts sectors relative to more dynamic manufacturing and agricultural sectors of the economy. This is the only way that the performing arts sector can compete for people with artistic skills in a nationally integrated labor market.

There are however some countervailing forces to productivity lag in the performing arts sector. These forces tend to ease the pressures generated by the productivity lag. These are as follows:

1. The effect of rising living standards. Technological progress in the economy tends to raise rising living standards. This implies more income accruing to individuals in the economy. Since with rising costs, prices of admissions increase, it implies reduced attendance at performances. However, since individual income has increased the income effect tends to offset the effect of price increases and attendance at performances is maintained despite higher prices.

2. The effect of economies of scale. This effect works in tandem with the rise in living standards. As individual income rises, demand for admissions shift to the right, more tickets get sold and the performance seasons get longer. This results in decreased per unit cost and offsets the cost increasing effect of productivity lags.

3. Income from mass media. Technology has small direct effect on the performing arts but the impact is much larger through the mass media. Technological advancements such as phonographs, motion pictures, television, LP records, tape recordings, video cassettes, satellite and cable systems, CD and video disks have improved the opportunity for royalty income for the performing arts. Although for sports, royalty income outweighs ticket sales, this is not the case for the performing arts. for eg. classical musical production went to Europe because they had lower production costs and the invention of audio casettes and VCRs have promoted self recording thus royalty income potential has been lost. Royalty income payments from TV programming have also been poor. In the 1950s and 1960s, there were high expectations since the networks wanted to promote "high art". But during the 1970s through the 1990s, TV has been blamed for programming more speed, violence and sex rather than "high art". Thus royalties contribute less than 1 percent of the income to the performing arts. Part of the problem lies in the fact that television itself is subject to productivity lags.

8. How do social scientists such as Edward Banfield and Leslie Singer define art?

Edward Banfield a political scientist and an art collector as well as the author of 'The Democratic Muse: Visual Arts and the Public Interest (pub 1984) says art can be defined as having the capacity to engender in a receptive viewer an aesthetic experience. The problem with the definition is that no two people may have the same notion as to what constitutes an aesthetic experience.

Leslie Singer who wrote about "Microeconomics of the Art Market" in the Journal of Cultural Economics (1978) sees art as an object having 2 attributes.

1. Decorativeness (size, weight, physical condition, subject matter) 2. Intellectual Appeal (art- historical significance, quality of work, artist's reputation).

These attributes apply to paintings, drawings, sculptures and related collectibles. The principles are similar for all media utilized by artists to express themselves.

9. What types of costs are particularly important to understanding the functioning of art markets?

These are transaction costs and information costs.

Transaction Costs - these are costs associated with over and above the payment of goods sold incurred by all parties involved in the transaction.

for buyers examples are costs of:

time looking for art works examining merchandise waiting in lines discerning alternatives

one would want to minimize these costs of transaction.

Information cost relate to gaining or improving upon imperfect information related to:

product quality resale value price and availability of substitutes risks involved

Developing accurate information results in costs associated with expended time, effort, material resources and money. Higher the cost of being wrong, more money is expended on information.

10. Describe the nature and functioning of the primary market and the secondary market for the visual arts?

More and more the art markets resemble the financial markets. They seem obscure, chaotic, esoteric, organized and sophisticated.

The primary market could be artist's studio art fairs festivals galleries and other similar outlets

Considerable risk is involved with the intellectual attribute since artists are generally unknown and thus the appeal is uncertain.

The decorativeness attribute on the other hand is recognized and understood.

For the neophyte buyer, it is difficult to know what works of art are for sale, quality of the art work and its availability without expending time and effort.

For the artist who sells he must know how to price the art work (above the reserve price - the minimum price acceptable to the artist) but not a price that is too high for the buyer.

When a artist works through a dealer who reprents him/her there is generally a 50 percent mark up in pricing over the costs of production. However costs of production is imprecise since there is no accurate information regarding the opportunity cost of the artist's time.

The Secondary Market. The exchange of existing works for established artists takes place in the secondary market. Buyers and artists work through dealers with whom they have had a business relationship. Prices may be posted or may not be posted. In the case prices are not posted, the dealer uses his experience to gauge the willingness to pay by the buyer. If the buyer's willingness to pay exceeds the artists reserve price plus the dealers commission the sale will go through. Both transaction and information costs are low in the secondary market. In the case of auction houses, commissions are about 20 percent of the sale price.