Answer to Question #157031 in Microeconomics for aqsa nabi

Question

Case Study – Are Diamonds Forever?

How much would you spend on a diamond engagement ring? If you answered around the national average of $4,000 then you too have fallen victim to one of the most incredible marketing campaigns of all time. A diamond is intrinsically worthless, and against popular belief, they really aren’t that rare. Their resale value is next to nothing.

So why are we willing to spend so much on a ring? Well, we can trace that back to the 19th century. Before 1866, diamonds had been rare, but when massive discoveries were found in South Africa, the rock was on the verge of losing its value. Thats when Cecil Rhodes stepped in and founded De Beers Corporation – consolidating the mines and restricting supply, maintaining the fiction that diamonds were scarce and had inherent value.

The real change was in 1938, when the company hired N.W. Ayer to increase sales. By tying their product to love, and specifically to a marriage proposal, by the end of the century, over 80% of all brides had received a diamond wedding ring.

The ad campaign a ‘Diamond is forever’ displayed a diamond as a symbol of love, and suggested that a man should spend up to two month salary on the symbol.

Until 1990, DeBeers had a iron-tight grip on the market, at one point accounting for 90% of all sales, but now this grip is loosening. Using our models for monopoly and monopolistic competition, let’s examine the effects of this changing market.

Below is a representation of the demand curve for diamonds. Assume DeBeers is operating as a monopoly.

1. As a monopolist, what is the total effect of a price change from $2,400 to $1,600 on revenue? Break this change into an increase and a decrease.

If you were to do exercise 1 in for every marginal change in price, you would find the marginal revenue curve. The marginal revenue diagram has been provided for the next exercises, along with the marginal costs for DeBeers.

2. As a monopolist, what quantity does DeBeers produce? What price do they charge?

An ATC curve has been provided for DeBeers. These costs include marketing, mining exploration, and more.

3. What are DeBeers profits? Why are they able to sustain these in the long-run?

From the 1990’s to now, the market has changed considerably, with DeBeer having to adapt to new challenges. The first is the introduction of direct competitors. Russia’s state-owned diamond company ALROSA now produces more diamonds than DeBeers itself. Some new firms even bought mines from DeBeers when the company was trying to support their balance sheet.

Another change is the introduction of substitutes, with synthetic diamonds becoming more appealing to price-conscious young shoppers. Advances on the production of these products are fairly recent, notably, in 2015 New Diamond Technology displayed the potential of synthetics by creating a ten-carat polished diamond. 

This means the market is changing from monopoly to monopolistic competition. We know that entry of other firms will cause the monopolists demand curve to shift.

 

 

4. From the 1990s to now, the market is changing from monopoly to monopolistic competition. Explain reasons for this change.

5. Show the effect of the changes on our demand curve. If the new marginal revenue intersects marginal cost at (45, 1,900) draw the new demand curve and new marginal revenue curve.

7. As a monopolistic competitor, what quantity does DeBeers produce? What price do they charge?

8. What are DeBeers profits now?

 

9. Are these market changes good or bad for consumers? 

 

Answer 1

1On the demand curve, when DeBeers decreases its prices two things happen – DeBeers loses money on the decrease in price Carats of diamonds they were originally selling, but they also gain from increase in number of new Carats they are able to sell. Calculating the areas of the increase and the decreases, we find that they are both equal to $64,000.

2.A monopolist charges the highest price possible where MR = MC.

3.We cial surplus is maximized where MC = MB, or where our MC intersects the demand curveo calculate DeBeers profits we must find the ATC @ our given quantity. Since we know that P-ATC = profit per unit, we can calculate the rectangular area between these two points to find profit.

6. firms enter the market, our demand curve no longer represents the demand curve for the entire market. Some of DeBeer’s consumers will go elsewhere, and the demand curve that DeBeer’s faces will shift inwards. As long as there are positive profits (P > ATC) then this process will continue to occur. These are the conditions for a monopolistic competitor.

7.Similar to a monopoly, a monopolistic competitor charges the highest price possible where MR = MC.

8.Under monopolistic competition, profits are 0 in the long-run. Since the diamond market has reached a state of long-run equilibrium, De Beers profits will be 0. In the diagram above we can see that P=ATC, meaning that there are no profits.

9.Remember that social surplus is maximized where MC = MB, or where our MC intersects the demand curve.

We could once again calculate the consumer, and producer surplus, or we could also note on the diagram that the decrease in surplus is equal to the red shaded area.

10.Remember that social surplus is maximized where MC = MB, or where our MC intersects the demand curve.