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Chapter 12: Problem 9

An article in the Wall Street Journal discusses the visual effects industry, which is made up of firms that provide visual effects for films and television programs. The article noted, "Blockbusters ... often have thousands of visual effects shots. Even dramas and comedies today can include hundreds of them." But the article also noted that the firms producing the effects have not been very profitable. Some firms have declared bankruptcy, and the former general manager of one firm was quoted as saying, "A good year for us was a \(5 \%\) return." If demand for visual effects is so strong, why is it difficult for the firms that supply them to make an economic profit?

Short Answer

Expert verified
Despite high demand for visual effects, visual effect industry finds it difficult to make economic profit due to high production costs, potential market saturation and stiff competition. Profits are squeezed because costs outweigh revenues, and a potentially saturated market could suppress prices.

Step by step solution

01

Understanding the Scenario

Firstly, noticeably comprehend the situation. The visual effects industry is in high demand but struggles to generate a significant profit. This is interesting because typically, high demand for a product or service usually leads to higher profitability.
02

Understand Demand and Supply Concepts

Remember that demand doesn't always result in profitability. Although there is a high demand for visual effects, this might not necessarily result in high profits. This could be due to the high costs of producing these visual effects.
03

Identifying the Issue

Analyze the profitability issues related to operation costs vs. returns. Profitability isn't solely determined by the demand for a product or service. A business can still be unprofitable, even with high demand, if its costs (fixed or variable) exceed its revenue. In the case of the visual effects industry, it seems that the costs of production outweigh the income generated from selling their services. This might be due to expensive software, licensing fees, or perhaps labour costs. The limited return cited in the exercise ('A good year for us was a \(5\%\) return.') further supports this assumption.
04

Conceptualize the Saturation

Consider the possibility of market saturation. High demand leads to more firms entering the industry, leading to competition. If the market is saturated with competitors, it can put downward pressure on the price that can be charged for services. This can contribute to lower profitability despite high demand.

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