Movie tickets have the same price for financial rather than economic reasons!
Tyler at Marginal Revolution poses the question today of why all movies at a multiplex have the same price (other than the evening/matinee difference). He offers eight worthy explanations based on economic theory, but has missed one based on finance. The quick and dirty answer offered here is that movie tickets are all priced the same because the differences in how a single viewer evaluates different movies is small relative to the differences in how different individuals evaluate the same movie.
This financial explanation relies on viewing buying a movie ticket as a form of call option.
A call option is a security whose purchase gives you the right (but not the obligation) to purchase a second security at a fixed price in the future. Options are an old form of financial instrument, but over the past 20 years or so, financial researchers have recognized that the methodology they use for understanding (say) an option to buy GM stock is applicable to a wide variety of other forms of human behavior (this field is called real options).
First, let's review the features of a movie ticket to see if it matches up with a call option. With both movie tickets and call options:
- You pay a set price in advance, without any additional charges after the fact due to unexpected events (for example, they don't charge you after you leave the movie based on how big the smile on your face is).
- You buy the right but not the obligation to something of value (for example, you can just walk out of the movie).
- You know the cutoff point at which you can claim something of value (for example, in a movie you know you have to go in on a set schedule and spend some of your time evaluating the movie).
- You know there is a set expiration date (theatres frown on people who buy a ticket for one show and use it for another).
- You know how much your purchase will potentially depreciate before you take away any extra value (for example, buying a movie ticket and using it immediately helps avoid having a plot secret revealed before you can find it out for yourself - as happened widely with Million Dollar Baby as the Oscars approached).
Now, there are 5 factors that affect the value of a call option, and viewing a movie ticket as a call option eliminates 3 of them off the top. These are the exercise price, the expiration date, and the discount rate. Since you buy a ticket, go into a theatre, and commit yourself for a few hours, those factors are the same for almost all movies. That leaves two features to determine the price of a ticket - the subjective value of the movie, and the variation in that subjective value of movies.
Tyler's position is that since movies apparently vary widely in quality that the prices people are willing to pay for the experience should vary as well. I suggest the opposite: the fact that prices don't vary too much is strong evidence that quality doesn't vary much either. This, of course, is heresy to armchair critics. But I'm quite sure there is a large element of truth in it. The reason is that the variability in the choice of whether or not to go to a movie is stronger across individuals than is the variability of choosing a particular movie by a certain individual (for statisticians, the variation across blocks is large relative to that across treatments). This makes intuitive sense: some people see lots of movies, some people see few, but both see masterpieces and clunkers. The upshot of this is that the movie experience (relaxing in a diversion free environment) is a big factor in what people are paying for, and perhaps a lot larger than the value of the individual movie. If you have doubts, read on.
What Tyler's economics based analysis misses is the effect of the variability of the outcome (one specialty of the finance sub-field of economics). Variability is positively related to the value of a call option. Since you have the right but not the obligation to get something of value, if it goes up you win, and if it goes down you walk. Since the change in your position can only occur on the upside, volatility works in your favor. But, while volatility can make the option cost more, it is also a second source of value that can make it much less important to get your value from the average quality of any particular movie.
If you doubt this story, consider that movie you now recognize as great that you didn't like the first time you saw it in the theatre (or the bomb that you loved in the theatre). The volatility of the movie going experience is capable of washing away large quality differences. In my case, my brother and I couldn't figure out why people liked Raiders of the Lost Ark so much when we didn't. Then we saw it when it came out on tape and loved it. We eventually recognized that we had been teenagers in allergy season who were too downed out on antihistamines to internalize all the surplus value that movie offered to us that July day in the 1970s.
So, here's why movie tickets are all the same price. You pay a small fee to engage in an otherwise pleasant experience - sit comfortably, somewhat deprived of outside stimulation, generally free of spouses, kids, bosses, and eat some popcorn. At worst you see a bad movie - and even the stinkers are not bad enough to get many people to walk out of. At best you walk out with a lot of surplus value for having taken a small gamble. And the expected value of that gamble is far larger than any gains you might make by planning on seeing a good movie and hoping to get out the same value that previous viewers said they got.
A quick and dirty test of this theory is that it implies that formal and informal reviews of particular movies are a form of cheap talk. But, of course, these are already generally recognized as some of the cheapest forms of talk.
A second quick and dirty test is that we should see similar pricing in forms of entertainment that have fixed times in which they need to be consumed, and somewhat less similar pricing in forms of entertainment without a fixed price. I suggest that DVD rentals (where fixed pricing is common) fit the former case, and DVD purchases (where sale prices are common) fit the latter case.
the fact that prices don't vary too much is strong evidence that quality doesn't vary much either.
How do you explain that some movies do very well at the box office, while others flop? Doesn't this suggest that there are huge differences in the total demand for different movies?
Posted by: Adam | March 07, 2005 at 06:04 PM
You pay a small fee to engage in an otherwise pleasant experience - sit comfortably, somewhat deprived of outside stimulation, generally free of spouses, kids, bosses, and eat some popcorn.
Although I occasionally go to movies alone, my wife normally likes to accompany me. Even if I agreed with you as to whether that subtracts from the value of the experience, I would never have the courage to post it.
More broadly, lots of "bad" movies are still fun as a shared experience - you can ridicule it afterwards with friends, and that is always a delight.
That said, I did have about a six month stretch where, no matter what movie I was watching, I would find myself thinking that I could have stayed home and rented "LA Confidential".
Posted by: TM | March 10, 2005 at 03:51 PM
I don't find anything particularly new in Adam's comment. He's right - lots of movies are hits and lots are flops. And yet, that usually reflects differences in demand. What he is outlining is a shift of demand back and forth. What I am outlining is why supply is flat - so that those shifts back and forth translate mostly into changes in quantity of tickets sold, and very little into the price charged for tickets.
Posted by: Dave Tufte | March 15, 2005 at 12:38 PM
I like TM's point so much there will be a post coming out about it on March 16.
Posted by: Dave Tufte | March 15, 2005 at 12:54 PM
Very interesting analysis. As much sense as the theories make, after I read it I still feel like I'm at square one. The glaring question in my view is why theater managers do not try to maximize the potential profit.
During much of the week (Sun-Thurs) in my area, one can go to the movies and be the only person in the theater for a 9pm show. And whether I want to go see "Gigli" or a 3 hours long "Lord of the Rings", it's the same price...Lord of the Rings was worth $10 to see, but from what I heard (and most everyone heard), Gigli was not. I would imagine that curiosity could induce people to see something like Gigli (or if theres nothing much else to see for $10) and they might say, "sure, I'll pay $4 to go see Gigli." There is also then potential for a positive word of mouth to spread to like-minded people who were otherwise dissauded by the negative reviews. Instead, theaters run terrible movies for weeks with extremely low and sometimes non-existent attendance and insist upon a $10 fee.
If I were manager of such a business, I do not see why I would abide such foolishness.
The similarity that you draw between the pricing scheme of renting movies and the watching of them in theaters is well taken, but in practice I again see a large difference. In a theater, the cost for a couple to see a movie with a soda is about $25. That can be a substantial chunk of one's income for many people. It's just a couple bucks to rent any movie you want and have any array of food and drink while in the comfort of one's favorite chair. There is a certain element of investment. So often people say, "I'll just wait until it's out on video." This is because of the reltively high cost vs benefit of particular movies. The relative cost of renting a movie is so low that it would not matter much if it was $3 to rent LOTR and just $1 to rent Gigli.
What do you think?
Posted by: Kyle | July 21, 2005 at 08:59 PM
I think this all makes sense (up to a point).
For my part, I'm not willing to assume that how theatre managers price their wares is not profit maximizing, as you do. I'm much more comfortable thinking of them as profit maximizers, and then assuming that they are seeing something that I don't.
The behavior of managers suggests that movie tickets are very inelastic with respect to quality, so that lowering prices also lowers revenue. To me, that says that this strategy is being driven by the insensitivity of demand to quality. I offered up one explanation of why that might be the case (and Marginal Revolution had a bunch more).
That covers some of what you said. As for the other parts, I'm not sure that word-of-mouth would benefit a theatre manager. How do they capture the benefits of that when they don't have a monopoly on a particular film? I think your point about renting is absolutely correct, but there are two levels of decision: renting vs. going to the theatre, and why you'll pay the same amount for a movie whether it is good or bad (as long as the venue is the same). I only addressed the latter, so I'll just agree with you on the former.
However, I do think that you've got to be getting something different between seeing a first run movie for $10-15 a person, and a DVD for $3-5. What could that be? The joy of going to a dark room where people talk to much? I doubt it. The joy of seeing the moving before eveyrone else? Possibly, but those people would be analogous to early adopters, and there don't seem to be too many of those around. That leaves the joy of comeradery (did I spell that correctly??) at seeing something at essentially the same time that others see it - so that the market is thick with commentary and understanding about that particular movie. I'm not sure if this is it or not, but everyone had a lot of fun saying "Hasta la vista, baby" in 1991, and that had to be worth something to them.
Posted by: Dave Tufte | July 27, 2005 at 11:58 AM
"A call option is a security whose purchase gives you the right (but not the obligation) to purchase a second security at a fixed price in the future. Options are an old form of financial instrument, but over the past 20 years or so, financial researchers have recognized that the methodology they use for understanding (say) an option to buy GM stock is applicable to a wide variety of other forms of human behavior (this field is called real options)."
Wow the relation to this and the market and movie tickets is amazing...this is good research!
Posted by: Ontario Highway Traffic Act | December 07, 2007 at 09:01 PM