I was reading the Dilbert blog the other day, and Scott Adams was trying to talk about a Dilbert movie. Before starting to ask the blogging community whether they thought it would be a hit, he linked to this article, and asked why movie producers keep making so many R rated films, when G rated films gave larger returns. He puts it down to the directors incentives not being aligned with those of the investors. So instead of making a film that will maximise profit, directors make films that maximise the chance of winning awards. This is all very good, and I’m sure that there is an agency problem in film making. However, the agency problem will be ex-post the decision on what type of film to make. It seems to me that if investors felt they would make the most money of G-rated films, they would make contracts with directors to force them to make G-rated film, thereby solving (most) of the agency problem.
Scott Adams has an extremely good understanding of economics (he did do a degree in it), however, in this case I feel that he has confused average and marginal revenue. Now the article states that the average revenue from a G-rated film is greater than the average revenue from a R-rated film. However, when an investor puts money into a film being made, they are interested in the marginal revenue of that film type that is available from the market. The investor is putting money into a project that creates 1 more of that type of film in the market place. In that case the marginal revenue of a film type is what the investor is after.
Now it is possible that the average revenue of R-rated films may be lower, while the marginal revenue of an R-rated film is the same as a G-rated film. All we need for this to happen is the initial returns from the first G-rated film on the market to be higher than the R-rated film, but for marginal revenue to then fall much faster for the G-rated film type than the R-rated film type. I think this is a good description of demand for movies. Families have a high value for taking their kids along to the first great animated film of the year, however once we get to the 3rd animated film for the month the family will stop going. However, R-rated films tend to get a specific crowd that is interested in that type of film. This crowd is willing to pay to see more movies, but may not be as large as the crowd that goes to the first animated film. Furthermore if there is more range among R-rated films than G-rated films, the set of products we are discussing is catering to a differentiated market. If this is the case, the release of an R-rated film would have less of an impact on the marginal revenue of another R-rated film than would be the case with G-rated films.
However, there are a number of other explanations for the difference in average revenue:
- R-rated films are less prone to failure (so the marginal profit can be lower)
- R-rated films are cheaper to make (so although marginal revenue is lower, marginal profits are equal)
- There is some bias among investors towards R-rated films
- There are too few directors and too many investors, and so directors they have some market power. As a result, directors can change the composition of movies
Personally, I think all these things come into play in some way. However, I’m confident that movie investors are often trying to maximise their profit, just like people who invest in companies or houses.