Question

Producers in the market for good X purchase advertising that helps to market it to consumers. Producers may profit from successful advertising but consumers cannot possibly benefit from it. Explain why or why not.

Futures contracts can benefit both producers and consumers. How can this possibly be true when these are just legal documents that cannot possibly affect the quantity of the underlying commodity that is produced? Explain.

Answer 1

=> Given that producers in the market for good 'X' purchase advertising to promote their product amongst the consumers. This can help producers as advertising would increase the reach of their product. As more and more people will know about it, the sales of the product is likely to go up. On the other hand, consumers cannot possibly benefit from this situation. This is because advertising would push the costs of production of the firms up. If the cost of the production goes up, firms will not bear this increased cost themselves and will rather transfer this burden onto the customers by raising the price of the product.

The profit of a firm is maximized when marginal cost is equal to marginal revenue. Advertising will increase the marginal cost and so the firms will have to raise their marginal revenue in order to maximize their profits which can be done by charging a higher price for the product adversely affecting the customers.

=> Futures contracts are standardized contracts wherein two parties agree to buy and sell a fixed quantity of a particular commodity at a future date and at a pre determined price. The quantity and the price at which the exchange will happen in the future is pre determined.

When the actual date of exchange comes -

CASE 1 - Actual price turns out to be higher than the price agreed to in the contract

In such a case, consumer benefits. This is because he/she would get the commodity at a price lower than the prevailing market price. Producer, however is in loss because he/she will get a lower price for the commodity than what he/she would have gotten if he/she sold it in the market at the current price.

CASE 2 - Actual price turns out to be lower than the price agreed to in the contract

In such a case,producer benefits. This is because he/she will be able to sell the commodity at a price higher than the current market price. Consumer, however is in loss because he/she will have to pay a price which is higher than the prevailing market price to get that commodity.

** What is important to know is that the futures contracts are standardized contracts regulated by the stock exchanges. So, neither of the parties (producers or customers) can back out in case price turns out to be different than what they had expected resulting in losses to them.