We’ve reached page 22 of the 154-page PDF, and alight on this piece of economic analysis, looking at how the demand curve for a trading fund may misrepresent the wider demand out there. Stay with it: it’s interesting.
…imagine there are a large number of downstream firms [from the trading fund] each demanding one unit of the product but each with different fixed costs. The trading fund’s demand curve [for its product, determining the price it sets for the product] then arises from aggregating across all these downstream firms.
Pick a point on the trading fund’s demand curve (p, q) say, and consider an increase of δp in the price charged, resulting in some reduction δq in purchases. Now this reduction in demand corresponds to some number of downstream firms who cease to purchase (and hence cease production).
Consider one of these firms and let initial revenue be R, and C their total costs (excluding the payment for data).
Then one must have R − C ≈ p (since R − C < p + δp and R − C ≥ p). What about the surplus generated by this firm? Its producer surplus is zero (R − C − p = 0) but consumer surplus, denoted CS, is almost certainly not zero.
Thus, from the point of view of society current total surplus produced by this firm is p + CS.
However using the demand curve of the trading fund all that would be recorded is the p coming from the payment for data.
Academic? Not at all – you could imagine the firm that ceases production at the δq rise in the cost of using, say, a map is the same as one which never starts because the startup costs of licensing the data are too high.
The summary of the section (p23):
if users of a trading fund’s information products are not end consumers but other firms, then there is good reason to think that the demand curve seen by the trading fund will significantly underestimate the welfare benefits (costs) of lower(higher) prices.
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