Not for the Layman

This here is a beer blog, see, and we don't like no fancy talk from the ivory tower. Well, we do, but in our befuddled state, we must confess that it goes over our head. Thus the beerconomist's formula looks more complex than a double-decoction mash:

In this picture the demand curve for the downstream firm, or distributor, (denoted d) is given in blue. [In this case we make the simplifying assumption that both firms are simple monopolists - but any market power is enough for the analysis to follow] This is the demand for beer from retail establishments which (since they are highly competitive) closely resembles the demand for beer in the market. Since the distributor is a monopolist they make their price and quantity decision where their marginal revenue (denoted MRd) equals their marginal cost (denoted MCd). Their marginal cost is the price they have to pay the brewer. From this quantity (qu = qd ) they would charge their margin which is the difference between MCd and Pd. Thus the distributor gets a profit equal to the dark red shaded area.

So where does MCd come from? Well, note that depending on what the brewer (the upstream firm = u) charges, the quantity demanded will be read off of the downstream firm's MR curve. Thus the downstream firm's MR curve is the same as the upstream firm's demand curve, creating an upstream firm MR curve. The brewer's MC curve comes from the cost of making the beer and so they set MRu=MCu and lo and behold, the quantity demanded from the brewer is the same as a the quantity sold by the distributor, qu = qd. The brewer's profits are given by the light red shaded area. So consumers would pay pd (assuming competitive retailers) and consume qu = qd beer.

Err, right. Did I mention that this here is a beer blog? Good lord. I believe this is a subtle analysis of the relationships in a three-tiered system of brewing/distributing/retailing, but it might also be a description of stem cell research. I believe the man who named econ the "dismal science" must have understood it about as well as I.

Whew, time for a nice porter.