South-Western College Publishing - Economics  
"You've Got a PC!!"
Subject AOL differentiates itself by offering PC with Internet service
Topics Monopolistic Competition; Profit Maximization and the Firm; Production and Costs
Key Words Price, Demand, Competition, Profit, Costs
News Story

America Online (AOL) has lost two million US subscribers in the last year, and is fighting back in the internet service market with a new promotion: Commit to one year of service, and they'll throw in a personal computer and color printer for only $299.

With the increase in upstart, cheap internet service providers, such as United Online, which offers monthly service for about half of the other firms, market leaders like Comcast and Earthlink have been forced to reduce their price of internet service. At the same time, prices for high-speed internet access (broadband, via cable, telephone line, etc) have been falling as well. However, AOL has decided to differentiate itself through the pc offer rather than significantly reduce price. The system includes a pc with Microsoft Windows, an Intel processor, 256 megabytes of RAM, a 40-gigabyte hard drive, and a Lexmark printer, all of which would retail for approximately $700, AOL, currently the leader in internet service provision, argues that the goal isn't short-term profit; rather, their hope is to create some brand loyalty among their subscribers.

This move is not without precedent. During the mid-to-late 1990s, technology firms gave away computers for the same reason. When the technology bubble burst, firms could ill afford such a promotion.

(Updated January, 2004)

Questions
1.

Since the goal of AOL in the article is to create brand loyalty, it can be restated as: "Making the demand curve of its customers more __________." Draw a graph to illustrate your answer.

2. It appears that, given the fate of the technology firms that tried this promotion in the late 1990s, there may not be much long-run profit involved in such a promotion. What else must AOL do to stimulate profitability in the long run?
3. What does AOL's promotion do to its short-run marginal cost, average variable cost, and average fixed cost curves? Show these changes on a graph and then explain why you made the changes.
Source Julia Angwin, "To Lure Subscribers Amid Price War, AOL Offers $299 PC," The Wall Street Journal, 4 December 2003.

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