Lingerie or boxer shorts?

An article in Bloomberg Businessweek tells the story of a clothing manufacturer in India that produces lingerie, but refuses to produce boxer shorts. The article presents two entirely different concepts that we thought we might discuss today. (Click here for article)

One reason that Mr. Bhagwat chooses to produce lingerie instead of boxers has to do with the amount of profit that he earns per unit produced. His profit depends on his cost of production and the price at which he can sell his products. While he has some control over his costs, the amount that he receives depends on how much people are willing to pay for the goods he produces. This, in turn, depends on the elasticity of demand, a measure of consumers’ response to a change in price. The more responsive they are, that is the more they react to price changes, the more elastic the demand. The demand for boxer shorts is more elastic than the demand for lingerie because men, in general, don’t usual care what they wear while women do care what they wear. Look around you for evidence to that. One implication of profit maximization is that the gross margin (price minus marginal cost all divided by price) is inversely proportional to elasticity. The less elastic is the demand for the product, the greater the gross margin. Production of lingerie maximizes profits.

The second reason has to do with Indian labour law. When a firm employs more than 100 workers, they are not permitted to reduce their workforce without the permission of the government. Cost minimization dictates that firms do not cross the 100 employee threshold. Mr. Bhagwat has 98 employees. This policy prevents firms from capturing economies of scale that may be available to larger firms, and the large number of relatively small firms is impeding economic growth in India. China, where no such labour law exists, is able to capture the economies of scale in production and thus able to grow faster.

Policy makers in India can do nothing about the elasticity of demand, but they can do something about the labour laws. Until then, we appreciate the efforts of the 98 workers making lingerie.