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Business Economics
Topic 3: Demand
Motivation & Overview
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Theories of individual consumer demand
Market demand
Market segmentation
Strategic groups
Price discrimination
Implications for strategy
Box 1 The fable of Damien and Norah
Damien is a young financial analyst living with his partner, Norah, a finance
manager of a major bank, in Paris, France. They have a high combined
disposable income, and so enjoy a relatively high standard of living. Among the
large variety of goods that Norah buys regularly are fruits (particularly oranges)
and designer clothing. She also pays a substantial subscription for membership
of a health and fitness centre. Damien shares many of his wife's pleasures, but
also gets particular pleasure from drinking cognac and eating good food,
listening to music, reading books, and going to the theatre and cinema. Norah
shares with Damien his love music, film and cinema, and his penchant for
luxury sports saloon cars. She does not, though, share one of Damien's passions:
going with friends to watch sports car racing and, occasionally, racing his car on
track days at famous race circuits. Norah and Damien have several holidays
each year, sometimes in exotic jet-set locations, others more adventurous in
remote forest or mountain areas. They also enjoy short weekend breaks with
friends.
Although both Norah and Damien value their time alone, they are highly social
animals. They give, and receive reciprocal invitations to, lavish dinner parties,
and spend a great deal with friends and colleagues in work and leisure activities.
Damien sees himself as a trend-setter. Each likes to be at the centre of various
social networks, and Norah likes to feel that she is highly regarded for her
bubbly personality and generosity.
health and
fitness clubs
cars
personal
computer
motor cycles
wine
cinema
Figure 9.1 A simplified product space
designer
clothes
fruit
Conventional theory of demand
• Represent preferences using utility function
– U=U(x,y)
x and y are two goods
• Indifference curves
– all points on a given indifference curve
represent same utility
– U  U(x 1 , y1 )
Quantity
of good
y per
period
Qy1
1
2
Qy2
U U
0
Qx1
Qx2
Fig 3.3 An indifference curve for the goods x and y
Quantity of good x
per period
Budget constraint
• Can only afford to buy limited amounts of
goods
– represent affordable combinations using budget
constraint
– position depends upon ratio of good prices and
income
Qy
M2
Py1
M2
M1
Py1
M2
0
Fig 3.6 A set of budget constraints
M3
M1
Px1
M1
Px2
M2
Px1
Qx
Utility maximisation
• Maximise utility subject to budget
constraint
• Most north easterly indifference curve
possible
• Point of tangency between budget constraint
and indifference curve
Qy

*
Y
Q

~
U U
U U

U U
0
QX*
Fig 3.7 Utility maximization subject to a budget constraint
Qx
Change in Price
• Fall in price
• Budget constraint swings outwards
• Relative prices change
– substitution effect
• Real income increases
– income effect
Figure 3 Market demand for mid-price luxury cars
Price of
product
Quantity demanded
per period
Figure 5 Strengthening of preferences for wine
Price of
product
Quantity demanded
per period
sports
hatchbacks
SUV
midprice
luxury
saloons
super
sport
estate
cars
Figure 9.2 Car product space
small,
city
budget
mass-market
family
The Characteristics (or
attributes) theory of consumer
demand
… and product differentiation
Table 1 Characteristics of luxury sports saloon cars [1]
Characteris
tic
Mercedes
VFR
BMW
916
Jaguar
Dragon
Lexus
Dream
Porsche
Bonneville
Performanc
e
60
80
75
60
85
Luxury
80
78
82
85
69
Distinctive
ness
70
65
65
55
75
Engineerin
g quality
70
75
70
80
80
[1] While manufacturers’ names are genuine, model names are fictitious in this example.
Better
Than
+3
+2
+1
Your
Product
0
Our Product
Product C
-1
Product A
-2
Not as
Good
-3
Product B
Styling
Performance
(30)
(25)
Marque
Strength
(20)
Engineering
Innovations
(15)
Most
Important
Build
Quality
(10)
Least
Important
DIMENSIONS OF PERCEIVED BENEFIT (PB)
Note: (30) weighting of PB dimensions
performance
distinctiveness
luxury
engineering
quality
Mercedes VFR
Jaguar Dragon
Porsche Bonneville
Performance: low
Performance: medium
Performance: very high
Luxury: very high
Luxury: very high
Luxury: low
Distinctiveness: medium
Distinctiveness: medium
Distinctiveness: high
Engineering: rather high
Engineering: high
Engineering: very high
Figure 6: Characteristics space, and product differentiation
performance
status
reinforcement
luxury
distinctiveness
engineering
quality
sexual
attractiveness
self-esteem
looking good
Sports saloons
Designer sports cars
Designer clothes
Performance
Performance
Self-esteem
Luxury:
Distinctiveness
Status reinforcement
Distinctiveness
Status reinforcement
Sexual attractiveness
Engineering
Sexual attractiveness
Looking good
Figure 7: Characteristics space and product space: their relationship.
WEIGHTING %
Ability to Impress Women
50
Ability to impress friends
25
Lots of toys to play with
20
Leg room in the back
5
The Household Production
Theory of consumer demand
Gary Becker’s (1965) 'household production function'
(HPF) model.
We continue to investigate the fable of Damien.
We suppose that the things that matter particularly to
Damien, and give him value, are sex appeal, social status,
a fine social and cultural life with a good set of friends,
and the admiration of others.
Damien's utility function:
UD = UD (sex appeal, social status, social and cultural
life, admiration of others, good company of friends)
The ‘commodities’ in brackets on the right-hand side of
this equation are not intrinsic, or genetic, qualities of the
individuals themselves.
They are also not goods and services that can be
purchased directly through markets. Nor are they
characteristics of purchased goods.
Rather they are goods and services 'produced' by
households, through their household production function,
just as was the home-made meal in our earlier example.
Figure 4 Consumer surplus and potential for price discrimination
Price of
product
Quantity demanded
per period
What might this be for your business?
Better
Than
+3
0
Not as
Good
Our Product
Or Service
-3
Most
Important
Least
Important