Transcript Lecture One

LECTURE TWO: DEMAND
Managerial Economics
Lecturer: Jack Wu
RISING GASOLINE PRICES

Between September 2004 and September 2005,
the monthly average retail price of gasoline
jumped from $1.85 per gallon to $3.08 per gallon.
Sales of full-size SUVs dropped 16.8% over the
same time period (with a particularly sharp
42.5% drop for full-size GM SUVs).
GM VICE CHAIRMAN: BOB LUTZ
May 31, 2004: “It sounds cavalier, but in any
household budget, gasoline isn't a factor”,
Business Week.
 July 1, 2005: “The demise of the full-size truck is
a figment of the imagination of the popular press.
Everybody assumes it is true but the market is
still buying”, Reuters.
 “The effect will decrease over time as people
adjust to the thought of $3 a gallon, just as they
did when it was $2 a gallon and just as they did
when it was $1 a gallon”, New York Times.

MANAGERIAL ECONOMICS
QUESTIONS
 How
important are gasoline prices to the sales of
SUVs and other types of automobiles?
 How should the auto manufacturers respond to
the increasing price of gasoline?
 Are manufacturer incentives (i.e. price reductions)
an effective response?
 What are the combined effects of incentives and
increasing gas prices?
MANAGERIAL ECONOMICS TOOL:
DEMAND

We apply demand to show how the rising price of
gasoline has caused decreases in large SUV sales,
and how manufacturer incentives can offset these
reductions.
INDIVIDUAL DEMAND CURVE
Definition: graph of quantity that buyer will
purchase at every possible price
 Construction -- “Other things equal, how many
would you buy at a price of ….?’’
 vertical axis -- price
 horizontal axis -- quantity
INDIVIDUAL DEMAND SCHEDULE

Price
($ per movie)
10.00
7.50
5.00
2.50
0.00
Quantity
(movies per month)
0
1
2
4
7
INDIVIDUAL DEMAND CURVE
Price ($ per movie)
10
7.50
individual demand curve
5
2.50
0
1
2
4
Quantity (Movies a month)
7
INDIVIDUAL DEMAND SCHEDULE II

Price
($ per movie)
20.00
19.00
18.00
….
0.00
Quantity
(movies per month)
0
1
2
…
20
ANOTHER TYPE OF INDIVIDUAL DEMAND
CURVE
TWO VIEWS
for every possible price, it shows the quantity
demanded
 for each unit of item, it shows the maximum price
that the buyer is willing to pay

DEMAND CURVE: SLOPE

diminishing marginal benefit -- each additional
unit of consumption/usage provides less benefit
than the preceeding unit
 demand
curve slopes downward
CONSUMER DIFFERENCES

individual preferences  different demand
curves
changes in consumer's preferences, eg, age
 different consumers

HOOVER, 1992
A negative price case:
Hoover’s special promotion -- two free air tickets
(worth more than £400) for purchase of appliance
over £100.


promotion attracted over 100,000 customers
Hoover incurred £48 million loss
DEMAND AND INCOME
Changes in income
normal product – demand
increases with income
inferior product – demand falls
with income
DEMAND AND INCOME
DEMAND AND OTHER FACTORS

prices of related products
substitutes
 complements


advertising
OTHER DEMAND FACTORS: SUBSTITUTES
 Direct
 MBA
education: Dartmouth / NYU / USC
 Transportation: American Airlines / British Airways
 Functional
 MBA
education – residential / distance learning
 Security: Lock and key / biometric / password
 Communication: airline / train / video-conferencing /
mail
OTHER DEMAND FACTORS:
COMPLEMENTS
RECORDED MUSIC
Argentina Canada
CD purchases
0.5
2.6
cassette
purchases
GDP/capita
0.2
0.4
$9,413
$19,831
CD price
$13.80
$11.55
cassette price
$ 7.80
$ 6.06
RECORDED MUSIC
Why the average Canadian bought more of both
CDs and cassettes?
 Why the ratio of CD to cassette purchases was
relatively higher in Canada?

RECORDED MUSIC
 Canadians
enjoyed higher incomes
 Cassettes were a relatively inferior product
compared to CDs
 Another possible explanation: difference in the
relative prices of CDs and cassettes
_ Canada: 11.55/6.06=1.9
_ Argentina: 13.80/7.80=1.77
* don’t not explain why Canadians bought
relatively more CDs than Argentines.
FOOTBALL: TO BROADCAST?
Live broadcasting of away games and attendance
at home games are complements
 Live broadcasting of home games and attendance
at home games are both substitutes and
complements

OTHER DEMAND FACTORS:
DURABLE GOODS
Expectations about future prices and income
 Financing costs
 Prices of used models

substitute for new good
 future value of new good

USED CARS
avg car age
1990
1997/98
7.5 yr
8.7 yr
median
household income
up 29.9%
avg new car price
up 48.4%
USED CARS
Reasons for the increasing demand for used cars:
_ fast rising price of new cars
_ increasing quality of used cars
_ auto manufacturer reduced frequency of
changing designs
_ financial institutions began to offer more
favorable rates.

MARKET DEMAND
Market demand = horizontal summation
of individual demands
Price
Joy
Max
Lucas
Market
$10
0
0
0
0
$7.50
1
0
0
1
$5
2
1
0
3
$2.50
4
2
3
9
$0
7
6
4
17
MARKET DEMAND: CONSTRUCTION
MARKET DEMAND: MACRO
FACTORS

Income
Average
 Distribution


Demographic
Population
 Age structure
 Urban-rural


Cultural-social
MARKET DEMAND: MICRO FACTORS
Price
 Advertising
 R&D

BUYER SURPLUS
individual buyer surplus: difference between
consumer’s benefit and price she must pay for the
item
 market buyer surplus: sum of individual buyer
surpluses.

INDIVIDUAL BUYER SURPLUS
Price ($ per movie)
10
individual buyer surplus at $2.50 price
7.50 d
5 c
a
b
e
individual demand
(marginal benefit) curve
f
2.50 g
h
j
0
1
2
4
Quantity (Movies a month)
7
BUYER SURPLUS: INDIVIDUAL
GAINS FROM PRICE CUT
lower price on the quantity that he/she would
have purchased at the original price
(inframarginal units)
 he/she can buy more (marginal units)
 Case: Student discount price for movie

PACKAGE DEAL
charge buyer just a little less than her/his total
benefit
 leave buyer with almost zero surplus

BUYER SURPLUS:
TWO-PART PRICING
fixed payment
 usage charge

fixed
payment
usage
charge
BUYER SURPLUS: TWO-PART PRICING
Business
Provider
Broadband
access, Hong
Kong
PCCW Netvigator HK$298 per HK$2 per
3M Single User
month (incl. additional
Plan
100 free
hr
hrs)
Mobile telephone Etisalat
service, UAE
Corporation,
GSM Standard
Service
Fixed Fee
125 dirham
connection
fee; 60
dirham per
qtr
Usage Fee
0.24/0.18
dirham per
min (peak/
offpeak)
BUYER SURPLUS: TWO-PART PRICING
Business
Provider
Fixed Fee
Usage Fee
Check-writing Bank of
bank account, America,
California
VERSATEL
Checking
nil
US$2 per
teller
transaction
Weekday car
rental,
Melbourne
A$70 for one
day (incl. 100
free km)
A$0.25 per
additional km
Airport
RentaCar,
Toyota Camry
BUSINESS DEMAND, I
Business demands items as inputs into further
production, not for consumption
 finished/semi-finished components - raw materials and energy
 labor and other services
 capital
BUSINESS DEMAND, II
Demand for inputs depends on
 quantity of final output
 prices of complements and substitutes in
production
BUSINESS DEMAND CURVE
marginal benefit = increase in revenue arising
from an additional unit of the input
 diminishing marginal benefit  downwardsloping demand

AUTOMATED TELLER MACHINES
increase in wages  teller service became
increasingly costly
 banks used ATMs to substitute for tellers

 compare
India
use of ATMs in US vs
GM: WHAT METAL TO USE?
aluminium vis-à-vis steel
 auto weight 
fuel consumption
 emissions


price
DISCUSSION QUESTION 1

In 1998, the value of worldwide sales of
recorded music in the form of singles, music
cassettes, and CDs was $38.7 billion.
Americans bought 3.1 CDs and 0.6 music
cassette per capita, while Mexicans bought 0.5
CD and 0.3 music cassette per capita.
Explain why per capita CD sales were relatively
higher while per capita sales of music cassettes
were relatively lower in the United States than
in Mexico.
DISCUSSION QUESTION 1 CONTINUED

On a suitable diagram, draw the U.S. demand
for music CDs. Explain how the following
changes would affect the demand curve: (i)
increase in the price of CDs; (ii) rise in the
ownership of CD players; and (iii) fall in the
price of music cassettes.
DISCUSSION QUESTION 1 CONTINUED

On another diagram, draw the demand for music
CDs in Mexico. Explain how the following
changes would affect the demand curve: (i) fall in
advertising by music publishers such as Sony and
Time Warner; (ii) reduction in the penalty for
copyright infringement; and (iii) increase in the
price of hamburgers.