INTRODUCTION AND DEMANDMBA NCCUManagerial EconomicsLecturer: Jack Wu

INTRODUCTION

NEW ECONOMY: INTERNET Managerial Economics also applies to the

new economy. Example: In pricing, Airlines use online

auctions to segment their market between business and leisure travelers.

Example: In competitive strategy, Google competes fiercely with Yahoo.

OLD/NEW ECONOMY Differences between “New” and “Old”

economy: _ role of network effects in demand **network effects – benefit/cost depends on

total number of other users example: Internt _ importance of economies of scale and scope example: Information in Yahoo is scalable

ORGANIZATION Vertical boundaries – closer to or further from

end user Samsung Electronics – vertical boundaries

longer than Intel – specializes in semiconductors (upstream) Motorola – specializes in mobile phones

(downstream)

ORGANIZATION Horizontal boundaries – scale and scope of

activities Samsung Electronics – horizontal boundaries

broader than LG.Philips LCD – specializes in LCD Motorola – specializes in mobile phones

MARKET Market: Buyers and sellers communicate with

one another for voluntary exchange market need not be physical industry -- businesses engaged in the

production or delivery of the same or similar items

MARKET: CONTINUED Competitive Markets Market Power Imperfect Markets

DEMAND

CASE: 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 CURVEDefinition: 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 Quantity ($ per movie) (movies per month) 10.00 0 7.50 1 5.00 2 2.50 4 0.00 7

0

2.50

5

7.50

10

1 4 72

individual demand curve

Quantity (Movies a month)

Price

($ p

er m

ovie

)

INDIVIDUAL DEMAND CURVE

INDIVIDUAL DEMAND SCHEDULE II Price Quantity ($ per movie) (movies per month) 20.00 0 19.00 1 18.00 2 …. … 0.00 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

HOOVER, 1992A 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 INCOMEChanges in incomenormal product – demand increases with income

inferior product – demand falls with income

DEMAND AND OTHER FACTORS prices of related products

substitutes complements

advertising

RECORDED MUSICArgentina Canada

CD purchases 0.5 2.6

cassette purchases

0.2 0.4

GDP/capita $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.

MARKET DEMAND

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 = horizontal summation of individual demands

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.

0

2.50

5

7.50

10

1 2 4 7

c b e

h

j

g

d aindividual buyer surplus at $2.50 price

individual demand(marginal benefit) curve

Quantity (Movies a month)

Price

($ p

er m

ovie

)

c

f

INDIVIDUAL BUYER SURPLUS

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

usage charge

fixed payment

BUYER SURPLUS: TWO-PART PRICINGBusiness Provider Fixed Fee Usage

Fee Broadband access, Hong Kong

PCCW Netvigator 3M Single User Plan

HK$298 per month (incl. 100 free hrs)

HK$2 per additional hr

Mobile telephone service, UAE

Etisalat Corporation, GSM Standard Service

125 dirham connection fee; 60 dirham per qtr

0.24/0.18 dirham per min (peak/offpeak)