On October 23rd, 2014, we updated our
By continuing to use LinkedIn’s SlideShare service, you agree to the revised terms, so please take a few minutes to review them.
Go Global !Go Global !Managerial Economics :Managerial Economics :Consumers, Markets &ElasticityByStephen OngStephen OngVisiting Fellow, Birmingham City UniversityVisiting Fellow, Birmingham City UniversityVisiting Professor, College of Management,Visiting Professor, College of Management,Shenzhen UniversityShenzhen UniversityMay 2013May 2013
AgendaAgenda1.1. Consumer BehaviourConsumer Behaviour2.2. Elasticity of DemandElasticity of Demand3.3. Demand Analysis &Demand Analysis &PricingPricing
Learning ObjectivesLearning ObjectivesTo identify and explain the factorsTo identify and explain the factorsthat influence consumer behaviourthat influence consumer behaviourTo explain the decision-makingTo explain the decision-makingprocess and how marketeers canprocess and how marketeers caninfluence buyer behaviourinfluence buyer behaviourTo understandTo understand elasticity and applyelasticity and applyconcepts of price elasticity, cross-concepts of price elasticity, cross-elasticity, and income elasticityelasticity, and income elasticityTo understand determinants ofTo understand determinants ofelasticity and how elasticity affectselasticity and how elasticity affectsbusiness revenuebusiness revenue
To WhichTo WhichSegment ofSegment ofConsumers WillConsumers WillThis Ad Appeal?This Ad Appeal?A Segment of Consumers WhoA Segment of Consumers Whoare Environmentally Concernedare Environmentally Concerned
Consumer BehaviourConsumer BehaviourThe behaviour thatThe behaviour thatconsumers displayconsumers displayin searching for,in searching for,purchasing, using,purchasing, using,evaluating, andevaluating, anddisposing ofdisposing ofproducts andproducts andservices that theyservices that theyexpect will satisfyexpect will satisfytheir needs.their needs.
Two Consumer Entities
ConsumersConsumers useproducts to help themdefine their identities
Consumer BehaviourConsumer Behaviour Consumer behaviour is aConsumer behaviour is aprocess.process.
Consumer BehaviourConsumer BehaviourTheory of consumer behaviourTheory of consumer behaviour•Description of how consumers allocateDescription of how consumers allocateincomes among different goods andincomes among different goods andservices to maximize their well-being.services to maximize their well-being.Consumer behaviour is best understoodConsumer behaviour is best understoodin 3 distinct steps:in 3 distinct steps:1.1. Consumer PreferencesConsumer Preferences2.2. Budget ConstraintsBudget Constraints3.3. Consumer ChoicesConsumer Choices
Consumer Tastes & PreferencesConsumer Tastes & PreferencesEffect on DemandEffect on DemandVideo : Domino’s Pizza TurnVideo : Domino’s Pizza TurnAroundAroundhttp://www.youtube.com/watchhttp://www.youtube.com/watch?
Consumer PreferencesConsumer PreferencesMarket basket (or bundle) List with specific quantitiesMarket basket (or bundle) List with specific quantitiesof one or more goods.of one or more goods.TABLE 1TABLE 1 ALTERNATIVE MARKET BASKETSALTERNATIVE MARKET BASKETSAA 2020 3030BB 1010 5050DD 4040 2020EE 3030 4040GG 1010 2020HH 1010 4040MARKET BASKET UNITS OF FOOD UNITS OF CLOTHINGTo explain the theory of consumer behaviour, we will ask whetherTo explain the theory of consumer behaviour, we will ask whetherconsumersconsumers preferprefer one market basket to another.one market basket to another.
Some Basic Assumptions aboutSome Basic Assumptions aboutPreferencesPreferencesCompleteness:Completeness:Preferences are assumed toPreferences are assumed tobebe completecomplete. In other words,. In other words,consumers can compare andconsumers can compare andrank all possible baskets.rank all possible baskets.Thus, for any two marketThus, for any two marketbasketsbaskets AA andand BB, a consumer, a consumerwill preferwill prefer AA toto BB, will prefer, will prefer BBtoto AA, or will be indifferent, or will be indifferentbetween the two. Bybetween the two. Byindifferentindifferent we mean that awe mean that aperson will be equallyperson will be equallysatisfied with either basket.satisfied with either basket.Note that these preferencesNote that these preferencesignore costs. A consumer mightignore costs. A consumer mightprefer steak to hamburger butprefer steak to hamburger butbuy hamburger because it isbuy hamburger because it ischeaper.cheaper.
Some Basic AssumptionsSome Basic Assumptionsabout Preferencesabout PreferencesTransitivity:Transitivity:Preferences arePreferences are transitivetransitive..Transitivity means that if aTransitivity means that if aconsumer prefers basketconsumer prefers basket AA totobasketbasket BB and basketand basket BB totobasketbasket CC, then the consumer, then the consumeralso prefersalso prefers AA toto CC..Transitivity is normallyTransitivity is normallyregarded as necessary forregarded as necessary forconsumer consistency.consumer consistency.More is better thanMore is better thanless:less:Goods are assumed to beGoods are assumed to bedesirable—i.e., to bedesirable—i.e., to be goodgood..Consequently,Consequently, consumersconsumersalways prefer more of anyalways prefer more of anygood to lessgood to less..In addition, consumers areIn addition, consumers arenever satisfied or satiated;never satisfied or satiated;more is always better, even ifmore is always better, even ifjust a little betterjust a little better..
Consumer Tastes and PreferencesConsumer Tastes and PreferencesPreference orderings arePreference orderings are completecomplete..MoreMore of the goods are preferred to lessof the goods are preferred to lessof the goods.of the goods.Consumers areConsumers are selfishselfish..The goods are continuouslyThe goods are continuously divisibledivisible sosothat consumers can always purchasethat consumers can always purchaseone more or one less unit of the goods.one more or one less unit of the goods.
Indifference CurvesIndifference Curves A consumer’sA consumer’sindifference curveindifference curvethatthat shows alternativeshows alternativecombinations of thecombinations of thetwo goods thattwo goods thatprovide the same levelprovide the same levelof satisfaction orof satisfaction orutility.utility.ΔYΔXY1Y2X1 X2U2U1
DESCRIBINGDESCRIBINGINDIVIDUALINDIVIDUALPREFERENCESPREFERENCESBecause more of eachBecause more of eachgood is preferred to less,good is preferred to less,we can compare marketwe can compare marketbaskets in the shadedbaskets in the shadedareas.areas.BasketBasket AA is clearlyis clearlypreferred to basketpreferred to basket GG, while, whileEE is clearly preferred tois clearly preferred to AA..However,However, AA cannot becannot becompared withcompared with BB,, DD, or, or HHwithout additionalwithout additionalinformation.information.Indifference CurvesIIndifference curvendifference curveCurve representing all combinations of market baskets thatCurve representing all combinations of market baskets thatprovide a consumer with the same level of satisfaction.provide a consumer with the same level of satisfaction.
The indifference curveThe indifference curve UU11that passes throughthat passes throughmarket basketmarket basket AA showsshowsall baskets that give theall baskets that give theconsumer the same levelconsumer the same levelof satisfaction as doesof satisfaction as doesmarket basketmarket basket AA; these; theseinclude basketsinclude baskets BB andand DD..AN INDIFFERENCEAN INDIFFERENCECURVECURVEOur consumer prefersOur consumer prefersbasketbasket EE, which lies, which liesaboveabove UU11, to, to AA, but, butprefersprefers AA toto HH oror GG, which, whichlie belowlie below UU11..An Indifference CurveAn Indifference Curve
An indifference map is a setof indifference curves thatdescribes a personspreferences.AN INDIFFERENCEINDIFFERENCE MAPIndifference MapsIndifference MapsIIndifference Mapndifference Map Graph containing a set of indifference curvesGraph containing a set of indifference curvesshowing the market baskets among which a consumer is indifferent.showing the market baskets among which a consumer is indifferent.Any market basket onindifference curve U3, suchas basket A, is preferred toany basket on curve U2(e.g., basket B), which inturn is preferred to anybasket on U1, such as D.
If indifference curves U1 andU2 intersect, one of theassumptions of consumertheory is violated.INDIFFERENCE CURVES CANNOT INTERSECTINDIFFERENCE CURVES CANNOT INTERSECTAccording to this diagram, theconsumer should beindifferent among marketbaskets A, B, and D. Yet Bshould be preferred to Dbecause B has more of bothgoods.
The magnitude of theThe magnitude of theslope of an indifferenceslope of an indifferencecurve measures thecurve measures theconsumer’s marginalconsumer’s marginalrate of substitutionrate of substitution(MRS) between two(MRS) between twogoods.goods.THE MARGINALTHE MARGINALRATE OFRATE OFSUBSTITUTIONSUBSTITUTIONIn this figure, the MRSIn this figure, the MRSbetween clothing (between clothing (CC))and food (and food (FF) falls from 6) falls from 6(between(between AA andand BB) to 4) to 4(between(between BB andand DD) to 2) to 2(between(between DD andand EE) to 1) to 1(between(between EE andand GG).).The Shape of Indifference CurvesThe Shape of Indifference Curves
Marginal Rate of SubstitutionMarginal Rate of SubstitutionThe ratioThe ratio ΔΔY/Y/ΔΔX,X, which showswhich showsthe rate at which the consumerthe rate at which the consumeris willing tois willing to trade offtrade off oneonegood for another and stillgood for another and stillmaintain a constant utility level,maintain a constant utility level,is called theis called the marginal rate ofmarginal rate ofsubstitution (MRSsubstitution (MRSxyxy).).
The Marginal Rate of SubstitutionThe Marginal Rate of SubstitutionMMarginal rate of substitution (MRS)arginal rate of substitution (MRS)Maximum amount of a good that a consumer isMaximum amount of a good that a consumer iswilling to give up in order to obtain onewilling to give up in order to obtain oneadditional unit of another good.additional unit of another good.CONVEXITYCONVEXITYObserve that the MRS falls as we move down theObserve that the MRS falls as we move down theindifference curve. The decline in the MRS reflects ourindifference curve. The decline in the MRS reflects ourfourth assumption regarding consumer preferences: afourth assumption regarding consumer preferences: adiminishing marginal rate of substitutiondiminishing marginal rate of substitution..When the MRS diminishes along an indifference curve,When the MRS diminishes along an indifference curve,the curve is convex.the curve is convex.
Perfect Substitutes and PerfectPerfect Substitutes and PerfectComplementsComplementsPPerfect substituteserfect substitutesTwo goods for which the marginal rate ofTwo goods for which the marginal rate ofsubstitution of one for the other is asubstitution of one for the other is aconstant.constant.PPerfect complementserfect complementsTwo goods for which the MRS is zero orTwo goods for which the MRS is zero orinfinite; the indifference curves areinfinite; the indifference curves areshaped as right angles.shaped as right angles.BBadsadsGood for which less is preferred rather than more.Good for which less is preferred rather than more.
In (In (aa), Bob views orange juice), Bob views orange juiceand apple juice as perfectand apple juice as perfectsubstitutes: He is alwayssubstitutes: He is alwaysindifferent between a glass ofindifferent between a glass ofone and a glass of the other.one and a glass of the other.In (In (bb), Jane views left shoes and right), Jane views left shoes and rightshoes as perfect complements: Anshoes as perfect complements: Anadditional left shoe gives her no extraadditional left shoe gives her no extrasatisfaction unless she also obtains thesatisfaction unless she also obtains thematching right shoe.matching right shoe.Perfect SubstitutesPerfect Substitutes && Perfect ComplementsPerfect Complements
Preferences for automobile attributes canPreferences for automobile attributes canbe described by indifference curves. Eachbe described by indifference curves. Eachcurve shows the combination ofcurve shows the combination ofacceleration and interior space that give theacceleration and interior space that give thesame satisfaction.same satisfaction.PREFERENCES FOR AUTOMOBILE ATTRIBUTESPREFERENCES FOR AUTOMOBILE ATTRIBUTESOwners of Ford Mustang coupes (Owners of Ford Mustang coupes (aa) are) arewilling to give up considerable interiorwilling to give up considerable interiorspace forspace for additional accelerationadditional acceleration..The opposite is true for owners ofThe opposite is true for owners ofFord Explorers. They preferFord Explorers. They preferinterior spaceinterior space to accelerationto acceleration((bb).).DESIGNING NEW AUTOMOBILES (I)DESIGNING NEW AUTOMOBILES (I)
A utility function can berepresented by a set ofindifference curves, each witha numerical indicator.This figure shows threeindifference curves (withutility levels of 25, 50, and100, respectively) associatedwith the utility function:UTILITY AND UTILITY FUNCTIONSUTILITY AND UTILITY FUNCTIONSUtilityUtility Numerical score representing the satisfaction that aNumerical score representing the satisfaction that aconsumer gets from a given market basket.consumer gets from a given market basket.Utility functionUtility function Formula that assigns a level of utility toFormula that assigns a level of utility toindividual market baskets.individual market baskets.UTILITY FUNCTIONS ANDUTILITY FUNCTIONS ANDINDIFFERENCE CURVESINDIFFERENCE CURVESu (F,C ) =FC
A cross-countryA cross-countrycomparisoncomparisonshows thatshows thatindividuals livingindividuals livingin countries within countries withhigher GDP perhigher GDP percapita are oncapita are onaverage happieraverage happierthan those livingthan those livingin countries within countries withlower per-capitalower per-capitaGDP.GDP.INCOME AND HAPPINESSINCOME AND HAPPINESSCAN MONEY BUY HAPPINESS?CAN MONEY BUY HAPPINESS?
Income andIncome andHappiness:Happiness:ComparingComparingCountriesCountries
The Budget ConstraintThe Budget Constraint The consumer’sThe consumer’sbudget constraintbudget constraintshows all theshows all thecombinations of twocombinations of twogoods that can begoods that can bepurchased with apurchased with agiven income andgiven income andgiven the prevailinggiven the prevailingprices of the twoprices of the twogoods.goods.
Market baskets associated with the budget lineMarket baskets associated with the budget line FF + 2+ 2CC = $80= $80Budget constraintsBudget constraintsConstraints that consumers face as a result of limitedConstraints that consumers face as a result of limitedincomes.incomes.BBudget lineudget lineAll combinations of goods for which the total amountAll combinations of goods for which the total amountof money spent is equal to incomeof money spent is equal to income..Budget ConstraintsBudget ConstraintsTABLE 2 MARKET BASKETS AND THE BUDGET LINEMARKETMARKETBASKETBASKETFOODFOOD((FF))CLOTHINGCLOTHING((CC))TOTALTOTALSPENDINGSPENDINGAA 00 4040 $80$80BB 2020 3030 $80$80DD 4040 2020 $80$80EE 6060 1010 $80$80GG 8080 00 $80$80
A budget line describes thecombinations of goods thatcan be purchased given theconsumer’s income and theprices of the goods.Line AG (which passesthrough points B, D, and E)shows the budget associatedwith an income of $80, a priceof food of PF = $1 per unit,and a price of clothing of PC =$2 per unit.The slope of the budget line(measured between points Band D) is −PF/PC = −10/20 =−1/2.FPPPIC CFC )/()/( −=A BUDGET LINEA BUDGET LINE
Shifts in the Budget ConstraintShifts in the Budget ConstraintIncrease in incomeIncrease in income Increase in price of good XIncrease in price of good XY1B1B2
INCOME CHANGESINCOME CHANGESA change in income (withA change in income (withprices unchanged)prices unchanged)causes the budget line tocauses the budget line toshift parallel to theshift parallel to theoriginal line (original line (LL11).).When the income of $80When the income of $80(on(on LL11) is increased to) is increased to$160, the budget line$160, the budget lineshifts outward toshifts outward to LL22..If the income falls to $40,If the income falls to $40,the line shifts inward tothe line shifts inward toLL33..EFFECTS OF AEFFECTS OF ACHANGE IN INCOMECHANGE IN INCOMEON THE BUDGET LINEON THE BUDGET LINEThe Effects of Changes in IncomeThe Effects of Changes in Incomeand Pricesand Prices
PRICE CHANGESPRICE CHANGESA change in the price ofA change in the price ofone good (with incomeone good (with incomeunchanged) causes theunchanged) causes thebudget line to rotatebudget line to rotateabout one intercept.about one intercept.When the price of foodWhen the price of foodfalls from $1.00 to $0.50,falls from $1.00 to $0.50,the budget line rotatesthe budget line rotatesoutward fromoutward from LL11 toto LL22..However, when the priceHowever, when the priceincreases from $1.00 toincreases from $1.00 to$2.00, the line rotates$2.00, the line rotatesinward from Linward from L11 toto LL33..EFFECTS OF AEFFECTS OF ACHANGE IN PRICE ONCHANGE IN PRICE ONTHE BUDGET LINETHE BUDGET LINEEFFECTS OF A CHANGE IN PRICE ON THEEFFECTS OF A CHANGE IN PRICE ON THEBUDGET LINEBUDGET LINE
Consumer ChoiceConsumer Choice The consumerThe consumermaximizes utilitymaximizes utilityby choosing aby choosing acombination ofcombination ofgood X and Y, lyinggood X and Y, lyingon the budgeton the budgetconstraint andconstraint andsimultaneouslysimultaneouslylying on thelying on theindifference curveindifference curvefurthest from thefurthest from theorigin.origin.
Consumer ChoiceConsumer ChoiceThe maximizing market basket must satisfyThe maximizing market basket must satisfytwo conditions:two conditions:1.1. It must be located on the budget lineIt must be located on the budget line..2.2. ItIt must give the consumer the mostmust give the consumer the mostpreferred combination of goods and servicespreferred combination of goods and services..
A consumer maximizesA consumer maximizessatisfaction by choosingsatisfaction by choosingmarket basketmarket basket AA. At this. At thispoint, the budget line andpoint, the budget line andindifference curveindifference curve UU22 arearetangent.tangent.No higher level ofNo higher level ofsatisfaction (e.g., marketsatisfaction (e.g., marketbasketbasket DD) can be attained.) can be attained.AtAt AA, the point of, the point ofmaximization, the MRSmaximization, the MRSbetween the two goodsbetween the two goodsequals the price ratio. Atequals the price ratio. AtBB, however, because the, however, because theMRS [− (−10/10) = 1] isMRS [− (−10/10) = 1] isgreater than the pricegreater than the priceratio (1/2), satisfaction isratio (1/2), satisfaction isnot maximized.not maximized.MAXIMIZING CONSUMERMAXIMIZING CONSUMERSATISFACTIONSATISFACTIONMAXIMIZING CONSUMER SATISFACTIONMAXIMIZING CONSUMER SATISFACTION
MMarginal Benefitarginal BenefitBenefit from the consumption of one additional unit ofBenefit from the consumption of one additional unit ofa good.a good.Marginal CostMarginal CostCost of one additional unit of a good.Cost of one additional unit of a good.So, we can then say that satisfaction is maximized whenSo, we can then say that satisfaction is maximized whenthe marginal benefit—the benefit associated with thethe marginal benefit—the benefit associated with theconsumption of one additional unit of food—is equal toconsumption of one additional unit of food—is equal tothe marginal cost—the cost of the additional unit of food.the marginal cost—the cost of the additional unit of food.The marginal benefit is measured by the MRS.The marginal benefit is measured by the MRS.Satisfaction is maximized (given the budgetSatisfaction is maximized (given the budgetconstraint) at the point whereconstraint) at the point whereMRS =MRS = PPFF//PPCC
The consumers in (The consumers in (aa) are willing to) are willing totrade off a considerable amount oftrade off a considerable amount ofinterior space for some additionalinterior space for some additionalacceleration.acceleration.CONSUMER CHOICE OF AUTOMOBILE ATTRIBUTESCONSUMER CHOICE OF AUTOMOBILE ATTRIBUTESGiven a budget constraint, theyGiven a budget constraint, theywill choose a car that emphasizeswill choose a car that emphasizesacceleration. The opposite is trueacceleration. The opposite is truefor consumers in (for consumers in (bb).).Different preferences of consumer groups for automobiles can affect theirDifferent preferences of consumer groups for automobiles can affect theirpurchasing decisions. Following up on Example 1, we consider twopurchasing decisions. Following up on Example 1, we consider twogroups of consumers planning to buy new cars.groups of consumers planning to buy new cars.DESIGNING NEW AUTOMOBILES (II)DESIGNING NEW AUTOMOBILES (II)
Corner solutionCorner solutionSituation in which the marginal rate of substitution for one good in aSituation in which the marginal rate of substitution for one good in achosen market basket is not equal to the slope of the budget linechosen market basket is not equal to the slope of the budget line..A CORNER SOLUTIONA CORNER SOLUTIONCorner SolutionsCorner SolutionsWhen a corner solutionWhen a corner solutionarises, the consumerarises, the consumermaximizes satisfaction bymaximizes satisfaction byconsuming only one of theconsuming only one of thetwo goods.two goods.Given budget lineGiven budget line ABAB, the, thehighest level ofhighest level ofsatisfaction is achieved atsatisfaction is achieved atBB on indifference curveon indifference curve UU11,,where the MRS (of icewhere the MRS (of icecream for frozen yogurt) iscream for frozen yogurt) isgreater than the ratio ofgreater than the ratio ofthe price of ice cream tothe price of ice cream tothe price of frozen yogurt.the price of frozen yogurt.
CONSUMER PREFERENCES FOR HEALTH CARE VERSUSCONSUMER PREFERENCES FOR HEALTH CARE VERSUSOTHER GOODSOTHER GOODSThese indifference curves show theThese indifference curves show thetrade-off between consumption of healthtrade-off between consumption of healthcare (H) versus other goods (O). Curvecare (H) versus other goods (O). Curve UU11applies to a consumer with low income;applies to a consumer with low income;given the consumer’s budget constraint,given the consumer’s budget constraint,satisfaction is maximized at point A.satisfaction is maximized at point A.As income increases the budget lineAs income increases the budget lineshifts to the right, and curveshifts to the right, and curve UU22 becomesbecomesfeasible. The consumer moves to point B,feasible. The consumer moves to point B,with greater consumption of both healthwith greater consumption of both healthcare and other goods.care and other goods.CurveCurve UU33 applies to a high-incomeapplies to a high-incomeconsumer, and implies less willingnessconsumer, and implies less willingnessto give up health care for other goods.to give up health care for other goods.Moving from point B to point C, theMoving from point B to point C, theconsumer’s consumption of health careconsumer’s consumption of health careincreases considerably (fromincreases considerably (from HH22 toto HH33),),while her consumption of other goodswhile her consumption of other goodsCONSUMER CHOICE OF HEALTH CARECONSUMER CHOICE OF HEALTH CARE
When given a collegeWhen given a collegetrust fund that musttrust fund that mustbe spent onbe spent oneducation, the studenteducation, the studentmoves frommoves from AA toto BB, a, acorner solution.corner solution.If, however, the trustIf, however, the trustfund could be spentfund could be spenton other consumptionon other consumptionas well as education,as well as education,the student would bethe student would bebetter off atbetter off at CC..A COLLEGE TRUST FUNDA COLLEGE TRUST FUNDA COLLEGE TRUST FUND
If an individual facing budgetline l1 chose market basket Arather than market basket B,A is revealed to be preferredto B.Likewise, the individual facingbudget line l2 chooses marketbasket B, which is thenrevealed to be preferred tomarket basket D.Whereas A is preferred to allmarket baskets in the green-shaded area, all baskets inthe pink-shaded area arepreferred to A.REVEALED PREFERENCE:TWO BUDGET LINESIf a consumer chooses one market basket over another, and if theIf a consumer chooses one market basket over another, and if thechosen market basket is more expensive than the alternative, thenchosen market basket is more expensive than the alternative, thenthe consumer must prefer the chosen market basket.the consumer must prefer the chosen market basket.Revealed PreferenceRevealed Preference
Facing budget line l3, theindividual chooses E, which isrevealed to be preferred to A(because A could have beenchosen).Likewise, facing line l4, theindividual chooses G, which isalso revealed to be preferredto A.Whereas A is preferred to allmarket baskets in the green-shaded area, all marketbaskets in the pink-shadedarea are preferred to A.REVEALED PREFERENCE:FOUR BUDGET LINESRevealed PreferencesRevealed Preferences
REVEALED PREFERENCE FOR RECREATIONWhen facing budget lineWhen facing budget line ll11, an individual chooses to use a health club for 10, an individual chooses to use a health club for 10hours per week at pointhours per week at point AA..When the fees are altered, she faces budget lineWhen the fees are altered, she faces budget line ll22..She is then made better off because market basketShe is then made better off because market basket AA can still be purchased, ascan still be purchased, ascan market basketcan market basket BB, which lies on a higher indifference curve., which lies on a higher indifference curve.REVEALED PREFERENCE FOR RECREATIONREVEALED PREFERENCE FOR RECREATION
MMarginal utility (MU)arginal utility (MU)Additional satisfaction obtained fromAdditional satisfaction obtained fromconsuming one additional unit of a good.consuming one additional unit of a good.DDiminishing marginal utilityiminishing marginal utilityPrinciple that as more of a good is consumed,Principle that as more of a good is consumed,the consumption of additional amounts willthe consumption of additional amounts willyield smaller additions to utility.yield smaller additions to utility.Equal marginal principleEqual marginal principlePrinciple that utility is maximized when the consumerPrinciple that utility is maximized when the consumerhas equalized the marginal utility per dollar ofhas equalized the marginal utility per dollar ofexpenditure across all goods.expenditure across all goods.Marginal Utility and Consumer ChoiceMarginal Utility and Consumer Choice
Changes in Consumer ChoiceChanges in Consumer ChoiceIncrease in incomeIncrease in income Increase in priceIncrease in priceB
MARGINAL UTILITY AND HAPPINESSMARGINAL UTILITY AND HAPPINESSA comparison of mean levels of satisfaction with life acrossA comparison of mean levels of satisfaction with life acrossincome classes in the United States shows that happinessincome classes in the United States shows that happinessincreases with income, but at a diminishing rate.increases with income, but at a diminishing rate.MARGINAL UTILITY AND HAPPINESSMARGINAL UTILITY AND HAPPINESSWhat, if anything, does research on consumer satisfaction tellWhat, if anything, does research on consumer satisfaction tellus about the relationship between happiness and theus about the relationship between happiness and theconcepts of utility and marginal utility?concepts of utility and marginal utility?
INEFFICIENCY OF GASOLINE RATIONINGINEFFICIENCY OF GASOLINE RATIONINGWhen a good is rationed, less isWhen a good is rationed, less isavailable than consumersavailable than consumerswould like to buy. Consumerswould like to buy. Consumersmay be worse off.may be worse off.Without gasoline rationing, upWithout gasoline rationing, upto 20,000 gallons of gasolineto 20,000 gallons of gasolineare available for consumptionare available for consumption(at point(at point BB).).The consumer chooses pointThe consumer chooses point CCon indifference curveon indifference curve UU22,,consuming 5000 gallons ofconsuming 5000 gallons ofgasoline.gasoline.However, with a limit of 2000However, with a limit of 2000gallons of gasoline undergallons of gasoline underrationing, the consumer movesrationing, the consumer movestoto DD on the lower indifferenceon the lower indifferencecurvecurve UU11..RationingRationing
Some consumers will be worseSome consumers will be worseoff, but others may be better offoff, but others may be better offwith rationing. With rationingwith rationing. With rationingand a gasoline price of $1.00,and a gasoline price of $1.00,she buys the maximumshe buys the maximumallowable 2000 gallons per year,allowable 2000 gallons per year,putting her on indifferenceputting her on indifferencecurvecurve UU11..Had the competitive marketHad the competitive marketprice been $2.00 per gallon withprice been $2.00 per gallon withno rationing, she would haveno rationing, she would havechosen pointchosen point FF, which lies, which liesbelow indifference curvebelow indifference curve UU11..However, had the price ofHowever, had the price ofgasoline been only $1.33 pergasoline been only $1.33 pergallon, she would have chosengallon, she would have chosenpointpoint GG, which lies above, which lies aboveindifference curveindifference curve UU11..COMPARING GASOLINE RATIONING TOCOMPARING GASOLINE RATIONING TOTHE FREE MARKETTHE FREE MARKET
CCost-of-living indexost-of-living indexRatio of the present cost of a typicalRatio of the present cost of a typicalbundle of consumer goods and servicesbundle of consumer goods and servicescompared with the cost during a basecompared with the cost during a baseperiod.period.IIdeal cost-of-living indexdeal cost-of-living indexCost of attaining a given level of utility at currentCost of attaining a given level of utility at currentprices relative to the cost of attaining the sameprices relative to the cost of attaining the sameutility at base-year prices.utility at base-year prices.Cost-of-Living IndexesCost-of-Living Indexes
The initial budgetThe initial budgetconstraint facing Sarahconstraint facing Sarahin 2000 is given by linein 2000 is given by line ll11;;her utility-maximizingher utility-maximizingcombination of food andcombination of food andbooks is at pointbooks is at point AA ononindifference curveindifference curve UU11..Rachel requires a budgetRachel requires a budgetsufficient to purchase thesufficient to purchase thefood-book consumptionfood-book consumptionbundle given by pointbundle given by point BBon lineon line ll22 (and tangent to(and tangent toindifference curveindifference curve UU ).).TABLE 3 IDEAL COST-OF-LIVING INDEXPrice of booksPrice of books $20/book$20/book $100/bk$100/bkNumber of booksNumber of books 1515 66Price of foodPrice of food $2.00/lb.$2.00/lb. $2.20/lb.$2.20/lb.Pounds of foodPounds of food 100100 300300ExpenditureExpenditure $500$500 $1260$12602010 (RACHEL)2000 (SARAH)COST-OF-LIVING INDEXES 1COST-OF-LIVING INDEXES 1
A price index, whichA price index, whichrepresents the cost ofrepresents the cost ofbuying bundlebuying bundle AA atatcurrent prices relativecurrent prices relativeto the cost of bundleto the cost of bundle AAat base-year prices,at base-year prices,overstates the idealoverstates the idealcost-of-living index.cost-of-living index.TABLE 3TABLE 3 IDEAL COST-OF-LIVING INDEXPrice of booksPrice of books $20/book$20/book $100/bk$100/bkNumber of booksNumber of books 1515 66Price of foodPrice of food $2.00/lb.$2.00/lb. $2.20/lb.$2.20/lb.Pounds of foodPounds of food 100100 300300ExpenditureExpenditure $500$500 $1260$12602010 (RACHEL)2000 (SARAH)COST-OF-LIVING INDEXES 2COST-OF-LIVING INDEXES 2
Fixed-weight indexFixed-weight indexCost-of-living index in which the quantities of goods and servicesCost-of-living index in which the quantities of goods and servicesremain unchanged.remain unchanged.CChain-weighted price indexhain-weighted price indexCost-of-living index that accounts for changes in quantities of goodsCost-of-living index that accounts for changes in quantities of goodsand services.and services.A commission chaired by Stanford University professorA commission chaired by Stanford University professorMichael Boskin concluded that the CPI overstated inflationMichael Boskin concluded that the CPI overstated inflationby approximately 1.1 percentage points—a significantby approximately 1.1 percentage points—a significantamount given the relatively low rate of inflation in the Unitedamount given the relatively low rate of inflation in the UnitedStates in recent years. Approximately 0.4 percentage pointsStates in recent years. Approximately 0.4 percentage pointsof the 1.1-percentage-point bias was due to the failure of theof the 1.1-percentage-point bias was due to the failure of theLaspeyres price index to account for changes in the currentLaspeyres price index to account for changes in the currentyearyear mix of consumption of the productsmix of consumption of the products in the base-yearin the base-yearbundle.bundle.THE BIAS IN THE CPITHE BIAS IN THE CPI
A Simple Model of Consumer Decision Making -Figure 1.4
Segmenting Consumers:DemographicsDemographics: Age Gender Family structure Social class/income Race/ethnicity Geography
1.1. Live on the Coke side of Life.Live on the Coke side of Life.2.2. Smarter together.Smarter together.3.3. Your potential. Our passion.Your potential. Our passion.4.4. Don’t do evil.Don’t do evil.5.5. Imagination at work.Imagination at work.6.6. I’m lovin’ it.I’m lovin’ it.7.7. Leap ahead.Leap ahead.8.8. Think different.Think different.9.9. Where dreams come true.Where dreams come true.10.10.Invent.Invent.11.11.It’s not the destination, it’sIt’s not the destination, it’sthe journey.the journey.Who are you?Who are you?
The Best Global BrandsThe Best Global Brands1.1. Coca-ColaCoca-Cola2.2. IBMIBM3.3. MicrosoftMicrosoft4.4. GEGE5.5. NokiaNokia6.6. ToyotaToyota7.7. IntelIntel8.8. McDonald’sMcDonald’s9.9. DisneyDisney10.10.GoogleGoogle
Top 10Top 10 Ranked U.S. Companies in Terms ofRanked U.S. Companies in Terms ofConsumers’ Trust and Respect of PrivacyConsumers’ Trust and Respect of PrivacyTop 10 Companies• American Express• eBay• IBM• Amazon• Johnson & Johnson• Hewlett-Packard• U.S. Postal Service• Procter and Gamble• Apple• Nationwide
The Mobile ConsumerThe Mobile Consumer• Wireless MediaWireless MediaMessages willMessages willexpand as:expand as:– Flat-rate dataFlat-rate datatraffictrafficincreasesincreases– Screen imageScreen imagequality isquality isenhancedenhanced– Consumer-userConsumer-userexperiencesexperienceswith webwith webapplicationsapplicationsimproveimprovePenetration of Internet Usage AmongPenetration of Internet Usage AmongMobile Subscribers in 16 Countries -Mobile Subscribers in 16 Countries -FIGURE 1.3FIGURE 1.3
Consumer and the InternetConsumer and the InternetThe WebThe Webisischangingchangingconsumerconsumerbehaviour.behaviour.
Social MediaSocial MediaSocial media are the online means of communication, conveyance,Social media are the online means of communication, conveyance,collaboration, and cultivation among interconnected andcollaboration, and cultivation among interconnected andinterdependent networks of people, communities, andinterdependent networks of people, communities, andorganizations enhanced by technological capabilities and mobility.organizations enhanced by technological capabilities and mobility.1-66
For ReflectionFor ReflectionDid you know If you were paid $1 for every time an article wasIf you were paid $1 for every time an article wasposted onposted on WikipediaWikipedia, you’d earn $156.23/hour?, you’d earn $156.23/hour? 80% of companies use80% of companies use LinkedInLinkedIn as their primaryas their primaryrecruiting tool?recruiting tool? More than 1.5 billion pieces of content are shared onMore than 1.5 billion pieces of content are shared onFacebookFacebook daily?daily?
Do Marketers Promise Miracles?Do Marketers Promise Miracles?Advertisers simply do not know enoughabout people to manipulate them
22Elasticity of DemandElasticity of Demand
OverviewOverviewThe economic concept ofThe economic concept ofelasticityelasticityThe price elasticity of demandThe price elasticity of demandThe cross-elasticity of demandThe cross-elasticity of demandIncome elasticityIncome elasticityOther elasticity measuresOther elasticity measuresElasticity of supplyElasticity of supply
How sticky isHow long ago sinceHow long ago sincethe price changed ?the price changed ?MonthsMonths MonthsMonthsDry cleaningDry cleaning McDonald’sMcDonald’sMealMealNewspaperNewspaper Small CarSmall CarHaircutHaircut MilkMilkTaxi fareTaxi fare ElectricityElectricityMedical servicesMedical services AirfareAirfareMagazineMagazine PetrolPetrolPersonal ComputerPersonal Computer Teh tarikTeh tarik
Sticky PricesSticky Prices• Average months between priceAverage months between pricechanges (USA)changes (USA)MonthsMonths MonthsMonthsCoin-operated LaundryCoin-operated LaundryMachineMachine46.446.4 BeerBeer 4.34.3NewspaperNewspaper 29.929.9 MicrowaveMicrowaveOvensOvens3.03.0HaircutHaircut 25.525.5 MilkMilk 2.42.4Taxi fareTaxi fare 19.719.7 ElectricityElectricity 1.81.8Vet servicesVet services 14.914.9 AirfareAirfare 1.01.0MagazineMagazine 11.211.2 GasolineGasoline 0.60.6PC SoftwarePC Software 5.55.5
Why Should Managers StudyWhy Should Managers StudyElasticity?Elasticity?Own-price elasticityOwn-price elasticity helps managershelps managersunderstand the impact that priceunderstand the impact that pricechanges will have on their revenue.changes will have on their revenue.Income elasticityIncome elasticity can help managerscan help managersunderstand what income groups tounderstand what income groups totarget their product to.target their product to.Cross-price elasticityCross-price elasticity can helpcan helpmanagers understand who their closestmanagers understand who their closestcompetitors are.competitors are.
Demand ElasticityDemand ElasticityDemand elasticity is theDemand elasticity is theresponsiveness of quantityresponsiveness of quantitydemanded to changes in thedemanded to changes in thefactors that influencefactors that influencedemand, product price,demand, product price,income, or prices of relatedincome, or prices of relatedproducts.products.
The economic concept ofThe economic concept ofelasticityelasticityElasticity: theElasticity: the percentagepercentagechangechange in one variablein one variablerelative to a percentagerelative to a percentagechange in another.change in another.BinchangepercentAinchangepercentElasticityoftCoefficien =
Price elasticity of demandPrice elasticity of demandPrice elasticity of demand:Price elasticity of demand:the percentage change inthe percentage change inquantity demanded causedquantity demanded causedby aby a 1 percent change in1 percent change inpricepricePrice%Quantity%E∆∆=p
Own Price ElasticityOwn Price Elasticityof Demandof Demand Measured as the percentage change inMeasured as the percentage change inquantity demanded of a given good,quantity demanded of a given good,relative to a percentage change in itsrelative to a percentage change in itsprice, all else constant.price, all else constant.eepp = %ΔQ= %ΔQxx ÷ %ΔP÷ %ΔPxx
Price elasticity of demandPrice elasticity of demandElasticity variesElasticity variesalong a linearalong a lineardemand curvedemand curve
Own Price Elasticity of Demand –Own Price Elasticity of Demand –Graphical RepresentationGraphical RepresentationPQP1P2Q1 Q2%∆P%∆QAB
Examples of Own-PriceExamples of Own-PriceElasticityElasticityCereal: -0.55Cereal: -0.55Fish: -0.29Fish: -0.29Neuman’s Own Pasta Sauce:Neuman’s Own Pasta Sauce:-2.32-2.32Orange juice: -1.39Orange juice: -1.39
Price elasticity of demandPrice elasticity of demandCategories of elasticityCategories of elasticityRelative elasticity of demand:Relative elasticity of demand: EEpp > 1> 1Relative inelasticity of demand:Relative inelasticity of demand: 0 < E0 < Epp < 1< 1Unitary elasticity of demand:Unitary elasticity of demand: EEpp = 1= 1Perfect elasticity:Perfect elasticity: EEpp == ∞∞Perfect inelasticity:Perfect inelasticity: EEpp == 00
Own Price Elasticity and Total RevenueOwn Price Elasticity and Total RevenueValue of priceValue of priceelasticityelasticitycoefficientcoefficientElasticityElasticitydefinitiondefinitionRelationshipRelationshipamong variablesamong variables Impact on revenueImpact on revenue|e|epp| > 1| > 1ElasticElasticdemanddemand %%ΔΔQQdd > %> %ΔΔPPxxPrice increase results inPrice increase results inlower total revenue.lower total revenue.Price decrease results inPrice decrease results inhigher total revenue.higher total revenue.|e|epp| < 1| < 1InelasticInelasticdemanddemand %%ΔΔQQdd < %< %ΔΔPPxxPrice increase results inPrice increase results inhigher total revenue.higher total revenue.Price decrease results inPrice decrease results inlower total revenue.lower total revenue.|e|epp| = 1| = 1Unit orUnit orunitaryunitaryelasticelastic%%ΔΔQQdd = %= %ΔΔPPxxPrice increase or decreasePrice increase or decreasehas no impact on totalhas no impact on totalrevenue.revenue.
If demand is elastic,a decrease in priceIf demand is elastic,a decrease in priceresults in an increase in total revenue,results in an increase in total revenue,and an increase in price results in aand an increase in price results in adecrease in total revenue.decrease in total revenue.If demand is inelastic,aIf demand is inelastic,adecrease In price resultsdecrease In price resultsin a decrease in totalin a decrease in totalrevenue, and an increaserevenue, and an increasein price results in ain price results in aincrease in total revenue.increase in total revenue.Graphical Representation of RelationshipGraphical Representation of RelationshipBetween Price Elasticity and Total RevenueBetween Price Elasticity and Total RevenuePQP1P2Q1 Q2ABYXPQP1P2Q1 Q2ABYX
Determinants of Own Price ElasticityDeterminants of Own Price Elasticity The number ofThe number ofsubstitute goods.substitute goods. The percent of aThe percent of aconsumer’s incomeconsumer’s incomethat is spent on thethat is spent on theproduct.product. The time periodThe time periodunderunderconsideration.consideration.Demand is generally moreDemand is generally moreinelastic:inelastic: The fewer the numberThe fewer the numberof substitutes orof substitutes orperceived substitutesperceived substitutesavailable.available. The smaller the percentThe smaller the percentof the consumer’sof the consumer’sincome that is spent onincome that is spent onthe product.the product. The shorter the timeThe shorter the timeperiod underperiod underconsideration.consideration.
Price elasticity of demandPrice elasticity of demandFactors affecting demandFactors affecting demandelasticityelasticityease ofease of substitutionsubstitutionproportion of totalproportion of total expendituresexpendituresdurabilitydurability of productof productpossibility of postponingpossibility of postponingpurchasepurchasepossibility of repairpossibility of repairused product marketused product marketlength oflength of timetime periodperiod
Price elasticity of demandPrice elasticity of demandDerived demandDerived demand: the: thedemand for products or factorsdemand for products or factorsthat are not directly consumed,that are not directly consumed,but go into the production of abut go into the production of aanother (final) productanother (final) productThe demand for such a productThe demand for such a productor factor exists because there isor factor exists because there isdemand for the finaldemand for the finalproductproduct
Price elasticity of demandPrice elasticity of demandThe derived demand curve will be moreThe derived demand curve will be moreinelastic:inelastic:the morethe more essentialessential is theis thecomponentcomponentthe more inelastic is the demandthe more inelastic is the demandcurve for thecurve for the final productfinal productthe smaller is the fraction of totalthe smaller is the fraction of totalcostcost going to this componentgoing to this componentthe more inelastic is thethe more inelastic is the supplysupplycurve of cooperating factorscurve of cooperating factors
Price elasticity of demandPrice elasticity of demand A long-run demandA long-run demandcurve will generallycurve will generallybe more elastic than abe more elastic than ashort-run curveshort-run curveAs the time periodAs the time periodlengthens consumerslengthens consumersfind ways to adjust tofind ways to adjust tothe price change, viathe price change, viasubstitution orsubstitution orshiftingshiftingconsumptionconsumption
Price elasticity of demandPrice elasticity of demand The relationship between price andThe relationship between price andrevenuerevenue depends on elasticitydepends on elasticityWhy? By itself, a price fall will reduce receiptsWhy? By itself, a price fall will reduce receipts……BUT because the demand curve is downwardBUT because the demand curve is downwardsloping, the drop in price will alsosloping, the drop in price will alsoincrease quantity demandedincrease quantity demanded Q: which effect will be stronger?Q: which effect will be stronger?
Price elasticity of demandPrice elasticity of demandAs price decreasesAs price decreasesrevenue rises whenrevenue rises whendemand is elasticdemand is elasticrevenue falls when itrevenue falls when itis inelasticis inelasticrevenue reaches itrevenue reaches itpeak ifpeak if elasticity =1elasticity =1 the lower chartthe lower chartshows theshows the effect ofeffect ofelasticity on totalelasticity on totalrevenuerevenue
Price elasticity of demandPrice elasticity of demandMarginal revenue: theMarginal revenue: thechange in total revenuechange in total revenueresulting from changingresulting from changingquantity by one unitquantity by one unitQuantityMR∆∆=RevenueTotal
Price elasticity of demandPrice elasticity of demandMarginalMarginalrevenue curverevenue curveis twice asis twice assteep as thesteep as thedemanddemandcurvecurve
Price elasticity of demandPrice elasticity of demandat the pointat the pointwhere marginalwhere marginalrevenue crossesrevenue crossesthe X-axis, thethe X-axis, thedemand curve isdemand curve isunitary elasticunitary elasticand totaland totalrevenue reachesrevenue reachesa maximuma maximum
Price elasticity of demandPrice elasticity of demandExamplesExamples: some real world elasticities: some real world elasticitiescoffee: short run -0.2, long run -0.33coffee: short run -0.2, long run -0.33kitchen and household appliances:kitchen and household appliances:-0.63-0.63meals at restaurants: -2.27meals at restaurants: -2.27airline travel in U.S.: -1.98airline travel in U.S.: -1.98beer: -0.84, Wine: -0.55beer: -0.84, Wine: -0.55
Price elasticity of demandPrice elasticity of demandExamplesExamples: some real world elasticities: some real world elasticitieswhite pan bread:-0.69white pan bread:-0.69cigarettes: short run -0.4, long runcigarettes: short run -0.4, long run-0.6-0.6wine imports: -0.15wine imports: -0.15crude oil: -0.06crude oil: -0.06internet services: -0.6/-0.7internet services: -0.6/-0.7
Cross-Price Elasticity of DemandCross-Price Elasticity of Demand The percentage change in the quantityThe percentage change in the quantitydemanded of a given good,demanded of a given good, X, relative to aX, relative to apercentagepercentage change in the price of good Ychange in the price of good Y,,assuming all other factors constant.assuming all other factors constant.eexyxy = %ΔQ= %ΔQxx ÷ %ΔP÷ %ΔPyy
Cross-elasticity of demandCross-elasticity of demandCross-elasticity of demand: theCross-elasticity of demand: thepercentage change in quantitypercentage change in quantityconsumed of one product as aconsumed of one product as aresult of a 1 percent change inresult of a 1 percent change inthe price of a related productthe price of a related productBAxPQE∆∆=%%
Cross-elasticity of demandCross-elasticity of demandThe sign of cross-elasticity forThe sign of cross-elasticity forsubstitutes is positivesubstitutes is positiveThe sign of cross-elasticity forThe sign of cross-elasticity forcomplements is negativecomplements is negativeTwo products are considered goodTwo products are considered goodsubstitutes or complements when thesubstitutes or complements when thecoefficient iscoefficient is larger than 0.5larger than 0.5(in ab. value)(in ab. value)
ComplementsComplementsIf two goods haveIf two goods haveaa negativenegative cross-cross-price elasticityprice elasticity ofofdemanddemandcoefficient, theycoefficient, theyare calledare calledccomplementaryomplementarygoods.goods.BreadBreadand eggsand eggseexyxy ==-0.03-0.03
Income Elasticity of DemandIncome Elasticity of Demand The percentage change in the quantityThe percentage change in the quantitydemanded of a given good,demanded of a given good, X, relativeX, relativeto a percentageto a percentage change in consumerchange in consumerincome(Y), assuming all other factorsincome(Y), assuming all other factorsconstant.constant.eeii = %ΔQ= %ΔQxx ÷ %ΔY÷ %ΔY
Income elasticityIncome elasticity Income elasticity of demand: theIncome elasticity of demand: thepercentage change in quantity demandedpercentage change in quantity demandedcaused by acaused by a 1 percent change in1 percent change inincomeincomeY is shorthand for incomeY is shorthand for incomeYQEY∆∆=%%
Income elasticityIncome elasticityCategories of incomeCategories of incomeelasticityelasticitysuperior goods:superior goods:EEYY > 1> 1normal goods: 0normal goods: 0 ≤≤ EEYY ≤≤ 11inferior goods:inferior goods:EEYY < 0< 0
Normal GoodNormal GoodGood X is aGood X is anormal good ifnormal good ifthe demand forthe demand forgood X movesgood X movesin thein the samesamedirectiondirection as aas achange inchange inincome.income.CreamCreameeii = 1.72= 1.72ApplesAppleseeii = 1.32= 1.32PotatoesPotatoeseeii = 0.15= 0.15
Inferior GoodInferior GoodGood X is anGood X is aninferior good ifinferior good ifthe demand forthe demand forgood X moves ingood X moves inthethe oppositeoppositedirectiondirection of aof achange inchange inincome.income.ChickenChickeneeii = -0.106= -0.106
Other demand elasticitiesOther demand elasticitiesExamplesExamples: elasticity is encountered: elasticity is encounteredevery time a change in some variableevery time a change in some variableaffects demandaffects demandadvertising expenditureadvertising expenditureinterest ratesinterest ratespopulation sizepopulation size
Elasticity of supplyElasticity of supplyPrice elasticity of supply: thePrice elasticity of supply: thepercentage change in quantitypercentage change in quantitysupplied as a result of asupplied as a result of a 1 percent1 percentchange in pricechange in priceThe coefficient of supply elasticity isThe coefficient of supply elasticity isa normally aa normally a positive numberpositive numberPrice%SuppliedQuantity%E∆∆=S
Elasticity of supplyElasticity of supplyWhen the supply curve isWhen the supply curve is moremore elasticelastic,,the effect of a change in demand willthe effect of a change in demand willbebe greater on quantitygreater on quantity than on thethan on theprice of the productprice of the productWhen the supply curve isWhen the supply curve is lessless elasticelastic, a, achange in demand will have achange in demand will have agreater effect on pricegreater effect on pricethan on quantitythan on quantity
Global applicationGlobal application ExampleExample: price elasticities in Asia: price elasticities in Asiaimportsimports almost alwaysalmost alwaysprice inelasticprice inelasticifif exportsexports price inelastic,price inelastic,export earnings will rise asexport earnings will rise asprices riseprices riseifif exportsexports price elastic,price elastic,export earnings will rise withexport earnings will rise withworld incomesworld incomes
Not Just for Lunch Anymore…Not Just for Lunch Anymore… Percent of revenues and profitsPercent of revenues and profitsMcDonald’s gets from breakfast.McDonald’s gets from breakfast. Revenues: 25%Revenues: 25% Profits: 50%Profits: 50% Opportunity relates toOpportunity relates to usage situationusage situationand is driven by time pressure andand is driven by time pressure andother factors.other factors. Portability is keyPortability is key as many eat inas many eat intheir cars or at their desk.their cars or at their desk.Consumer Behaviour In The News…Consumer Behaviour In The News…Source: K. Macarthur, “Rise and Shine,” Advertising Age, July 31, 2006, p. 3 and 26.13-112
DEMAND ANALYSISDEMAND ANALYSISA firm’s quantity of sales dependsA firm’s quantity of sales dependson multiple economic factors.on multiple economic factors.For instance, an airline’s seat demandFor instance, an airline’s seat demandmight be described by the equation:might be described by the equation:Q = 25 + 3Y + PQ = 25 + 3Y + P°° – 2P.– 2P.Here, demand depends on:Here, demand depends on:customer income (Y),customer income (Y),the rival’s price (Pthe rival’s price (P°°),),and the airline’s price (P).and the airline’s price (P).
SHIFTS IN DEMANDSHIFTS IN DEMANDAny change in the firm’s own priceAny change in the firm’s own priceshows up as a movement along theshows up as a movement along thefirm’s demand curve.firm’s demand curve.A change in any other variableA change in any other variableconstitutes a shift in the positionconstitutes a shift in the positionof the demand curveof the demand curveFor instance, an increase in aFor instance, an increase in acompetitor’s price would causecompetitor’s price would causea favourable demand shift as shown.a favourable demand shift as shown.
ELASTICITY OF DEMANDELASTICITY OF DEMANDHow Responsive are Sales to Changes in Price?How Responsive are Sales to Changes in Price?The Concept of Elasticity Supplies the Answer.The Concept of Elasticity Supplies the Answer.EEPP = [% Change Q]/[% Change P] = [= [% Change Q]/[% Change P] = [∆∆Q/Q]/[Q/Q]/[∆∆P/P].P/P].Example: PExample: P00 = 100 & Q= 100 & Q00 = 1200= 1200PP11 = 110 & Q= 110 & Q11 = 1160= 1160EEPP = [(1160 – 1200)/1200]/[(110 – 100)/100]= [(1160 – 1200)/1200]/[(110 – 100)/100]= -3.33%/10%= -3.33%/10%== -.-.333.333.
USING ELASTICITYMaximizing Profit and Revenue inMaximizing Profit and Revenue inPure Selling Problems (MC = 0).Pure Selling Problems (MC = 0).Examples:Selling SoftwareSelling SoftwareSelling a CDSelling a CDUtilizing a Sports StadiumUtilizing a Sports StadiumPricing Olympics CableCoverage on Triple CastOptimal Solution: MR = 0Optimal Solution: MR = 0or equivalently: Eor equivalently: EPP = -1.= -1.CapacityRevenueWith high demand, price to fillWith high demand, price to fillstadium.stadium.With low demand, do not cut priceWith low demand, do not cut priceto fill stadium.to fill stadium.Hoped for DemandActualDemandMinimize loss, by drasticallyMinimize loss, by drasticallycutting price.cutting price.
OPTIMAL PRICINGOPTIMAL PRICING1. The Markup Rule1. The Markup Rule[P - MC]/P = -1/E[P - MC]/P = -1/EPPor P = [Eor P = [EPP /(1+ E/(1+ EPP )] MC)] MCMC = 100MC = 100EEPP PP-2-3-4-62. Price Discrimination2. Price DiscriminationApply Markup rule to separateApply Markup rule to separatesegments. More inelastic segmentssegments. More inelastic segmentsget the higher markups (over common MC).get the higher markups (over common MC).Equivalently, Set MREquivalently, Set MR11 = MR= MR22 = MC.= MC.200150133120
MAXIMIZING REVENUE W/ LIMITEDMAXIMIZING REVENUE W/ LIMITEDCAPACITYCAPACITYAirline Yield Management:Airline Yield Management:Maximizing Revenue utilizingMaximizing Revenue utilizingBusiness Class and Economy Class seats.Business Class and Economy Class seats.The key is to set: MRB = MRE.Example: Airline has 180 seats and faces demand:Example: Airline has 180 seats and faces demand:PPBB = 330 – Q= 330 – QBB and Pand PEE = 250 – Q= 250 – QEE. Therefore,. Therefore,MRMRBB = 330 - 2Q= 330 - 2QBB = MR= MREE = 250 – 2Q= 250 – 2QEE..We also know that: QWe also know that: QBB + Q+ QEE = 180.= 180.The solution to these simultaneous equations is:The solution to these simultaneous equations is:QQBB = 110 seats and Q= 110 seats and QEE = 70 seats.= 70 seats.In turn, PIn turn, PBB = $220 and P= $220 and PEE = $180.= $180.
Casestudy : TESCOCasestudy : TESCO1.1. Read and prepare theRead and prepare theCasestudy on TESCOCasestudy on TESCO(Johnson, Whittington &(Johnson, Whittington &Scholes (2011)) forScholes (2011)) fordiscussion and presentationdiscussion and presentationnext week.next week.2.2. Identify and evaluate theIdentify and evaluate thechallenges facing TESCO’schallenges facing TESCO’sglobal expansion byglobal expansion byconducting Externalconducting ExternalEnvironment analysisEnvironment analysis(PESTEL);and Industry(PESTEL);and Industry(5+1 Forces) analysis.(5+1 Forces) analysis.
ConclusionConclusion““In a free-market economy, theIn a free-market economy, thegovernment generally lets peoplegovernment generally lets peopledecide what to buy with theirdecide what to buy with theirmoney... in the interests ofmoney... in the interests ofpersonal freedom the governmentpersonal freedom the governmentshould respect their preferences.”should respect their preferences.”Paul SamuelsonPaul Samuelson
Core ReadingCore Reading• Keat, Paul G. and Young, Philip KY (2009)Managerial Economics, 6thedition, Pearson• Samuelson, William F. and Marks, Stephen G.(2010) Managerial Economics, 6thedition, JohnWiley• Pindyck, Robert S. and Rubinfeld, Daniel L.(2013)Microeconomics, 8thedition, Pearson• Samuelson, P.A. and Nordhaus, W. D.Samuelson, P.A. and Nordhaus, W. D.(2010)(2010)“Economics”“Economics” Irwin/McGraw-Hill, 19Irwin/McGraw-Hill, 19ththEditionEdition• Porter, Michael E. (2004)Porter, Michael E. (2004)“Competitive Strategy –“Competitive Strategy –Techniques for Analyzing Industries and Competitors”Techniques for Analyzing Industries and Competitors”Free PressFree Press