L ECTURE T WO : D EMAND IPEM Tohoku University Managerial Economics Lecturer: Jack Wu Period 2 and 3/ February

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 V ICE C HAIRMAN : B OB L UTZ 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.

I NDIVIDUAL D EMAND C URVE 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

I NDIVIDUAL D EMAND S CHEDULE Price Quantity ($ per movie) (movies per month)

individual demand curve Quantity (Movies a month) Price ($ per movie) INDIVIDUAL DEMAND CURVE

I NDIVIDUAL D EMAND S CHEDULE II Price Quantity ($ per movie) (movies per month) …. …

A NOTHER T YPE OF I NDIVIDUAL DEMAND C URVE

T WO V IEWS 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

D EMAND C URVE : S LOPE diminishing marginal benefit -- each additional unit of consumption/usage provides less benefit than the preceeding unit  demand curve slopes downward

C ONSUMER D IFFERENCES individual preferences  different demand curves changes in consumer's preferences, eg, age different consumers

H OOVER, 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

D EMAND AND INCOME

D EMAND AND O THER F ACTORS prices of related products substitutes complements advertising

O THER DEMAND FACTORS : S UBSTITUTES  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

O THER DEMAND FACTORS : C OMPLEMENTS

C ASE : R ECORDED M USIC ArgentinaCanada CD purchases cassette purchases GDP/capita$9,413$19,831 CD price$13.80$11.55 cassette price$ 7.80$ 6.06

R ECORDED M USIC Why the average Canadian bought more of both CDs and cassettes? Why the ratio of CD to cassette purchases was relatively higher in Canada?

F OOTBALL : T O 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

U SED C ARS /98 avg car age7.5 yr8.7 yr median household income up 29.9% avg new car priceup 48.4%

U SED C ARS 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.

M ARKET DEMAND Market demand = horizontal summation of individual demands

M ARKET DEMAND : C ONSTRUCTION

MARKET DEMAND: MACRO FACTORS Income Average Distribution Demographic Population Age structure Urban-rural Cultural-social

MARKET DEMAND: MICRO FACTORS Price Advertising R&D

c be h j g da individual buyer surplus at $2.50 price individual demand (marginal benefit) curve Quantity (Movies a month) Price ($ per movie) c f INDIVIDUAL BUYER SURPLUS

B UYER SURPLUS : I NDIVIDUAL

G AINS 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

P ACKAGE D EAL charge buyer just a little less than her/his total benefit leave buyer with almost zero surplus

B UYER SURPLUS : T WO - PART PRICING fixed payment usage charge fixed payment

B UYER SURPLUS : T WO - PART PRICING BusinessProviderFixed FeeUsage 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)

B USINESS D EMAND, 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

B USINESS D EMAND, II Demand for inputs depends on quantity of final output prices of complements and substitutes in production

B USINESS D EMAND C URVE marginal benefit = increase in revenue arising from an additional unit of the input diminishing marginal benefit  downward- sloping demand

A UTOMATED T ELLER M ACHINES increase in wages  teller service became increasingly costly banks used ATMs to substitute for tellers compare use of ATMs in US vs India

GM: W HAT METAL TO USE ? aluminium vis- à -vis steel auto weight  fuel consumption emissions price