2015 Managerial Economics Stefan Markowski Managerial Economics Stefan Markowski How? When? What? The economics of competitive advantage Why? Where? Who? Product valuation and pricing decisions by buyers/users

Detailed course schedule Day no TopicTextbook ch. 1 (24 Nov; 3 hrs) 1. Introduction. Decision making process and its elements. The scope of economic decision making. Application of marginal analysis Chs (25 Nov; 3 hrs) 2. Demand analysis and demand elasticitiesCh. 3 3 (26 Nov; 3 hrs) 3. Buyer product valuation and choices. Consumer surplus. Buyer pricing decisions Ch. 4 4 (27 Nov; 2 hrs) 4. Production/transformation process. Production technologies and input-output structure Ch. 5 5 (28 Nov; 2 hrs) 5. Cost structure and cost drivers of producer pricing strategies. Production scale and scope Chs. 5 and 7 6 (1 Dec; 3 hrs) 6. Structure-conduct-performance. Market structures: competition and contestability. Pricing strategies of buyers and sellers Ch. 8 7 (2 Dec; 3 hrs) 7. Market structures: monopoly/monopsony, monopolistic competition and oligopoly. Pricing strategies and strategic behaviour Chs (3 Dec; 3 hrs) 8. Input sourcing and investment. Pricing and market powerChs. 6 and 11 9 (4 Dec; 2 hrs) 9. Decision making under conditions of uncertainty. Informational asymmetries and risk management Ch (5 Dec; 2 hrs) 10. Market research and market analysis. Auction and rings. Strategic behaviour Ch (8 Dec; 2 hrs ) 11. Public sector perspectiveCh (9 Dec; 2 hrs) 12. Revision 13. Examination 13 (11 Dec; 2 hrs) Examination

Topic 3: Product valuation by buyers/users Consumer surplus and pricing decisions Topic Contents 3.1 Managerial perspective 3.2 Product valuation and willingness to pay 3.3 Valuation of intangibles Business and economic forecasting 3.5Questions for review and self- assessment 3.6Further reading

2.1Managerial perspective

3.3Product valuation and willingness to pay Ordinary demand schedule market priceOrdinary demand schedule shows the (average) market price the buyer is prepared to pay for an indicated quantity of a good or service Demand priceDemand price is the highest price a consumer is willing to pay for an indicated quantity of a good if faced with a take-it-or-leave-it offer All-or-nothing demand scheduleAll-or-nothing demand schedule shows the demand price Willingness to payWillingness to pay is a buyer’s maximum offer price (say a price the buyer is willing to offer at an auction) Consumer surplusConsumer surplus is the difference between demand price and market price – an area under the ordinary demand schedule above market price

3.3Product valuation and willingness to pay Benefit vs price Price ($) Consumer surplus (shaded) 6 Market price 3 1 All-or-nothing demand Quantity

3.3Product valuation and willingness to pay Market demand curveMarket demand curve is a graph showing total (market) quantities that (all) buyers are willing to buy at each indicated price It is a horizontal summation of individual demand curves P a b a+b Q Market demand may fragment into demands facing individual sellers

3.3Product valuation and willingness to pay Government price hike:Government price hike: increasing prescription charges from $4 to $7 a prescription. Thus, an average buyer makes fewer purchases (down from 12 a year to 6) and pays extra $3 per prescription. Initial expenditure $48 = 12 x $4, post-hike $42 (6x$7), and the CS loss of 0.5x$3x6=$9 (shaded area) P Q Net loss $9 + (6x$4) – ($48-$42) = $27

3.3Product valuation and willingness to pay Two-part tariffTwo-part tariff – a pricing scheme which consist of, say, an upfront fixed payment and a charge based on usage (e.g., golf club membership of $1000 per year plus a charge of $20 for each use of the golf course) The seller may try to soak up consumer surplus by offering a two-part tariff product package Example, a phone company tariff Under standard pricing of 50 cents per minute, the phone user buys 30 calls (minutes) a month at $15. His/her consumer surplus is 0.5 x 30 x (200-50) = $ Total consumer benefit $37.50 (see below)

Price (cents/minute) minutes/ month The telco may offer a package of 30 minutes of calls/month for say $30 on a take-it-or-leave basis; or a two-part tariff of $15 per month plus 50 cents a minute (cost to the user $15 plus $15). Both capture most of the consumer surplus 3.3Product valuation and willingness to pay

3.3 Valuation of intangibles Stated Preference (SP) methods have been developed to value non-transacted goods (e.g., new product to be launched or environmental amenities) The SP technique most widely used is the Contingent Valuation Method (CVM), i.e., eliciting willingness to pay from the public for some well specified good, service, or activity (e.g., converting a wasteland into a free-access nature park) How to value a national park with free access for all? Or a bike path?

3.4Business and economic forecasting Forecasting involves making estimates now of future variables –Qualitative forecasting –Quantitative forecasting Qualitative forecasting –the Delphi method –market surveys/opinion polls –life cycle analogies Problems with bias (is the sample representative?), validity (are people telling the truth?), and reliability (is the sample large enough to give reliable results?)

3.4Business and economic forecasting Quantitative forecasting –Auto-regressive/time-series methods (extrapolating past experiences, e.g., exponential smoothing) –Structural modelling (cause-and-effect, e.g., regression analysis) –Barometric methods (leading, coincidental, and lagging indicators of change)

3.5 Questions for review and self-assessment Basic concepts and applications (1) What is the relationship between the demand schedule and the demand curve? (2) Why does the 'ordinary' demand curve slope downwards? (3) Give an example of event that would shift this demand curve (4) Define: (own-) price elasticity of demand income elasticity of demand cross-elasticity of demand

3.5 Questions for review and self-assessment (5) If the demand is inelastic, how will an increase in (own) price of a good affect the consumer spending on that good? Why? (6) Explain the difference between certain and expected demands. (7) Can you give an example of an upward-sloping demand curve? (8) What happens to the demands for lubricating oil and for car engines if the price of petrol increases: (a) for three weeks and declines to its previous level? (b) and decreases at regular intervals in a cyclical fashion? (c) and remains at the higher level for at least two years?

3.5 Questions for review and self-assessment (9) Explain the relationship between the revenue that a petrol station derives from petrol sales and the (own) price elasticity of demand for (regular) unleaded petrol? (10) Why some people buy home content insurance while others, in apparently similar circumstances, elect not to? (11) Sketch a straight-line demand curve that is inelastic over the likely price range for the product. (Although you do not need to draw the figure to scale, be sure to label your axes and indicate why the figure illustrates the situation.)

3.6Further reading Baye (2010): chs. 3-4