1. IMBA NCCU Managerial Economics Lecturer: Jack Wu
Lecture Two: Demand
IMBA NCCU
Managerial Economics
Lecturer: Jack Wu

2. Demand Two fundamental building blocks of managerial economics: demand
costs

3. 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).

4. 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.
Sources:
Business Week, May 31, 2004
Reuters, July 1, 2005
Bob Lutz quoted at Milford, Michigan: “G.M. Hopes a Line of Pickups Will Lead Back to Prosperity”, New York Times, August 3, 2006.

5. 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?

6. 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.

7. OUTLINE Individual Demand Demand and income Other demand factors
Market Demand
Buyer Surplus
Business Demand

8. 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

9. Individual Demand Schedule
Price Quantity
($ per movie) (movies per month)

10. INDIVIDUAL DEMAND CURVE10
7.50
Price ($ per movie) 5
individual demand curve
2.50 1 2 4 7
Quantity (Movies a month)

11. Individual Demand Schedule II
Price Quantity
($ per movie) (movies per month)
… …

12. Another Type of Individual demand Curve

13. 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

14. Demand Curve: Slope
diminishing marginal benefit -- each additional unit of consumption/usage provides less benefit than the preceeding unit
 demand curve slopes downward

15. Consumer Differences individual preferences  different demand curves
changes in consumer's preferences, eg, age
different consumers

16. A negative price case: Hoover, 1992
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

17. OUTLINE Individual Demand Demand and income Other demand factors
Market Demand
Buyer Surplus
Business Demand

18. normal product – demand increases with income
Demand and Income
Changes in income
normal product – demand increases with income
inferior product – demand falls with income

19. Demand and income

20. OUTLINE Individual Demand Demand and income Other demand factors
Market Demand
Buyer Surplus
Business Demand

21. Demand and Other Factors
prices of related products
substitutes
complements
advertising

22. 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
Substitutes: increase in price  demand for substitute shifts up

23. Other demand factors: Complements
Complements: increase in price  demand for complement shifts down

24. Recorded Music Argentina 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

25. 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?

26. 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.

27. 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

28. 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
Consumer examples:
housing
automobiles
boats
computer equipment
Industrial examples:
oil tankers
tractors and agricultural machinery
airplanes

29. Used Cars 1990 1997/98 avg car age 7.5 yr 8.7 yr
median household income
up 29.9%
avg new car price
up 48.4%

30. 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.

31. OUTLINE Individual Demand Demand and income Other demand factors
Market Demand
Buyer Surplus
Business Demand

32. Market demand
Market demand = horizontal summation of individual demands
Horizontal summation:
at every price, add the quantities demanded by each person in the market;
can show through table
also show graphically (section 5 of text)

33. Market demand: Construction

34. MARKET DEMAND: MACRO FACTORS
Income
Average
Distribution
Demographic
Population
Age structure
Urban-rural
Cultural-social
Macro factors are difficult for business to influence

35. MARKET DEMAND: MICRO FACTORS
Price
Advertising
R&D

36. OUTLINE Individual Demand Demand and income Other demand factors
Market Demand
Buyer Surplus
Business Demand

37. 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.

38. INDIVIDUAL BUYER SURPLUS10
individual buyer surplus at $2.50 price d a
7.50
Price ($ per movie)
individual demand
(marginal benefit) curve 5 b e c c f
2.50 h g j 1 2 4 7
Quantity (Movies a month)

39. Buyer surplus: Individual
Total benefit (the benefit yielded by all the units that the buyer purchases) = area under the buyer's demand curve up to an including the last unit purchased
Maximum price that a seller can charge is the buyer's total benefit
Buyer surplus (the difference between buyer's total benefit from some quantity of purchases and her or his actual expenditure) = area under demand curve and above price line

40. 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

41. Package Deal
charge buyer just a little less than her/his total benefit
leave buyer with almost zero surplus

42. Buyer surplus: Two-part pricing
fixed payment
usage charge
fixed payment
usage charge
Fixed payment
area under the demand curve and above the usage charge
leaves zero buyer surplus

43. Buyer surplus: Two-part pricing
Business
Provider
Fixed Fee
Usage Fee
Broadband access, Hong Kong
PCCW Netvigator 3M Single User Plan
HK$298 per month (incl 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)
Other examples:
credit card: annual subscription + percentage on each charge + interest on outstanding balance

44. Buyer surplus: Two-part pricing
Business
Provider
Fixed Fee
Usage Fee
Check-writing bank account, California
Bank of America, VERSATEL Checking
nil
US$2 per teller transaction
Weekday car rental, Melbourne
Airport RentaCar, Toyota Camry
A$70 for one day (incl free km)
A$0.25 per additional km

45. OUTLINE Individual Demand Demand and income Other demand factors
Market Demand
Buyer Surplus
Business Demand

46. 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

47. Business Demand, II Demand for inputs depends on
quantity of final output
prices of complements and substitutes in production

48. Business Demand Curve
marginal benefit = increase in revenue arising from an additional unit of the input
diminishing marginal benefit  downward- sloping demand

49. Automated Teller Machines
increase in wages  teller service became increasingly costly
banks used ATMs to substitute for tellers
compare use of ATMs in US vs India

50. GM: What metal to use? aluminium vis-à-vis steel auto weight  price
fuel consumption
emissions
price

51. 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.

52. 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.

53. 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.