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Quick Review

Quick Review. Methodology of Managerial Economics --model -- marginal analysis -- other things equal -- timing: time discount rate, net present value Market --Demand --Supply -- Equilibrium. Bob Lutz –GM’s Vice-chairman in 2004.

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Quick Review

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  1. Quick Review • Methodology of Managerial Economics --model -- marginal analysis -- other things equal -- timing: time discount rate, net present value • Market --Demand --Supply -- Equilibrium

  2. Bob Lutz –GM’s Vice-chairman in 2004 • May 31, 2004: “It sounds cavalier, but in any household budget, gasoline isn't a factor”, Business Week quoted Bob Lutz • 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.

  3. Is this sound optimism? • From sept 2004 to sept 2005, full-size truck sales drop by 16.8% in the U.S. • During the same time, the sales of hybrid electricity-gasoline vehicles increased by 333%. • Big auto makers were forced to provide more incentives to boost sales, such as price cuts, easy access to loans, and etc.

  4. Outline • Individual demand • Demand and income • Other demand factors • Market demand • Buyer surplus

  5. Individual demand • 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

  6. Individual demand

  7. Individual demand • Two views of demand curve • For every possible price, demand curve shows the quantity demanded • For each additional unit, demand curve shows how much the buyer is willing to pay at most

  8. Brain Tweezing • What is the demand function the previous picture? • Q=20-p

  9. Individual demand: Marginal benefit • Definition: benefit provided by additional unit of item • Diminishing marginal benefit – each additional unit of consumption/usage • This is WHY demand curve slopes downward

  10. Individual demand:Consumer differences • Individual preferences  different demand curves • Changes in consumer's preferences over time • Different consumers

  11. Outline • Individual demand • Demand and income • Other demand factors • Market demand • Buyer surplus

  12. Demand and income • Construction – “Suppose that your income is […] per year. Other things equal, how many would you buy at a price of ….?’’ • vertical axis – price • horizontal axis – quantity • Different demand curve for each income level

  13. Demand and income

  14. Demand and income • Changes in price vis-a-vis income • Normal product – demand increases with income • Inferior product – demand falls with income

  15. Outline • Individual demand • Demand and income • Other demand factors • Market demand • Buyer surplus

  16. Other demand factors: Substitutes • Direct • MBA education:-- Dartmouth / NYU / USC -- Guanghua/ Tsinghua • Transportation: --American Airlines / British Airways -- Air China/ China Southern • Functional • MBA education – IMBA/ MBA • Transportation: airline / train

  17. Other demand factors: Hardware-software complements • Shaver – blade • Water purification equipment –filter • Machinery – maintenance service

  18. Other demand factors: Complements

  19. 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

  20. Outline • Individual demand • Demand and income • Other demand factors • Market demand • Buyer surplus

  21. Market demand Market demand = horizontal summation of individual demands

  22. Market demand: Construction

  23. Market demand: Macro factors • Income • Average • Distribution • Demographic • Population • Age structure • Urban-rural • Cultural-social Trendy or not? Green food

  24. Brain Tweezing • Compared to individual demand curve, is the market demand curve flatter or steeper?

  25. Market demand: Micro factors • Price • Advertising • R&D: quality, new function

  26. Outline • Individual demand • Demand and income • Other demand factors • Market demand • Buyer surplus

  27. Buyer surplus • Individual buyer surplus: buyer’s benefit minus price must pay for the item • Market buyer surplus: sum of individual buyer surpluses.

  28. Buyer surplus: Individual

  29. Brain Tweezing • Simple calculation of buyer’s surplus when price is 12: =total benefit-total payment =area(d08c)-area(a08c) =area of the top triangle =0.5*8*(20-12) =32

  30. Buyer surplus: Individual

  31. Buyer surplus:Gains from price cut: price is 10 now! • Lower price on the quantity that he/she would have purchased at the original price (infra-marginal units)= area(aebc) • He/she can buy more (marginal units)=area(bfc)

  32. Buyer surplus: Package deal • Charge buyer just a little less than her/his total benefit • Leave buyer with almost zero surplus

  33. fixed payment Buyer surplus:Two-part pricing • fixed payment • usage charge usage charge

  34. Buyer surplus: Two-part pricing

  35. Buyer surplus: Two-part pricing

  36. Brain Tweezing • Why package deal or two part pricing • How could this be possible • Should China Mobile adopt similar strategy? Or have it already done so?

  37. Why package deal • Suppose a typical consumer’s demand function for mobile phone minutes per month is Q=40-0.2*p • A typical consumer makes 30 minutes mobile call a month when the price is set at 50 cents per minute, so the company’s sales revenue is 30*50=1500 cents. • Consumer’s total benefit is (200+50)*30/2=3750 cents. The cost he has to pay is 30*50=1500 cents. • So the consumer surplus is 2250 cents. Company’s sales revenue is 1500 cents.

  38. Why package deal? • If the mobile phone company provides a package deal of 30 minutes that charges the consumer 2200+1500 cents, then the consumer will only get 50 cents of surplus. • And the company will make 3700 cents of sales revenues instead of 1500 cents.

  39. Why two-part pricing • If the phone company charges a 700 cents monthly fee, and 50 cents per minute. • Again, the consumer will make 30 mintues of call. The company now will make 700+30*50=2200 cents of sales revenues • The consumer surplus is only 500 cents.

  40. How could it be possible? • Lack of competitors. • Have freedom of pricing

  41. Summary • Individual demand • Demand and income • Other demand factors • Market demand • Buyer surplus

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