Lecture Two:

Demand
IMBA NCCU
Managerial Economics
Lecturer: Jack Wu
 Case

• 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).
 Case
Interview with GM Vice Chairman
• 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.
 Questions

²How important are gasoline prices to the sales of SUVs

and other types of automobiles?
²How should the auto manufacturers respond to the
increasing price of gasoline?
²Are manufacturer incentives (i.e. price reductions) an
effective response?
²What 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.
 Individual Demand Curve

Definition: graph of quantity that buyer will purchase at

every possible price
Construction -- “Other things equal (ceteris paribus),
how many would you buy at a price of ….?’’
ü vertical axis -- price
ü horizontal axis -- quantity
 Individual Demand Schedule -1

• Price Quantity
($ per movie) (movies per month)
10.00 0
7.50 1
5.00 2
2.50 4
0.00 7
 Individual Demand Curve
(Non-linear)
10
Price ($ per movie)

7.50

5 individual demand curve

2.50

0 1 2 4 7
Quantity (Movies a month)
 Individual Demand Schedule-2

• Price Quantity
($ per movie) (movies per month)
20.00 0
19.00 1
18.00 2
…. …
0.00 20
Individual demand Curve
(Linear, Straight Line)
 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
 Slope of Demand Curve

• Diminishing marginal benefit -- each

additional unit of consumption/usage
provides less benefit than the preceding unit

àdemand curve slopes downward (negative

slope)
 Consumer Differences

•individual preferences à different demand

curves
• changes in consumer's preferences,
(eg. Age, Gender, ….)
• different consumers
 A Negative Price Case

Hoover’s special promotion -- two free air

tickets (worth more than £400) for purchase
of appliance over £100.
qpromotion attracted over 100,000
customers
qHoover incurred £48 million loss
 Demand and Income

• normal product – demand increases

with income
• inferior product – demand falls with
income
 Demand and Other Factors

• prices of related products

• substitutes
• complements
• advertising
 Active Learning 1: Recorded Music

Argentina Canada

CD purchases 0.5 2.6

cassette 0.2 0.4

purchases
GDP/capita $9,413 $19,831

CD price $13.80 $11.55

cassette price $ 7.80 $ 6.06

 Active Learning 1: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?
 Market demand
Market demand = horizontal summation of
individual demands
Price Joy Max Lucas Market
$10 0 0 0 0
$7.50 1 0 0 1
$5 2 1 0 3
$2.50 4 2 3 9
$0 7 6 4 17
Market demand: Construction
 Market demand: Macro factors

• Income
• Average
• Distribution
• Demographic
• Population
• Age structure
• Urban-rural
• Cultural-social
 Market demand: Micro factors

• Price
• Tax
• Advertising
• R&D
 Buyer Surplus
(Consumer 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
 Individual Buyer Surplus
10
individual buyer surplus at $2.50 price
Price ($ per movie)

7.50 d a

individual demand
5 c b e (marginal benefit) curve

f
2.50 g h

j
0 1 2 4 7

Quantity (Movies a month)

Buyer surplus: Individual
 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
 Package Deal

• charge buyer just a little less than her/his

total benefit
• leave buyer with almost zero surplus
 Buyer surplus:
Two-part pricing
• fixed payment
• usage charge
fixed
payment
usage
charge
 Discussion

• Suppose that Mary makes zero minute mobile call during

a week if the price of mobile call is $10 per minute. On
the other hand, she makes 150 minutes mobile call during
a week if the price of mobile call is $0 per minute.
• Suppose that Mary’s demand curve for mobile call is a
linear (straight) line.
• You serve as the marketing manager of one of two
leading mobile phone service providers in the country.
 Questions
• 1. Draw Mary’s demand curve for mobile call.
• 2. How many minutes mobile call would Mary make if the price
of mobile call is $1 per minute?
• 3. How much is Mary’s buyer surplus if you charges $1 per
minute?
• Suppose you plan to use the package deal to reduce Mary’s
buyer surplus. How much will you charge for 150 minutes per
week?
• Suppose you plan to use two-part pricing to reduce Mary’s
buyer surplus, and you decide to charge $1 per minute. How
much will you charge for fixed weekly basic fee?