LECTURE TWO: DEMAND

IMBA NCCU
Managerial Economics
Lecturer: Jack Wu
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 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.
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.
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

INDIVIDUAL DEMAND SCHEDULE
 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
10
Price ($ per movie)

7.50

5 individual demand curve

2.50

0 1 2 4 7
Quantity (Movies a month)
INDIVIDUAL DEMAND SCHEDULE II
 Price Quantity
($ per movie) (movies per month)
20.00 0
19.00 1
18.00 2
…. …
0.00 20
ANOTHER TYPE OF INDIVIDUAL
DEMAND CURVE
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
DEMAND CURVE: SLOPE
 diminishing marginal benefit -- each additional unit of
consumption/usage provides less benefit than the
preceeding unit
 demand curve slopes downward
CONSUMER DIFFERENCES
 individual preferences  different demand curves
 changes in consumer's preferences, eg, age
 different consumers
HOOVER, 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
DEMAND AND INCOME

Changes in income
normal product – demand increases
with income
inferior product – demand falls with
income
DEMAND AND INCOME
DEMAND AND OTHER FACTORS
 prices of related products
 substitutes
 complements

 advertising
OTHER DEMAND FACTORS:
COMPLEMENTS
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

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
variable Demand Curve Shift

Income (Normal) rises rises Right /Up

Income (Inferior) rises falls Left /Down

Price of substitute rises rises Right /Up

Price of complement rises falls Left /Down

Tax rate rises falls Left/Down

Expected Price rises rises Right /Up

Number of buyers rises rises Right /Up

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.
 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
BUYER SURPLUS: TWO-PART PRICING
Business Provider Fixed Fee Usage Fee

Broadband PCCW Netvigator HK$298 per HK$2 per

access, Hong 3M Single User month (incl. additional
Kong Plan 100 free hr
hrs)
Mobile telephone Etisalat 125 dirham 0.24/0.18
service, UAE Corporation, connection dirham per
GSM Standard fee; 60 min (peak/
Service dirham per offpeak)
qtr