1. Managerial Economics Lecturer: Jack Wu
Lecture Two: Demand
Managerial Economics
Lecturer: Jack Wu
Two fundamental building blocks of managerial economics:
demand
costs

2. Individual Demand Curve, I
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

3. Individual Demand Curve
Price Quantity
($ per movie) (movies per month)

4. Individual Demand Curve10
7.50
Price ($ per movie) 5
individual demand curve
2.50 1 2 4 7
Quantity (Movies a month)

5. 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
price  quantity view: the way to construct individual demand curve;
quantity  price view: very useful in pricing policy; indicates the maximum that the buyer is willing to pay

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

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

8. 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
Hoover is British home appliance manufacturer; in 1992, was owned by Maytag
Autumn 1992 promotion: for a £100 appliance, Hoover’s effective price was - £300;
what is quantity demanded at negative price?
Maytag sacked senior managers; sold business to Italian company.

9. Demand and Income Changes in income
normal product – demand increases with income
inferior product – demand falls with income
Graphically, changes in
price – movement along demand curve
income – shift of entire demand curve
Examples:
fast food chains & upscale restaurants
afternoon matinees & evening shows
public vis-à-vis private transportation
music cassettes vis-à-vis CDs
Broad product categories tend to be normal, particular products within the categories may be inferior
distinction between normal and inferior products is important for business strategy when the economy is growing/contracting
demand for normal products is relatively higher in richer countries, while the demand for inferior products is relatively higher in poorer countries

10. Demand and Other Factors
prices of related products
substitutes
complements
advertising
Substitutes:
chicken/beef
video/movie
sound cards/sound chips
Complements:
meat/wine
movie/popcorn
microprocessor/memory/disk drive
automobile/gasoline
Durability:
cross-ply  radial tyres
music cassettes  audio CDs  MP3 (too durable?)

11. Complement 10 demand curve with $1 popcorn 7.50 Price ($ per movie) 5
2.50 1 2 7
Quantity (Movies a month)

12. 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
Canadians bought
more of both formats
relatively more CDs
Economic explanations:
Canadians enjoyed higher income
price of CDs relatively higher in Canada -- not consistent with the observed difference, unless music cassettes were relatively inferior product

13. 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?

14. 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.

15. 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
Other factors:
higher live attendance
boosts sales of concession items
improves TV picture and audience
other factors in demand
fans’ income
weather
complements – parking facilities, public transportation

16. 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%
Median household income grew more slowly than average new car price  demand for new cars grew more slowly.

17. 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.

18. 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)

19. Market Demand
Market demand = horizontal summation of individual demands
Market Demand Factors
--own price (move along the demand curve)
--other factors (shift the demand curve)
_ income level and distribution
_ prices of related goods
_ population
_ demographics
_ consumer tastes
Market demand factors same as individual demand factors plus:
distribution of income
population and demographic factors, eg, Japan has aging population compared with China --> differences in demand for health care and pharmaceuticals

20. 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.
Business applications of buyer surplus – pricing:
package deals
two-part tariff
Essential objective: to extract all buyer surplus

21. 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
The more you buy, the more you save?
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 a buyer's total benefit from some quantity of purchases and her or his actual expenditure) = area under demand curve and above price line g j 1 2 4 7
Quantity (Movies a month)

22. 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
Buyer surplus concept gives exact way of measuring buyer’s gain from price cut;
simple view that gain is no. of units x saving on each unit is wrong (only works with completely inelastic demand)

23. Package Deal
charge buyer just a little less than her/his total benefit
leave buyer with almost zero surplus
Examples of package deals:
AOL unmetered service for $21.95/month
mobile telephone service -- $X for Y minutes per month
car rental – “200 free kilometers”

24. Two-Part Tariff fixed payment usage charge eg, advertisng
area under the demand curve and above the usage charge
leaves zero buyer surplus
Examples:
mobile phone service: $Y for X free minutes plus p per minute for additional calls
golf club: monthly membership fee plus additional green fee
credit card: annual fee plus interest charges

25. 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
Simple textbooks suppose that businesses are completely vertically integrated, and buy only raw materials, labor, and capital;
actually, large portion of purchases are
finished/semi-finished products, eg, machine tools, trucks, electrical components, parts
other services: information technology, advertising, logistics, transportation

26. Business Demand, II Demand for inputs depends on
quantity of final output
prices of complements and substitutes in production
Quantity of final output:
When demand for GM automobiles drops, GM will cut back on purchases of all inputs;
GM’s demand for inputs is derived from demand for GM products.
Inputs may be
substitutes, eg, using machines or workers to sort packages, advertising on TV/internet
complements, eg, trucks and drivers, advertising and production

27. Business Demand Curve
marginal benefit = increase in revenue arising from an additional unit of the input
diminishing marginal benefit  downward-sloping demand
Similarities between consumer and business demand curve
change in price  movement along the curve
change in other factors  shift of the curve

28. 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
Retail bank:
major service is dispensing cash to customers;
traditionally, cash dispensed by tellers operating within the bank office.
Eventually, used ATMs to provide better service
outside bank premises
24-hour service
US vs India:
demand side: cost of labor should be high
infrastructure: need reliable telecommunications network

29. GM: What metal to use? aluminium vis-à-vis steel auto weight  price
fuel consumption
emissions
price
Market conveys information from end-user to manufacturer:
End-user concerned about fuel consumption  auto manufacturer responds by supplying lighter car.
However, aluminium is more expensive than steel

30. 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.

31. 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.

32. 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.

33. Discussion Question 2
Suppose that a typical household's demand for long-distance calls is represented by the equation, D = p + 0.4Y, where D is the quantity demanded in minutes a month, p is the price of calls in cents per minute, and Y is the household's income in thousands of dollars a year. Assume that Y = 100.

34. Discussion Question 2 continued
Draw the household's demand curve.
How many minutes will the household buy at a price of 25 cents a minute?
What is the maximum lump sum that a long-distance carrier can charge the household for a package of 140 minutes of calls?