managerial economics
DESCRIPTION
Professor Geoffrey Heal 616 Uris Hall Phone: (212) 854-6459 e-mail: [email protected] (note - gmh “one” not “L”). Managerial Economics. Course Outline:. (I) Analyzing the structure of a market Part A: Demand & Supply Part B: Costs (II) Pricing (most important part of course) - PowerPoint PPT PresentationTRANSCRIPT
Managerial Economics
Professor Geoffrey Heal616 Uris Hall
Phone: (212) 854-6459e-mail: [email protected](note - gmh “one” not “L”)
Course Outline:
(I) Analyzing the structure of a market
Part A: Demand & Supply
Part B: Costs
(II) Pricing (most important part of course)
(III) e-con.com (application and review)
(IV) Foundations of Strategy
Aim: to understand key aspects of markets:
nature of demands for the products
closeness or otherwise of competitors
structure of costs
dependence of profits on the level of output
Analyzing the Structure of a Market
Material to be covered: Analysis of demand
– demand curves, – price, income & cross elasticities of demand– use of demand parameters in forecasting
Structure of costs:– fixed & variable costs– break-even analysis– opportunity costs and sunk costs– learning curves & economies of scale.
How much product should you produce and what price should you charge for it?
How can you best segment your market if there are different types of buyers with different demand characteristics (e.g., business travelers vs. vacation travelers, home PC buyers vs. corporate buyers)?
What are the types of pricing schemes available (e.g., bundling, promotional offers, loyalty bonuses, volume discounts)?
Pricing
e-con.com
Applications of market analysis to electronic commerce
How does the internet affect demand, pricing, and other aspects of running a business.
e-commerce business strategies. Auctions and the internet.
Foundations of Strategy
Interacting with competitors Anticipating their reactions Forecasting the final outcome when
everyone has reacted.
Aim of Course
To teach you to use basic economic ideas in making business decisions.
Decisions about opening and closing businesses.
Decisions about pricing and other policies.
Level of Course
Emphasis on understanding concepts and where and how they can be used.
Don’t aim to make you an economist, but an intelligent consumer of economics.
Evaluate and understand works of consultants, staff. Ask the right questions.
Recognize BS when you see it!
Consumption & Price of Copper 1880-1998
Profit margin 1999/2001
Operating margin 1999/2001
MSFT
40.0%/30.5% 49.5%/46.3%
INTC 25%/17.7% 34.2%/20.7%
CPQ 1.5%/0.8% 2.4%/1.2%
DELL 7%/6.7% 9.9%/8%
Compare Internet companies
eBay AOL Yahoo Amazon.com
Demand and Supply
Demand Curve Shows amount purchased as a function of price
Depends on:- income- tastes- prices of competitive products- prices of complementary products
Supply Curve
Amount offered for sale as a function of priceDepends on costs of production, which in turn depend on
- costs of inputs- technology
The Market Mechanism
Quantity
D
S
The curves intersect atequilibrium, or market-
clearing, price. At P0 thequantity supplied is equalto the quantity demanded
at Q0 .
P0
Q0
Price($ per unit)
The Market Mechanism
Characteristics of the equilibrium or market clearing price: QD = QS
No shortage No excess supply No pressure on the price to change
Demand Curve -Income Rises
Demand Shifts
Supply shifts
D & S shift
The Market Mechanism
D
S
Q1
Assume the price is P1 , then:1) Qs : Q1 > Qd : Q2 2) Excess supply is Q1:Q2.3) Producers lower price.4) Quantity supplied decreases
and quantity demanded increases.
5) Equilibrium at P2Q3
P1
Surplus
Q2 Quantity
Price($ per unit)
P2
Q3
The Market Mechanism
The market price is above equilibrium There is excess supply Producers lower prices Quantity demanded increases and quantity
supplied decreases The market continues to adjust until the
equilibrium price is reached.
A Surplus
The Market Mechanism
D
S
Q1 Q2
P2
Shortage
Quantity
Price($ per unit)
Assume the price is P2 , then:1) Qd : Q2 > Qs : Q1
2) Shortage is Q1:Q2.3) Producers raise price.
4) Quantity supplied increases and quantity demanded decreases.
5) Equilibrium at P3, Q3
Q3
P3
The Market Mechanism
The market price is below equilibrium: There is a shortage Producers raise prices Quantity demanded decreases and quantity
supplied increases The market continues to adjust until the new
equilibrium price is reached.
Shortage
The Market Mechanism
Market Mechanism - Summary:
1) Supply and demand interact to determine the market-clearing price.
2) When not in equilibrium, the market will adjust to alleviate a shortage or surplus and return the market to equilibrium.
3) Markets must be competitive for the mechanism to be efficient.
Consumption & Price of Copper 1880-1998
The Long-Run Behaviorof Natural Resource Prices
Observations Consumption of copper has increased about a
hundred fold from 1880 through 1998 indicating a large increase in demand.
The real price for copper has remained relatively constant.
S1998
D1998
D1900
S1900
S1950
D1950
Long-Run Path of
Price and Consumption
Changes In Market Equilibrium
Quantity
Price
Conclusion Decreases in the costs of production have
increased the supply by more than enough to offset the increase in demand.
Changes In Market Equilibrium
Changes In Market Equilibrium
Wage Inequality in the United States Real after-tax income from 1977 to 1999:
– Rose 40+% for the top 20% of the income distribution
– Fell 10+% for the bottom 20%
Changes In Market Equilibrium
Question Why did the income distribution become more
unequal for 1977 to 1999?
Price elasticity of demand:
Measures responsiveness of demand to price.
Defined as E = (Q/Q)/(P/P) = (Q/P)*(P/Q)
Why is it defined in proportional terms?
- Unit free.
- Scale sensitive.
A negative number.
Q = 8 - 2P or P = 4 - 0.5Q
Elasticity = (Q/Q)/(P/P) = (Q/P)*(P/Q) = -2*(P/Q)
Elasticity and Pricing
If elasticity is between 0 and -1 then raising price will raise profits - it will raise revenues and lower costs.
If elasticity is lower than -1 then raising price will lower revenues and also costs, so the effect on profits is not clear.
Moral - never operate where the elasticity is between 0 and -1.
Q = 8 - 2P
or
P = 4 - 0.5Q
so as revenue R is price times quantity
R = 4Q - 0.5Q2
Relationship between demand, quantity and revenue:
PED = -1 PED = 0
Revenue rises as price risesRevenue falls as price rises
This is a quadratic pointing up.
The slope is:
R Q
which is zero at Q = 4.
Slope is positive for Q<4 and vice versa.
Maximum revenue comes when Q = 4, therefore P = 2, and max revenue is 8
= 4 - Q
PED when revenue is maximum
Revenue is max when Q = 4, P = 2. E = (Q/Q)/(P/P) = (Q/P)*(P/Q) So E = (Q/P)*(1/2) and Q/P = -2 so E = -2 * 1/2 = -1 when R is
at a maximum.
The responsiveness of demand for good A to change in price of good B:QA/QA = QA * PB
PB/PB PB PA
Example:
responsiveness of demand for Dell computers to prices of Gateway computers
Cross price elasticity of demand:
Supply Elasticity
The responsiveness of supply to price changes.
(S/S)/(P/P), proportional change in supply divided by proportional change in price.
Usually positive.
Elasticities of Supply and Demand
1981 Supply Curve for Wheat QS = 1,800 + 240P
1981 Demand Curve for Wheat QD = 3,550 - 266P
The Market for Wheat
Elasticities of Supply and Demand
Equilibrium: Q S = Q D
PP 266550,3240800,1
750,1506 P
bushelP /46.3
bushels million 630,2)46.3)(240(800,1 Q
The Market for Wheat
The Market for Wheat
Elasticities of Supply and Demand
ED=(P/Q) (QD/P) = (3.46/2630)(-266)= -0.35 ES=(P/Q) (QS/P) = (3.46/2630)(+240)= 0.32
1981 1800 + 240P 3550 - 266P 1800+240P = 3550-266P506P = 1750
P1981 = $3.46/bushel
1998 1,944 + 207P 3,244 - 283P 1,944+207P = 3,244-283P P1998 = $2.65/bushel
Supply (Qs) Demand (QD) Equilibrium Price (Qs = QD)
Changes in the Market: 1981-1998The Market for Wheat
Marginal Revenue
Increase in revenue from one extra sale Rate of change of revenue with respect to
sales Typically less than price as demand curve
slopes down Depends on PED
Marginal Revenue & PED
MR = P{1 + 1/PED} Remember PED < 0 so MR < P. The larger PED as a number the nearer MR is to P If PED = - 1, then MR = 0. (Top of revenue curve) ………………………………………… Derivation - dR/dQ = d{P(Q).Q}/dQ = P + Q*dP/dQ = P{1 + (Q/P)*dP/dQ}
Responsiveness of demand to changes in income
IED = (Q/Q)/I/I) = (Q/I)*(I/Q)
Use to define necessities and luxuries
Income Elasticity of Demand:
Necessities - IED < 1
Luxuries - IED > 1
Cyclical vs. defensive sectors
Cyclical - high IED - foreign travel, consumer durables
Defensive - low IED - food, utilities
Critical in understanding oil market, energy markets, metal markets
Responding to a price movement takes time - possibly many years
Long-run elasticity measures total responseShort-run elasticity measures immediate response
Short-run vs. long-run elasticities
Short-run dropin demand
Long-run drop in demand
Po
P1
Short-rundemand
Long-run demand
Price -0.11 -0.22 -0.32 -0.49 -0.82 -1.17
Income 0.07 0.13 0.20 0.32 0.54 0.78
Years Following Price or Income Change
Elasticity 1 2 3 4 5 6
The Demand for Gasoline
Short-Run Versus Long-Run Elasticities
Price -1.20 -0.93 -0.75 -0.55 -0.42 -0.40
Income 3.00 2.33 1.88 1.38 1.02 1.00
Years Following Price or Income Change
Elasticity 1 2 3 4 5 6
The Demand for Automobiles
Short-Run Versus Long-Run Elasticities
Data Explains:
1) Why the price of oil did not continue to rise above $30/barrel even though it rose very rapidly in the early 1970s.
2) Why automobile sales are so sensitive to the business cycle.
Short-Run Versus Long-Run Elasticities
The Demand forGasoline and Automobiles
The World Oil Market
In 1995: P* = $18/barrel World demand and total supply = 23 bb/yr (= 63
mbd) OPEC supply = 10 bb/yr (= 27 mbd) Non-OPEC supply = 13 bb/yr (= 35 mbd) US consumption about 17 mbd = 5.5 bb/yr
Price of Crude Oil
D
Quantity(billions barrels/yr)
Price($ per barrel)
5
18
ST
0 5 15 20 25 30 3510
10
15
20
25
30
35
40
45
23
Impact of Saudi Production CutSC
Short-RunEffect
S’T
D
Quantity(billions barrels/yr)
Price($ per barrel)
5
ST
0 5 15 20 25 30 3510
10
15
20
25
30
35
40
45
23
18
Impact of Saudi Production Cut
SC
Due to the elasticityof the long-run
supply and demand curves, the long-run
effect of a cutin production is
much less.
S’T Long-run Effect
AMAX Case
Price (1980 $)
0
1
2
3
4
5
6
7
8
9
10
1975 1976 1977 1978 1979 1980
Year
Price (1980 $)
Moly Consumption & Production
0
50
100
150
200
250
1975 1976 1977 1978 1979
Year
ConsumptionProduction
MC
0
2
4
6
8
10
12
140 25 50 75 100
125
150
175
200
225
250
275
300
325
350
Output
Mar
gina
l Cos
t
MC
Marginal Costs