summary of the plot. price quantity demanded or supplied demand curve – shows how d depends on p....
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Summary of the Plot
Price Quantity demanded or suppliedDemand curve shows how D depends on P.Also depends on income.Demand curve shifts out as incomeRises.
The Market MechanismQuantity Price($ per unit)
The Market Mechanism
Consumption & Price of Copper 1880-1998
Price elasticity of demand:Measures responsiveness of demand to price.Defined as E = (dQ/Q)/(dP/P) = (dQ/dP)*(P/Q)Why is it defined in proportional terms?- Unit free. - Scale sensitive.A negative number.
Short-run vs. long-run elasticitiesCritical 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
Summary on demand:How demand depends on prices and income.How the time period (s-r vs l-r) affects response to prices and incomes. How D and S interact to determine prices. How revenue varies with output.
The Learning CurveThe horizontal axis measures the cumulative number of hours of machine tools the firm has producedThe vertical axis measures the number of hours of labor needed to produce each lot.Hours of laborper machine lot10203040500246810
Breakeven:Occurs at the output level at which total cost equals total revenue.Let P(N) be the price at which N units can be sold. Then breakeven means:
P(N) . N = FC + VC(N)
Study the elasticity of profits with respect to output Q. Let output change from Q to Q + Q, and profits from to + Intuition - must be greater, the greater are fixed costs. Leverage
Table 4Reconfigured Income Statement for Product A Using a Variable Budget Format (1000s)Sales (40 million lbs. @ 50 cents/lb) $20,000less:Variable Costs:Materials8,000Direct labour2,000Manufacturing overhead1,000Sales Commissions1.000Total Variable Costs 12,000Variable Margin (Profit Contribution) 8,000less:Fixed Costs:Advertising 800Promotion 200Field Sales2,200Product Management 50Marketing Management 300Product Development 300Marketing Research 150Manufacturing Overhead1,200General and Administrative1,400Total Fixed Costs 6,600Net Profit Before Taxes 1,400
Summary on Costs:Identify which cost are relevant to a decision.Distinguish fixed and variable costs and use this to determine impact of output change on profits.Understand allocation of overhead costs. Determine when to shut down in short and long runs. Analyze breakeven.
Example of Profit MaximizationObservationsSlope of rr = slope cc and they are parallel at 10 unitsProfits are maximized at 10 unitsP = $30, Q = 10, TR = P x Q = $300AC = $15, Q = 10, TC = AC x Q = 150Profit = TR - TC$150 = $300 - $150
Example of Profit MaximizationObservationsAC = $15, Q = 10, TC = AC x Q = 150Profit = TR = TC = $300 - $150 = $150 orProfit = (P - AC) x Q = ($30 - $15)(10) = $150
Elasticity of Demand and Price Markup$/Q$/QQuantityQuantity
For maximum profits, MR = MC so
P + P = MCOr
1 Ep P - MC = - 1 P Ep
Consumer SurplusWith a downward sloping demand curve, and uniform price for all buyers, some buyers will be paying less than they are willing to pay for the good (for example, the buyers at the top left hand end of the demand curve)
Buyer #:Will Pay:Revenue:Price:
Buyer #:Will Pay:Revenue:Price:
Examples of Price DiscriminationBy country Cars, pharmaceuticals, Reuters. (Becoming more difficult.)By income level catalogs (zip code), The Gap, Mexican retail, supermarkets chains by location, Switzerland in food brands, On line double click (possible bypass via anonymizer etc.). No price list individualized prices.
The Two-Part TariffThe purchase of some products and services can be separated into two decisions, and therefore, two pricesDecision to enter market and decision about how much to buy
The Two-Part TariffExamples1)Amusement ParkPay to enterPay for rides and food within the park2)Tennis ClubPay to joinPay to play
The Two-Part TariffPricing decision is setting the entry fee (T) and the usage fee (P)Choosing the trade-off between free-entry and high user charges or high-entry and zero user charges
Two-Part Tariff with a Single Type of ConsumerQuantity$/QD
BundlingSelling several goods in one bundleHardware and softwareSoftware suitesAuto accessories
A will pay $9.25 for the bundle and B, $11.50. To sell 1 and 2 separately and get both customers to buy both, cannot charge more than $3.25 for either good. Gives revenue of 4x$3.25 = $13. Bundling gets $2x$9.25 = $18.50. Selling only to customer willing to pay most gets $6 + $8.25 = $14.25. Selling 1 for $8.25 and 2 for $3.25 gets $8.25 + $6.50 = $14.75. A & B are individuals described by the amounts they are willing to pay for each good.
Mixed Versus Pure Bundlingr2r1102030405060708090100102030405060708090100
Pricing Cell-PhonesA mix of discrimination, bundling and two-part pricingBuy the phone (connection/membership charge) & pay for service - like Polaroid, Gilette. Phones at different price points. Then you have a choice between several two-part tariffs
Typically $40 per month with 400 minutes free and 40c/min additionallyor $60 per month with 600 minutes free and 30c/min additionally, etc.Choice of two-part tariffs - intended to price discriminate. Heavy users - willing to pay a lot - will opt for high fixed charge to get the lower per unit price, and vice versa. Different two-part tariffs
Pricing policyFor each market segment try to estimate Maximum consumption if marginal consumption cost is zero. Consumer surplus at this consumption level. Use this surplus as a fixed monthly charge and then have a steep fee for going over the allotted number of minutes.
Key aspectsSo selling 400 minutes for $40 is NOT the same as selling each minute at the average price, 40/400 = $0.10. Selling the 400 minutes together is twice as profitable as selling each minute at $0.10. WHY? Bundling earlier and later minutes together.
e-con.comHow do the principles of managerial economics apply in the internet world? Look at Cost structures Selling informationPricing strategies & auctionsIndustry Standards.
Information ProductsMuch of what the Internet excels at is providing informationInformation is expensive to Produce butCheap to ReproduceSo average cost is high but marginal cost is low.Competition may lead prices down to MC
Encyclopedia Britanica1991: EB sold @ $1,6001992: Microsoft introduced Encarta (bought rights to Funk & Wagnalls), sold @ $49.951995: EBs sales have halved 1995: EB offers on-line subscription for $120 p.a. or CD for $200
Encyclopedia Britanica1996: EB lowers cost of sub to $851999: EB offers FREE on-line service (www.britanica.com)Key point: costs of producing EB are fixed and sunk. Cost of reproducing - MC- is low, zero on-line. Similar story with Yellow Pages. Long distance?
Selling InformationReuters, financial analysts are bundling information with something else that makes it possible to chargeFew examples of successful businesses that sell information only usually sell it bundled with something else
Intellectual Property RightsDigital distribution of information (which includes music, videos, software and book) poses serious challenges to property rights of the owners MC is zeroHence legal & economic activity on IPR front. Napster, BMG, peer-to-peer file sharing etc. (Another issue unbundling disk tracks)
Information ProductsBottom line - Few good business models for making money from selling information over the internet. Business models still needed for Yahoo et al. (eBay is an exception)Napster shows clearly the likely impact of internet distribution on pricing of digital information.
AuctionsAuctions facilitate price discriminationAuction FormatsTraditional English (oral, ascending prices, first or second price)Dutch auction (descending prices)Sealed-bid (as in T Bills, oil exploration)First priceSecond price
AuctionsWinners CurseThe winner is worse off than those who did not winWinner is bidder who estimates value of object to be greatest, and so is likely to be overestimating. Common Value Auction
Economies of Adoption:Examples - software for Windows vs. Mac, Palm operating system and third party support for these. Large user base means more third party products. Also third party services such as training. Network Effects of Standards
Network EffectsMain issue in these cases - fax, e-mail etc are more useful, the more people use themSo once they take off there is p