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LECTURE TWO: DEMAND
MBA NCCU
Managerial Economics
Lecturer: Jack Wu
CASE: 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 $1 a gallon”, New York Times.

MANAGERIAL ECONOMICS
QUESTIONS
 How
important are gasoline prices to the sales of
SUVs and other types of automobiles?
 How should the auto manufacturers respond to
the increasing price of gasoline?
 Are manufacturer incentives (i.e. price reductions)
an effective response?
 What are the combined effects of incentives and
increasing gas prices?
MANAGERIAL ECONOMICS TOOL:
DEMAND

We apply demand to show how the rising price of
gasoline has caused decreases in large SUV sales,
and how manufacturer incentives can offset these
reductions.
INDIVIDUAL DEMAND CURVE
Definition: graph of quantity that buyer will
purchase at every possible price
 Construction -- “Other things equal, how many
would you buy at a price of ….?’’
 vertical axis -- price
 horizontal axis -- quantity
INDIVIDUAL DEMAND SCHEDULE

Price
($ per movie)
10.00
7.50
5.00
2.50
0.00
Quantity
(movies per month)
0
1
2
4
7
INDIVIDUAL DEMAND CURVE
Price ($ per movie)
10
7.50
individual demand curve
5
2.50
0
1
2
4
Quantity (Movies a month)
7
INDIVIDUAL DEMAND SCHEDULE II

Price
($ per movie)
20.00
19.00
18.00
….
0.00
Quantity
(movies per month)
0
1
2
…
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
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 OTHER FACTORS

prices of related products
substitutes
 complements


advertising
RECORDED MUSIC
Argentina Canada
CD purchases
0.5
2.6
cassette
purchases
GDP/capita
0.2
0.4
$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?

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.
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
$0
7
6
4
17
BUYER SURPLUS
individual buyer surplus: difference between
consumer’s benefit and price she must pay for the
item
 market buyer surplus: sum of individual buyer
surpluses.

INDIVIDUAL BUYER SURPLUS
Price ($ per movie)
10
individual buyer surplus at $2.50 price
7.50 d
5 c
a
b
e
individual demand
(marginal benefit) curve
f
2.50 g
h
j
0
1
2
4
Quantity (Movies a month)
7
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
Broadband
access, Hong
Kong
PCCW Netvigator HK$298 per HK$2 per
3M Single User
month (incl. additional
Plan
100 free
hr
hrs)
Mobile telephone Etisalat
service, UAE
Corporation,
GSM Standard
Service
Fixed Fee
125 dirham
connection
fee; 60
dirham per
qtr
Usage Fee
0.24/0.18
dirham per
min (peak/
offpeak)