Demand Analysis - Key Factors Affecting Demand

Demand analysis

Economic rent = Revenue – Economic Cost →[ Accounting Cost + Opportunity Cost ( the return available from the next best use of the resources used in the venture)]

Marginal value (i.e. the maximum amount that a person is willing to pay for one more unit)-- The incremental value that a person receives from consuming one more unit of a good or service.

Demand curve: Consumer Surplus = Benefit or Value – Price[pic 1]

     [pic 2][pic 3][pic 4][pic 5]

Key Factors Affecting Demand

1.Price of substitutes, 2. Price of complements,

3. Advertising 4. Consumers’ disposable income and other characteristics 5.Bandwagon effects: influential buyers， herding  6.Information visibility

Change in own price affects quantity demanded along the demand curve.

Change in other factors causes shifts of the whole demand curve.[pic 6]

1.Cheaper (or high-quality) substitutes hurt your own demand, but cheaper (or high-quality) complements help your own demand.

2.Building strategic alliance with your complements or raising more competitors for your complementary products may increase your sales.

3.advertising expenditure may capture consumer awareness, loyalty, bandwagon, fashion and fads.

4. Demand and Income: Normal / inferior products

– Normal: positively related to income. (consume more of it when income increases)

– Inferior: negatively related to income. (consume less of it when income increases)

Economy of Scale： Average cost declines as the scale of production increases.

Minimum Efficient Scale (MES) is the minimum “Q” required to produce at minimum average cost.

maximum number of firms a market can support = size of the market (i.e.total potential demand) /minimum efficient scale

[pic 7] [pic 8]

Custom Value Model is to identify and quantify the additional value a product or service brings to customers above what they receive from the next-best alternative. This model can be used as a benchmark in setting price and estimating market demand. The starting point is to identify benchmark[pic 9][pic 10][pic 11]

find a break-even point for both strategies.1395000+300*(2000-Y) = 1455000+100*(2000-Y), Y= 1700

Easy entry market[pic 12]

In a free/easy entry (or perfectly competitive) market, all firms sell almost identical products. There is only one prevailing market price. Any firm charging higher than the market price won’t sell any.

If MR price> marginal cost, produce till the maximum capacity. MR Price< MC reduce/ don’t produce

Market equilibrium: The price that equates quantity demanded and quantity supplied→ predicted market price

Supply vs Demand curve

demand increase [pic 13]

-Short run —> demand curve shifts right—> increase price.

-Long run—> the market is more attractive, more suppliers—> supply curve shift right—> decrease price. demand drop (same shift left)

-Long run —> the reasons for slow growth in price. (Uncertainty of demand/ Expectation for recovery, exist costs, switching costs, wait for competitors to leave)

Short run price change is often larger than long run price change: In the long run, the demand curve is more elastic (due to additional substitution possibilities) and supply curve is also more elastic (due to more ways for existing firms to adjust and due to more firms to enter or exit).

Externality: is the cost or benefit that affects a party who did not choose to incur that cost or benefit. (like min wage policy affect other people’s wages)

Monopoly market

Uniform pricing methods

                                                              Profit maximized: 

marginal revenue MR =marginal cost MC. Under “uniform pricing” to sell extra units, the firm not only has to lower the price for these extra units, but also to lower the price for all previous units.[pic 14]

Cost-based pricing: PRC=P/MC

Value-based pricing methods set prices based on the understanding of (perceived or estimated) value to customers

Non-uniform pricing

Two-part tariff

[pic 15]

The “free” effect, the “price framing” effect, Projection bias, Over-precision, Customers are inattentive and subject to decision making biases, so add-on fees extract additional revenue from customers.

Oligopoly

[pic 16]

– If one firm dominates the market, the firm enjoys the “Market Power” advantage.

– When there is competition, if one firm can dominate a unique market segment of certain customers (typically not the main segment in the industry) and deter potential entrants into this segment, the firm enjoys the “Niche Advantage”.

–compete over the same market segment or customers, if one firm can offer higher benefits to customers with the same or close costs as compared to major competitors, the firm enjoys the “Benefit Advantage”.