Business Economics

1. Business Economics Topic 3: Demand

2. Motivation & Overview • Theories of individual consumer demand • Market demand • Market segmentation • Strategic groups • Price discrimination • Implications for strategy

3. Box 1 The fable of Damien and Norah Damien is a young financial analyst living with his partner, Norah, a finance manager of a major bank, in Paris, France. They have a high combined disposable income, and so enjoy a relatively high standard of living. Among the large variety of goods that Norah buys regularly are fruits (particularly oranges) and designer clothing. She also pays a substantial subscription for membership of a health and fitness centre. Damien shares many of his wife's pleasures, but also gets particular pleasure from drinking cognac and eating good food, listening to music, reading books, and going to the theatre and cinema. Norah shares with Damien his love music, film and cinema, and his penchant for luxury sports saloon cars. She does not, though, share one of Damien's passions: going with friends to watch sports car racing and, occasionally, racing his car on track days at famous race circuits. Norah and Damien have several holidays each year, sometimes in exotic jet-set locations, others more adventurous in remote forest or mountain areas. They also enjoy short weekend breaks with friends. Although both Norah and Damien value their time alone, they are highly social animals. They give, and receive reciprocal invitations to, lavish dinner parties, and spend a great deal with friends and colleagues in work and leisure activities. Damien sees himself as a trend-setter. Each likes to be at the centre of various social networks, and Norah likes to feel that she is highly regarded for her bubbly personality and generosity.

4. health and fitness clubs motor cycles designer clothes wine cars personal computer fruit cinema Figure 9.1 A simplified product space

5. Conventional theory of demand • Represent preferences using utility function • U=U(x,y) x and y are two goods • Indifference curves • all points on a given indifference curve represent same utility

6. Quantity of good y per period Qy1 1 2 Qy2 0 Qx1 Qx2 Quantity of good x per period Fig 3.3 An indifference curve for the goods x and y

7. Budget constraint • Can only afford to buy limited amounts of goods • represent affordable combinations using budget constraint • position depends upon ratio of good prices and income

8. Qy M2 M3 M2 0 Qx Fig 3.6 A set of budget constraints

9. Utility maximisation • Maximise utility subject to budget constraint • Most north easterly indifference curve possible • Point of tangency between budget constraint and indifference curve

10. Qy 0 Qx Fig 3.7 Utility maximization subject to a budget constraint

11. Change in Price • Fall in price • Budget constraint swings outwards • Relative prices change • substitution effect • Real income increases • income effect

12. Figure 3 Market demand for mid-price luxury cars Price of product Quantity demanded per period

13. Figure 5 Strengthening of preferences for wine Price of product Quantity demanded per period

14. sports hatchbacks saloons small, city budget SUV super sport mid-price luxury mass-market family estate cars Figure 9.2 Car product space

15. The Characteristics (or attributes) theory of consumer demand … and product differentiation

16. Table 1 Characteristics of luxury sports saloon cars [1] [1] While manufacturers’ names are genuine, model names are fictitious in this example.

17. +3 +2 +1 0 -1 -2 -3 Better Than Your Product Not as Good Our Product Product C Product A Product B Styling Performance Marque Engineering Build Strength Innovations Quality (30) (25) (20) (15) (10) Most Least Important Important DIMENSIONS OF PERCEIVED BENEFIT (PB) Note: (30) weighting of PB dimensions

18. performance luxury distinctiveness engineering quality Mercedes VFR Performance: low Luxury: very high Distinctiveness: medium Engineering: rather high Jaguar Dragon Performance: medium Luxury: very high Distinctiveness: medium Engineering: high Porsche Bonneville Performance: very high Luxury: low Distinctiveness: high Engineering: very high Figure 6: Characteristics space, and product differentiation

19. status reinforcement performance luxury distinctiveness self-esteem engineering quality sexual attractiveness looking good Sports saloons Performance Luxury: Distinctiveness Engineering Designer sports cars Performance Distinctiveness Status reinforcement Sexual attractiveness Designer clothes Self-esteem Status reinforcement Sexual attractiveness Looking good Figure 7: Characteristics space and product space: their relationship.

20. WEIGHTING %

21. The Household Production Theory of consumer demand

22. Gary Becker’s (1965) 'household production function' (HPF) model. We continue to investigate the fable of Damien. We suppose that the things that matter particularly to Damien, and give him value, are sex appeal, social status, a fine social and cultural life with a good set of friends, and the admiration of others. Damien's utility function: UD = UD (sex appeal, social status, social and cultural life, admiration of others, good company of friends)

23. The ‘commodities’ in brackets on the right-hand side of this equation are not intrinsic, or genetic, qualities of the individuals themselves. They are also not goods and services that can be purchased directly through markets. Nor are they characteristics of purchased goods. Rather they are goods and services 'produced' by households, through their household production function, just as was the home-made meal in our earlier example.

24. Figure 4 Consumer surplus and potential for price discrimination Price of product Quantity demanded per period

25. Better Than +3 0 -3 Our Product Or Service Not as Good Most Important Least Important What might this be for your business?