In many countries, primary education is provided for free. This means that in these countries consumers' WTP for primary education is zero; otherwise, a private market for education would have developed. T/F?
False - Just because a good is provided for free does not mean that WTP for the good is zero.
Suppose that normally your WTP for a cashmere sweater is $100. What would your WTP for a cashmere sweater be if they marked it 50% off?
$100 - Price does not affect your WTP, so your WTP will not change based on a sale.
You walk into a small grocery store with a list of 4 items to purchase. Having found every item on your list, you decide to purchase only 3 items: milk, cereal, and a pound of bananas. We can conclude that your willingness to pay for the other item was less than its price. T/F?
True - If your WTP for the item were higher than its price, you would have purchased it. You may have decided not to purchase the item because it wasn't the brand you like, or you remembered you already had the item at home, or for some other reason—but any of those reasons would lower your WTP for the item.
Two companies, A and B, are bidding to acquire a target firm. Their initial bids are $300 million by firm A and $350 million by firm B. The internal analysis done by each company indicates that the value of the target firm is $500 million to company A and $450 million to company B. In this example, which of the following values is likely to approximate company A's willingness to pay?
$500 million - Company A would be willing to pay up to $500 million, which is the approximate value it will derive from the target firm.
Under its original offering, customers of media company Netflix were charged $9.99 for a service that included a one-DVD-at-a-time plan and unlimited streaming of movies. In July 2011, Netflix announced a change to its pricing policy. The $9.99 plan would be eliminated. Instead, consumers could choose one of three plans—$7.99 per month for one-DVD-at-a-time, $7.99 per month for unlimited streaming, or $15.98 for both DVD and streaming.In October 2011, Netflix announced that it had lost 800,000 subscribers in the U.S. during the third quarter of 2011. Which of the following MUST be true for all subscribers that Netflix lost in the third quarter? (Choose all that apply.)
Their WTP for streaming only is less than $7.99.Their WTP for DVDs only is less than $7.99.Their WTP for the two services together is less than $15.98.
Suppose that your WTP for one stick of deodorant is normally $5. The price of deodorant is also typically $5. However, this week your local store is having a buy one, get one ("BOGO") free sale on your favorite brand. What is your WTP for one stick of deodorant now?
$5 - Even with the buy one, get one ("BOGO") free sale, your WTP remains at $5. This is because price does not affect your WTP.
In honor of National Coffee Day, Starbucks runs a promotion giving away a free grande coffee to all customers that come into the store that day. As a result, Starbucks sees its number of patrons double. What conclusion can Starbucks draw from this promotion?
The number of customers that bought coffee all had a WTP greater than $0. - This is the only plausible conclusion that the company can draw. Based on this one promotion, it cannot infer anything about customer WTP (other than people really enjoy free things).
The share price of a company is $20 at the beginning of the month, and $10 at the end of the month. Assuming that the company did not issue new stock during the month, which of the following statements is true? (Select all that apply)
The WTP for the company's stock fell by an average of 50% amongst all interested buyers.The overall valuation of the company fell over the course of the month.Some investors may be willing to pay more than $10 for the stock.
Fred is going on a vacation, but cannot take his dog, Lulu, with him. Fred has found a company called Pampered Pets Resort that offers dog babysitting for $30 per night, and decides to leave Lulu there. Fred's willingness to pay for dog babysitting is:
At least $30 per night. - If Fred purchased the babysitting for $30 per night, he must be willing to pay at least that much.
When a factor that affects people's WTP changes, the demand curve will shift (left or right) in response. Why?
Because now, at any given price the number of people with a WTP equal to that price will be different (higher or lower, depending on the event).
Price is not a factor that shifts the demand curve. Why?
By convention, price is on the y-axis of any demand curve. So a change in price will move us up or down along the existing demand curve but it will not shift the curve. In other words, price affects quantity demanded, but doesn't change the underlying WTP or demand.
Increase demand (shift right). Examples?
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Decrease demand (shift left). Examples?
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Leave demand unchanged (no shift). Examples?
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This graph shows a leftward shift in the demand curve faced by Pampered Pets Resort. Which of the following events can explain the shift in the graph?
A recession has decreased salaries in the region, and as a result, fewer pet owners can afford to go on vacation.This would decrease WTP, shifting the demand curve to the left.
So if we want to know how sensitive our customers are to price changes, we need to know something about the slope of the demand curve for our product. But what factors determine whether the demand curve for a product is steep or flat?
- whether the product has close substitutes or not. Chocolate ice cream has a lot of close substitutes (cookie dough ice cream, chocolate cake, other desserts). If the price of chocolate ice cream suddenly rises, consumers will simply switch to the other products. Baby formula on the other hand has few close substitutes.- it depends on whether the product is a necessity or a luxury. Chocolate ice cream is a luxury good. (That is, despite what some of us may think, we can live without it.) On the other hand, baby formula is considered a necessity. Even if its price rises, consumers will continue purchasing it.- the time horizon also matters. Consider the demand for gasoline. In the short run, the demand curve for gasoline is quite steep—there are few substitutes and, for many people, driving is a necessity. But over time, people can move closer to work, we can discover alternate fuels, etc. This can cause the demand curve for gasoline to flatten out in the longer run.
On one extreme, a demand curve can be so steep that it is perfectly vertical. Here customers will buy a given quantity no matter what the price. What's an example?
the demand for insulin by diabetics
A demand curve can be so flat that even a small increase in price would drive all customers away. What's an example?
A classic example is demand for paper currency. If someone tried to sell us a $20 bill for anything more than $20 worth of value, we would take our business elsewhere.
A steep demand curves is "inelastic
insulin is an example
A flat demand curves is "elastic
...
Which of the following events would, all else equal, cause a rightward shift of the demand curve for yachts?
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What scenario illustrates the concept of diminishing marginal returns?
Alexis would pay $3 for a cup of coffee, but would only pay $4 total for two cups.
The slope of a curve depends on the units of measurement. Change the units and you change the slopes.
That's why we use elasticity
The elasticity of a curve?
the price-sensitivity of the demand for a productit measures the responsiveness of quantity demanded to changes in some underlying factor (like price)
Elasticity
the percentage change in quantity demanded divided by the percentage change in price. Here's the formal definition:ε=|ΔQ/QΔP/P|ε=|ΔQ/QΔP/P|Recall that percentage changes should be calculated as:(New−Old)/Old
A store owner is selling shirts at a price of $25 each. At this price, 300 shirts are sold. The owner then puts the shirts on sale, offering them for $20 each. At this price, 400 shirts are sold. What is the price elasticity of demand in this example?
5/3Elasticity is the percent change in quantity demanded divided by the percent change in price. Quantity increased by 33%, or 1/3, and price decreased by 20%, or 1/5.
After selling 400 shirts at a price of $20, the owner decides to cut prices once again. At a price of $15, 500 shirts are sold. What is the price elasticity of demand in this case?
1Elasticity is the percent change in quantity demanded divided by the percent change in price. Quantity increased by 25%, or 1/4, and price decreased by 25%, or 1/4.
The Volume-Profit Tradeoff
You gain customers by lowering prices—but that reduces revenues on all your existing customers as well. In other words, you need to ensure that the revenue loss from existing customers will be more than offset by the revenues you gain from new customers. Simply put, it's a tradeoff between volume and profit.
A coffee company lowers the price of its one-pound bags of coffee from $10 to $9 and as a result, quantity demanded increases from 4 million to 5 million units. Assuming the company's demand curve is linear, what is the slope of the demand curve? Please treat the quantity increase as an increase from 4 to 5, ignoring the millions. [Recall, one formula for slope is Rise / Run]
Price decreases by $1 and quantity increases by 1, so slope is -1/1 = -1.
A coffee company lowers the price of its one-pound bags of coffee from $10 to $9 and as a result, quantity demanded increases from 4 million to 5 million units.What is the elasticity at that point of the demand curve? [Recall, one formula for calculating percentage changes is (New-Old)/Old.]
Quantity has increased by 25% and price has decreased by 10%. Elasticity is 25%/10% = 2.5.
If the price of natural gas rises, when is the price elasticity of demand likely to be the highest?
One year after the price change.In the short-term, customers may be unable to find substitutes and will exhibit a relatively inelastic demand for natural gas. However, over a longer time period, consumers can adjust their behavior and use substitutes, so the price elasticity of demand is higher a year after the price change.
For a company facing a linear demand curve, revenue is maximized:
Midway down the demand curve.Revenue is maximized midway down the demand curve, where elasticity equals 1.
Pampered Pets Resort has had an average of 25 dog guests per night at its price of $30. In order to attract more customers, the company lowers its price to $26 (per dog per night), and the average number of dog guests per night increases to 27. What is the impact of the price change on Pampered Pets Resort's revenue?
Revenue decreases.The additional $52 in revenue from new customers is not enough to make up for the $100 lost as Pampered Pets charges its original 25 customers less.
What is the price elasticity of demand as the price drops from $30 to $26? Remember that quantity demanded increased from 25 to 27.
0.6Quantity has increased by 8% (2/25), and price has decreased by 13.3% (4/30). Elasticity is 8%/13.3%, 0.6.
Income elasticity of demand
the elasticity of demand is with respect to variable X:ε=(ΔQ/Q)/ (ΔX/X)We can replace X by incomeHow sensitive is demand to changes in consumer incomes? Some products might not be much affected by changes in your income.
Cross-price elasticity of demand
How sensitive is demand for your product to changes in prices of other products? This is particularly useful to understand the effects of competitive responses and actions—and which other products really affect your demand
A budding tech startup has created a unique compression algorithm that consumers can use to reduce the size of their computer files. The company was previously charging $40 a month for their "unlimited plan" that allows users to compress as many files as they want. The company decides that it is not making enough revenue, however, and increases the price for their "unlimited plan" from $40 to $60. They notice that the amount of users that subscribe to the unlimited plan decreases from 5,000 to 4,500 once the price change comes into effect.
At the original price the demand is relatively inelasticThe price elasticity of demand at the original price point would be equal to the absolute value of [((4500-5000)/(5000)) / ((60-40)/(40))] = 0.2, relatively inelastic. The company can make more revenue by charging a higher price.
Which of the following statements regarding price elasticity of demand is true?
- Price elasticity of demand is a better measure of price sensitivity than slope. This is true because slope measures absolute changes in quantity and is sensitive to the units of measurement; in contrast, elasticity is not.- Price elasticity of demand tends to increase as price increases. This is generally true. The higher the price, the less willing consumers will be to put up with increases in price for a particular product. For example, consumers might be willing to put up with a 100% price increase for a $1 candy bar, but not for a $20,000 car.-Price elasticity of demand for a particular product will tend to increase as more substitute goods become available.The more available are substitute goods, the less willing consumers will be to put up with increases in price for a particular product.
A certain product has a negative income elasticity of demand. What might this product be?
Rice.A negative income elasticity of demand implies that a consumer will buy less of a good as his or her income increases. This could be the case for cheaper foods such as rice. A consumer with a higher income might be able to afford more expensive foods and switch to, say, quinoa, fish or steak instead.
Willingness to Pay (WTP)
Willingness to pay is the maximum amount of money a customer is willing to pay for a product or service.
Demand Curve
A demand curve for an individual buyer simply summarizes that consumer's willingness to pay for various quantities of a product.The convention for graphing demand curves is to represent price on the y-axis, and quantity demanded on the x-axis.Demand curves are convenient representations because one can easily see how a firm's revenues correspond to different prices.
Demand Curve - slope
A firm's revenue is given by price*quantity demanded, or the area under a demand curve.An individual's demand curve is typically downward sloping because a consumer will have a higher WTP for the first unit of a product, but a lower WTP for subsequent units. This is due to "diminishing marginal returns."The market demand curve reports, at any given price, the aggregate quantity demanded. Market demand curves are downward sloping because fewer consumers are willing to purchase the product at higher prices.
Shifting the Demand Curve
Changes in consumer willingness to pay result in shifts of the demand curve. For example, an increase in a consumer's WTP for a product will shift her demand curve outward; a decrease in WTP will shift her demand curve inward.
Demand Curve Slopes vs Shifts
Slopes versus shifts: Changes in price correspond to movements along the demand curve. Non-price factors that affect WTP correspond to shifts in the demand curve (inward or outward).Factors that shift individual demand curves up or down also shift the market demand curve.
Elasticity
The slope of a market demand curve measures how responsive buyers are to changes in price. When the curve is flat or near-flat, a small dip in price sparks a large surge in the quantity demanded. When the curve is steep or vertical, changes in price have little impact on the quantity demanded.
inelastic vs. elastic demand
Steep curves are often called "inelastic," and flat curves are often called "elastic." Demand is typically more elastic if a product is a luxury rather than a necessity, or if the product has many substitutes.
price elasticity" of demand formula
the percentage change in quantity demanded divided by the percentage change in price.
Which of the following statements regarding price elasticity of demand is true? Select all that apply.
Price elasticity of demand is a better measure of price sensitivity than slope.This is true because slope measures absolute changes in quantity and is sensitive to the units of measurement; in contrast, elasticity is not.Price elasticity of demand tends to increase as price increases.This is generally true. The higher the price, the less willing consumers will be to put up with increases in price for a particular product. For example, consumers might be willing to put up with a 100% price increase for a $1 candy bar, but not for a $20,000 car.Price elasticity of demand for a particular product will tend to increase as more substitute goods become available.
Suppose that Alex, Maria, and Raj are the only 3 buyers of chocolate ice cream in the market. Based on the chart below showing each buyer's willingness to pay for each additional cone, what is the price elasticity of demand for a change in price from $3 to $4 dollars?
3/4We can determine the total market demand at $3 by adding together the total number of cones at which Alex, Maria, and Raj's WTP is $3 or higher. We can see that Alex will buy 3 cones at $3 or higher, Maria will also buy 3, and Raj will buy 2, which adds up to a total of 8 cones demanded at $3. Repeating the same process for $4 (or higher), we get 2 cones for Alex, 2 cones for Maria, and 2 cones for Raj, which adds up to a total of 6 cones demanded at $4. Once we have these quantities for demand at the new and old prices, we can plug them into the equation for price elasticity of demand = absolute value of [(6-8)/8]/[(4-3)/3] = 3/4.
The share price of a company is $20 at the beginning of the month, and $10 at the end of the month. Assuming that the company did not issue new stock during the month, which of the following statements is true? (Select all that apply)
The WTP for the company's stock fell by an average of 50% amongst all interested buyers.True. The company is now valued at 50% of what it was originally, meaning that the average investor's WTP for the company is 50% lower as well.The overall valuation of the company fell over the course of the month.True, since in this situation valuation and average WTP are synonymous.Some investors may be willing to pay more than $10 for the stock.True. The $10 valuation represents the average investor valuation of the company's stock. However, some investors may still be willing to pay more than $10 for the stock.
QQ: A jewelry store has a discount for customers who purchase multiple pairs of earrings: after paying full price for one pair of earrings, the second pair is 15% off. John goes to the store and finds a pair of earrings he likes that is sold for $40 per pair, so he purchases two pairs for a total cost of $74. Which of the following MUST be true?
John's willingness to pay for the two pairs of earrings is at least $74.Since John purchased the earrings for $74, he must have been willing to pay that much for them.
To obtain the demand curve for the whole market
simply sum horizontally all individual demand curves.
If a company that faces a downward-sloping demand curve charges the same price to all its customers?
there are usually some customers who are paying less than their willingness to pay.
A product has a price elasticity of demand of 0.6, which means that:
Total revenue increases when the price increases.The price elasticity is less than 1, which shows that the percentage change in quantity demanded will be less than the percentage change in price.
Elasticity does not depend on units whereas slope does. T/F?
T.A demand curve's slope might change if the unit's demand is measured in change.
The graph shows a perfectly inelastic demand curve where changes in price have no effect on the quantity demanded. Does the product have substitutes?
the product has no substitutes.
A bakery sells individual cupcakes for $3, and boxes of 12 cupcakes for $30. A customer enters the bakery and purchases 4 cupcakes. Which of the following statements must be true of the customer's willingness to pay?
The customer's willingness to pay for 5 cupcakes is less than $15.The customer had the option to purchase 5 individual cupcakes for $15. Since the 5th cupcake was not purchased, the customer's willingness to pay for 5 cupcakes must be less than $15.
A second customer enters the bakery, where cupcakes are being sold, as before, for $3 per individual cupcake and $30 per box of 12 cupcakes. This customer purchases 15 cupcakes—1 box for $30, and 3 individual cupcakes for $3 each. Which of the following must be true of the customer's willingness to pay?
The customer's willingness to pay for 16 cupcakes is less than $42.If the customer were willing to pay $42 or more for 16 cupcakes, an additional cupcake would have been purchased for an additional $3.
After increasing its average subscription prices in 2011, Netflix lost 800,000 subscribers. Despite this decrease in quantity sold, revenue for Netflix increased 49%. We can conclude that, prior to the price increase, Netflix was pricing at a point on its demand curve where demand was:
InelasticWhen Netflix increased prices, revenue increased. This suggests that the company was previously operating at a part of the demand curve where demand was inelastic.
A heavy snowstorm is predicted to occur in Boston on the same night as the city's professional basketball team is playing a game. The snowstorm, if it occurs, will make it difficult for people to drive into the city. In anticipation of lower demand, the arena lowers the prices of tickets to the game. When compared to quantity demanded in the absence of the storm and the price change, the new quantity demanded:
cannot be determined.The bad weather shifts the demand curve to the left, lowering quantity demanded. At the same time, the price decrease moves quantity demanded to the right along the new demand curve. Depending on the size of the relative effects, the new quantity demanded could be higher, lower, or the same as before.
A company that wishes to maximize revenue should try to:
set the price where elasticity of demand will be equal to 1.Revenue is always maximized at prices where the elasticity of demand is equal to 1.
Which of the following will cause the demand curve for a low-price wine produced in California to become flatter?
Other wine manufacturers decide to make and sell low-price wine.The demand curve for the California wine will become flatter as more substitutes become available.
Suppose a gelato shop increases its prices by 5 percent and sees a resulting 10 percent decrease in the quantity of gelato sold. Price elasticity of demand for gelato is:
2Price elasticity of demand is the percentage change in quantity demanded divided by percentage change in price (10/5 = 2).
Which of the following are factors that can directly impact a consumer's WTP for a good? Select all that apply.
Price of substitute goodsIn general, lower prices for substitute goods will result in lower willingness to pay for the original good.Consumer incomeIn general, higher consumer incomes will increase the willingness to pay for a good.Consumer ageIn many cases, age can affect willingness to pay for a good. For example, a senior citizen would likely be willing to pay more for a cane than a young adult would.