EM Module 1
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
Here is the demand for scones again: Price per scone: for $3 : everyone is willing to buy 4 If these are the only consumers in the market, and scones are sold at a price of $3 per scone, what is the market quantity demanded?
16 Quantity demanded is calculated by summing up the quantity demanded by each consumer. Notice that even though Aaron's demand curve doesn't indicate strictly diminishing marginal returns, the market demand curve is downward sloping. 4 people willing to buy 4 = 16
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?
5/3 Elasticity 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.
Which of the following scenarios 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. This scenario illustrates the concept of diminishing marginal returns. The first cup is worth more to Alexis than the second cup, so she is not willing to pay as much for the second cup.
Which of the following events would, all else equal, cause a rightward shift of the demand curve for yachts? Select all that apply.
An increase in household income (An increase in income would allow more households to be able to afford yachts, shifting the overall demand for yachts at any given price to the right) The elimination of a regulation, which had prevented boats from sailing on a particular series of lakes (The elimination of a regulation on boats would increase the demand for yachts to sail in previously forbidden waters)
A company is planning to purchase data from a social network on characteristics of that network's users. It can then use this data to decide which customers to advertise to. The company decides to purchase data on the users' location (ZIP code) and relationship status (it believes both these attributes are important in understanding customer demand), but does not purchase data on user characteristics such as number of friends, gender, current employment, etc. Which of the following products is the company most likely selling?
An online dating service The company is targeting single people of both genders, and is probably interested in location because consumers will be more interested in its service if there are other users nearby.
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. Based on this information, which of the following must be true?
At the original price the demand is relatively inelastic The 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.
The table below shows one consumer's demand for blueberry scones. What is the consumer's willingness to pay for his sixth scone?Price per scone Dan's quantity demanded $5 - 2 $4 - 3 $3 - 4 $2 - 5 $1 - 6
Between $1 and $2 If the price of scones is $2, Dan will purchase only five scones. If the price drops to $1, Dan will purchase the sixth scone. His WTP for the sixth scone must be between $1 and $2.
Which of the following statements is true?
Elasticity does not depend on units whereas slope does. A demand curve's slope might change if the unit's demand is measured in change.
The graph below demonstrates the demand for an unknown product. We can conclude that this product: Graph looks like: Quantity vs price I I ㅣ I ㅣ I ㅣ Iㅡ ㅡ ㅡ ㅡ ㅡ (Quantity)
Has no substitutes The graph shows a perfectly inelastic demand curve where changes in price have no effect on the quantity demanded. Thus, it shows that the product has no substitutes.
What other factors can affect the U.S. demand for gasoline? Drag each of the following events into one of three categories below depending on whether you think they increase demand (shift the demand curve to the right), decrease demand (shift the demand curve to the left), or leave demand unchanged (no shift):
Increase demand (shift right) AN ECONOMIC BOOM RAISES NATIONAL INCOME POPULATION GROWTH INCREASES THE NUMBER OF LICENSED DRIVERS Decrease demand (shift left) MORE COMPANIES ALLOW PEOPLE TO WORK FROM HOME, REDUCING THE NUMBER OF COMMUTERS LARGE INVESTMENTS IMPROVE THE AVAILABILITY OF PUBLIC TRANSPORTATI-ON CAR COMPANIES DEVELOP MORE FUEL-EFFICIE-NT MODELS THE GOVERNMENT PROVIDES A SUBSIDY FOR HYBRID CARS Leave demand unchanged (no shift) THE PRICE OF GASOLINE INCREASES THE PRICE OF GASOLINE FALLS DUE TO NEW SOURCES OF SUPPLY
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:
Inelastic When Netflix increased prices, revenue increased. This suggests that the company was previously operating at a part of the demand curve where demand was inelastic.
Let's make it simple and consider two points at either extreme, A and B. At point A, the price is $98 and the quantity demanded is two tickets. At point B, the price is $2 and the quantity demanded is 98 tickets. In other words, total revenue is exactly the same at both points. Now, let's say you were considering raising the price of a ticket by $1. Where would it be more profitable to do so—at point A or point B?
It's better to raise prices at B.
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.
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. price/quantity (y/x)
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.
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.
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.
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.
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.
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.
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.
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.
What is the price elasticity of demand as the price drops from $30 to $26? Remember that quantity demanded increased from 25 to 27.
0.6 Quantity has increased by 8% (2/25), and price has decreased by 13.3% (4/30). Elasticity is 8%/13.3%, 0.6.
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?
1 Elasticity 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. change in quantity: 400 -> 500 (500/400 - 1.25 increase by 25%/1/4) price decrease (20->15: 0.72 (1/4 decrease) 0.25/0.25 = 1
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? 1st cone $8 $6 $4 2nd cone $5 $4 $4 3rd cone $3 $3 $1 4th cone $2 $1 $0
3/4 We 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.
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
Just as perceptions of fairness can impact customer WTP, a customer's perception of the reputation of the seller of a product or service can have an impact on his or her purchasing decisions. Based on what you know about factors that determine WTP, which of the following is plausible?
Despite higher prices, shoppers in a local town prefer to shop at Joe's Groceries over chain supermarkets in order to support small businesses. After reports of child labor in its factories abroad, a clothes manufacturer sees a decline in quarterly sales of 10%. The stock price of BIG Inc., a large company, rises after its CEO decides to forgo a salary and increase the minimum company wage. (all of the above)
According to Forbes' list of the wealthiest Americans, the net worth of the richest Americans increased from an average of $3.8 billion in 2011 to $4.2 billion in 2012. According to the same source, the total amount committed to charity by the top 50 donors declined from $10.4 billion in 2011 to $7.4 billion in 2012. These statistics suggest that income is not an important driver of people's WTP for charity.
False Income is indeed one of the key drivers of people's WTP for charity, but other factors also matter and can skew the data. For example, the above pattern was generated mostly due to the idiosyncratic timing of certain donations - in this case, a $6 billion donation from one donor that occurred in 2011!
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.
False Just because a good is provided for free does not mean that WTP for the good is zero.
Which of the following statements is true?
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. (Unless the company sells only one unit to the customer with the highest WTP, at any price it charges there will always be people who were willing to pay even more and are paying less than their WTP at the given price)
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.
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.
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.
If this graph shows the entire demand curve faced by Pampered Pets Resort (a hotel for dogs), which of the following events is consistent with the arrows shown in the graph?
Pampered Pets Resort has increased its price, and fewer customers have sent their dogs to the resort as a result.
According to research by HBS professor Max Bazerman and others, people's perceptions of fairness can impact their purchasing decisions. Suppose that a hardware store in Harvard Square has been selling flashlights for $10, but on the day of a hurricane they raise the price to $20. Meanwhile Target, located in nearby Watertown, has kept the price of the same flashlight unchanged at $10. Based on what you know about factors that determine WTP which of the following is most plausible?
People's WTP for a flashlight at the hardware store will decrease after customers learn of this price increase. People's WTP for the flashlight at the hardware store will likely decrease because of the perceived unfairness of the price increase. Note that even the decreased WTP might still be high enough for customers to make the purchase, if they really need flashlights.
Which of the following statements regarding price elasticity of demand is true? Select all that apply. (important)!
Price elasticity of demand is a better measure of price sensitivity than slope. Price elasticity of demand tends to increase as price increases. Price elasticity of demand for a particular product will tend to increase as more substitute goods become available.
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.
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).
Suppose that the table below shows the daily demand amongst vacationers and commuters for train tickets from Boston to New York. As the price increases from $50 to $100, who has the higher price elasticity of demand? Why might this group's demand be more elastic? Price of one-way ticket Quantity demanded (vacationers) /(commuters) $50 - 2,000 / 1,000 $100 - 1,500 / 800 $150 - 1,000 / 600
The vacationers. They are likely to have more flexible travel plans and therefore more elastic demand. The vacationers have a price elasticity of demand equal to 0.25, compared to 0.2 for commuters. This more elastic demand could be due to vacationers' more flexible travel schedules—the flexibility to travel at different times essentially gives the vacationers more substitutes.
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.
This question builds on the previous one. Here is the information again: 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. Although Netflix had expected to continue to lose subscribers in the fourth quarter of 2011, in January 2012 the company announced that it had instead added 610,000 subscribers by the end of that quarter. Which of the following MUST be true for the subscribers that Netflix added in the fourth quarter of 2011?
Their WTP for streaming only is more than $7.99. Their WTP for DVDs only is more than $7.99. Their WTP for a bundle is more than $15.98.
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.
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.
For a company facing a linear demand curve, revenue is maximized:
midway down the demand curve.
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.