Efefred - CORe - Econs (67)

What market factors might you want to know more about as you make your decision?

prices, costs, output

value means

profit

large fixed costs that lose a little business %5 (airlines, hotels)

profitability is destroyed

diminishing marginal returns

usually people are willing to pay less for the second ticket, even less for the third, etc etc. that is diminishing marginal return, its like 8,6,4,2,...etc.

revenue

the rectangle under demand price x number of consumers

WTP VS. WTS price vs. cost

value created valye captured

opportunity cost

value of foregone opportunities

This is called confirmation bias:

we have a hypothesis in mind and design experiments around this hypothesis, wasting our time seeking data to confirm it.

WTP

willingness to pay *maximum price you are willing to pay for a product or service. ** it does not relate to you necessarily ***WTP AND PRICE are two totally different concepts

if there is a sale going on

your WTP does not change

example of an opportunity cost

The interest foregone by the owner on the personal savings invested in the restaurant

Actual value

= WTP

competitors

A business' competitors include not only other companies in its industry, but also parties with which the business competes to capture value, such as suppliers and customers.

negative income elasticity of demand

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.

RMB

An exchange rate is the rate at which one currency (say, Chinese renminbi) can be exchanged for another (say, US dollars, abbreviated USD). Renminbi is commonly abbreviated to RMB, but in currency exchange markets it is called CNY (for Chinese Yuan, the unit of renminbi). If the CNY/USD exchange rate is 0.16, that means that 1 yuan can be exchanged for 16 US cents. In other words, an exchange rate is just the price of a particular "good"—RMB—in dollars. A company based in the US hoping to purchase inputs for its products from suppliers in China

anti gouging

Anti-gouging laws are restrictions or laws (typically enacted by states) against increasing prices in the face of an event like Hurricane Sandy.

why is randomization important?

But randomization can allow you to circumvent the problem of "missing variables" or a biased sample.

inelastic vs elastic

Colloquially, we sometimes refer to steep demand curves as "inelastic" curves, and to flat demand curves as "elastic" ones. (In the next lesson, we'll get more precise about this terminology and the concept of price elasticity.)

two types of auctions

Consider two common types of auctions. The first type of auction we all know is the "open outcry" auction, where the auctioneer opens the bidding with a minimum price and then each bidder can increase his or her bid. This is also known as an English auction. It's the usual way to sell artwork or rare antiques. It's also how most charity auctions work. A second common approach to auctions is where the bids are hidden. In a so-called Vickrey auction (named after Columbia University Professor William Vickrey), the highest bidder wins the item, but only pays the amount of the second-highest bid. For this reason, this type of auction is often referred to as a "sealed-bid second-price auction".

intrinsic vs extrinsic

Differences in consumer WTP that arise from differences in, say, age, gender, income, or education are what we call "extrinsic" or "observable" differences Other differences are "intrinsic"—things that you couldn't know about a person without asking him or her. They're hard to observe (and for that reason are also referred to as "unobserved differences"). For example, a person's tolerance for risk, his or her wish to fit in with others or stand out from others, or even the intensity of his or her passion for Taylor Swift or the New England Patriots.

economic costs vs accounting costs

Economic costs include all costs of a decision, direct and opportunity costs, whereas accounting costs do not include opportunity costs. economic: keep track of them in deciding where to allocate resources

relative costs analysis

First, understanding your costs. Second, estimating your competitor's cost—which can require a fair amount of creative or "detective work," as Professor Rivkin describes. Third, using the relative cost estimates to explore how decisions are affected. These could be decisions about whether or not to enter a business (are your costs low enough), about whether you can compete in

The English auction, however, comes pretty close to revealing the buyers' willingness to pay.

In fact, at the end of the auction, the seller knows exactly the willingness to pay of all buyers except one—the highest bidder.

sealed first-price auction

In fact, this is exactly the same as the Vickrey auction, only now the winner really has to pay what she bid, not the second-highest bid.

Revenue wise the two methods are

In other words, even though the auctions look very different, from a revenue point of view, they are roughly identical!

In summary, a well-designed experiment:

In summary, a well-designed experiment: avoids confirmation bias isolates key features of the hypothesis focuses on the most important question and avoids the problem of missing variables through randomization.

Customers value your product less when a substitute product exists than when it does not.

In terms of buyer WTP what this means is that two products A and B are substitutes if WTP(A+B)<WTP(A)+WTP(B). Another intuitive way to define substitutes is in terms of the impact of product prices: A decrease in the price of a substitute reduces demand for your product.

And what is the seller's revenue?

It's generally equal to the second-highest willingness to pay (plus the bidding increment).

Avoiding the Winner's Curse

One way to avoid the winner's curse is that in such situations you always want to bid lower than your appraiser's estimate. While the winner's curse is surprising, it reinforces a fundamental idea about auctions and economics. You do well not by winning or obtaining a product. You win only when the price you paid is lower than the true value. Conversely, as a seller, you win only when the price you receive is greater than your cost. In other words, you don't win by completing a transaction but by capturing value from it.

demand curve tell you about price sensitivity?

So far we have learned that a steep curve is associated with low price-sensitivity, and that a flat curve is associated with high price-sensitivity. However there is a problem with using slope as a measure of price sensitivity because the slope is dependent on the units of measurement. In addition, we can't see how significant the change in price is.

slope

Recall, one formula for slope is Rise / Run

Auction Design

So auction design often does matter. The revenue equivalence result is not inevitable, as we just heard. One of the key assumptions that revenue equivalence depends on is that the buyers' valuations are independent of each other. The assumption of independent WTP is also called the "private values" assumption. This means that each bidder's valuation of the item is his or her own. It is not correlated with how much others would be willing to pay for the same item. This also means that as a buyer, you don't get any additional useful information by knowing how others value the item - that won't change your mind about how you value it.

revenue in a sealed first-price auction

So the revenue in a sealed first-price auction is approximately the same as the revenue in the English auction or the Vickrey auction. In fact, this is a very general, and famous, result about auctions. (For natural reasons, it's called the "revenue equivalence result,") and it applies to every auction where each buyer's willingness to pay is independent of each other.

The Definition of Elasticity

The elasticity of a demand curve is the percentage change in quantity demanded divided by the percentage change in price. *The elasticity of a demand curve is the percentage change in quantity demanded divided by the percentage change in price. Here's the formal definition Percentage change: (New−Old)/Old formula takes the absolute value

The rule of experimentation

The numbers are in increasing order

stable market

The only stable outcome—where there are no buyers who are willing to pay for the product but can't get it and no sellers who produce the product but can't sell it—is the intersection of the demand and supply curves. At that outcome, there is neither excess demand nor excess supply. As a result, there's no incentive to raise or lower prices further.

willingness to pay for an ad

The willingness to pay for the advertisement can be calculated simply as: Average profit*expected increase in quantity demanded where the increase in quantity demanded is just the number of relevant viewers who would be more likely to purchase a Pampers diaper as a result of the advertisement (300,000*0.03 = 9,000).

conjoint analysis

There are two key elements of conjoint analysis. Pair-wise rankings: First, rather than ask a customer her preference across 27 (or more) different products, the conjoint approach requests a comparison only across two or three offerings at any one time. Infer values from rankings: Second, rather than asking a customer to fill out her dollar value for each feature-combination, in conjoint analysis we don't even need to ask her that. Instead, we infer the dollar value she might assign to any product based on her rankings.

price war

This one is a little harder. Even though HiRise's per-unit profits are greater than Butterflake's, that doesn't imply that it's in a stronger position in a price war. That depends on how low each bakery is willing to go in dropping its prices.

shortages

To avoid this outcome, suppose that Springsteen decides to have concert tickets allocated by a lottery

penguin random house

To summarize, Penguin Random House was trying to reduce its fixed costs per print book in three ways. First, as publisher demand for print facilities decreased, they contracted with third-party publishers for the use of their own print infrastructure, generating valuable added revenue in the process. Second, even as print volumes went down, they began investing more, counterintuitively, in certain print capabilities—for example, time to delivery—in order to increase their market share relative to other publishers and also increase their title sales where possible. Third, they attempted to reduce fixed costs using more familiar levers where they could—as, for example, with the "office compression" within their headquarter building in New York City.

steps of conjoint

We have now walked you through the basic steps of a conjoint analysis. These steps are: Collect data from customers on how they would rank different combinations of features of the product. Use this information to infer each customer's willingness to pay for each product feature. Estimate how many customers would buy the product with particular features.

And that illustrates how "optimal prices" are closely linked to elasticities.

When demand is elastic, you can't afford to raise prices. When demand is inelastic, you surely can!

elasticity of demand and revenue!

When elasticity of demand = 1, revenue is maximized. When elasticity of demand is less than 1, demand is inelastic and lowering price will lower revenue. When elasticity of demand is greater than 1, demand is elastic and lowering price increases revenue.

What is the demand?

You need a benchmark, find out what people are willing to pay

shifting demand curve

You recall that the demand curve is nothing more than a depiction of many people's WTP. So as people's WTP changes, the demand curve will also change. Specifically, 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). A cautionary note: notice that price is not a factor that shifts the demand curve

price it at

a little over variable cost UNLESS you don't have start up cost then just make it equal to your variable cost

Part-worth

an implied numeric value that users attach to each feature of a product.

Selection Bias

asking people that are already bias SUCH AS loyal customers

exercises choosing between companies

look at variable costs

individual vs. aggregate demand curve

both are downward sloping because diminishing marginal returns

But what factors determine whether the demand curve for a product is steep or flat?

close substitutes necessity vs luxury time horizon

cobweb

described here—of how prices adjust to reach the market outcome—was very stylized: it's a bit like imagining that there's a marketplace for lawyers where everyone (lawyers and law firms) meets every year and looks for someone else to transact with and where prices are bid up or down. Of course, we don't really see this precise mechanism in every real market—other than a bazaar or marketplace. (Indeed, in many markets, firms set prices directly rather than there being an auction or marketplace or bazaar.)

Revenue-Maximizing Prices and Demand Elasticity

elasticity of 1~

The demand curve

flip graph, create steps, inversely related demand curve- quantity on x axis, price on y axis

the advertising elasticity of demand (or AED

how sensitive it is to advertising

fixed vs variable

how they are affected by more consumers/less consumers

When do you think auctions are especially effective for sellers? When might it be better to sell at a fixed price?

if the seller knows a lot about WTP, there's a far better chance he knows what price to directly set. A second consideration when deciding whether an auction is likely to generate more revenue than a fixed-price sale is the time it takes. In a fixed price sale, the seller gives the buyer the option to buy the item at a given price, usually immediately. If the buyer chooses to purchase the item, she knows almost immediately whether or not she will receive it. In an auction, however, the buyer likely will not learn whether she will receive the item until the very end. So auctions will be more effective when buyers are not time-constrained. Otherwise their constraints or their impatience might make them decide to buy what they want elsewhere rather than wait to see how an auction plays out. Here's a recent advertisement highlighting that point. It's not just buyers who are concerned with timing. Sellers might care as well, but the sellers can always select an auction format to fit a schedule. Third, another important consideration is how different the buyers' WTPs are. Remember the revenue equivalence result? An auction will generate more revenue (and will be more likely to do better than a fixed-price sale) if the buyers' valuations are relatively close together, since the highest WTP and the next-highest WTP will be close together. As a result, an auction will lead the highest bidder to bid closer to his true valuation. If there are large differences in WTP across buyers, an auction may not be particularly effective in driving up prices. Fourth, we already saw that several different kinds of auction all yield practically the same revenue if buyers' valuations are private, but that some types are more effective (for the seller) than others when the various buyers' valuations are interconnected. For example, if the buyers include experts to whom others will be looking for clues to what is more valuable than they had thought, bidding is likely to go higher than it would have otherwise—which is all to the benefit of the seller. So if the seller knows that buyers' valuations are interdependent, he might want to use an open outcry auction.

market adjustments

if there's excess demand or excess supply at any particular price, there are strong incentives for either buyers or sellers to change their behavior and move the market away from that outcome. When there are shortages in a market, prices typically rise. When there are surpluses, prices fall. Prices adjust in order to correct or eliminate excess supply and demand. And they do so by creating incentives for firms to produce more or less of the good and for buyers to demand more or less of the good, depending on the circumstance.

This problem of "missing variables"

is one of the core challenges in determining demand or supply. Simply looking at prices or quantities won't tell you whether the price-quantity relationship captures the

willingness to sell

least amount of money seller is willing to get for the product

zero-sum game

like in politics when only one person can win you can bad mouth

market equilibrium

market equilibrium. (As in other contexts, the term equilibrium indicates a balance between opposing forces—in this case, the forces that might raise or lower prices.)

compliments

mirror image of substitutes COMPLIMENTS CHEAP AS POSSIBLE SUBSTITUTES AS EXPENSIVE AS POSSIBLE

irrationality

paying more than WTP

demand increases

so price increases

steep vs flat

steep: quantity demanded is not sensitive to price flat: customers are much more sensitive to price changes