EM 1 - Customer Demand: Foundations

Question 1

Willingness to Pay (WTP) definition

Answer 1

Willingness to Pay is the highest price a customer is willing to pay for a product or service
- i.e. the price at which a consumer is just indifferent between purchasing the product and not purchasing it

Question 2

WTP

Answer 2

i. Not the same as price;
ii. Challenging because it isn’t easily observable; and
iii. Influenced by observable factors (age, gender, etc.) and intrinsic preferences.

Question 3

Demand curve - individual and aggregate

Answer 3

An individual buyer’s demand curve is a summary of their willingness to pay for various quantities of a product.
A demand curve for a market is an aggregate of individuals demand curves.

Question 4

Demand curve - graph

Answer 4

i. X-axis - quantity; Y-axis - price; and

ii. Revenue = area under the graph, i.e. price*quantity at any point on the graph.

Question 5

Downward slope of the demand curve

Answer 5

The slope for a demand curve is downward sloping because -

i. for an individual consumer, their WTP is higher for the first unit but lower for subsequent units due to DMR;
ii. for market curves, since fewer customers are willing to purchase the product at higher prices.

Question 6

Shift in the demand curve

Answer 6

Changes in WTP result in shifts in the demand curve -
WTP increase, dd increases, curve shifts to the right; and
WTP decrease, dd decreases, curve shifts to the left.

Factors that shift an individual demand curve also shift the market demand curve.

Question 7

Slope of the demand curve

Answer 7

The slope of a market demand curve measures how responsive buyers are to changes in price.
Flatter => small change in price leads to big change in demand - elastic.
Steeper => small change in price leads to little impact demand - inelastic.
Necessities are generally inelastic, luxuries are generally elastic.

Question 8

Price elasticity of demand

Answer 8

|(del.Q/Q)/(del.P/P)|

Question 9

Elasticity v. slope

Answer 9

Elasticity preferred because it’s a unit-less measurement.
=> easier to compare across products.

Elasticity is different at each point along a dd curve, slope is constant for a linear one. Curve as a whole can be called in/elastic depending on its slope.

Question 10

Approaches to pricing

Answer 10

i. Cost-plus pricing - what you paid plus some more (e.g. 10%); and
ii. Value-based pricing - dependent on WTP rather than costs.

Question 11

Revenue maximizing point

Answer 11

In a linear demand curve, the point of revenue maximization is where the elasticity is 1. This occurs exactly at the halfway point of a linear demand curve.