Economic_Globalisation

Economics essay Student name: Lin Sheng Tutor name: Lorna Course Code: ET10005 Date: 2010, May 15th With the emergence of globalization, free market and technology advances, business firms are increasingly exposed to competition from other rivals both domestically and internationally. Consequently, a thorough understanding and analysis pertinent to the mechanism of the competitive enterprise economy is of great importance to both large corporations as well as small firms. Among various economic theories and principles, demand which refers to how much (quantity) of a product or service is desired by buyers, is one of the most fundamental concepts and the backbone of a market economy. A comprehensive demand analysis capacitates the decision makers of the company to understand consumer behavior within the marketplace and how the market variables determine the intensity of desire and quantity demanded for a specific product or service. With the aid of demand analysis, companies can adjust themselves to the changeable market condition and consumers’ preference as soon as possible to satisfy consumers’ appetite to the largest extent, and therefore improve company’s performance and maximize the profit. This essay is going to evaluate the three commonly used tools including price elasticity, price discrimination and advertising in terms of demand analysis for manufacturing companies. ‘The law of demand states: other things remaining the same, the higher the price of a good, the smaller is the quantity demanded’ (Parkin et al, 1997:71). However, it is obviously not enough when it comes to decision making about pricing and production and more importantly, managers should be informed of how the consumers will respond to the changes in prices which can be reflected and analyzed by examining the price elasticity of demand. Mathematically, the elasticity of quantity demanded with respect to price changes can be computed by taking the percent change in the quantity demanded divided by the percent change in price.(Normally, we use the absolute value of the results) If the result is greater than 1, then it can be shown that demand is elastic. Under this circumstance, a small proportionate change in the price can generate a larger proportionate change in the quantity demanded. (See figure 1A) Discretionary and even luxury items such as jewelry, electronics, and dining at restaurants usually demonstrate high elastic properties. For example if the price of a plasma television drops by one percent and demand increases by 2.5 percent, the price elasticity of demand is 2.5 indicating that this is a highly elastic item. On the opposite side, if the result is less than 1, then demand is categorized as inelastic. This is caused when a change in price causes a smaller percent change in quantity demanded. (See figure 1B) Inelastic demand is usually associated with necessary goods such as gas, bread, or salt. An example would be if the price of gas rose one percent and the resulting demand dropped by 0.6 percent; this would yield a -0.6 elasticity showing that gas is inelastic. Price Elasticity is impacted by measurable factors that allow managers to understand demand and pricing for their product or service; ‘including the availability of substitutes, the consumer budgets for the product or service, and the time period for demand adjustments’ (McDowell et al, 2009:92, 93).The proper consideration and evaluation of this measurement allows manufacture managers to set pricing such that the effect on total revenue is predictable and adjustments to production are timely which can contribute to the desired sales result dramatically. For instance, fashion retailers can use Price Elasticity to manage inventories and directly control sales and revenue levels. The stores are able to manipulate sales levels based on seasonal preferences for clothing and the sensitivity of consumers to pricing. This knowledge of consumer preference can enable a retailer to control revenue. When retailers are faced with pressure from investors, they can increase revenue by offering promotional sales; they can also maintain full pricing on items they know to be in high demand. Similarly, when new seasonal clothing arrives to the retailer, the store can reduce prices on existing stock to encourage demand and rapidly increase sales. Retailers also used principles of Price Elasticity in establishing outlet stores, knowing the small reduction in pricing and retail environment would alter demand and increase sales for certain high-end brands. Retail fashion is an industry where the concept of price elasticity is a fundamental tool in managing sales and revenues. All in all, the price elasticity of demand which is applicable to most industries is a particularly useful tool for manufacture managers which enable them to have a comprehensive understanding of how price change can alter the market situation and, therefore, occupy a competitive position in the marketplace. With the increasingly complexity and diversification of the consumers’ needs, price discrimination becomes an effective method for companies to develop additional ways to obtain profits. ‘Price discrimination is the practice of charging different buyers different prices for essentially the same good or service ’ (McDowell et al, 2009: 263). Price discrimination allows a company to earn higher profits than standard pricing because it allows firms to capture every last pence of revenue available from each of its customers. For example, bus companies usually charge four different prices for a ride. The prices target various age groups, including youth, students, adults and seniors. The prices fluctuate with the expected income of each age bracket, with the highest charge goes to the adult population. The main reason why price discrimination is feasible for some market conditions is that some markets can be segmented into several sub populations on the basis of readily observable characteristics among which consumers have different demand elasticities, or different willingness or ability to purchase a goods or service. Furthermore, the constraints of time, location or availability of the products which make resale impossible allow producers to separate consumers into different classes and not need to worry about the existence of arbitrage. Let us examine how the application of price discrimination can increase the profitability by illustrating the underlying meaning of the demand graph. As showed in figure 2, the company may incur excess capacity and inefficient utility of recourses by simply equating the marginal revenue with marginal cost to determine the optimal output Q1 and charge all the consumers with the corresponding price P1. However, the perfect price discrimination (first degree price discrimination) is where it is possible to change every customer a different price for the same good relevant to each individual demand elasticity. If successful, the firm can extract all consumer surpluses that lie beneath the demand curve and turn it into extra producer revenue (or producer surplus). Suppose the company takes perfectly price discrimination into practice, the first unit can be sold for price E to the highest bidder who has the strongest willingness to possess the good, the next unit is sold to the second highest bidder, and so on. Thus, under the condition of perfect price discrimination the demand curve is the marginal revenue curve and producer will continue to expand their output as long as the extra revenue exceeds the marginal cost of the production. As illustrated in the figure, the output has now expanded to Q2 which leads to additional profit of area EP1A and ABC and eliminates the excess capacity simultaneously. Although the perfect price discrimination is impractical in the real business context due to the unavailability of every consumers’ preference and huge amount of market research cost, entrepreneurs can still use price lists and price menus from which trade can take place rather than having to negotiate a price for each unit of a product bought and sold. The mobile phone market is a great example for this. There are various combinations of handsets and price plans, bundles of text or picture messages and phone insurance offered on the market with different levels of prices which let the consumers reveal their willingness to pay themselves. (See figure 3) Besides the first degree price discrimination, there are still two categories known as the second degree and the third degree price discrimination. The former, also referred to as bulk discount means charging a different unit price depending on the quantity purchased (non-linear pricing) involving businesses selling off packages of a product deemed to be surplus capacity at lower prices than the previously published/advertised price. Most people have experienced this in a store where it says, "buy three, get one free!" Someone who is willing to buy three units is charged less per unit than someone who is only willing to buy one or two. Examples of this can often be found in manufacturing industries where the fixed costs of production are high and the marginal or variable costs are small and predictable. If there are unsold products, it is often in the businesses best interest to clear the unpleasant inventory at a discount prices. There is nearly always some supplementary profit to be made from this strategy. And, it can also be an effective way of securing additional market share within an oligopoly as the main suppliers’ battle for market dominance and try to steal an advantage on their rival firms. The latter is the most frequently found form of price discrimination and involves charging different prices for the same product in different segments of the market. The market is usually separated in two ways: by time or by geography. For example, exporters may charge a higher price in overseas markets if demand is estimated to be more inelastic than it is in home markets. ‘Coca-Cola in the two-litre plastic bottles cost twice as much in Australia as on the west coast of the USA’ (McDowell et al, 2009: 268). Similarly, there is peak and off-peak pricing which is common in the electricity and telecommunication industry. At off-peak times, there is plenty of spare capacity and marginal costs of production are low (the supply curve is elastic) whereas at peak times when demand is high, we expect that short run supply becomes relatively inelastic as the supplier reaches capacity constraints. A combination of higher demand and rising costs forces up the profit maximizing price. In the final analysis, manufacturing companies can extract surplus from high valued-users and expand sales to low valued-users by adopting price discrimination which enables the company to earn higher profits, improve production efficiency and conquer larger market share than standard pricing. Due to the high visibility and pervasiveness, advertising as a promotional and communicational tool is addressed to selected public for the purpose of informing and influencing them to buy products or services or to act or to be inclined favorably towards ideas, persons, trademarks or institutions featured. Consequently, it has a great impact on demand of consumers and plays a significant role in the modern business sector. Generally speaking, there are mainly two functions of advertisements which have different underlying indication for changes in demand and thus the actual consumption. ‘First, it provides consumers with information about products. Advertising informs consumers that new products have arrived on the market, that a product has new features, or that a product is being offered at a lower price’ (Begg & Ward, 2006: 28).In this manner, companies boost their sales by informing targeted customers the availability of the newly launched products or special offers. As shown in the figure 4, the previous market equilibrium is at A1 after the interaction between D1 and S1. With the prevailing market price set at P1, Q1 of the commodities will be purchased during a given time. Nevertheless, the demand condition changes dramatically after the application of effectively targeted advertisements. Thanks to dissemination of products message, an increasingly more amount of customers are attracted to the retail stores, supermarkets or other shops and there is a surge for the consumption. As reflected in the diagram, the demand curve shifts outwards to D2 with the supply curve unaffected which means a larger quantity of this specific merchandise will be consumed at any given price. Additionally, the prevalent market price rises to P2 accompanied with a greater amount of commodities demanded, undoubtedly, makes the companies better off. ‘The other effect of advertising is about trying to change consumers’ tastes and preferences’ (Begg & Ward, 2006: 29). Commercial advertisers often seek to generate increased consumption of their products or services through branding, which involves the repetition of an image or product name in an effort to associate related qualities with the brand in the minds of consumers which, in fact, change the price elasticity of the commodity. According to figure 5, demand for product H is very elastic before the brand loyalty is established among the consumers which is largely due to the wide rang e of substitutes and the existence of ‘brand switchers’. On the other hand, the demand of the commodity becomes relatively inelastic as a result of brand loyalty which means an increase in price will only give rise a smaller reduction in the quantity demanded proportionately. Therefore, the company can raise the price of its commodity to pursue higher revenue. To sum up, advertising helps the manufacturing factory apprehend the attention of potential customers and affecting communication by appealing to people's unfulfilled urges and motives in their minds which actually shift out and steepen the demand curve to generate desirable sales outcomes. In a nutshell, there are numerous factors, such as income levels, advertising and preferences, can pose potentially impact on consumers purchases and personal or commercial budgets which influence the demand of the products and services ultimately. Therefore, a comprehensive evaluation and appropriate application of the demand theories and principles, which ‘enable manufacturing companies to understand the nature of the market for their products so that they can use this information to their commercial advantages,’ is crucial to the success or even survival of the enterprises’ (Wetherly, & Otter, 2008: 47). Equipped with these theories and informed of the possible outcomes, the managers of manufacturing companies can adopt different practice, such as price discrimination and advertising campaigns, to fully exploit the market conditions to achieve the predetermined company objectives and satisfy consumers’ needs. ‘Take example of the car manufacturer, who offer several different models of what is basically the same car with different external appearances, some technical differences and differences in trim and accessories. This reflects a strategy of designing and pricing models to appeal to buyer groups with different reservation prices.’ (McDowell et al, 2009: 267, 268) The similar strategy is adopted by VW group, Ford, Fiat and General Motors and leads these companies to the success. Recently, more advanced demand theory and analysis, such as regression models and demand simulation analysis, are applied in various business contexts. Combined with quantitative approach and statistics, the demand analysis is becoming more effective and reliable. Overall, the ability of conducting demand analysis gradually becomes a necessity for the managers of manufacturing companies which will continue and developed further in the future. Appendix: Figure1A Figure1B (The University of Rhode Island, 2010, May 10th) Figure2 (Begg et al, 2003: 69) Figure3 (Chengmng, 2010, May 10th) Figure 4 (Absolute Astronomy, 2010, May 10th) Figure 5 (The University of Rhode Island, 2010, May 10th) Reference: Absolute Astronomy.(2010 May 10th). Supply and Demand. Available at http://www.absoluteastronomy.com/topics/Supply_and_demand. Begg, D. & Fischer, S. & Dornbusch, R. (2003). Foundations of Economics. (2nd edition) New York: McGraw-Hill Education ltd. Begg, D. & Ward, D. (2006). Economics for business. (2nd edition) New York: McGraw-Hill Education ltd. Chengmng. (2010, May 10th). First Degree Price Discrimination in Practice. 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