ECONOMICS 3200M Lecture 19 March 27, 2006

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ECONOMICS 3200MLecture 19March 27, 2006
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Advertising

• Sales/marketing
• Segmentation of customers
• Individuals income, ethnicity, age, education,
  etc., strategies of rivals
• Firms size, location, alternative sources of
  supply, strategies of rivals
• Advertising strategies and budgets different
  media
• Trade shows
• Internal sales force vs. independent sales agents
  exclusive arrangements
• Technical skills pharmaceutical companies
  (basis for competitive advantage), aircraft
  manufacturers
• Internet sites
• Distribution channels commission overrides,
  promotional budgets

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Advertising

• Profit maximization and advertising
• P P(Q, A) ? inverse demand function with demand
  depending upon quantum of advertising
  expenditures
• Past advertising expenditures investment
  capital stock
• Possibility of depreciation of stock of
  advertising rate of depreciation may vary with
  media
• Profit function P(Q, A)Q C(Q) A
• Profit maximization conditions
• MRMC
• Q?P/ ?Q P ?C/ ?Q
• Q ?P/ ?A 1 ? A/PQ ?A/?
• However, different media for reaching consumers
  relative importance of informational vs.
  persuasive advertising
• Prisoners dilemma

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Advertising

• Marketing/sales/advertising as entry barriers
• Example of pharmaceutical companies (big pharma)
  and control of distribution channel doctors for
  prescription medicines
• Sunk cost for incumbents
• Increase entry costs
• Legal restrictions on false or misleading
  advertising

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Durable Products

• Definition of durable products useful lifetime
  (provides services/value to consumers) exceeds
  length of time period between price revisions or
  basic time period
• Durable products
• Demand depends upon costs to consumers/customer
  per unit of service provided per period of time
• Autos provide transportation and other services
  over their useful lives
• Per unit per period costs
• Expected life-span of product
• Service per period of time without maintenance
• Re-sale value
• Maintenance costs (maintain quality/reliability/pe
  rformance)

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Durable Products

• Durable products offered by monopolist at 2
  different dates are substitutes
• Monopolist creates own competition sell today,
  reduce demand tomorrow (assuming no growth in
  market)
• With lower residual demand in period 2,monopoly
  price in period 2 lt period 1
• Rational expectations by consumers expect lower
  prices in future, thus decrease demand in period
  1
• Non-rational expectations
• Only consumers with V(utility) gt P1(1) buy in
  period 1
• Only consumers with V lt P1(1) available in period
  2 residual demand in period 2

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V, P
P1(1)
P2(2)
MC
D(1)
D(2)
MR(1)
MR(2)
Q
Q1(1)
Q2(2)
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Durable Products

• Durable products offered by monopolist at 2
  different dates are substitutes
• With rational expectations, group of consumers
  with V ? P1(1), P1(1) ? and (1?)V- P1(1) lt
  ?V- P2(2) (has product for two periods) ? )V-
  P1(1) lt ?P1(1)- P2(2) shift demand to period 2
• Lower demand in period 1 leads to price lt P1(1)
  in period 1
• Residual demand in period 2 may or may not be
  higher

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Durable Products

• Monopoly and planned obsolescence
• By reducing durability, monopolist reduces stocks
  carried forward to future time periods
• Increases future period residual demands and
  future prices, making waiting less attractive ?
  increases demand in period 1
• Fashion products
• PLC reputation, entry barriers

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Durable Products

• Coase conjecture durable product monopolist that
  sells has less market power than monopolist that
  rents/leases
• If customer buys product in period 1, unlikely
  to buy same product in period 2
• Monopolist that sells has incentive to cut price
  in future time periods, but not in case of
  monopolist that rents/leases

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Durable Products

• Example 1 Monopolist who produces product that
  can be recycled in future aluminum and scrap
• Higher price in period 1 (than in case where
  recycling not possible) to reduce sales volumes
  and accumulation of scrap for future re-sale
• Delay competition from scrap

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Durable Products

• Example 2 Product has useful life span of X
  years but becomes technologically obsolete after
  ZltX years
• Consumers willing to pay maximum price (P) per
  year for Z years value of annual services
  provided
• Maximum price consumers willing to pay at
  beginning of period 1 PV of lease payments,
  assuming that future prices P
• If at some future time T (0ltTltZ) price
  expected to fall below maximum lease price (P),
  consumers will prefer to lease on annual basis
  and wait till time T to buy product
• Maximum price consumers willing to pay in this
  case at beginning of period 1 less than in case
  where price not expected to fall below P until
  time period Z
• Because of life cycle and technological
  obsolescence, producers will decrease price over
  time
• Consumers must choose when to buy product and
  price to pay

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Durable Products

• Example 2 Product has useful life span of X
  years but becomes technologically obsolete after
  ZltX years
• Price in period 2 should decline to PV of lease
  payments over remaining life (Z-1 Years)
• Similarly for all future prices
• With this pricing strategy, consumers will buy in
  period 1 no sales in future time periods
• To generate future sales, prices will have to
  decline more rapidly and/or rate of technological
  obsolescence will have to increase in this
  case, consumers will trade off price vs.
  technological characteristics of product

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Durable Products

• Leasing more attractive for consumers because
  producers best positioned to determine future
  value of product
• Rate of production per period of time
• Rate of technological obsolescence
• Economies of scale in maintenance
• Producer should assume risk associated with
  uncertainty re. resale or terminal value can be
  influenced by production and technology decisions
  on producer

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Durable Products

• When price signal for quality, price will not
  decline
• Mercedes example with warranty conditional on
  maintenance at authorized MB dealer
• Higher price for maintenance
• Reduced uncertainty re. credence product
  maintenance service
• Higher re-sale value reinforces reputation
• Longer expected life span