ECO600 Economics and Finance for Business

ICMS

Week 2 exercise sheet

Your name: ____________________________

1. Which of these three options is false about diminishing marginal utility?

(a) The utility that a consumer gets from successive units of a product consumed over
time falls as the consumer consumes more and more of the product
(b) It causes total utility from consuming a product to decrease when more of it is
consumed
(c) When we consume our second ice cream, the marginal increase in utility is bigger
than when we consume our tenth ice cream

Answer: (b)

Total utility increases (it does not decrease) as you keep consuming. It’s just that it
increases by less and less.

2. What does the law of demand say?

If prices increase, quantity demanded will decrease, and vice versa, if all other conditions
remain the same.

3. Which of these is not a factor that causes shifts in the demand curve of a product?
(a) Future expectations
(b) Income levels
(c) Population size
(d) The price of inputs used to make
the product
Answer: (d)
4. Can you draw demand curves for the
underlined products to show what
happens to their demand curve (does
it stay put, shift to the left or shift to
the right) when:
(i) the price of vanilla beans rises
because of a shortage of
vanilla beans (recently, the
price of vanilla beans equalled
the price of silver)
Draw a demand curve, a line
that is downward sloping, like
this  ‘ \’ and then a change
in price, whether a rise or a
fall, will induce a movement
ALONG the demand curve. No
shift.
(ii) people expect the price of
houses in Sydney will crash
show with diagrams of
demand curves what happens
to the demand curve
If people expect house prices
to fall next year, for example,
they will withdraw their
purchases now – demand
now will fall, at all price levels
of homes, meaning this will
induce a SHIFT of the demand
curve towards the LEFT
(iii) there is a reduction in the
taxes that people have to pay
and the amount of money
they spend on eating out at a
restaurant
A SHIFT of the demand curve
for eating out to the RIGHT
(because lower taxes means
higher amount of

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discretionary income for
spending on things)
(iv) An entrepreneur creates a
new smartphone called
Cardphone that is flat like a
credit card and people who
own Apple and Samsung
phones begin to love this new
phone
The demand curve for Apple
and Samsung phones will
SHIFT to the LEFT as people
prefer Cardphone over Apple
and Samsung phones (a
change in taste)
5. Describe a product or service that has
a highly inelastic demand, and
another one that has a highly elastic
demand. Give each of them a price
elasticity score, Ed. Which one would
have a > 1 score and which one would
have a < 1 score?
Salt: perhaps an Ed of 0.5 (that is, less
than 1)  inelastic (meaning, even if
price doubles, demand for salt will fall
by less than double). The demand
curve would be fairly steep.
A brand of bread: An Ed of, say, 2 (that
is, more than 1)  elastic (meaning, if
the price of one brand of bread
doubles, demand will fall by more
than double – people can easily buy
another brand of bread). The price
elasticity of demand for bread in
general is likely to also be elastic,
because if bread prices in general
goes up, people could easily switch to
substitutes like pasta or rice.
6. State briefly what you understand
about each of these ideas. Then write
down what business strategies you
could apply using each concept to
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ECO600 Economics and Finance for Business
ICMS
manipulate demand and
consumption.
(a) Diminishing marginal utility
(consider also otaa.com’s
strategy:
tinyurl.com/otaadotcom)
To induce purchase:
Add value to product, physically,
and/or experientially or through
service (empathise with the
customer/put yourself in their
shoes: how would they like to be
treated? See, e.g., Harvard
Business Review, 2018, Influence
+ Persuasion, ‘To win people over,
speak to their wants and needs’).
Customers will be impressed,
want to support you and see your
business do well, want you to be a
shining example to others, and
they get the product they want.
Check whether you could add
more value than it would raise
your costs (find opportunities to
add value at low cost). Add value
to your product in an ingenious
way so that people keep giving
your company sales (a feature
they want, but cannot get from a
substitute; see also point (d)
later). See, e.g., Switch Flops,
which are flip flops with
interchangeable straps (see here:
https://tinyurl.com/switchflop;
and here:
https://tinyurl.com/switchflop2)
Devise ways to provide effective
discounts
(b) Consumer surplus and
manipulating it
Use price discrimination to
expand market while at the same time
improving earnings
(c) The price elasticity of demand

Aim to make product more
inelastic. Prices of inelastic
products, when raised, can raise
revenue
If product is elastic, lowering
prices can raise revenues (but
competitors could initiate a
detrimental price war)
(d) The factors that cause shifts in the
demand curve
Population growth
To increase revenue, target areas
where there is a higher rate of
growth or influx of new
people/new, potential customers
(e.g., if you are a furniture
company, focus on Sydney during
the property boom or specifically,
focus on areas where the growth
in construction is at its highest
rates; or, sell your product where
new people are likely to come all
the time, e.g., in Manly)
Substitutes and complements
If your product has substitutes
produced by competitors, either
seek to eliminate (or reduce the
influence of) your competitor and
the substitute, or gain an edge
over the substitute. One way to
gain an advantage over rival
products is to (i) make your
product more distinguishable
from other products (good
advertising/marketing/positioning
in the market— e.g., in vending
machines), or (ii) have qualities
that make it appear to be less of a
substitute (make a product that is
different or has something the
substitutes do not have but which
people desire).
If you have identified an industry
which has a product or a range of
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ECO600 Economics and Finance for Business
ICMS
products that are selling well, sell
a product that is a complement to
it (or design your product so that
it will be considered a
complement). For example,
casings for smartphones, or if
people go to the beach during
summer, sell flip flops or a type of
ice cream people might like. The
idea is to piggyback on the rising
demand for the other product to
elevate the demand for your own
product.
Income
Target higher income
societies/groups/suburbs, or price-
discriminate accordingly
Future expectations
Find ways to raise the demand for
your product now. One example is
to make limited-edition versions
of it; if it is a desirable product,
and people know that it will not
be on the market for long,
demand for it could rise. Also, you
may piggyback as a complement
product on another product
which has the ‘future
expectations’ effect (furniture
market or interior designing in a
location where home prices are
likely to continue to rise in the
future).
(e) Advertising (which affect tastes)
Advertise your product in a cost-
effective way. Use social media if
possible, or, through word of
mouth (generating word of mouth
requires you creating goodwill in
customers: refer to the case of
otaa.com which creates a good
experience for customers who
buy ties from it— these
customers are likely to introduce
 ECO600 Economics and Finance for Business
the company and its products to
others)
(f) Thorstein Veblen’s conspicuous
consumption (the ‘Veblen effect’)
Imbue your product with a quality
that makes it desirable to
customers because it makes them
think that your product is
attached to the ‘leisure class’ or
the rich (status goods). Give it a
luxurious sheen, or connect it to a
certain celebrity, the celebrity’s
preferences, or to a desirable
lifestyle. It should seem like
something not everyone can
have. Develop a good brand
name, logo, design.
(g) Barry Schwartz’s paradox of
choice
It may be possible to raise
revenue by cutting down the
number of choices you have.
Schwartz’s book argues that there
is a threshold number of choices
beyond which it becomes
cognitively costly for customers to
choose from, and it may dissuade
them from choosing and buying,
or buying more. This is especially
an issue in physical locations
rather when it comes to online
shopping.
(h) Planned obsolescence (see also
Nicholas Georgescu-Roegen on
durability, Reading #2b)
It may be possible to raise
revenues by incorporating
obsolescence into your product
(by inducing customers to discard
older versions for newer versions
with extra features). This may
have connections to the idea of
conspicuous consumption in some
cases (people may discard their
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ICMS
old smartphones not because it
lacks the extra megapixels in the
new model’s camera, but because
they do not want to seem, in the
eyes of their peers, that they are
not up-to-date/current when it
comes to their consumption). But
design it so that your impact on
the environment is minimal (e.g.,
it is biodegradable, or recyclable),
to be ethical about it. You may
even use this idea to induce
customers to increase their
purchases (give customers
rebates or discounts if they return
the older product of the new
ones); see the ideas under
countering diminishing marginal
utility, section (a) above.
(i) Tibor Scitovsky’s insights into
comfort, novelty and pleasure
Customers get accustomed to
comfort, and may discard or
desire newer products that are
increasingly more novel or
exciting to them. Design your
products to capitalise on this (this
could be connected to the
planned obsolescence idea).
Scitovsky also said that a more
lasting pleasure or happiness are
obtained not mainly from
consumer products but by having
enjoyable friendships or
relationships, the arts, or a career
one is passionate about. How can
you design your products or
services so that it gains from
people seeking out lasting
pleasures, by incorporating these
factors?
(j) Behavioural economics
https://lms.icms.edu.au/mod/url/
view.php?id=89295
 ECO600 Economics and Finance for Business
ICMS

https://trackmaven.com/blog/8-
marketing-takeaways-from-
behavioral-economics/

https://www.forbes.com/sites/piy
ankajain/2018/03/01/5-
behavioral-economics-principles-
for-marketeers/#6b057e9028eb

7. Create a business plan for a new

product or service. How would you
design, price and market the product
or service by using the strategies you
outlined above?

This exercise was done in class.