HBX Core Economics for Managers -
concepts and definitions
WTP - ANS Willingness To Pay
The maximum price you are willing to pay for a product or service.
Irrationality - ANS Paying more than WTP
Actual Value - ANS = WTP
Intrinsic vs. Extrinsic Differences - ANS 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, etc.
Does a sale affect WTP? - ANS No
What does each axis of the demand curve show? - ANS Cumulative quantity on x-axis
Price on y-axis
How is revenue represented on a demand curve? - ANS The rectangle under the demand
curve.
Price × Number of Consumers
How does demand curve shift based on WTP? - ANS Increased WTP = rightward shift
Decreased WTP = leftward shift
Price does *not* affect WTP or shift demand curve.
Diminishing Marginal Returns - ANS If buying more than one of a specific item, generally,
people are willing to pay less for the second item, even less for the third, etc.
For example, this is why buying in bulk is often cheaper than buying individual products --
companies price bulk items cheaper because of this concept.
, Determining steep vs. flat curve - ANS (1) Close substitutes (flatter)
(2) Necessity (steeper) vs. luxury (flatter)
(3) Time horizon (closer = steeper, farther = flatter)
Slope of demand curve (elasticity) - ANS In general:
Steep curve = inelastic = demand not sensitive to price changes = less substitutes available
"If you raise the price, I don't have very many other options, so I will still pay what you charge
me."
Flat curve = elastic = demand is sensitive to price changes = more substitutes available
"If you raise the price, I have plenty of other options so I am not willing to pay the higher price."
The Definition of Elasticity (equation) - ANS The elasticity of a demand curve is the percentage
change in quantity demanded divided by the percentage change in price.
ε = (ΔQ/Q) / (ΔP/P)
Δx = (New−Old)/Old
Revenues are maximized where elasticity = 1.
ε >= 1: Elastic
ε <= 1: Inelastic
Elasticity - when should you raise prices? - ANS When demand is elastic, you can't afford to
raise prices.
When demand is inelastic, you surely can!
Negative income elasticity of demand - ANS 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.
Selection Bias - ANS Selecting people for e.g. surveys that are not representative of all
pertinent demographics.
English Auction - ANS A "traditional" auction, aka "Open Outcry". Starts with an opening bid,
then increases until no one raises the bid anymore. This reveals everyone's WTP except for the
final bidder -- who may have a higher WTP than he ended up bidding.
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