ECONOMICS FOR MANAGERS MODULE 2

Strategies for Assessing and Increasing Demand

The first part of Module 2 introduced a variety of tools that managers use to learn about consumer WTP and demand –
and the pros and cons of each approach. The second part of Module 2 explored strategies that firms use to increase
demand.

STRATEGIES TO ASSESS DEMAND:

Surveys and Focus Groups

 Surveys and focus groups are used by firms to directly ask consumers about their preferences. Surveys are cheaper to
run than focus groups. Surveys typically result in large amounts of quantifiable data, while focus groups can provide
more nuanced, qualitative information.

 Some challenges with surveys and focus groups are designing them in a way that makes respondents willing and able
to respond truthfully, and choosing the right target sample of consumers.

Auctions

 Auctions are a more effective approach for eliciting a consumer’s true WTP because they tie the act of revealing one’s
preference for the good to the probability of obtaining it. There are several types of auctions:

 Open outcry auctions (or English auctions): buyers submit increasing bids. The consumer with the highest WTP wins,
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typically bidding (and paying) just above the consumer with the 2 highest WTP.

 Sealed second-price auctions (or Vickrey auctions): buyers submit sealed bids. The highest bidder wins the auction,
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and pays the 2 highest bid. Bidders are motivated to bid their exact WTP, to maximize their chance of winning the
product without the risk of overpaying.

 Sealed first-price auctions: buyers submit sealed bids. The highest bidder wins the auction and pays what he or she bid.
Bidders might be motivated to bid below their WTP in order to ensure that if they win, they will capture some value.

 The Revenue Equivalence Result states that, under certain general conditions, each of these types of auctions should
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result in approximately the same revenue for the seller. This revenue will be approximately equal to the 2 highest
bidder’s WTP.

 Auctions are useful tools for a seller who has little information about consumers’ WTP, but can result in uncertainty and
delay for consumers. As a result, fixed prices may be preferred to auctions in certain settings.

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ECONOMICS FOR MANAGERS MODULE 2

Strategies for Assessing and Increasing Demand

 The winner’s curse occurs when the winner of an auction “overpays” for a product – that is, pays more than what turns
out to be the true value of the product. This tends to occur when the product is worth about the same amount to each
bidder; the winner is the person who most overestimated the value of the product.

Relying on Experiments and Revealed Preference

 Increasingly, firms are using data on consumers’ past choices to determine their true preferences. An advantage of this
approach is that firms infer WTP from consumer actions (i.e., what consumers choose), rather than from what they say:
this is the principle of revealed preference.

 One challenge of using data on past outcomes is to ensure that missing variables don’t confound the correct
interpretation. One advantage of running experiments in order to determine WTP (e.g., by adjusting prices) is that firms
can avoid the problem of missing variables by randomizing treatment and control groups.

Conjoint Analysis

 Conjoint analysis is a specialized survey design, which determines consumers’ preferences for individual features of a
product. Conjoint analysis asks respondents to rank different bundles of features, and uses responses to assign a
numerical value (called a “part-worth”) to each feature. Firms can then use these numerical values to predict consumer
reactions to a product, and to decide what product features to offer.

STRATEGIES TO INCREASE DEMAND

Firms can often influence demand rather than taking it as a given. We examined three strategies.

Advertising

 Firms can advertise for a product, thereby influencing consumers’ WTP and shifting the demand curve outward.
Advertisements can be persuasive or informative.

 Commonly observed forms of advertising are: (a) Advertising a specific firm’s product, (b) Advertising an industry (e.g.,
diamonds), or (c) Negative advertising against a competitor (“badmouthing”).

 Advertising its own product shifts the demand curve facing a firm to the right. Advertising an industry is more beneficial
when a firm has few important competitors: this will shift the demand curve for the entire industry to the right, and since
the firm has a large share of the market, most increased purchases in the industry will benefit the firm. Running
negative advertisements about a firm’s competitor will shift the demand curve for the competitor’s product to the left and

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ECONOMICS FOR MANAGERS MODULE 2

Strategies for Assessing and Increasing Demand

(if the competitor’s product is a substitute for the firm’s own product) shift the curve demand for the firm’s product to the
right.

Substitutes and Complements

 Substitutes are products that can replace each other (the combined WTP for two products that are substitutes is lower
than the sum of the WTP for each individual product). As the availability of substitutes increases, or their prices fall, the
demand curve for a firm’s product shifts left.

 Complements are products that consumers wish to consume together (the combined WTP for two products that are
complements is greater than the sum of WTP for each individual product). As the availability of complements increases,
or their prices fall, the demand curve for a firm’s product shifts right.

 Firms can increase demand for their products by making substitutes less available or more expensive, or by making
complements more available or cheaper.

Network Effects

 Network effects occur if a product is more valuable to its users, the more users it has (e.g., telephones, fax machines,
social networks). In effect, an individual’s demand curve shifts right as other users purchase the product.

 Network effects can be a function of a product’s intrinsic technology (e.g., PC operating systems), or they can be
created by firms (e.g., trading cards). For products exhibiting network effects, a firm may wish to price low initially in
order to encourage early adopters - and then increase its price later once the product commands a large installed base
(and network effect).

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