Tuesday, October 20, 2009

Elementary Economics: Preference and Demand

I mentor a Talented and Gifted Student at my son's school in economics. Benjamin was asking me what I was doing at his school today. I told him I was teaching economics to a student. He said, "Daddy, let me remind you that you are a pastor." I explained to him that I have a very expensive piece of paper in a nice frame on my office wall that qualifies me to teach economics to an elementary student. Benjamin still isn't convinced but here is the lesson for the day:

My Pie Eating Distribution Chart

Assume that I am at a restaurant and there are four choices of pie. Each pie has an unlimited supply and cost the same to produce. Further assume that I am the only customer. Which pie should the restaurant charge me the most for? The Key Lime pie, of course, because it is the pie with the greatest demand. Although it doesn't cost any more to produce, I demand more Key Lime Pie than all others kinds of pie combined. If they charged twice as much for Strawberry Rhubarb pie than the Key Lime pie, chances are I would never eat the Strawberry Rhubarb pie.

A company who gets this: Apple. They own the market for MP3 players. The iPod is the Key Lime Pie of MP3 players. Apple knows that most customers prefer iPods over other models. So, they can price the iPod higher than their competitors. Today over seventy percent of portable music devices sold are made by Apple and Apple is making gobs of money off it's iPods.

A company who doesn't get this: General Motors. The company prices their vehicles similar to Toyota and Honda. (GM has bigger issues like labor costs, but I'll stick with preferences and demand for now.) What happens is the consumer buys Key Lime Pie (Honda and Toyota) since it costs the same as Cherry and Pumpkin Pie (Chevrolet and Buick). Then the restaurant has too much Cherry and Pumpkin Pie, so they offer special deals on the Cherry and Pumpkin Pie, like employee pricing and letting people pay for the pies interest free over the next five years. And they wonder why they are losing money.

In two weeks: What would happen if Apple raised its prices too high?

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