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Unformatted text preview: Marketing Management Professor Arjun Chakravarti Homework #2 – Due Beginning of Week 5 Economic Value to the Consumer (EVC) I. Conceptual Questions about EVC 1. Define the reference value of a product. What is it composed of? 2. What is the differentiation value of a product in the market? Does differentiation value always need to be positive? Give an example of when it is not. 3. You ask an employee to do an EVC analysis on a new product line. The reference value of the product is calculated to be $100 and the differentiation value is $44,000. Is this necessarily a mistake? Explain why or why not. In general, provide a reason for why you may not be able to charge the differentiation price in the market. II. Computing EVC Values 1. EASY: Suppose a chemical plant uses 200 O‐Rings to seal the valves on pipes that carry corrosive materials. The plant pays $5 each for every o‐ring and must change them during regular maintenance every two months. A new O‐Ring product has twice the corrosive resisting power. What is the price that you can charge for the O‐Ring to make its value equal to the old O‐ring? 2. DIFFICULT: BACKGROUND: The AC company has developed a resin designed to compete with other resins in the manufacture of flexible pipe. They believe that their pipe is substantially more durable than the competition: experiments show that pipes made with AC company resin fail only 3 percent of the time compared to an 8 percent failure rate for its nearest competitor. Consumers currently pay $6.50 per hundred feet for pipe made with low‐quality resin. The AC Company estimates that savings from its pipe are due to users having to buy less replacement pipe and lower labor costs associated with cleaning up damage caused by a ruptured lower‐quality pipe. The value of these attributes depends on what the user uses the pipe for: some users bury the pipe underground, while others leave it exposed. Some use the pipe to carry water, while others use it to transport toxic/offensive waste. Those who transport toxic waste are especially interested in stronger pipes because they must pay the government a $1000 fine for every spill of toxic material. The labor required to cleanup damaged pipes is $60.00 for water damage and $200 for toxic waste damage. All firms save 31 cents per hundred feet by not having to purchase new pipes as often. Those who transport water are usually farmers. Pipe failures, if not caught quickly, can also damage their crops 20 percent of the time. When the damage does occur, farmers must pay $40 to replace damaged or lost seeds. NOTE: remember that the units of analysis are “Per one hundred feet” (a) Given the information in the paragraph, define all of the segments of pipe users in the market using tables. (b) For each segment define the types of ways in which they can save money by purchasing the AC company product. (c) What is the REFERENCE VALUE of AC company’s resin to each of the consumers in this market? (d) What is the TOTAL ECONOMIC VALUE of the AC company resin if the consumer is a farmer who only uses pipe to transport water underground? (e) What is the DIFFERENTIATION VALUE of the AC Company resin for the consumer described in Part d? EVC CALCULATION PART II: Keep in mind that AC Company sells resin to pipe manufacturers, NOT to the end user. Currently, pipe manufacturers purchase low‐
quality resin on the commodities market for 28 cents per pound. AC Company resin costs the same amount to produce. These resins enabled pipe manufacturers to make a $6.50 pipe in which resins contribute $4.55 to the cost. However, these companies do incur some costs of using the new resin: First, consumers will purchase the manufacturer’s pipe less frequently (assume that this pipe does not attract new users to the market), resulting on a loss of 1 cent per pound. Manufacturers also face the risk of sourcing resin from a single manufacturer at a cost of 2 cents per pound. Finally, they will face higher sales costs of 8 cents per pound. ASSUME that the manufacturer only sells pipe to farmers who are transporting water underground: (f) How many pounds of resin are required to use pipe? (g) What is the minimum POSITIVE DIFFERENTIATION VALUE value per pound to the pipe manufacturer of producing pipes with AC Company Resin? (h) What is the negative differentiation value per pound of using the AC company resin? (i) What is the TOTAL ECONOMIC VALUE to the pipe manufacturer? III. Estimating Demand and Willingness to Pay from Regression Models 1. Imagine that we have a demand function for cars specified by the following equation: Q1 = aP1br‐cP2d , where P1 = Price of Good 1, P2 = Price of Good 2, r = Interest Rates for cars Q1 = Quantity demanded of Good 1 in the overall market. (a) Respecify the model so that you can directly interpret elasticities. What are the own price, cross‐price, and “interest‐rate” elasticities of demand for this product? (b) Describe the relationship between Good 1 and Good 2 in the market. (c) Interpret the effect of interest rates on the quantity demanded for cars. Does this result make sense based on what you know about interest rates? Explain why. 2. Look at the EVC analysis from the notes with the Apple Juice Manufacturer. Using the variables provided for the EVC analysis, construct a hypothetical regression model (without using numbers) that explains how changes in the independent variables would affect the price charged in the market 3. Note: For this question you will need data from the excel sheet called “salary_dataset.” This question is simply an exercise to make you more familiar with the act of working with a software package and interpreting data. There are several other crucial steps for running regressions that are very important but we are unable to cover in this class. Hedonic Regressions are generally used by industry analysts to evaluate how product attributes might affect the price of a product sold. This might reflect a general observed prices exchanged in the market (e.g., what a house actually sold for), or could be performed at the individual level in which one person makes many judgments about the willingness to pay for a product given many attributes (what I would pay for a bunch f hypothetical examples). In the same way, you can think about the degree to which different skills affect the salary that a job candidate can command in the market. Imagine that you observe a series of applicants who are hired in a company to perform a number of tasks. Further, assume that I have properly specified that model and that only these variables affect the salary commanded by a person in the market. Using any standard regression package (e.g., SAS, SPSS, Minitab, Excel – if you have the data analysis plugin), simply input the data and run a standard linear regression using all of the variables. Interpret the coefficients. ...
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- Spring '11