Please help! Trying to study for exam!
An article in the New York Times (Oct. 18, 1990) described a successful marketing campaign by the French champagne industry. The article also noted that “many executives felt giddy about the stratospheric champagne prices. But they also feared that such sharp price increases would cause demand to decline, which would then cause prices to plunge.”
What mistakes are the executives making in their analysis of the situation? Illustrate your answer with a demand and supply diagram.
Well, those executives seem to be in quite a fizzy predicament! It appears they are overlooking a couple of key points in their analysis.
Firstly, they are assuming that sharp price increases will automatically lead to a decline in demand. While this might seem like a logical conclusion, it's important to remember that luxury goods like champagne often rely on factors beyond just price. Consumers may associate higher prices with higher quality, exclusivity, and prestige, which could actually reinforce demand rather than dampen it.
Secondly, the executives are neglecting the concept of price elasticity of demand. This refers to the responsiveness of demand to changes in price. If the demand for champagne is relatively inelastic (not very responsive to price changes), even substantial price increases might not significantly impact demand. Inelastic demand implies that consumers are less sensitive to price changes because they perceive champagne as a unique and luxurious product. So, the fear of a plunge in prices might not be as imminent as they believe.
To illustrate this on a demand and supply diagram: Imagine an upward-sloping supply curve for champagne production, indicating that higher prices incentivize producers to increase output. Now, draw a downward-sloping demand curve, representing the relationship between price and quantity demanded. If the demand curve is relatively steep (inelastic), even a significant price increase might not greatly affect the quantity demanded, avoiding a price plunge. However, if the demand curve were flatter (elastic), a price increase could lead to a more substantial decrease in quantity demanded and potentially cause prices to fall.
Remember, in the world of champagne, economics can be just as bubbly as the drink itself! So, take these concepts with a grain of salt, or perhaps should I say, a sip of champagne! Good luck with your exam!
To answer this question and illustrate the mistakes the executives are making, we need to understand the basic concepts of supply and demand and how they relate to price in a market.
Supply and demand are the fundamental forces that determine the price and quantity of a good or service in a market. The demand curve represents the quantity of a good or service that consumers are willing and able to buy at various price levels, while the supply curve represents the quantity of a good or service that producers are willing and able to offer at different price levels.
Based on the information provided, the executives are making two key mistakes in their analysis:
1. Assuming that sharp price increases will cause demand to decline: The executives fear that if they sharply increase champagne prices, consumers will stop buying and demand will decrease. This assumption is based on the notion that higher prices lead to lower demand. However, this assumption may not hold true for luxury goods like champagne, which have a strong association with status and prestige. In the case of luxury goods, higher prices may actually increase demand as consumers perceive them as more exclusive and desirable. Therefore, the executives' assumption that a sharp price increase will lead to a decline in demand may be flawed.
2. Assuming that declining demand will cause prices to plunge: The executives also fear that a decline in demand will cause prices to plunge. This assumption is based on the idea that a decrease in demand will create surplus inventory, forcing producers to lower prices to sell their goods. While this may be true for some goods, it may not necessarily apply to luxury goods like champagne. Luxury goods often have inelastic demand, meaning that changes in price have a relatively small impact on demand. In such cases, even if demand declines, producers may be able to maintain high prices due to the exclusivity and prestige associated with the product.
To illustrate these mistakes, we can create a basic demand and supply diagram. Let's assume that initially, the champagne market is in equilibrium, with the supply and demand curves intersecting at a certain price and quantity level. The diagram would show a downward-sloping demand curve and an upward-sloping supply curve.
The executives' first mistake is assuming that a sharp increase in prices will cause demand to decline. If we were to show this on the diagram, we would shift the demand curve to the left, indicating a decrease in demand due to higher prices. However, for luxury goods like champagne, the demand curve may not shift as much as expected or may even remain relatively unchanged due to the perceived exclusivity and prestige associated with higher prices.
The executives' second mistake is assuming that declining demand will cause prices to plunge. If we were to show this on the diagram, we would shift the supply curve to the right, indicating an increase in supply due to lower demand. However, if champagne has inelastic demand, the supply curve may not shift as much, allowing producers to maintain high prices despite a decrease in demand.
In summary, the executives' mistakes are assuming that a sharp price increase will cause demand to decline and that declining demand will cause prices to plunge. These mistakes are based on a simplistic view of supply and demand dynamics and may not apply to luxury goods like champagne, where price elasticity and perceptions of exclusivity play a significant role.