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Discussion Board Chapter 11 - 12

BADM 535 - Managerial Economics

Sarah Cox

Mr. Phillips

University of Cumberlands

March 26, 2020

Chapter 11

Chapter 11 of our text covers the market for foreign exchange, the effects of a currency devaluation, and bubbles. Our text used Iceland as an example of foreign exchange. In 2001 Iceland's banks entered the world of investment banking, borrowed as much as possible from other banks and bought as much as they could as quickly as they could. By 2006 they would struggle to borrow from other banks and began taking deposits through the internet, mostly from the UK. In 2008 there was a decline in asset prices, rating agencies downgraded banks, and foreign depositors began withdrawing their money. As a result of this, Iceland's currency, which is called krona, began to depreciate. At this time, the prices of important goods were on the rise. The began to sell krona to buy pounds. This market of foreign exchange brings together the demand of pounds and those who supply the pounds, and the equilibrium price is the price of a pound measured in krona (Froeb & Ward, 2018, p. 138). Foreign borrows would increase borrowing in dollars as a result of the lower US interest rates. These lower interest rates encourage US investors to look overseas and the US borrows to look domestically.

There are several effects of a currency devaluation. Overall, devaluation can help domestic producers and foreign consumers but can hurt domestic consumers and foreign producers. Devaluation helps producers because it makes exports less expensive, but it hurts consumers because imports will become more expensive.

Bubbles are defined as the prices that cannot be explained by normal economic forces. Expectations about the future play a significant role in lifespan of bubbles. If a buyer believes that the price of a product will increase, they will buy quickly to avoid the price increase. The sellers will delay selling their product so they can take advantage of the price rise. Both of these actions will lead to a price increase. Economist have documented several characteristics of bubbles which include bubbles emerge when investors have disagreements about the importance of particular economic, bubbles involve very large increases in trading volume, bubbles may continue even when many suspect a bubble and it will not pop until sufficient number of skeptical investors act simultaneously (Froeb & Ward, 2018, p. 143). Bubbles can be identified using the indifference principle as it will tell when market prices will move away from their long-run equilibrium.

Chapter 12

Chapter 12 covers realistic and complex pricing. For companies selling multiple products or those who use low prices to win new customers, the MR=MC pricing rule does not apply. For pricing commonly owned substitutes, it is best to raise the price on both products but raise the price higher on the product that is more elastic. Doing this will reduce the competition between the products. When setting prices for complementary products, you would do the opposite and lower the prices for both products. By reducing the prices for the complementary products, it will increase the demand for both products. By reducing the cost, you will maximize profits.

Promotional spending will affect demand in different ways. Promotions such as coupons or end-of-aisle displays often make the demand more elastic. If this type of promotion makes the demand more elastic, it would be most effective to reduce the price concurrently. Promotions that include celebrity endorsements and quality advertising make demand less elastic. At this time, it would be best to raise prices. Price and the customers perception of quality are linked, to the consumer a higher price equals a higher quality.

Daniel Kahneman developed the Prospect theory that is based on consumers being motivated not by the actual price of a product but the comparison to a reference price. If the consumer believes the "win" they are more likely to make the purchase (Froed & Ward, 2018, p.158). Another theory is to integrate losses but separate gains. Consumers have a tendency to feel their losses more than gains so it is key to highlight a gain and not the loss. Our text uses the example of airlines taking away the in-flight snacks.

References

Froeb, McCann, Shor, & Ward (2018).  Managerial Economics: A Problem Solving Approach 5th edition, Cengage.