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Marginal Utility Theory, Product Differentiation, And Revenue/Profit Maximization

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“Apply the concepts of marginal utility theory, product differentiation, and revenue/profit maximization to some event in your personal, daily lives.” [1]

Marginal Utility Concept Application

From the three concepts at hand this is by far the easiest to exemplify. According to Sloman and Sutcliffe the concept of utility is directly related to that of satisfaction [2]. The satisfaction that one individual takes from consuming something is called utility.

Now when we consider the utility concept we must differentiate first between total utility and marginal utility.

Total utility is the total satisfaction that one individual gets from consuming all the units of one same thing during a specific timeframe. ie. We can analyze the utility of consumption of coke during one day to analyze the “optimum” number of cokes to be consumed or we could analyze the utility of each sip we take from a can of coke to analyze the best size of can to offer in the market for example. No matter which, to the analysis of this as a whole, the total utility of the consumption of coke would be in one scenario the added utilities of all the cans of coke drank during the say in the first example, or the total utility of drinking one can of coke in the second example.

Marginal utility on the other hand is the utility that one individual gets from consuming one extra unit of one same thing during a specific timeframe. ie. We can look at the marginal utility of drinking one more can of coke on the same day, or from taking another sip from the coke bottle. In the marginal utility concept we can say that it focus on the satisfaction that individual units of one same thing give to the person consuming it.

Having said this I am going to give as a personal example something that happened to me a while back (not a pretty story). I was addicted to the Pokemon game a few years back when it was launched on the GameBoy console.

Initially I spent as much as 5 to 6 hours straight on the game as my Pokemons grew stronger and I went on my missions. Every pokemon caught and trained gave me a very high marginal utility that ensured I kept playing, until I had to close the game either due to having to sleep, eat or batteries running flat. As the game progressed I got less and less satisfaction from playing the game and catching pokemons. The marginal utility for every pokemon caught decreased considerably to the point where it just wasn’t fun anymore to catch pokemons and my marginal utility for playing the game became negative (I created an aversion to the game) and I stopped playing.

Product Differentiation Concept Application

Product differentiation as the name implies relates to how different products that target a specific audience differentiate from each other and achieve consumer spending preference. The concept of product differentiation can be seen from many perspectives, but in this case we’ll be talking from the viewpoint where there is a non-price competition [3] ie. the consumer will be looking at features of the product itself apart from the price to decide where he’ll spend his money.

In this case there are many factors that can drive the consumer to choose product A in favor of product B. Sloman and Sutcliffe consider that one of the ways to achieve this is by differentiating a product using one or more of the following areas: technical standards, quality standards, design characteristics and service characteristcs [4].

With these areas in mind, the products can be differentiated vertically and horizontally. Vertical differentiation is when a product has a perceived or de facto higher or lower quality than another. This is generally related to things like durability, quality of materials and technical characteristics.

Horizontal differentiation is when products that are considered to be in the same quality range appeal to different consumers for a matter of taste or preference for reasons like design, maybe it’s a newer model (but not necessarily better quality).

I have come across inumerous examples once again, but there was one that I though could be interesting to give as even though it’s may not be considered a product, in reality given the situation it bears the same exact characteristics.

I am currently actively looking for a career change and have had a few interviews with HR managers, company presidents and so on. It has come to my attention that on a job interview we are just like products. HR receives so many CV’s and analyzes them for a triage prior creating a list of acceptable “products”.

Now, to the best of my understanding, if everyone is applying to the same position, the employer will be looking for a set of characteristics just like in a normal product, which can be related to the for areas described above. Technical standards could be the technical ability of the person to perform the function desired. The quality standards could be the different universities where prospective employees took a degree. Design characteristics could be related to how well a person presents herself, or even to the race, gender, age or country of birth. Service characteristics could be related to the track record of the person to deal with suppliers or customers or even colleagues.

Now for this specific example I think it would be fair to assume that what would differentiate hiring or not a person would be vertical differentiation and not horizontal. Most employers will be looking for quality not design.

In an interview at Barlows a couple of weeks ago, upon my arrival to the meeting with the HR manager, the Financial Manager and the Managing Director (after an initial interview with the HR manager) I was surprised to hear the MD’s first comment of “Ah, this is the University of Liverpool gentleman. I remember this CV”. It immediately drew to my attention that he had paid extra attention to my CV as I included on it that I was undertaking an MBA and planning to finish my dissertation by Aug 2007. That was definitely a differentiator in my job application.

Revenue/Profit Maximization Concept Application

The Profit Maximization Concept was the most complex of the three concepts for me to actually understand. The argument that “there is a very simple profit-maximizing rule: if profits are to be maximized, MR [Marginal Revenue] must equal MC [Marginal Cost]” [5] took me a bit longer than usual to decode.

What bugged me was that this is based on the fact that price goes down for every unit we produce extra (demand and supply rule apply here) as there is more of the product to be offered in the market, meaning that we can only sell more if we bring our price down which is not the case. Now after having understood the concept, if I had to redo the concept to be presented to non-financials I would say there is an even simpler profit-maximizing rule: if profits are to be maximized it is so in the point where marginal profit is higher. After understanding the charts and the tables one realizes that that happens at MR=MC and then can go break his head learning that concept.

Now as an example I can relate this in a way to something that I have done recently even though it is not production and it is in such a small number that I cannot cause a fluctuation of the market price.

I recently bought some cars in the USA to import and sell in Angola. Obviously my aim was to profit from this as I had some spare money and I decided to invest it. I have a friend who regularly goes to the States and puts vehicles in containers to import to Angola and looked at the best way to do it in order to maximize my profit.

Now a 20ft container takes one vehicle and costs USD 3100 to bring from the USA to Angola. If I have a vehicle which costs USD 5000 in the US, cost plus freight is already 8100. Duties and taxes in Angola is 40% meaning that on top of that I pay USD 3240 giving me a total cost for the vehicle of USD 11340. Now considering that the average selling price for the vehicle is USD 12000 my profit if I chose that route would be USD 660.

The other option is to bring two vehicles in a 40ft container. A 40ft container usually takes two vehicles and costs USD 5800 to bring from the USA to Angola. If I have two vehicles which cost combined USD 10000 in the US, cost plus freight is USD 15800. Duties and taxes at 40% is USD 6320 for both vehicles, giving me a total cost for each vehicle of USD 11060. This route considering that the average selling price of the vehicle is USD 12000 my profit per vehicle would be USD 940.

The last option is to bring three vehicles in a 40ft container. This can be achieved by putting the cars in a special way in the container. This means that if I have three vehicles which cost combined USD 15000 in the US, plus freight this is USD 20800. Duties and taxes at 40% is USD 8320 for all the vehicles, giving me a total cost for each vehicle of USD 9707. This route considering that the average selling price of the vehicle is USD 12000 my profit per vehicle would be USD 2293.

This meant that in my quest to maximize my profit in this investment, I chose to import vehicles in batches of three.

REFERENCES

[1] BE Syllabus, Discussion Questions, page 20, paragraph 1
[2] Sloman J. and Sutcliffe M., Economics for Business, page 109, paragraph 5
[3] Sloman J. and Sutcliffe M., Economics for Business, page 144, paragraph 2
[4] Sloman J. and Sutcliffe M., Economics for Business, page 144, paragraph 5 and after
[5] Sloman J. and Sutcliffe M., Economics for Business, page 201, paragraph 3

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