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Sunday, June 6, 2010

Set Sail for the High Accountanseas, Again

After writing up a couple of articles in support of GW's impending price increase, I got to thinking that maybe there was a simpler way to explain some of what's going on, without so much math.
Then I realized that a Marshallian Cross (supply and demand graph) can really be used to illustrate my point about why the increase is necessary. You can read the original material by following these links if you need to get caught up: post 1 and then there's post 2

Caught up? Good. Make sure you brush up on the part about Supply and Demand graphing in post #2 before you proceed. Or, if you're familiar with (extremely) basic economics come on in, the water's fine. I promise that I'll try not to make any controversial comments this time around either like "the recession is over," "the holocaust never happened," or "I like turtles"- too soon?

While reading what follows, I think it's important to hear some authentic sea shanties, don't you. Well instead, here is a Japanese choir singing a shanty

Moving right along, let me lay out my assumption for you. We will, again, be using a Landraider model as an example, although it could really be any product. GW, in their continued product improvement has increased their production costs. This could be due to purchasing new technologies (better plastic injection equipment, CAD software, etc etc), increased material costs, increased labor costs, or any number of other things. It doesn't really matter the exact reason, or even the amount, but we'll say that some combination of things has caused their costs to go up. When this happens we expect the Supply curve to actually change positions under this new set of circumstances.

Take a gander at the graph below-

The "before" portion shows us a basic graph of what supply and demand may look like for a land raider. Don't forget that the P and Q labels on the axes stand for Price and Quantity.  As I mentioned in previous posts, I expect the Demand curve to actually be very steep for this, due to its inelasticity, but drawing the graph that way will make this explanation harder to illustrate, so I've just shown a very basic version of this graph. Now the intersection of the Supply (S) and Demand (D) will form, if you recall previous discussions, a point that is most efficient for the market place. This is where revenue is highest and there is no excess of supply or demand. I have since recalled that this is called the equilibrium point as the market is in balance here.

Sticking to the "before" graph, we can then assume that the price p will be established for a Landraider in this market.

Now when production costs increase, the supply curve shifts to the left as seen in the "after" graph. Here it shifts to S*. This happens because the company needs to maximize their profits and will respond to a change in costs by increasing the price. The new equilibrium price for the market is then established at p* which you will note is higher than the original price p. This is fundamentally the way that free, competitive markets will behave in a very broad sense.

You will also note that the quantity of product sold now decreases as customers will want less if they have to pay more (not illustrated, but draw an imaginary line from the equilibrium point to the Q axis and this will give you your quantity). But remember that as we talked about previously, their total revenue and margin is likely to increase slightly or remain relatively constant here with the price increase. Without having their current financials available I don't know how their costs have actually increased, so any actual mathematical analysis is pretty much impossible for me at the moment. That shouldn't really be important though in understanding why GW needs to increase their prices. You can be butt-hurt all you want over the price hike, but hopefully you are at least getting an understanding of why it needs to happen.


SandWyrm said...

That's a nice bit of theory, but a chart can't tell us WHY GW needs to increase prices. That's assuming that it's a "need" at all and not just a "want" on their part.

Remember, this is a company that's now mostly controlled by a couple of hedge funds. So they may be responding to outside demands that have nothing to do at all with the cost of production. Or they may just be trying to keep up with inflation as the value of the British Pound drops. Who the hell knows?

All we can really do as their customers is to decide whether the price of collecting their product justifies the enjoyment we get out of it.

Jason said...

Nicely written, except that chances are, production costs have decreased.

The new plastic technology was paid for with LotR money. Oil prices are down. Many members of the staff have been sacked (it's a British company, after all).

So overhead should be quite a bit lower.

Factor in currency values, such as a declining pound sterling or euro, and maybe you're onto something?

I'm just an English teacher, so I don't even know what I don't know.

kennedy said...

Most of what you said flies right over my head (I've ignored economics after I passed micro and macro econ in college), but what rings truest for me is:

"All we can really do as their customers is to decide whether the price of collecting their product justifies the enjoyment we get out of it." as said by Sandwyrm.

Honestly, that's most of what matters.

Chumbalaya said...

Grammar or no grammar, 'tis troof.

Matt Varnish said...

Problem though is, when you decide to hold a Manager's meeting for every single manager in North America, on company dime, in Vegas, 4 times a year, when you are a small company (less than 4000 employees worldwide) makes upping your prices the way they do seem a bit more like a Dick Move than responsible economics.