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Demand Curves

Between 1991 and 1994, Apple Computer engaged in a holding action in the desktop market dominated by PCs using Intel chips and running Microsoft's operating systems. In 1994, Apple's flagship model, the Power Mac, sold roughly 10,000 units per month at an average price of $3000 per unit. AT the time, Apple claimed about a 9% market share of the desktop market (down from greater than 15% in the 1980s).

By the end of 1995, Apple had witnessed a dramatic shift in the competitive environment. In the preceding 18 months, Intel had cut the prices of its top-performing Pentium chip by some 40%. Consequently, Apple's tow largest competitors, Compaq and IBM, reduced average PC prices by 15%. Mail- order retailers Dell continued to gain market share via aggressive pricing. At the same time, Microsoft introduced Windows 95, finally offering the PC world the look and feel of the Mac interface. Many software developers began producing applications only for the Windows operating system or delaying development of Macintosh applications units months after Windows versions had been shipped. Overall, fewer users were switching from PCs to Macs.

Apple's top managers grappled with the appropriate pricing response to these competitive events. Driven by the speedy new PowerPC chip, the Power Mac offered capabilities and a user-interface that compared favorably to those of PCs. Analysts expected that Apple could stay competitive by matching its rivals' price cuts. However, John Sulley, Apple's CEO, was adamant about retaining a 50% gross profit margin and maintaining premium prices. He was confident that Apple would remain strong in the key market segments- the home PC market, the education market, and desktop publishing.

Questions.

1. What effect (if any) did the events of 1995 have on the demand curve for Power Macs? Should Apple preserve its profit margins or instead cut its prices?

2. In 1994, the marginal cost of producing the Power Mac was about $1500 per unit, and a rough estimate of the monthly demand curve was: P= 4,500-.15Q. At the time, what was Apple's optimal output and pricing policy?

3. By the end of 1995, some analysts estimated that the Power Mac's user value (relative to rival PCs) had fallen by as much as $600 per unit. What does this mean for Apple's new demand curve at the end of 1995? How much would sales fall if Apple held to its 1994 price? Assuming a marginal cost reduction of $1,350 per unit, what output and price policy should Apple now Adopt?

Solution Preview

Answer 1:
The effects of 1995 reduced the demand for Apple's products. Thus the competitive reactions shifted Apple's demand curve to the left thereby reducing demand at each price level. The decision to preserve profit margins or cut prices depends on the price elasticity of Apple's products. If Apple's products have an elastic demand (which seems to be the true from the case), then apple should follow suit and cut prices. ...

Solution Summary

The solution goes into a lot of detail about the Power Macs and explains several economic concepts using the scenario given below. It does a great job of answering all the questions below.

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