SHIFTS IN SUPPLY AND DEMAND

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Lecture 9

• SHIFTS IN SUPPLY AND DEMAND
• UNDERSTANDING INDUSTRY CHANGES

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Summary of main points

• A market has a product, geographic, and time
  dimension. Define the market before using
  supplydemand analysis.
• Market demand describes buyer behavior market
  supply describes seller behavior in a competitive
  market.
• If price changes, quantity demanded increases or
  decreases (represented by a movement along the
  demand curve).
• If a factor other than price (like income)
  changes, we say that demand curve increases or
  decreases (a shift of demand curve).

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Lecture 8 Summary (cont.)

• Supply curves describe the behavior of sellers
  and tell you how much will be sold at a given
  price.
• Market equilibrium is the price at which quantity
  supplied equals quantity demanded. If price is
  above the equilibrium price, there are too many
  sellers, forcing price down, and vice versa.
• Currency depreciation in a country increases
  demand for exports (supply to another country)
  and decreases demand for imports (demand for
  another countrys products).
• Prices are a primary way that market participants
  communicate with one another.
• Making a market is costly, and competition
  between market makers forces the bidask spread
  down to the costs of making a market. If the
  costs of making a market are large, then the
  equilibrium price may be better viewed as a
  spread rather than a single price.

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Anecdote Y2K and generator sales

• From 1990-98, sales of portable generators grew
  2 yearly.
• In 1999, public anticipation of Y2K power outages
  increased demand for generators.
• Walters, Rosenberg and Matthews invested to
  increase capacity in anticipation of this demand
  growth they vertically integrated their company
  to increase capacity and reduce variable costs.
• Demand grew as expected - Industry shipments
  increased by 87. Prices also increased by an
  average of 21.

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Which industry or market?

• Every industry or market has a time, product, and
  geographic dimension.
• For example The yearly market for portable
  generators in the U.S.
• Time annual
• Product portable generators
• Geography US
• When analyzing a problem, or investment
  opportunity, it helps to first define the time,
  product and geographic dimensions of the market
  in question.

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Shifts in the demand curve

• Movement along the demand curve indicates the
  quantity demanded increased.
• Shifts in demand curve can occur for multiple
  reasons
• Uncontrollable factor affects demand and is out
  of a companys control.
• Income, weather, interest rates, and prices of
  substitute and complementary products owned by
  other companies.
• Controllable factor affects demand but can be
  controlled by a company
• Advertising, warranties, product quality,
  distribution speed, service quality, and prices
  of substitute or complementary products also
  owned by the company

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Anecdote Microsoft

• In the late 1970s, Microsoft developed DOS, an
  operating system to control IBM computers.
• The price for DOS depended on the price and
  availability of computers that could run it and
  the applications that ran under it as well as the
  price of DOS itself.
• To increase demand for DOS Microsoft
• Licensed its operating system to other computer
  manufacturers
• Developed its own versions of complimentary
  products
• To affect the quantity demanded, they also kept
  the price of DOS low.

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Demand increase

• At a given price, more quantity demanded

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Supply curves

• Definition Supply curves are functions that
  relate the price of a product to the quantity
  supplied by sellers.
• Discussion Why do supply curves slope upwards?

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Market equilibrium

• Definition Market equilibrium is the price at
  which quantity supplied equals quantity demanded.
  
• At the equilibrium price, there is no pressure
  for the price to change given the equality of
  quantity demanded and supplied.

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Market equilibrium (cont.)

• Proposition In a competitive equilibrium there
  are no unconsummated wealth-creating transactions.

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KEY POINT 1

• The market equilibrium is the single price at
  which the quantity demanded equals the quantity
  supplied.

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Review question

• Consider a competitive market where tupperware is
  bought and sold. Suppose there are five sellers,
  each willing to sell tupperware at the following
  prices 30,29,20,16,12. Five buyers are
  willing to buy one tupperware at the following
  prices 10,12,20,24, and 29. Construct
  the supply and demand curves and determine the
  equilibrium quantity and equilibrium price.

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Using supply and demand

• Supply and demand curves can be used to describe
  changes that occur at the industry level

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Using supply and demand (cont.)

• Discussion over the past decade, the price of
  computers has fallen, while quantity has risen.
  How? Why?

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Key point number 2

• Changes in supply and demand can be used to
  understand why equilibrium quantities and prices
  change.
• Demand rises Prices and quantities increase
• Demand falls Prices and quantities fall
• Supply rises Prices fall, quantities rise
• Supply falls Prices rise, quantities fall

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Review question 2

• In the 1990s, many people had rising incomes. At
  the same time, there was a rise in cost of wood.
  Holding other factors constant,
• What happens to the supply of houses?
• What happens to the demand for houses?
• If demand effect dominates, what happens to the
  equilibrium price and quantity of houses sold?

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Prices convey information

• Prices are a primary way that market participants
  communicate with one another
• Buyers signal their willingness to pay, and
  sellers signal their willingness to sell with
  prices
• Price information especially important in
  financial markets

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Anecdote

• Discussion Gas pipeline burst between Tucson and
  Phoenix
• What happened to gas prices in Phoenix, in Tucson
  and in Los Angeles?