Any Questions from Last Class?

Chapter 8Understanding Markets and Industry Changes

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Chapter 8 – Take Aways

A market has a product, geographic, and time dimension. Define the market before using supply–demand 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).

Chapter 8 – Take Aways

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 devaluation in a country increases demand for exports (supply to another country) and decreases demand for imports (demand for another country’s products).

Prices convey valuable information.

Making a market is costly, and competition between market makers forces the bid–ask 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.

Review of Chapter 7

Increasing marginal costs Increasing returns to scale Learning curves Economies of Scope

Cost(Q1,Q2) <Cost(Q1)+Cost(Q2)

Bottom line: begin with a decision, not a cost

Anecdote: Y2K and Generator Sales 1990-98, sales of portable generators grew

2% yearly. In 1999, public anticipation of Y2K power

outages increased demand for generators Industry shipments increased by 87%. Prices also increased by an average of 21%.

Discussion: What will happen next?

Which Industry or Market?

Time, product, and geographic dimension Yearly market for portable generators in the

U.S. Time: LR vs. SR

Product

Geography

Which do you use? It depends on what you want to use it for

Shifts in the Demand Curve

Movement along the demand curve

“Quantity demanded” increased (in response to price change)

Shifts in demand curve

“Demand increased”

Uncontrollable factor

Controllable factor

Discussion: In early 80s, what strategy did Microsoft employ to increase demand for its DOS operating system?

Contrast to Apple

Demand Shift

At a given price, more quantity demanded

Price DemandNew

Demand12.00$ 1 511.00$ 2 610.00$ 3 79.00$ 4 88.00$ 5 97.00$ 6 106.00$ 7 115.00$ 8 124.00$ 9 13

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

0 2 4 6 8 10 12 14

Quantity

Pric

e

New Demand

Demand

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?

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

0 2 4 6 8 10

Quantity

Pric

e

Market Equilibrium

Definition: Market equilibrium is the price at which quantity supplied equals quantity demanded.

At the equilibrium price, there is no pressure on price to change given the equality of quantity demanded and supplied.

Market Equilibrium (cont.) Proposition: In a

competitive equilibrium there are no unconsummated wealth-creating transactions.

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

0 2 4 6 8 10

Quantity

Pric

e

Supply

Demand

Price Demand Supply$12 1 9$11 2 8$10 3 7$9 4 6$8 5 5$7 6 4$6 7 3$5 8 2$4 9 1

Using Supply and Demand

$0

$5

$10

$15

0 5 10 15Quantity

Pric

e

Demand

Supply

NewDemand

Price Demand SupplyNew

Demand$12 1 9 5$11 2 8 6$10 3 7 7$9 4 6 8$8 5 5 9$7 6 4 10$6 7 3 11$5 8 2 12$4 9 1 13

Portable Generator Market 1997-1999

1997- Stable industry sales with intense competition (2% avg. sales growth)

1997- Industry anticipates record demand will occur in 1999

1998 – Massive capital expenses throughout industry on vertical integration projects

Portable Generator 1999 +

Demand shift due to fear of power grid failure caused by Y2K

Supply shift caused by manufacturer’s eagerness to capitalize on record demand for product

Manufacturers fail to anticipate reduced demand in 2000

Sales from 2000 pulled forward into 1999

Supply and Demand of Generators

0

200

400

600

800

1000

1200

1400

0 500 1000 1500 2000

Unit Sales (000's)

$/U

nit

(In

du

stry

Ave

rage

)

19981999

2000

1998Demand

1999Demand

1998Supply

1999Supply

BA

C

Using Supply and Demand (cont.) Discussion: “over the past decade, the price of

computers has fallen, while quantity has risen.”

Initial Supply

Final Supply

Q0 Q1

P1

P0

Using Supply and Demand (cont.) Discussion: Following a dramatic devaluation of the

Peso, what happens to your golf course in Tijuana?

Supply of Golf in Tijuana

Demand for Golf in Tijuana

Quantity

New Demand

Supply of Golf in San Diego

Demand for Golf in San Diego

New Demand

Dollars Pesos

Quantity

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 Discussion: Gas pipeline bursting between Tucson

and Phoenix Without high gasoline prices, consumers would consume

too much and suppliers would supply too little. Price information especially important in financial

markets

Market Makers

Market Makers

Discussion: Compute the optimal “spread”

Discussion: Competition forces spread down to the costs of market making, $2. What is bid-ask spread?

Bid Ask Quantity Profit$8 $8 5 $0$7 $9 4 $8$6 $10 3 $12$5 $11 2 $12$4 $12 1 $8

Competition among Market Makers

On May 26, WSJ & LA Times published results of Christie’s research On May 27, spreads collapsed Discussion: WHY?

Alternate Intro Anecdote Video enhancement products are state-of-the-art

graphics systems that capture, analyze, enhance, and edit all major video formats without altering underlying footage.

In 1998, this market consisted of a small number of companies, and demand was relatively light due to the extremely high price of the technology (prices ranged between $45,000 and $80,000)

In 2000, Intergraph entered the market at a price of $25,000, attempting to quickly capture a major share of the market. Intergraph produced a product at a substantially lower cost than the competition.

Alternate Into Anecdote (cont.) What happened??

Entry caused an increase in supply and a strong downward pressure on price (average pricing fell to around $40,000).

A number of firms exited and prices rose back to around $45,000.

Later, the events of 9/11/01 caused demand to spike.

What happened?? In the short run, average prices shot up. Higher prices eventually attracted more entrants,

increasing supply. Pricing fell back down to an average level of around $30,000.

Extra: Using Demand and Supply Discussion: Is there a shortage of affordable

housing?

Discussion: Is there a shortage of kidneys?