Mba1014 supply and demand 010513

Go Global !Go Global !Managerial Economics :Managerial Economics :Supply & Demand

By

Stephen OngStephen OngVisiting Fellow, Birmingham City UniversityVisiting Fellow, Birmingham City UniversityVisiting Professor, College of Management, Visiting Professor, College of Management,

Shenzhen UniversityShenzhen UniversityMay 2013May 2013

AgendaAgenda

1.1. Market DemandMarket Demand

2.2. Market SupplyMarket Supply

3.3. Market EquilibriumMarket Equilibrium

Learning ObjectivesLearning Objectives

To define supply, demand, and equilibrium To define supply, demand, and equilibrium pricepriceTo identify non-price determinants of supply To identify non-price determinants of supply and demandand demandTo distinguish between short-run rationing To distinguish between short-run rationing function and long-run guiding function of function and long-run guiding function of pricepriceTo predict how changing world economic To predict how changing world economic conditions affect market price and conditions affect market price and productionproductionTo illustrate how supply and demand can be To illustrate how supply and demand can be used to improve management decisionsused to improve management decisions

11Market DemandMarket Demand

Market demandMarket demand

Demand for a good or service is Demand for a good or service is defined as defined as quantitiesquantities that people that people are ready (willing and able) to buy are ready (willing and able) to buy at various at various pricesprices within some given within some given time periodtime period Other factors besides price are Other factors besides price are

held constant held constant


Market demand is the sum of Market demand is the sum of all the individual demandsall the individual demands

ExampleExample: demand for : demand for pizzapizza

Market demandMarket demandThe The inverse inverse relationship relationship between price between price and the and the quantity quantity demanded of a demanded of a good or service good or service is called the is called the

Law of DemandLaw of Demand


Changes in price result in changes Changes in price result in changes in the quantity demandedin the quantity demanded

This is shown as movement This is shown as movement alongalong the demand curve the demand curve

Changes in non-price factors result Changes in non-price factors result in changes in demandin changes in demand

This is shown as a This is shown as a shiftshift in the in the demand curvedemand curve


Nonprice determinants of Nonprice determinants of demanddemand

tastes and preferencestastes and preferences incomeincome prices of related productsprices of related products future expectationsfuture expectations number of buyersnumber of buyers

Consumer Tastes & Preferences Consumer Tastes & Preferences Effect on DemandEffect on Demand

Video : Domino’s Pizza Turn Video : Domino’s Pizza Turn AroundAroundhttp://www.youtube.com/watch?v=AH5R56jILag

22Market SupplyMarket Supply

Market supplyMarket supply

The supply of a good or service is The supply of a good or service is defined as defined as quantitiesquantities that people that people are ready to sell at various are ready to sell at various pricesprices within some given time period within some given time period

Other factors besides price held Other factors besides price held constant constant

Market supplyMarket supplyChanges in price result in Changes in price result in

changes in the quantity changes in the quantity suppliedsupplied

shown as movement shown as movement alongalong the supply curve the supply curve

Changes in non-price determinants Changes in non-price determinants result in changes in supplyresult in changes in supply

shown as a shown as a shiftshift in the supply in the supply curvecurve

Market supplyMarket supply

Nonprice determinants of supplyNonprice determinants of supply

costs and technologycosts and technology

prices of other goods or services prices of other goods or services offered by the selleroffered by the seller

future expectationsfuture expectations

number of sellersnumber of sellers

weather conditionsweather conditions

33Market EquilibriumMarket Equilibrium

Market equilibriumMarket equilibrium

Equilibrium priceEquilibrium price: the price that : the price that equates the quantity demanded equates the quantity demanded with the quantity suppliedwith the quantity supplied

Equilibrium quantityEquilibrium quantity: the amount : the amount that people are willing to buy and that people are willing to buy and sellers are willing to offer at the sellers are willing to offer at the equilibrium price level equilibrium price level


Shortage:Shortage: a market situation in which a market situation in which the quantity demanded exceeds the the quantity demanded exceeds the quantity suppliedquantity supplied shortage occurs at a price shortage occurs at a price belowbelow the the

equilibrium levelequilibrium level

Surplus: Surplus: a market situation in which a market situation in which the quantity supplied exceeds the the quantity supplied exceeds the quantity demandedquantity demanded surplus occurs at a price surplus occurs at a price aboveabove the the

equilibrium levelequilibrium level


From 1970 to 2010, From 1970 to 2010, the real price of eggs fell by 55 %the real price of eggs fell by 55 %•The mechanization of poultry farms The mechanization of poultry farms sharply reduced the cost of producing sharply reduced the cost of producing eggs, eggs, shifting the supply curve shifting the supply curve downward. downward. •The The demand curve for eggs shifted to demand curve for eggs shifted to the left the left as a more health-conscious as a more health-conscious population tended to avoid eggs.population tended to avoid eggs.

THE PRICE OF EGGS & COLLEGE EDUCATION THE PRICE OF EGGS & COLLEGE EDUCATION

• while the real price of a college while the real price of a college education rose by 82 %.education rose by 82 %.

• As for college, increases in the costs of As for college, increases in the costs of equipping and maintaining modern equipping and maintaining modern classrooms, laboratories, and libraries, classrooms, laboratories, and libraries, along with increases in faculty salaries, along with increases in faculty salaries, pushed pushed the supply curve up. the supply curve up.

• The The demand curve shifted to the right demand curve shifted to the right as a as a larger percentage of a growing number of larger percentage of a growing number of high school graduates decided that a high school graduates decided that a college education was essential.college education was essential.

THE PRICE OF A COLLEGE EDUCATION THE PRICE OF A COLLEGE EDUCATION

(a) MARKET FOR EGGS

(a) The supply curve for eggs shifted downward as production costs fell; the demand curve shifted to the left as consumer preferences changed. As a result, the real price of eggs fell sharply and egg consumption rose.

(b) The supply curve for a college education shifted up as the costs of equipment, maintenance, and staffing rose. The demand curve shifted to the right as a growing number of high school graduates desired a college education. As a result, both price and enrollments rose sharply.

(b) MARKET FOR COLLEGE EDUCATION

THE PRICE OF EGGS & COLLEGE EDUCATION THE PRICE OF EGGS & COLLEGE EDUCATION

Comparative statics analysisComparative statics analysis

Comparative statics is a form of sensitivity (or what-if) analysis

Commonly used method in economic analysis


Process of comparative statics Process of comparative statics analysis:analysis:state all the state all the assumptionsassumptions needed to needed to

construct the modelconstruct the modelbegin by assuming that the model is begin by assuming that the model is

in in equilibriumequilibriumintroduce a change in the model, so introduce a change in the model, so

a condition of a condition of disequilibriumdisequilibrium is is createdcreated

find the new point of equilibriumfind the new point of equilibriumcompare the compare the new equilibrium new equilibrium point point with the original onewith the original one

Comparative statics: exampleComparative statics: example

Step 1Step 1

assume all factors assume all factors except the price of except the price of pizza are constantpizza are constant

buyers’ demand buyers’ demand and sellers’ supply and sellers’ supply are represented by are represented by lines shown lines shown


Step 2Step 2

begin the begin the analysis in analysis in equilibrium as equilibrium as shown by Qshown by Q11 and Pand P11


Step 3Step 3 assume that a new assume that a new

study shows pizza to study shows pizza to be the most be the most nutritious of all fast nutritious of all fast foodsfoods

consumers consumers increase increase their demand their demand for for pizza as a result pizza as a result


Step 4Step 4the the shift in shift in

demand demand results results in a new in a new equilibrium price equilibrium price (P(P22))

and a new and a new equilibrium equilibrium quantity (Qquantity (Q22) )


Step 5Step 5comparing the comparing the

new new equilibrium equilibrium point point with the with the original one, we original one, we see that both see that both equilibrium price equilibrium price and quantity have and quantity have increased increased


The short run is the period of The short run is the period of time in which:time in which:

sellers already in the market respond to sellers already in the market respond to a change in equilibrium price by a change in equilibrium price by adjusting adjusting variable inputsvariable inputs

buyers already in the market respond to buyers already in the market respond to changes in equilibrium price by changes in equilibrium price by adjusting the quantity demanded for the adjusting the quantity demanded for the good or servicegood or service


Short run changes show the rationing Short run changes show the rationing function of price function of price

The rationing function of price is the The rationing function of price is the change in market price to eliminate the change in market price to eliminate the imbalance between quantities supplied and imbalance between quantities supplied and demanded is the change in market price to demanded is the change in market price to eliminate the imbalance between quantities eliminate the imbalance between quantities supplied and demandedsupplied and demanded

Short-run analysisShort-run analysis

an increase in an increase in demand demand causes causes equilibrium equilibrium price and price and quantity to quantity to riserise


a a dedecrease in crease in demanddemand causes causes equilibrium equilibrium price and price and quantity to fallquantity to fall


an an inincrease in crease in supplysupply causes causes equilibrium equilibrium price to fall price to fall and and equilibrium equilibrium quantity to quantity to riserise


a a dedecrease in crease in supplysupply causes causes equilibrium equilibrium price to rise price to rise and and equilibrium equilibrium quantity to quantity to fallfall

WAGE INEQUALITY WAGE INEQUALITY IN USAIN USA Over the past two decades, the wages of skilled high-income Over the past two decades, the wages of skilled high-income

workers have grown substantially, while the wages of unskilled workers have grown substantially, while the wages of unskilled low-income workers have fallen slightly.low-income workers have fallen slightly.

From 1978 to 2009, people in the top 20 percent of the From 1978 to 2009, people in the top 20 percent of the income distribution experienced an increase in their income distribution experienced an increase in their average real (inflation-adjusted) pretax household average real (inflation-adjusted) pretax household

income of income of 45%45%, while those in the bottom 20 , while those in the bottom 20 percent saw their average real pretax income increase percent saw their average real pretax income increase

by only by only 4%4% While the supply of unskilled workers—people with limited While the supply of unskilled workers—people with limited

educations—has grown substantially, the demand for them has educations—has grown substantially, the demand for them has risen only slightly.risen only slightly.

On the other hand, while the supply of skilled workers—e.g., On the other hand, while the supply of skilled workers—e.g., engineers, scientists, managers, and economists—has grown engineers, scientists, managers, and economists—has grown slowly, the demand has risen dramatically, pushing wages up.slowly, the demand has risen dramatically, pushing wages up.

Income Inequality

Long run analysisLong run analysis

The long run is the period of The long run is the period of time in which:time in which: new sellers new sellers may enter a market existing sellers may exitexit from a

market existing sellers may adjust fixed

factors of productionfactors of production buyers may react to a change in

equilibrium price by changing their tastes and preferencestastes and preferences

Long run analysisLong run analysis

Long run changes show the Long run changes show the

allocating function of priceallocating function of price

The guiding or allocating function of The guiding or allocating function of price is the movement of resources price is the movement of resources into or out of markets in response to a into or out of markets in response to a change in the equilibrium price change in the equilibrium price

Long-run analysisLong-run analysis initial change: initial change:

dedecrease in demand crease in demand from Dfrom D11 to D to D22

result: reduction in result: reduction in equilibrium price and equilibrium price and quantity (to Pquantity (to P22,Q,Q22))

follow-on adjustment:follow-on adjustment:movement of movement of

resources out of the resources out of the marketmarket

leftward shift in the leftward shift in the supply curve to Ssupply curve to S22

equilibrium price equilibrium price and quantity (to and quantity (to PP33,Q,Q33))

Long-run analysisLong-run analysis initial change: initial change:

inincrease in demand crease in demand from Dfrom D11 to D to D22

result: increase in result: increase in equilibrium price and equilibrium price and quantity (to Pquantity (to P22,Q,Q22))

follow-on adjustment:follow-on adjustment: movement of movement of

resources into the resources into the marketmarket

rightward shift in the rightward shift in the supply curve to Ssupply curve to S22

equilibrium price and equilibrium price and quantity (to Pquantity (to P33,Q,Q33))

Supply, demand, and price:Supply, demand, and price:the managerial challengethe managerial challenge

in the extreme case, the forces of supply and in the extreme case, the forces of supply and demand are the sole determinants of the demand are the sole determinants of the market price, not any single firmmarket price, not any single firm this type of market is ‘perfect this type of market is ‘perfect

competition’competition’

in many cases, individual firms can exert in many cases, individual firms can exert market power market power over price because of over price because of their:their: dominant sizedominant size ability to differentiate their product ability to differentiate their product

through advertising, brand name, through advertising, brand name, features, or servicesfeatures, or services

Supply, demand, and price: Supply, demand, and price: the managerial challengethe managerial challenge

Eg.Eg.: COFFEE: COFFEE ‘‘buy lowbuy low, sell , sell

high’high’2000:over 2000:over

production led to production led to price fallsprice falls

2004: prices 2004: prices moved up againmoved up again

Starbucks effectsStarbucks effects

Supply, demand, and price: Supply, demand, and price: the managerial challengethe managerial challenge

Eg.Eg.: Air Travel: Air Travel

‘ ‘buy high, buy high, sell low’sell low’ industry de-industry de-

regulated in late regulated in late 1970s1970s

tight competitiontight competition post 9/11, a low-cost post 9/11, a low-cost

structure is neededstructure is needed

Global applicationGlobal application

Eg.Eg.: COPPER market: COPPER market

abundant metalabundant metal strategic itemstrategic item nominal prices nominal prices

risingrising improved mining improved mining

technologytechnology closure of closure of

uneconomic minesuneconomic mines

THE LONG-RUN BEHAVIOUR OF NATURAL THE LONG-RUN BEHAVIOUR OF NATURAL RESOURCE PRICESRESOURCE PRICESCONSUMPTION CONSUMPTION

AND PRICE OF AND PRICE OF COPPERCOPPER

Although annual Although annual consumption of consumption of copper has copper has increased about increased about a hundredfold,a hundredfold,

the real the real (inflation-(inflation-adjusted) price adjusted) price has not changed has not changed much.much.

• After reaching a level of about After reaching a level of about $1.00 per pound in 1980, the price $1.00 per pound in 1980, the price of copper fell sharply to about 60 of copper fell sharply to about 60 cents per pound in 1986.cents per pound in 1986.• Worldwide recessions in 1980 Worldwide recessions in 1980

and 1982 and 1982 contributed to the contributed to the decline of copper prices.decline of copper prices.

THE BEHAVIOUR OF COPPER PRICESTHE BEHAVIOUR OF COPPER PRICES

Why did the price increase so sharply after Why did the price increase so sharply after 2003? 2003?

• First, the First, the demanddemand for copper from for copper from China and other Asian countries China and other Asian countries began increasing dramatically.began increasing dramatically.

• Second, because prices had dropped Second, because prices had dropped so much from 1996 through 2003, so much from 1996 through 2003, producers closed unprofitable mines producers closed unprofitable mines and and cut productioncut production..

What would a decline in demand do to the What would a decline in demand do to the price of copper? price of copper?



Copper prices are shown in both nominal (no adjustment for inflation) Copper prices are shown in both nominal (no adjustment for inflation) and real (inflation-adjusted) terms. In real terms, copper prices declined and real (inflation-adjusted) terms. In real terms, copper prices declined steeply from the early 1970s through the mid-1980s as demand fell. In steeply from the early 1970s through the mid-1980s as demand fell. In 1988–1990, copper prices rose in response to supply disruptions 1988–1990, copper prices rose in response to supply disruptions caused by strikes in Peru and Canada but later fell after the strikes caused by strikes in Peru and Canada but later fell after the strikes ended. Prices declined during the 1996–2002 period but then increased ended. Prices declined during the 1996–2002 period but then increased sharply starting in 2005.sharply starting in 2005.

COPPER PRICES, 1965–2011COPPER PRICES, 1965–2011

COPPER COPPER SUPPLY AND SUPPLY AND DEMANDDEMAND

The shift in the The shift in the demand curve demand curve corresponding corresponding to a 20% to a 20% decline in decline in demand leads demand leads to a 10.7% to a 10.7% decline in decline in priceprice..


THE LONG-RUN BEHAVIOUR OF NATURAL THE LONG-RUN BEHAVIOUR OF NATURAL RESOURCE PRICESRESOURCE PRICES

LONG-RUN MOVEMENTS OF SUPPLY AND DEMAND FOR MINERAL RESOURCES

Although demand for most resources has increased dramatically over Although demand for most resources has increased dramatically over the past century, prices have fallen or risen only slightly in real the past century, prices have fallen or risen only slightly in real

(inflation-adjusted) terms because (inflation-adjusted) terms because cost reductions cost reductions have shifted the have shifted the supply curve to the right just as dramatically.supply curve to the right just as dramatically.

SUPPLY AND DEMAND FOR NEW YORK CITY OFFICE SPACESUPPLY AND DEMAND FOR NEW YORK CITY OFFICE SPACE

Following 9/11 the supply curve shifted to the Following 9/11 the supply curve shifted to the left, but the demand curve also shifted to the left, but the demand curve also shifted to the left, so that the average rental price fell.left, so that the average rental price fell.

THE EFFECTS OF 9/11 ON THE SUPPLY AND THE EFFECTS OF 9/11 ON THE SUPPLY AND DEMAND FOR NEW YORK CITY OFFICE SPACEDEMAND FOR NEW YORK CITY OFFICE SPACE

ConclusionConclusion

“The key is to make things as The key is to make things as simple as possible, but not simple as possible, but not one bit simpler” one bit simpler” Albert EinsteinAlbert Einstein

Casestudy : TESCOCasestudy : TESCO

1.1. Read and prepare the Read and prepare the Casestudy on TESCO Casestudy on TESCO (Johnson, Whittington & (Johnson, Whittington & Scholes (2011)) for Scholes (2011)) for discussion and discussion and presentation next week. presentation next week.

2.2. Identify and evaluate the Identify and evaluate the challenges facing TESCO’s challenges facing TESCO’s global expansion by global expansion by conducting External conducting External Environment analysis Environment analysis (PESTEL);and Industry (PESTEL);and Industry (5+1 Forces) analysis.(5+1 Forces) analysis.

Core ReadingCore Reading

• Keat, Paul G. and Young, Philip KY (2009) Managerial Economics, 6th edition, Pearson

• Samuelson, William F. and Marks, Stephen G.(2010) Managerial Economics, 6th edition, John Wiley

• Pindyck, Robert S. and Rubinfeld, Daniel L.(2013) Microeconomics, 8th edition, Pearson

• Samuelson, P.A. and Nordhaus, W. D. Samuelson, P.A. and Nordhaus, W. D. (2010)(2010)“Economics”“Economics” Irwin/McGraw-Hill, 19Irwin/McGraw-Hill, 19thth EditionEdition

• Porter, Michael E. (2004)Porter, Michael E. (2004)“Competitive Strategy – “Competitive Strategy – Techniques for Analyzing Industries and Competitors”Techniques for Analyzing Industries and Competitors” Free PressFree Press

Questions?Questions?

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Mba1014 supply and demand 010513

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