Transcript Unit 2

Unit 2
Market Demand, Supply,
And Prices (Ch. 2)
Input Suppliers to Cut Production
 Sam, the CEO of PC Solutions, recently read a WSJ
article that quoted executives of Samsung and of Hyundia
indicating those companies would be reducing their
production of PC memory chips. The article went on to
say a third company, LG Semicon, would likely follow
suit. Collectively, these three companies produce about
one-third of the world’s basic semiconductor chips. As
part of their operations, PC Solutions buys PC memory
chips. The company is relatively small but has been
growing (e.g. 100% last year) and is in the process of
deciding whether or not to double its workforce. Should
PC Solutions’ plans be impacted by the WSJ article?
Using S & D Projections
 Sue, a commodity merchandiser for KonAgra, is
aware that the current market price of a
commodity she trades is $1.50 per unit. Her
company has just projected for this commodity a
new near-term market supply of P = .01Q and
market demand of P = 4 - .01Q. What should she
expect to happen to the price of this commodity
near term? Should her merchandising actions be
impacted by this new, updated information?
A Shortage?
In recent years, there has been a significant
increase in the amount of corn-based
ethanol produced in the state of Iowa. As a
result, numerous popular press articles
have questioned whether or not the state
will see a “shortage” of corn production.
What would this mean and is it likely to
happen?
Demand of Microsoft’s Dos
In the late 1970’s, Microsoft developed the
DOS operating system, initially designed
for IBM computers. Microsoft pursued a
relatively low pricing strategy for its DOS
product to encourage consumers to buy
more ‘DOS” computers. Were there any
other controllable factors that Microsoft
used to its advantage to increase the
demand for its product?
S & D Managerial Implications
 Understand how P’s are determined in order to
anticipate P changes
 Understand how P changes impact consumers &
producers (i.e. coordinate economic activities)
 Understand how to capitalize on anticipated P
changes
• buying
• maintaining inventory
• selling
• contracting
• producing
• staffing
Why Prices are Important to Firms
1. Influence $ sales if a firm is a seller
e.g.
total revenue = TR = P  Q
2. Influence $ expenses if a firm is a buyer
e.g. Total cost = TC = P  Q
=> Firms want to “Buy low, sell high”!
Market Demand Curve
Shows the amount of a good that will be
purchased at alternative prices.
Law of Demand
– The demand curve is downward sloping.
Demand Curves are associated with
a given:
1. Product (specified ‘dimensions’)
→ quality or type
→ location
→ time period
2. Number of buyers
→ one consumer/buyer
→ all customers of a given firm
→ all customers in a given geographic
area (i.e. market)
Output or Product
Markets
Firms
Households
D Outputs
S Inputs
D Inputs
S Outputs
Input or Factor
Markets
Note: Physical items flow clockwise; payments flow
counter clockwise.
General Demand Function
 An equation representing the demand curve
Qxd  f ( Px , PY , M , H ,)

Qxd
=
 Px
=
 PY
=
M
H
=
=
quantity demand of good X.
price of good X.
price of a related good Y (substitute or
complement).
income.
any other variable affecting demand.
Factors That Affect D for X
(controllable and non controllable)
Px = P of that product (or item) (note ΔP could be caused by Δ supply)
P and/or availability of another item (e.g. Y)
1.
2.
a.
b.
Income (I)
3.
a.
b.
Inferior (↑ I => ↓ D for X)
Normal (↑ I => ↑ D for X)
Type of Item
4.
a.
b.
Luxury
Necessity
Buyer concerns or expectations
5.
a.
b.
c.
d.
6.
7.
8.
9.
10.
11.
12.
Substitutes (↑ P => ↑ D for X)
Complements (↑ PY => ↓ D for X)
Safety and/or health
Quality (warranty ?)
Future cost/availability
Service
Advertising
Tastes and preferences
No. of buyers or alternative uses
Govt. policy (e.g. tax)
Seasonality
Interest rates
Profitability of an input (i.e. = derived demand)
Specific Demand Function
Q  a  bPx  cPY  dM  eH
d
x

inverse’ demand equation would be the
above equation solved for Px given
the values of all the other demand
factors
Effects of D Factor Changes
Qx
  Qx for each 1unit  Px  b
Px
Qx
  Qx for each 1unit  M  d
M
Change in Demand
(due to P of THAT product)
Change in Demand
(Due to a  other than P of THAT product)
Quote of the Day
“In this world, there are two ways to get rich:
#1. Produce something valuable and sell
it to others.
#2. Steal from those who are successful
at pursuing the first strategy.”
N. Gregory Mankiw
Fortune (June 12, ’00)
The Progression of Economic
‘Value’
Product
Commodity
Goods
Services
Experiences
Transformation
‘Activity’
Extract
Produce
Deliver
Stage
Guide
Buyer
Market
Customer
Client
Guest
Aspirant
Mass Customization (by Pine, ’93)
Specific D Function Example
Qx = 20 – Px + 2Py
If Py = 5,
=> Px = 30-Qx (= ‘inverse’ D function equation)
 If Py = 10,
=> Px = 40-Qx
Note, an increase in the price of Y has increased
The vertical axis intercept without changing the
Slope of the original D curve. Thus, there has
Been a parallel shift to the right of the D curve for X.
Consumer Surplus
• The value consumers get from a good but do not
have to pay for.
Market Supply Curve
The supply curve shows the amount of a
good that will be produced at alternative
prices.
Law of Supply
– The supply curve is upward sloping.
General Supply Function
 An equation representing the supply curve:
QXS=f(PX, PR, W, H,)
 QXS = quantity supplied of good X.
 PX = price of good X.
 PR = price of a related good.
 W = price of inputs (e.g. wages)
 H = other variable affecting supply
Factors that Affect S of X
(controllable and non controllable)
Px = P of that product or item (note ΔP could be caused
by ΔD)
2. P or profitability of an alternative production item (e.g.
Y) (↑ PY => ↓ S of X)
3. P or cost of an input (e.g. Z) (↑ PZ => ↓ S of X)
4. Taxes
5. Interest rates
6. Gov’t policies/regulations
7. Technology
8. Producer expectations
9. Weather
10. Number of producers
1.
Specific Supply Function
 QXS = a+bPX+cPY+dW+eH
 ‘inverse’ supply equation would be the
above equation solved for PX given the
values of all the other supply factors
Effects of S Factor Changes

Qx
  Qx for each 1unit  Px  b
Px
Qx
  Qw for each 1unit  W  d
W
Change in Supply
(Due to P of THAT product)
 A to B: Increase in quantity supplied
Change in Supply
(Due to  other than P of THAT product)
S0 to S1: Increase in supply
Specific S Function Example
 QX = 2PX – W
if W = 5,
 QX = 2PX – 5
 PX = 2.5 + .5QX
if W = 10,
 PX = 5 + .5QX
Producer Surplus
The amount producers receive in excess of
the amount necessary to induce them to
produce the good.
Market Equilibrium
 Balancing supply and demand
QXS = QXD
 Steady-state
If price is too high . . .
If price is too low . . .
Equilibrium Price =
That price for which the amount buyers are
willing and able to buy equals the amount
producers are willing and able to sell
Solving for Equil P
Equil  S price = D price
 0 + .01Q = 4 - .01Q
 .02Q = 4
 Q = 200
 P = 0 + .01 (200)
 P = 2.00
Equilibrium Over Time
Equilibrium Changes
Case
1. D
2. D
3. S
4. S
5. D, S
6. D, S
7. D, S
8. D, S
P




?


?
Q





?
?

S and D Observations
1.A shift of a D curve  P  QS
(movement along S curve)
P
S
D1
D2
Q
S and D Observations
2. A shift of a S curve  P 
QD (movement along D curve)
P
S2
S1
D
Q
S and D Observations
3. A P in ONE market may  shift in S or
D in ANOTHER market
(e.g. all products if they become too expensive, are
likely to have substitutes)
Favorite Trading Rules
“The reaction of the market to news is
more important than the news itself.”
“People who buy headlines end up selling
newspapers.”
“Facts are priceless – opinions are
worthless.”
Rich Felthaus, Refco, July 2004
Big Picture: Impact of decline in
component prices on PC market
Big Picture: Impact of lower PC
prices on the software market
Market Equilibrium & NSW
NSW
=
net social welfare
=
PS + CS
Max NSW  P = Pe
P
S
CS
Pe
PS
D
Qe
Q
NSW Impacts: Q & P

NSW
=
=
=
=
=
 net social welfare
PS + CS
(a-c) + (-a-b)
-c –b
net welfare loss (deadweight loss)
Price Restrictions
 Price Ceilings
– The maximum legal price that can be charged
– Examples:
• Gasoline prices in the 1970s
• Housing in New York City
• Proposed restrictions on ATM fees
 Price Floors
– The minimum legal price that can be charged
– Examples:
• Minimum wage
• Agricultural price supports
Impact of a Price Ceiling
Impact of a Price Floor
Incidence of a Tax
Pb is the price (including the tax) paid by buyers. Ps is the price that sellers
receive, net of the tax. Here the burden of the tax is split about evenly
between buyers and sellers. Buyers lose A + B, sellers lose D + C, and the
government earns A + D in revenue. The deadweight loss is B + C.