Lecture 9:

SHIFTS IN SUPPLY AND DEMANDUNDERSTANDING INDUSTRY CHANGES

– Summary of main points

• 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).

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 country’s 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 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.

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%.

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.

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 company’s 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

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.

Demand increase• At a given price, more quantity demanded

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?

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.

Market equilibrium (cont.)• Proposition: In a competitive

equilibrium there are no unconsummated wealth-creating transactions.

KEY POINT #1

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

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.

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

Using supply and demand (cont.)• Discussion: “over the past decade, the price of

computers has fallen, while quantity has risen.” How? Why?

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

increaseDemand falls: Prices and quantities fallSupply rises: Prices fall, quantities riseSupply falls: Prices rise, quantities fall

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?

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

Anecdote

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

Tucson and in Los Angeles?