Any Questions from Last Class?

Chapter 8 Understanding Markets and Industry Changes COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

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(Q 1,Q 2 ) <Cost(Q 1 )+Cost(Q 2 ) Bottom line: begin with a decision, not a cost

Anecdote: Y2K and Generator Sales , 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

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 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.

Using Supply and Demand

Portable Generator Market Stable industry sales with intense competition (2% avg. sales growth) Industry anticipates record demand will occur in – Massive capital expenses throughout industry on vertical integration projects

Portable Generator 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

Using Supply and Demand (cont.) Discussion: “over the past decade, the price of computers has fallen, while quantity has risen.”

Using Supply and Demand (cont.) Discussion: Following a dramatic devaluation of the Peso, what happens to your golf course in Tijuana?

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

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?