Mba1014 supply and demand 010513

Go Global !Go Global !
Managerial Economics :Managerial Economics :
Supply & Demand
By
Stephen OngStephen Ong
Visiting Fellow, Birmingham City UniversityVisiting Fellow, Birmingham City University
Visiting Professor, College of Management,Visiting Professor, College of Management,
Shenzhen UniversityShenzhen University
May 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 equilibriumTo define supply, demand, and equilibrium
priceprice
To identify non-price determinants of supplyTo identify non-price determinants of supply
and demandand demand
To distinguish between short-run rationingTo distinguish between short-run rationing
function and long-run guiding function offunction and long-run guiding function of
priceprice
To predict how changing world economicTo predict how changing world economic
conditions affect market price andconditions affect market price and
productionproduction
To illustrate how supply and demand can beTo illustrate how supply and demand can be
used to improve management decisionsused to improve management decisions

Market demandMarket demand
Demand for a good or service isDemand for a good or service is
defined asdefined as quantitiesquantities that peoplethat people
are ready (willing and able) to buyare ready (willing and able) to buy
at variousat various pricesprices within some givenwithin some given
time periodtime period
 Other factors besides price areOther factors besides price are
held constantheld constant

Market demand is the sum ofMarket demand is the sum of
all the individual demandsall the individual demands
ExampleExample: demand for pizza: demand for pizza

TheThe inverseinverse
relationshiprelationship
between pricebetween price
and theand the
quantityquantity
demanded of ademanded of a
good or servicegood or service
is called theis called the
Law of DemandLaw of Demand

Changes in price result in changesChanges in price result in changes
in the quantity demandedin the quantity demanded
 This is shown as movementThis is shown as movement alongalong
the demand curvethe demand curve
Changes in non-price factors resultChanges in non-price factors result
in changes in demandin changes in demand
 This is shown as aThis is shown as a shiftshift in thein the
demand curvedemand curve

Nonprice determinants ofNonprice 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 & PreferencesConsumer Tastes & Preferences
Effect on DemandEffect on Demand
Video : Domino’s Pizza TurnVideo : Domino’s Pizza Turn
AroundAround
http://www.youtube.com/watchhttp://www.youtube.com/watch?

Market supplyMarket supply
The supply of a good or service isThe supply of a good or service is
defined asdefined as quantitiesquantities that peoplethat people
are ready to sell at variousare ready to sell at various pricesprices
within some given time periodwithin some given time period
 Other factors besides price heldOther factors besides price held
constantconstant

Changes in price result inChanges in price result in
changes in the quantity suppliedchanges in the quantity supplied
 shown as movementshown as movement
alongalong the supply curvethe supply curve
 Changes in non-price determinantsChanges in non-price determinants
result in changes in supplyresult in changes in supply
 shown as ashown as a shiftshift in the supplyin the supply
curvecurve

Nonprice determinants of supplyNonprice determinants of supply
costs and technologycosts and technology
prices of other goods or servicesprices of other goods or services
offered by the selleroffered by the seller
future expectationsfuture expectations
number of sellersnumber of sellers
weather conditionsweather conditions

33
Market EquilibriumMarket Equilibrium

Market equilibriumMarket equilibrium
Equilibrium priceEquilibrium price: the price that: the price that
equates the quantity demandedequates the quantity demanded
with the quantity suppliedwith the quantity supplied
Equilibrium quantityEquilibrium quantity: the amount: the amount
that people are willing to buy andthat people are willing to buy and
sellers are willing to offer at thesellers are willing to offer at the
equilibrium price levelequilibrium price level

 Shortage:Shortage: a market situation in whicha market situation in which
the quantity demanded exceeds thethe quantity demanded exceeds the
quantity suppliedquantity supplied
 shortage occurs at a priceshortage occurs at a price belowbelow thethe
equilibrium levelequilibrium level
 Surplus:Surplus: a market situation in whicha market situation in which
the quantity supplied exceeds thethe quantity supplied exceeds the
quantity demandedquantity demanded
 surplus occurs at a pricesurplus occurs at a price aboveabove thethe
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 farmsThe mechanization of poultry farms
sharply reduced the cost of producingsharply reduced the cost of producing
eggs,eggs, shifting the supply curveshifting the supply curve
downward.downward.
•TheThe demand curve for eggs shifted todemand curve for eggs shifted to
the leftthe left as a more health-consciousas a more health-conscious
population tended to avoid eggs.population tended to avoid eggs.
THE PRICE OF EGGS & COLLEGE EDUCATIONTHE PRICE OF EGGS & COLLEGE EDUCATION

• while the real price of a collegewhile the real price of a college
education rose by 82 %.education rose by 82 %.
• As for college, increases in the costs ofAs for college, increases in the costs of
equipping and maintaining modernequipping and maintaining modern
classrooms, laboratories, and libraries,classrooms, laboratories, and libraries,
along with increases in faculty salaries,along with increases in faculty salaries,
pushedpushed the supply curve up.the supply curve up.
• TheThe demand curve shifted to the rightdemand curve shifted to the right as aas a
larger percentage of a growing number oflarger percentage of a growing number of
high school graduates decided that ahigh school graduates decided that a
college education was essential.college education was essential.
THE PRICE OF A COLLEGE EDUCATIONTHE 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 EDUCATIONTHE 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 staticsProcess of comparative statics
analysis:analysis:
state all thestate all the assumptionsassumptions needed toneeded to
construct the modelconstruct the model
begin by assuming that the model isbegin by assuming that the model is
inin equilibriumequilibrium
introduce a change in the model, sointroduce a change in the model, so
a condition ofa condition of disequilibriumdisequilibrium isis
createdcreated
find the new point of equilibriumfind the new point of equilibrium
compare thecompare the new equilibriumnew equilibrium
pointpoint with the original onewith the original one

Comparative statics: exampleComparative statics: example
Step 1Step 1
 assume all factorsassume all factors
except the price ofexcept the price of
pizza are constantpizza are constant
 buyers’ demand andbuyers’ demand and
sellers’ supply aresellers’ supply are
represented by linesrepresented by lines
shownshown

Step 2Step 2
begin thebegin the
analysis inanalysis in
equilibrium asequilibrium as
shown by Qshown by Q11
and Pand P11

Step 3Step 3
 assume that a newassume that a new
study shows pizza tostudy shows pizza to
be the mostbe the most
nutritious of all fastnutritious of all fast
foodsfoods
 consumersconsumers increaseincrease
their demandtheir demand forfor
pizza as a resultpizza as a result

Step 4Step 4
thethe shift inshift in
demanddemand resultsresults
in a newin a new
equilibrium priceequilibrium price
(P(P22))
and a newand a new
equilibriumequilibrium
quantity (Qquantity (Q22))

Step 5Step 5
comparing thecomparing the
newnew
pointpoint with thewith the
original one, weoriginal one, we
see that bothsee that both
equilibrium priceequilibrium price
and quantity haveand quantity have
increasedincreased

The short run is the period ofThe short run is the period of
time in which:time in which:
 sellers already in the market respond tosellers already in the market respond to
a change in equilibrium price bya change in equilibrium price by
adjustingadjusting variable inputsvariable inputs
 buyers already in the market respond tobuyers already in the market respond to
changes in equilibrium price by adjustingchanges in equilibrium price by adjusting
the quantity demanded for the good orthe quantity demanded for the good or
serviceservice

Short run changes show the rationingShort run changes show the rationing
function of pricefunction of price
 The rationing function of price is theThe rationing function of price is the
change in market price to eliminate thechange in market price to eliminate the
imbalance between quantities supplied andimbalance between quantities supplied and
demanded is the change in market price todemanded is the change in market price to
eliminate the imbalance between quantitieseliminate the imbalance between quantities
supplied and demandedsupplied and demanded

Short-run analysisShort-run analysis
an increase inan increase in
demanddemand
causescauses
price andprice and
quantity to risequantity to rise

aa dedecrease increase in
demanddemand
causescauses
price andprice and
quantity to fallquantity to fall

anan inincrease increase in
supplysupply causescauses
price to fallprice to fall
andand
quantity to risequantity to rise

aa dedecrease increase in
supplysupply causescauses
price to riseprice to rise
andand
quantity to fallquantity to fall

WAGE INEQUALITYWAGE INEQUALITY IN USAIN USA
 Over the past two decades, the wages of skilled high-incomeOver the past two decades, the wages of skilled high-income
workers have grown substantially, while the wages of unskilledworkers 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 theFrom 1978 to 2009, people in the top 20 percent of the
income distribution experienced an increase in theirincome distribution experienced an increase in their
average real (inflation-adjusted) pretax householdaverage real (inflation-adjusted) pretax household
income ofincome of 45%45%, while those in the bottom 20, while those in the bottom 20
percent saw their average real pretax income increasepercent saw their average real pretax income increase
by onlyby only 4%4%
 While the supply of unskilled workers—people with limitedWhile the supply of unskilled workers—people with limited
educations—has grown substantially, the demand for them haseducations—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 grownengineers, scientists, managers, and economists—has grown
slowly, the demand has risen dramatically, pushing wages up.slowly, the demand has risen dramatically, pushing wages up.

Long run analysisLong run analysis
The long run is the period ofThe long run is the period of
time in which:time in which:
 new sellersnew 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 theLong run changes show the
allocating function of priceallocating function of price
The guiding or allocating function ofThe guiding or allocating function of
price is the movement of resourcesprice is the movement of resources
into or out of markets in response to ainto or out of markets in response to a
change in the equilibrium pricechange in the equilibrium price

Long-run analysisLong-run analysis
 initial change:initial change: dedecreasecrease
in demand from Din demand from D11 to Dto D22
 result: reduction inresult: reduction in
equilibrium price andequilibrium price and
quantity (to Pquantity (to P22,Q,Q22))
 follow-on adjustment:follow-on adjustment:
movement ofmovement of
resources out of theresources out of the
marketmarket
leftward shift in theleftward shift in the
supply curve to Ssupply curve to S22
 equilibrium priceequilibrium price
and quantity (toand quantity (to
PP33,Q,Q33))

Long-run analysisLong-run analysis
 initial change:initial change:
inincrease in demandcrease in demand
from Dfrom D11 to Dto D22
 result: increase inresult: increase in
equilibrium price andequilibrium price and
 follow-on adjustment:follow-on adjustment:
 movement ofmovement of
resources into theresources into the
marketmarket
 rightward shift in therightward shift in the
supply curve to Ssupply curve to S22
 equilibrium price andequilibrium price and

Supply, demand, and price:Supply, demand, and price:
the managerial challengethe managerial challenge
 in the extreme case, the forces of supply andin the extreme case, the forces of supply and
demand are the sole determinants of thedemand are the sole determinants of the
market price, not any single firmmarket price, not any single firm
 this type of market is ‘perfectthis type of market is ‘perfect
competition’competition’
 in many cases, individual firms can exertin many cases, individual firms can exert
market powermarket power over price because ofover price because of
their:their:
 dominant sizedominant size
 ability to differentiate their productability to differentiate their product
through advertising, brand name,through advertising, brand name,
features, or servicesfeatures, or services

Eg.Eg.: COFFEE: COFFEE
 ‘‘buy lowbuy low, sell, sell
high’high’
 2000:over2000:over
production led toproduction led to
price fallsprice falls
 2004: prices2004: prices
moved up againmoved up again
 Starbucks effectsStarbucks effects

Eg.Eg.: Air Travel: Air Travel
 ‘‘buy high,buy high, sell low’sell low’
 industry de-industry de-
regulated in lateregulated in late
1970s1970s
 tight competitiontight competition
 post 9/11, a low-post 9/11, a low-
cost structure iscost structure is
neededneeded

Global applicationGlobal application
Eg.Eg.: COPPER market: COPPER market
 abundant metalabundant metal
 strategic itemstrategic item
 nominal pricesnominal prices
risingrising
 improved miningimproved mining
technologytechnology
 closure ofclosure of
uneconomic minesuneconomic mines

THE LONG-RUN BEHAVIOUR OF NATURALTHE LONG-RUN BEHAVIOUR OF NATURAL
RESOURCE PRICESRESOURCE PRICESCONSUMPTIONCONSUMPTION
AND PRICE OFAND PRICE OF
COPPERCOPPER
Although annualAlthough annual
consumption ofconsumption of
copper hascopper has
increased aboutincreased about
a hundredfold,a hundredfold,
the realthe real
(inflation-(inflation-
adjusted) priceadjusted) price
has not changedhas not changed
much.much.

• After reaching a level of aboutAfter 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 60of copper fell sharply to about 60
cents per pound in 1986.cents per pound in 1986.
• Worldwide recessions in 1980Worldwide recessions in 1980
and 1982and 1982 contributed to thecontributed 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 afterWhy did the price increase so sharply after
2003?2003?
• First, theFirst, the demanddemand for copper fromfor copper from
China and other Asian countriesChina and other Asian countries
began increasing dramatically.began increasing dramatically.
• Second, because prices had droppedSecond, because prices had dropped
so much from 1996 through 2003,so much from 1996 through 2003,
producers closed unprofitable minesproducers closed unprofitable mines
andand cut productioncut production..
What would a decline in demand do to theWhat 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 declinedand real (inflation-adjusted) terms. In real terms, copper prices declined
steeply from the early 1970s through the mid-1980s as demand fell. Insteeply from the early 1970s through the mid-1980s as demand fell. In
1988–1990, copper prices rose in response to supply disruptions1988–1990, copper prices rose in response to supply disruptions
caused by strikes in Peru and Canada but later fell after the strikescaused by strikes in Peru and Canada but later fell after the strikes
ended. Prices declined during the 1996–2002 period but then increasedended. 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

COPPERCOPPER
SUPPLY ANDSUPPLY AND
DEMANDDEMAND
The shift in theThe shift in the
demand curvedemand curve
correspondingcorresponding
to a 20%to a 20%
decline indecline in
demand leadsdemand leads
to a 10.7%to a 10.7%
decline indecline in
priceprice..

THE LONG-RUN BEHAVIOUR OF NATURALTHE 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 overAlthough demand for most resources has increased dramatically over
the past century, prices have fallen or risen only slightly in realthe past century, prices have fallen or risen only slightly in real
(inflation-adjusted) terms because(inflation-adjusted) terms because cost reductionscost reductions have shifted thehave 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 theFollowing 9/11 the supply curve shifted to the
left, but the demand curve also shifted to theleft, 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 ANDTHE 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 asThe key is to make things as
simple as possible, but notsimple as possible, but not
one bit simpler”one bit simpler”
Albert EinsteinAlbert Einstein

Casestudy : TESCOCasestudy : TESCO
1.1. Read and prepare theRead and prepare the
Casestudy on TESCOCasestudy on TESCO
(Johnson, Whittington &(Johnson, Whittington &
Scholes (2011)) forScholes (2011)) for
discussion and presentationdiscussion and presentation
next week.next week.
2.2. Identify and evaluate theIdentify and evaluate the
challenges facing TESCO’schallenges facing TESCO’s
global expansion byglobal expansion by
conducting Externalconducting External
Environment analysisEnvironment 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

Mba1014 supply and demand 010513

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