economics for businesschris mulhearn and howard r. vane

Markets are the arenas in which firms & consumers (& governments) interact to determine how resources are allocated

We’re going to focus here on goods markets – markets for goods & services – as supplied by firms to consumers

Other markets that we’ll look at later include, for example, the labour market, where we’ll use the same general principles we introduce here

Because we’re looking at goods markets, we need to reflect on the aspirations of consumers & firms in these markets – what do they want & what are the chief influences on their behaviour?

Lecture 2: The market – introducing demand & supply

What determines the quantity demanded for a good or service in a market? How many Big Macs / cinema tickets / mobile phone contracts, etc.?

The most evident factor here is price

If we assume that all other influences upon demand remain unchanged (the so-called ceteris paribus assumption), then higher prices will usually be associated with a lower quantity demanded

Similarly, lower prices will usually be associated with a greater quantity demanded. We can illustrate the inverse nature of the relationship between price & quantity demanded graphically

Consumers & demand

Price

Quantity demanded0

D1

Q1 Q2 Q3

P2

A contraction in quantity demanded

An extension in quantity demanded

Demand extends

P3

P1

Demand contractsA price rise prompts

A price cut prompts

Note: this and later material suggests that consumers behave rationally. We’ll question this assumption later

The effect of a change in price on quantity demanded

None-price influences on demand

Beyond price, there are other factors which have some bearing upon the demand for a good

Here, demand refers not to a particular quantity & a particular price but to all possible prices & quantities demanded

Consider, for example, the influence of a change in the incomes of consumers on demand

If incomes rise then, ceteris paribus, we would anticipate that the demand for a normal good to increase whatever its particular price

On the other hand, a fall in consumer incomes would prompt a decrease in the demand for a normal good

The effect of a change in income on the demand for a normal good

Price

Quantity demanded0

D1

Q1 Q2 Q3

P1

Decrease in demand at all possible prices

Increase in demand at all possible prices

Demand curve shifts right or left

D2D3

The prices of other goods & services

Some goods and services have substitutes - viewing a downloaded film at home might be thought of as substitute for a visit to the cinema

On the other hand, some other goods & services are said to be complementary, in the sense that they are consumed jointly - apps for an iPhone are useless without an iPhone

So, considering the demand for paid-for apps, what would be the outcome of a fall in the price of iPhones? The expectation is that, ceteris paribus, the demand for apps would increase as more people demand iPhones & the apps that enhance them

Other non-price influences on demand

The preferences or tastes of consumers

At different times, consumers take different views as to the attractiveness of particular goods & services

For example, in every city in Britain over the last ten years there has been an explosion in the number of internationally branded coffee shops: Starbucks; Costa Coffee; Caffé Nero

This means the demand curve for coffee-shop coffee has shifted to the right

Other non-price influences on demand (cont.)

Factors that influence the demand for a particular good

Factor Effect

PricePrice

Price changes cause movements along a demand curve. Price decreases are associated with extensions in the particular quantity demanded. Price increases are associated with contractions in the particular quantity demanded.

Price changes cause movements along a demand curve. Price decreases are associated with extensions in the particular quantity demanded. Price increases are associated with contractions in the particular quantity demanded.

IncomeIncome

Tastes & preferences

Tastes & preferences

Prices of other goods

Prices of other goods

A change in any one of these factors will cause a shift in the demand curve itself, with increases or decreases in demand at every possible price.

A change in any one of these factors will cause a shift in the demand curve itself, with increases or decreases in demand at every possible price.

The role of the firm is to supply goods & services to the marketplace

So what influences firms’ decisions in respect of the quantity supplied of a particular good or service? Answer - price

The higher the price of a particular good, the greater the incentive for firms to supply it

Firms seek to maximize the profits they earn & they do this by producing as many profitable commodities as they can

A higher price for a particular good will prompt firms to raise the quantity supplied in the pursuit of greater profit.

Firms and supply

The effect of a change in price on quantity supplied

Price

Quantity supplied0

S1

Q1 Q2 Q3

P2

A contraction in quantity supplied

An extension in quantity supplied

Supply extendsP3

P1Supply contracts

A price rise prompts

A price cut prompts

There are other factors beyond price that have some bearing upon the supply of a good

Here, supply refers not to a particular quantity & a particular price but to all possible prices & quantities supplied

We have already noted that firms are interested in the profit yielded by their output & that this is a function of both price & the cost of production

It follows that lower production costs will occasion increases in supply. The nature of the link between the cost of production & supply can be illustrated graphically

Non-price influences on supply

The effect of a change in production costs on supply

Price

Quantity supplied0

S1

Q1 Q2 Q3

P1

Decrease in supply at all possible prices

Increase in supply at all possible prices

Supply curve shifts to left or right

S3 (higher production costs)S2 (lower production costs)

Factors that influence the demand for a particular good

Factor Effect

PricePricePrice changes cause movements along a supply curve. Higher prices are associated with extensions in the particular quantity supplied. Lower prices are associated with contractions in the particular quantity supplied.

Price changes cause movements along a supply curve. Higher prices are associated with extensions in the particular quantity supplied. Lower prices are associated with contractions in the particular quantity supplied.

A change in either of these factors will cause a shift in the supply curve itself, with increases or decreases in supply at every possible price.

A change in either of these factors will cause a shift in the supply curve itself, with increases or decreases in supply at every possible price.

Input costsInput costs

TechnologyTechnology

Market – bringing demand and supply together

Price

Quantity demanded0

D1

Q1 Q2 Q3

P2

S1

P3

P1

Excess supply

Excess demand

For each market a unique equilibrium price

Let’s buy a men’s T shirt – what price to pay?Primark = £2Paul Smith = £100

How can the market analysis we’ve introduced make sense of T shirt prices that vary so widely?

We have two separate markets here, with different products on offer & different conditions prevailing in each

If this were not the case people would be unwilling to pay fifty times as much as they needed to for a T shirt & Paul Smith would not be the fashion icon he undoubtedly is

Market analysis – two examples

Primark claims that its clothing is the cheapest on the high street & that its low prices arise from bulk purchasing & costless word-of-mouth advertising

Primark’s prices are also low because it sources its products globally, taking advantage of low labour cost locations

Because labour is the largest cost input, much of the world’s clothing production now takes place in countries where wages are low

It appears that Primark has a cost-driven business model: it identifies the fashions that it thinks will sell & then gets them into its shops in significant quantities as quickly & as cheaply as possible

Primark T shirts

Paul Smith’s business model is different

His products are organized in twelve distinct collections with design based in Nottingham & London, & materials sourcing & production mostly in Britain, Italy & France

Here then there is less emphasis on cost control & more on bespoke design, product quality & the personal imprimatur that Paul Smith himself places on a relatively limited range of goods

Paul Smith T shirts

By now you may be able to see where we’re going with this

On the one hand we have a bulk producer that sources globally & aspires to get price-competitive fashion into (& out of) its shops as quickly as possibleThe result is crystallized in the £2 T shirt; the £10 dress & so on: high-turnover fashion for the majority

On the other hand, there is the design-intensive western European producer of a limited range of clothing & related products in relatively constrained quantitiesThe result is the £100 T shirt, the £300 shoes, and the £650 dress: fashion for the discerning & affluent

Really, there are two distinct markets here

Primark and Paul Smith compared

The stylized markets compared

PP

0 0 QQ

D S

D S

P2

P1

Q1

Q2

Paul Smith’s market Primark’s market

Gold is a robust & highly-prized metal held in three forms

About half is used as jewellery; a further ten per cent is used in dentistry & industry; the rest is devoted to investment by the private sector, or held by the world’s central banks

Of these three sources of demand, one is especially volatile

Gold is a safe-haven asset - in turbulent periods it’s a way to store value, or even profitably speculate, so the price of gold may be thought of as largely demand-driven

In March 2008 the price of gold passed the $1,000 mark for the first ever time

Market analysis – the price of gold

The price of gold 1971-2010

1970s stagflation

Inflation controlled and economies growing

The 2008-09 recession

Will gold prices remain above $1,000?

If the world economy recovers only slowly from the 2008-09 recession then investors’ demand for gold is likely to remain strong because of the continuing risks attached to rival assets, such as property & stocks

On the other hand, a sharp upturn in the world’s economic prospects may spark fears about the macroeconomic phenomenon of inflation, which erodes the purchasing power of money

Again, in these circumstances, gold’s status as a haven asset makes it attractive to investors

Gold prices in the future