economics for business
chris mulhearn and howard r. vane
Lecture 2: The market
– introducing demand
& supply
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?
Consumers & demand
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
The effect of a change
in price on quantity
demanded
Price
A price rise
prompts
Note: this and later material
suggests that consumers behave
rationally. We’ll question this
assumption later
D1
Demand contracts
P3
P2
A price cut
prompts
Demand extends
P1
0
Q1
A contraction in
quantity demanded
Q2 Q3
An extension in
quantity demanded
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
D3
D1
D2
Demand curve shifts
right or left
P1
0
Q1
Q2 Q3
Decrease in demand
at all possible prices
Quantity demanded
Increase in demand
at all possible prices
Other non-price
influences on demand
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
(cont.)
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
Factors that influence
the demand for a
particular good
Factor
Price
Effect
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.
Income
Tastes &
preferences
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.
Firms and supply
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.
The effect of a
change in price on
quantity supplied
Price
A price rise
prompts
S1
P3
Supply extends
P2
A price cut
prompts
P1
0
Supply contracts
Q1
A contraction in
quantity supplied
Q2
Q3
An extension in
quantity supplied
Quantity supplied
Non-price influences
on supply
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
The effect of a change
in production costs on
supply
Price
S3 (higher production costs) S
1
S2 (lower production costs)
Supply curve shifts
to left or right
P1
0
Q1
Decrease in supply
at all possible prices
Q2
Q3 Quantity supplied
Increase in supply at
all possible prices
Factors that influence
the demand for a
particular good
Factor
Price
Input costs
Technology
Effect
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.
Market – bringing
demand and supply
together
Price
D1
S1
Excess supply
For each market a unique
equilibrium price
P3
P2
P1
Excess demand
0
Q1
Q2 Q 3
Quantity demanded
Market analysis – two
examples
Let’s buy a men’s T shirt – what price to pay?
Primark = £2
Paul 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
Primark T shirts
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
Paul Smith 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
Primark and Paul Smith
compared
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 possible
The 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 quantities
The 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
The stylized markets
compared
Paul Smith’s market
D
P
Primark’s market
S
P
P2
D
S
P1
0
Q1
Q
0
Q2
Q
Market analysis – the price
of gold
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
The price of gold
1971-2010
The 2008-09
recession
Inflation controlled
and economies
growing
1970s
stagflation
Gold prices in the future
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