Chapter 8
Understanding Markets and
Industry Changes
Managerial Economics: A Problem Solving Approach (2nd Edition)
Luke M. Froeb, luke.froeb@owen.vanderbilt.edu
Brian T. McCann, brian.mccann@owen.vanderbilt.edu
Website, managerialecon.com
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 – 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).
Chapter 8 – Summary (cont.)
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•
•
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 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%.
• Discussion: What will happen next? Why?
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
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
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
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 wealthcreating transactions.
Price
$12
$11
$10
$9
$8
$7
$6
$5
$4
Demand
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Supply
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Using supply and demand
• Supply and demand curves can be used to describe changes
that occur at the industry level
Portable generator market 1997-1998
• 1997- Stable industry sales with intense competition (2% avg. sales
growth)
• 1997- Industry anticipates record demand will occur in 1999
• 1998 – Massive capital expenses throughout industry on vertical
integration projects
Portable generator market 1999 +
• 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
Generator demand shifts graph
Using supply and demand (cont.)
• Discussion: “over the past decade, the price of computers
has fallen, while quantity has risen.” How? Why?
Problem: commercial paper
• In September 2008 there was a significant
increase in prices and decrease in quantity in
the commercial paper market
Commercial paper problem (cont.)
• In the second week of September the price of
the loans (interest rate) shot up
Commercial paper: Question
• These changes spooked Treasury Secretary
Paulson and Federal Reserve Chairman Ben
Bernanke, and they were characterized as a
“freeze” in the market for short-term
lending, the essential “grease” that
facilitates the movement of assets to highervalued uses.
• What could have accounted for these
changes?
Commercial paper: Answer
• After a few big bank failures, commercial
lenders became increasingly worried that
borrowers would not be able to repay the
commercial paper loans.
• This resulting decrease in supply caused both
an increase in the price of borrowing (the
interest rate) and a decline in the amount of
lending.
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
Prices convey information
(cont.)
• Discussion: Gas pipeline burst between Tucson and
Phoenix
• What happened to gas prices in Phoenix, in Tucson and in
Los Angeles?
Market makers (cont.)
• If there were but a single (monopoly) market
maker, how much would she offer the sellers
(the bid)?
• How much would she charge the buyers (the
ask)?
• How many transactions would occur?
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 Bill Christie’s research
• On May 27, spreads collapsed
• Discussion: WHY?
Alternate intro anecdote
• Video enhancement products are state-of-theart 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
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?
1. Introduction: What this book is about
Managerial Economics 2. The one lesson of business
3. Benefits, costs and decisions
Table of contents
4. Extent (how much) decisions
5. Investment decisions: Look ahead and reason back
6. Simple pricing
7. Economies of scale and scope
8. Understanding markets and industry changes
9. Relationships between industries: The forces moving us towards long-run equilibrium
10. Strategy, the quest to slow profit erosion
11. Using supply and demand: Trade, bubbles, market making
12. More realistic and complex pricing
13. Direct price discrimination
14. Indirect price discrimination
15. Strategic games
16. Bargaining
17. Making decisions with uncertainty
18. Auctions
19. The problem of adverse selection
20. The problem of moral hazard
21. Getting employees to work in the best interests of the firm
22. Getting divisions to work in the best interests of the firm
23. Managing vertical relationships
24. You be the consultant
EPILOG: Can those who teach, do?
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