Managerial economics 3rd by froeb ch08

11

Chapter 8
Understanding
Markets and
Industry
Changes
1

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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).

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Chapter 8 – Summary (cont.)

•

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.

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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?
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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 market in question.
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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
be controlled by a company
•

Price, advertising, warranties, product quality,
distribution speed, service quality, and prices of

substitute or complementary products also owned by
the company

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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 products

•

Kept the price of DOS low

• Discussion: How did Microsoft control demand
using these factors? How did competitors

(Apple, for example) operate differently?
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Demand
increase

• At a given price, more quantity
demanded

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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?

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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.

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Market equilibrium (cont.)
• Proposition: In a competitive
equilibrium there are no
unconsummated wealth-creating
transactions.

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Using supply and demand
• Supply and demand curves can be used to describe
changes that occur at the industry level

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Portable generator market 19971998
• 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

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Generator demand shifts
graph

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Using supply and demand
(cont.)

• Discussion: “over the past decade, the price of
computers has fallen, while quantity has risen.”
How? Why?

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Problem: commercial paper
• In September 2008 there was a
significant increase in prices and
decrease in quantity in the
commercial paper market

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Commercial paper problem
(cont.)

• In the second week of September the
price of the loans (interest rate) shot up

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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 higher-valued uses.
• What could have accounted for these
changes?

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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.

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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

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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?

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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?

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Market makers

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

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Competition among market
makers
• On May 26, WSJ & LA Times published results of Bill
Christie’s research
• On May 27, spreads collapsed
• Discussion: WHY?

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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.
Copyright ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.