1. economics for business
chris mulhearn and howard r. vane

2. 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?

3. 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

4. The effect of a change in price on quantity demanded
Note: this and later material suggests that consumers behave rationally. We’ll question this assumption later
Price D1 P3
Demand contracts
A price rise prompts P2
Demand extends
A price cut prompts P1
Quantity demanded Q1 Q2 Q3
A contraction in quantity demanded
An extension in quantity demanded

5. 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

6. 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
Quantity demanded Q1 Q2 Q3
Decrease in demand at all possible prices
Increase in demand at all possible prices

7. 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

8. 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

9. Factors that influence the demand for a particular good
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.
Price
Income
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.
Tastes & preferences
Prices of other goods

10. 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.

11. The effect of a change in price on quantity supplied
A price rise prompts
Supply extends P2
A price cut prompts P1
Supply contracts Q1 Q2 Q3
Quantity supplied
A contraction in quantity supplied
An extension in quantity supplied

12. 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

13. The effect of a change in production costs on supply
S3 (higher production costs)
Price S1
S2 (lower production costs)
Supply curve shifts to left or right P1 Q1 Q2 Q3
Quantity supplied
Decrease in supply at all possible prices
Increase in supply at all possible prices

14. Factors that influence the demand for a particular good
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.
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 costs
Technology

15. Market – bringing demand and supply together
Price
Excess supply
For each market a unique equilibrium price P3 P2 P1
Excess demand Q1 Q2 Q3
Quantity demanded

16. 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

17. 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

18. 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

19. 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

20. The stylized markets compared
Paul Smith’s market
Primark’s market D S P P P2 D S P1 Q2 Q Q1 Q

21. 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

22. The price of gold 1971-2010 The 2008-09 recession
Inflation controlled and economies growing
1970s stagflation

23. Gold prices in the future
Will gold prices remain above $1,000?
If the world economy recovers only slowly from the 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