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 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

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

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 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

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 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

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

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

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 Primark’s market D S P P P2 D S P1 Q2 Q Q1 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