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Any Questions from Last
Class?
Chapter 8
Understanding Markets and
Industry Changes
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 – Take Aways

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 – Take Aways

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 convey valuable information.

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.
Review of Chapter 7




Increasing marginal costs
Increasing returns to scale
Learning curves
Economies of Scope


Cost(Q1,Q2) <Cost(Q1)+Cost(Q2)
Bottom line: begin with a decision, not a cost
Anecdote: Y2K and Generator Sales


1990-98, sales of portable generators grew
2% yearly.
In 1999, public anticipation of Y2K power
outages increased demand for generators



Industry shipments increased by 87%.
Prices also increased by an average of 21%.
Discussion: What will happen next?
Which Industry or Market?

Time, product, and geographic dimension

Yearly market for portable generators in the
U.S.

Time: LR vs. SR

Product

Geography

Which do you use?

It depends on what you want to use it for
Shifts in the Demand Curve

Movement along the demand curve



“Quantity demanded” increased (in response to price change)
Shifts in demand curve

“Demand increased”

Uncontrollable factor

Controllable factor
Discussion: In early 80s, what strategy did Microsoft employ to increase
demand for its DOS operating system?

Contrast to Apple
Demand Shift
$
$
$
$
$
$
$
$
$
Price
12.00
11.00
10.00
9.00
8.00
7.00
6.00
5.00
4.00
Demand
1
2
3
4
5
6
7
8
9
New
Demand
5
6
7
8
9
10
11
12
13
$14.00
$12.00
Price
$10.00
New Demand
$8.00
Demand
$6.00
$4.00
$2.00
$0.00
0
2
4
6
8
10
12
Quantity
At a given price, more quantity demanded
14
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?
Price
$12
$11
$10
$9
$8
$7
$6
$5
$4
Supply
9
8
7
6
5
4
3
2
1
Price

$14.00
$12.00
$10.00
$8.00
$6.00
$4.00
$2.00
$0.00
0
2
4
6
Quantity
8
10
Market Equilibrium

Definition: Market equilibrium is the price at
which quantity supplied equals quantity
demanded.

At the equilibrium price, there is no pressure
on 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
1
2
3
4
5
6
7
8
9
Supply
9
8
7
6
5
4
3
2
1
$14.00
$12.00
$10.00
Price

$8.00
Supply
$6.00
Demand
$4.00
$2.00
$0.00
0
2
4
6
Q u an ti ty
8
10
Using Supply and Demand
Price
$12
$11
$10
$9
$8
$7
$6
$5
$4
Demand
1
2
3
4
5
6
7
8
9
Supply
9
8
7
6
5
4
3
2
1
New
Demand
5
6
7
8
9
10
11
12
13
$15
Demand
Price
$10
Supply
$5
New
Demand
$0
0
5
Quantity
10
15
Portable Generator Market 1997-1999



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 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
Supply and Demand of Generators
1400
1998
Demand
1999
Demand
1998
Supply
$/Unit (Industry Average)
1200
1999
Supply
1000
800
B
A
600
1998
400
1999
C
200
2000
0
0
500
1000
Unit Sales (000's)
1500
2000
Using Supply and Demand (cont.)

Discussion: “over the past decade, the price of
computers has fallen, while quantity has risen.”
Initial Supply
P0
Final Supply
P1
Q0
Q1
Using Supply and Demand (cont.)

Discussion: Following a dramatic devaluation of the
Peso, what happens to your golf course in Tijuana?
Pesos
Supply of Golf in Tijuana
Dollars
Supply of Golf in San Diego
Demand for Golf in San Diego
New Demand
New Demand
Demand for Golf in Tijuana
Quantity
Quantity
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
Discussion: Gas pipeline bursting between Tucson
and Phoenix


Without high gasoline prices, consumers would consume
too much and suppliers would supply too little.
Price information especially important in financial
markets
Market Makers

Market Makers
Bid
$8
$7
$6
$5
$4
Ask Quantity
$8
5
$9
4
$10
3
$11
2
$12
1
Profit
$0
$8
$12
$12
$8

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 Christie’s
research
On May 27, spreads collapsed
Discussion: WHY?
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.
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?