l as Causas de la guerra e tiope -s omalí de
3. El desarrollo de la guerra
a. Period of time in which new sellers may enter a market or the original sellers may exit from a market. This period is long enough for existing sellers to either increase or decrease their fixed factors of production. Examples of fixed factors include prop-erty, plant, and equipment. A long-run adjustment by sellers can be seen graphically as a shift in a given supply curve.
b. Period of time in which buyers may react to a change in equilibrium price by chang-ing their tastes and preferences or buychang-ing patterns. (The Wall Street Journal and other sources of business news may refer to this as a “structural change” in demand.) A long-run adjustment by buyers can be seen graphically as a shift in a given demand curve.
Another good way of distinguishing the short run from the long run is to note that the rationing function of price is a short-run phenomenon, whereas the guiding function is a long-run phenomenon.
Let us summarize the short-run “rationing function” and the long-run “guiding function” of price in terms of our example involving pizza and hot dogs:
1. Changing tastes and preferences cause the demand for pizza to increase and the de-mand for hot dogs to decrease.
2. The changing demand for the two products causes a shortage in the pizza market and a surplus in the hot dog market.
3. In response to the surplus and shortage in the two markets, price serves as a rationing agent by decreasing in the hot dog market and increasing in the pizza market. That is, the short-run response by suppliers of the two products is to change their variable inputs (i.e., movement downward along the supply line in the market for hot dogs, and move-ment upward along the supply line in the market for pizza).
4. In the long run, price fulfills its guiding function by causing sellers and potential sellers to respond by increasing capacity or entering the market for pizza and by decreasing
2For Smith, the “visible” hand was that of the government, which might try to dictate the allocation of resources among different markets by the command process rather than by the market process.
capacity or leaving the market for hot dogs (i.e., rightward shift in the supply line for pizza and leftward shift in the supply line for hot dogs).
5. As a result of the shifts in supply, new equilibrium levels of price and quantity are es-tablished. The new quantities bought and sold represent shifts in resources out of one market and into the other.
The distinction between short- and long-run changes in the market can also be made in cases that begin with changes in supply rather than in demand. A classic ex-ample is the case of the Organization of Petroleum Exporting Countries (OPEC) and the world oil market. In the early 1970s, OPEC conspired to raise the price of oil by limiting production to an amount that would support a price above the current level.
The supply-and-demand diagram shown in Figure 3.8 illustrates this action. Table 3.6 provides a brief description of this illustration. As we can see, limiting the production of oil can be envisioned as a leftward shift in the supply line to the level where it in-tersects the demand curve for oil at some designated point above the current market price (i.e., P2 rather than P1). The short-run response by consumers to the increase in oil prices was to reduce their consumption of oil. However, in the terms specific to our analysis, this reduction can be seen as a decrease in the quantity demanded for oil.
In other words, the decrease in the supply of oil (i.e., the shift of the supply line to the left) prompted a movement back along the demand curve for oil.
Over time, U.S. consumers began to change their pattern of oil consumption as a result of the high price. They formed car pools, bought more fuel-efficient cars, lowered their thermostats in their homes, and even tried to follow the new 55-mph speed limit established on highways throughout the country. Industrial users of oil responded by substituting more fuel-efficient machinery as soon as it became cost efficient to make these changes. The effect of this long-run change in the pattern of oil usage caused the demand for oil to gradually fall. Graphically, this is presented by a leftward shift of the demand curve for oil from D1 to D2. Notice that as a result of this long-run shift in demand, the equilibrium price and quantity fell. As seen in Figure 3.8, the long-run quantity that is bought and sold (i.e., Q3) was now even less than it was before this decrease in demand took place. This indicates a further shift of resources out of this market.
P2 P1 P3
Q3 Q2 Q1
D2 D1 S2
S1
"Long-run" shift in demand
"Short-run"
shift in supply
Figure 3.8 Short-Run and Long-Run Changes in Demand (in Response to an Initial Change in Supply)
The previous events occurred more than 35 years ago. After a series of ups and downs associated with such world events as the U.S. problem with Iran in the late 1970s and the 1990 Gulf War, the price of oil settled at around $20 per barrel through-out the second half of the 1990s. Sometimes, the average price even fell into the teens.
In mid-2003, the price of oil began to climb to about $50 per barrel. At first, American consumers appeared to continue with “business as usual.” An article in the New York Times at that time quoted an oncologist from Wisconsin as saying, “I don’t like gas be-ing this expensive. My drivbe-ing is integral to my job. It’s integral to my pleasure in life.
I won’t cut back on that. I might cut back on other things.” (He drove an SUV that got 18 miles to the gallon.) Another SUV owner, a nurse from Massachusetts, was also quoted. “I have to have a car,” she explained. “I have a little girl I have to drive every-where. In the suburbs you have to drive.”3
Throughout the rest of the last decade, oil prices ranged from about $30 to $90 a barrel. In 2011, the average price was about $87.4 At the time this textbook was writ-ten, the price of oil had climbed to over $100 a barrel. Among the factors cited for this increase are the effect of speculation; uncertainty in the Middle East; and the growing demand for oil by China, India, and other growth economies. (See this chapter’s sec-tion on “Global Applicasec-tions.”)
using Supply and Demand in Forecasting
Chapter 5 is devoted to the subject of demand estimation and forecasting. But we should point out here that a fundamental part of economic forecasting is to under-stand the nature of the determinants of supply and demand. Forecasting supply is somewhat easier than forecasting demand, particularly if factors such as natural disas-ters (e.g., droughts or floods in the market for food products), international conflicts, or political crises (e.g., turmoil in the Middle East) are not involved. For example, in the market for manufactured goods, one essentially needs to assess the current and future capacity of the producers. This could be done by counting the number of
INITIAL CHANGE FOLLOW-ON CHANGE
(Short-Run Time Period) (Long-Run Time Period) Increase in demand causes
price to rise
Supply increases as new sellers enter the market and original sellers increase production capacity
Decrease in demand causes price to fall
Supply decreases as less profitable firms or those experienc-ing losses exit the market or decrease production capacity
Increase in supply causes
price to fall Demand increases as tastes and preferences of consumers eventually change in favor of the product relative to substitutes
Decrease in supply causes
price to rise Demand decreases as tastes and preferences of consumers eventually change away from the product and toward the substitutes
Table 3.6 Short-Run and Long-Run Changes in the Market
3“Laissez-Faire My Gas Guzzler, Already: Never Mind the Price, Just Fill ’er Up,” New York Times, September 7, 2004.
4http://inflationdata.com/inflation/inflation_rate/historical_oil_prices_table.asp
factories in operation and their utilization rates, or by looking at the overall level of inventories in the industry.
The more difficult challenge is to estimate demand. As you see in Chapter 5, economists try to understand and forecast demand by using the statistical analysis of data collected either from historical records or from a cross section of economic en-tities (e.g., consumers, households, companies, states, regions, or countries). Much effort is made to understand the quantitative relationship between changes in the de-terminants of demand and the amount of demand of a particular good or service.
Although companies work very hard to try to quantify their understanding of the demand for their products, it is important to at least have a good understanding of the forces that affect this demand. For example:
1. Makers of PCs and notebooks are facing slower growth in the demand for their products as the demand for tablet PCs and smart phones (e.g., substitute products) continue to increase.
2. Makers of jump drives are starting to experience the same decrease in demand (as are the makers of CDs and DVDs) as more digital storage and transfer of data is done through the Internet.
Using the above examples as a guide, what impact do you think cloud computing will have on the demand for stand-alone applications such as Microsoft Office or storage devices for computers?
Supply, DeManD, anD prIce: the ManaGerIal challenGe
A critical factor that managers must consider when making decisions such as the pric-ing of products and the allocation of a company’s scarce resource is the market envi-ronment in which their company is competing. This chapter focuses on the mechanics of supply and demand in a highly competitive market. In the extreme case, the forces of supply and demand are the sole determinants of market price. This type of market is called “perfect competition.” (For complete details about this market, see Chapter 8.) Managers operating in perfectly competitive markets are simply “price takers” trying to earn a profit by making decisions about the allocation of resources based on their short- and long-run assessment of the movements of supply, demand, and prices.
There are other types of competitive markets in which firms act as “price mak-ers” by exercising varying degrees of control over the price of their product. We refer to this type of market as “imperfectly competitive” and the control of market price as market power. This power to strongly influence market price may stem from these firms’ ability to differentiate their product through advertising, brand name, or spe-cial features or add-on services. Also, many oligopolistic firms hold extremely large shares of the market, and their sheer size enables them to dictate prices. (Microsoft and its products for the PC immediately come to mind as an example.) Nonetheless, supply and demand do establish the overall framework in which prices are set. For example, regardless of how strong the market power of a firm, it would be extremely difficult for it to raise prices in the face of falling or sluggish market demand.
Global applIcatIon: the brIc countrIeS anD the Supply anD DeManD For oIl
By now, you must have seen many photos or YouTube videos of traffic jams in the major cities of China. Perhaps you have personally experienced a Beijing traffic jam.
If you have, then you will not need any statistics to tell you that, along with the amaz-ing growth of the BRIC countries over the past decade has come their increasamaz-ing
appetite for oil as well as for coal and natural gas. The graphs in Figure 3.9 give you a general idea of the current supply and demand conditions for oil. Notice that one of the BRICs, Russia, is the leading producer of oil among the BRIC and G6 coun-tries. Of course, the United States is the leading consumer. But notice how China has reached the point where its daily oil consumption is about half that of the United States. Indeed, the growing demand for gasoline by Chinese drivers was cited as one of the reasons for the marked increase in gasoline prices in the United States in the first half of 2012. More important, oil consumption by China and India is expected to quadruple by 2030.5
0 2,000 4,000 6,000 8,000 10,000 12,000 Oil production
(thousand barrels per day)
Russia China Brazil India U.S. Britain Italy Japan Germany France (a)
0 5,000 10,000 15,000 20,000 Oil consumption
(thousand barrels per day)
U.S. Japan Germany France Britain Italy China India Russia Brazil (b)
Figure 3.9 Production and Consumption of Oil in the BRICs and Other Countries
Source: Charts © 2011 Deloitte Global Services Limited (“DGSL”), used with permission. Charts incorporate preexisting information from BP Statistical Review of World Energy, June 2010 edition (based on 2009 year-end data). DGSL has no connection or affiliation with BP or the BP Statistical Review of World Energy publication.
Please see the copyright page for the full attribution and disclaimer notices pertaining to these charts.
5http://the-diplomat.com/china-power/2011/11/07/china-brics-and-the-environment/
6John Gapper, “Comment: Organic Foods Stores Are on a Natural High,” Financial Times, September 16, 2004.
The Solution
Rather than present her findings in a formal report using overhead slides, Nicole believed she would be more effec-tive by simply providing her boss with an informal briefing. In fact, Nicole noticed a backlash among senior execueffec-tives regarding the excessive use of huge “decks” of slides. They actually seemed to detract from the presenter’s message.
She knew she could send Bob all the details in a complete deck after she made her key points to him in this informal discussion.
“Bob, my staff has carefully gone over all available information about the potential market for tea. Right now the supply of the standard tea in a bag that the majority of Americans continue to drink is provided by three dominant players: Lipton (owned by our archrival, Unilever), Bigelow (with its leading brand, Constant Comment), and Twinings (with its British teatime image). But the real growth of this market is in the hundreds of varieties of green teas, exotic black teas, and even white and red teas. And right now, the supply for these varieties is being met by hundreds of specialty companies, many of whom distribute their product online and through retail stores. More important, these suppliers of ‘designer teas’ are able to charge a higher price than the standard teas sold by the large incumbents be-cause of the strength and nature of the demand for this product. And it’s not just the successful startups such as The Republic of Tea and Adagio Teas that are making an impact in this market. In 1999, Starbucks began offering Tazo, a brand that was started 10 years before by a small company in Portland, Oregon. Once Starbucks began selling this brand, tea sales per store tripled. In fact, there is a company based in Atlanta called Teavana that has started a chain of tea houses.
“I believe that the explosive demand for the new teas can be explained simply by using the traditional economic factors that drive the demand for any product. Let me summarize these factors:
1. The impact of income on demand: The new designer teas appeal to consumers with higher incomes. (After all, who would be more willing to pay a premium price for a cup of tea?) One way that we got an insight into this aspect of demand for expensive teas is by looking at the phenomenal growth of the retail food chain Whole Foods. Whole Foods (sometimes called jokingly ‘Whole Paycheck’) caters to exactly the same type of consumer that would buy designer teas. Indeed, next time you visit this store, check out its display of tea and coffee. You’ll be amazed at the variety (and prices) of their stock. One of the key reasons for the success of Whole Foods is an increase in the proportion of U.S. households earning $100,000 or more from 18 percent 10 years ago to 22 percent in 2004. This increase in the income segment that desires and can afford this product has clearly helped boost the overall market demand for designer teas, exotic coffees, and most of the other products sold at Whole Foods.6
2. The impact of tastes and preferences on demand: Our preliminary marketing studies indicate that the people who buy this product actually consider it a ‘necessary’ part of their life. In other words, designer tea is not simply a product, but part of a tea drinker’s lifestyle. Moreover, many people in our survey tell us that the preparation and the drinking of tea counteracts the day-to-day stresses of the high-tech, 24/7 work life that we all now seem to lead. Tea is perceived to have a more calming effect than any other beverage, particularly coffee, and even the process of brewing tea becomes a soothing ritual that breaks up the hectic pace of the work day.
3. Prices of related products: We do not know for certain, but we believe that coffee is considered a closer substi-tute for tea than either bottled water or carbonated beverages (particularly those without caffeine). Starbucks’
great success with its Tazo brand of tea indicates that many of the same people who demand fancy coffee seem to desire designer teas. In fact, tea has even been dubbed ‘the new coffee.’7 We all know what has been happen-ing to the price of coffee. No doubt the recent increase in coffee prices has helped increase the demand for its close substitute, tea.”
“Okay, Nicole, I really like this idea. But I’m not fully convinced, and I also think we should see how our new initia-tives in the energy drink business turn out before we try something else. Have your staff send me more details, and I would be particularly interested if you were able to provide me with a quantitative analysis of the impact of those fac-tors you mentioned on the demand for designer teas. But to be honest, you have really got me thinking seriously about this product. In fact, I wonder how much we would have to pay for The Republic of Tea? But maybe that’s jumping too far ahead. Let’s see the analysis first.”
7http://www.wired.com/business/2009/04/tech-millionair/
SummaRy
This chapter presents the basic elements of supply and demand. We begin by introducing the law of demand and the law of supply and the nonprice factors that affect demand and supply.
The law of demand states that, other factors held constant, the quantity demanded is inversely related to price. The law of supply states that, other factors held constant, the quantity supplied is directly related to price. Other factors that affect demand are (1) tastes and preferences, (2) income, (3) prices of related products, (4) number of buyers, and (5) future expectations.
Other factors that affect supply are (1) costs, (2) technology, (3) prices of other products that sellers can supply, (4) number of sellers, (5) future expectations, and (6) weather conditions.
Both numerical and graphical examples of supply and demand and how they interrelate to determine the equilibrium price and quantity were presented. Appendix 3A presents the same material in algebraic terms.
We study how price serves a short-run rationing function and a long-run guiding function
We study how price serves a short-run rationing function and a long-run guiding function