EC 252 UNA Local Market Conditions Consultant Paper

Description

You have been hired as a consultant to summarize local market conditions for a particular model of energy-efficient automobile for a US automaker. The automaker is concerned that US incomes are falling and inflationary pressures may increase in the future. Increased demand for one of the unique resources needed to produce this model are liking to rise in the future as well. Using the demand and supply schedules provided below, create a two-page report that identifies current equilibrium price and quantity in this market. In addition to identifying the current equilibrium, your client has asked you to include the following discussions in your report:Describe how consumers and producers make decisions to participate in the market.Expected change to equilibrium price and quantity if the price of a substitute good (an alternative make of auto) decreases vs the expected change if the price of a complement decreases (lithium batteries).If the increased input prices do occur as predicted, explain how the company would react and what action they would take.Finally, evaluate the change to equilibrium as income is falling and inflation is expected in the future.Make sure to include how the firm will be impacted in each scenario

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Module 2
Basics of Supply and Demand
What is supply and demand? Well, you’ll have to watch the video to really
understand it, but it’s kind of important for everything economically. Supply and
demand sets prices and indicates to manufacturers how much to produce. Also, it
has a lot to do with strawberries.

Supply and Demand of Blueberries
What do blueberries have to do with economics? Find out in less than 2 minutes.

Market for Resources
An introduction to the unique nature of resource or factor markets.

Module 2 Required Reading
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Gwartney, Stroup, Sobel and Macpherson Chapter 3: “Demand, Supply and
the Market Process”
Notes from AmosWeb Encyclonomic: Demand
The willingness and ability to buy a range of quantities of a good at a range of
prices, during a given time period. Demand is an inverse relation between price
(demand price) and quantity (quantity demanded). Demand is one half of the
market exchange process–the other is supply. This demand side of the market
draws inspiration from the unlimited wants and needs dimension of the scarcity
problem.
Demand is a fundamental aspect of market exchanges and economic activity.
Even more, it is an essential feature of human existence. People demand goods
and services to satisfy their unlimited wants and needs.
A Closer Look
Three aspects of demand are worthy of further consideration:
•
Willingness and Ability: Demand requires both willingness and ability. To
demand a good, a buyer must have a WILLINGNESS to buy it. Willingness
generally arises because the good satisfies a want or need. But while wants
and needs in total are essentially unlimited, everyone does NOT necessarily
want or need every good. Duncan Thurly, for example, does not like
asparagus. He considers asparagus vile, nasty stuff. As such, he has NO
demand for asparagus because he has NO willingness.
Demand, however, also requires ABILITY. While demand can be constrained by
the physical ability to purchase a good, income is often more important. Wants and
needs may be unlimited, but income is not. A buyer must have enough income to
make a purchase. Lisa Quirkenstone, for example, loves asparagus. Unfortunately,
she is between jobs and deeply in debt. She lacks the income needed to buy
asparagus. As such, she has NO demand for asparagus because she has NO
ability to buy.
•
Range of Prices and Quantities: Demand is a range of prices and quantities.
It includes not just the quantity purchased at the current price, but any and all
quantities that would be purchased at other prices–higher and lower. Gerald
Johnson, for example, is NOT willing and able to purchase asparagus if the
price is $1 a pound. However, if the price is 50 cents a pound, he is inclined
to purchase a few stalks. If the price is even lower, say 25 cents a pound,
Gerald will purchase an even larger quantity.
Practicing the fine art of economic analysis—market-style–involves a lot of “What
if?” questions, such as: “What would happen in the asparagus market if the price is
$1 a pound, or 25 cents a pound, or $0 a pound, or…?” Limiting analysis ONLY to
the current price, ignores a vast range of alternatives that might occur. And this
eliminates a lot, in fact almost all, of the really important analyses of markets.
•
Given Time Period: Supply is identified for a specified time period. The
analysis of asparagus supply needs information on the time period. Is the
supply for an hour, a day, a week, a month, a year, or a decade?
Presumably, people sell a larger quantity of asparagus, at a given price, over
a decade than over a week. When economists work with supply they need a
specific time period. Like adding apples and oranges, it makes no sense to
combine MegaMart’s daily asparagus supply with Discount Grocer’s annual
asparagus supply.
Price and Quantity
Supply is a range of prices and quantities. The price part of this relation is
termed supply price and the quantity part is termed quantity supplied.
•
•
Supply Price: This is the minimum price that sellers are willing and able to
accept for a given quantity of a good. They would be willing to accept more
than this price, but not less. Supply price is based on the opportunity cost of
producing the good.
Quantity Supplied: This is the specific amount of a good that sellers are
willing and able to sell at a given supply price. The quantity supplied is the
maximum amount of the goods that sellers are willing and able to sell at the
given price.
Supply price and quantity supplied come together as matched pairs. One supply
price, one quantity supplied. Supply is then the combination of these matched
price-quantity pairs.
The Law of Demand
The specific demand relation between price and quantity is termed the law of
demand. The law of demand is the inverse relation between demand price and
quantity demanded. If, in other words, the demand price increases, then the
quantity demanded decreases. The law of demand is one of the most important
and most fundamental economic principles identified in the study of markets and
economics.
The law of demand is attributable to two effects.
•
•
Income Effect: This is a change in the purchasing power of income caused
by a change in the price of a good, which then affects how much of the good
is purchased. If the price increases, for example, buyers cannot purchase as
much of the good with existing income.
Substitution Effect: This is a change in the relative price of substitute goods
caused by a change in the price of a good, which then affects how much of
the good is purchased. If the price increases, for example, buyers tend to
purchase less of the good because they are purchasing more of other goods.
A Supply Curve
The supply relation between supply price and quantity supplied is commonly
represented by a supply curve. A supply curve is nothing more than a graphical
representation of the law of supply. The supply curve presented in this exhibit
shows the relation between the supply price, measured on the vertical axis, and
quantity supplied measured on the horizontal axis.
The positive slope of the supply curve graphically illustrates the direct law of supply
relation between supply price and quantity supplied. As the supply price increases
from 5 to 50, the quantity supplied increases from 0 to 900. Sellers are willing and
able to sell more at higher prices.
Five Determinants
While supply price is the most important factor that affects the sale of a good, it is
not the only factor. Five other factors, termed supply determinants, are also
important. These determinants cause a change in the supply of a good, that is,
more or less of the good is sold at existing prices.
•
•
•
Resource Prices: The prices paid for the use of resources in the production
process affects production cost and the ability to sell a good. If resource
prices increase, then sellers are able to sell less of a good.
Technology: The information and techniques known about the production
process has a direct impact on the ability to sell a good. If sellers have an
advance in production technology, then they are able to sell more of a good.
Prices of Other Goods: The supply of one good is interrelated with the
production of other goods, and the prices of those goods. Some goods are
substitutes, produced with the same resources in an either-or fashion, others
are complements, produced jointly with the same resources. If the price of a
•
•
substitute good increases, then sellers switch to the production of that good
and sell less of this good. If the price of a complement good increases, then
sellers produce more of both goods.
Sellers’ Expectations: Sellers decide how much to sell based on a
comparison of current and expected future prices. If sellers expect a higher
price in the future, then they sell less of a good today.
Number of Sellers: The total number of sellers participating in a market
affects how much of a good is supplied. If there is an increase in the number
of sellers, then there is a greater supply of the good.
Two Changes
The study of supply highlights two related, but distinct, changes. To understand
these changes, first considered two related, but distinct, notions of supply.
•
•
Quantity Supplied: This is the specific amount that sellers are willing and
able to sell at a specific price. It is indicated as a single point on the supply
curve.
Supply: This, in contrast, is the entire set of price-quantity pairs that reflect
seller’s willingness and ability to sell a good. It is the entire supply curve.
Two interrelated changes are implied directly from the two notions.
•
•
A Change in Quantity Supplied: This is a change in the specific amount of
the good that sellers are willing and able to sell. It is caused by a change in
the supply price and is indicated by a movement along the supply curve from
one point to another.
A Change in Supply: This a change in the overall supply relation, a change in
all price-quantity pairs. It is caused by a change in one of the five supply
determinants and is indicated by a shift of the supply curve.
The difference between a change in supply and a change in quantity supplied is
essential for understanding how the market adjusts to external shocks.
Notes from AmosWeb Encyclonomic: Equilibrium
A state that exists when opposing forces are in balance, with each force exactly
offsetting the other, such that there is no inherent tendency for change. Once
achieved, an equilibrium persists unless or until it is disrupted by an outside force.
The notion of equilibrium is an essential feature in most economic models, such as
the market model.
Equilibrium is a balance of opposing forces. In the physical world, the opposing
forces might be something like positive and negative electrical charges or the north
and south poles of a magnet. In the economic world, common forces include that
of market demand and market supply.
A Little Background
Equilibrium is one of the most useful, and widely used, notions in economics.
Building on the successful use of equilibrium by physicists of the 18th century to
explain gravity, planetary motion, and other phenomena of the physical world,
economists of the 19th century adopted this useful notion when they applied
the scientific method to study the economic world.
How about a quick example?
Suppose that the twins Donna and Rhonda Newberry encounter one of those
doors that swings in and out, like what is commonly found separating the kitchen
and the dining area in restaurants. Donna is on one side trying to come into the
kitchen, and Rhonda is on the other side trying to go out. They both push and
push, but being twins with equal strength and tenacity, neither can go through.
If each continues to push for hours on end, with neither making progress (like the
Three Stooges or the Marx Brothers), then they have encountered the notion of
equilibrium. Donna is one opposing force and Rhonda is the other. And until
someone or something (perhaps the Keystone Cops) intervenes, then they
continue this stalemate, unsuccessfully pushing in opposite ways, in a state of
equilibrium.
Political Views
Although extensively used in economics, economists have two minds about
equilibrium.
•
•
Rhonda represents one mind. She contends that equilibrium is THE natural
state of the world that perpetually persists unless it is disrupted. Such
disruptions are thought to be infrequent and short lived.
Donna exhibits the other mind. She feels that equilibrium is more of a goal
that the economy pursues. This equilibrium goal is seldom if ever achieved.
And if achieved persists temporarily.
The source of this ongoing debate can be traced back at least to the ancient Greek
philosophers. The common argument is whether the universe is best characterized
by a state of “being” or a state of “flux.” This debate has yet to be settled.
More relevant to the study of economics, these two views also underlie alternative
economic policies that tend to be affiliated with different political views.
•
•
If the world tends to be IN equilibrium, then there is little or no need
for government intervention, which is consistent with a conservative political
view of limited government.
Alternatively, if the world tends to PURSUE equilibrium, then there is a
definite role for government intervention to help it along the way, which is
consistent with a liberal political view of a paternalistic government.
Alternative Theories
Whichever view is preferred, equilibrium is a handy concept underlying all sorts of
economic analysis, including the study of the market, the aggregate market,
Keynesian economics, consumer demand theory, and short-run production.
Perhaps the best-known use is the market. In a market, equilibrium is reached at a
price in which the quantity supplied is exactly the same as the quantity demanded.
•
•
Macroeconomic Flux: The study of macroeconomics tends to lean more
toward the “flux” view of equilibrium. Two key equilibrium states that are
pursued are found in the aggregate market and Keynesian economics.
Equilibrium is reached in the aggregate market at a price level in
which aggregate demand is equal to aggregate supply. Equilibrium is
reached in the study of Keynesian economics at a production level in which
aggregate expenditures are equal to aggregate production.
Microeconomic Being: Microeconomic analysis tends to be more comfortable
with the “being” view of equilibrium. In addition to the standard market model,
two other cornerstone analyses–consumer demand theory and short-run
production–rely heavily on this notion. In the theory of consumer demand,
equilibrium is reached by when consumers select a combination of two or
more goods that equate the marginal utility-price ratios. In the analysis of the
short-run production by a firm, equilibrium is reached at a production level in
which marginal cost is equal to marginal revenue.
Stable and Unstable
By its very nature, an equilibrium does not change once achieved unless it is
disrupted by an outside force. However, the manner in which equilibrium reacts to
an external disruption makes it either stable or unstable. A stable equilibrium is one
that moves BACK to equilibrium, if disrupted. An unstable equilibrium is one that
moves AWAY from equilibrium, if disrupted.
An example of a stable equilibrium is a ball resting peacefully at the bottom of a
bowl. If the ball is nudged up the side of the bowl, it falls back, and it eventually
returns to rest at the bottom of the bowl. An unstable equilibrium, in contrast, is like
a ball perched tenuously atop an upside-down bowl. If the ball is nudged, it rolls
down the side of the bowl, onto the table, off the table, onto the floor, out the door,
down the street, into traffic, and then causes a 27-car traffic pile-up that kills 7
people. In other words, it does not return to equilibrium.
Fortunately, an economic equilibrium tends to be of the stable kind. If or when an
equilibrium is disrupted, the economic world tends to adapt, adjust, compensate,
and work its way back. However, this does not preclude the possibility of some
instability. Some economists suggest that business-cycle recessions,
economic depressions, and stock market crashes are due in part to an unstable
equilibrium.

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local market conditions

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