Market Disruption

- Why Should I Care?

Markets are supposed to be stable and self-regulating. But social and natural events can disrupt markets and wreak havoc on regular peoples’ lives. Predicting how markets will react to outside factors can make you rich, or at least avoid becoming poor.

- This Lecture Has 2 Parts

Shifts in Demand and Supply
New Equilibrium

- What is a Market Disruption?

Markets are stable and self-regulating. Under an assumption of perfect competition, buyers and sellers react to changes in price, that’s obvious. That is the Free Market Mechanism, which sets equilibrium prices and output. Even in a monopoly, the market is in a stable equilibrium.

But changes in nature like an earthquake, or social events like a labour strike, can disrupt an otherwise stable market. There will be a “new normal”, a new equilibrium. The supply and demand model enables us to predict the market outcome of such disruptions. The trick is to analyze changes to the demand and supply curves independently.

Shifts in Demand and Supply

The model allows us to sort out the effects of a multitude of factors that can change the quantities of product on a market.

Essentially, the variables are sorted out where Qs, and Qd, are a function of several factors. Quantity is thus considered a Dependent variable. All other variables explain quantity, so they are considered Independent variables.

Q_d = f ( Price, Population, Income, Expectations, Tastes and Preferences, Prices of related goods )

Q_s = f ( Price, Number of producers, Prices of related goods, Technology, Expectations, Price of Inputs )

Notice that the Price of a good influences both Q_d, and Q_s. This is basically the reason why Price is a variable that was chosen to be on the graph at all times (vertical axis).

Qd and Qs are also on the graph, simultaneously on the same axis (horizontal).

Price and Quantity are therefore considered ENDOGENOUS variables. Any change in price is always included on the Supply curve, and the Demand curve. The graph has already taken these into account.

All other variables are EXOGENOUS. Their effect is not already factored into the Demand and Supply curves. Their effect will SHIFT either curve.

An exogenous shift will bring about an unbalance in the market forces, a market condition of shortage, or surplus. This will generate a change in price, which will move the Qs and Qd along the new curves.

An example: the level of education is often cited as a major problem in many poor countries. Higher education is associated with higher wages. Higher wages generates an increase in demand for consumer products.

Another example: new robots will increase production without increasing costs. More robots will increase the supply of automobiles.

Variable	Moves Curve	Function	Role in model
Qs	No	Dependent	Endogenous
Qd	No	Dependent	Endogenous
Price	No	Independent	Endogenous
Population	Demand	Independent	Exogenous
Income	Demand	Independent	Exogenous
Expectations	Demand	Independent	Exogenous
Tastes and Preferences	Demand	Independent	Exogenous
Prices of related goods	Demand	Independent	Exogenous
Number of producers	Supply	Independent	Exogenous
Prices of related goods	Supply	Independent	Exogenous
Technology	Supply	Independent	Exogenous
Expectations	Supply	Independent	Exogenous
Price of Inputs	Supply	Independent	Exogenous

Economists can predict how the market will react to these shifts. The factors mentioned will shift the whole curve, whether demand or supply.

The curve will shift left if demand (or supply) decreases, or right if it increases. (The curve does not shift up or down.)

The DD curve will shift to the __LEFT___ if demand decreases, or to the ___RIGHT___, if demand increases.

Why does the curve shift?

These outside factors are exogenous variables. They are “game-changers” that were not taken in consideration when building the theory, which focusses on prices and quantities. Price is an endogenous variable, which means it is included on the graph. This is why changes in price are already accounted for in the shape of the demand curve.

In English, for the same price, people’s demand has completely changed for the product. You could say they love the product more, or less, for the same price. Because the “love” has changed, there has to be a new curve to depict the new level of demand.

Market Changes and the Reaction of Buyers

Market Change	Buyer’s Reaction	On graph
A - Price increases	Love it the same, but buy less	Quantity demanded slides to the left
B - Price decreases	Love it the same, but buy more	Quantity demanded slides to the right
C - External factor increases Demand	Love it more, Buy more at same price	Qd jumps right
D - External factor decreases Demand	Love it less, Buy less at same price	Qd jumps left

Exercise

Complete the following table. Draw the different scenarios on the following graphs. Don’t forget to identify the axes.

Product	Price ($)	Qe / mth	Shock	New Qd	Price change	New Qe
Shoes	600	100	Out of fashion	50	Down	Between 50-100
Ice cream	5	250	New immigrants	300	Up	250-300
Internet Access	45	3,000	New movies on Netflix	4,000	Up	3-4,000
iPhone 11	700	400	iPhone 12 released	350	Down	350-400

HINT: Plot the Old and New Qd on the Graph first. Then draw the curves.

Market Changes and the Reaction of Sellers

Market Change	Seller’s Reaction	On graph
A - Price increases	Happy to produce more	Quantity supplied slides to the right
B - Price decreases
C - External factor increases Supply
D - External factor decreases Supply

Draw the different scenarios on the following graphs.

Don’t forget to identify the axes.

New Equilibrium

The shifts in Demand and Supply create disruptions on the market for any good or service. But before you shift any curves, make sure you understand what to do, and the proper sequence of the model.

Three Questions

Who is affected first and foremost?

Do the S&D Dance

Price shock:
Slide on the curve

External shock:
The curve Jumps

> Producers: Supply curve

> Buyers: Demand curve

Is this a price change?

Yes > Price shock: Quantity will slide

No > External shock: Curve will shift

Which direction?

> More quantity: Right

> Less quantity: Left

Let’s say a sunny heat wave is increasing demand for sunglasses.

This will affect buyers, so it affects the demand curve (DD).

This is an exogenous shock, so the DD curve will shift.

Buyers will buy more, at all prices, so DD will shift right.

Suppliers will see higher prices, and a shortage of sunglasses.

Suppliers will increase production, so SS will shift right.

- Exercises

Oprah Winfrey praises a brand of soap on her TV station. Predict price and sales of said soap.

Kia enters the Canadian automobile market in 2005. Predict price and sales on Canadian auto market.

High gas prices have softened demand for gas-guzzling vehicles. Predict price and sales of SUVs.

A disease killing cattle has affected the supply of beef. Predict price and sales of steaks.

Scientists discover reserves of natural gas in Quebec. Predict impacts on the world natural gas market.

A worker’s strike in steel mills halts production of steel to the automobile industry. Predict price and sales.

Turmoil in the Middle-East interrupts the supply of oil. Predict the price and sales of gas.

The 2010 Olympics have increased the sales of HD TV’s. Predict prices and sales of HD cable service.

Principles

Positive: Variable prices, aka “market forces”, are an efficient feedback mechanism which allows markets to adapt quickly to external changes.

Normative:

(Right-wing) Regulators should not interfere with variable prices, especially when they swing wildly, as this information is crucial to a dynamic process of readjusting resource allocations to adequate production ventures.

(Left-wing) Regulators should interfere with prices that are too high, or wages that are too low, to protect the poor and middle classes from exploitation.

- Green Policy

Many economists believe that you can use the market mechanism, the Marshallian Supply and Demand model, to reduce pollution. The trick is to include the social cost of pollution into the final price of the product. By taxing BADS, you can swiftly impact meaningful change without sending anyone to jail, or having the government make critical allocation decisions. The market can solve the problem.

How this works is simple. A tax is a supply factor. An increase in taxes will shift the supply curve to the left. As markets adapt, part of the increased tax will turn into a higher price for consumers, and part of the tax will decrease the quantity of sales of the BAD product.

Note that this type of policy works best when there are alternatives which are ready and waiting to be consumed. If you tax, without preparing an alternative product, the consumers will bear the brunt of the tax and there won’t be a reduction in quantity.

- Climate Change Solution

Most economists agree that a tax on carbon is a fair and efficient solution to reducing GHG emissions. Rather than ask consumers to stop using their cars, implementing a tax on gasoline would have a direct impact on demand for gasolines, and for cars. It’s fair because those who are responsible for emitting GHG’s have to pay for it.

The capitalists and the industrialists will receive a clear signal that these products are doomed, and their efforts show be going towards GHG-free production. One would expect consumers, as well as producers, to look for alternatives (substitution effect).

- Democracy Booster

It is obvious that many industries stand to lose millions and billions of dollars if carbon taxes were to be implemented. However, it is not economical to leave the situation as it is. Money never disappears. It would be invested in cleaner projects. This is not a lose-lose scenario. It is a win-win scenario.

Do the S&D Dance

Price shock:
Slide on the curve

External shock:
The curve Jumps

- Wrap-Up

Markets are stable, but society is not. An outside change will disrupt markets. But markets do stabilize, in theory, at a new equilibrium because of the market forces behind the theory of supply and demand.

This new combination of price-quantity will be stable. To find it, and predict it properly, shift the proper curve according to the relevant factors. Suppliers and demanders will meet once again at the new equilibrium combination of price and quantity.

- Cheat Sheet with Memory Helper

Price shock: A change in price that affects the quantity demanded or supplied of a particular product.

External shock: A social or natural event that deeply affects the supply or demand curve.

Demand shifters: Income, Tastes and Preferences, Expectations Demographics, Supply of Related Goods.

Supply shifters: Number of producers, Change in technology, Demand for Related products, Expectations, Input costs.

- References and Further Reading