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 of 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 Marshallian 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).

CONTINUE HERE

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 market graph has already taken thesethis 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.shifts because they suppose certain behaviours and relationships ahead of time. 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.)

down,

it

shifts

Thehorizontally DD curve will shift toalong the __LEFT___quantity ifaxis demandkeeping decreases,prices or to the ___RIGHT___, if demand increases.

constant.)

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 focussesfocuses 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

Inplain 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	QuantityQd demanded slides to the left
B - Price decreases	Love it the same, but buy more	QuantityQd 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

 Scenario

Here

are

some

market

values

Exercise

Complete the following table. Draw thefor different scenariosproducts. onQe therepresents followingan graphs.equilibrium Don’tmarket forgetproduction tolevel identifywhere theQd axes.

=

Qs. For each market, a demand-side shock triggers a disruption. 

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	3-3,000-4,000
iPhone 11	700	400	iPhone 12 released	350	Down	350-400

 The supply and demand framework allows us to identify where the market will be going. But it's not possible, at this level of analysis, to be really precise about the final Quantity and Price the market will settle on. For example, if a certain model of shoes go out of fashion, of course the Quantity demanded would decrease, and those shoes will be on sale. This is pretty predictable. Where the model adds value to our analysis, is to keep in mind that as the price goes down, a few more people will buy those shoes. The quantity decrease, in the end, will not be as drastic as a simple analysis would predict. To see this in more detail, we have to look at a graph.

 Graph

HINT:

Plot

The graph shows that the Oldmarket andequilibrium Newproduction Qdlevel could have dropped to 50. That's where the new demand curve sits, at the unchanged price of 600$ per pair of shoes. Of course this situation is untenable, because it creates a surplus condition on the Graphmarket, first.of Then50 drawpairs of shoes per month. This overstock needs to be liquidated so prices will drop. As we can see on the curves.graph, to which we've added a supply schedule for clarity, the lower price on the new demand curve allows for a little more quantity demanded than we might have initially anticipated. Also, the lower price discourages producers a little bit. In the end, the model predicts a new equilibrium at 75 pairs per month, at a price of 550$.

Keep in mind that when a market is disrupted, economists have to make assumptions about the slope of each curve, in order to find a new equilibrium. If the demand and/or supply curves were steeper, or flatter, the final equilibrium won't end up at the same place.

 

A

C

D

B

 

 

 

Market Changes and the Reaction of Sellers

Market Change	Seller’s Reaction	On graph
A - Price increases	HappyEncouraged to produce more	Quantity suppliedQs slides to the right
B - Price decreases	Discouraged, will produce less	Qs slides to the left
C - External factor increases Supply	Capacity to produce more, for the same unit price	Qs jumps	right
D - External factor decreases Supply	Capacity to produce less, for the same unit price	Qs jumps	right

Draw the different scenarios on the following graphs.

Don’t forget to identify the axes.

 

A

C

D

B

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

• 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.

Supply and Demand Algorithm

1. Three

   The Questions

first

step is to identify what's going to move on the graph.

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.

1-

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

2-

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

3-

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

• Suppliers

  The second step is to identify the market condition that will seemove higherthe prices,price, and agenerate shortage of sunglasses.

• Suppliers will increase production, so SS will shift right.

adaptation.

Is it a shortage or a surplus?
                        >          Shortage                     Price increases
                        >          Surplus                        Price decreases

Adaptation
                        >          Price increases              Qd slides left, Qs slides right
                        >          Price decreases             Qd slides right, Qs slides left       

Let’s

 

 

 

 - Exercises

1. Oprah Winfrey praisessay a brandsunny ofheat soapwave onis her TV station. Predict price and sales of said soap.

P Q

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

P Q

3. High gas prices have softenedincreasing demand for gas-guzzlingsunglasses.
   1- vehicles.The Predict price and sales of SUVs.

P Q

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

P Q

5. Scientists discover reserves of natural gasshift in Quebec.demand Predictcreates impactsa onshortage, thewhich worldincreases naturalprices. gasNew market.
Qd

slides P left, Qs Q slides

6. A worker’s strike in steel mills halts production of steelright, to thenew automobileequilibrium.
   2- industry.End Predictresult, pricehigher andprices, sales.
higher

P Q

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

P Q

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

P Q

quantities.

• 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,gasoline, 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, ExpectationsExpectations, Demographics, Supply of Related Goods.

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

- References and Further Reading