PowerPoint Slides © Michael R. Ward, UTA 2014

Valentine's Day• On Valentine's Day, the price of roses increases by more

than the price of greeting cards. • Why? • What makes roses and cards different and how does that

affect supply's responsiveness to price?

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Market DefinitionMarket definition has three dimensions:1. Geography2. Product characteristics3. Timing

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Geography• What level of geography is relevant for the

pharmaceutical retailing market?• What level of geography is relevant for the

pharmaceutical manufacturing market? • What level of geography is relevant for the

pharmaceutical research market?

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Product Characteristics• Often market definition depends on question being asked

and can get subjective • We can talk about the “car market” when addressing

factors that affect all cars (e.g. gas prices)• But are cars by Kia and Lexus “close substitutes?” • If you sell Lexus cars are you more worried about a new

Infiniti dealer of a new Kia dealer? • Is a customer looking at the Infiniti SUV likely to be

interested in a Lexus sedan? • The questions being addressed are different and so the

market definition is different

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Timing• Supply and Demand quantities refer to quantities per

period of time• Sometimes it is easy to substitute across “periods” and

sometimes not• Ex Is a movie showing on Wednesday afternoon a close

substitute for one Saturday night?• Depends on what question we are asking• Does this affect desired staffing levels for the concession

stand?• Does this distinction help you forecast the demand for a

new action picture to be released in two summers?

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Hand Sanitizer• During the H1N1 flu outbreak, the demand for hand

sanitizer has tripled. • Should Johnson & Johnson have increased production of

their Purell hand sanitizer? • Should it have invested in doubling production capacity?

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Pit ExperimentClassroom experiment replicating Chicago Pit

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Shifts in Demand• Shifts in demand curve can occur for multiple reasons• Uncontrollable factor: affects demand and is out of a

company’s control• Income, weather, interest rates, and prices of substitute and

complementary products owned by other companies.

• Controllable factors: affects demand but can be controlled by a company• Advertising, warranties, product quality, distribution speed,

service quality, and prices of substitute or complementary products also owned by the company

• “Hudsucker Proxy” scene on demand and price movements

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College Park Center• UT Arlington’s new basketball arena opened in February

2012. This facility can accommodate many other smaller events such as concerts, high school graduations, and boxing matches that had been booked at other venues around the DFW.

• How does this new facility affect the booking fees these venues can charge?

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Shifts in SupplyShifts in supply curve usually can be classified into a few separate reasons1. Change in the prices of inputs

• Ex Scarce labor drives wages up. New suppliers compete materials prices down.

2. Change in productivity • Ex Less scrap wasted in production process. Improved

technology requires less labor (or less skilled labor)

3. Change in product characteristics• Ex More features. Dropped warranty

4. Change in suppliers • Ex New competitor or foreign trade

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Durability and the Car Market• Cars are lasting longer. The expected number of miles

traveled over a vehicle's life has risen to 180,000 miles in 2001 from 128,000 in 1977

• How does this improved quality affect the demand for new cars?

• How does this affect the supply of used cars?• How does this affect the price of used cars?• How does the price affect of used cars affect the demand

for new cars?

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Comparative Statics• The power of the Supply and Demand framework is in

determining how equilibrium changes when either supply or demand shift

• Economists call this “comparative statics”• First, identify which is shifting• Second, and harder, identify how big• When supply shifts up (in) the effect depends on the

steepness or flatness of demand• When demand shifts up (out) the effect depends on the

steepness or flatness of supply• Knowing elasticities matters

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at&t/T-Mobile near merger• On August 31, 2011 at 10:30am, the DOJ Antitrust Division

announced it would seek to block the at&t/T-Mobile proposed merger. By 11:00am, at&t's share price fell by 4% on the news, but the share price of its competitor, Sprint, rose by 6%.

• Why is a firm not a party to the merger affected?• Are at&t, T-Mobile and Sprint substitutes?• If the merger would have only raised prices, what would

have happened to demand for Sprint’s service?• Since Sprint’s market value rose when the merger was

blocked, what did “the market” think the effect of the merger would have been on mobile prices?

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Equilibrium as a Process• Economists can get sloppy taking about equilibrium. • We know that: 1) supply and demand are always shifting

around and 2) often there is not just one price.• What does equilibrium mean then?• But talking as if there is a well defined equilibrium usually

does no harm and facilitates discussion• Also misses the point. Better to think of equilibrium in

terms of the forces at work to consummate all wealth creating transactions

• “All models are wrong, but some are useful”

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Supply or Demand?• Over the past decade, the price of computers has fallen,

while quantity has risen. Why?• In last few years, US manufacturing firms have begun to

abandoned outsourcing projects in China. Why?• Over the past generation or more, the university tuition

increases have outpaced inflation. Why?

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Information in Prices• Prices are a primary ways that market participants

communicate with one another• Buyers signal their willingness to pay, and sellers signal

their willingness to sell with prices• Price information especially important in financial markets• More exotic?

• Ex Internal markets for products (HP, Lilly, Microsoft)• Ex Prediction markets (Intrade) (IEM) (Inkling)• Ex Terror markets? (DoD)

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Market Makers• What do “market makers” in financial markets do?• They are the conduit through which buyers find sellers• Buyer willing to pay 8.375 and seller willing to accept

8.250 means that the market maker can earn the “spread” (0.125 = 8.375-8.250) on the transaction

• If the spread is higher, they earn more per transaction

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Market Makers• For this “instantaneous” demand and supply for a stock

what prices and quantity would the market maker choose?

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Market Makers• Easier to see in tabular form:

• What is the market maker’s optimal “spread?”• What if other market maker’s could enter with an MC of

$2 per transaction?

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Bid Ask Quantity Profit$8 $8 5 $0$7 $9 4 $8$6 $10 3 $12$5 $11 2 $12$4 $12 1 $8

No “odd-eighths” Trading

• On May 26, WSJ & LA Times published results of Bill Christie’s research

• On May 27, spreads collapsed. What happened?

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Other Market Makers• In general, anyone who brings buyers and sellers together

is a “Market Maker.”• Example Real Estate Agent• Example Ebay• Example Expedia• Example Department Store

• The “Distributive Trades” serve a valuable function and are rewarded based on the “bid-ask spread.”• Disparaged as mere “middlemen”

• Relentless drive to reduce spread has made fortunes for many entrepreneurs

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From the Blog• Chapter 8• Some Economics of Sex• When supply fixed, demand causes prices to rise• “The Bet”• Uber• The ROBOT Act

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Main Points• Market definition has three components

• Geography, Product Characteristics and Timing

• Price decreases cause increases in the quantity demanded• a movement along a demand curve

• Other factors, e.g. income, can cause a change in demand• a shift in the demand curve

• Price decreases cause decreases in the quantity supplied• a movement along a supply curve

• Other factors, e.g. costs, can cause a change in supply• a shift in the supply curve

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Main Points• Market equilibrium is the price at which supply equals

demand• You can also think of equilibrium as the process whereby

demanders and suppliers do not change their behavior

• Prices convey valuable information very cheaply• Hence prediction markets

• “Making” a market is costly• “Middlemen” bear these costs to bring demanders and suppliers

together• Much of the technological advances have been in improving the

efficiency of these activities.

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