Principle 6 Markets work well with competition, the rule of law, information, incentives, and property rights
Objectives
List some events that can change the minds of buyers and sellers
Why do you want to learn this?
Price changes are often a mystery or a rumored “plot” to many people. This summary will help you understand how buyers and sellers are affected by different events. It will then lead to an understanding of why prices change in a competitive market. This can be particularly important when we discuss labor markets.
OK, here’s a tough one. If supply and demand determine prices, what could possibly cause price changes? If you said to yourself, “a change in supply or demand,” you are a genius. Buyers and sellers can often change their minds.
Buyers – Demand - PRINTE
There are many things that can change buyers’ minds about a product. Assume that you are a businessperson and you are thinking of introducing your product in a new area. Here are some of the questions you would want to know about.
How many people are there in the area? Is the market large enough to support your investment?
What do they like? Are they young, old, families, singles, rich, poor, highly educated? If you are thinking of a restaurant, the ethnicity of the area is important?
Is there much competition for your type of product or will your product be unique so that there is no competition?
What is the average income of the people in the area? Is your product one that matches the income level of the area population?
Let’s try to get into the heads of buyers. If a buyer thinks that a peanut butter sandwich is not a peanut butter sandwich without jelly, an increase in the price of jelly will affect her demand for peanut butter. The Price of Related goods and services affect buyers demand for a product. Complements go together (peanut butter and jelly); substitutes compete against each other (butter and margarine). Buyers are likely to adjust their demand for one product depending upon the price of related goods.
An increase in buyers’ Incomes is likely to increase the demand for most products; a fall in income will decrease the demand for most products. As mentioned above, a change in the Number of buyers in an area will change the demand for a product. For established products, people want to know if the product is going to be available consistently and if the price likely to go up or down in the near future. This is particularly true for big ticket items such as houses. If they think the prices of houses are going to go down, they will wait to see if their expectations are met. If they expect the prices of houses to rise, they are likely to buy now before the price increase.
A list of things that are likely to change demand for a particular product include:
Income of potential buyers, Number of potential buyers in the market, Tastes and preferences of potential buyers in the market, and Expectations about the availability and price of the product in the near future. These PRINTE factors are some of the categories of events that will change demand but don’t get frustrated by trying to fit a demand changing event into one of these categories. Other events that may not fit nicely into one of these categories can also change demand.
Sellers – Supply – GINEW -
Business people have to decide what products to supply. Their main goal is to maximize profits, the difference between total revenue (the price for which the product sells multiplied by the number of products they sell) minus total cost (the average cost of producing a product multiplied by the number of products they produce. Total cost is what it takes to produce the product and total revenue is what the sellers get when they sell the product.
TR = P Q; TC = AC Q; PROFIT = TR – TC
So, in deciding what to produce, businesses have to consider production costs.
The most common changes in supply are listed below. They are government actions, input prices, number of sellers, expectations, and weather, GINEW.
Government – governments influence the supply of products by taxing or subsidizing their production. In addition, they can impose regulations on the production of a product that can influence production costs. As government actions influence production costs, supply will increase or decrease. Assume that the federal government subsidizes the production of solar panels. That means that it is less expensive to produce. As a result, producers can produce more of the product at any given price than they could before the subsidy. Anything that reduces production costs can cause an increase in supply; anything that increases production costs can reduce supply.
Input prices - this should be a no brainer. If input prices fall, production becomes less costly, meaning that suppliers can supply a greater quantity at each price. Lower input prices cause an increase in supply, higher input prices cause a decrease in supply. One of the major causes of changes in input prices is technology. Advances in technology usually make the product easier and less costly to produce increasing the quantity that suppliers can supply at each price. Occasionally, however, technological advances lead to discoveries of harmful effects of current production methods, leading to more costly forms of production to combat the harmful effects. In cases such as these, technological advances actually decrease supply. Labor productivity can also influence the amounts of products that sellers can offer at different prices. If workers become more productive, producing more of the product for each hour worked, the cost of production falls. In these cases, suppliers can offer more of the product at each price.
Number of suppliers in the market - This one doesn’t require much thought. The more sellers in the market, the greater the level of competition, the greater the amount available at each price. The fewer the sellers in the market, the less will be available at each price.
Expectations - Just as buyers are affected by expectations, so are sellers. Expectation about future prices of commodities will affect farmers’ decisions to grow certain crops. Producers who think that prices of some products will earn profits will produce those products.
Weather - Obviously, a good weather year increases crops and a bad weather year decreases crops. Less obviously, activities such as construction work that require good weather will decrease with bad weather!
The same message for supply determinants (GINEW) as mentioned above for demand determinants is relevant. These GINEW factors are some of the categories of events that will change supply but don’t get frustrated by trying to fit a supply changing event into one of these categories. Other events that may not fit nicely into one of these categories can also change supply.
Bottom Line:
Influences on buyers can cause changes in demand. While the PRINTE factors are among those influences, it is not necessary to try to fit changes in demand into those categories.
Influences on sellers can cause changes in supply. While the GINEW factors are among those influences, it is not necessary to try to fit changes in supply into those categories.
1. In the table below, indicate which of these changes is likely to cause an increase (I) in demand and which is likely to cause a decrease (D) in demand.
Increase (I) or Decrease (D) | ||
Orange Juice | Buyers view orange juice as too much sugar and too many calories | |
Bottled water | Orange juice and bottled water are substitutes. Orange juice prices increase. | |
Tea | Coffee and tea are substitutes. The price of coffee has been cut in half. | |
Restaurant and Entertainment Workers | Restaurants and entertainment centers are reopening. | |
Small home appliances – insta pots, air fryers, bread makers, coffee machines | During the Covid epidemic many people worked from home and ate out less | |
Lumber | People build more houses. |
2. In the table below, indicate which of these changes is likely to cause an increase (I) in supply and which is likely to cause a decrease (D) in supply.
Increase (I) or Decrease (D) | ||
California wines | Fires destroy grapes in Northern California. Grapes are the main ingredient in wine. | |
Cars | The federal government imposes a tax (tariff) on steel and aluminum from overseas. Steel and aluminum are inputs into car production. | |
Beef | Beef packers go on strike for a prolonged period of time. | |
Workers | After the pandemic, some workers retire earlier than planned.. | |
Strawberries | Summer arrives | |
Strawberries | Fall arrives |