Price Elasticity for Electronic Chips - Essay Example

? Table of Contents 0 Article Summary 2 2.0 Introduction 2 3.0 Analysis 2 3 Supply and Demand 2 3.2 Oversupply 4 3.3 Price elasti for electronic chips 5 3.4 Implications for downstream consumer products 6 3.5 Repercussions for exports 7 4.0 Conclusion 7 Bibliography 9 1.0 Article Summary The DRAM was reported to have reached record low prices in the post-holiday season, due to oversupply of the memory chip, sending PC prices down as a consequence. This development occurs in an industry that had been marred by price-fixing schemes not too long ago, and has special implications for production forecasting and price determination. 2.0 Introduction The DRAM is short for dynamic random access memory, a type of random access memory in semiconductor chip form. It is a type of RAM that retains its data only if it is continuously accessed by a refresher circuit, in the absence of which it loses its contents. All personal computers use DRAM, as against SRAM (static random access memory), because they are much cheaper and occupy much less space (PC Guide, 2001). Online technology news publication Network World reported on January 4, 2011, that towards the end of 2010 until the date of writing, there had been an oversupply of DRAM which sent prices to its lowest price in one year (Jennings, 2011). The situation was blamed on post-holiday oversupply, also sending prices for personal computers lower. 3.0 Analysis 3.1 Supply and Demand Demand is “a desire for a good, backed by ability and willingness to pay.” Market demand is the cumulative demand of all buyers (Dwivedi, 2005, p. 34). The law of demand is “all things being equal, the amount demanded increases with a fall in price and diminishes with a rise in price” (Marshall, quoted in Dwivedi, 2005, p. 35). In the article, it was mentioned that earlier in 2010 there had been a forecast of shortage for the DRAM. The forecast was based on a Goldman Sachs PC unit growth forecast made in March 17, 2010 (Telecoms Korea, 2010). Because DRAMs are major components of PCs, there was a projected increase in demand for DRAMs to service the higher demand for PC manufactures. As the market unfolded for the rest of the year, however, it became apparent that the forecasted demand was overestimated. Supply is “the quantity of a commodity which its producers or sellers offer for sale at a given price, per unit of time.” Market supply is the sum of supplies of commodity by all individual firms (Dwivedi, 2005, p. 47). The law of supply is “all things being equal, the quantity supplied increases with the increase in price, and decreases with the decrease in price” (Dwivedi, 2005, p. 47). In the article, it was mentioned that beginning December, as the holiday shopping season lost momentum, major semiconductor manufacturers continued to output DRAMs in large volume, purported to stay competitive. This was due to the earlier forecast of a DRAM shortage, for which companies increased factory capacity, that in turn required higher production outputs to even out the additional overhead and maintain a lower per unit cost. Figure 1 following is a graph of the superimposed supply and demand curves. It is evident that increasing price leads to an increase in quantity supplied and decrease in quantity demanded. The point at which the two curves intersect is the equilibrium point, representing the price at which the quantity demanded is equal to the quantity supplied, and transactions take place. It is at this point where the market is made. There are shaded portions of the graph where surplus and shortages are represented. The interest of this paper is the area above the equilibrium point, where surplusage, or oversupply, occurs. At these prices, the quantity supplied exceeds the quantity demanded, forcing the suppliers to lower their prices. Figure 1: Law of Supply and Demand 3.2 Oversupply (Surplus) Oversupply occurs when the quantity supplied exceeds quantity demanded. This would tend to drive prices down, because suppliers would tend to outbid each other in a price war and settle for lower prices and margins, as long as inventory gets sold in the market. In a condition of oversupply, imports tend to take an increasingly bigger share of the market, since prices are low and quality is generally regarded as higher for imports (Taylor & Weerapana, 2007, p. 533). A reduction in the price of DRAMs and personal computers for export would tend to increase competition in the market. However, where prices drop too far, profit margins become too thin and even turn negative for some companies who are unable to lower their manufacturing costs fast enough. The result is that in a regime of oversupply and price wars, the less efficient producers are drive out of the market (Doorman, 2000). 3.3 Price elasticity for electronic chips The price elasticity of demand for electronic B2B (business-to-business) products tends to trend towards greater elasticity, because demand tends to transfer easily to other similar producers who could offer more affordable prices. The price elasticity of demand is defined as: Percentage change in quantity demanded Price elasticity of demand = ------------------------------------------------------ Percentage change in prices Figure 2: Price elasticity of demand Source: http://tutor2u.net/economics/revision-notes/as-markets-price-elasticity-of-demand.html There is more elastic demand in narrowly defined markets than those broadly defined, because substitutes are easier to find for such goods. (Mankiw, 2008, p. 91). In the case of DRAMs, because of the highly standardized construction and performance specification of the technology, the DRAMs manufactured by one producer could be easily replaced by those of another producer. Therefore, a price war in the DRAM manufacturing industry would lead to the closure of the less efficient firms, restoring the oversupply situation and bringing prices back up to profitable levels for companies still in operation. 3.4 Implications for downstream consumer products DRAMs find their greatest application as components in the manufacture of personal computers, and therefore constitute part of the input costs of PCs. Given a drop in DRAM prices, this should impact as a drop in materials costs for PCs, for which the prices of PCs may then also be either reduced, or allow manufactures to improve on product performance (such as increase memory capacity) for the same price. DRAMs may also find other use in electronic consumer products, with the increased demand for personal gadgets such as multi-use cellular phones and MP3 players. There have been conjectures, however, that the long-term prospect for the demand for personal computers is on the wane as the PC becomes obsolete. Should this happen, companies would do well to either find new applications for the DRAM, if demand for the product is to be sustained. The effect on downstream consumer products of the DRAM oversupply may be seen as a shift in the supply curve at the right in Figure 3. The price of raw materials is a factor other than the price of the good itself, and as far as the latter is concerned is a non-price determinant of supply. With cheaper raw materials, the supply curve moves right towards increasing supply, causing a decrease in the equilibrium price, given the demand curve remains unchanged. Figure 3: Shifts in the demand and supply curves 3.5 Repercussions for exports For countries such as Taiwan which manufacture and export DRAMs, the global oversupply of the product tends to reduce its attractiveness to suppliers, prompting some manufacturers to shift product lines to other, more profitable goods. Generally, the production system for semiconductors are not necessarily specialized to DRAMs, and may be reprogrammed to produce other semiconductor products such as the slightly more expensive SRAMs. On the other hand, if the current slow demand is seen to be merely seasonal and expected to recover soon, firms in more developed countries or multinationals with a global presence may have lower production costs, and may offer the product at reduced prices, since they are able to survive tighter margins. This may shake out the competition in some target markets. 4.0 Conclusion At present, there is a post-holiday oversupply of DRAMs, due to an attempt by companies to remain competitive. The increase in capacity undertaken by these companies was supposedly in response to what should have been a shortage of DRAMs. This does not mean that the forecasts are necessarily wrong, because according to Taiwan manufacturers, seasonality accounts for part of the market downturn. It is expected that the oversupply situation will continue for the first quarter of 2011, after which it is expected to swing in the other direction as market demand picks up for the newer PC models and other similar applications. For the moment, however, prices are expected to remain depressed in the short term, and companies which are not properly diversified may find difficulty keeping up production if the slim margins are not sufficient to cover fixed costs. With the improving demand condition towards the middle of the year, there should be a commensurate rise in prices that would provide sufficient room for companies to continue DRAM manufacture at more profitable levels, thereby easing the competitive situation. References Doorman, F 2000 Global Development: Problems, Solutions and Strategy: A Proposal for Socially Just, Ecologically Sustainable Growth. Jan van Arkel International Books. Dwivedi, D N 2005 Macroeconomics: Theory and Policy, Second edition. Tata McGraw-Hill Publishing Company Limited, Delhi Jennings, R 2011 “Oversupply sends DRAM prices to one-year low.” NetworkWorld, 4 January 2011. http://www.networkworld.com/news/2011/010411-oversupply-sends-dram-prices-to.html (accessed 7 January 2011) Mankiw, N G 2008 Principles of Economics. Fifth edition. South-Western Cengage Learning, Mason, OH PC Guide 2001 “Dynamic RAM (DRAM). PC Guide.com. http://www.pcguide.com/ref/ram/typesDRAM-c.html (accessed 7 January 2011). Taylor, J B & Weerapana, A 2009 Principles of Microeconomics, Sixth edition. Houghton Mifflin Company, Boston, MA Telecoms Korea 2010 “Goldman Sachs Predicts DRAM Chip Shortage Next Year,” Telecom Korea, 17 March 2010. http://www.telecomskorea.com/market-9149.html (accessed 7 January 2010). Read More