The Law of Supply and Demand - Case Study Example

Knowledge of the law of supply and demand to managers 18 August Contents Page No. Introduction……………………………………………………..3 Diagrams…………………………………………………………5 Figure 1 (The relationship of supply and demand) ……...5 Pricing behaviour and demand…………………………………..7 Case study: BMW………………………………………………..7 Figure 2: Supply and demand for beef…………………...8 Conclusion………………………………………………………..9 References………………………………………………………..10 Introduction Many believe that successful leaders are those who respond most appropriately to the demands of the specific situation. Managers as leaders can do this by expertly and continuously knowing the environment in which the business thrives. Their professional lives revolve around supply, demand and prices. Knowledge of the law of supply and demand – on how these three forces interact – gives the manager a clear bird’s eye view as he/she sets out to study the environment around the business amidst the globalising economy. This essay is about management and economics, two interrelated subjects which encompass broad areas but which can be narrowed down into a simple essay. The law of supply and demand is a broad subject, but can be interesting to talk about in a few pages. This has influenced man’s activities, major activities to say the least, and has a broader role to play in our interrelationships, especially in the midst of globalisation. Economics is the study of the production of goods, the distribution of these goods, and their consumption. The law of supply and demand revolves around this area of study. In agriculture, demand refers to buyers of farm products and supply to farmers who produce the goods. In a free market economy, the interests of both buyers and sellers are reconciled by market forces of demand and supply. Sellers want high prices; buyers want low prices. As interaction between buyers and sellers continue, a market price is established, which is called the equilibrium price. (Fajardo, 1999, p. 131) In the age of the information revolution, demand represents the quest for new softwares, technological know-how, data bases and knowledge repositories. While the quest or the longing represents the demand, the supply refers to the software itself, which is in the form of programme for database or knowledge repository. Demand is intangible because it is a desire, a need or want, and there is the willingness and capacity to buy the particular product. When we demand something, we have that longing to acquire it, we seek methods and ways to own it, with means such as money or service as the case maybe. Demand is determined by factors such as income, population, tastes and preferences, price expectation, and prices of related goods. These are determinants which can either increase or decrease the demand for products. For example, when people have more income, they can buy more goods. In a densely populated community, there is greater demand for goods and services. Less income and less population mean less demand. (Fajardo, 1999, p. 132) Supply on the other hand represents goods, services, and whatever that can be longed for and demanded, which can be bought or possessed in exchange of money, services, or even goods. The forces of demand and supply determine prices (Mastrianna, 2010, p. 77). Laws on economics The law of supply and demand can be reduced into simple sentences. According to Henderson (2009, p. 27), three laws define the cornerstone of economic theory, and these are: When demand exceeds supply, the price tends to rise; conversely, when supply exceeds demand, the price tends to fall. We can understand this in our ordinary course of doing business. The price goes with the supply and demand. If there are more than enough goods or products in the market, the price falls, and if there is not enough, the price goes up. Price is not only affected by demand and supply; it also influences or affects demand and supply. Henderson (2009, p. 27) says that “A rise in price tends, sooner or later, to decrease demand and to increase supply. Conversely a fall in price tends, sooner or later, to increase demand and to decrease supply.” Price tends to level when demand is equal to supply. The rise and fall may continue until the demand and supply equalises (Mill, 2008, p. 272). These three laws are the framework of economic theory, according Henderson. The law of supply and demand is simply said: the more the supply, the less the demand, and vice versa. But there is more to this in economics, and in the globalising world, the theory of supply and demand is more complex than is usually understood. Pricing depends on the supply and demand of goods. We can explain the three laws with some of the more pronounced ideas which seem to be common in academic life. When the demand is greater than the supply, the tendency is for the price to rise. After the price has risen, the supply will become larger, while the demand will fall away. The excess of demand will thus clearly be diminished. The third law implies a prevailing tendency for demand to be equal to supply. This tendency can be verified by anyone from experience and observation. But it can also be deduced as a corollary from the two preceding laws. (Henderson, 2009, p. 27) In ordinary times the prices of most commodities and services do not change by very much, unless indeed over a long period of years; the amounts demanded and supplied may therefore seem to maintain a fairly constant level. (Thurman, 2000, p. 133) However, the relationship between price and demand is generally affected by several factors. Suppose a product has a prestigious image, for example cars, like BMW or Mercedes Benz. Since these cars (products) are unique, the supply can be controlled by their manufacturer or producer. The price can be increased without getting the demand curtailed. A company selling a product at a premium price may hold the argument that there is no advantage owning a product that can be owned by anyone. Diagrams The relationship between demand, supply and price can best be understood when explained in the form of a diagram. The economic theory can reduce the complexities of the various statements of the law through a simpler medium of expression like the diagram which vividly retains the essential facts of the complex relations. Figure 1: The relationship of supply and demand Two lines X and Y, which intersect, represent two variables: distances measured along OY represent prices, and distances measured along OX represent quantities of the commodity, or service, or whatever it may be. Henderson (2009) introduced this diagram which says that the curve DD’ represents the conditions of demand. The demand curve, DD’, must slope downwards from left to right, since the lower the price asked, the greater will be the amount demanded. Similarly the curve SS’ represents the conditions of supply. This supply curve must slope upwards from left to right, since the higher the price obtainable, the greater will be the quantity offered. Point P is where the two curves meet, and drawing a perpendicular line PM can allow us to meet OX. PM or Om represents the price at which the commodity or service will be exchanged. (Henderson, 2009, pp. 29-30) Let’s say for example, the price of ice cream. This delicious product could rise up and down depending on some factors. If the price of ice cream rose to $20 per scoop, we normally change our mind by buying less ice cream. Instead, we might buy frozen yogurt. If the price of ice cream fell to $0.20 per scoop, we prefer to buy more. This relationship between price and quantity demanded is true for most goods in the economy and, in fact, is so pervasive that economists call it the law of demand. (Mankiw, 2007, p. 67) SOURCE: Principles of Economics, by N. Mankiw (2007, p. 68) In this figure, the demand schedule is a table that shows the quantity demanded at each price. The demand curve, which graphs the demand schedule, illustrates how the quantity demanded of the good changes as its price varies. Because a lower price increases the quantity demanded, the demand curve slopes downward. This table shows the relationship between the price of a good and the quantity demanded, and the quantity a customer can demand of it. The table shows how many ice-cream cones a customer buys each month at the different prices of ice cream. If ice cream is free, the customer eats 12 cones per month. At $0.50 per cone, the customer buys 10 cones each month. As the price rises further, the customer buys fewer and fewer cones. When the price reaches $3.00, the customer doesn’t buy any ice cream at all. (Mankiw, 2007, p. 67) Kennedy (2000) states that the demand curve traces out the quantity of the good or service people want to buy in a particular market, other things remaining the same (this is termed ceteris paribus). The supply curve traces out the quantity of the good or service that people/firms want to supply to this market as the price changes. Pricing behaviour and demand The law of supply and demand can be the starting point for explaining pricing behaviour. In a market oriented economy, demand is affected by competition and consumers usually take informed decisions. In these cases, price acts as an equalizer of supply and demand. (Srinivasan, 2005, p. 82) Demand is also said to be elastic. Competitive market does not give too much leverage for companies to change or hold their prices independent of the action taken by competitors. This is due to elasticity and cross elasticity that operates in the market. Even a company that may be holding a leader’s position cannot move unilaterally towards its own decisions. (Srinivasan, 2005, p. 83) Case study: BMW An example of demand and pricing was applied by the makers of the high-priced car BMW with its Z1 Series launched in 1995. At the 1998 Paris Motor Show, BMW launched its Z1 two-seater sports car. Intended initially as a limited edition pilot project, critical acclaim and consumer interest persuaded the German car giant to put the Z1 into production but only in limited, deliberately withheld numbers. The quota for the UK in 1989 was just 25 cars, but it rose to 50, due to the demand from motorists and lovers of BMW cars. BMW was swamped with orders, which required a mandatory £5,000 deposit. The official price of the Z1 in August 1989 was £36,925. In the press that summer, however, 16 Z1s were advertised by owners or dealers with an average asking price of £46,822. Some cars were even re-sold for over £50,000. BMW purposely held down production so that prices for Z1 cars rose. For a company whose products represent superior brand image, the success of BMW Z1 reflected the demand for the rest of the BMW range of luxury executive cars. When BMW re-launched its re-modelled 3 Series, it slightly lowered the price of its entry point model, the 316i, to only £16,000. This was because production in greater number was introduced by the company. (Hamilton, 1989, p. 568) Another case study showing the effects of the law and supply and demand is provided by Peter Kennedy (2000), with a corresponding diagram. Figure 2: Supply and demand for beef SOURCE: Macroeconomic essentials: understanding economics in the news, by P. Kennedy (2000, p. 326) The intersection of supply and demand curves concerns a particular point in economy. Figure 2 shows an example of the price of beef. Supposed the price of beef is $2 per pound, a price below the intersection of the supply and demand curves. The quantity of beef demanded, from the demand curve, would be Q1, and the quantity of beef supplied, from the supply curve, would be a smaller quantity, Q2. At the price of $2, demand would exceed supply, and there would be less beef. In this situation, either those unable to obtain beef will offer a higher price to beef producers to ensure that they get the available beef, or beef producers will increase the price. These two instances reflect an aspect of supply and demand: excess demand causes price to rise. Another thing happens if the price is increased to $2.50, as shown in the figure, quantity demanded falls as we slide up the demand curve, and quantity supplied rises as we slide up the supply curve, shrinking the excess demand. The excess demand pressure on price continues until the excess demand for beef disappears, which happens at a price of $3, given by the intersection of the supply and demand curves. The forces of supply and demand operate automatically to push the economy to the intersection of relevant supply and demand curves, a position in which there is no further pressure for change. This is called the equilibrium position. Managers should analyze a market by describing its equilibrium position, examining how quickly the automatic forces of supply and demand push the market to this equilibrium and noting how the equilibrium position changes whenever the market is subjected to a shock of some kind. (Kennedy, 2000, p. 326) Conclusion The economic law deals with demand, supply and pricing and the mechanics of the law should be the primary concern of the manager because major decisions here reverberate in the short run and long run. The manager can also have a starting point in studying how people produce, distribute and consume. Knowing these three activities of people in a community can precisely enable the manager and the organisation he/she represents enough information and knowledge for good management. Word Count: 2210 (not including References and Contents Page) References Fajardo, F., 1999. Agricultural economics ’99 ed. Manila: Rex Book Store, Inc. p. 131. Geetika, Ghosh, P., and Choudhury, P., 2008. Managerial economics. Tata McGraw-Hill. ISBN0070263655, 9780070263659. Gregor, A., 2009. Marxism, China, and development: Reflections on theory and reality. New Jersey: Transaction Publishers. p. 114. Hamilton, D., 1989. BMW. Cited in Jobber, D. and Lancaster, G., 2003. Selling and Sales Management, Sixth Edition. England: Pearson Education Limited. p. 568. Henderson, H., 2009. Supply and demand. BiblioBazaar, LLC. ISBN: 0559086679, 9780559086670. Hollander, S., 1997. The economics of Thomas Robert Malthus. London: University of Toronto Press Incorporated. p. 541. Homan, P., 2002. Economic theory – institutionalism: what it is and what it hopes to become. Cited in G. M. Hodgson, The Evolution of Institutional Economics: Agency, structure and Darwinism in American Institutionalism. London: Routledge. Kennedy, P., 2000. Macroeconomic essentials: Understanding economics in the news (second edition). United States of America: Massachusetts Institute of Technology. Mankiw, N. G., 2007. Principles of economics. United States of America: Cengage Learning. pp. 86-7. Mastrianna, F., 2010. Basic economics. Ohio: South-Western, Cengage Learning. Mill, J. S., 2008. Principles of political economy: with some of their applicages to social philosophy. United States of America: Harvard University. p. 272. Srinivasan, R., 2005. International Marketing, Second Edition. New Delhi: Prentice-Hall of India Private Limited. Thurman, A., 2000. The folklore of capitalism. London: Beard Books. p. 133. Wanniski, J., 1998. The way the world works. Washington DC: Regnery Publishing, Inc. p. 41. Read More