Economics Coursework - Demand and Supply

2. Explain the meaning of supply and demand, and using the mobile phone industry as an example, explain and illustrate what factors may cause shifts/movements in the curves. The market mechanism is the tendency for supply and demand to equilibrate, so that there is neither excess demand nor excess supply. Provide a graphical and written explanation of that statement.

One of the most fundamental principles that exist for economics is demand and supply which play an important role in the economic decisions. Demand is the amount of goods a consumer is willing and able to buy. It is connected to wants, which are the unlimited desires or wishes that people have for goods and services. The amount of a good or service that consumers plan to buy during a given time period at a certain price is called the quantity demanded. In contrast to demand, supply is the amount of goods a seller is willing and able to sell. It reflects a decision about which items to produce. Unlike demand, supply is limited and related to resources. The resources and available technology control the amount that firms can supply. The amount of a good or service that producers plan to sell during a given time period at a particular price is called the quantity supplied (Parkin 2008). According to Moffatt (2009) economists define demand as a relationship between quantity of a good or service consumers will purchase and the price charged for that good. The general relationship between price and consumption is known as the law of demand which states that: “other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded”. There are two reasons for this law. First of them is the income effect and the second substitution effect (Sloman 2007). To see these effects at work, using a mobile phone industry as an example we can think about the results of a change in the price. According to Barker (2009), more than 60 percent of the world's citizens are in posses of a mobile phone. One of the main substitutes of a mobile phone is a home phone. The cost of mobile phones had dropped 47% between 2003 and 2008, while that of landlines fell by only 18%. The average mobile bill, at £16.71 a month is lower than the average landline bill at £21.57. People prefer to substitute landline phones for a mobile phone because is cheaper (Hussain 2009) – the substitution effect. And because the price of a mobile phone falls, people can afford to buy more – the income effect. The quantity demanded increases for these two reasons. Similarly if we suppose that a mobile phone cost rises, consumers faced with a tighter budget, will buy fewer mobile handsets – the income effect, and will switch to cheaper alternative goods – the substitute effect. The quantity demanded decreases for these two reasons (Sloman 2007). We can show graphically how changes in a price affect quantity demanded using one of the two most used curves in economics: the demand curve which is presented by a downward sloping line. The movement along the demand curve represents a change in the quantity demanded and it occurs because the price of the product has changed. 1

Demand curve

The figure 1 (Cal Poly Pomona 2000) shows demand curve with quantity demanded on the x-axis and the price on the yaxis. We can observe as prices increase consumers buy less and as prices decrease consumers buy more.

However, as well as the price, demand depends on other factors. These factors make changes in demand which result in shifts in demand to the right or left. One of the main factors is income. When people earn higher incomes, they are able to afford not only more of the same goods or services, but also more expensive products they could not afford before (Mastrianna 2007). For example, consumers with higher incomes can afford to own a cell phone and use more expensive handsets than people with lower incomes. Americans who earn more are nearly eight times more likely to have purchased a PDA than those who earn less (Poll 2009). As incomes raise the demand for mobile phones increases, as incomes fall the demand decreases. Expected future income can also make changes in demand. If someone gets news that will get a bonus, promotion, etc. can decide to buy a mobile phone or change it for a more expensive one now. The next factor is the prices of complement goods. For example a complement service for a mobile phone is a mobile phone service provider. As the prices of phone calls, messages and other mobile phone services decrease, the demand for mobile phones increases, which results in higher quantity demanded. By contrast, as the cost of services increases the quantity demanded falls. Changes in future prices also affect the demand. If the prices of mobile phones are expected to rise, people will buy more mobile phones now to avoid higher opportunity cost when the prices increase. So, the demand for mobile phones will increase. Comparably, if the prices are expected to fall in the future, people will retime their purchase and the demand will decrease today but increase in the future (Parkin 2007). Population is one of another factors; demand depends on the size and the age of the population. The bigger the size of a population, the greater the demand. In big cities such as New York or London where population is 7.5 million, the demand for mobile phones is much higher than the demand is in smaller cities such as Liverpool (460.000) (Parkin 2008). The research confirmed that age is a determining factor in cell-phone ownership: 94% of Americans under age 45 have cell phones, whereas slightly more than eight in 10 Americans 45 or older tote the devices (Poll 2009). Preferences also play a big role in the demand for cell phones. Aspects such as ease of operation, physical design and handling influence consumer’s decision. The more desirable people find a 2

mobile phone, the more the quantity demanded. For example the large number of features and high satisfaction increases demand for iPhone. According to Elliot (2009) iPhone caused that Orange UK made sales records for a phone in UK during the first days of sales. Shifts in demand curve

The figure 2 (Cal Poly Pomona 2000) shows shifts in demand curve D1. As demand decreases it shifts to the left D3. An increase in demand is a shift to the right D2.

In contrast to demand, the law of supply states that the higher the price of a good, the greater the quantity supplied; and the lower the price of a good, the smaller the quantity supplied. To see these relations we can use the second of the two most used curves in economics: the supply curve, which is represented by an upward sloping line. The same as the demand curve, any changes in the price of a good cause movement along the supply curve – a change in the quantity supplied. If the price of the iPhone rises, it will be worth producing more and incurring higher cost which rises more and more rapidly with higher output, the quantity supplied increases – a movement along the curve to the right. If the price decreases, the less profitable it becomes to produce and the quantity supplied will decrease – a movement to the left. Supply curve

The figure 3 (Cal Poly Pomona 2000) shows the supply curve (S) with quantity supplied on the x-axis and the price on the y-axis. As prices increase (B) suppliers produce more, as prices decrease (A) suppliers produce less.

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Like demand, supply is not simply determined by price. Due to other changes (except price), the supply curve shifts to the right – an increase in supply, or shifts to the left – a decrease in supply. One of the other determinants is the cost of production. This factor applies to any areas of production process. According to Hesseldahl (2009) the cost of components of the iPhone normally goes down from one generation of a product to the next but the cost of the newest iPhone rose by $5, one of the reasons is that the costs of the components has not declined as quickly as in the past – it causes a decrease in quantity supplied. Credit crunch also makes changes in supply, as it reduces consumer’s disposable income sales of mobile phones that are expected to fall. As a result of that Nokia has announced it will cut cost of production due to falling demand (Skinner 2009). However, in preparation for the holiday rush, suppliers such as Apple have stepped up iPhone production (Caolo 2009). Technological advancement is one of another determinants; this means introduction to new machines and better methods of production. This reduces the cost of production and increases profit. So the producer is able to supply more goods at the same price – an increase in the quantity supplied (Mastrianna 2009).

Shifts in supply curve

The figure 4 (Cal Poly Pomona 2000) shows shifts in supply curve S2. As supply decreases it shifts to the left S1. An increase in supply is a shift to the right S3.

Every market has a stable point when the price balances the plans of sellers and buyers, called equilibrium point. At this point market is in equilibrium, with no excess demand (shortage) or excess supply (surplus) in the market. The supply and demand mechanism is the natural consequences of economic and provides the most efficient economic outcomes. A shortage forces the price to rise because consumers cannot push producers to sell more than they plan; therefore suppliers increase the price which reduces the shortage and rises towards its equilibrium. As the price approaches the point where there is no longer a shortage, it stops rising. Similarly, a surplus forces the price to fall. As producers cannot push consumers to buy more than they plan, they need to lower the price to increase demand. The falling price decreases the surplus and when it meets the equilibrium point, it does not change anymore (Parkin 2008). 4

Equilibrium

The figure 5 (Cal Poly Pomona 2000) shows the equilibrium point (E). At any point higher than equilibrium point there will be a surplus. And at any point lower there will be a shortage.

To conclude, supply and demand is the root of all economic pricing. The relations between them is fundamental is analysis buyers and sellers and of their interactions in a market.

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References: Barker C. (2009) Sixty percent of the world use mobile phones, Internet WWW page at URL: http://asia.cnet.com/crave/2009/03/10/sixty-percent-of-the-world-uses-mobile-phones/ (accessed 12/11/08) Cal Poly Pomona (2000) Market Analysis, Internet WWW page at URL: http://www.csupomona.edu/~mrsafarzadeh/content_w3.htm (accessed 13/11/09) Caolo D. (2009) Apple amps up iPhone production, Internet WWW page at URL: http://www.tuaw.com/2009/11/01/apple-amps-up-iphone-production/ (accessed 21/11/09) Elliot A. (2009) Orange reveals 30,000 iPhones sold on first day, Internet WWW page at URL: http://www.pocket-lint.com/news/29434/orange-iphone-sales-smash-records (accessed 12/11/09) Hesseldahl A. (2009) Consumer Electronics Teardowns, Internet WWW page at URL: http://images.businessweek.com/ss/07/01/0118_teardown/2.htm (accessed 20/11/09) Hussain A. (2009) Is this the end for the landline phone?, Internet WWW page at URL: http://www.timesonline.co.uk/tol/money/consumer_affairs/article6831871.ece (accessed 12/11/08) 5

Mastrianna F. (2009) Basic Economics, 15th edition, United States: South Western Educational Publishing Moffatt M. (2009) Demand - The Economics of Demand, Internet WWW page at URL: http://economics.about.com/od/demand/p/demand.htm (accessed 12/11/09) Parkin M. (2008) Economics, 8th edition, United States: Pearson Education Poll M. (2009) Employment & Age Top Factors in Cell-Phone, Internet WWW page at URL: http://www.marketingcharts.com/interactive/employment-age-top-factors-in-cell-phone-pda-use9678/ (accessed 13/11/09) Skinner C.A. (2009) Nokia to Slash Mobile Phone Production, Internet WWW page at URL: http://www.pcworld.com/businesscenter/article/159450/nokia_to_slash_mobile_phone_production. html (accessed 20/11/09) Sloman J. (2007) Essentials of Economics, 4th edition, United Kingdom: Financial Times/ Prentice Hall

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