Answer to Pointrider's demand question

[Econ101]

pointrider
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Joined: 20 Mar 2005
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PostPosted: Wed Dec 14, 2005 1:15 pm Post subject: Re: pop quiz Reply with quote
Econ101 wrote:
pointrider wrote:
POP QUIZ

Is it possible for the average price received for a commodity to go up if the total supply of that commodity does not change and the demand for that total number of pounds of commodity does not change?

If you think it can, provide an example of how and when it can happen.


Pointrider, this happens every day. One example of this happening is in the hyperinflation countries. In that instance, all commodities go up because they are bought in a devaluing currency. In fairness, Agman did say in one of his posts he was talking about inflation adjusted. There are other examples too. What are you thinking about?


Congratulations! You are right Econ. It does happen a lot for various reasons. What I wanted to get around to here is the subject of product mix. One product mix can be more valuable on the average than another when the demand for total pounds and the supply of total pounds do not change.

For example, if suddenly 25% of all beef produced were to be sold today as organic beef at higher prices, the average value of the product mix would be substantially higher. Specialty markets and products represent an opportunity for all producers. Some will get in on the game and some will not - for various reasons. Marketing will become more important in the total mix of "beef business" as more niche markets and more niche products are developed.

There have been many examples of successful niche marketing programs in agriculture, and the producer or packer or marketer (or "all of the above") who has a substantial percentage of his business in successful niche marketing programs will have a substantial profit advantage on those who don't. I've seen it with my own eyes for the past 15 years or so.

"The best mix wins!"

 

[Econ101]

Pointrider, I like your example. It points out the fact that demand curves depend on competition. When there is none, there is no demand curve. There are only prices that the people with market power can get away with that best serves their interests.

In all of the below scenarios, the demand for a certain quantity of water is the same. It is 1/2 gallon per day.

Let us take a pertinent example to illustrate the point. Suppose during Katrina five thousand people went to the superdome. Those five thousand people have to drink water every day. The amount of water that they need to drink is relatively inelastic (in other words, cost or price is not a significant factor). We have to define some economic terms here. Elasticity means that a measure in of the percentage change in one variable resulting from a 1 percent increase in the other variable. When the supply is inelastic, it means that a 1 percent price increase leads to a less than one percent quantity decrease demanded.

Let us suppose that they require a half a gallon of water per day for each person for survival. Let us also suppose that there is enough water to supply this need for the 5 day period. We also have to assume perfect market information and that people know that there is enough water for them to consume 1/2 gallon per day. Now we can talk about the different scenarios of market power that can exist.

The first scenario is that there is no market power, that there are 5,000 faucets each assigned to supply each person with the 1/2 gallon per day, and there is no percieved shortage of water and everyone gets the amount they need per day. Under this scenario, water would have a demand curve. The demand curve would be one that allows people to substitute drinking the water with using it to pour over themselves to cool down or sell it to others for something else of value. Maybe the only cost is going over to the faucet that was yours and and getting your allotted 1/2 gallon per day. We assume each individual's demand is the for the same quantity.

The second scenario is one where there is market power, and it is concentrated in the hands of a few people. In this instance you would have an oligopoly (few people controlling supply). Here we have a group of say 20 people that control the total water supply for all of the people. Under this scenario, the people controlling the water supply have market power. If any of the 20 people decided to hold back on the water, there would be a percieved shortage. This percieved shortage would result in people willing to sell items to the 20 people who had the water to get what they needed (this is similar to your example, Pointrider). It would make the supply curve described above much more inelastic. The supply curve would be more inelastic to the extent that the 20 people were able to exert their control over the supply of water. Some would share it willingly, and some would hold on to the tap and make people pay for that water. If someone charged too much, people could go over to the next person and get water for what they were willing to sell it for, so there would some competition. Each individual's demand for water as measured by quantity is the same.

The third scenario is one where there is only one person (monopoly) controlling the water supply. In this scenario, the water supply would be VERY, VERY inelastic. This one person could make everyone give him/her whatever they have of value to be able to get the water they want. In this third scenario, the quantity demanded for water remained the same as in the first scenario, 1/2 a gallon of wate per day, but because of market power, the one monopolist could extract from everyone else all of the things of value they had. He could still give everyone their 1/2 gallon as in the first scenario, but he would enrich himself with the market power that he had over the water. Each individual's "demand" for water remained the same at 1/2 gallon.

The cattle markets are in a similar, although not as extreme, as the above example. When there is market power, you can not necessarily tell if there is an increase in demand based on the price and quantity. It is a comparative figure only. You can only use that rule if there is pure competition.

This is not a perfect example, but it illustrates the point of market power on the price times quantity assumption of measuring demand.

Agman is just wrong to say that changes in the price times quantity mean shifts in demand. That only happens in competitive markets (scenario 1).

Maybe it means market power is being exerted in some way. It sure did in the Pickett case.