MANAGERIAL ECONOMICS

Market and Market Evolution

Diana Tsai
IBM, NCTU

Tanker service industry :

Frontline

Frontline: a large independent crude carrier

Market conditions during the financial crises

Demand for oil transportation fell
Declining freight rates
Falling utilization
2

Tanker service industry :

Frontline

Decisions
Entire company
Continue in business or shut down
If continue, scale of operation

For each ship

Operate or sell ships

The demand for oil transportation and the supply

for tanker services

3

Analysis

Appreciate the impact of excess supply on the market price.

Appreciate the impact of excess demand on the market price.

Apply the price elasticities of demand and supply to predict

the impact of shifts in supply on market price and production.

Apply the price elasticities of demand and supply to predict

the impact of shifts in demand on market price and
production.

Market equilibrium
Definition: Price at which quantity demanded equals

quantity supplied
When market out of equilibrium,

market forces push

price towards equilibrium

Market equilibrium

Market equilibrium
Excess supply = excess of quantity supplied over
quantity demanded
Triggers price decrease
Business implication: (Short run) Shrink
production and (long run) exit
Excess demand = excess of quantity demanded
over quantity supplied
Triggers price increase
Business opportunity: (Short run) Increase
production and (long run) enter the industry

Supply shift
Supply shift (cost): down/up
Represents change in cost at all quantities of
production
Supply shift (quantity): right/left
Represents change in quantity of production at all
prices
New equilibrium depends on elasticities of demand
and supply

Supply shift (cost)

Supply shift
(cost):
Price elasticities
of demand and
supply

10

Supply shift (cost)

Price change no more than dollar amount of the
supply shift
Price change greater if
Demand is more inelastic
Supply is more elastic

11

French products:
Foie gras vis--vis butter

Two major French agricultural exports

foie gras
French butter

12

French products:
Foie gras vis--vis butter
If Euro becomes 10% more expensive, compare the

effect on prices of
foie gras
French butter
The demand for foie gras is less elastic (fewer

substitutes)

13

Demand shift
Demand shift (willingness to pay): down/up
Represents change in willingness to pay (marginal
benefit) at all quantities of consumption
Demand shift (quantity): right/left
Represents change in quantity demanded at all
prices
New equilibrium depends on elasticities of demand
and supply

14

Demand shift (quantity)

15

Demand shift (quantity)

Price change no more than dollar amount of the
demand shift
Price change greater if
Demand is more inelastic
Supply is more inelastic

16

Valentines Day

Price of roses always rises much more than the price

of greeting cards. Why?

Which one is more elastic in supply?

Greeting cards can be stored, but roses are

perishable

17

1840, 1910, and Today

The

years 1840, 1910 and 2009 represent

widely disparate business conditions.
The general economic principles behind
business strategy are enduring.
Business practices evolve with changing
environment.

Doing Business in 1840

Numerous

intermediaries - Farmers to
factors to brokers/agents to buyers
Substantial price risk for participants
Infrequent transactions
Scarcity of information regarding sales and
prices of comparable goods

Infrastructure in 1840
Infrastructure

in transportation,
communication and finance were poorly
developed in 1840.
Poor infrastructure meant the dominance of
small family run firms.
Markets were local.

Transportation in 1840
Railroads,

in their infancy, were fragmented.

National railway network had not yet arrived.
Waterways were used for long distance
transportation. Yet routes were limited.
With poor transportation, producers were
limited to local markets

Communication in 1840
Postal

service was the dominant mode of

long distance communication.
Postal service relied on the horse and
stagecoach.
Telegraph was expensive and was used
only for important time-sensitive information.

Finance in 1840

Most businesses were sole proprietorships or

partnerships which made long term debt difficult to
obtain.
Shares of stock were not easily traded and cost of
capital was high.
No institutional mechanism existed for handling
business risk.
Futures trading to manage price risk was yet to
come about.

Production Technology in 1840

Most

factories used century old methods of

production.
Textile manufacture was mechanized.
Use of standardized parts (prevalent in
clocks and guns then) was just beginning.
Scale intensive industries and high volume
production were non existent.

Government in 1840
Government

was involved in large

infrastructure investments such as canals
and railroads.
Later in the century government regulation
of the business environment was emerging.
Prime Meridian Conference led to the
system of standard time.

Business in 1840
Technology

limited production to traditional

modes.
Production served local markets.
Without transportation infrastructure and
access to large markets, mass production
technologies would not have been useful.

Business in 1840
Without

communication infrastructure,
information on prices, sellers and buyers
was not readily available.
Credit was available based on personal
relationships.
As a result businesses were small and
informally organized.

Business Conditions in 1910

Mass-production

technologies made
possible high volume low cost manufacture
of goods.
Railroads dominated transportation and
allowed mass distributors to reach widely
scattered customers.
Telegraph and telephones greatly improved
long distance communications.

Business Conditions in 1910

Manufacturing

became more vertically

integrated.
Multidivisional firms emerged in response to
the size and complexity of operations.
Industries were becoming concentrated.
As standardization increased so did labor
related conflicts.

Finance in 1910
Securities

markets traded shares of large

industrial firms.
Credit bureaus made credit related
information easily accessible.
Innovations appeared in monitoring and
reporting business activities.
Public disclosure of accounting information
was in vogue.

Government in 1910
Government

regulation extended to such

areas as corporate law, antitrust and worker
safety.
Increased regulation forced managers to
collect a lot of data on internal operations.
Mandatory secondary schooling provided
the labor force needed by large bureaucratic
organizations.

Business in 1910
Expanded

infrastructure allowed firms to

expand their markets, product lines and
production scale.
New technologies allowed high volume
standardized production.
Growth of financial infrastructure made
large scale firms viable.

Doing Business Today

Large

vertically integrated firms have been

declining.
Alliances and joint ventures could work
better than mergers and acquisitions.
Diversification yields to deconglomeration.
Firms adopt complex matrix structures.

Transportation Infrastructure
Today
Air,

rail and ground transportation have

become better coordinated.
Sophisticated communication and data
processing technologies enable container
shipping.
Cities like Atlanta have grown relying on air
transport in spite of poor rail and water
connections.

Communications Technology
Today
Capacity

for instantaneous transmission of

complex information makes possible global
markets for products and services.
Technology has enhanced worker
productivity.
Coordination of activities has become easier
with modern computer and communication
technologies.

Finance Today
Regulation

of banking and securities markets

resulted in a stable financial services sector.
Capital markets and financial institutions
became more active in evaluating firm
performance.
Globalization of financial markets made many
mergers and acquisitions possible.
Liquidity crisis of 2008 has slowed economic
and entrepreneurial activity.

Production Technology Today

Modern

technologies such as CAD/CAM

have made low cost tailor-made production
feasible.
Use of new technologies often means
reorganizing the firm around these
technologies.

Government Today
In

some areas (airlines, trucking and

financial services) traditional regulation has
been relaxed.
Regulation has increased in other areas
(workplace safety, discrimination and
environmental protection).

Government Today
Intergovernmental

treaties and agreements

create regional free trade zones.
Governments anti trust policy encourages
in-house development of capabilities.
Government policy supports basic research
and the commercialization of R & D projects.

Business Today
With

rising demand from developing nations

the market size has increased.
Firms focus on a narrow range of activities
and enjoy the economies of scale.
Financial innovation enables faster growth
of firms and the ability of new entrants to
challenge the incumbents.

Infrastructure in Emerging
Markets
Unlike

the advanced nations, many

developing nations still lack transportation
and finance infrastructures.
Businesses are reluctant to invest in
countries where corruption, cronyism and
conflicts are rampant.

Business Conditions and

Strategy
Business

conditions change over time and

so do the optimal strategies.
Principles needed to arrive at successful
strategies do not change.
Recipes change from period to period but
principles behind the recipes do not.