(continued)
In understanding the root cause of supply-change and its corresponding effect on cost, the odd variable out is technology. We generally consider an increase in technology as an improvement and a cost-reducer. Naturally, we do not expect an improvement to lead to an overall rise in cost. Instead, better technology should lead to a decrease in cost and a resulting increase in our supply of the final product. The most relevant way to understand the behavior of technology rests with whether or not an improvement reduces cost while not running afoul of patent law. The rational process in deciding whether or not to acquire new technology requires estimating the expected increase in production per day, in contrast to the relative reduction in the cost of maintenance and repair. To illustrate this point, let us consider the electric light-bulb. Modern fluorescent, halogen, and LED bulbs are more expensive than their incandescent counterparts. However, these newer technologies result in lower energy-costs along with longer bulb-life. In business, a bulb with double the life expectancy of the older type of bulbs only needs to be changed half as often. The savings in terms of paying to replace a bulb may justify paying a higher initial cost for the newer type of bulb.
Demand “Is” Revenue
Let us turn our discussion to the matter of customer demand for a product as well as the thought processes and resulting decisions that buyers make. In this section, we will discuss the five major variables that affect demand for a product. The first one is the number of buyers in the market. In respect to our supply-side analysis, let us return to our bakery example and hold our loaf-price constant at $2.00. On a typical visit, each customer tends to buy one loaf of bread. Between ten and eleven A.M., twelve customers come into our shop; each of them buys one loaf. However, many of our customers do their shopping during their lunch hour between noon and one o’clock. If twenty-four customers enter the shop during that hour and each of them purchases one loaf, we sell twenty-four loaves of bread. Ergo, more customers, more loaves sold.
In considering the other demand-variables, three of them work in the same direction as the number of customers. These variables include the income of the buyer, the personal tastes of that person, and the price of a competing brand. If any of these three variables increase, then demand will increase for the loaf of bread that we are selling.
In general, customers are willing and able to buy more of our product at the going price if their incomes increase. For a fresh example, let us put ourselves into the movie-theatre business. In this type of entertainment concern, we provide a service by selling tickets to our customers that allow them to enter our enclosed space, to sit in a seat, and to watch a film. When they have finished, we still have the film, seats, and enclosed space, our fixed costs, along with electricity, wages, and other variable costs. In this case, we provide a service rather than giving a tangible physical good, like a DVD of the film, to our patrons. As the incomes of entertainment-seekers increase, they purchase more of our service—if they are loyal to us--or similar entertainment,
such as live concerts and sporting events. This tendency holds for all “normal” goods and services, for which demand increases because of increases in income.
In contrast, we tend to buy fewer goods that we deem inferior and to buy higher-quality brands as income increases. For example, the food intake of college students often consists of fast food like burgers and tacos, chicken pot-pies, pizza, Ramen Noodles, and some canned protein combined with a box of inexpensive pasta such as Road-Kill Helper. Their choices of products result from low incomes. As their incomes increase, the normal course of events follows a path toward higher-quality meals that are more expensive but also are more nutritious and better-tasting.
Per another variable, our decision to buy products depends upon our tastes or preferences that are influenced by social trends. Many years ago, I (Dr. Sase) noticed that virtually all of my female Economics students wore “banana clips” in their hair. These devices were a spring-loaded hair-clamp with two banana-shaped curved pieces of plastic with teeth. When these clips reigned as the height of student fashion, the demand for this relatively inexpensive accessory soared to its apex. After the popularity of this product waned, shopkeepers consigned this Twentieth-Century artifact to the bargain bins near the front door of neighborhood stores. This event exemplifies the rise and fall of consumer tastes and preferences.
Our third and fourth variables require a more involved explanation. Demand for the brand that we sell tends to increase when competitors raise prices for similar goods that they produce. However, to comprehend the dynamics of this market eventfully, we need to fill in the intermediate steps. Let us imagine that we are one of two major producers of colorful, fizzy, sugar-flavored water. Apart from the packaging and minor differences in the taste of the effervescent liquid, the two brands virtually perform the same. Each of us competitors sells a comparable quantity of our drink at $1.00 for an eight-ounce bottle. One day, our competitor raises the price of its beverage to $1.50. As a result, our sales of bottles that still are priced at $1.00 rise sharply. What has occurred? Due to a sudden increase in price, indifferent customers viewed the product of our competitor as excessively priced in contrast to our product. These customers, who decided not to buy the competing brand at $1.50, chose to buy our brand at $1.00 instead. In summary, our competitor raised his/her price, we kept our price the same, and many customers “substituted” our product for that of our competitor. Customers will make a substitution between brands if it feels economically rational to do so.
Our fourth and final variable is the odd one out. Again, our scenario involves two sets of producers. This time, the demand and the quantity sold of our product increases when the price of a different but related good decreases. Let us imagine that our little company makes fruit jellies. Another company specializes in the manufacture of peanut butter. Everyone who makes peanut-butter-and-jelly sandwiches (PB&Js) are potential customers for both companies. Peanut butter and jelly go together and “complement” one another in sandwiches. For reasons unknown to us, the peanut-butter manufacturer lowers its price from $5.00 to $4.00 per one-pound jar. Our sales of one-pound jars of jelly increase even though our price remains the same as before. What has happened? Customers have purchased more jars of peanut butter because of the price reduction and, consequently, plan to make more peanut-butter-and-jelly sandwiches. Therefore, customers need to purchase more jars of jelly in order to complement the additional amount of peanut butter that they buy. In summary, our customers will purchase more of both goods if it seems economically rational to do so.
Wrapping up the Groceries
In the preceding sections, we have focused on the interworking of the major elements of markets. Now, let us put theory into practice. Everyone, from the very poor to the very affluent, in the metropolitan region needs to develop a basic understanding of markets, revenues, costs, supply, and demand in order to continue the recovery of Metro Detroit. For this understanding to take place, a workable social contract must develop. A significant portion of this contract focuses on wages. Due to the way that the world works, those offering their labor for hire need to have a clear understanding of the relationship between the wages that they desire in respect to the value of the productivity that they offer. Those who work for wages and those who have other vested interests in the success of a business that needs productive employees must understand the need for a fair and balanced division of the revenue generated as well as the human responsibility that owners, managers, and employees have to one another.
In order for a city and region to thrive, all parties must work with a basic understanding of the market dynamics of supply and demand. These dynamics include the seven variables outlined earlier: (1) the number of sellers, (2) the number of buyers, (3) costs, (4) incomes, (5) tastes and preferences, (6) the price of a substitutable good, and (7) the price of a complementary product. To clarify these seven variables, we need to understand the cause and effect of relations between the number of sellers willing and able to produce products and the number of buyers willing and able to purchase these products. The interconnections in the social and legal contract of production; the wages demanded by workers and paid by employers; taxes raised for needed public goods and services; and the private funding of education, research, and development in respect to technological progress must harmonize with one another.
In summary, the complete and sustained recovery of our hub-city of Detroit depends upon these elements: dialogue among all groups involved to reach an understanding of the need for relevant education and training as well as the affordable delivery of this education and training to those who need and desire it. Furthermore, we want to develop other industries that complement the existing ones. These industries include automotive and related manufacturing, health-care delivery, and local institutions of higher education. We continue to see progress in these areas with developments such as Downtown, Midtown (e.g., TechTown), and Corktown as well as bio-medical research sites and a global multi-modal freight-hub, among others. We hope that smaller businesses in the fields of art, retail, and hospitality continue to develop and, subsequently, to use available real estate to its optimum. In future episodes, we will continue to delve into the economics of the planet, the nation, Southeast Michigan, and Detroit as well as the financial markets.
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Dr. John F. Sase teaches Economics at Wayne State University and has practiced Forensic and Investigative Economics for twenty years. He earned a combined M.A. in Economics and an MBA at the University of Detroit, followed by a Ph.D. in Economics from Wayne State University. He is a graduate of the University of Detroit Jesuit High School (www.saseassociates.com).
Gerard J. Senick is a freelance writer, editor, and musician. He earned his degree in English at the University of Detroit and was a supervisory editor at Gale Research Company (now Cengage) for over twenty years. Currently, he edits books for publication (www.senick-editing.com).
Julie G. Sase is a copyeditor, parent coach, and empath. She earned her degree in English at Marygrove College and her graduate certificate in Parent Coaching from Seattle Pacific University. Ms. Sase coaches clients, writes articles, and edits copy (royaloakparentcoaching.com).
