ECONOMICS U$A
Episode 16

SUPPLY AND DEMAND
PURPOSE:
To help viewers understand the factors that determine the quantity of goods demanded by consumers, and the factors that determine the quantity of goods supplied.

OBJECTIVES:

1. The amount of a good consumer’s purchase depends on how much they value it in relation to the selling price.
a) The more units of a good an individual (or society in general) has consumed in a given period, the less he values an additional unit (diminishing marginal utility).
b) If the value the consumer places on an additional unit of a good is less than the selling price, he will not purchase it.

2. At a given price, consumers will generally demand more of a good if their income rises, if the price of a substitute good rises, if the price of a complementary good falls, or if consumers’ tastes change in favor of the good in question. All these factors will shift the demand curve.

3. As producers expand production they may initially experience economies of scale, but as they continue to expand production the cost of producing each additional unit will increase.

4. A firm will not maximize its profits if it expands production past the point at which the additional cost per unit is greater than the revenue earned by selling that unit (the marginal revenue = marginal cost criterion for profit maximization).
a) If the selling price increases, firms will produce more units of output because they will then be able to make a profit on these units.
b) If the costs of production increase, firms will produce fewer units.

KEY ECONOMIC CONCEPTS:
marginal utility, shifts in the supply and demand curves, substitute goods, movement along the supply and demand curve, marginal cost marginal revenue, profit, diminishing returns, complementary goods

Contemporary Issues Supply and Demand

Cable companies have to make large investments and incur sizeable fixed costs in order to serve any given community. The average cost per user of these fixed investments falls as more people subscribe to the cable services. Based on this, is it reasonable to assume that there are economies of scale in the cable industry? Could this lead to the domination of the local cable markets by one or possibly a couple of providers? Would it be wasteful for more companies to make the same type of investment? Is this necessarily bad? How should governments respond?

For a complete transcript of this video program download TVpdf#16

California’s Thirst for Water
In 1974, water was cheap. But, 1975 marked the beginning of one of the worst droughts in California’s history. It’s a semi-arid state with the gigantic agriculture industry dependent on water from its northern snow-pack and winter rains. But in the fall and winter of 1975, the relief of seasonal winter rains and snow did not come. Accustomed to "dry-spells", Californians showed little concern. But that winter wore on with no rain or snow, and soon what was great weather for some began to cause problems for others.
The summer of ’76 exploded into flames as over 1,400 fires swept the state.
Marin County was particularly hard hit by the drought. It was one of the first areas forced to begin rationing water and people were penalized if they used more than their allotted amount. Rising to the challenge, Marin residents reduced their water
consumption by 66%. As the drought continued, Marin County saw more and more evidence of just how valuable water was. Besides being motivated to conserve, Marin residents were also willing to spend a lot more money…and make a long term commitment so they wouldn’t be as vulnerable again. There were costly bond issues proving that people were willing to pay a high price for water, so they wouldn’t have to deal with drought again.
Torrential rains in the final days of 1977 marked the end of this drought. But six years later, with memories fading and plenty of water at hand, consumption slowly climbed back to where it had been.

Comment and Analysis by Richard Gill
One thing the Marin County experience clearly brought out was that when you have a shortage of a commodity like water, you get very careful about how you use it. When you have very little of a commodity, an additional unit of it will bring you more added satisfaction…more marginal utility, than if you had an abundant supply. The principle expressed here is called the "Law of Diminishing Marginal Utility". It explains why we’re willing to pay more for a commodity when it’s in short supply and why we’ll pay only a low price for it when it is abundant.
Producing American Oil
In response to the 1973 Arab-Israeli War, OPEC put the squeeze on America by quadrupling its prices for oil. So Americans looked to domestic producersto increase the supply. The price of oil which is the critical factor in the incentive to drill had been very stable o through 1971. So as inflation began to accelerate beginning in 1965, it meant that in terms of purchasing power, the real price of oil was declining… therefore there was less incentive for producers to drill, and drilling activity declined to a low point in 1971.
With world prices rising, President Nixon offered the American oil industry an incentive. The price of old oil was fixed, but new oil, found after 1972, was free to follow the higher "world price". By allowing this source of oil to follow the "world price,’ the
government encouraged additional oil research and technology
The new high price for oil, coupled with government decontrol, were the financial carrots needed to lure suppliers back into domestic production. Many of these producers were independents who accounted for 90% of domestic drilling.
With the lure of rising oil prices and profits, oil production almost doubled in America as well as the OPEC countries. As profits soared, more producers decided to pump even more oil. Soon there was a glut. By 1985 the price of oil had plummeted.

Comment and Analysis by Richard Gill
With higher oil prices, American consumers found ways to use less oil. They economized on the more expensive oil, just as in the California drought, they economized on the temporarily expensive water. But the oil episode also tells us a good deal about producer reactions to higher prices. The higher price of oil served as an incentive to search for and produce larger quantities of domestic oil. This search was expensive and risky. It required the promise of higher prices and a higher profit.
The Blue Jean Revolution A fascinating part of our culture is our preoccupation with "fads." …whether it’s "Cabbage-Patch" dolls or "hula-hoop." The blue jeaning of America took place in several stages…and peaked when this almost basic commodity became "high fashion"…designer
jeans. Though they were double the price of regular jeans, America bought them in droves.
It was Jordache, through creative advertising that created the demand for designer jeans. Brands were built up with a lot of TV hype and consumers were willing to pay a premium for those reasons.
Jordache’s success caused other designers to jump on the bandwagon…Any designer who had a name was putting his name on the back pocket of a jean. To keep up the momentum, even more money was poured into advertising.
Back in 1965, jeans were bought on the order of less than one pair per capita. Now it had increased to almost three per capita. Soon the market was over saturated. At that point designer jeans lost its status or cachet, and the consumer was no longer willing to pay a premium price for it.

Comment and Analysis by Richard Gill
A great Greek philosopher once summed up the world in the phrase, "All is flux." He could have been talking about the jeans craze, or, for that matter, about the American economy generally. One year, the demand curve for jeans shoots way up.A few years later, people tire of jeans or find substitutes in athletic sportswear and the demand falls back down again. People’s tastes change, their incomes change, the availability of other products changes…All such factors can shift the demand curve for any product and down and back up again.