Catalysts to Changes in Supply and Demand
In an effort to reflect real world scenarios, the Supply and Demand Simulation runs participants through a number of situations which cause changes to supply and demand to the apartment rental business as experienced by GoodLife Management in the city of Atlantis. In each scenario, we look at what were the catalysts to the changes in supply and demand and discuss how these shifts affected the decision making process. In essence, we will see that there are numerous reasons like income, population changes, and government intervention that can cause changes to supply and demand, yet equilibrium if often met by changing prices as supported by the invisible hand theory.
In the first scenario, the GoodLife team was seeking to maximize revenues and lower the number of un-rented apartments. At the original price of $1300, only 1200 units were demanded. Yet, once price was dropped to $950, 1900 units represented the quantity demanded, and at the same time, revenues are maximized at a total of $1.81 million—at prices lower than that, revenues would decrease due to the associated costs of maintaining all the apartments at such low rates.
In the second scenario, the GoodLife team sought to understand the price at which apartments would have to be leased in order to lease all 2500 apartments. Due to the associated maintenance costs, the rental rate would have to be $1550. While this type of a price increase certainly motivates the rental company to rent more apartments, there are other factors that play into the scenario. For example, people who work in Atlantis live in neighboring towns due to lower rental costs and as a result there is less demand for the rental apartments—it is a matter of personal economics causing shift in demand. In order to increase quantity demanded, the property company must lower its rental prices. Once prices are dropped to $1050, there is equilibrium between quantity demanded and quantity supplied (2000 apartments), and at this rate there is no reason for neither demand nor supply to change—$1500 is the equilibrium price.
The addition of a large corporation basing it headquarters in Atlantis marks the next change in the relationship between the supply and demand of apartments. More job opportunities means more residents and a higher demand for lodging. Although the supply of apartments has remained the same, the increase in demand for lodging causes the demand curve to shift to the right. When this happens and supplies remain the same, an increase in price will restore equilibrium. In this case, 2350 units are demanded at the price of $1400. Any rate lower than this would increase quantity demanded and the result would be a shortage. This increase in price lowers quantity demanded and restores equilibrium—therefore the equilibrium price is $1400.
As they say, all good things must come to an end and so it goes for the rental lodging boom in Atlantis. An increase in the income of its citizens causes a shift towards a higher demand for single family homes and as a result less of a demand for apartments. This decreased demand causes the demand curve to shift to the left and balances at the lower equilibrium price of $1300 which would accommodate 2250 apartments.
The simulation also demonstrated the effect of changes to the supply curve. As the interest in apartments continued to diminish and 400 apartments are converted into luxury condominiums, both the supply and demand shift to left. In this scenario, because the decrease in available apartments causes the supply curve to shift to the left, there is pressure to increase the price to $1475. At this new price, the shortage is eliminated by reducing the quantity demanded to just 1900.
The final scenario demonstrated the effects of a price ceiling of $1550 on monthly rates. Because GoodLife is forced to keep priced at no more than $1550, the result is a reduced supply which creates a shortage because the GoodLife is less willing rent at lower rates. In this example the quantity demanded at $1550 is 3150, but the quantity supplied at this price is 2275, creating a shortage of 875 apartments.
There are numerous catalysts that can cause a shift in the demand or supply of a particular good or service. In many cases, equilibrium is met by changes in price which in turn change quantities demanded and quantities supplied as stated by the invisible hand theory. In this simulation, pricing played a huge role by increasing demand when prices were lowered and lowering demand as prices increased. Such modifications helped curtail any shortages or non-cost-effective surpluses and became and important part of learning to adjust the business in order to ensure long term success.
Real World Application
In my workplace, market research plays a huge role in understanding what the best strategy may be in terms of making business decisions based on changes in supply and demand. Huge players in the market have caused significant market saturation and a reduction in overall demand. We need to have an understanding of exactly what the needs of the market are and what is the incremental cost they are willing to pay for one feature versus another? Lowering prices is one way which we remain competitive, as it helps drive higher quantities demanded. It is by no means an exact science. As a matter of fact, much of our online promotions are created in such a way so that we can test the efficacy of campaigns by conducting A/B tests on pricing. For example, we send out a promotion and send it at one price for 50% of the recipients, and at another price for the other 50%. Depending on click-through rates and purchases, we start to develop an understanding of how pricing affects demand. That way, we know that the next time we need to run the same type of promotion, we will need to ensure we have the appropriate supply on hand to meet fulfillment. Interestingly, with the growth of electronic software delivery (ESD) the issue of supply to meet demand has been much reduced that in years past since no physical components are required. What has become more important is the need to provide the correct product feature mix in order to meet the needs of the market, so R&D teams have had to learn to better understand how to react to the supply and demand relationship, whereas previously it had been the fulfillment and sales departments that focused on supply and demand.
In conclusion, it is important to reevaluate on a regular basis the effects of supply, demand, and price on your business so that you can make adjustments accordingly. It is also important to be aware of the external factors that affect supply and demand so that decisions are made based on a consolidated view of the market. Price can often help bring equilibrium to the situation, but sometimes changes in price may not be the most feasible strategy, and understanding what other decisions can be made, like reducing supplies becomes essential. In the end, the ability to make intelligent, well informed business decisions to proactively and reactively deal with changes in supply and demand seems to be an iterative, learning process.
Reference
Colander, D. C. (2004). Macroeconomics (5th ed.). Burr Ridge: Prentice-Hall.
