Using supply and demand analysis explain and illustrate how the major factors determining supply and demand have determined equilibrium price and quantity traded.

University Degree Business and Administrative studies

Mark Nsianguana - 21123801

Economics Assignment

Using supply and demand analysis explain and illustrate how the major factors determining supply and demand have determined equilibrium price and quantity traded. (40%)

Quantity demanded is the amount of a good that a consumer is willing and able to buy at a given price over a given period of time (Sloman, 2005:35). The major determinants of demand are: Tastes, Substitutes/Complements, Income, Income distribution and Expectations of future price changes.

Recession is a factor that had a major effect on demand within the battery market. This had caused a fall in consumer incomes and confidence as ‘more adults stayed at home in order to save money’ which they are likely more to save which brings a leakage in the economy. As a result, there is a fall in demand in the market.

Promotion also affected demand as manufacturers introduced ‘attractive deals’ as the UK went into recession. As a result, this happen to attract customers to ‘stockpile large packs’ when ‘promotions were at their height’ and thus increasing demand of number of batteries purchased per pack in 2008 from ‘4.5 to 4.7’.

Population and the growth in one-person households were also determinants that helped increase demand because overtime as there are more people in the future, there will be an increasing need for batteries. Furthermore, this has a knock-on effect on household items as this will increase demand for smoke alarms, clocks etc. because the relationship between household items and non-rechargeable batteries is that they are complements. As the report even says ‘everyday household items are likely to continue to relying on removable batteries’ which shows the relationship both complements have. Therefore as current prices for batteries fall in the future, there is increase in demand for household items.

Within the battery market, there are four different types of batteries such as alkaline, zinc carbon, rechargeable and specialist batteries. For instance, alkaline and zinc are close substitutes and because the UK is in recession, zinc carbon attracts ‘consumers with lower incomes’. This means that due to the fall in income in recession, consumers are more likely to switch to consuming zinc carbon because it is relatively cheaper compared to alkaline. Thus increasing demand for zinc.

Expectation of future price changes take part within the influence of demand in the battery market. According to the forecast, it is said that prices will fall in the future between 2010 and 2013; therefore consumers are less likely to purchase batteries before the price goes down and thus a fall in demand in the short-term.

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The shortage of batteries had an effect on both supply and demand. Firstly, due to a shortage in batteries because of the promotions of free batteries, this decreased the supply for the production of batteries. This also led to excess demand from consumers as they were ‘relying heavily on their accumulated stocks’ which resulted a fall in demand because manufacturers were unable to produce.

Quantity supplied is the amount a producer is willing to supply at a given price (Sloman and Sutcliffe, 2005:40). The major determinants of supply are: Cost of production, Profitability of alternative products, Aim of producers and Nature, ‘random shocks’ and other unpredictable events.

VAT is one of the factors that affect supply for batteries; this is because the tax will still shift the supply curve upwards as manufacturers will want a higher price to compensate it to supply the same quantity. However, because the tax is a percentage of the value of the good, it will shift by different amounts according to the price of the battery. The impact on the equilibrium price and quantity therefore depends on the amount of the tax and the original price level. The effect of this on the supply is shown in the diagram below:

Manufacturer tactics were also a factor for supply because due to the ‘promotions based on free batteries’, this gave them an incentive to supply more in order to maximise sales rather than push prices to maximise profits. This was one of the reasons batteries were being sold because of promotion leading to ‘average price of sold falling by 2.4% in 2009, due in part to manufacturers’ sales tactics.

Technological advances are being met to increase the supply of batteries. Manufacturers are using innovative ideas ‘rather than push prices, new products will only serve to prop up existing values’ because they believe that increasing price will attract cheaper rivals since the market is highly competitive. This would increase supply as new battery products will become more profitable to supply.

a) How does the concept of price and cross price elasticity of demand relate to sales of batteries? (25%)

Price elasticity of demand measures the responsiveness of quantity to demand to a change in price (Sloman, 2005: 48). The major determinants of price elasticity of demand are the number and closeness of substitute goods, the proportion of income spent on the good and the time period. The formula is percentage change in quantity demanded divided by the percentage in price.

The price elasticity of demand for the battery market tends to be relatively inelastic because there are no close substitutes. According to the report, the imposition of VAT caused ‘average spending on batteries fell by 3% in 2009 but would have remained largely unchanged’, however, because batteries are relatively inelastic, it means VAT being imposed, the burden of the tax falls on the consumer, which would cause demand to fall proportionately less, but will have insignificant effect on consumption for batteries because total consumer expenditure rises.

However, there are four different segments within the battery market such as such as zinc carbon, alkaline/manganese, speciality and rechargeable cells. These tend to be close substitutes, therefore demand tends to be relatively elastic because differentiated goods are being produced which mean consumers can more easily switch their demand if the price of one segment changes relative to other segments in the market.

Cross-price elasticity measures the responsiveness of demand for one good to a change in price another (Sloman, 2005:60). The major determinant of cross-price elasticity is the closeness of the substitute or complement. The formula is percentage change in demand for good A divided by the percentage change in price of good B.

Alkaline and zinc batteries are close substitutes and tend to have a positive cross-price elasticity of demand. This is because since there is a recession, consumer incomes falls in which they are ‘cash-strapped’ so they tend to purchase cheaper batteries such as zinc batteries because these attract consumers with lower incomes which is also seen as an inferior good.

Also, the relationship between non-rechargeable batteries and household items is said to be complements because the report says ‘everyday household items are likely to continue to relying on removable batteries, rather than built in ones’ this shows the significance of how strong the relationship of these complementary goods are. According to the forecast, current prices for batteries will tend to fall, thus increasing demand for household items, in which it is said to have a negative cross-price elasticity of demand.

Specialist batteries and sex toys are complements because due to the cheap prices of specialists at ‘£1’, there is a spurred growth by the activities of ‘discounters and pound stores’ and therefore, in turn there is a greater demand for specialists. This means that manufacturers have substituted a better way of using button cells than AAs which stimulates more demand for sex toys.

b) Certain segments of the market for batteries may be inferior. What is meant by this and what would you expect to have happened to this segment since 2009? (15%)

Income elasticity of demand measures the responsiveness of demand to a change in consumer incomes (Sloman, 2005: 59). The word ‘inferior’ refers to ‘inferior goods’ in which these goods whose demand decreases as consumer income increase. Such goods have a negative income elasticity of demand (Sloman, 2006: 60). The formula is percentage change in demand divided by the change in income.

Rechargeable batteries were one of the certain segments seen as inferior because according to the recession, ‘cash-strapped consumers realised that they can save money by buying a rechargeable battery’. This is because consumers with lower incomes are benefited to purchase a rechargeable battery that has a longer life span and can save their costs rather than a non-rechargeable battery, in which this forgoes alkaline batteries. Therefore these batteries are said to have negative income elasticity of demand and since 2009, there has been a substantial growth of ‘56% since 2005’.

Zinc-carbon batteries are also one of the certain segments seen as inferior because despite the recession, they introduced ‘cheaper own-label zinc carbon ranges’ which was more of a low-quality product. Also, cheap stores such as the pound stores had introduced ‘mega value packs of 24-packs of AA zinc carbon’ which stimulates demand from ‘less affluent consumers and from consumers using low drain devices’. Therefore these batteries are said to have negative income elasticity of demand and since 2009, they have had a smaller fall of ‘10%’ compared to the greater fall of ‘14% seen in 2008’.

What sort of market structure characterises the market for batteries? Why is there little incentive for new firms to enter the market? (20%)

The market structure for batteries is oligopoly. Oligopoly is one of the market structures where there are few enough firms to enable barriers to be erected against the entry of new firms (Sloman, 2005: 157). The degree of market concentration is very high. Firms within an oligopoly only produce branded products and there are barriers to entry. These barriers to entry include advertising, economies of scale, government regulations, research and development etc. Another important feature is interdependence between firms. This means that each firm must acknowledge the likely reactions of other firms in the market when making pricing decisions. The dominating brands that are leading the battery market are Energizer ‘33%’ and Duracell ‘43%’ because according to the pie chart on Figure 29, they both have more than 25% of market share in the industry.

There is little incentive for firms to enter the market because of the significant entry barriers in the oligopolistic market prevents the dilution of ‘small manufacturers’ in the long run which maintains supernormal profits for the dominant brands. It is possible for these ‘small manufacturers’ to operate on the periphery of the battery market, but none of them would be large enough to have any significant effect on market prices and output. In addition, the report clearly says ‘smaller manufacturers have typically found life difficult in a market where brand awareness and distribution are both important’ which shows the importance of barriers to entry is present within the market.

Also, another reason to why smaller manufacturers struggle to enter is because the major brands are taking part in non-price competition which is a competitive strategy they pursue in order to gain competitive advantage. Example of this is advertising as the ‘number of promotions’ the major brands are displaying is a powerful technique of influencing consumers thus increasing demand for their brand. ‘Promotions such as buy four get four free’ is an incentive for consumers to purchase more batteries because in return they get additional free batteries, thus forgoing ‘small manufacturers’ and substituting to buying batteries from major brands like Panasonic and Duracell.

References

Sloman, J. (2005) Economics Published Harlow: Financial Times Prentice Hall 2005

6th edition