No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Five: Supply & Demand: Markets at Work 118 Let’s say that we have an initial equilibrium such as seen in Figure 5.4 ; the search process for the equilibrium or market transaction price is complete, and now a change in demand occurs. Let’s continue considering what might happen with a new version of the iPhone. While introduced with great fanfare and rave reviews, the product is experiencing numerous failures due to a previously unidentified conflict in the software that causes the phone not to work when certain apps are in use. This will cause a drop in demand (why not a drop in quantity demanded? See Figure 3.9 in chapter 3) as seen in Figure 5.7 . Note that nothing has changed in the supply curve; we’ve only had a change in demand, so the movement occurs down the supply curve as indicated by the blue arrow. The result will be a lower price and quantity sold. There are still marginal buyers, of course. Perhaps they don’t use the “killer app” that is having the software glitch; perhaps they expect Apple to be able to quickly come up with a fix and are willing to forego that app for a while (or the use of the phone feature) to get the product at a cheaper price. So saleswill continue, but at a lower price and quantity. WOULD APPLE REALLY RAISE PRICES IN RESPONSE TO A SHORTAGE? For the example of a shortage and how the price system would respond, we used a rather specialized product: a new iPhone. While using an iPhone to illustrate a surplus is reasonable, the use of an iPhone for a shortage may not look like our example, although the market pricing adjustment is broadly applicable. Apple may not deal with scarcity by raising prices directly; they may choose to allow demand to remain unsatisfied. There are several reasons (at least) why Apple might choose this strategy. First, they might be concerned with public perceptions of being “greedy,” and the loss to their brand name from this might outweigh the short term profit opportunities. Second, they may delay any future price cuts or improvements that they might have made, so that they capture the profit later. If demand is strong, why add more memory at the same price? Or if Apple does make an improvement, they may charge a higher price for the improved model. Nevertheless, even if Apple doesn’t raise prices (or allow its retailers to), prices will rise to meet the demand as the secondary market of consumers will resell (similar to concert ticket scalpers) at the true equilibrium price. Unfortunately for Apple, the bad news doesn’t end there in our imaginary construct. Despite their best efforts to have great working conditions in their domestic production facilities, the ongoing economic crisis has led to a new wave of populism and a furor of anger at “big business” exploiting the worker. Since Apple has continued with high levels of profit from their music and computer sales, the domestic workers have unionized and successfully obtained much higher wage and benefit levels than they previously enjoyed. Figure 5.7, Drop in Demand. A drop in demand (which could be due to any number of variables changing {anything other than price changes} such as consumer preferences, expectations, price changes in substitutes or complements, etc.) will result in lower price and quantity. P ($) Q (#) Q 1 P 1 P 2 Q 2 S D 1 D 2