Intro to Econ: Sixth Lecture – From market demand to demand for a particular producer

One should differentiate between the demand for a good generally and the demand for a good from a particular producer. Think about the market for holiday apartments in Upper Styria (at some time of the year). As we discussed before we would expect that the demanded number of apartments will depend on the price of these apartments, the lower the price the more people would be interested in renting a holiday apartment. I don’t quite know what the slope (or shape) of this demand function is exactly, but we would expect to be properly downward sloping (as a function of the price).

This is all interesting, you might say, but there is no such thing as a uniform price for holiday apartments. Each apartment is different and each apartment will have a different rental price. True. I guess what we did is a fairly rough approximation to the real situation. Far from perfectly correct. But recall that no model (or story that we can tell) is ever a perfect fit to any real life situation. The model we build always depends on the question we are trying to address. If we are only interested in explaining why holiday apartments in Upper Styria are, on the whole or on average, cheaper in summer than in winter, while at the same time fewer people actually rent them in the summer than in the winter, then the rough story of market supply and demand suffices for an explanation. If you recall, the simple rough idea that people are more interested in renting holiday apartments in Upper Styria in the winter, that is there is a higher demand (function) in winter, can explain these two observations. In fact, I believe this to be a very appropriate explanation. This does not mean that all apartments in Upper Styria will be cheaper in winter than in summer. There could well be some that are relatively more attractive in summer than in winter. For instance, take an apartment that is actually quite far away from a ski resort, and in winter always in the shadow of a mountain (because the sun does not climb that high), but is perfectly sunny and yet cool in the summer and close to the top of a mountain and what not. One could well imagine that such an apartment could have a higher rental price in summer than in winter. Our story was a rough one and probably true for the average apartment but not necessarily for all.

Now suppose that you own a house with a few (fairly typical) apartments in Upper Styria and you are interested in renting them out as holiday apartments (in winter or summer). Is the market demand for holiday apartments in Upper Styria also relevant for you? Well, yes and no. Yes, in the sense that the rental price that you will be able to achieve will be more or less determined by the market demand function but the market demand function is actually not the demand function you face. What am I saying? Suppose you have a few apartments. Then the demand function you are interested in is one that tells you how many of your apartments you can rent out as a function of the price. You will find that you have a very steep demand function. I mean that your demand function will look more or less like this: there is a price (in fact essentially the market price) such that for any price lower than that market price you will find it easy to rent out all your apartments and for any price above this price you find it virtually impossible to rent out any. This means that you as a small contributor to the total market of holiday apartments have very little discretion as to which price you could choose. It is more or less all or nothing for you. You may have more discretion with the price if you have a very special location or a very special set of apartments, but for most apartment owners their individual demand function will be very steep.

This is probably even more true for the market for apples (in Southern Styria). If you are one of really very many apple farmers and you grow more or less the same apples as many others, then you will find that you have virtually no discretion when it comes to the price of your apples. Your demand function is extremely steep around the market price. The market price is determined by the market supply and demand, but for you it is essentially simply falling down from the sky. If you follow news reports about farm products you will hear farmers complaining (or simply stating the facts) that “the price is so low this year, so that even though I have a higher apple crop this year I will end up with less income than in the previous year” or statements like these. For a farmer the price is just what it is. You would have to produce a very unique product to have an influence on its price. If you produce Xboxes, which are somewhat unique, even though there is a similar product called PlayStation, then you may well find that you have some discretion over price, meaning that you can sell more of the product for a lower price and less for a higher price and you can try and find a price that you like best overall (perhaps one that gives you the most income – or profit if we are talking about firms).

Let me provide you with a useful economic term, the term of “substitute”. A substitute for a product is another product that potential consumers of your product find somewhat similar to yours. A “close substitute” is very similar to yours; a “distant substitute” is only somewhat similar to yours.

One can explain the difference between market demand and individual demand in terms of substitutes. If we consider the market demand of all holiday departments in Upper Styria, then while there are substitutes for these they are perhaps not super close. There are holiday apartments in other areas in the world of course, but for some people driving so far may not be an interesting option. Well, I actually guess that even the market demand for holiday apartments in Upper Styria in winter is quite a steep function of prices. But if we look at a single house with only a few apartments in Upper Styria, then suddenly we have a lot more substitutes. Now all apartments in the same area are also substitutes. This makes the demand function for one house with few apartments probably extremely steep.

One thought on “Intro to Econ: Sixth Lecture – From market demand to demand for a particular producer

  1. Pingback: Intro to Econ: Sixth Lecture – When Air Berlin went out of business | Graz Economics Blog

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