Pre Module: Economics Introduction Demand & Supply

Lesson
Materials

 

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In this module, lets look at Airline Industry as an example. It is a simple model based on the pandemic and explains how demand and supply equilibrium works. We understand the impact of changes in safety (safety concerning travel) and price of jet fuel on price and the number of airline tickets sold, keeping other factors constant. Herein, jet fuel safety and price are Exogenous Variables, and the price of an airline ticket and the number of airline tickets sold are Endogenous Variables that the model explains.

Graph: BCI | OECD

First, let's look at an example of the unemployment rate. Business Consumer Confidence is the exogenous factor in this simplistic model, while unemployment is the endogenous variable. We mention keeping other factors/variables constant. This is because many other variables affect the unemployment rate, including policies implemented by a country. Business Confidence Index & Economic Business Cycle are related; during the time of expansion, the business confidence index is positive/high as demand for goods and services is more, so the unemployment rate is less. On the other hand, during the recession, the business consumer confidence dips, usually there are layoffs, and the unemployment rate increases. In the Airline Industry model, let's understand the effect of change in perception of safety and Cost cost of jet fuel on the price of an airline ticket and the number of airline tickets sold.  

In the Airline Industry model, let's understand the effect of change in perception of safety and Cost cost of jet fuel on the price of an airline ticket and the number of airline tickets sold. We look at the demand and supply model using the Airline Industry example. From the Demand and Supply equilibrium, at Qd = Qs, the price of the airline ticket adjusts so 

that the quantity supplied is equal to the amount demanded. 

The demand curve is downward sloping, i.e., as the price of the airline ticket reduces, the number of airline tickets demanded increases. The demand curve is the relationship between the cost of the airline ticket and the number of airline tickets required to keep travelers' safety constant. 

The supply curve is upward sloping, i.e., as the price of the airline ticket increases, the number of airline tickets supplied increases. 

The supply curve is the relationship between the price of the airline ticket and the number of airline tickets provided, keeping the cost of jet fuel constant. 

The term market clearing is essential to understand. The market prices for goods and services adjust quickly to the demand and supply intersections. However, wages and prices change slowly in labor markets. In the short run, the prices of goods and services are sticky, i.e., they take time to adjust to the market equilibrium—for example, automobiles, labor markets, etc. Understanding the behavior of prices over the short and long term varies and is covered in detail in later tutorials. In the short run, prices are sticky, but prices are flexible over the long run. Commodity prices like the price of Oil and Soybeans traded on exchanges are real-time adjustments. However, the retailers of crude oil follow a sticky-price model. Retailers of global oil employ a “sticky price method,” during the pandemic, a demand-side shock led to falling in travel along with an oversupply of oil, leading to a fall in global crude oil prices. However, retailers did decrease costs, and for this model, we are considering the price of global crude oil and jet fuel oil is flexible to a certain extent. 

We look at the Impact of the COVID-19 pandemic on prices for petroleum products as the cost of jet fuel is closely linked to global crude oil prices. The pandemic induced a jolt to the world economy, and the OPEC Russian oil war jacked down the global crude oil prices. In 2016 China became the largest importer of oil. In February, due to lockdown due to COVID-19, China’s Purchasing Managers’ Index fell nearly 49 percent, reaching its lowest level since 2005-- the most considerable demand-side shock to the market since the 2008–09 global recession. The OPEC Russia price war and major international lockdowns led to a further drop in global crude oil prices. By 1 May 2020, the US had a near-record level of 535.2 million barrels of crude petroleum stockpiles. Refer to the US Bureau of Labor Statistics report.  Restrictions imposed due to COVID-19 due to safety concerns example, lockdowns, and restricted travel to fall in demand for air travel keeping other factors constant. The demand curve moves leftward, leading to a new equilibrium point Q1 as the equilibrium moves from Q to Q1.  The number of tickets sold (demanded) reduces as the prices of airline tickets fall. A drop in the fuel cost (due to oversupply) leads to an outward/ rightward shift of the supply curve, keeping other factors constant. The supply of airline tickets increases as prices of airline tickets reduce at the new equilibrium. 

The equilibrium price of the ticket falls from P to P1 and the supply of the airline tickets increased from Q to Q1

This part explains the theoretical aspect of demand and supply equilibrium. In reality, countries’ scenarios could differ depending on the pandemic response, travel restrictions, social distancing norms, etc.  Conduct a research project and find the price of airline tickets (commercial) in your respective countries over the time of the pandemic.

Fig: The demand-supply equilibrium - shift in the demand curve | The middle Road

Did the price of tickets change? Did they remain constant, go down or increase? Why? The purpose of this exercise is to illustrate the demand and supply equilibrium concerning the cost of goods and services.  An increase or lowering of the cost of goods or services always affects the supply curve leading to a shift in the supply curve.  Note: People are always confused with the cost aspect here. An increase in the cost of goods is passed on to the consumer, leading to a rise in the selling price. 

(This is the assumption). Cost of goods/service depends on input cost of materials, commodities, ingredients, work hours, etc.