Supply Management Economics Part III

The goal of this series is to bring economics to the forefront in Supply Management where it has been swept under the rug for too long. How do I know this? When I look at any of the list of critical skills for Supply Management that have been produced by experts over the past few years, few, if any, mention economics (although many mention finance) and none give it any importance.

And this is wrong when you consider that economics is essentially a study of Supply Management. After all, the three basic questions revolved around what to produce, for whom, and how! If that isn’t Supply Management, what is? In Part II, we decided that we had to go back to the basics — back to 1776 when Adam Smith published An Inquiry into the Nature and Causes of the Wealth of Nations and gave modern economics its independence from politics and moral philosophy, where it was subservient ever since Aristotle embedded it in his Politics.

We went back to the basics by starting with the production possibility curve and the concept of comparative advantage, the two foundations you need when trying to figure out what to produce and in what ratio among the options at your disposal. In other words, we answered the what. The next question we need to answer is for whom?

To answer this, we turn to the basic laws of supply and demand and the supply vs. demand curves. Supply and demand is the classic microeconomic model of price determination in a market that attempts to find the economic equilibrium between price and quantity. There are four basic laws in this model:

  1. The Law of Demand Increase
    If demand increases and supply remains unchanged,
    a shortage occurs and this leads to a higher equilibrium price.
  2. The Law of Demand Decrease
    If demand decreases and supply remains unchanged,
    a surplus occurs and this leads to a lower equilibrium price.
  3. The Law of Supply Increase
    If demand remains unchanged and supply increases,
    a surplus occurs and this leads to a lower equilibrium price.
  4. The Law of Supply Decrease
    If demand remains unchanged and supply decreases,
    a shortage occurs and this leads to a higher equilibrium price.

In other words, demand increases and supply decreases can result in shortages and higher prices, while demand decreases and supply increases can result in surpluses and lower prices. In this theory, supply, under one set of assumptions, is modelled as a supply curve that relates price to quantity that can be supplied at that price and demand, under one set of assumptions, is modelled as a demand curve that relates price to the quantity that will be bought at that price. The equilibrium, or optimal production, is where the curves intersect.

So how does this help you with the “whom” question, as it looks like the answer is gives you is “how much”. It helps indirectly. You see, there is more than one supply curve and one demand curve. There is a supply curve for each potential product, and variant of the product, a corresponding demand curve for each of these product under current market assumptions, and a corresponding demand curve for each shift in the market that could occur as a result of changing tastes, market expectations, and/or total market size, just for starters. Some of these shifts will increase demand and others will decrease demand. As a result, it’s not just equilibrium that you’re after, but optimal equilibrium — defined as the intersection point between a supply curve and a corresponding demand curve that maximizes profit. So, if the result of your comparative advantage analysis says you should produce shoes as one of your product, and you can produce running shoes and walking shoes with equal advantage, and running shoes gives you a higher overall profit, than you produce running shoes and your market is running shoe buyers. In addition, if you can shift the demand curve in your favour by focussing on your ability to offer the extra support required by female runners (who have a wider Q-angle) and selling primarily to women, you sell women’s running shoes to women and the whom, after diving into the data, is women who are recreational runners and want extra support.

This just leaves the how.

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