QUESTION ONE [6 marks]:

Read the case "Demand and Supply in the Copper Industry" and answer the following questions.

1.List and clearly discuss factors that affected the producer (supply) side of the copper market [3 marks].

2.List and discuss the macroeconomic factors that affected the demand (consumer) side of the copper market [3 marks]

Note 1: The case is provided in Chap 2, pages 47 to 48 of your text book (Economics for Managers, 3^rd ed, by Paul Farnham).

Note 2: The answer must be specific to the case, not general]

The copper industry illustrates all the factors on the demand

and supply side of a competitive market that we discuss in this

chapter. Shifts in these factors can cause current and expected

future prices of copper to change rapidly. In addition, the cop-

per industry serves as a signal for the status of the global econ-

omy. Because copper is used in so many industries around the

world, the metal has been given the name "Dr. Copper," since a

strong demand and high prices for it can indicate that the over-

all economy is healthy.1

In February 2011, copper prices reached an all-time high of

$4.62 per pound, having almost quadrupled after a two-year series

of increases. At that time there was a fear that this rally in prices

had stopped, given speculation about events in China. Previously,

traders and industry observers had thought that China had an

insatiable demand for the metal. However, rising interest rates in

China could have forced speculators to sell copper to reduce their

financing costs, while consumers kept their inventories low to

save capital. At this time previously unreported stockpiles of cop-

per were also discovered in China, many of which were in bonded

warehouses where traders stored goods before moving them in or

out of the country. Analysts observed that these supplies could

easily have been moved into the market.2

In April 2011, copper analysts worried about further

decreases in prices. The worldwide economic downturn had

caused demand to decrease in key markets, such as housing and

construction. Copper consumers had reacted to previous high

prices by seeking cheaper alternative substitute materials, such

as aluminum and plastic.3 In June 2011, analysts reported that

copper prices surged to the highest level in two weeks due to

the reporting of better-than-expected Chinese industrial produc-

tion data. Unfavorable U.S. economic data and concern over

Chinese inflation had caused prices to decrease, but the indus-

trial output report indicated that demand could increase again.4

However, later that month concerns over economic conditions

in Europe, an important consumer of copper for plumbing and

electrical wiring, put further downward pressure on prices.5

During the summer of 2011, copper prices increased in

response to a U.S. Department of Labor report that new claims

for unemployment benefits fell for the first time in three weeks.

The widespread use of the metal in construction and manufac-

turing meant that any changes in unemployment could impact

copper prices. There was also concern on the supply side,

given that recent severe winter weather in Chile and a potential

strike at a large copper plant could disrupt production.6

The extreme volatility of the copper market was illustrated

in September 2011. On September 27 the Wall Street Journal

reported that copper prices rose sharply, given a report that the

European Union might expand its support of the Euro zone's

troubled banks and a Federal Reserve Bank of Chicago report

showing increased manufacturing output in the Midwest region

of the United States.7 However, one day later it was reported

that price declines had erased the previous market increase of

more than 5 percent as investors continued to worry about the

European financial crisis and whether previously anticipated

strong imports into China might not occur.8

Unforeseen events have also influenced the copper market.

Copper prices reached a seven-week high after a massive earth-

quake hit Chile in March 2010. There were concerns that supply

from the world's largest copper producer would be impacted by

the quake. Analysts attempted to determine as quickly as possi-

ble how much the country's infrastructure had been damaged.9

Similar factors affected the copper market in 2006 and

2007.10 Analysts predicted a decrease in the supply of copper

in 2007 after many strikes limited production in 2006. This

decreased production along with strong worldwide demand

caused the price of copper to remain at historic highs during

that year. Much of this demand was stimulated by the eco-

nomic growth in China. A lack of new mining projects also

limited supply, given that many large, known copper deposits

were in areas with unstable governments or were difficult to

reach.11 Another impact of the high prices was the increased

theft of copper coils in air-conditioning units, copper wires,

and copper pipes used for plumbing in homes and businesses

in many parts of the United States.12 Thefts, even of cem-

etery bronze vases containing large amounts of copper, con-

tinued with the relatively high prices of copper in subsequent

years.13

Analysts predicted that increased quantities of copper

would be available in 2007 due to several factors. (1) The

strikes that occurred in 2006 were not expected to continue the

next year. (2) The higher copper prices encouraged companies

to mine lower-grade copper that would not have been econom-

ically feasible with lower prices. However, the high copper

prices also gave many copper users the incentive to find sub-

stitutes for the metal. Aluminum producers benefited from the

high copper prices, and these prices stimulated the increased

use of plastic piping in home construction.

Forecasts of future prices and production can be very uncer-

tain, given the variety of factors operating on both the demand

and supply side of the market. One report estimated a surplus

of 108,000 metric tons for the first 11 months of 2006, while

another estimated a surplus of 40,000 metric tons for the entire

year. The extent of substitution with other products was also

difficult to estimate, as was the substitution with scrap metal.14

Moreover, in February 2007, the first impacts of the slowing

housing market on the U.S. economy were just beginning to

appear. This is another example of changes in the macroecon-

omy impacting this industry, leading to the name "Dr. Copper."

Copper prices continued to be influenced by the demand

from China. This demand slowed in 2008 as the Chinese drew

down their inventories when global prices were high and shut

down some industrial activity preceding the Olympics in August

2008. The slowing Chinese economy in fall 2008 also impacted

the world copper market where prices continued to fall.15

An analysis of a substantial decline in copper prices 10

years earlier from November 1997 to February 1998 illus-

trated many of these same factors.16 The 1997 financial cri-

sis and recession in Southeast Asia had a significant impact

on the copper industry, as did uncertain demand from China

and the increased use of copper in communications technol-

ogy in North America. Expectations also played a role as many

copper users were hesitant to buy because they thought prices

might continue their downward trend.

On the supply side, the low price of copper forced mining

companies to decide whether certain high-cost mines should

be kept in operation. However, a new mining process called

"solvent extraction" also allowed some companies to mine

copper at a lower cost, which permitted more copper mines to

stay in business.

We can see from this discussion that a variety of factors

influence the price of copper and that these factors can be cat-

egorized as operating either on the demand (consumer) side or

the supply (producer) side of the market. Sometimes the influ-

ence of one factor in lowering prices is partially or completely

offset by the impacts of other factors that tend to increase

prices. Thus, the resulting copper prices will be determined by

the magnitude of the changes in all of these variables.

Note also that the case discusses general influences on the

copper industry. There is no discussion of the strategic behav-

ior of individual firms. This focus on the entire industry is a

characteristic of a perfectly or highly competitive market,

where there are many buyers and sellers and the product is rela-

tively homogeneous or undifferentiated. Prices are determined

through the overall forces of demand and supply in these mar-

kets. All firms, no matter where they are located on the market

structure continuum, face a demand from consumers for their

products. The factors influencing demand, which are discussed

in this chapter, thus pertain to firms operating in every type

of market. However, the demand/supply framework and the

resulting determination of equilibrium prices apply only to

perfectly or highly competitive markets. We'll now examine

the concepts of demand and supply in more detail to see how

managers can use this framework to analyze changes in prices

and quantities of different products in various markets.