Question

Explain why this statement is false: Since there are many hotels and many hotel customers in San Francisco, it is definitely appropriate to use the supply and demand model to analyze the market for hotel rooms in San Francisco. [Hint: Under what circumstances is the supply and demand model appropriate?]

Answer 1

The problems with the supply and demand model are:

i. The supply and demand curves are always asssumed to take the given shapes in the market. However, this s cannot be the case every time. The shape of supply and demand curve can be different in different situations. For instance, the demand curve can be upward sloping for some individuals. These are the individuals who will book a hotel room only if the prices are higher. High price is the indicator of quality to them. Similarly, the demand curve can have different shapes according to different tastes or preferences or other assumptions.

ii. The supply and demand model shows that the equilibrium is reached through the intersection of demand and supply curves and a equilibrium price and quantity is determined. However, this might not happen at all. For instance, in case of hotel rooms, the hotel managers might price discriminate and charge different prices to people according to their needs. This might happen despite the fact that there are so many buyers and sellers in the market.

iii. It might be difficult to construct the suuply and demand curves in the first place. Even if they are constructed, they might not reflect the true picture.

The market structure might be perfect, but individuals cannot behave in that perfect way. Producers will always try to maximize profits and individuals will always try to bargain and get a better deal.