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Managerial Economics ninth edition Thomas Maurice Chapter 2 Demand, Supply, & Market Equilibrium McGraw-Hill/Irwin McGraw-Hill/Irwin Managerial Economics, 9e Managerial Economics, 9e Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved. Managerial Economics Demand • Quantity demanded (Qd) • Amount of a good or service consumers are willing & able to purchase during a given period of time 2-2 Managerial Economics General Demand Function • Six variables that influence Qd • Price of good or service (P) • Incomes of consumers (M) • Prices of related goods & services (PR) • Taste patterns of consumers ( ) • Expected future price of product (Pe) • Number of consumers in market (N) • General demand function • 2-3 Qd f ( P, M , PR , , Pe , N ) Managerial Economics General Demand Function Qd a bP cM dPR e fPe gN • b, c, d, e, f, & g are slope parameters • Measure effect on Qd of changing one of the variables while holding the others constant • Sign of parameter shows how variable is related to Qd • Positive sign indicates direct relationship • Negative sign indicates inverse relationship 2-4 Managerial Economics General Demand Function Variable 2-5 Relation to Qd Sign of Slope Parameter P Inverse b = Qd/P is negative M Direct for normal goods Inverse for inferior goods c = Qd/M is positive c = Qd/M is negative PR Direct for substitutes Inverse for complements d = Qd/PR is positive d = Qd/PR is negative Direct e = Qd/ is positive Pe Direct f = Qd/Pe is positive N Direct g = Qd/N is positive Managerial Economics Direct Demand Function • The direct demand function, or simply demand, shows how quantity demanded, Qd , is related to product price, P, when all other variables are held constant • Qd = f(P) • Law of Demand • Qd increases when P falls & Qd decreases when P rises, all else constant (ceteris paribus) • Qd/P must be negative 2-6 Managerial Economics Inverse Demand Function • Traditionally, price (P) is plotted on the vertical axis & quantity demanded (Qd) is plotted on the horizontal axis • The equation plotted is the inverse demand function, P = f(Qd) 2-7 Managerial Economics Graphing Demand Curves • A point on a direct demand curve shows either: • Maximum amount of a good that will be purchased for a given price • Maximum price consumers will pay for a specific amount of the good 2-8 Managerial Economics A Demand Curve (Figure 2.1) 2-9 Managerial Economics Graphing Demand Curves • Change in quantity demanded • Occurs when price changes • Movement along demand curve • Change in demand • Occurs when one of the other variables, or determinants of demand, changes • Demand curve shifts rightward or leftward 2-10 Managerial Economics Shifts in Demand 2-11 (Figure 2.2) Managerial Economics Supply • Quantity supplied (Qs) • Amount of a good or service offered for sale during a given period of time 2-12 Managerial Economics Supply • Six variables that influence Qs • • • • • • Price of good or service (P) Input prices (PI ) Prices of goods related in production (Pr) Technological advances (T) Expected future price of product (Pe) Number of firms producing product (F) • General supply function • 2-13 Qs f ( P, PI , Pr , T , Pe , F ) Managerial Economics General Supply Function Qs h kP lPI mPr nT rPe sF • k, l, m, n, r, & s are slope parameters • Measure effect on Qs of changing one of the variables while holding the others constant • Sign of parameter shows how variable is related to Qs • Positive sign indicates direct relationship • Negative sign indicates inverse relationship 2-14 Managerial Economics General Supply Function Variable 2-15 Relation to Qs Sign of Slope Parameter P Direct k = Qs/P is positive PI Inverse l = Qs/PI is negative Pr Inverse for substitutes Direct for complements m = Qs/Pr is negative m = Qs/Pr is positive T Direct n = Qs/T is positive Pe Inverse r = Qs/Pe is negative F Direct s = Qs/F is positive Managerial Economics Direct Supply Function • The direct supply function, or simply supply, shows how quantity supplied, Qs , is related to product price, P, when all other variables are held constant • Qs = f(P) 2-16 Managerial Economics Inverse Supply Function • Traditionally, price (P) is plotted on the vertical axis & quantity supplied (Qs) is plotted on the horizontal axis • The equation plotted is the inverse supply function, P = f(Qs) 2-17 Managerial Economics Graphing Supply Curves • A point on a direct supply curve shows either: • Maximum amount of a good that will be offered for sale at a given price • Minimum price necessary to induce producers to voluntarily offer a particular quantity for sale 2-18 Managerial Economics A Supply Curve 2-19 (Figure 2.3) Managerial Economics Graphing Supply Curves • Change in quantity supplied • Occurs when price changes • Movement along supply curve • Change in supply • Occurs when one of the other variables, or determinants of supply, changes • Supply curve shifts rightward or leftward 2-20 Managerial Economics Shifts in Supply 2-21 (Figure 2.4) Managerial Economics Market Equilibrium • Equilibrium price & quantity are determined by the intersection of demand & supply curves • At the point of intersection, Qd = Qs • Consumers can purchase all they want & producers can sell all they want at the “market-clearing” or price 2-22 Managerial Economics Market Equilibrium 2-23 (Figure 2.5) Managerial Economics Market Equilibrium • Excess demand (shortage) • Exists when quantity demanded exceeds quantity supplied • Excess supply (surplus) • Exists when quantity supplied exceeds quantity demanded 2-24 Managerial Economics Value of Market Exchange • Typically, consumers value the goods they purchase by an amount that exceeds the purchase price of the goods • Economic value • Maximum amount any buyer in the market is willing to pay for the unit, which is measured by the demand price for the unit of the good 2-25 Managerial Economics Measuring the Value of Market Exchange • Consumer surplus • Difference between the economic value of a good (its demand price) & the market price the consumer must pay • Producer surplus • For each unit supplied, difference between market price & the minimum price producers would accept to supply the unit (its supply price) • Social surplus • Sum of consumer & producer surplus • Area below demand & above supply over the relevant range of output 2-26 Managerial Economics Measuring the Value of Market Exchange (Figure 2.6) 2-27 Managerial Economics Changes in Market Equilibrium • Qualitative forecast • Predicts only the direction in which an economic variable will move • Quantitative forecast • Predicts both the direction and the magnitude of the change in an economic variable 2-28 Managerial Economics Demand Shifts (Supply Constant) (Figure 2.7) 2-29 Managerial Economics Supply Shifts (Demand Constant) (Figure 2.8) 2-30 Managerial Economics Simultaneous Shifts • When demand & supply shift simultaneously • Can predict either the direction in which price changes or the direction in which quantity changes, but not both • The change in equilibrium price or quantity is said to be indeterminate when the direction of change depends on the relative magnitudes by which demand & supply shift 2-31 Managerial Economics Simultaneous Shifts: (D, S) P S S’ S’’ B P’ P P’’ A • • •C D’ D Q Q Q’ Q’’ Price may rise or fall; Quantity rises 2-32 Managerial Economics Simultaneous Shifts: (D, S) P S S’ S’’ A • P B P’ • •C P’’ D D’ Q Q’ Q Q’’ Price falls; Quantity may rise or fall 2-33 Managerial Economics Simultaneous Shifts: (D, S) P S’’ S’ P’’ • S C B • P’ A • P D’ D Q Q’’ Q Q’ Price rises; Quantity may rise or fall 2-34 Managerial Economics Simultaneous Shifts: (D, S) P S’’ S’ S P’’ P P’ •C A • B • D D’ Q’’ Q Q’ Q Price may rise or fall; Quantity falls 2-35 Managerial Economics Ceiling & Floor Prices • Ceiling price • Maximum price government permits sellers to charge for a good • When ceiling price is below equilibrium, a shortage occurs • Floor price • Minimum price government permits sellers to charge for a good • When floor price is above equilibrium, a surplus occurs 2-36 Managerial Economics Ceiling & Floor Prices (Figure 2.12) Px Sx 2 1 Price (dollars) Price (dollars) Px Sx 3 2 Dx Dx 22 50 62 Quantity Panel A – Ceiling price 2-37 Qx 32 50 84 Quantity Panel B – Floor price Qx
