Download QUANTITY DEMANDED

Economic Analysis and Public Policy
Lecture
1
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Slide 1
Economics …
• … is the study of how individuals and societies
choose to use the scarce resources that nature
and previous generations have provided. The
key word in this definition is choose. Economics
is a behavioral, or social, science. In large
measure it is the study of how people make
choices. The choices that people make, when
added up, translate into societal choices.
Slide 3
Micro/Macro Economics
• microeconomics The branch of economics that
examines the functioning of individual industries
and the behavior of individual decision-making
units—that is, business firms and households.
• macroeconomics The branch of economics that
examines the economic behavior of aggregates—
income, employment, output, and so on—on a
national scale.
Slide 4
Three basic questions must be answered in
order to understand an economic system:
• What gets produced?
• How is it produced?
• Who gets what is produced?
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capital Things that are themselves
produced and that are then used in
the production of other goods and
services.
factors of production (or factors)
The inputs into the process of
production. Another word for
resources.
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production The process that
transforms scarce resources into
useful goods and services.
inputs or resources Anything
provided by nature or previous
generations that can be used directly
or indirectly to satisfy human wants.
outputs Usable products.
opportunity costs The best
alternative that we give up, or forgo,
when we make a choice or decision.
Slide 7
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Capital Goods and Consumer Goods
consumer goods Goods produced for
present consumption.
investment The process of using
resources to produce new capital.
Because resources are scarce, the opportunity cost of every investment in capital is forgone
present consumption.
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DEMAND IN PRODUCT/OUTPUT MARKETS
quantity demanded The amount
(number of units) of a product that a
household would buy in a given period if
it could buy all it wanted at the current
market price.
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Determinants of the
Quantity Demanded
i.
price, P
ii.
price of substitute goods, Ps
iii. price of complementary goods, Pc
iv.
income, Y
v.
advertising, A
vi.
advertising by competitors, Ac
vii. size of population, N,
viii. expected future prices, Pe
xi.
adjustment time period, Ta
x. taxes or subsidies, T/S
• The list of variables
that could likely affect
the quantity demand
varies for different
industries and
products.
• The ones on the left
tend to be significant.
Slide 21
Slide 22
DEMAND IN PRODUCT/OUTPUT MARKETS
CHANGES IN QUANTITY DEMANDED
VERSUS CHANGES IN DEMAND
The most important relationship in
individual markets is that between
market price and quantity demanded.
Changes in the price of a product affect the quantity demanded per period. Changes in any
other factor, such as income or preferences, affect demand. Thus, we say that an increase
in the price of Coca-Cola is likely to cause a decrease in the quantity of Coca-Cola
demanded. However, we say that an increase in income is likely to cause an increase in the
demand for most goods.
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DEMAND IN PRODUCT/OUTPUT MARKETS
PRICE AND QUANTITY DEMANDED:
THE LAW OF DEMAND
demand schedule
A table showing how
much of a given
product a household
would be willing to
buy at different
prices.
Anna’s Demand Schedule
forr Telephone Calls
PRICE (PER
CALL)
$
QUANTITY
DEMANDED
(CALLS PER
MONTH)
0
30
.50
25
3.50
7
7.00
3
10.00
1
15.00
0
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DEMAND IN PRODUCT/OUTPUT MARKETS
demand curve A graph illustrating how
much of a given product a household
would be willing to buy at different prices.
Slide 25
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DEMAND IN PRODUCT/OUTPUT MARKETS
Demand Curves Slope Downward
law of demand The negative
relationship between price and quantity
demanded: As price rises, quantity
demanded decreases. As price falls,
quantity demanded increases.
It is reasonable to expect quantity demanded to fall when price rises, ceteris paribus,
and to expect quantity demanded to rise when price falls, ceteris paribus. Demand
curves have a negative slope.
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DEMAND IN PRODUCT/OUTPUT MARKETS
Other Properties of Demand Curves
Two additional things are notable about
Anna’s demand curve.
As long as households have limited incomes and wealth, all demand curves will intersect
the price axis. For any commodity, there is always a price above which a household
will not, or cannot, pay. Even if the good or service is very important, all households
are ultimately constrained, or limited, by income and wealth.
That demand curves intersect the quantity axis is a matter of common sense. Demand
in a given period of time is limited, if only by time, even at a zero price.
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DEMAND IN PRODUCT/OUTPUT MARKETS
To summarize what we know about the shape of
demand curves:
1. They have a negative slope. An increase in
price is likely to lead to a decrease in
quantity demanded, and a decrease in price
is likely to lead to an increase in quantity
demanded.
2. They intersect the quantity (X-) axis, a result
of time limitations and diminishing marginal
utility.
3. They intersect the price (Y-) axis, a result of
limited incomes and wealth.
Slide 28
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DEMAND IN PRODUCT/OUTPUT MARKETS
OTHER DETERMINANTS OF HOUSEHOLD DEMAND
Income and Wealth
income The sum of all a household’s
wages, salaries, profits, interest payments,
rents, and other forms of earnings in a
given period of time. It is a flow measure.
wealth or net worth The total value of
what a household owns minus what it
owes. It is a stock measure.
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DEMAND IN PRODUCT/OUTPUT MARKETS
normal goods Goods for which demand
goes up when income is higher and for
which demand goes down when income
is lower.
inferior goods Goods for which demand
tends to fall when income rises.
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DEMAND IN PRODUCT/OUTPUT MARKETS
Prices of Other Goods and Services
substitutes Goods that can serve as
replacements for one another: when the
price of one increases, demand for the
other goes up.
perfect substitutes Identical products.
complements, complementary goods
Goods that “go together”: a decrease in
the price of one results in an increase in
demand for the other, and vice versa.
Slide 31
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DEMAND IN PRODUCT/OUTPUT MARKETS
Tastes and Preferences
Expectations
Slide 32
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DEMAND IN PRODUCT/OUTPUT MARKETS
SHIFT OF DEMAND VERSUS MOVEMENT ALONG
A DEMAND CURVE
Shift of Anna’s Demand Schedule Due to
increase in Income
SCHEDULE D0
Price
(Per Call)
$
SCHEDULE D1
Quantity
Quantity
Demanded
Demanded
(Calls Per Month
(Calls Per
at an Income of
Month at an
$300 Per Month) Income of $600
Per Month)
0
30
35
.50
25
33
3.50
7
18
7.00
3
12
10.00
1
7
15.00
0
2
20.00
0
0
Slide 33
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DEMAND IN PRODUCT/OUTPUT MARKETS
shift of a demand curve The change that
takes place in a demand curve corresponding
to a new relationship between quantity
demanded of a good and price of that good.
The shift is brought about by a change in the
original conditions.
movement along a demand curve The change
in quantity demanded brought about by a change
in price.
Change in price of a good or service
leads to
Change in quantity demanded (movement along the demand curve).
Change in income, preferences, or prices of other goods or services
leads to
Change in demand (shift of the demand curve).
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DEMAND IN PRODUCT/OUTPUT MARKETS
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DEMAND IN PRODUCT/OUTPUT MARKETS
FROM HOUSEHOLD DEMAND TO
MARKET DEMAND
market demand The sum of all the
quantities of a good or service demanded
per period by all the households buying in
the market for that good or service.
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DEMAND IN PRODUCT/OUTPUT MARKETS
Slide 37
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SUPPLY IN PRODUCT/OUTPUT MARKETS
Successful firms make profits because they
are able to sell their products for more than it
costs to produce them.
profit The difference between revenues
and costs.
Slide 38
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SUPPLY IN PRODUCT/OUTPUT MARKETS
PRICE AND QUANTITY SUPPLIED:
THE LAW OF SUPPLY
quantity supplied The amount of a
particular product that a firm would be
willing and able to offer for sale at a
particular price during a given time period.
Slide 39
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SUPPLY IN PRODUCT/OUTPUT MARKETS
supply schedule A table showing how
much of a product firms will sell at different
prices.
Clarence Brown’s Supply Schedule for
Soybeans
PRICE (PER
BUSHEL)
QUANTITY SUPPLIED
(BUSHELS PER
MONTH)
$1.50
0
1.75
10,000
2.25
20,000
3.00
30,000
4.00
45,000
5.00
45,000
Slide 40
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SUPPLY IN PRODUCT/OUTPUT MARKETS
law of supply The positive relationship
between price and quantity of a good
supplied: An increase in market price will
lead to an increase in quantity supplied,
and a decrease in market price will lead to
a decrease in quantity supplied.
Slide 41
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SUPPLY IN PRODUCT/OUTPUT MARKETS
supply curve A graph illustrating how
much of a product a firm will sell at
different prices.
Slide 42
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SUPPLY IN PRODUCT/OUTPUT MARKETS
OTHER DETERMINANTS OF SUPPLY
The Cost of Production
Regardless of the price that a firm can
command for its product, revenue must
exceed the cost of producing the output for the
firm to make a profit.
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SUPPLY IN PRODUCT/OUTPUT MARKETS
The Prices of Related Products
A soybean farm is a producer
that supplies soybeans to the
market.
Assuming that its objective is to maximize profits, a firm’s decision about what quantity
of output, or product, to supply depends on
1. The price of the good or service
2. The cost of producing the product, which in turn depends on
■ The price of required inputs (labor, capital, and land)
■ The technologies that can be used to produce the product
3. The prices of related products
Slide 44
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Determinants of the Supply Function
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.
x.
price, P
input prices, PI, e.g., sheet metal
Price of unused substitute inputs, PUI, such as fiberglass
technological improvements, T
entry or exit of other auto sellers, EE
Accidental supply interruptions from fires, floods, etc., F
Costs of regulatory compliance, RC
Expected future changes in price, PE
Adjustment time period, TA
taxes or subsidies, T/S
Note: Anything that shifts supply can be included and varies for different
industries or products.
Slide 45
Slide 46
SUPPLY IN PRODUCT/OUTPUT MARKETS
SHIFT OF SUPPLY VERSUS MOVEMENT ALONG
A SUPPLY CURVE
movement along a supply curve The
change in quantity supplied brought about
by a change in price.
shift of a supply curve The change that
takes place in a supply curve corresponding
to a new relationship between quantity
supplied of a good and the price of that
good. The shift is brought about by a
change in the original conditions.
Slide 47
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SUPPLY IN PRODUCT/OUTPUT MARKETS
TABLE 3.4 Shift of Supply Schedule for Soybeans
Following Development of a New
Disease-Resistant Seed Strain
SCHEDULE S0
SCHEDULE S1
Quantity Supplied
Quantity
Price
(Bushels Per Year
Supplied
(Per Bushel) Using Old Seed) (Bushels Per Year
Using New Seed)
$1.50
0
5,000
1.75
10,000
23,000
2.25
20,000
33,000
3.00
30,000
40,000
4.00
45,000
54,000
5.00
45,000
54,000
Slide 48
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SUPPLY IN PRODUCT/OUTPUT MARKETS
As with demand, it is very important to
distinguish between movements along supply
curves (changes in quantity supplied) and
shifts in supply curves (changes in supply):
Change in price of a good or service
leads to
Change in quantity supplied (movement along a supply curve).
Change in income, preferences, or prices of other goods or services
leads to
Change in supply (shift of a supply curve).
Slide 49
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SUPPLY IN PRODUCT/OUTPUT MARKETS
FROM INDIVIDUAL SUPPLY TO MARKET SUPPLY
market supply The sum of all that is
supplied each period by all producers of a
single product.
Slide 50
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SUPPLY IN PRODUCT/OUTPUT MARKETS
Slide 51
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MARKET EQUILIBRIUM
equilibrium The condition that exists
when quantity supplied and quantity
demanded are equal. At equilibrium, there
is no tendency for price to change.
Slide 52
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MARKET EQUILIBRIUM
EXCESS DEMAND
excess demand or shortage The condition
that exists when quantity demanded exceeds
quantity supplied at the current price.
Slide 53
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MARKET EQUILIBRIUM
When quantity demanded exceeds quantity supplied, price tends to rise. When the price in
a market rises, quantity demanded falls and quantity supplied rises until an equilibrium is
reached at which quantity demanded and quantity supplied are equal.
Slide 54
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MARKET EQUILIBRIUM
EXCESS SUPPLY
excess supply or surplus The condition
that exists when quantity supplied exceeds
quantity demanded at the current price.
Slide 55
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MARKET EQUILIBRIUM
When quantity supplied exceeds quantity demanded at the current price, the price tends to
fall. When price falls, quantity supplied is likely to decrease and quantity demanded is likely
to increase until an equilibrium price is reached where quantity supplied and quantity
demanded are equal.
Slide 56
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MARKET EQUILIBRIUM
CHANGES IN EQUILIBRIUM
When supply and demand curves shift, the
equilibrium price and quantity change.
Slide 57
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MARKET EQUILIBRIUM
Slide 58
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DEMAND AND SUPPLY IN PRODUCT MARKETS:
A REVIEW
Here are some important points to remember about the mechanics
of supply and demand in product markets:
1. A demand curve shows how much of a product a household would buy if it could buy
all it wanted at the given price. A supply curve shows how much of a product a firm
would supply if it could sell all it wanted at the given price.
2. Quantity demanded and quantity supplied are always per time period—that is, per day,
per month, or per year.
3. The demand for a good is determined by price, household income and wealth, prices of
other goods and services, tastes and preferences, and expectations.
4. The supply of a good is determined by price, costs of production, and prices of related
products. Costs of production are determined by available technologies of production
and input prices.
5. Be careful to distinguish between movements along supply and demand curves and
shifts of these curves. When the price of a good changes, the quantity of that good
demanded or supplied changes—that is, a movement occurs along the curve. When
any other factor changes, the curve shifts, or changes position.
6. Market equilibrium exists only when quantity supplied equals quantity demanded at
the current price.
Slide 59
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Break Decisions Into Smaller Units:
How Much to Produce ?
• Graph of output and
profit
• Possible Rule:
» Expand output until
profits turn down
» But problem of
local maxima vs.
global maximum
gets you to point A
not B
profit
GLOBAL
MAX
Local
MAX
A
quantity B
Slide 60
Average Profit = Profit / Q
PROFITS
MAX
C
B
» Rise / Run
» Profit / Q = average profit
• Maximizing average
profit doesn’t maximize
total profit
profits
Q
• Slope of ray from the
origin
quantity
Slide 61
Marginal Profits =
/ Q
• Q1 is breakeven (zero profit)
• maximum marginal profits occur at the inflection
point (Q2)
• Max average profit at Q3
• Max total profit at Q4 where marginal profit is
zero
• So the best place to produce is where marginal
profits = 0.
Slide 62
Total, Average, and Marginal Profit
Functions
Slide 63
Present Value
» Present value recognizes that a dollar received in the
future is worth less than a dollar in hand today.
» To compare monies in the future with today, the future
dollars must be discounted by a present value interest
factor, PVIF=1/(1+i), where i is the interest
compensation for postponing receiving cash one
period.
» For dollars received in n periods, the discount factor is
PVIFn =[1/(1+i)]n
Slide 64
Net Present Value (NPV)
•
•
•
Most business decisions are long term
» capital budgeting, product assortment, etc.
Objective: Maximize the present value of profits
NPV = PV of future returns - Initial Outlay
NPV = t=0 NCFt / ( 1 + rt )t
•
»
•
•
where NCFt is the net cash flow in period t
NPV Rule: Do all projects that have positive net present values. By
doing this, the manager maximizes shareholder wealth.
Good projects tend to have:
1.
2.
3.
high expected future net cash flows
low initial outlays
low rates of discount
Slide 65
Sources of Positive NPVs
1. Brand preferences for 5.
established brands
2. Ownership control
6.
over distribution
3. Patent control over
7.
products or techniques
4. Exclusive ownership
over natural resources
Inability of new firms to acquire
factors of production
Superior access to financial
resources
Economies of large scale or size
from either:
a. Capital intensive processes,
b.
or
High start up costs
Slide 66
Coefficients of Variation
or Relative Risk
• Coefficient of Variation (C.V.) =
•
•
•
•
/ r.
_
» C.V. is a measure of risk per dollar of expected return.
Project T has a large standard deviation of $20,000 and
expected value of $100,000.
Project S has a smaller standard deviation of $2,000 and
an expected value of $4,000.
CVT = 20,000/100,000 = .2
CVS = 2,000/4,000 = .5
» Project T is relatively less risky.
Slide 73
Projects of Different Sizes:
If double the size, the C.V. is not changed!!!
Coefficient of Variation is good for comparing projects of
different sizes
Example of Two Gambles
A:
Prob
.5
.5
X
10
20
}
}
}
B:
Prob
.5
.5
X
20
40
}
}
}
R = 15
 = SQRT{(10-15)2(.5)+(20-15)2(.5)]
= SQRT{25} = 5
C.V. = 5 / 15 = .333
R = 30
 = SQRT{(20-30)2 ((.5)+(40-30)2(.5)]
= SQRT{100} = 10
C.V. = 10 / 30 = .333
Slide 74
The Empirical Rule
• The empirical rule approximates the variation of
data in a bell-shaped distribution
• Approximately 68% of the data in a bell shaped
distribution is within ± one standard deviation of the
μ  1σ
mean or
68%
μ
μ  1σ
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall
SlideChap
75 3-75
The Empirical Rule
• Approximately 95% of the data in a bell-shaped distribution
lies within ± two standard deviations of the mean, or µ ± 2σ
• Approximately 99.7% of the data in a bell-shaped distribution
lies within ± three standard deviations of the mean, or µ ± 3σ
95%
99.7%
μ  2σ
μ  3σ
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall
SlideChap
76 3-76
A Sample Illustration of Areas under the
Normal Probability Distribution Curve
Slide 77
Using the Empirical Rule
 Suppose that the variable Math SAT scores is bellshaped with a mean of 500 and a standard
deviation of 90. Then,
 68% of all test takers scored between 410 and
590
(500 ± 90).
 95% of all test takers scored between 320 and
680
(500 ± 180).
 99.7% of all test takers scored between 230 and
770
(500 ± 270).
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall
SlideChap
78 3-78
Locating Extreme Outliers:
Z-Score
 To compute the Z-score of a data value, subtract the
mean and divide by the standard deviation.
 The Z-score is the number of standard deviations a
data value is from the mean.
 A data value is considered an extreme outlier if its
Z-score is less than -3.0 or greater than +3.0.
 The larger the absolute value of the Z-score, the
farther the data value is from the mean.
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall
SlideChap
79 3-79
Locating Extreme Outliers:
Z-Score
XX
Z
S
where X represents the data value
X is the sample mean
S is the sample standard deviation
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall
SlideChap
80 3-80
Locating Extreme Outliers:
Z-Score
 Suppose the mean math SAT score is 490, with a
standard deviation of 100.
 Compute the Z-score for a test score of 620.
X  X 620  490 130
Z


 1.3
S
100
100
A score of 620 is 1.3 standard deviations above the
mean and would not be considered an outlier.
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall
SlideChap
81 3-81