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Managerial Economics &
Business Strategy
Chapter 2
Market Forces: Demand and Supply
Are we following? (number 4)
• The demand for good X is given by
1
1
1
Q  1,200  Px  Py  8Pz  M
2
4
10
d
x
• Research shows that the price of related goods are given by Py=$5,900
and that Pz=$90, while the average income of individuals consuming
this product is M=$55,000.
• Are good Y and Z substitutes or compliments for good X?
• Is X an inferior or normal good?
• How many units of good X will be purchased when Px=$4,910?
• Determine the demand function and the inverse demand function for
good X. Graph the demand curve for good X.
Consumer Surplus:
• The value consumers get from a good but do not
have to pay for.

Satisfaction you receive from not having to pay the highest price
that you were ABLE and WILLING to pay
Consumer Surplus:
The Discrete Case (price =$2.00)
Price
Consumer Surplus:
The value received but not
paid for. Consumer surplus =
(8-2) + (6-2) + (4-2) = $12.
10
8
6
4
2
D
1
2
3
4
5
Quantity
Consumer Surplus:
The Continuous Case (price =$2.00)
Price $
10
Consumer
Surplus =
$24 - $8 =
$16
Value
of 4 units = $24
8
6
Expenditure on 4 units =
$2 x 4 = $8
4
2
D
1
2
3
4
5
Quantity
Can we do it?
• Sally sells lemonade for $2.00 per glass. If we
know that the demand curve is Qx = 20 – 2P what
is the consumer surplus??
• What is price where Q = 0?

10
• What is the quantity sold at P=2?

16 units
• What is the consumer surplus?

½ (10-2)*(16-0) = 64
What???
P
10
CS=½(16-0)*(10-2)= 64
2
D
16
Q
Market Supply Curve
• The supply curve shows the amount of a good
that will be produced at alternative prices.
• Law of Supply


As the price increases (decreases) firms are able and
willing to produce more (less)
Positive slope
Price
S0
Quantity
Change in Quantity Supplied
Price
A to B: Increase in quantity supplied
S0
B
20
A
10
5
10
Quantity
Change in Supply
S0 to S1: Increase in supply
Price
S0
S1
8
6
5
7
Quantity
Supply Shifters
• Input prices
• Technology or government
regulations
• Number of firms


Entry
Exit
• Taxes


Excise tax (flat tax)per unit tax
Ad valorem tax  percentage tax
(sales tax)
• Producer expectations
What happens to supply? (number 2)
•
•
Good X is produced in a competitive market using input
A. Explain what would happen to the supply of good X
in each of the following situations:
The price of input A increases

•
An excise tax of $1 is imposed on good X


•
The supply of good X will decrease.
How??
• Shift vertically up by exactly $1 at each level of output.
An ad valorem tax of 5% is imposed on good X



•
The supply of good X will decrease (shift to the left).
The supply of good X will decrease.
How??
Supply curve will rotate counter-clockwise.
A technological change reduces the cost of producing
additional units of good X

The supply curve for good X will increase (shift to the right)
The Supply Function
• The functional form of the supply curve:
QxS = f(Px , PR ,W, H,)





QxS = quantity supplied of good X.
Px = price of good X.
PR = price of a production substitute.
W = price of inputs (e.g., wages).
H = other variable affecting supply.
Inverse Supply Function
• Linear supply curve is Qx = f (P….)
• BUT…when we graph it we use price as a function
of quantity supplied.
• Example:


Supply Function
• Qxs = 10 + 2Px
Inverse Supply Function:
• 2Px = 10 + Qxs
• Px = 5 + 0.5Qxs
Producer Surplus
• The amount producers receive in excess of the amount
necessary to induce them to produce the good.
Price
S0
P*
Q*
Quantity
Market Equilibrium
• Balancing supply and demand
S
d
 Qx = Qx
• Interaction of supply and
demand determines the
equilibrium price