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PPA 723: Managerial
Economics
Lecture 3:
Market Equilibrium
Managerial Economics, Lecture 3: Market Equilibrium
Outline
Review Supply and Demand
Market Equilibrium
Applications
Managerial Economics, Lecture 3: Market Equilibrium
Demand Curves
 Demand Curve: relationship between quantity
demanded and price, other factors fixed
 Law of Demand: demand curves slope down
 Change in price causes movement along the
demand curve
 Change in income or other background factor
causes shift of demand curve
 A demand curve is hypothetical
Managerial Economics, Lecture 3: Market Equilibrium
Supply Curves
 Supply Curve: relationship between quantity
supplied and price, other factors constant
 Market supply curve need not slope up but
frequently does
 Change in price causes movement along the
supply curve
 Change in input price or other background
factor causes shift of the supply curve
 Supply curve is hypothetical
Managerial Economics, Lecture 3: Market Equilibrium
Market Equilibrium
The intersection of demand and
supply curves determines market
equilibrium price and quantity.
An equilibrium is a situation, perhaps
temporary, in which nobody has an
incentive to change behavior.
Managerial Economics, Lecture 3: Market Equilibrium
P ($ per kg)
Figure 2.6 Market Equilibrium
Excess supply = 39
S
3.95
e
3.30
2.65
Excess demand = 39
D
0
176
194
207
220
233
246
Q (Million kg of pork per year)
Managerial Economics, Lecture 3: Market Equilibrium
Reaching Equilibrium
When P > P *, there is a surplus,
inventories build up, suppliers get the
message and lower price
When P < P *, there are shortages, every
store sells out by noon, suppliers get the
message and raise price.
A market sends signals and people
respond to them; it’s not just because
the curves cross!
Managerial Economics, Lecture 3: Market Equilibrium
Shocking the Equilibrium
Once an equilibrium is achieved, it may
persist indefinitely because no one
applies pressure to change the price
An equilibrium changes if
The demand curve shifts
The supply curve shifts
The government intervenes
Managerial Economics, Lecture 3: Market Equilibrium
Figure 2.7a Effects of a Shift of the Pork Demand Curve
Effect of a $0.60 Increase in the Price of Beef
P ($ per kg)
e2
3.50
3.30
e1
S
D2
D1
0
176
220
228 232 Q (Mil. kg of pork/year)
Excess demand = 12
Managerial Economics, Lecture 3: Market Equilibrium
Figure 2.7b Effects of a Shift of the Pork Demand Curve
Effect of $0.25 Increase in the Price of Hogs
P ($ per kg)
S2
e2
3.55
3.30
S1
e1
D
0
176
205
215 220
Excess demand = 15
Q (Mil. kg of pork/year)
Managerial Economics, Lecture 3: Market Equilibrium
Direction and Magnitude
 Theory alone often gives the direction of an effect:
Does a given change lead to an increase in price?
 Sometimes this is enough.
 But sometimes the magnitude of the effect also matters:
Is the effect large enough to be significant?
 Calculating the magnitude generally requires more
information.
Managerial Economics, Lecture 3: Market Equilibrium
Limits of Supply and Demand Model
Supply and demand model directly
applies only in competitive markets
Competitive markets: homogeneous
goods, many buyers and sellers (price
takers)
Managerial Economics, Lecture 3: Market Equilibrium
Applications of Supply and Demand Model
Supply and demand model can help to
understand:
• Price ceilings
• Price floors
Managerial Economics, Lecture 3: Market Equilibrium
Price Ceiling
P, price
S
e
p
Price ceiling
p*
D
Qs
Q
Excess demand
Qd
Q, Quantity per year
Managerial Economics, Lecture 3: Market Equilibrium
Usury Law’s Effect on Interest Rate
i, Interest
rate per $
S
e
i
i*
Usury law
D
Qs
Q
Excess demand
Qd
Q, Money loaned per year
Managerial Economics, Lecture 3: Market Equilibrium
Minimum Wage
w, wage
S
w*
Minimum wage
e
w
D
Hd
H
Hs
Excess supply: Unemployment
H, Hours worked
Managerial Economics, Lecture 3: Market Equilibrium
Supply Need not Equal Demand
 Price ceilings or price floors  quantity
supplied does not necessarily equal quantity
demanded
 Quantity supplied = amount firms want to sell
at a given price, holding constant other
factors that affect supply
 Quantity demanded = amount consumers
want to buy at a given price, holding constant
other factors
Managerial Economics, Lecture 3: Market Equilibrium
Summing Demand and Supply Curves
Market curves equal horizontal
summation of individual curves
They show total quantity demanded
or supplied at each possible price
Managerial Economics, Lecture 3: Market Equilibrium
Total Supply with and without a Ban on Imports
(a) Japanese Domestic Supply
p, Price
per ton
Sd
(b) Foreign Supply
p, Price
per ton S f (ban)
Sf
(no ban)
(c) Total Supply
p, Price
per ton
p*
p*
p*
p
p
p
Qd*
Qd , Tons per year
Qf*
Qf , Tons per year
S (ban)
Q = Qd*
S (no ban)
Q * = Qd* + Qf*
Q, Tons per year
Managerial Economics, Lecture 3: Market Equilibrium
p, Price of rice per pound
Figure 2.8 A Ban on Rice Imports Raises The Price in Japan
–
S (ban)
S (no ban)
p2
e2
p1
e1
D
Q2
Q1
Q, Tons of rice per year
Managerial Economics, Lecture 3: Market Equilibrium
Total Supply with an Quota on Imports
(a) U.S. Domestic Supply
p, Price
per ton
Sd
(b) Foreign Supply
p, Price
per ton
Sf
Sf
(c) Total Supply
p, Price
per ton
S
S
p*
p*
p*
p
p
p
Qd
Qd*
Qd , Tons per year
Qf
Qf*
Qf , Tons per year
Qd + Qf Qd*+ Qf Qd* + Qf*
Q, Tons per year
p (Price of steel per ton)
Managerial Economics, Lecture 3: Market Equilibrium
Page 34 Solved Problem 2.3
–
S (quota)
S (no quota)
e3
p3
e2
p2
–
p
p1
e1
D h (high)
D l (low)
Q1
Q 3 Q2
Q (Tons of steel per year)