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Managerial Economics eighth edition Thomas Maurice Chapter 2 Demand, Supply, & Market Equilibrium McGraw-Hill/Irwin 2 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 The McGraw-Hill Series 3 Managerial Economics Demand • 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) • Generalized demand function • 3 Qd f ( P, M , PR , , Pe , N ) The McGraw-Hill Series 4 Managerial Economics Generalized 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 4 The McGraw-Hill Series 5 Managerial Economics Generalized Demand Function Relation to Qd Variable 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 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 PR 5 Sign of Slope Parameter Direct for substitutes The McGraw-Hill Series 6 Managerial Economics Demand Function • Demand function, or demand, shows relation between P & Qd 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 • Qd/P must be negative 6 The McGraw-Hill Series 7 Managerial Economics Graphing Demand Curves • 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) 7 The McGraw-Hill Series 8 Managerial Economics Graphing Demand Curves • A point on a 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 8 The McGraw-Hill Series 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 9 The McGraw-Hill Series 10 Managerial Economics Shifts in Demand (Figure 2.2) P 80 70 Price (dollars) 60 D1 Demand increase D0 $50, 300 40 • $50, 600 • 50 D2 • $40, 500 • $40, 200 30 Demand decrease 20 10 Qd 0 100 300 500 700 900 Quantity 10 The McGraw-Hill Series 1,100 1,300 1,500 11 Managerial Economics Supply • Quantity supplied (Qs) • Amount of a good or service offered for sale during a given period of time 11 The McGraw-Hill Series 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) • Generalized supply function • 12 Qs f ( P, PI , Pr , T , Pe , F ) The McGraw-Hill Series 13 Managerial Economics Generalized 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 13 The McGraw-Hill Series 14 Managerial Economics Generalized Supply Function Relation to Qs Variable 14 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 The McGraw-Hill Series 15 Managerial Economics Supply Function • Supply function, or supply, shows relation between P & Qs when all other variables are held constant • Qs = g(P) 15 The McGraw-Hill Series 16 Managerial Economics Graphing Supply Curves • A point on a 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 16 The McGraw-Hill Series 17 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 17 The McGraw-Hill Series 18 Managerial Economics Shifts in Supply (Figure 2.4) P S2 80 S0 70 $60, 400 Price (dollars) 60 50 $60, 700 Supply decrease • • $40, 500 40 S1 • $40, 650 • 30 Supply increase 20 10 Qs 0 100 300 500 700 Quantity 18 The McGraw-Hill Series 900 19 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” price 19 The McGraw-Hill Series Managerial Economics 20 Market Equilibrium (Figure 2.5) P 80 S0 70 Price (dollars) 60 • 50 • • 40 30 • • 20 10 D0 Qd , Qs 0 100 300 500 700 900 Quantity 20 The McGraw-Hill Series 1,100 1,300 1,500 Managerial Economics 21 Demand Shifts (Supply Constant) (Figure 2.6) P 80 S0 70 Price (dollars) 60 B 50 A • 40 C • • • • 30 20 10 0 100 300 500 700 900 Quantity 21 D0 D2 The McGraw-Hill Series D1 Qd , Qs 1,100 1,300 1,500 22 Managerial Economics Supply Shifts (Demand Constant) (Figure 2.7) P S2 S0 80 S1 70 Price (dollars) 60 T • 50 • • 40 R 30 • •S 20 10 D0 Qd , Qs 0 100 300 500 700 900 Quantity 22 The McGraw-Hill Series 1,100 1,300 23 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 23 The McGraw-Hill Series 24 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 24 The McGraw-Hill Series 25 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 25 The McGraw-Hill Series 26 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 26 The McGraw-Hill Series 27 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 27 The McGraw-Hill Series 28 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 28 The McGraw-Hill Series Managerial Economics 29 Ceiling & Floor Prices (Figure 2.11) Px Sx 2 1 Price (dollars) Price (dollars) Px Sx 3 2 Dx Dx 22 50 62 Quantity Panel A – Ceiling price 29 The McGraw-Hill Series Qx 32 50 84 Quantity Panel B – Floor price Qx