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 Figure 2.6 Market Equilibrium D S e Q (Million kg of pork per year) Excess supply = 39 Excess demand = 39 P ($ per kg)

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; its 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 D 1 D 2 S Q (Mil. kg of pork/year) Excess demand = e 2 e 1 P ($ per kg) Effect of a $0.60 Increase in the Price of Beef

Managerial Economics, Lecture 3: Market Equilibrium Figure 2.7b Effects of a Shift of the Pork Demand Curve S 1 S 2 Q (Mil. kg of pork/year) e 1 e 2 D P ($ per kg) Effect of $0.25 Increase in the Price of Hogs Excess demand = 15

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 Q s Q Q d D S Q, Quantity per year Excess demand p e p* Price ceiling

Managerial Economics, Lecture 3: Market Equilibrium Usury Laws Effect on Interest Rate i, Interest rate per $ Q s Q Q d Usury law D S Q, Money loaned per year Excess demand i e i*

Managerial Economics, Lecture 3: Market Equilibrium Minimum Wage w, wage H s H H d Minimum wage D S H, Hours worked Excess supply: Unemployment w e w*

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 p, Price per ton p, Price per ton p, Price per ton Q d * S d S f (ban) Q f * Q = Q d * Q * = Q d * +Q f * Q d, Tons per yearQ f Q (a) Japanese Domestic Supply(b) Foreign Supply(c) Total Supply p*p*p* S (ban)S (no ban)S f ppp

Managerial Economics, Lecture 3: Market Equilibrium Figure 2.8 A Ban on Rice Imports Raises The Price in Japan Q 2 Q 1 S (no ban) D Q, Tons of rice per year p 2 e 2 e 1 p 1 S (ban) – p, Price of rice per pound

Managerial Economics, Lecture 3: Market Equilibrium p, Price per ton p, Price per ton p, Price per ton S d Q, Tons per year (a) U.S. Domestic Supply(b) Foreign Supply(c) Total Supply p*p*p* ppp S S Q d Q f Q d, Tons per yearQ f Q d *Q f * S f S f Q d * +Q f *Q d * +Q f Q d +Q f Total Supply with an Quota on Imports

Managerial Economics, Lecture 3: Market Equilibrium Page 34 Solved Problem 2.3 Q 2 Q 3 D h (high) Q 1 S (no quota) Q (Tons of steel per year) p 2 p 3 e 2 e 3 e 1 p 1 S (quota) – p – D l (low) p (Price of steel per ton)