Managerial Economics & Business Strategy Chapter 2 Market Forces: Demand and Supply

Are we following? (number 4) The demand for good X is given by 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) 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) Value of 4 units = $24 10 8 6 4 Expenditure on 4 units = $2 x 4 = $8 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 CS=½(16-0)*(10-2)= 64 10 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 Quantity S0

Change in Quantity Supplied Price Quantity S0 A to B: Increase in quantity supplied B 20 10 A 10 5

Change in Supply S0 to S1: Increase in supply Price S0 S1 8 6 5 7 Quantity S0 S1 8 5 7 6

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 The supply of good X will decrease (shift to the left). 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 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 QxS = Qxd Interaction of supply and demand determines the equilibrium price