Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 1 Chapter 3 Supply and Demand

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 2 Overview Market demand Market supply Market equilibrium Comparative statics analysis short-run analysis, long-run analysis Supply, demand, and price

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 3 Learning objectives define supply, demand, and equilibrium price identify non-price determinants of supply and demand distinguish between short-run rationing function and long-run guiding function of price

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 4 Learning objectives  illustrate how supply and demand can be used to improve management decisions  use supply and demand diagrams to determine price in the short and long run

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 5 Market demand  Demand for a good or service is defined as quantities that people are ready (willing and able) to buy at various prices within some given time period Other factors besides price are held constant

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 6 Market demand Market demand is the sum of all the individual demands Example: demand for pizza

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 7 Market demand The inverse relationship between price and the quantity demanded of a good or service is called the Law of Demand

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 8 Market demand  Changes in price result in changes in the quantity demanded This is shown as movement along the demand curve  Changes in non-price factors result in changes in demand This is shown as a shift in the demand curve

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 9 Market demand  Nonprice determinants of demand tastes and preferences income prices of related products future expectations number of buyers

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 10 Market supply  The supply of a good or service is defined as quantities that people are ready to sell at various prices within some given time period Other factors besides price held constant

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 11 Market supply  Changes in price result in changes in the quantity supplied  shown as movement along the supply curve  Changes in non-price determinants result in changes in supply  shown as a shift in the supply curve

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 12 Market supply  Nonprice determinants of supply costs and technology prices of other goods or services offered by the seller future expectations number of sellers weather conditions

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 13 Market equilibrium  Equilibrium price: the price that equates the quantity demanded with the quantity supplied  Equilibrium quantity: the amount that people are willing to buy and sellers are willing to offer at the equilibrium price level

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 14 Market equilibrium  Shortage: a market situation in which the quantity demanded exceeds the quantity supplied  shortage occurs at a price below the equilibrium level  Surplus: a market situation in which the quantity supplied exceeds the quantity demanded  surplus occurs at a price above the equilibrium level

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 15 Market equilibrium

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 16 Comparative statics analysis  Comparative statics is a form of sensitivity (or what-if) analysis Commonly used method in economic analysis

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 17 Comparative statics analysis  Process of comparative statics analysis: state all the assumptions needed to construct the model begin by assuming that the model is in equilibrium introduce a change in the model, so a condition of disequilibrium is created find the new point of equilibrium compare the new equilibrium point with the original one

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 18 Comparative statics: example Step 1  assume all factors except the price of pizza are constant  buyers’ demand and sellers’ supply are represented by lines shown

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 19 Comparative statics: example Step 2  begin the analysis in equilibrium as shown by Q 1 and P 1

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 20 Comparative statics: example Step 3  assume that a new study shows pizza to be the most nutritious of all fast foods  consumers increase their demand for pizza as a result

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 21 Comparative statics: example Step 4  the shift in demand results in a new equilibrium price (P 2 )  and a new equilibrium quantity (Q 2 )

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 22 Comparative statics: example Step 5  comparing the new equilibrium point with the original one, we see that both equilibrium price and quantity have increased

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 23 Comparative statics analysis  The short run is the period of time in which: sellers already in the market respond to a change in equilibrium price by adjusting variable inputs buyers already in the market respond to changes in equilibrium price by adjusting the quantity demanded for the good or service

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 24 Comparative statics analysis  Short run changes show the rationing function of price The rationing function of price is the change in market price to eliminate the imbalance between quantities supplied and demanded is the change in market price to eliminate the imbalance between quantities supplied and demanded

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 25 Short-run analysis  an increase in demand causes equilibrium price and quantity to rise

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 26 Short-run analysis  a decrease in demand causes equilibrium price and quantity to fall

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 27 Short-run analysis  an increase in supply causes equilibrium price to fall and equilibrium quantity to rise

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 28 Short-run analysis  a decrease in supply causes equilibrium price to rise and equilibrium quantity to fall

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 29 Long run analysis  The long run is the period of time in which: new sellers may enter a market existing sellers may exit from a market existing sellers may adjust fixed factors of production buyers may react to a change in equilibrium price by changing their tastes and preferences

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 30 Long run analysis  Long run changes show the allocating function of price  The guiding or allocating function of price is the movement of resources into or out of markets in response to a change in the equilibrium price

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 31 Long-run analysis  initial change: decrease in demand from D 1 to D 2  result: reduction in equilibrium price and quantity (to P 2,Q 2 )  follow-on adjustment: movement of resources out of the market leftward shift in the supply curve to S 2  equilibrium price and quantity (to P 3,Q 3 )

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 32 Long-run analysis  initial change: increase in demand from D 1 to D 2  result: increase in equilibrium price and quantity (to P 2,Q 2 )  follow-on adjustment: movement of resources into the market rightward shift in the supply curve to S 2  equilibrium price and quantity (to P 3,Q 3 )

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 33 Supply, demand, and price: the managerial challenge  in the extreme case, the forces of supply and demand are the sole determinants of the market price, not any single firm this type of market is ‘perfect competition’  in many cases, individual firms can exert market power over price because of their: dominant size ability to differentiate their product through advertising, brand name, features, or services

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 34 Supply, demand, and price: the managerial challenge  Example: coffee  ‘buy low, sell high’  2000: overproduction led to price falls  2004: prices moved up again  Starbucks effects

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 35 Supply, demand, and price: the managerial challenge  Example: air travel  ‘buy high, sell low’  industry deregulated in late 1970s  tight competition  post 9/11, a low-cost structure is needed

Chapter ThreeCopyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. 36 Global application  Example: the market for cobalt  rare metal  produced as a by-product  strategic item  prices rising