Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Managerial Economics, 9e Managerial Economics Thomas Maurice ninth edition Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Managerial Economics, 9e Managerial Economics Thomas Maurice ninth edition Chapter 2 Demand, Supply, & Market Equilibrium

Managerial Economics 2-2 Demand Quantity demanded ( Q d ) Amount of a good or service consumers are willing & able to purchase during a given period of time

Managerial Economics 2-3 General Demand Function Six variables that influence Q d Price of good or service (P) Incomes of consumers (M) Prices of related goods & services (P R ) Expected future price of product (P e ) Number of consumers in market (N) General demand function

Managerial Economics 2-4 General Demand Function b, c, d, e, f, & g are slope parameters Measure effect on Q d of changing one of the variables while holding the others constant Sign of parameter shows how variable is related to Q d Positive sign indicates direct relationship Negative sign indicates inverse relationship

Managerial Economics 2-5 General Demand Function VariableRelation to Q d Sign of Slope Parameter P PePe N M PRPR Inverse Direct Direct for normal goods Inverse for inferior goods Direct for substitutes b =  Q d /  P is negative c =  Q d /  M is positive c =  Q d /  M is negative d =  Q d /  P R is positive d =  Q d /  P R is negative f =  Q d /  P e is positive g =  Q d /  N is positive Inverse for complements e =  Q d /  is positive

Managerial Economics 2-6 Direct Demand Function The direct demand function, or simply demand, shows how quantity demanded, Q d, is related to product price, P, when all other variables are held constant Q d = f(P) Law of Demand Q d increases when P falls & Q d decreases when P rises, all else constant (ceteris paribus)  Q d /  P must be negative

Managerial Economics 2-7 Inverse Demand Function Traditionally, price (P) is plotted on the vertical axis & quantity demanded (Q d ) is plotted on the horizontal axis The equation plotted is the inverse demand function, P = f(Q d )

Managerial Economics 2-8 Graphing Demand Curves A point on a direct 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

Managerial Economics 2-9 A Demand Curve (Figure 2.1)

Managerial Economics 2-10 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

Managerial Economics 2-11 Shifts in Demand (Figure 2.2)

Managerial Economics 2-12 Supply Quantity supplied ( Q s ) Amount of a good or service offered for sale during a given period of time

Managerial Economics 2-13 Supply Six variables that influence Q s Price of good or service (P) Input prices (P I ) Prices of goods related in production (P r ) Technological advances (T) Expected future price of product (P e ) Number of firms producing product (F) General supply function

Managerial Economics 2-14 General Supply Function k, l, m, n, r, & s are slope parameters Measure effect on Q s of changing one of the variables while holding the others constant Sign of parameter shows how variable is related to Q s Positive sign indicates direct relationship Negative sign indicates inverse relationship

Managerial Economics 2-15 General Supply Function VariableRelation to Q s Sign of Slope Parameter P PePe F PIPI PrPr Direct Inverse Inverse for substitutes k =  Q s /  P is positive l =  Q s /  P I is negative m =  Q s /  P r is negative m =  Q s /  P r is positive r =  Q s /  P e is negative s =  Q s /  F is positive Direct for complements n =  Q s /  T is positive T

Managerial Economics 2-16 Direct Supply Function The direct supply function, or simply supply, shows how quantity supplied, Q s, is related to product price, P, when all other variables are held constant Q s = f(P)

Managerial Economics 2-17 Inverse Supply Function Traditionally, price (P) is plotted on the vertical axis & quantity supplied (Q s ) is plotted on the horizontal axis The equation plotted is the inverse supply function, P = f(Q s )

Managerial Economics 2-18 Graphing Supply Curves A point on a direct 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

Managerial Economics 2-19 A Supply Curve (Figure 2.3)

Managerial Economics 2-20 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

Managerial Economics 2-21 Shifts in Supply (Figure 2.4)

Managerial Economics 2-22 Market Equilibrium Equilibrium price & quantity are determined by the intersection of demand & supply curves At the point of intersection, Q d = Q s Consumers can purchase all they want & producers can sell all they want at the “market-clearing” or price

Managerial Economics 2-23 Market Equilibrium (Figure 2.5)

Managerial Economics 2-24 Market Equilibrium Excess demand (shortage) Exists when quantity demanded exceeds quantity supplied Excess supply (surplus) Exists when quantity supplied exceeds quantity demanded

Managerial Economics 2-25 Value of Market Exchange Typically, consumers value the goods they purchase by an amount that exceeds the purchase price of the goods Economic value Maximum amount any buyer in the market is willing to pay for the unit, which is measured by the demand price for the unit of the good

Managerial Economics 2-26 Measuring the Value of Market Exchange Consumer surplus Difference between the economic value of a good (its demand price) & the market price the consumer must pay Producer surplus For each unit supplied, difference between market price & the minimum price producers would accept to supply the unit (its supply price) Social surplus Sum of consumer & producer surplus Area below demand & above supply over the relevant range of output

Managerial Economics 2-27 Measuring the Value of Market Exchange (Figure 2.6)

Managerial Economics 2-28 Changes in Market Equilibrium Qualitative forecast Predicts only the direction in which an economic variable will move Quantitative forecast Predicts both the direction and the magnitude of the change in an economic variable

Managerial Economics 2-29 Demand Shifts (Supply Constant) (Figure 2.7)

Managerial Economics 2-30 Supply Shifts (Demand Constant) (Figure 2.8)

Managerial Economics 2-31 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

Managerial Economics 2-32 S D’ S’’ S’ D Simultaneous Shifts: (  D,  S) Q Price may rise or fall; Quantity rises P A Q P B P’ Q’ Q’’ C P’’

Managerial Economics 2-33 D Simultaneous Shifts: (  D,  S) S D’ S’’ S’ Q Price falls; Quantity may rise or fall P A Q P B P’ Q’ Q’’ C P’’

Managerial Economics 2-34 S’’ Simultaneous Shifts: (  D,  S) D S D’ S’ Q Price rises; Quantity may rise or fall P A Q P B P’ Q’ Q’’ C P’’

Managerial Economics 2-35 Simultaneous Shifts: (  D,  S) S’’ D S D’ S’ Q Price may rise or fall; Quantity falls P A Q P B P’ Q’ Q’’ C P’’

Managerial Economics 2-36 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

Managerial Economics 2-37 Ceiling & Floor Prices (Figure 2.12) QxQx Quantity Price (dollars) QxQx PxPx PxPx Quantity Price (dollars) SxSx DxDx Panel A – Ceiling price SxSx DxDx 2 50 Panel B – Floor price