1. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Business Economics Unit-II Market Forces: Demand and Supply

2. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Overview III. Market Equilibrium IV. Price Restrictions V. Comparative Statics II. Market Supply Curve n The Supply Function n Supply Shifters n Producer Surplus I. Market Demand Curve n The Demand Function n Determinants of Demand n Consumer Surplus

3. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Market Demand Curve Shows the amount of a good that will be purchased at alternative prices. Law of Demand – Other things remaining constant, if price of a good rises its demand falls and vice-versa. n The demand curve is downward sloping. Quantity D Price

4. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Determinants of Demand Income Prices of substitutes Prices of complements Advertising Population Consumer expectations

5. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 The Demand Function An equation representing the demand curve Q x d = f(P x, P Y, M, H,) n Q x d = quantity demand of good X. n P x = price of good X. n P Y = price of a substitute good Y. n M = income. n H = any other variable affecting demand

6. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Change in Quantity Demanded Price Quantity D0D0 4 7 10 6 A A to B: Increase in quantity demanded B

7. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Price Quantity D0D0 D1D1 6 7 D 0 to D 1 : Increase in Demand Change in Demand 13

8. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Consumer Surplus: The value consumers get from a good but do not have to pay for.

9. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Price Quantity D 10 8 6 4 2 1 2 3 4 5 Consumer Surplus: The value received but not paid for Consumer Surplus: The Discrete Case

10. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Market Supply Curve The supply curve shows the amount of a good that will be produced at alternative prices. Law of Supply – Other things remaining constant, if price of a good rises its supply increases and vice-versa. n The supply curve is upward sloping Price Quantity S0S0

11. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Supply Shifters Input prices Technology or government regulations Number of firms Substitutes in production Taxes Producer expectations

12. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 The Supply Function An equation representing the supply curve: Q x S = f(P x, P R,W, H,) n Q x S = quantity supplied of good X. n P x = price of good X. n P R = price of a related good n W = price of inputs (e.g., wages) n H = other variable affecting supply

13. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Change in Quantity Supplied Price Quantity S0S0 20 10 B A 5 A to B: Increase in quantity supplied

14. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Price Quantity S0S0 S1S1 8 5 7 S 0 to S 1 : Increase in supply Change in Supply 6

15. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Producer Surplus The amount producers receive in excess of the amount necessary to induce them to produce the good. Price Quantity S0S0 Producer Surplus Q*Q* P*P*

16. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Market Equilibrium Balancing supply and demand n Q x S = Q x d Steady-state

17. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Price Quantity S D 5 6 12 Shortage 12 - 6 = 6 6 If price is too low… 7

18. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Price Quantity S D 9 14 Surplus 14 - 6 = 8 6 8 8 If price is too high… 7

19. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Price Restrictions Price Ceilings n The maximum legal price that can be charged n Examples: Gasoline prices in the 1970s Housing in New York City Proposed restrictions on ATM fees Price Floors n The minimum legal price that can be charged. n Examples: Minimum wage Agricultural price supports

20. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Price Quantity S D P* Q* Ceiling Price Q s PFPF Impact of a Price Ceiling Shortage Q d

21. Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc., 1999 Impact of a Price Floor Price Quantity S D P* Q* QSQS QdQd Surplus PFPF