1. Executive Economic Analysis
BUS 571
Module 2, lecture 2

2. Topics Supply & Demand Supply Curve Changes in Supply & Demand
Elasticity of Supply
Supply, Demand & Price
Three Essential Principles of the Market System
Shortages & Surpluses
Four S&D scenarios
Role of the Price System
Consumers’ Surplus
Sellers’ Rent
Prices Determined at the Margin

3. Supply & Demand Recall… Law of Demand Law of Supply
The lower the price the higher the number of buyers
Demand is like an inverted cone, a wizard's hat
Law of Supply
The higher the price, the higher the number of sellers.
Supply is like an ice-cream cone.

4. Supply & Demand
Supply and Demand helps us understand micro markets just as they do highly aggregated (i.e., macro) markets
Supply and demand analysis is limited
Each graph/diagram applies to one product
Cannot how or why a producer may adjust the quality of its product or introduce a new one, e.g.
Despite its limitations, it offers a great deal of insight about how markets work

5. Supply & Demand
Supply and demand is at the heart of the market economy
Individual consumers, through their collective choices, set prices and determine the production of goods and services
Supply schedule is quantity of goods a producer is willing to sell at various prices

6. Supply Curve The supply curve is upward sloping (to the right)
Reflects firm’s perceived improvement in profitability
As demand increases producers expand output and, ceteris paribus, raise their prices
Recall: Prices are the signal producer’s look to when determining how much to produce and at what price point

7. Changes in Supply & Demand
Factors that shift demand
Changes in real wealth
Changes in the real rate of interest
Increased optimism/pessimism about future economic conditions: firms and households
Changes in regulation/taxes
Changes in expected rate of inflation

8. Changes in Supply & Demand
Factors that shift supply
Long-run
Changes in availability of resources
Changes in technology and productivity
Institutional changes that affect efficiency of resource use
Short-run
Changes in resource prices (i.e., production costs)
Changes in expected rate of inflation
Supply shocks (e.g., oil price changes brought about by OPEC pricing or weather patterns that affect the supply chain)

9. Elasticity of Supply Elastic = flexible and adaptable
Markets are responsive to price changes
Law of Supply: Producers tend to increase or decrease their supply when prices for G&S change
Elasticity = Responsiveness
Responsiveness refers to the connection between prices and # of people who will buy at each price

10. Elasticity of Supply Helps the discovery process
Where does the firm’s most profitable opportunities lie?
How will a price increase or decrease impact market share and profitability?
What market segments might the firm enter into or lose share in by a change in price, quality, quantity?

11. Elasticity of Supply How do we calculate price elasticity of supply?
PES = Price Elasticity of Supply
Q = Quantity
P = Price
See illustration on board
How do we measure elasticity?
0 = perfect inelasticity > price increase will not affect demand
0-1 = inelastic demand
1 = unitary elasticity
> 1 - infinity = elastic demand
Infinity = perfectly elastic demand
Calculations are based on historical data; as substitutes rise, demand changes and, thus, so do prices

12. Elasticity of Supply Price Elasticity of Supply
What happens to supply when price changes?
PES measures the responsiveness of suppliers (output) to changes in price
As price moves up, % of supply typically increases
As price moves down, % of supply typically decreases
Example: Market for high school math and science teachers > “How much do we need to increase salaries in order to have more of both?”

13. Elasticity of Supply
How do we measure price elasticity of supply (PES)?
PES = Percentage Change in Quantity Supplied/Percentage Change in Price
PES = % ▲QS/% ▲P

14. Supply, Demand & Price
Prices tend to stabilize at the point where supply equals demand
Three possibilities
Quantity supplied exceeds quantity demanded > surplus
Quantity demanded exceeds quantity supplied > shortage
Quantity demanded is equal to quantity supplied
Supply and demand clear the market > equilibrium
See figure 6.10

15. Supply, Demand & Price
Prices tend to stabilize at the point where supply equals demand
Three possibilities
Quantity supplied exceeds quantity demanded > surplus
Quantity demanded exceeds quantity supplied > shortage
Quantity demanded is equal to quantity supplied
Supply and demand clear the market > equilibrium
See figure 6.10

16. Three Essential Principles of the Market System
The Principle of Non-Discrimination
Effort on the part of firms to discover new markets
As markets become more competitive, price discrimination becomes more the exception than the rule
The Market as Incentive System
Because more one earns, the more resources one can command and the more G&S one can obtain the market rewards productivity and discourages the lack of productivity
The Benefit Principle
Those who benefit from a good or service should pay for it
Also known as the Principle of Accountability

17. Consumer Choice & Marginal Utility
People make decisions on the margin
Why?
Limited income
Nature of human action: purposeful choice
Available substitutes/alternatives
Imperfect knowledge
Law of diminishing utility

18. Shortages & Surpluses
The market consists of persons, consumers and producers who make decisions about prices and production based on available information
If demand exceeds supply, prices will rise and bring the market back to equilibrium
If supply exceeds demand, prices will decrease and bring the market back to equilibrium

19. Four Supply & Demand Scenarios
Increase in demand
Decrease in demand
Increase in supply
Decrease in supply
See figure 6.14

20. Role of the Price System
Prices ration scarce resources
They tell producers what to produce, how much, when and how
Prices influence human behavior
They inform consumers and help them decide whether or not to make a purchase
Prices are a signal to both buyers and sellers
Buyers and sellers perceive they are getting the better value
Buyers value the product or service more than the money required to purchase it; sellers value the money more than the product or service they must provide

21. Consumers’ Surplus
Consumers’ surplus = the net benefits buyers receive from a given exchange
A measure of economic well-being
Arises when a consumer pays less than they expect to pay for a product or service
If producers can cause prices to decrease, they expand consumers’ surplus

22. Sellers’ Rent
Sellers’ Rent = the net benefits producers receive from a given exchange
A measure of economic well-being
Arises when a producer receives more than they expect to be paid for a product or service
If buyers cause prices to increase, they expand sellers’ rent

23. Prices Are Determined at the Margin
Prices are determined by the number of buyers and sellers in the market…
In relation to the available quantity of a good or service
While the number of buyers and sellers may be large, it is those who come the closest in price (willing to buy at, willing to sell at) that set the market rate, i.e., “at the margin”

24. Wrap-Up/Close
Questions?
Comments?