1. PPA 723: Managerial Economics
The Maxwell School, Syracuse University Professor John Yinger
PPA 723: Managerial Economics
Lecture 2:
Demand and Supply

2. Managerial Economics, Lecture 2: Demand and Supply
Outline
Demand
Demand Curves
Movement Along vs. Shift In Demand Curve
Examples
Supply
Supply Curves
Movement Along vs. Shift in Supply Curve

3. Managerial Economics, Lecture 2: Demand and Supply
Demand Curve
A demand curve shows quantity demanded as a function of product price.
Quantity demanded is the amount consumers are willing to buy at a given price, holding constant other factors that affect purchases
Note the strange demand curve convention: price is on the vertical axis

4. Managerial Economics, Lecture 2: Demand and Supply
Figure 2.1 A Demand Curve
14.30
P ($ per kg)
Demand curve for pork
4.30
3.30
2.30
200
220
240
286 Q
(Million kg of pork per year)

5. Managerial Economics, Lecture 2: Demand and Supply
Effect of a Price Changes
A price change leads to movement along the demand curve.
A demand curve indicates:
What happens to the quantity demanded as the price changes, holding all other factors constant?

6. Managerial Economics, Lecture 2: Demand and Supply
The Law of Demand
Demand curves slope downward
A drop in price results in an increase in quantity demanded, holding other factors constant.
This is one of the most important empirical finding in economics.

7. Managerial Economics, Lecture 2: Demand and Supply
Other Factors That Might Affect Demand
Income
Prices of other goods (compliments, substitutes)
Preferences
Number of consumers
Information  

8. Managerial Economics, Lecture 2: Demand and Supply
Background Factors
Background factors are variables in the background of a given graph
We can only plot two variables at a time (three if we are careful) but the world is more complex than this!
So we distinguish between movement along a demand curve (caused by a change in price) and a shift in a demand curve (caused by changes in background factors)

9. Managerial Economics, Lecture 2: Demand and Supply
Example: The Impact on Pork Demand of a Rise in the Price of Beef
Beef is a substitute for pork
At a given price of pork, a rise in the price of beef causes some people to switch from beef to pork.

10. Managerial Economics, Lecture 2: Demand and Supply
Figure Shift in Demand Curve
Effect of a 60
increase in the price of beef
P ($ per kg)
3.30 D 2 D 1
176
220
232
Q (Mil. kg of pork/ year)

11. Managerial Economics, Lecture 2: Demand and Supply
Demand Functions
A more general approach is to say that quantity demanded is a function of many variables, not just price.
We focus on price because it is what adjusts to make markets clear.
But sometimes we want to focus on other variables.

12. Managerial Economics, Lecture 2: Demand and Supply
Demand Function
General function:
Q = D(P, Pb, Pc, Y)
Specific (linear) pork demand function:
Q = 171 – 20P + 20Pb + 3Pc + 2Y

13. Managerial Economics, Lecture 2: Demand and Supply
Other Graphs
Once we have a demand function, we can draw graphs with any two variables.
Consider, e.g., an income-consumption curve:
How much do people consume (Y-axis) at different income levels (X-axis)?
Price is a background factor in this curve
We still can only plot two factors at a time!

14. Managerial Economics, Lecture 2: Demand and Supply
Determining Price
One cannot determine the market price without the supply side.
If we know price, can determine quantity demanded.
If we know change in price, can determine movement along the demand curve.
Demand curves are only hypothetical.
They indicate what people would demand if the price were at a certain level -- not what they actually demand.
To find actual demand we must combine supply and demand, the topic of our next class.

15. Managerial Economics, Lecture 2: Demand and Supply
Example: Public Transportation
What happens to ridership if the fare goes up?
What happens to ridership if the elderly get a lower fare?
What happens to ridership as incomes go up?
What happens to ridership if the price of gasoline goes up?

16. Managerial Economics, Lecture 2: Demand and Supply
Example: Energy
What happens to consumption when the price or energy goes up?
What form does this change take?  lower thermostats? more sweaters? less driving?  smaller cars?
What happens to natural gas consumption when oil prices go up?
What happens to energy consumption with a new conservation ethic? How would you distinguish this from a price increase?

17. Managerial Economics, Lecture 2: Demand and Supply
Example: Health Care
What happens to consumption when the price goes to zero because of insurance?
 What happens to consumption of (legal) drugs as generic drugs become more available?

18. Managerial Economics, Lecture 2: Demand and Supply
Example: Local Public Services
There is lots of evidence that demand is reflected in voting and in public spending.
So:
What happens to school quality when teachers' salaries rise?
What happens to school quality when the cost of police goes up?
What happens to school quality when the state gives grants that lower the price of schools to city residents?

19. Managerial Economics, Lecture 2: Demand and Supply
The Supply Side
The behavior of suppliers is quite different from the behavior of demanders.
But the analytical issues are similar.
Quantity supplied is the amount of a good or service that firms want to sell at a given price, holding constant other factors that affect supply.
We focus for now on firms that are small relative to the market, so they can each sell as much as they want at the market price.

20. Managerial Economics, Lecture 2: Demand and Supply
Supply Curve
An increase in price of pork causes a movement along the supply curve (holding fixed other variables that affect supply)
A supply curve answers the question:
What happens to the quantity supplied as the price changes holding all other factors constant?

21. Managerial Economics, Lecture 2: Demand and Supply
Figure 2.3 Supply Curve of Canadian Processed Pork
P ($ per kg)
5.30
Supply curve
3.30
176
220
300
Q (Million kg of pork per year)

22. Managerial Economics, Lecture 2: Demand and Supply
Effect of Price on Supply
Supply curve for pork is upward sloping
Increase in the price of pork leads to movement along the supply curve, resulting in larger quantity of pork supplied

23. Managerial Economics, Lecture 2: Demand and Supply
Background Factors in Supply Curve
input prices
Technology
number of firms (and conditions in other markets)
goals of the firm
regulation

24. Managerial Economics, Lecture 2: Demand and Supply
Figure 2.4 A Shift of Pork Supply Curve
P ($ per kg)
Effect of a 25
increase in the price of hogs S 2 S 1
3.30
176
205
220
Q (Mil. kg of pork per year)

25. Managerial Economics, Lecture 2: Demand and Supply
General Supply Function
Q = S(P, Ph)
Q = the quantity of processed pork supplied (million kg per year)
P = price of processed pork ($ per kg)
Ph = price of a hog ($ per kg)

26. Managerial Economics, Lecture 2: Demand and Supply
Supply Curves and Market Outcomes
Supply curves, like demand curves are hypothetical.
We cannot determine what the price will be without combining supply and demand.

27. Managerial Economics, Lecture 2: Demand and Supply
Summing Demand Curves
Market demand curve:
equals horizontal summation of individual demand curves
shows total quantity demanded by all demanders at each possible price

28. Managerial Economics, Lecture 2: Demand and Supply
Application: Aggregating the Demand for Cling Peaches
P($ per ton)
275
183
Total demand
Demand for canned peaches
Demand for fruit cocktail Q = 4 Q = 18 Q = 22 50 f c
Q (Tons of peaches per 10,000 people per year)

29. Managerial Economics, Lecture 2: Demand and Supply
Summing Supply Curves
Market supply curve:
equals horizontal summation of individual supply curves
shows total quantity produced by all suppliers at each possible price

30. Managerial Economics, Lecture 2: Demand and Supply
Total Supply: The Sum of Domestic and Foreign Supply
(a) Japanese Domestic Supply
(b) Foreign Supply
(c) Total Supply p
, Price p
, Price p
, Price
per ton S d
per ton S f
per ton S p * p * p * p p p Q * Q * Q * = Q * + Q * d f d f Q
, Tons per year Q
, Tons per year Q
, Tons per year d f