Managerial Economics

ninth edition

Thomas Maurice

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

Managerial Economics

Demand
Quantity demanded (Qd)
Amount of a good or service consumers are willing & able to purchase during a given period of time

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General Demand Function

Six variables that influence Qd
Price of good or service (P) Incomes of consumers (M) Prices of related goods & services (PR) Taste patterns of consumers ( ) Expected future price of product (Pe) Number of consumers in market (N)

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General demand function

Qd f ( P, M , PR , , Pe , N )

Managerial Economics

General Demand Function

Qd a bP cM dPR e fPe gN
b, c, d, e, f, & g are slope parameters Measure effect on Qd of changing one of the
variables while holding the others constant

Sign of parameter shows how variable is related to Qd

Positive sign indicates direct relationship Negative sign indicates inverse relationship

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General Demand Function

Variable Relation to Qd
Inverse
Direct for normal goods Inverse for inferior goods

Sign of Slope Parameter

P M PR

b = Qd/P is negative c = Qd/M is positive c = Qd/M is negative

Direct for substitutes Inverse for complements

Direct Direct Direct

d = Qd/PR is positive d = Qd/PR is negative

e = Qd/ is positive f = Qd/Pe is positive g = Qd/N is positive

Pe N
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Direct Demand Function

The direct demand function, or simply demand, shows how quantity demanded, Qd , is related to product price, P, when all other variables are held constant Qd = f(P) Law of Demand
Qd increases when P falls & Qd decreases when

P rises, all else constant Qd/P must be negative

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Inverse Demand Function

Traditionally, price (P) is plotted on the vertical axis & quantity demanded (Qd) is plotted on the horizontal axis
The equation plotted is the inverse demand function, P = f(Qd)

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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

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A Demand Curve (Figure 2.1)

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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
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Shifts in Demand

(Figure 2.2)

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Supply
Quantity supplied (Qs)
Amount of a good or service offered for sale during a given period of time

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Supply
Six variables that influence Qs

Price of good or service (P) Input prices (PI ) Prices of goods related in production (Pr) Technological advances (T) Expected future price of product (Pe) Number of firms producing product (F)

General supply function

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Qs f ( P, PI , Pr , T , Pe , F )

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General Supply Function

Qs h kP lPI mPr nT rPe sF
k, l, m, n, r, & s are slope parameters Measure effect on Qs of changing one of the
variables while holding the others constant

Sign of parameter shows how variable is related to Qs

Positive sign indicates direct relationship Negative sign indicates inverse relationship

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General Supply Function

Variable Relation to Qs
Direct
Inverse

Sign of Slope Parameter

P PI Pr T Pe F
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k = Qs/P is positive l = Qs/PI is negative

Inverse for substitutes Direct for complements

Direct Inverse Direct

m = Qs/Pr is negative m = Qs/Pr is positive

n = Qs/T is positive r = Qs/Pe is negative s = Qs/F is positive

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Direct Supply Function

The direct supply function, or simply supply, shows how quantity supplied, Qs , is related to product price, P, when all other variables are held constant Qs = f(P)

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Inverse Supply Function

Traditionally, price (P) is plotted on the vertical axis & quantity supplied (Qs) is plotted on the horizontal axis
The equation plotted is the inverse supply function, P = f(Qs)

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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

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A Supply Curve

(Figure 2.3)

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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
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Shifts in Supply

(Figure 2.4)

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Market Equilibrium
Equilibrium price & quantity are determined by the intersection of demand & supply curves
At the point of intersection, Qd = Qs Consumers can purchase all they want & producers can sell all they want at the market-clearing or price

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Market Equilibrium

(Figure 2.5)

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Market Equilibrium
Excess demand (shortage)
Exists when quantity demanded exceeds quantity supplied

Excess supply (surplus)

Exists when quantity supplied exceeds quantity demanded

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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
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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 For each unit supplied, difference between market price & the minimum price producers would accept to supply the unit (its supply price)
Sum of consumer & producer surplus Area below demand & above supply over the relevant range of output

Producer surplus

Social surplus

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Measuring the Value of Market Exchange (Figure 2.6)

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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

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Demand Shifts (Supply Constant)

(Figure 2.7)

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Supply Shifts (Demand Constant)

(Figure 2.8)

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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

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Simultaneous Shifts: (D, S)

P S S S

P P P

C
D D Q

Price may rise or fall; Quantity rises

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Simultaneous Shifts: (D, S)

P S S S

C
D Q Q Q

Price falls; Quantity may rise or fall

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Simultaneous Shifts: (D, S)

P S S P P

S B

D D Q Q Q Q

Price rises; Quantity may rise or fall

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Simultaneous Shifts: (D, S)

P

S S

P P P

C
B

D
D Q Q Q Q

Price may rise or fall; Quantity falls

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Ceiling & Floor Prices

Ceiling price
Maximum price government permits sellers to charge for a good When ceiling price is below equilibrium, a shortage occurs
Minimum price government permits sellers to charge for a good When floor price is above equilibrium, a surplus occurs

Floor price

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Ceiling & Floor Prices (Figure 2.12)

Px Px

Price (dollars)

Price (dollars)

Sx

Sx
3 2

2 1

Dx 22 50 62 Qx 32 50 84

Dx Qx

Quantity

Quantity

Panel A Ceiling price

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Panel B Floor price