1. Managerial Economics & Business Strategy
Chapter 2
Market Forces: Demand and Supply

2. Market Equilibrium Balancing supply and demand QxS = Qxd
Interaction of supply and demand determines the equilibrium price

3. If price is too low… Price S D 7 8 6 5 6 12 Shortage 12 - 6 = 6
Quantity

4. If price is too high… Surplus 14 - 6 = 8 Price S D 9 6 14 8 7 8
Quantity

5. Price Restrictions Price Ceilings
The maximum legal price that can be charged.
Examples:
Gasoline prices in the 1970s.
Housing in New York City.
Proposed restrictions on ATM fees.

6. Impact of a Price CeilingS PF P* Q*
P Ceiling
Q s
Shortage
Q d D
Quantity

7. Price Restrictions cont.
Price Floors
The minimum legal price that can be charged.
Examples:
Minimum wage.
Current PA minimum wage $6.25
Increased from $5.15 January 1, 2007
Increase to $7.15 by July,
Agricultural price supports.

8. Impact of a Price Floor
Price
Surplus S D PF Qd QS P* Q*
Quantity

9. Do we understand? (number 6)
Suppose demand and supply are given by Qd=50-P and Qs=1/2P-10.
What are the equilibrium quantity and price in this market?
Determine the quantity demanded, the quantity supplied and the magnitude of the surplus if a price floor of $42 is imposed in this market.
Determine the quantity demanded, the quantity supplied and the magnitude of the shortage if a price ceiling of $30 is imposed in this market.
Determine the Full Economic Price paid by the consumers

10. Comparative Static Analysis
How do the equilibrium price and quantity change when a determinant of supply and/or demand change?

11. Applications of Demand and Supply Analysis
Event: The WSJ reports that the prices of PC components are expected to fall by 5-8 percent over the next six months.
Scenario 1: You manage a small firm that manufactures PCs.
Scenario 2: You manage a small software company.

12. Use Comparative Static Analysis to see the Big Picture!
Comparative static analysis shows how the equilibrium price and quantity will change when a determinant of supply or demand changes.

13. Scenario 1: Implications for a Small PC Maker
Computers are now going to be cheaper to produce
What curve is impacted??
supply

14. Big Picture: Impact of decline in component prices on PC market
PCs
Quantity of PC’s S D S* P0 Q0 P* Q*

15. Scenario 2: Software Maker
More people buying computers means consumers will want more software
Which curve is impacted??

16. Big Picture: Impact of lower PC prices on the software market
of Software S D* D P1 Q1 P0 Q0
Quantity of
Software

17. Is this really used?? (number 12)
You are the manager of an organization in America that distributes blood to hospitals in all 50 states and the District of Columbia. A recent report indicates that nearly 50 Americans contract HIV each year through blood transfusions. Although every pint of blood donated in the US undergoes a battery of nine different tests, existing screening methods can detect only the antibodies produced by the body’s immune system, not foreign agents in the blood. Since it takes weeks or even months for these antibodies to build up in the blood, newly infected HIV donors can pass along the virus through blood that has passed existing screening tests. Happily researchers have

18. Developed a series of new tests aimed at detecting and removing infections from donated blood before it is used in transfusions. The obvious benefit of these tests is the reduced incidence of infections through blood transfusions. The report indicates that the current price of decontaminated blood is $80 per pint. However, if the new screening methods are adopted, the demand and supply for decontaminated blood will change to Qd=175-P and Qs=2P-200.
What price do you expect to prevail if the new screening methods are adopted?
How many units of blood will be used in the US?
What is the level of Consumer Surplus and Producer Surplus? Illustrate your findings in a graph

19. What if BOTH supply and demand shift?
Depends on the magnitudes and directions of the shifts
Examples….

20. Chapter 2 homework
Numbers 7, 10, and 13