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1 1 Getting acquainted What is Managerial Economics? Managerial Economics blends intermediate microeconomics, game theory, and industrial organization.

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Presentation on theme: "1 1 Getting acquainted What is Managerial Economics? Managerial Economics blends intermediate microeconomics, game theory, and industrial organization."— Presentation transcript:

1 1 1 Getting acquainted What is Managerial Economics? Managerial Economics blends intermediate microeconomics, game theory, and industrial organization to help managers make profitable decisions. It emphasizes the rationality and logic of decisions, and so differs from the psychological and sociological problems in Organizational Behavior (BA 366). Managerial Economics also emphasizes formulating and anticipating changes in decision problems, and so differs from solving fully-formed, fixed decision problems in Quantitative Analysis (BA 452). Welcome to BA 445 Managerial Economics A.1 Demand and Supply

2 2 2 Welcome to BA 445 Managerial Economics A.1 Demand and Supply Getting started Read and bookmark the online course syllabus: It provides review questions for each lesson, and serves as a contract specifying our mutual obligations. (You may need Internet Explorer.) In particular, note: Linear Algebra (solve 2 equations for 2 variables), Calculus (take a derivative), and Introduction to Microeconomics are prerequisites, so review as needed. Linear Algebra (solve 2 equations for 2 variables), Calculus (take a derivative), and Introduction to Microeconomics are prerequisites, so review as needed. Before each class meeting, download and read the PowerPoint lesson, available under the Schedule link. Before each class meeting, download and read the PowerPoint lesson, available under the Schedule link.

3 3 3 A.1 Demand and Supply ReadingsReadings For background or for an alternative description of the concepts in the following PowerPoint slides, I recommend Baye 6 th edition or 7 th edition, Chapter 2

4 4 4 A.1 Demand and Supply OverviewOverview

5 5 5 Part A Overview Demand and Supply Analysis from Part A helps managers make profitable decisions when there are impersonal markets of large numbers of customers and workers and, sometimes, of firms. Game Theory in Parts B and C completes demand and supply analysis when personal decisions interact. A.1 Demand and Supply Overview

6 6 6 For example, when merchants try to attract tourist shoppers, there may be many potential destinations and vacationers competing in a market, with market price determined by aggregate supply and demand. But once Carlos sets up a stall selling Foakleys (Fake Oakleys) outside the Tijuana Wax Museum, he becomes tied to Aleisha and the few other tourists walking by his stall, and the merchant sets his prices separately from the worldwide competitive market for Foakleys by bargaining with those tourists. A.1 Demand and Supply Overview

7 7 7 Lesson Overview Each of the lessons in the three parts of the course are broken into a few individual topics. Often, each topic contains one question and answer to help you prepare for your exam. Lesson A.1 (the first lesson in Part A) divides into 4 topics. A.1 Demand and Supply Overview

8 8 8Overview Demand Curves show the amount a good that will be bought at alternative prices when those prices cannot be changed by any single buyer. For example, grocery prices are outside buyers control when enough buyers compete to buy. Supply Curves show the amount a good that suppliers are willing to supply at alternative prices when those prices cannot be changed by any single supplier. For example, mall prices are outside each sellers control when enough sellers compete to sell. Competitive Markets require enough competing buyers and competing sellers so prices are outside of everyones control. At the other extreme, one buyer and one seller negotiate price. Market Equilibrium is the price that equates supply and demand. At any lower price, shortage raises the price; and at any higher price, surplus lowers the price.

9 9 9 A.1 Demand and Supply Demand Curves

10 10 Overview Demand Curves show the amount a good that consumers are willing to buy at alternative prices when those prices cannot be changed by any single buyer. For example, oranges sold in a popular grocery have a demand curve since many buyers compete to buy. But a right-handed sequined glove worn by Michael Jackson has no demand curve since so few of his fans would want one that each potential buyer can negotiate price. A.1 Demand and Supply Demand Curves

11 11 The Demand Curve The demand curve is typically downward sloping. There are exceptions, like when poor people eat more beans when the price of beans increases from $0.10 per hundred calories to $0.20 per hundred calories because they can no longer afford to add any pork (selling for $1.00 per hundred calories) and so must add even more beans to avoid loosing weight. Quantity Price A.1 Demand and Supply Demand Curves

12 12 The Inverse Demand Cuve Alternative reading of demand, with price a function of quantity. Example: n Demand Function for Good X: Q x = 10 – 2P x n Inverse Demand Function for Good X: 2P x = 10 – Q x P x = 5 – 0.5Q x A.1 Demand and Supply Quantity Price Demand Curves

13 13 Demand shifters Since the demand curve only describes the relation of demand for a good to its own price, demand shifts when there is a change in any other factor that affects demand. IncomeIncome n An increase in consumer income increases demand for normal goods (like meat for the typical middle-class consumer) n An increase in consumer income decreases demand for inferior goods (like beans) Prices of Related GoodsPrices of Related Goods n An increase in the price of another good increases demand for a [gross] substitute good (like Windows computers and Apple computers) n An increase in the price of another good decreases demand for a [gross] complement good (hardware and software) n (Ill explain the gross later.) A.1 Demand and Supply Demand Curves

14 14 Price Quantity D0D A to B: Increase in quantity demanded B 10 A A.1 Demand and Supply Change in Quantity Demanded When computer demand changes with the price of computers Demand Curves

15 15 A.1 Demand and Supply Change in Demand Curve When computer demand changes with decreased software price D0D0 D1D1 6 7 D 0 to D 1 : Increase in Demand for computers. 13 Price Quantity Demand Curves

16 16 Consumer Surplus is the happiness left over after a consumer buys a good. Sellers measure consumer surplus then try to capture some or all of it by changing their marketing.Sellers measure consumer surplus then try to capture some or all of it by changing their marketing. For example, suppose Disney determined that typical customers value a day at Disneyland at $160.For example, suppose Disney determined that typical customers value a day at Disneyland at $160. Suppose also that the admission price to Disneyland is currently $140, so there is currently $20 consumer surplus.Suppose also that the admission price to Disneyland is currently $140, so there is currently $20 consumer surplus. Disney would then raise its admission price by $20 to capture all of the consumer surplus.Disney would then raise its admission price by $20 to capture all of the consumer surplus. A.1 Demand and Supply Demand Curves

17 17 A.1 Demand and Supply Getting a good deal means large consumer surplus. You got a lot of bang for the buck! You got a lot of bang for the buck! Total value greatly exceeds the total amount paid. Total value greatly exceeds the total amount paid. Consumer surplus is large. Consumer surplus is large. Demand Curves

18 18 A.1 Demand and Supply Getting a fair deal means small consumer surplus. Disneyland is fun, but they drive a hard bargain! Disneyland is fun, but they drive a hard bargain! I almost decided not to go! I almost decided not to go! They tried to squeeze the very last cent from me! They tried to squeeze the very last cent from me! Total amount paid is close to total value. Total amount paid is close to total value. Consumer surplus is low or zero.Consumer surplus is low or zero. Demand Curves

19 19 A.1 Demand and Supply Getting a bad deal or making a mistake means negative consumer surplus. Economics is only appropriate when mistakes are rare.Economics is only appropriate when mistakes are rare. Little children (or stupid big children) can make frequent mistakes, so their parents make decisions for them.Little children (or stupid big children) can make frequent mistakes, so their parents make decisions for them. You can only have one candy.You can only have one candy. Dont bounce the basketball off the house!Dont bounce the basketball off the house! Demand Curves

20 20 A.1 Demand and Supply Price Quantity D Consumer Surplus: The value received but not paid for. For demand P = 10-2Q and price P = 2, consumer surplus = (8-2) + (6-2) + (4-2) = $12. Computing surplus from demand in discrete units (like numbers of refrigerators). Demand Curves

21 21 A.1 Demand and Supply Computing surplus from demand in continuous units (like pounds of meat). Price $ Quantity D Value of 4 units = $24 C onsumer Surplus = $24 - $8 = $16 Expenditure on 4 units = $2 x 4 = $8 Demand Curves

22 22 A.1 Demand and Supply Supply Curves

23 23 Overview the amount a good that suppliers are willing to supply at alternative prices when those prices cannot be changed by any single supplier. Market Supply Curves show the amount a good that suppliers are willing to supply at alternative prices when those prices cannot be changed by any single supplier. For example, mall prices are outside each sellers control when enough sellers compete to sell. A.1 Demand and Supply Supply Curves

24 24 Market Supply Curves apply when producers are price takers, in perfect competition with other firms producing products that are identical or perfectly substitutable to consumers. Price makers (like Monopolists) choose their price, and do not have supply curves. Law of Supply: The supply curve is upward sloping. That Law has no exceptions. Quantity Price A.1 Demand and Supply Supply Curves

25 25 Supply shifters When supply is affected by factors other than its own price. Input prices (wages) direction? --- other examples? Prices of production substitutes or complements (like cars and trucks) direction? --- other examples? Technology (marginal cost) or government regulations direction? Number of firms n Entry (like coffee houses) --- other examples? n Exit (like airlines) --- other examples? A.1 Demand and Supply Supply Curves

26 26 Change in Quantity Supplied When computer supply depends on the price of computers Price Quantity S0S A 5 A to B: Increase in quantity supplied B 10 A.1 Demand and Supply Supply Curves

27 27 Change in Supply When computer supply depends on wages. Direction? --- Other examples? Price Quantity S1S1 S0S S 0 to S 1 : Decrease in supply 6 A.1 Demand and Supply Supply Curves

28 28 Producer Surplus When producers receive more than necessary to induce them to produce a good. Producer surplus is the source of profit when producers are in perfect competition with each other (when they have supply curves). Producer surplus is the source of profit when producers are in perfect competition with each other (when they have supply curves). A.1 Demand and Supply Supply Curves

29 29 The continuous case Price Quantity S0S0 Q*Q* P*P* A.1 Demand and Supply Supply Curves

30 30 A.1 Demand and Supply Competitive Markets

31 31 Overview Competitive Markets require enough competing buyers and competing sellers so prices are outside of everyones control. At the other extreme, one buyer and one seller negotiate price. A.1 Demand and Supply Competitive Markets

32 32 Question: Suppose Aleisha is willing to pay up to $59 for a pair of shoes.Aleisha is willing to pay up to $59 for a pair of shoes. Brad, to pay $44; Claudia, $34.01; Darren, $24; Edwina, $10.Brad, to pay $44; Claudia, $34.01; Darren, $24; Edwina, $10.Suppose Andrew is willing to sell down to $8 for a pair of shoes.Andrew is willing to sell down to $8 for a pair of shoes. Betty, to sell $20; Carlos, $34; Donna, $48; Engelbert, $62.Betty, to sell $20; Carlos, $34; Donna, $48; Engelbert, $62. Compute the competitive-equilibrium price of shoes if all 10 people trade shoes and money on eBay? (Ignore postage costs.) Alternatively, suppose Aleisha and Carlos do not use eBay, but Aleisha walks by Carloss trading stall outside the Tijuana Wax Museum. Compute the gains if Aleisha and Carlos trade a pair of shoes for money. Compute the price of shoes if they divide the gains A.1 Demand and Supply Competitive Markets

33 33 Competitive Markets Answer: Competitive Markets have Many Independent Buyers... Aleisha is willing to pay up to $59 for a pair of shoes.Aleisha is willing to pay up to $59 for a pair of shoes. Brad, $44; Claudia, $34.01; Darren, $24; Edwina, $10.Brad, $44; Claudia, $34.01; Darren, $24; Edwina, $10. A.1 Demand and Supply Aleisha Brad Claudia Darren Edwina

34 34 Competitive Markets A.1 Demand and Supply Aleisha Brad Claudia Darren Edwina … and Many Independent Sellers Andrew is willing to sell down to $8 for a pair of shoes.Andrew is willing to sell down to $8 for a pair of shoes. Betty, $20; Carlos, $34; Donna, $48; Engelbert, $62.Betty, $20; Carlos, $34; Donna, $48; Engelbert, $62. Engelbert Donna Carlos Betty Andrew

35 35 Competitive Markets A.1 Demand and Supply Aleisha Brad Claudia Darren Edwina Demand equals Supply determines Competitive Price At some price between $34 and $34.01, Aleisha, Brad and Claudia buy 1 pair each from Andrew, Betty and Carlos.At some price between $34 and $34.01, Aleisha, Brad and Claudia buy 1 pair each from Andrew, Betty and Carlos. Engelbert Donna Carlos Betty Andrew

36 36 A.1 Demand and Supply Bargaining Occurs with One Buyer and One Seller If Aleisha and Carlos meet separate from the competitive market, then the gains if they were to trade a pair of shoes is the difference between willingness to pay and willingness to sell. Aleisha is willing to pay up to $59 for a pair of shoes.Aleisha is willing to pay up to $59 for a pair of shoes. Carlos is willing to sell down to $34 for a pair of shoes.Carlos is willing to sell down to $34 for a pair of shoes. The gain from trade is the difference, $25 = $59-$34.The gain from trade is the difference, $25 = $59-$34. If Aleisha and Carlos divided the gains from trade 50-50, then each gets $12.50 gain, meaning Aleisha pays price $46.50 = $59.00-$12.50, and Carlos receives price $46.50 = $34.00+$12.50 Competitive Markets

37 37 A.1 Demand and Supply Market Equilibrium

38 38 Overview Competitive Market Equilibrium is the price that equates supply and demand. At any lower price, shortage raises the price; and at any higher price, surplus lowers the price. A.1 Demand and Supply Market Equilibrium

39 39 Market Equilibrium The Price that equates supply and demandThe Price that equates supply and demand Why predict that price?Why predict that price? A.1 Demand and Supply Price Quantity S D Market Equilibrium

40 40 Market Equilibrium The Price (P) that equates supply and demandThe Price (P) that equates supply and demand n Q x S = Q x D n No shortage or surplus It is a steady state (rest point) when shortage (D > S) drives prices up, and surplus (D S) drives prices up, and surplus (D < S) drives prices down. A.1 Demand and Supply Market Equilibrium

41 41 Price Quantity S D Shortage = 6 6 Graphing the equilibrium story: If price is too low, like the initial price of hybrid cars … Other examples? 7 A.1 Demand and Supply Market Equilibrium

42 42 Price Quantity S D 9 14 Surplus 14-6 = If price is too high, like airline prices just after 9/11 … Other examples? 7 A.1 Demand and Supply Market Equilibrium

43 43 Market Equilibrium does not occur when the government intervenes to change prices, like keeping child-costs low (through tax credits that subsidize the consumption of children). Managerial economics treats children like other commodities, with the family as the consumer.Managerial economics treats children like other commodities, with the family as the consumer. Managerial economics deals with families that make a rational choice about the number of children. They never make the mistake of having more children than they can afford.Managerial economics deals with families that make a rational choice about the number of children. They never make the mistake of having more children than they can afford. A.1 Demand and Supply Market Equilibrium

44 44 Since poverty levels in the U.S. depend on the number of children in a household, the U.S. assumes having children is not a rational choice. Otherwise, having more children makes you wealthy, not poor and needing government subsidies.Since poverty levels in the U.S. depend on the number of children in a household, the U.S. assumes having children is not a rational choice. Otherwise, having more children makes you wealthy, not poor and needing government subsidies. Here are 2013 federal poverty levels used as guidelines for government-subsidized health programs.Here are 2013 federal poverty levels used as guidelines for government-subsidized health programs. A.1 Demand and Supply Market Equilibrium Household SizeIncome Level 1$11,490 2$15,510 3$19,530 4$23,550 5$27,570 6$31,590

45 45 A.1 Demand and Supply SummarySummary

46 46 The lesson uses demand and supply curves, and so all results are only for perfectly competitive markets.The lesson uses demand and supply curves, and so all results are only for perfectly competitive markets. One purpose is to help managers in competitive markets predict changes in equilibrium, so they can plan their future.One purpose is to help managers in competitive markets predict changes in equilibrium, so they can plan their future. Another purpose is to exercise the use of demand curves, which are used even when markets are not competitive.Another purpose is to exercise the use of demand curves, which are used even when markets are not competitive. A.1 Demand and SupplySummary

47 47 End of Lesson A.1 BA 445 Managerial Economics A.1 Demand and Supply


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