1. Demand and Supply Chapter 3

2. Chapter 3 OVERVIEW   Basis for Demand   Market Demand Function   Demand Curve   Basis For Supply   Market Supply Function   Supply Curve   Market Equilibrium

3. Chapter 3 KEY CONCEPTS   demand   direct demand   utility   derived demand   demand function   demand curve   change in the quantity demanded   shift in demand   Supply   supply function   supply curve   change in the quantity supplied   shift in supply   equilibrium   market equilibrium price   surplus   shortage   comparative statics analysis

4. Demand The Demand Curve is the relationship between the price of a good or service and the quantity demanded by consumers of the good or service. The Law of Demand P  Qd  We work with equations because they are easier to work with they are becoming increasingly popular for managerial purposes computers have simplified the process of estimation

5. Demand Curve   Demand Curve Determination Demand curve shows price and quantity relation holding everything else constant.   Change in Quantity Demanded Quantity demanded falls if price rises. Quantity demanded rises if price falls.   Role of Non-Price Variables Change in non-price variables will define a new demand curve.

6. Relation Between the Demand Curve and Demand Function   Movements Along Demand Curve A rise in price causes upward movement along a given demand curve. A price decline causes downward movement along a given demand curve.   Demand Curve Shifts Demand increases if a non-price change allows more to be sold at every price. Demand decreases if a non-price change causes less to be sold at every price.

7. Basis for Demand   Direct Demand Demand is the quantity customers are willing to buy under current market conditions. Direct demand is demand for consumption.   Derived Demand Derived demand is input demand. Firms demand inputs that can be profitably employed.

8. Determinants of Demand Demand is determined by Price – movements along the demand curve prices of related goods – shifts the demand curve Income - shifts the demand curve Advertising – shifts the demand curve Taste and preferences of buyers - shifts demand Price expectations, population, ect.

9. Industry Demand Versus Firm Demand Industry demand is subject to general economic conditions. Cyclical factors Systemic factors Political decisions Firm demand is determined by economic conditions and competition.

10. Market Demand Functions Consumer A P = 12 – Q A Consumer B P = 10 – 2Q B Consumer C P = 10 – Q C P = 10Market Demand = 2 P = 6 Market Demand = 12 P = 2 Market Demand = 22 P’s are the same add the Q’s Q A = 12 – P Q B = 5 – 0.5 P Q C = 10 – P Q A + Q B + Q C = Q M = 27-2.5 P [ P = 10 ] [ Q M = 2 ]

11. General Demand Function with Shift Factors This would be the typical demand curve for a product. It could be the company’s specific product, or the industry’s demand for a specific product. For example, Ford’s demand for mid-sized cars, or all auto-makers demand for mid-sized cars Q XM = f(P X,P Y,I,A,POP) Prices of Related Goods – Substitutes / Complements Income - Inferior / Normal Population at an Aggregated Level

12. Linear Demand Curve Demand for Apples Q XM = a 1 P x + a 2 P Y + a 3 I + a 4 A + a 5 POP Q M = -500(P x ) + 450(P Y ) + 1,000(I) + 1500(A) + 220(POP) P (X in pennies) P Y = Price of Grapes 1.00 a pound; I = 20; A= 10 thousand; POP in thousands = 50 Q = -500(P x ) + 450(100) + 1,000(20) + 1500(10) + 220(50) Q = -500(P x ) + 45,000) + 20,000 + 15,000 + 11,000 Q = -500(P x ) + 91,000 P = 182 -.002Q

13. Changes in demand determinants An increase in advertising by 1 thousand dollars Would result in a 1500 increase in Q Q = -500(P x ) + 92,500 Q – 92,500 = -500(P x ) -.002Q + 185 = (P x ) The individual firms demand curve would be a fraction of the total market demand curve. i.e. If company A controlled 50% of the apple market, a $1Million dollar increase in income would raise the sale of their apples by approximately, 500 pounds. Don’t forget, direct demand is demand for actual consumption (output) derived demand is demand for inputs that stems from demand for outputs. i.e. The demand for wood or brick increases because of the demand for new homes.

14. Basis For Supply   Firms Offer Supply To Make Profits When prices rise, firms boost the quantity supplied. When prices fall, firms cut the quantity supplied.   Everything That Affects Marginal Production Costs Affects Supply If MC falls, supply rises. If MC rises, supply falls.

15. Market Supply Function   Determinants of Supply Supply is determined by price, prices of other goods, technology, and so on.   Industry Supply Versus Firm Supply Firm supply is determined by economic conditions and competition. Industry supply is the sum of firm supply.

16. Supply © 2009, 2006 South-Western, a part of Cengage Learning The supply curve is from a firm’s perspective. How much will the firm supply of product X at a given P X ?

17. Supply Curve   Supply Curve Determination Supply curve shows price and quantity relation holding everything else constant.   The Price-quantity Supplied Relation A rise in price will increase the quantity supplied. A fall in price will decrease the quantity supplied.   Along a supply curve, all non-price variables are held constant

18. Relation Between Supply Curve and Supply Function   Movements Along Supply Curve A rise in price causes upward movement along a given supply curve. A price decline causes downward movement along a given supply curve.   Supply Curve Shifts Supply increases if a non-price change allows more to profitably produced and sold. Supply decreases if a non-price change causes less to be profitably produced and sold.

19. Supply Determinants   Anything that affects the cost of doing business will impact the firm’s decision to supply. Labor costs Materials costs Overhead Advertising Productivity Technology Taxes Also, changes in the number of suppliers.

20. Market Supply Curve Market Supply Q = B 1 P X + B 2 P Y + B 3 W + B Y G PX = price of apples in cents PY = price of grapes in pennies, as a substitute labor picks applies or grapes can’t do both effectively W = wages of workers in dollars G = other goods such as pesticides on government regulations cost of chemicals the cost is 1,000 Q = 350(P X ) – 100(P Y ) – 1,000(W) – 200(O) Assume P X, P Y = 100; W = 4 dollars an hour; O = 50,000; Q = 350P X – 10,000 – 4,000 – 10,000 Q = 350P X – 24000 P X =.003Q – 68.57

21. When do suppliers enter the market? How much does the price of apples have to be for the apple industry to produce any apples? ANS. 24,000/350 = 68.6; About 70 cents per pound What if wages drop down to 2 per hour? Q = 350PX – 22,000; 22,000/350; then firms will startr63 cents…

22. Market Equilibrium   Demand and Supply Balance Equilibrium exists if perfect balance exists in the quantities demanded and supplied. Equilibrium reflects productive and allocative efficiency.   Surplus and Shortage Surplus is excess supply. Shortage is excess demand.

23. Market Equilibrium Using the demand curve from slide 12 and the supply curve from slide 20. 350P X – 24,000 = -500P X + 91,000 P X = 135.3 or $1.35 per pound… At a price of Q $1 what is the amount of the supply? Change the shift factors of either supply or demand.

24. The Market for Autos   Demand Shifts in the demand curve   Supply Shifts in the supply curve   Equilibrium Changes in market equilibrium

30. Comparative Statics   Changes in Equilibrium Equilibrium exists when there is no economic incentive for change in demand or supply. Changing demand or supply affects equilibrium.   Comparative Statics Study of how equilibrium changes with changing demand or supply. Change continues until a new equilibrium is established.

32. © 2009, 2006 South-Western, a part of Cengage Learning