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

2. Market Demand Curve
Shows the amount of a good that consumers are willing and able to purchase at various prices (AKA MB curve because represents WTP)
Law of Demand
The demand curve is downward sloping. WHY?
Price
Quantity D

3. Change in Quantity Demanded
Price
Quantity D0
A to B: Increase in quantity demanded A
Move along the curve when price changes 10 4 B 6 7

4. Change (shifts) in Demand
Price
Quantity D0
D0 to D1: Increase in Demand (a rightward shift) D1 6 7 13

5. Determinants of Demand
Demand Shifters
Income (M)
Prices of substitutes
Prices of complements
Advertising
Tastes and preferences
Population
Consumer expectations

6. Changes in Demand Increases in Demand (rightward shifts)
Increase in M if good X is a normal good.
Decreases in M if good X is an inferior good.
Increase in the price of substitute good.
Decrease in the price of a complement good.
Increase in # of consumers
Expect higher future prices for good X
Decreases in Demand (leftward shifts)
Decrease in M if good X is a normal good.
Increase in M if good X is an inferior good.
Decrease in the price of a substitute good.
Increase in the price of a complement good.
Decrease in the # of consumers
Expect lower future prices

7. As income increases, demand for inferior good falls
Example
As income increases, demand for inferior good falls D0
Price per package of ramen soup D0
Ramen Soup

8. The Demand Function An equation representing the demand curve
Qxd = f(Px , PY , M, H)
Qxd = quantity demand of good X.
Px = price of good X.
PY = price of a substitute (or complement) good Y.
M = income.
H = any other variable affecting demand

9. Consumer Surplus (CS)
The value consumers get from a good but do not have to pay for.
“I got a great deal.” The value exceeds total amount paid. CS is high.
“I got a lousy deal. They drive a hard bargain. They Squeezed the very last cent from me.” CS is low.

10. Consumer Surplus: The Discrete Case
Price
Quantity D 10 8 6 4 2
Consumer Surplus:
The value received but not
paid for
Total amount paid for 4 goods.

11. Consumer Surplus: The Continuous Case
Price $
Consumer
Surplus
Value
of 4 units 10 8 6 4
Total Cost of 4 units 2 D
Quantity

12. Exercise The demand for good X is given by
Research shows that the prices of goods Y and Z are $100 and $600, respectively. Average income of individuals who consume this product is M=$32,000.
Indicate whether goods Y and Z are complements or substitutes with X. Is X an inferior or normal good? Determine the demand function and inverse demand function for X. Graph it. Calculate consumer surplus when the price of good X is $12,000.

13. Market Supply Curve
The supply curve shows the amount of a good that sellers are willing to sell at alternative prices (AKA a MC curve)
Law of Supply
The supply curve is upward sloping. Why?
Price
Quantity S0

14. Change in Quantity Supplied
A to B: Increase in quantity supplied
(move along the curve)
Price
Quantity S0 B 20 A 10 5 10

15. Supply Shifters Input prices (higher costs, S)
Technology or government regulations (if reduce costs, S)
Number of firms (more, S)
Substitutes in production
Taxes (per-unit, S, represented by an upward shift equal to the per-unit tax amount)
Producer expectations
Supply decrease (S) represented by leftward or upward shift.
Supply increase (S) represented by rightward or downward shift.

16. Change in Supply
Suppose a new technology is developed, which reduces the costs of production.
S0 to S1: Increase in supply (a rightward shift)
Price
Quantity S0 S1 8 5 6 7 3

17. Change in Supply S1 S0 Price per gallon 3.70 2.70 2.10 1.10 1.00
Suppose a government imposes a $1 per-unit tax on each gallon of gasoline sold. This increases the firm’s costs. Supply shifts from S0 to S1: a decrease in supply (a left shift, or supply shifts upward by $1). S1
1.00 S0
Distance between S0 and S1 is $1. Although the supply curve shift up by $1, this still represents a decline in supply (supply shifted left)
Price per gallon
2.10
3.70
2.70
1.10 3 5
Gal. of Gasoline
(in billions)

18. The Supply Function An equation representing the supply curve:
QxS = f(Px , PR ,W, H,)
QxS = quantity supplied of good X.
Px = price of good X.
PR = price of a related good
W = price of inputs (e.g., wages)
H = other variable affecting supply

19. Producer Surplus
The amount received (price) minus the MC of producing the Qth unit.
Price S0 P*
Producer Surplus Q*
Quantity

20. Market Equilibrium
Where supply equals demand
QxS = Qxd

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

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

23. Exercise Suppose demand and supply (in thousands) are given by
Determine equilibrium price and quantity. Suppose a $2 per-unit tax is imposed on the good and collected from producers. Determine the new equilibrium price and quantity.

24. Price Regulations Price Ceilings Price Floors
The maximum legal price that can be charged
Examples:
Housing in New York City
Parking passes
CA blackouts
Water prices in Utah
Price Floors
The minimum legal price that can be charged.
Minimum wage
Agricultural price supports

25. Impact of a Price Ceiling
Quantity S D P* Q* PF
To be “binding” must be set below equilibrium price
Price Ceiling
Q s
Q d
Shortage

26. Impact of a Price Floor Price Quantity S D P* Q* Surplus Price FloorQd QS
To be “binding” must be set above equilibrium price

27. Applications of Demand and Supply Analysis
Event: Suppose the WSJ reports that the prices of cellphones and cellphone services are expected to fall by more than 20% over the next six months.
What do you think may be causing this change?

28. Let’s Analyze Supply? Increasing or Decreasing?
Demand? Increasing or Decreasing?
If supply is increasing and demand is also increasing, then why are prices falling?
When demand increases, prices should increase.
When supply increases, prices will fall.

29. Graphically Price Cell- S phones S* P0 P* D D* Quantity of Q0 Q*
Cellphones S D S* P0 Q0 P* Q* D*

30. Other Industry Effects
Suppose you are a car dealer
Automatic
Manual Transmission

31. Impact of lower Cellphone prices on the car market
Automatic
car S D* D P1 Q1 P0 Q0
Quantity of
Automatic Cars

32. Summary Use supply and demand analysis to
clarify the “big picture” (the general impact of a current event on equilibrium prices and quantities)
organize an action plan (needed changes in inventories, marketing plans, etc.)