1. Chapter 3 Supply and Demand Managerial Economics: Economic Tools for Today’s Decision Makers, 5/e By Paul Keat and Philip Young

2. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Supply and Demand Market Demand Market Supply Market Equilibrium Comparative Statics Analysis Short-run Analysis Long-run Analysis Supply, Demand, and Price

3. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Learning Objectives Define supply, demand, and equilibrium price. List and provide specific examples of non-price determinants of supply and demand. Distinguish between short-run rationing function and long-run guiding function of price Illustrate how concepts of supply and demand can be used to analyze market conditions in which management decisions about price and allocations must be made. Use supply and demand diagrams to show how determinants of supply and demand interact to determine price in the short and long run

4. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Demand Demand for a good or service is defined as quantities of a good or service that people are ready (willing and able) to buy at various prices within some given time period, other factors besides price held constant ceteris paribus = partial derivative!!! Q d = f(P, P s, P c, I, Exp, T&P, # b )

5. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Demand Market demand is the sum of all the individual demands. Example demand for pizza:

6. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Demand The inverse relationship between price and the quantity demanded of a good or service is called the Law of Demand.

7. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Demand Changes in price result in changes in the quantity demanded. This is shown as movement along the demand curve.  Shift in Supply ceteris paribus!!!  4 MKTs!!! Changes in non-price determinants result in changes in demand. This is shown as a shift in the demand curve.

8. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Demand Non-price (CP) determinants of demand: Prices of related products (P s, P c ) Income (I) Future expectations (Exp) Tastes and preferences (T&P) Number of buyers (#) Q d = f(P, P s, P c, I, Exp, T&P, # b )

9. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Supply The supply of a good or service is defined as quantities of a good or service that people are ready to sell at various prices within some given time period, other factors besides price held constant. ceteris paribus = partial derivative!!!

10. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Supply Changes in price result in changes in the quantity supplied. This is shown as movement along the supply curve.  Shift in Demand ceteris paribus!!!  4 MKT !!! Changes in non-price determinants result in changes in supply. This is shown as a shift in the supply curve.

11. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Supply Non-price (CP) determinants of supply Costs and technology ($, Tech) Prices of other goods or services offered by the seller (P other ) Future expectations (Exp) Number of sellers (# s ) Weather conditions (W) Q s = f($, Tech, P other, Exp, Weather, # s )

12. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Equilibrium Equilibrium price: The price that equates the quantity demanded with the quantity supplied. Equilibrium quantity: The amount that people are willing to buy and sellers are willing to offer at the equilibrium price level.

13. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Equilibrium Shortage: A market situation in which the quantity demanded exceeds the quantity supplied. A shortage occurs at a price below the equilibrium level. Shortage Implies: 1.Either Demand Increases (Supply does NOT). ↑ D||S = k (constant) 2.OR, Supply Decreases (Demand does NOT). ↓ S||D = k (constant)

14. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Equilibrium Surplus: A market situation in which the quantity supplied exceeds the quantity demanded. A surplus occurs at a price above the equilibrium level. Surplus Implies: 1.Either Supply Increases (Demand does NOT). ↑ S||D = k (constant). 2.OR, Demand Decreases (Supply does NOT). ↓ D|| S = k (constant).

15. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Market Equilibrium

16. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics Analysis A commonly used method in economic analysis: a form of sensitivity, or what-if analysis. Process of comparative statics analysis: 1.State all the assumptions needed to construct the model. 2.Begin by assuming that the model is in equilibrium. 3.Introduce a change in the model. In so doing, a condition of disequilibrium is created. Change CP (S or D) conditions!!! 4.Find the new point at which equilibrium is restored. 5.Compare the new equilibrium point with the original one. Interpret !!!

17. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics: Example Step 1 Assume all factors except the price of pizza are constant. Buyers’ demand and sellers’ supply are represented by lines shown.

18. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics: Example Step 2 Begin the analysis in equilibrium as shown by Q 1 and P 1.

19. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics: Example Step 3 Assume that a new study shows pizza to be the most nutritious of all fast foods.  ∆CP D (T&P)!!! Consumers increase their demand for pizza as a result.

20. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics: Example Step 4 The shift in demand results in a new equilibrium price, P 2, and quantity, Q 2.

21. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics: Example Step 5 Comparing the new equilibrium point with the original one we see that both equilibrium price and quantity have increased. NOTE: ↑P  ↑ MC Q !!!

22. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics Analysis The short run is the period of time in which: Sellers already in the market respond to a change in equilibrium price by adjusting variable inputs. Buyers already in the market respond to changes in equilibrium price by adjusting the quantity demanded for the good or service.

23. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics Analysis The rationing function of price is the change in market price to eliminate the imbalance between quantities supplied and demanded. SHORT RUN !!!

24. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Short-run Analysis An increase in demand causes equilibrium price and quantity to rise. Implies Excess Economic ∏ to cost efficient firms!!! ↑ returns to fixed factors!!! Induces 4MKT Entry

25. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Short-run Analysis A decrease in demand causes equilibrium price and quantity to fall. Implies Economic Losses ↓ returns to fixed factors!!! Induces 4MKT Exit…

26. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Short-run Analysis An increase in supply causes equilibrium price to fall and equilibrium quantity to rise.

27. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Short-run Analysis A decrease in supply causes equilibrium price to rise and equilibrium quantity to fall.

28. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics Analysis The long run is the period of time in which: 1)New sellers may enter a market 2)Existing sellers may exit from a market 3)Existing sellers may adjust fixed factors of production 4)Buyers may react to a change in equilibrium price by changing their tastes and preferences or buying preferences

29. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Comparative Statics Analysis The guiding or allocating function of price is the movement of resources into or out of markets in response to a change in the equilibrium price. LONG RUN !!!

30. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Long-run Analysis Initial change: decrease in demand from D 1 to D 2 Result: reduction in equilibrium price and quantity, now P 2,Q 2 Follow-on adjustment: movement of resources out of the market leftward shift in the supply curve to S 2 Equilibrium price and quantity now P 3,Q 3

31. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Long-run Analysis Initial change: increase in demand from D 1 to D 2 Result: increase in equilibrium price and quantity, now P 2,Q 2 Follow-on adjustment: movement of resources into the market rightward shift in the supply curve to S 2 Equilibrium price and quantity now P 3,Q 3

32. 2006 Prentice Hall Business Publishing Managerial Economics, 5/e Keat/Young Supply, Demand, and Price: The Managerial Challenge In the extreme case, the forces of supply and demand are the sole determinants of the market price. This type of market is “perfect competition” In other markets, individual firms can exert market power over their price because of their: dominant size. ability to differentiate their product through advertising, brand name, features, or services. Joel Karlin Example: “the Funds” trump S&D…