Managerial Economics & Business Strategy

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

2. 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? Quantity Market Demand Curve Price D

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

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

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

6. 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 Changes in Demand

7. D0 Example As income increases, demand for inferior good falls 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. Price 10 8 6 4 2 D 1 2 3 4 5 Quantity Consumer Surplus: The Discrete Case Consumer Surplus: The value received but not paid for Total amount paid for 4 goods.

11. Value of 4 units Consumer Surplus Consumer Surplus:The Continuous Case Price $ 10 8 6 4 Total Cost of 4 units 2 D 1 2 3 4 5 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. Price S0 Quantity 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?

14. Price S0 Quantity Change in Quantity Supplied A to B: Increase in quantity supplied (move along the curve) 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. Price S0 5 Quantity Change in Supply Suppose a new technology is developed, which reduces the costs of production. S0 to S1: Increase in supply (a rightward shift) S1 8 6 7 3

17. S1 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) 3.70 2.10 1.00 Change in Supply 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). S0 Price per gallon 2.70 1.10 Gal. of Gasoline (in billions) 5 3

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… S 7 6 5 D Shortage 12 - 6 = 6 6 12 Price Quantity

22. If price is too high… Surplus 14 - 6 = 8 S 7 8 9 D 6 8 14 Price 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 • 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. • Examples: • Minimum wage • Agricultural price supports

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

26. Surplus Price S P* D Quantity Qd Q* QS Impact of a Price Floor Price Floor 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- phones S S* P0 P* D Quantity of Cellphones Q* Q0 D*

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

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