Transcript A.1 Demand and Supply

Welcome to BA 445
Managerial Economics
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).
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Welcome to BA 445
Managerial Economics
Getting started
Read and bookmark the online course syllabus:
http://faculty.pepperdine.edu/jburke2/ba445/index.htm
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.
• Before each class meeting, download and read the
PowerPoint lesson, available under the “Schedule” link.
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Readings
Readings
For background or for an alternative description of the
concepts in the following PowerPoint slides, I recommend
Baye 6th edition or 7th edition, Chapter 2
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Overview
Overview
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Overview
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.
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Overview
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.
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Overview
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.
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Overview
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 seller’s control when enough sellers
compete to sell.
Competitive Markets require enough competing buyers and competing sellers so
prices are outside of everyone’s 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.
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Demand Curves
Demand Curves
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Demand Curves
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.
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Demand Curves
The Demand Curve
• The demand curve is typically downward sloping.
Price
Quantity
• 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.
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Demand Curves
The Inverse Demand Cuve
Alternative reading of demand, with price a function of
quantity.
Price
Quantity
• Example:

Demand Function for Good X:
• Qx = 10 – 2Px

Inverse Demand Function for Good X:
• 2Px = 10 – Qx
• Px = 5 – 0.5Qx
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Demand Curves
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.
• Income

An increase in consumer income increases demand for normal
goods (like meat for the typical middle-class consumer)

An increase in consumer income decreases demand for inferior
goods (like beans)
• Prices of Related Goods

An increase in the price of another good increases demand for a
[gross] substitute good (like Windows computers and Apple
computers)

An increase in the price of another good decreases demand for
a [gross] complement good (hardware and software)

(I’ll explain the “gross” later.)
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Demand Curves
Change in Quantity Demanded
When computer demand changes with the price of
computers
A to B: Increase in quantity
Price
demanded
A
10
B
6
D0
4
7
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Demand Curves
Change in Demand Curve
When computer demand changes with decreased software
price
D0 to D1: Increase in Demand for
computers.
Price
6
D1
D0
7
13
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Quantity
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Demand Curves
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.
• 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.
• Disney would then raise its admission price by $20 to
capture all of the consumer surplus.
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Demand Curves
Getting a good deal means large consumer surplus.
• You got a lot of bang for the buck!
• Total value greatly exceeds the total amount paid.
• Consumer surplus is large.
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Demand Curves
Getting a fair deal means small consumer surplus.
• Disneyland is fun, but they drive a hard bargain!
• I almost decided not to go!
• They tried to squeeze the very last cent from me!
• Total amount paid is close to total value.
• Consumer surplus is low or zero.
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Demand Curves
Getting a bad deal or making a mistake means negative
consumer surplus.
• 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.
• You can only have one candy.
• Don’t bounce the basketball off the house!
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Demand Curves
Computing surplus from demand in discrete units
(like numbers of refrigerators).
Price
Consumer Surplus:
The value received but not paid
10
for.
For demand P = 10-2Q and
8
price P = 2, consumer surplus
6
= (8-2) + (6-2) + (4-2) = $12.
4
2
D
1
2
3
4
5
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Quantity
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Demand Curves
Computing surplus from demand in continuous units
(like pounds of meat).
Price $
10
Consumer
Surplus =
$24 - $8 = $16
Value
of 4 units = $24
8
6
Expenditure on 4 units
= $2 x 4 = $8
4
2
D
1
2
3
4
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Quantity
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Supply Curves
Supply Curves
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Supply Curves
Overview
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 seller’s control when
enough sellers compete to sell.
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Supply Curves
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.
Price
Quantity
• That “Law” has no exceptions.
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Supply Curves
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
 Entry (like coffee houses) --- other examples?
 Exit (like airlines) --- other examples?
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Supply Curves
Change in Quantity Supplied
When computer supply depends on the price of computers
A to B: Increase in quantity supplied
Price
S0
B
20
10
A
5
10
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Quantity
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Supply Curves
Change in Supply
When computer supply depends on wages. Direction? --Other examples?
S0 to S1: Decrease in
Price supply
S1
S0
8
6
5
7
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Supply Curves
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).
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Supply Curves
The continuous case
Price
S0
P*
Q*
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Competitive Markets
Competitive Markets
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Competitive Markets
Overview
Competitive Markets require enough competing buyers and
competing sellers so prices are outside of everyone’s
control. At the other extreme, one buyer and one seller
negotiate price.
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Competitive Markets
Question: Suppose
• Aleisha is willing to pay up to $59 for a pair of shoes.
• 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.
• 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 Carlos’s 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 50-50.
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Competitive Markets
Answer: Competitive Markets have Many Independent Buyers ...
• Aleisha is willing to pay up to $59 for a pair of shoes.
• Brad, $44; Claudia, $34.01; Darren, $24; Edwina, $10.
Aleisha
Brad
Claudia
Darren
Edwina
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Competitive Markets
… and Many Independent Sellers
• Andrew is willing to sell down to $8 for a pair of shoes.
• Betty, $20; Carlos, $34; Donna, $48; Engelbert, $62.
Aleisha
Engelbert
Brad
Donna
Claudia
Carlos
Darren
Betty
Edwina
Andrew
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Competitive Markets
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.
Aleisha
Engelbert
Brad
Donna
Claudia
Carlos
Darren
Betty
Edwina
Andrew
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Competitive Markets
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.
• Carlos is willing to sell down to $34 for a pair of shoes.
• 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
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Market Equilibrium
Market Equilibrium
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Market Equilibrium
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.
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Market Equilibrium
Market Equilibrium
• The Price that equates supply and demand
S
• Why predict that price?
Price
D
Quantity
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Market Equilibrium
Market Equilibrium
• The Price (P) that equates supply and demand
S
D
 Qx = Qx
 No shortage or surplus
• It is a steady state (rest point) when shortage (D > S)
drives prices up, and surplus (D < S) drives prices down.
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Market Equilibrium
Graphing the equilibrium story: If price is too low, like
the initial price of hybrid cars … Other examples?
Price
S
7
6
5
D
Shortage
12 - 6 = 6
6
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Quantity
41
Market Equilibrium
If price is too high, like airline prices just after 9/11 …
Other examples?
Price
Surplus 14-6 = 8
S
9
8
7
D
6
9
14
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Market Equilibrium
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 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.
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Summary
Summary
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Summary
• 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.
• Another purpose is to exercise the use of demand
curves, which are used even when markets are not
competitive.
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BA 445
Managerial Economics
End of Lesson A.1
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