Transcript Lecture 2

PPA 723: Managerial
Economics
Lecture 2:
Demand and Supply
Managerial Economics, Lecture 2: Demand and Supply
Outline
Demand
Demand Curves
Movement Along vs. Shift In Demand Curve
Examples
Supply
Supply Curves
Movement Along vs. Shift in Supply Curve
Examples
Managerial Economics, Lecture 2: Demand and Supply
Demand Curve
• A demand curve shows quantity demanded
as a function of product price.
– Quantity demanded is the amount consumers are
willing to buy at a given price, holding constant
other factors that affect purchases
• Note the strange demand curve convention:
price is on the vertical axis
Managerial Economics, Lecture 2: Demand and Supply
P ($ per kg)
Figure 2.1 A Demand Curve
14.30
Demand curve for pork
4.30
3.30
2.30
0
200 220 240
286
Q (Million kg of pork per year)
Managerial Economics, Lecture 2: Demand and Supply
Effect of a Price Changes
A price change leads to movement
along the demand curve.
A demand curve indicates:
 What happens to the quantity
demanded as the price changes,
holding all other factors constant?
Managerial Economics, Lecture 2: Demand and Supply
The Law of Demand
Demand curves slope downward
A drop in price results in an increase
in quantity demanded, holding other
factors constant.
This is one of the most important
empirical finding in economics
Managerial Economics, Lecture 2: Demand and Supply
Other Factors That Might Affect Demand
Income
Prices of other goods (compliments,
substitutes)
Preferences
Number of consumers
Information
Managerial Economics, Lecture 2: Demand and Supply
Background Factors
 Background factors are variables in the background of
a given graph
 We can only plot two variables at a time (three if we
are careful) but the world is more complex than this!
 So we distinguish between movement along a demand
curve (caused by a change in price) and a shift in a
demand curve (caused by changes in background
factors)
Managerial Economics, Lecture 2: Demand and Supply
Example: The Impact on Pork Demand
of a Rise in the Price of Beef
Beef is a substitute for pork
At a given price of pork, a rise in the price
of beef causes some people to switch
from beef to pork.
Managerial Economics, Lecture 2: Demand and Supply
P ($ per kg)
Figure 2.2. Shift in Demand Curve
Effect of a 60¢increase in the price of beef
3.30
D2
D1
0
176
220
232 Q (Mil. kg of pork/ year)
Managerial Economics, Lecture 2: Demand and Supply
Demand Functions
A more general approach is to say that
quantity demanded is a function of many
variables, not just price.
We focus on price because it is what
adjusts to make markets clear.
But sometimes we want to focus on other
variables.
Managerial Economics, Lecture 2: Demand and Supply
Demand Function
General function:
 Q = D(P, Pb, Pc, Y)
Specific (linear) pork demand function:
Q = 171 – 20P + 20Pb + 3Pc + 2Y
Managerial Economics, Lecture 2: Demand and Supply
Other Graphs
 Once we have a demand function, we can draw
graphs with any two variables.
 Consider, e.g., an income-consumption curve:
 How much do people consume (Y-axis) at different
income levels (X-axis)?
 Price is a background factor in this curve
 We still can only plot two factors at a time!
Managerial Economics, Lecture 2: Demand and Supply
Determining Price
 One cannot determine the market price without the
supply side.
 If we know price, can determine quantity demanded.
 If we know change in price, can determine movement along the
demand curve.
 Demand curves are only hypothetical.
 They indicate what people would demand if the price were at a
certain level -- not what they actually demand.
 To find actual demand we must combine supply and demand,
the topic of our next class.
Managerial Economics, Lecture 2: Demand and Supply
Example: Public Transportation
• What happens to ridership if the fare goes up?
• What happens to ridership if the elderly get a
lower fare?
• What happens to ridership as incomes go up?
• What happens to ridership if the price of
gasoline goes up?
Managerial Economics, Lecture 2: Demand and Supply
Example: Energy
• What happens to consumption when the price or
energy goes up?
• What form does this change take? lower
thermostats? more sweaters? less
driving? smaller cars?
• What happens to natural gas consumption when
oil prices go up?
• What happens to energy consumption with a
new conservation ethic? How would you
distinguish this from a price increase?
Managerial Economics, Lecture 2: Demand and Supply
Example: Health Care
• What happens to consumption when the
price goes to zero because of insurance?
• What happens to consumption of (legal)
drugs as generic drugs become more
available?
Managerial Economics, Lecture 2: Demand and Supply
Example: Local Public Services
 There is lots of evidence that demand is
reflected in voting and in public spending.
 So:
• What happens to school quality when teachers'
salaries rise?
• What happens to school quality when the cost of
police goes up?
• What happens to school quality when the state gives
grants that lower the price of schools to city
residents?
Managerial Economics, Lecture 2: Demand and Supply
The Supply Side
 The behavior of suppliers is quite different from the
behavior of demanders.
 But the analytical issues are similar.
 Quantity supplied is the amount of a good or service
that firms want to sell at a given price, holding constant
other factors that affect supply.
 We focus for now on firms that are small relative to the
market, so they can each sell as much as they want at
the market price.
Managerial Economics, Lecture 2: Demand and Supply
Supply Curve
An increase in price of pork causes a
movement along the supply curve
(holding fixed other variables that affect
supply)
A supply curve answers the question:
What happens to the quantity supplied
as the price changes holding all other
factors constant?
Managerial Economics, Lecture 2: Demand and Supply
Figure 2.3 Supply Curve of Canadian Processed Pork
P ($ per kg)
Supply curve
5.30
3.30
0
176
220
300
Q (Million kg of pork per year)
Managerial Economics, Lecture 2: Demand and Supply
Effect of Price on Supply
Supply curve for pork is upward sloping
Increase in the price of pork leads to
movement along the supply curve,
resulting in larger quantity of pork
supplied
Managerial Economics, Lecture 2: Demand and Supply
Background Factors in Supply Curve
input prices
technology
number of firms (and conditions in other
markets)
goals of the firm
regulation
Managerial Economics, Lecture 2: Demand and Supply
Figure 2.4 A Shift of Pork Supply Curve
P ($ per kg)
Effect of a 25¢ increase in the price of hogs
S2
S1
3.30
0
176
205
220 Q (Mil. kg of pork per year)
Managerial Economics, Lecture 2: Demand and Supply
General Supply Function
Q = S(P, Ph)
Q = the quantity of processed pork
supplied (million kg per year)
P = price of processed pork ($ per kg)
Ph = price of a hog ($ per kg)
Managerial Economics, Lecture 2: Demand and Supply
Supply Curves and Market Outcomes
Supply curves, like demand curves are
hypothetical.
We cannot determine what the price will
be without combining supply and demand.
Managerial Economics, Lecture 2: Demand and Supply
Summing Demand Curves
Market demand curve:
equals horizontal summation of
individual demand curves
shows total quantity demanded by all
demanders at each possible price
Managerial Economics, Lecture 2: Demand and Supply
Application: Aggregating the Demand for Cling Peaches
P($ per ton)
275
183
Total demand
Demand for canned peaches
Demand for fruit cocktail
0
Qf = 4
Q c = 18 Q = 22
50
Q (Tons of peaches per 10,000 people per year)
Managerial Economics, Lecture 2: Demand and Supply
Summing Supply Curves
Market supply curve:
equals horizontal summation of
individual supply curves
shows total quantity produced by all
suppliers at each possible price
Managerial Economics, Lecture 2: Demand and Supply
Total Supply: The Sum of Domestic and Foreign Supply
(a) Japanese Domestic Supply
p, Price
per ton
Sd
(b) Foreign Supply
p, Price
per ton
Sf
(c) Total Supply
p, Price
per ton
p*
p*
p*
p
p
p
Qd*
Qd , Tons per year
Qf*
Qf , Tons per year
S
Q * = Qd* + Qf*
Q, Tons per year