Transcript Supply and Demand Analysis

Managerial Economics
& Business Strategy
Chapter 2
Market Forces: Demand and
Supply
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Overview
I. Market Demand
Curve



The Demand
Function
Determinants of
Demand
Consumer Surplus
III. Market
Equilibrium
IV. Price
Restrictions
V. Comparative
Statics
II. Market Supply
Curve



The Supply
Function
Supply Shifters
Producer Surplus
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Market Demand Curve
• Shows the amount of a good
that will be purchased at
alternative prices.
• Law of Demand
If the price goes down, the quantity
demanded goes up.
Price
D
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Determinants of
Demand
• Income
• Prices of
substitutes
• Prices of
complements
• Advertising
• Population
• Consumer
expectations
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
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 good Y.
M = income.
H = any other variable affecting
demand
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Change in Quantity
Demanded
Price
A to B: Increase in quantity
demanded
A
10
B
6
D0
4
7
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Change in Demand
Price
D0 to D1: Increase in
Demand
6
D1
D0
7
13
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Consumer Surplus:
• The value consumers get from a
good but do not have to pay for.
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
I got a great deal!
• That company
offers a lot of bang
for the buck!
• Gateway 2000
provides good
value.
• Total value greatly
exceeds total
amount paid.
• Consumer surplus
is large.
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
I got a lousy deal!
• That car dealer
drives a hard
bargain!
• I almost decided
not to buy it!
• They tried to
squeeze the very
last cent from me!
• Total amount paid
is close to total
value.
• Consumer surplus
is low.
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Consumer Surplus:
The Continuous Case
Price $
10
Value
of 4 units
8
Consu
mer
6
Surplu
s
4
Total Cost of 4
units
2
D
1
5
2
3
4
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Market Supply Curve
• The supply curve shows the
amount of a good that will be
produced at alternative prices.
• Law of Supply

If the price goes up, the quantity supplied
will go up.
Price
S0
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Supply Shifters
• Input prices
• Technology or
government
regulations
• Number of
firms
• Substitutes in
production
• Taxes
• Producer
expectations
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
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
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Change in Quantity
Supplied
Price
A to B: Increase in quantity supplied
S0
B
20
A
10
1
Quantity
0
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
5
1999
Change in Supply
S0 to S1: Increase in
supply
Price
S0
S1
8
6
5
7
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Producer Surplus
• The amount producers receive in excess
of the amount necessary to induce them
to produce the good.
Price
S0
P
*
Produce
r
Surplus
Q*
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
If price is too low…
Price
S
7
6
5
D
Shortage
12 - 6 = 6
6
12
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
If price is too high…
Surplu
s
14 - 6
=8
Price
9
S
8
7
D
6
8
14
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Price Restrictions
• Price Ceilings


The maximum legal price that can be
charged
Examples:
• Gasoline prices in the 1970s
• Housing in New York City
• Proposed restrictions on ATM fees
• Price Floors


The minimum legal price that can be
charged.
Examples:
• Minimum wage
• Agricultural price supports
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Impact of a Price
Ceiling
Price
S
PF
P*
Ceiling
Price
D
Shortage
Qs
Q*
Quantity
Qd
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
An Example from the
1970s
• Ceiling price of gasoline - $1
• 3 hours in line to buy 15 gallons of
gasoline
 Opportunity cost: $5/hr
 Total value of time spent in line: 3
 $5 = $15
 Non-pecuniary price per gallon:
$15/15=$1
• Full economic price of a gallon of
gasoline: $1+$1=2
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Impact of a Price Floor
Price
Surplu
s
S
P
F
P*
D
Qd
Q*
QS
Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Big Picture: Impact of
decline in component
prices on PC market
Price
of
PCs
S
S*
P0
P*
D
Q
Q*
Quantity of PC
0
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
• So, the Big Picture is:

PC prices are likely to fall, and more
computers will be sold
• Use this to organize an action
plan






contracts/suppliers?
inventories?
human resources?
marketing?
do I need quantitative estimates?
etc.
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Scenario 2: Software
Maker
• More complicated chain of
reasoning to arrive at the “Big
Picture”
• Step 1: Use analysis like that in
Scenario 1 to deduce that lower
component prices will lead to


a lower equilibrium price for computers
a greater number of computers sold.
• Step 2: How will these changes
affect the “Big Picture” in the
software market?
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999
Big Picture: Impact of
lower PC prices on the
software market
Price
of Software
S
P1
P0
D*
D
Q0 Q1
Quantity of
Software
Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. ,
1999