Chapter 2 - Demand Supply and Equilibrium

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Demand, Supply and EquilibriumPrices

Chapter 2


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Why Should Managers Study

Supply and Demand?

Managers need to understand supply anddemand to develop their own competitivestrategies and to respond to the actions of theircompetitors.

Managers need to understand how thestructure of the market that their firm operatesin impacts supply and demand.

Managers need to understand how publicpolicy will impact supply and demand.

Copyright 2010 Pearson Education, Inc.Publishing as Prentice Hall


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Demand

The functionalrelationship betweenthe price of a good orservice and thequantity demandedby consumers in a

given period of time,all else heldconstant.

0

1

2

3

4

5

6

7

0 5 10 15

Quantity

Price



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Nonprice Factors Influencing

Demand

Tastes and preferences

Income Prices of goods related in consumption

Future expectations

Number of potential consumers



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Tastes and Preferences

Tastes and preferences are how potential

consumers feel about a good or service andhow well a good or service meets aconsumers desire.



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Tastes and Preferences in Action

In the aftermath of the September 11, 2001,terrorist attacks on New York and Washington,D.C., the tastes and preferences of U.S.consumers for airline travel changeddramatically.

In spring, 2006, the National Chicken Councilwaged a campaign to prevent fears of theavian flu in Asia from impacting the demand forchicken in the United States.



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Income

The level of a persons income also affects demand,

because demand incorporates both willingness and

ability to pay for the good.

If an increase (decrease) in income causes a person tobuy more (less) steak, then for that person, steak issaid to be a normalgood.

If an increase (decrease) in income causes a person tobuy less (more) hamburger, then for that person,hamburger is said to be an inferiorgood.



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Income in Action

Firms selling normal goods, like, jewelry,

automobiles and clothing experience increasesin sales when the general economy isbooming, like, in the late 1990s.

Firms selling inferior goods, like, hamburger,

used clothing and generic bleach experienceincreases in sales when the general economyis in recession, like, in the second half of 2008.



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Prices of Related Goods

Prices of related goods will also affect the

demand for a good or service. Products or services are substitute goodsfor

each other ifone can be used in place ofanother.

Complementary goodsare products orservices thatconsumers use together.



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Prices of Related Goods in Action

By 2006 the abundance and relatively low prices of cellphones, iPods, and laptop computers resulted in many

teens and young adults no longer purchasingwristwatches. These all serve as substitutesforwatches.

As prices of personal computers have dropped over

time, there has been an increased demand for printersand printer cartridges. Personal computers andprinters are complementaryproducts.



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Future Expectations

Expectations about future prices also play a

role in influencing current demand for aproduct.



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Future Expectations in Action

In summer, 2004, many consumers responded

to high lumber prices by waiting to purchaseuntil fall when a normal seasonal decline wasexpected to occur. One developer in Marylandbought only as much wood as he needed

week-by-week because the high summerprices had increased the cost of wood for atypical apartment by 50 percent.



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Number of Potential Consumers

The number of consumers in the marketplace

influences the demand for a product.



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Number of Potential Consumers in

Action

The effect of growing populations on demand

and grain prices can be seen as both increasesin the size of the population in Asian and LatinAmerican economies and growth in themiddleclass segments of these economies had

a stimulating effect on the demand for manytypes of grain from US farmers.



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Expressing Demand Functions

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2

3

4

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0 5 10 15

Quantity

Price

Qxd = f(Px,T,I,Py,Pz,EXP,N) where

Qxd = quantity of good xdemanded

Px = price of good x T = variables representing

tastes and preferences

I = income

Py = price of related good y

Pz = price of related good z EXP = expected future prices

N = number of consumers



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Demand

Demand curves are generally portrayed as

downward sloping, suggesting an inverse ornegative relationship between the price of thegood and the quantity demanded, all elseequal.

When the price of a good rises the quantitydemanded falls, all else equal.



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Individual vs. Market Demand

Market demand is

the horizontal sum ofindividual demandcurves.

P

Q

D1 D2D1 + D2



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Demand Curve Shift vs. Movement

Along a Demand Curve

18 Copyright 2010 Pearson Education, Inc.Publishing as Prentice Hall

P

Q

D1

D2

P1

Q1 Q2

P

Q

D1

P1

Q1

P2

Q2

A

B

A B

A to B: change (increase)

in demandA to B: change (increase)

in quantity demanded


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Supply

The functional

relationship betweenthe price of a good orservice and thequantity supplied by

producers in a giventime period, all elsehelp constant. Quantity

Price



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Nonprice Factors Influencing

Supply

Technology

Input prices Prices of goods related in production

Future expectations

Number of producers



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Technology

The state of technology, or the body of

knowledge about how to combine the inputs ofproduction, affects what output producers willsupply because technology influences how thegood or service is actually produced, which, in

turn, affects the costs of production.



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Technology in Action

In the nickel industry, most of the worlds production

has come from deposits that were relatively easy to

exploit. However, these deposits comprise only about40 percent or less of the worlds remaining reserves.

During the 1990s companies tried to develop a processcalled high pressure acid leaching to remove nickel

from other rock deposits. This new technology couldfundamentally alter the supply of nickel on worldmarkets.



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Input Prices

Input prices are the prices of all the inputs or

factors of productionlabor, capital, land, andraw materialsused to produce the givenproduct. These input prices affect the costs ofproduction and, therefore, the prices at which

producers are willing to supply differentamounts of output.



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Input Prices in Action

For broiler chickens, feed costs represent 70

to 75 percent of the costs of growing a chickento a marketable size. Thus, changes in feedcosts are so important that market analystsoften use them as a proxy to forecast broiler

prices and returns to broiler processors.



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Prices of Related Goods

The prices of other goods related in production

can also affect the supply of a particular good. Two goods are substitutesin production if thesame inputs can be used to produce either of thegoods, such as land for different agricultural crops.

Two goods are complementaryin production if theproduction of one is a by-product of the productionof the other.



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Prices of Related Goods in Action

Switching from corn totobacco, a farmer in Illinois

netted $1,800 per acrefrom his 150 acres oftobacco compared with$250 per acre for corn andthat planting tobacco had

increased his annualincome by 35 percent overthe previous three years.

As more oil and naturalgas are produced, the

supply of sulfur, which isremoved from theproducts, also increases.Sixty-foot-high blocks ofunwanted sulfur were

reported in Alberta,Canada, and Kazakhstanin 2003.



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Future Expectations

If producers expect prices to increase in thefuture, they may supply less output now thanwithout those expectations. The opposite couldhappen if producers expect prices to decreasein the future.



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Number of Producers

The number of producers influences the totalsupply of a product at any given price. Thenumber of producers may increase because ofperceived profitability in a given industry orbecause of changes in laws or regulations

such as trade barriers.



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Number of Producers in Action

For example, the lumber market was reportedto be exceedingly strong in January 1999,largely due to demand from the booming U.S.housing market. However, quotas on theamount of wood that Canada could ship into

the United States also played a role in keepingthe price of lumber high in the United States inJanuary of that year.



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Supply

Supply curves are generally portrayed asupward sloping, suggesting a direct or positiverelationship between the price of the good andthe quantity supplied, all else equal.

When the price of a good rises the quantity

supplied rises, all else equal.



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Expressing Supply Curves

Quantity

Price

Qxs=f(Px,TX,Pi,Pa,Pb,EXP,N) where

Qxs = quantity of good xsupplied

Px = price of good x T = variables representing

tastes and preferences

I = income

Py = price of related good y

Pz = price of related good z EXP = expected future prices

N = number of consumers



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Supply Curve Shift vs. Movement

Along a Supply Curve

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P

Q

S1P

Q

S1S2

P1

Q1 Q2

A B

A

B

P1

P2

Q1 Q2

A to B: change (increase)

in demand

A to B: change (increase)in quantity demanded


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Market Equilibrium

The market equilibriumprice and quantity is that

price for which thequantity supplied isequal to the quantitydemanded.

Quantity

Price

PE

QE

Copyright 2010 Pearson Education,Inc. Publishing as Prentice Hall


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Surplus Disequilibrium

At prices where thequantity supplied

exceeds the quantitydemanded there exists asurplus in that market atthat price.

P

Q

P1 surplus

D

S



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Shortage Disequilibrium

At prices where thequantity demanded

exceeds the quantitysupplied there exists ashortage in that marketat that price.

P

Q

D

S

P2 shortage



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Changes in Equilibrium Demand

Induced

When nonprice demandfactors change, the

demand curve shifts andproduces a change inthe equilibrium price andquantity.

S

D1 D2 D3

Q

P

P1

P2

P3

Q1 Q2 Q1



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Changes in Equilibrium Supply

Induced

When nonpricefactors change, thesupply curve shiftsand produces achange in the

equilibrium price andquantity.

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P

Q

S1

S2S3

D1

P1

P2

P3

Q1 Q2 Q3



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Changes in Equilibrium Changes

in Demand andSupply

When nonpricefactors change, thesupply and demandcurves may both shiftand produce a

change in theequilibrium price andquantity.

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P

Q

D1

D2

S1

S2

P1

P2

Q1 Q2

C i ht 2010 P Ed ti I

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Chapter 2 - Demand Supply and Equilibrium