Economics for Managersby Paul Farnhamy

Chapter 2:Chapter 2:Demand Supply andDemand, Supply, and

Equilibrium Prices

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DemandDemand

The functional relationship between the price of a goodbetween the price of a good or service and the quantity demanded by consumers indemanded by consumers in

a given time, all else held constantconstant

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Non-Price Factors I fl i D dInfluencing Demand

1. Tastes and preferencesAffected by socioeconomic factorsAffected by socioeconomic factors such as age, sex, race, marital status, and education level,

2. IncomeTh l l f i ff tThe level of income affects demand for normal goods and inferior goods

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inferior goods

Non-Price Factors I fl i D dInfluencing Demand

3. Prices of related goodsSubstitute goods – when one goodSubstitute goods when one good can be used in the place of anotherComplementary goods – two or more p y ggoods that consumers use together

4. Future expectations5. Number of consumers

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Demand FunctionDemand Function

QXD = f (PX, T, I, PY, PZ, EXC, NC, … where

Q tit d d d f d XQXD = quantity demanded of good X

P = price of good XPX = price of good X

T = variables representing tastes andT variables representing tastes and preferences

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I = income(continued on next slide)

The Demand FunctionThe Demand Function

QXD = f (PX, T, I, PY, PZ, EXC, NC, … where

P and P = prices of goods Y and ZPY and PZ = prices of goods Y and Z, which relate to consumption of good XEXC t ti b tEXC = consumer expectations about future pricesNC b fNC = number of consumers(NOTE: Ellipsis is used to indicate many other

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( p yvariables that influence demand)

Demand CurvesDemand CurvesFigure 2.1

The demand curve shows the relationship between

AP1

relationship between price of a good and quantity demanded,A

BP1

P2

quantity demanded, all else constant

0 Q QDemand

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Quantity0 Q1 Q2

More About D d CDemand Curves

Demand shifters: variables held constant when defining a demand

b t ld hift if th i lcurve but would shift if their values changedN ti (i ) l ti hi hNegative (inverse) relationship: where an increase in one variable causes a decrease in anotherdecrease in anotherChange in quantity demanded: results when consumers react to change in

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when consumers react to change in price of a good

Increase in DemandIncrease in DemandFigure 2.2

D2A change in demand occurs when one or

D1more of the factors are held constant in d fi i i

P1

defining a given demand curve change

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Quantity0 Q1 Q2

Individual Versus M k t D d CMarket Demand Curve

Horizontal summation of individual demand curves: for every price, the y p ,quantity that each person demands at that price determines market quantity demanded at that priceThe market demand curve, DM,The market demand curve, DM, considers quantities demand at other prices

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p

Individual Versus Market D d CDemand Curve Figure 2.3

P1

DB

DM = DA + DB

DA

0 Q Q Q Q2.11© 2005 Prentice Hall, Inc. Quantity

0 Q1 Q2 Q3 Q4

Linear Demand F ti d CFunctions and Curves

Mathematical relationships with no exponents that take a value pother than 1Simplification of analysisSimplification of analysisBest representation of individuals’ behaviorbehaviorNot all demand functions are li

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linear

Demand Function as an E ti (f )Equation (for copper)

QD = 10 - 50PC + 0.3I + 1.5TC + 0.5E where

QD = quantity demanded of copper

P = price of copperPC = price of copper

I = consumer income indexTC = index showing uses for copper

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E = expectations index

Managerial Rule of Thumb: D d C id tiDemand Considerations

Managers must • Understand what influences• Understand what influences

demandDetermine which factors they can• Determine which factors they can influence D t i h t h dl f t• Determine how to handle factors they cannot influence

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SupplySupply

The functional relationship between the price of a good or service and

the quantity that producers arethe quantity that producers are willing to supply in a given time,

all else held constant.

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Non-Price Factors I fl i S lInfluencing Supply

State of technologyInput pricesInput pricesPrices of goods related in

d tiproductionFuture expectationspNumber of producersCh i t d b i

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Changes in trade barriers

The Supply FunctionThe Supply Function

QXS = f (PX, TX, PI, PA, PB, EXP, NP, … where

Q tit li d f d XQXS = quantity supplied of good X

P = price of good XPX = price of good X

TX = state of technologyTX = state of technology

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PI = prices of the inputs of production(continued on next slide)

The Supply FunctionThe Supply Function

QXS = f (PX, TX, PI, PA, PB, EXP, NP, … where

P P = price of goods A and B relatedPA, PB = price of goods A and B, related to good X

EXP = producer expectations aboutEXP = producer expectations about future prices

NP = number of producersNP = number of producers

(NOTE: Ellipsis is used to indicate many other

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( p yvariables that influence supply)

Supply Curvef P d tfor a Product Figure 2.4

rice

SupplyBPr

P2

ARelationship between price

P2

P between price of a good and quantity

P1

quantity supplied

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Quantity0 Q1 Q2

Supply RelationshipsSupply Relationships

Not all supply curves are linearSupply curve does not show actualSupply curve does not show actual price of product but the relationship of alternative prices and quantitiesp qA positive relationship is shown as upward line where increase in one pvariable causes increase in another variable

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Changes (Increase)i S lin Supply Figure 2.5

S1A change in supply occurs

S2

when one or more of the factors held constant in

P1

constant in defining a given supply curve

0

supply curve change

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Quantity0 Q1 Q2

Change inQ tit S li dQuantity Supplied

A price change causes movement from one point to another

• An increase in price of a substitute good causes the supply curve to shift to the left; a decreases shifts it to theto the left; a decreases shifts it to the right

• If the price of a complementary goodIf the price of a complementary good increases, the supply increases

• An increase in the number of

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producers shifts it to the right

Managerial Rule of Thumb: S l C id tiSupply Considerations

Managers must• Examine technology and costs of• Examine technology and costs of

productionFind ways to increase productivity• Find ways to increase productivity while lowering production costs

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Demand, Supply,d E ilib iand Equilibrium

A price for a good or service is determined when the market reaches equilibriumThe quantity demanded of good XThe quantity demanded of good X equals the quantity producers are willing to supplyg pp yAn upset in equilibrium pushes the price back toward equilibrium

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the price back toward equilibrium

Market EquilibriumMarket EquilibriumFigure 2.6

Market equilibrium

Supply

PE

equilibrium occurs wheredemanddemand equals supply

Demand

Quantity0 Q

e a d

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QuantityQE = equilibrium quantityPE = equilibrium price

0 QE

Lower-Than-E ilib i P iEquilibrium Prices

Consumers demand more of a good than producers are willing to g p gsupply at that priceSupply and demand becomeSupply and demand become unstableAn adjustment process beginsAn adjustment process begins which seeks to again bring equilibrium

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equilibrium

Changes in Equilibrium P i d Q titiPrices and Quantities

Change in demandChange in supplyChange in supplyChanges on both sides of the

k tmarket

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Summary of Key TermsSummary of Key Terms

DemandFunctional relationshippNormal and inferior goodsSubstitute and complementary goodsp y gIndividual and market demand functionsDemand shiftersNegative (inverse) and positive (direct) relationships

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relationships

Summary of Key TermsSummary of Key Terms

Change in quantity demandedLinear demand and supply functionspp ySupplyInput prices and prices related in p p pproductionSupply shiftersEquilibrium priceLower-than-equilibrium price

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Do you have any Do you have any questions?questions?

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