# PPA 723: Managerial Economics Lecture 2: Demand and Supply The Maxwell School, Syracuse University Professor John Yinger.

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• PPA 723: Managerial EconomicsLecture 2:Demand and SupplyThe Maxwell School, Syracuse UniversityProfessor John Yinger

• Managerial Economics, Lecture 2: Demand and SupplyOutlineDemandDemand CurvesMovement Along vs. Shift In Demand CurveExamples

SupplySupply CurvesMovement Along vs. Shift in Supply CurveExamples

• Managerial Economics, Lecture 2: Demand and Supply

Demand CurveA 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

Figure 2.1 A Demand Curve200220Demand curve for pork 240286Q (Million kg of pork per year)02.303.304.3014.30 P (\$ per kg)

• Managerial Economics, Lecture 2: Demand and Supply

Effect of a Price ChangesA 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 DemandDemand 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 SupplyOther Factors That Might Affect Demand Income Prices of other goods (compliments, substitutes) Preferences Number of consumers Information

• Managerial Economics, Lecture 2: Demand and SupplyBackground 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

Figure 2.2. Shift in Demand Curve220176Effect of a 60 increase in the price of beefD1D2232Q (Mil. kg of pork/ year)03.30 P (\$ per kg)

• Managerial Economics, Lecture 2: Demand and SupplyDemand 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 SupplyOther 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 SupplyDetermining 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 SupplyExample: 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 SupplyExample: 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 energyconsumption with a new conservation ethic? How would you distinguish this from a price increase?

• Managerial Economics, Lecture 2: Demand and SupplyExample: Health Care

What happens to consumption when the price goes to zero because of insurance?

What happens to consumptionof (legal) drugs as generic drugs become more available?

• Managerial Economics, Lecture 2: Demand and SupplyExample: 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 SupplyThe 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 CurveAn 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 PorkP (\$ per kg)220176Supply curve 300Q (Million kg of pork per year)03.305.30

• Managerial Economics, Lecture 2: Demand and Supply

Effect of Price on SupplySupply 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 SupplyBackground 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 CurveP (\$ per kg)205176Effect of a 25 increase in the price of hogsS1S2220Q (Mil. kg of pork per year)03.30

• 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 SupplySupply 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 CurvesMarket 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 PeachesP(\$ per ton)50Q (Tons of peaches per 10,000 people per year)0275183Total demandDemand for canned peachesDemand for fruit cocktailQc = 18Q = 22Qf = 4

• Managerial Economics, Lecture 2: Demand and Supply

Summing Supply CurvesMarket 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 Supplyp, Priceper tonp, Priceper tonp, Priceper tonQd*SdQf* Q* = Qd* + Qf*Qd, Tons per yearQf, Tons per yearQ, Tons per year(a) Japanese Domestic Supply(b) Foreign Supply(c) Total Supplyp*p*p* S Sfppp