PPA 723: Managerial Economics Lecture 3: Market Equilibrium

PPA 723: Managerial Economics

Lecture 3:

Market Equilibrium

Managerial Economics, Lecture 3: Market Equilibrium

Outline

Review Supply and Demand

Market Equilibrium

Applications


Demand Curves Demand Curve: relationship between quantity

demanded and price, other factors fixed

Law of Demand: demand curves slope down

Change in price causes movement along the demand curve

Change in income or other background factor causes shift of demand curve

A demand curve is hypothetical


Supply Curves Supply Curve: relationship between quantity

supplied and price, other factors constant

Market supply curve need not slope up but frequently does

Change in price causes movement along the supply curve

Change in input price or other background factor causes shift of the supply curve

Supply curve is hypothetical


Market EquilibriumThe intersection of demand and

supply curves determines market equilibrium price and quantity.

An equilibrium is a situation, perhaps temporary, in which nobody has an incentive to change behavior.


Figure 2.6 Market Equilibrium

220176

D

S

e

233 246194 207

Q (Million kg of pork per year)0

3.95

3.30

2.65

Excess supply = 39

Excess demand = 39

P (

$ p

er

kg)


Reaching Equilibrium

When P > P *, there is a surplus, inventories build up, suppliers get the message and lower price

When P < P *, there are shortages, every store sells out by noon, suppliers get the message and raise price.

A market sends signals and people respond to them; it’s not just because the curves cross!


Shocking the Equilibrium

Once an equilibrium is achieved, it may persist indefinitely because no one applies pressure to change the price

An equilibrium changes if The demand curve shiftsThe supply curve shiftsThe government intervenes


Figure 2.7a Effects of a Shift of the Pork Demand Curve

D 1

D2

S

1760 220 228 232Q (Mil. kg of pork/year)

Excess demand = 12

3.303.50

e2

e1

P ($ per kg)

Effect of a $0.60 Increase in the Price of Beef


Figure 2.7b Effects of a Shift of the Pork Demand Curve

S1

S2

Q (Mil. kg of pork/year)

3.303.55

e1

e2

D

P ($ per kg)

Effect of $0.25 Increase in the Price of Hogs

1760 220205 215

Excess demand = 15


Direction and Magnitude

Theory alone often gives the direction of an effect: Does a given change lead to an increase in price?

Sometimes this is enough.

But sometimes the magnitude of the effect also matters: Is the effect large enough to be significant?

Calculating the magnitude generally requires more information.


Limits of Supply and Demand Model

Supply and demand model directly applies only in competitive markets

Competitive markets: homogeneous goods, many buyers and sellers (price takers)


Applications of Supply and Demand Model

Supply and demand model can help to understand:

• Price ceilings• Price floors


Price CeilingP, price

Qs Q Qd

D

S

Q, Quantity per year

Excess demand

pe

p* Price ceiling


Usury Law’s Effect on Interest Ratei, Interest rate per $

Qs Q Qd

Usury law

D

S

Q, Money loaned per year

Excess demand

ie

i*


Minimum Wagew, wage

HsH H d

Minimum wage

D

S

H, Hours worked

Excess supply: Unemployment

we

w*


Supply Need not Equal Demand Price ceilings or price floors quantity

supplied does not necessarily equal quantity demanded

Quantity supplied = amount firms want to sell at a given price, holding constant other factors that affect supply

Quantity demanded = amount consumers want to buy at a given price, holding constant other factors


Summing Demand and Supply Curves

Market curves equal horizontal summation of individual curves

They show total quantity demanded or supplied at each possible price


Total Supply with and without a Ban on Imports

p, Priceper ton

p, Priceper ton

p, Priceper ton

Qd*

Sd S f (ban)

Qf* Q = Qd

* Q* = Qd* + Qf

*

Qd, Tons per year Qf, Tons per year Q, Tons per year

(a) Japanese Domestic Supply (b) Foreign Supply (c) Total Supply

p * p* p *

S (ban) S (no ban)S f (no ban)

p p p


Figure 2.8 A Ban on Rice Imports Raises The Price in Japan

Q2 Q1

S (no ban)

D

Q, Tons of rice per year

p2 e2

e1p1

S (ban)–

p, P

rice

of r

ice

per

po

und


p, Priceper ton

p, Priceper ton

p, Priceper ton

S d

Q, Tons per year

(a) U.S. Domestic Supply (b) Foreign Supply (c) Total Supply

p* p* p*

p p p

S

S

Qd Qf

Qd, Tons per year Qf , Tons per year

Qd* Qf*

Sf

Sf

Qd* + Qf*Qd* + QfQd + Qf

Total Supply with an Quota on Imports


Page 34 Solved Problem 2.3

Q2Q 3

Dh (high)

Q1

S (no quota)

Q (Tons of steel per year)

p2

p3 e2

e3

e1p1

S (quota)–

p–

D l (low)

p (

Pri

ce o

f s

tee

l per

to

n)

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PPA 723: Managerial Economics Lecture 3: Market Equilibrium