Chapter 2 - Demand Supply and Market Equilibrium

Managerial Economics
Discussion Points.ppt
• Review on Basic Demand and Supply
• General Demand Function
• Inverse Demand Function
• Derivation of Direct Demand Function From
General Demand Function
• Comparative Statics
• Demand and Supply Applications
• Exercises
2-1
Recap
“What is ought to be”
“What is”
Chapter 4
DEMAND, SUPPLY, AND MARKET

EQUILIBRIUM
2-4
Demand refers to the quantity of goods and services that

the consumers are willing and able to get off from the
market at various prices, ceteris paribus.
Demand is the basis of all productive activities.
NEED WANT DEMAND
5
Concept of Effective Demand
Want Demand
Demand in Product/Output Markets

• Demand Curves Slope Downward
Law of demand The negative relationship between price and

quantity demanded: As price rises, quantity demanded decreases;
as price falls, quantity demanded increases.
It is reasonable to expect quantity demanded to fall when price rises, ceteris paribus, and
to expect quantity demanded to rise when price falls, ceteris paribus. Demand curves have
a negative slope.
2-7
Price and Quantity Demanded: The Law of Demand
Demand schedule A table showing how much of a given

product a household would be willing to buy at different prices.
. Demand curve A graph illustrating how much of a given

product a household would be willing to buy at different prices
2-8
• Price and Quantity Demanded: The Law of Demand

Other Properties of Demand Curves
1. They have a negative slope.
2. They intersect the quantity (X-) axis.
3. They intersect the price (Y-) axis.
The actual shape of an individual household demand curve—whether it

is steep or flat, whether it is bowed in or bowed out—depends on the
unique tastes and preferences of the household and other factors.
2-9
Graphing Demand Curves
• A point on a direct demand curve shows either:

• Maximum amount of a good that will be purchased for a
given price
• Maximum price consumers will pay for a specific amount

of the good
2-10
A Demand Curve
2-11
Important Distinctions
• Change in quantity demanded

• Occurs when price changes
• Movement along the demand curve
• Change in demand
• Occurs when one of the other variables, or determinants
of demand, changes
• Demand curve shifts rightward or leftward
2-12
Movements along the Demand Curve

Price
Price increase moves
us leftward along
demand curve
P2 Price decrease moves

us rightward along
demand curve
P1
P3
Q2 Q1 Q3 Quantity
Change in Demand
If any of the other determinants of demand (income, price of other goods,

tastes, and so on) changes, then the whole demand curve will shift.
Sources of Change
 Tastes and preferences (dangers of cholesterol…think of advertising,
promotions, etc )
 Income ( as incomes rise.. demand tend to rise)
 Price of related products (for complementary…demand for software if price
of computer hardware falls; for substitutes…demand for banana if price of
oranges fall)
 Future expectations if (buyers expect price of good to rise in the future
current demand will increase)
 Changes in legal rules (Congress passes a law allowing guns to be
carried freely)
A Shift of The Demand Curve

Price
per An increase in income
Bottle shifts the demand curve
for the good from D1 to
D 2.
At each price, more
goods are demanded
after the shift
Php2.00 B C
D1 D2
60,000 80,000 Number of Bottles
per Month

• Six variables that influence Qd
• Price of good or service (P)
• Incomes of consumers (M)
• Prices of related goods & services (PR)
• Taste patterns of consumers (  )
• Expected future price of product (Pe)
• Number of consumers in market (N)
• General demand function
• Qd  f ( P, M , PR , , Pe , N )
2-18

Qd  a  bP  cM  dPR  e   fPe  gN
• b, c, d, e, f, and g are slope parameters
• Measure effect on Qd of changing one of the variables
while holding the others constant
• Sign of parameter shows how variable is related to Qd
• Positive sign indicates direct relationship
• Negative sign indicates inverse relationship
2-19

Variable Relation to Qd Sign of Slope Parameter
P Inverse b = Qd/P is negative

Direct for normal goods c = Qd/M is positive
M
c = Qd/M
Inverse for inferior goods is negative
PR Direct for substitutes d = Qd/PR is positive

Inverse for complements d = Q /P is negative
d R
 Direct e = Qd/  is positive
Pe Direct f = Qd/Pe is positive
N Direct g = Qd/N is positive

2-20
Direct Demand Function

• The direct demand function, or simply demand, shows
how quantity demanded, Qd , is related to product price,
P, when all other variables are held constant
• Qd = f(P)
• Law of Demand
• Qd increases when P falls and Qd decreases when P rises, all
else constant
 Qd/P must be negative
2-21
Inverse Demand Function
• Traditionally, price (P) is plotted on the vertical

axis and quantity demanded (Qd) is plotted on
the horizontal axis
• The equation plotted is the inverse demand

function, P = f(Qd)
2-22
• Given: 1. Qd = 100 – ½ P
• 2. Qd = 500 – 10P
• 3. Qd = 30 – 1.5P
• The inverse demand function is:
• 1.
• 2.
• 3.
2-23
Derivation of Direct Demand Function

• Qd = f(P,X1, ……Xn) …… (1)
• Where Qd= Quantity demanded, P= Price, X’s other factors
• Let us use Pizza as Q,

• Qp = - 100P + 1.5Phd – 5Psd + 20A +15Pop … (2)
• Where: Qd = Quantity demanded for pizza (pies)

• Phd = Price of hot dogs (cents)
• Psd = Price of soft drinks (cents)
• A = Advertising expenditures (thousand of dollars)
• Pop = % of pop. (ages 10-35)
2-24
Phd =Price of hot dogs = 100

Psd = Price of soft drinks =75
A = Advertising expenditures (thousand of pesos) = 20(PhP20,000)
Pop = % of pop. (ages 10-35)= 35 (35%)
Qd = - 100P + 1.5(100) – 5(75) + 20(20) + 15(35) ….. (3)

Qd = 700 – 100P
Graph the D-curve…

Supply
• Quantity supplied (Qs)

• Amount of a good or service offered for sale during a
given period of time at various prices, ceteris paribus
• The direct supply function, or simply supply, shows

how quantity supplied, Qs , is related to product price,
P, when all other variables are held constant
• Qs = f(P)
2-26
Define:
• Law of supply
• Supply function
• Supply schedule
• Supply curve
• Change in quantity supplied
• Change in supply
2-27
A Supply Curve (Figure 2.3)
2-28
Graphing Supply Curve
• A point on a direct supply curve shows either:

• Maximum amount of a good that will be offered for sale
at a given price
• Minimum price necessary to induce producers to
voluntarily offer a particular quantity for sale
2-29
Graphing Supply Curves
• Change in quantity supplied

• Occurs when price changes
• Movement along the supply curve
• Change in supply
• Occurs when one of the other variables, or determinants
of supply, changes
• Supply curve shifts rightward or leftward
2-30
Movements along versus Shifts of a Supply Curve
S0
S1
c
Price per XBox
$400
f
310
S0
S1
Quantity Supplied
in Billions of XBox per Year
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Market Supply
Supply Curves for Pizza

P ($)
S3 S1 S2
7
The supply curve has a
6
positive slope, reflecting
5
Decrease the direct relationship
4 Increase
between price and
3
quantity supplied. WHY?
2
1
0
100 200 300 400 500 600 700 Q
Changes in price result in changes in the quantity supplied (movements along the supply
curve).
Changes in non-price determinants result in changes in the supply (shifts of the supply curve.)
Supply
• Six variables that influence Qs
• Price of good or service (P)
• Input prices (PI )
• Prices of goods related in production (Pr)
• Technological advances (T)
• Expected future price of product (Pe)
• Number of firms producing product (F)
• Weather (W)
• General supply function
• Qs = f (P, Pi, Pr, T, Pe, F, W)
•
2-34
Factors Affecting Supply

• Price of good or service (P) – The higher the price of the product, the greater
the quantity supplied by firms.
• Input prices (PI ) – Increase in the price of inputs will increase production cost.
This will bring about less quantity supplied.
• Prices of goods related in production (Pr) – This will affect producers in two
ways: (a) substitutes – If “A” and “B” are substitutes in production, example if
price of corn (A) increases and price of wheat (B) remains the same, farmers
may shift to corn production resulting in less wheat production; (b)
• complements - If “A” and “B” are complements, meaning increase in the price
of A causes the production of B to increase – ex: bacon and pork chops.
General Supply Function

Qs  h  kP  lPI  mPr  nT  rPe  sF
• k, l, m, n, r, and s are slope parameters
• Measure effect on Qs of changing one of the variables while
holding the others constant
• Sign of parameter shows how variable is related to Qs
• Positive sign indicates direct relationship
• Negative sign indicates inverse relationship
2-37
General Supply Function

Variable Relation to Qs Sign of Slope Parameter
P Direct k = Qs/P is positive
PI Inverse l = Qs/PI is negative
Inverse for substitutes m = Qs/Pr is negative

Pr Direct for complements m = Qs/Pr is positive
T Direct n = Qs/T is positive
Pe Inverse r = Qs/Pe is negative
F Direct s = Qs/F is positive

2-38
Inverse Supply Function
• Traditionally, price (P) is plotted on the vertical axis

and quantity supplied (Qs) is plotted on the
horizontal axis
• The equation plotted is the inverse supply function, P =

f(Qs)
2-40
Derivation of supply function from general
supply function
Qs  f ( P, PI , Pr , T , Pe , F )  f ( P ).................(1)
To illustrate, assume that general supply function is

Qs  100  20 P  10 PI  20 F ..........................(2)
Other determinants in equation (1) are omitted.

Suppose price of important input is 100, and 25 firms are in the
industry. Supply function will be:
Qs  100  20 P  10(100)  20(25).................(3)
= - 400 + 20P
• Graph the supply curve
2-42
What is supply price?

 The minimum price necessary to induce producers to offer a
given quantity for sale.
 A change in quantity supplied can be caused only by PRICE.
 From the supply curve shown, price increase from 40 to 60,

will increase quantity supplied from 400 to 800 units – this is a
movement along the same supply curve.
Shifts in Supply
 Occurs only when one of the determinants of supply

changes value.
 Assume that the price of input falls to $60 (plug in this

value into equation 3 and obtain new supply function,
Qs =
Verify that decrease in price causes supply curve to shift to
the right. Why?.
• Again, assume that price of input remains at

$100, but the number of firms decreases to 10
firms (plug in this value into equation 3 and
obtain new supply,
• Qs =
• Verify that decrease in the number of firms
causes the new supply curve to shift to the left.
2-45
Market Equilibrium
• Equilibrium price and quantity are determined

by the intersection of demand and supply
curves
• At the point of intersection, Qd = Qs
• Consumers can purchase all they want and
producers can sell all they want at the “market-
clearing” or price
2-46
Market Equilibrium
Supply and Demand for Pizza

P QD QS
Php7.00 0 600
6.00 100 500
5.00 200 400
4.00 300 300
3.00 400 200
2.00 500 100
1.00 600 0
0 700 0
• This
table shows that at the price of Php 4.00, the market is cleared in the sense that the
quantity demanded (300) is equal to the quantity supplied (300).
Thus, Php 4.00 is called the equilibrium price, and 300 is referred to as the equilibrium
quantity.
The Market Mechanism

Price
(Php per unit) S
D & S curves intersect at

equilibrium, or market-
clearing, price. For instance@ P0 the
Qs is equal
P0 To Qd at Q0 .
Q0 Quantity

Price
S
(Php per unit)
Surplus
P1
At P1 :
1) Qs = Q2;Q1 Qd : Q1
2) Excess supply is Q1:Q2.
P2 3) Producers lower price.
4) Quantity supplied decreases
and quantity demanded
increases.
5) Equilibrium at P2Q3
Q1 Q3 Q2 Quantity

Price
(Php per unit) S
At P2 :
1) Qd : Q2 ; Qs : Q1
2) Shortage is Q1:Q2.
P3 3) Producers increase price.
4) Quantity supplied increases
and quantity demanded
decreases.
P2 5) Equilibrium at P3 Q3
Shortage
D
Q1 Q3 Q2 Quantity
1. If the demand and supply curve for computers is:

•D = 100 - 6P, S = 28 + 3P
•Where P is the price of computers, what is the quantity of computers
bought and sold at equilibrium?
2. Qs = 200 + 20P
•Qd = 500 – 10P
a)Interpret the equations
b)Determine the equilibrium P and Q
2-54
Comparative Statics
• An increase in
demand causes
equilibrium
price and
quantity to rise.
Comparative Statics
• An increase in
supply causes
equilibrium
price to fall and
equilibrium
quantity to rise.
Comparative Statics
• A decrease in
supply causes
equilibrium price
to rise and
equilibrium
quantity to fall.
Demand Shifts (Supply Constant)
2-58
Supply Shifts (Demand Constant)
2-59
Changes in Demand and Supply

• When both demand and supply increase
• Change in price is indeterminate
• Quantity will increase
• When both demand and supply decrease

• Change in price is indeterminate
• Quantity will decrease
60
Simultaneous Shifts
• When demand and supply shift simultaneously

• Can predict either the direction in which price changes
or the direction in which quantity changes, but not both
• The change in equilibrium price or quantity is said to
be indeterminate when the direction of change
depends on the relative magnitudes by which demand
& supply shift
2-61
Changes in Demand and Supply

• When supply decreases and demand increases
• Price will increase
• Change in quantity is indeterminate
• When supply increases and demand decreases
• Price will decrease
• Change in quantity is indeterminate
62
Simultaneous Shifts: (D, S)

P
S
S’
S’’
B
P A •
’
P •
P’’ •C
D’
Q
Q Q’ Q’’
Price may rise or fall; Quantity rises

2-63
Simultaneous Shifts: (D, S)

P
S
S’
S’’
A
P •
B
P
’
•
P’’ •C D
D’
Q
Q’ Q Q’’
Price falls; Quantity may rise or fall

2-64
Simultaneous Shifts: (D, S)

P
S’’
S’
S
P’’ • C
B
P
’
•
A
P •
D’
Q
Q’’ Q Q’
Price rises; Quantity may rise or fall

2-65
Simultaneous Shifts: (D, S)

P
S’’
S’
S
P’’ •C A
P •
P • B
’
D
D’
Q
Q’’ Q’ Q
Price may rise or fall; Quantity falls

2-66
Question: Why Gasoline Prices Have Increased?
2-67
Example: Why Gasoline Prices
Have Increased
• One factor—an increase in demand, shown by a
rightward shift in the demand curve
• Another factor—a reduction in supply, shown
by a leftward shift in the supply curve
• As a result, the market clearing price of
gasoline increased.
68
The Effects of a Simultaneous Decrease in Gasoline
Supply and Increase in Gasoline Demand
69
The Policy of Government-Imposed Price
Controls - Ceiling and Floor Prices
• Price Controls
• Government-mandated minimum or maximum prices
• Ceiling price
• Maximum price government permits sellers to charge for a
good; legal maximum price
• When ceiling price is below equilibrium, a shortage occurs
• Floor price
• Minimum price government permits sellers to charge for a
good
• When floor price is above equilibrium, a surplus occurs
2-70
Ceiling and Floor Prices
Px Px
Sx Sx
Price (dollars)
Price (dollars)
3
2 2
1
Dx Dx
Qx Qx
22 50 62 32 50 84
Quantity Quantity
Panel A – Ceiling price Panel B – Floor price

2-71
Agricultural Price Support
Support Price
 The governmentally
established price floor
 Associated with agricultural
products
72
The Effect of Minimum Wages

Minimum Wage
A wage floor, legislated by
the government, setting the
lowest hourly wage rate
that firms may legally pay
their workers
73
Who Benefits and Who Is
Hurt by Minimum Wage
• Everybody who would be making PhP500/day but is now

getting PhP600/hour benefits from minimum wage.
• Everybody who would have been employed at PhP500/day but
is now unemployed at PhP600/hour is hurt.
• Consumers who could have purchased the good or service
produced at a lower price but cannot because of the higher
cost of making the good or service are hurt.
• Most economists generally believe efficiency is a good thing
and distorting the price mechanism that gives us this
efficiency does more harm than good.
Value of Market Exchange

• Typically, consumers value the goods they
purchase by an amount that exceeds the
purchase price of the goods
• Economic value
• Maximum amount any buyer in the market is willing to
pay for the unit, which is measured by the demand
price for the unit of the good
2-75
Measuring the Value of Market
Exchange
• Consumer surplus
• Difference between the economic value of a good (its demand
price) and the market price the consumer must pay
• Producer surplus
• For each unit supplied, difference between market price and
the minimum price producers would accept to supply the unit
(its supply price)
• Social surplus
• Sum of consumer and producer surplus
• Area below demand and above supply over the relevant range
of output
2-76
Measuring the Value of Market
Exchange (Figure 2.6)
2-77
END OF PRESENTATION
Thank
you!
2-78

Chapter 2 - Demand Supply and Market Equilibrium

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Managerial Economics

“What is ought to be”

DEMAND, SUPPLY, AND MARKET

Demand refers to the quantity of goods and services that

Demand is the basis of all productive activities.

NEED WANT DEMAND

Concept of Effective Demand

Demand in Product/Output Markets

Law of demand The negative relationship between price and

Demand in Product/Output Markets

Price and Quantity Demanded: The Law of Demand

Demand schedule A table showing how much of a given

. Demand curve A graph illustrating how much of a given

• Price and Quantity Demanded: The Law of Demand

1. They have a negative slope.

2. They intersect the quantity (X-) axis.

3. They intersect the price (Y-) axis.

The actual shape of an individual household demand curve—whether it

Graphing Demand Curves

• A point on a direct demand curve shows either:

• Maximum price consumers will pay for a specific amount

• Change in quantity demanded

Movements along the Demand Curve

P2 Price decrease moves

If any of the other determinants of demand (income, price of other goods,

A Shift of The Demand Curve

General Demand Function

General Demand Function

General Demand Function

P Inverse b = Qd/P is negative

PR Direct for substitutes d = Qd/PR is positive

 Direct e = Qd/  is positive

Pe Direct f = Qd/Pe is positive

N Direct g = Qd/N is positive

Direct Demand Function

Inverse Demand Function

• Traditionally, price (P) is plotted on the vertical

• The equation plotted is the inverse demand

Derivation of Direct Demand Function

• Where Qd= Quantity demanded, P= Price, X’s other factors

• Let us use Pizza as Q,

• Where: Qd = Quantity demanded for pizza (pies)

Phd =Price of hot dogs = 100

Qd = - 100P + 1.5(100) – 5(75) + 20(20) + 15(35) ….. (3)

Graph the D-curve…

• Quantity supplied (Qs)

• The direct supply function, or simply supply, shows

A Supply Curve (Figure 2.3)

Graphing Supply Curve

• A point on a direct supply curve shows either:

Graphing Supply Curves

• Change in quantity supplied

Movements along versus Shifts of a Supply Curve

Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Supply Curves for Pizza

Factors Affecting Supply

General Supply Function

General Supply Function

P Direct k = Qs/P is positive

PI Inverse l = Qs/PI is negative

Inverse for substitutes m = Qs/Pr is negative

T Direct n = Qs/T is positive