Chapter 02

Managerial Economics Thomas
ninth edition Maurice
Demand, Supply, &

Market Equilibrium
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Managerial Economics, 9e
Managerial Economics, 9e Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
Managerial Economics
Demand
• Quantity demanded (Qd)
• Amount of a good or service
consumers are willing & able to
purchase during a given period of time
2-2
General Demand Function

• 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 )
2-3

Qd  a  bP  cM  dPR  e   fPe  gN
• b, c, d, e, f, & 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
2-4

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

2-5
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 & Qd decreases when
P rises, all else constant
 Qd/P must be negative
2-6
Inverse Demand Function

• Traditionally, price (P) is plotted on
the vertical axis & quantity
demanded (Qd) is plotted on the
horizontal axis
• The equation plotted is the inverse
demand function, P = f(Qd)
2-7
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
2-8
A Demand Curve (Figure 2.1)
2-9
Graphing Demand Curves

• Change in quantity demanded
• Occurs when price changes
• Movement along demand curve
• Change in demand
• Occurs when one of the other
variables, or determinants of demand,
changes
• Demand curve shifts rightward or
leftward
2-10
Shifts in Demand (Figure 2.2)
2-11
Supply
• Quantity supplied (Qs)
• Amount of a good or service offered
for sale during a given period of time
2-12
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)
• General supply function
•
Qs  f ( P, PI , Pr , T , Pe , F )
2-13
General Supply Function

Qs  h  kP  lPI  mPr  nT  rPe  sF
• k, l, m, n, r, & 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
2-14
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

2-15
Direct Supply Function

• 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)
2-16
Inverse Supply Function

• Traditionally, price (P) is plotted on
the vertical axis & quantity
supplied (Qs) is plotted on the
horizontal axis
• The equation plotted is the inverse
supply function, P = f(Qs)
2-17
Graphing Supply Curves

• 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
2-18
A Supply Curve (Figure 2.3)
2-19
Graphing Supply Curves

• Change in quantity supplied
• Occurs when price changes
• Movement along supply curve
• Change in supply
• Occurs when one of the other
variables, or determinants of supply,
changes
• Supply curve shifts rightward or
leftward
2-20
Shifts in Supply (Figure 2.4)
2-21
Illustration of Derivation of Demand Function
Qd = 1,800 – 20P + 0.6M – 50PR

To derive the demand function Qd =f(P)
Suppose income is 20,000
Price of related good is 250
To find the demand function the fixed values of M and
PR are substituted in the generalized demand
function.
Qd = 1,800-20P+0.6(20,000)-50(250)
= 1,800-20P+12,000-12,500
Qd = 1,300 – 20P Direct Demand Function
Inverse Demand 20P = 1,300-Qd
P = 65 – 1 Qd
20
2-22
Illustration of Derivation of Demand Function
Qd = 1,300 – 20P PRICE QTY

DEMANDED
If P = 50 ; Qd = 300
65 0
If P = 40 ; Qd = 500
60 100
The inverse demand 50 300
Function is 40 500
P = 65 - 1/20Qd
30 700
20 900
10 1,100
2-23
P-P1 P2-P1
Q-Q1 = Q2-Q1
P-50/Q-300 = 40-50/500-300
P-50/Q-300 = -10/200
-10(Q-300) = 200(P-50)
-10Q+3,000 = 200P-10,000
-10Q=200P-10,000-3,000
-10Q=200P-13,000
Q=-20P+1,300
Q=1,300-20P
20P=1,300-Q
P=65-(1/20)Q P=65-.05Q
2-24
A Demand Schedule (or table) shows

a list several prices and the quantity
demanded per period of time at each
of the prices (holding all variables
constant)
A Demand Curve is the graphical
demand function. It shows the
relationship between price and
quantity demanded.
2-25
Demand Curve
2-26
Illustration of Derivation of Supply Function
Qs = 50 + 10P -8PI + 5F
Suppose the price of input is 50
Suppose there are 90 firms in the
industry producing the product
Substituting the values in the
generalized supply function
Qs = 50+10P-8(50)+5(90)
Qs = 50+10P-400+450
Qs = 100 + 10P
2-27
Illustration of Derivation of Supply Function
Qs = 100 + 10P PRICE QTY

DEMANDED
If P = 20 ; Qs = 300
65 750
If P = 50 ; Qs = 600
60 700
The inverse Supply 50 600
Function is 40 500
P = -10 + 1/10Qd
30 400
20 300
10 200
2-28
Supply Curve
2-29
Market Equilibrium
• Equilibrium price & quantity are
determined by the intersection of
demand & supply curves
• At the point of intersection, Qd = Qs
• Consumers can purchase the desired
amount & producers can sell all their
produce at the “market-clearing” or
price
2-30
Market Equilibrium (Figure 2.5)
2-31
Demand and Supply Schedule

PRICE QTY DEMANDED QTY SUPPIED
65 0 750
60 100 700
50 300 600
40 500 500
30 700 400
20 900 300
10 1,100 200
2-32
Graphical Equilibrium
2-33
Illustration of Market Equilibrium

Qd = 1,300 – 20P
Qs = 100 + 10P
Equate Demand and Supply Function
1,300 – 20P = 100 + 10P
1,300 -100 = 10P+20P
1,200 = 30P
1,200/30 = 30P/30
40 = P
P = 40
At the market clearing price of 40
Qd = 1,300 – (20x40) = 500
Qs = 100 + (10x40) = 500
2-34
Market Equilibrium
• Excess demand (shortage)
• Exists when quantity demanded
exceeds quantity supplied
• Excess supply (surplus)
• Exists when quantity supplied exceeds
quantity demanded
2-35
Excess Demand or Excess Supply
If Price = 50
Qd = 1,300 – (20x50) = 300
Qs = 100 + (10 x 50) = 600
Qs – Qd = 600 – 300 = 300
2-36
Suppose the generalized demand function for good X is

Qd=60-2Px+0.01M+7Pr
a.Suppose M=40,000 and Pr=20 what is the direct demand
function
b.Suppose the supply function is Qs=-600+10Px, what are the
equilibrium price and quantity?
c.What happens to equilibrium price and quantity if other
things remain the same as in part (b) but income increases to
52,000?
d.What happens to equilibrium price and quantity if other
things remain the same as in part (b) but the price of the
related good decrease to 14?
e.What happens to equilibrium price and quantity if other thing
remain the same, income and price of related goods are at their
original levels and supply shifts to Qs=-360+10Px?
2-37
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
2-38
Measuring the Value of Market
Exchange
• Consumer surplus
• Difference between the economic value of a
good (its demand price) & the market price
the consumer must pay
• Producer surplus
• For each unit supplied, difference between
market price & the minimum price producers
would accept to supply the unit (its supply
price)
• Social surplus
• Sum of consumer & producer surplus
• Area below demand & above supply over the
relevant range of output
2-39
Measuring the Value of Market
Exchange (Figure 2.6)
2-40
Changes in Market Equilibrium
• Qualitative forecast
• Predicts only the direction in which an
economic variable will move
• Quantitative forecast
• Predicts both the direction and the
magnitude of the change in an
economic variable
2-41
Demand Shifts (Supply Constant)
(Figure 2.7)
2-42
Supply Shifts (Demand Constant)
(Figure 2.8)
2-43
Simultaneous Shifts
• When demand & 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
2-44
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

2-45
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

2-46
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

2-47
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

2-48
Ceiling & Floor Prices

• Ceiling price
• Maximum price government permits
sellers to charge for a good
• 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
2-49
Ceiling & Floor Prices (Figure 2.12)
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

2-50
• The Research Department of the Corn Flakes Corporation

(CFC) estimated the following regression for the demand of
the corn flakes it sells: Qx = 1.0 – 2.0Px + 1.5I + 0.8 Py –
3.0Pm + 1.0A with R2 = 0.78 where : Qx = sales of CFC corn
flakes in millions of boxes per year, Px = price of CFC corn
flakes in dollars, I = personal disposable income , Py =
price of competitive brand, Pm = price of milk, A =
advertising expenditures.
a. Derive the direct demand function if this year, I = $4 , Py =
$2.50 , Pm = $1 and A = $2.
b. Discuss how and to what extent each of factors affect
demand for cornflakes.
c. what is the expected sales of corn flakes if the price is set
at $2
2-51
1. Derive the direct demand function

if this year, I = $4 , Py = $2.50 , Pm
= $1 and A = $2.
Qx = 1.0 – 2.0Px + 1.5I + 0.8 Py –
3.0Pm + 1.0A
Qx = 1.0 – 2.0Px+ 1.5(4) + 0.8 (2.5) – 3.0
(1) + 1.0(2)
Qx = 1.0-2.0Px+6+2-3+2
Qx = 8-2Px
2-52
3. what is the expected sales of

corn flakes if the price is set at $2
Qx = 8-2Px
Qx = 8-2(2)
Qx = 8-4
Qx = 4M boxes
2-53
Example:
Use the graph below to answer the following
•What is the equilibrium price and quantity?
•What is the effect of a price ceiling of 40?
•What is the effect of a price floor of 70?
Pe = 60
Qe = 400
If Pc = 40
Qd = 600
Qs = 200
Excess demand =
400
If Pf=70
Qd = 300
Qs = 500
Excess Supply =
200
2-54
Example 1
The generalized demand function for good A is Qd= 600-4PA – 0.03M
– 12PB+15T+6Pe +1.5N where:
Qd = quantity demanded each month
PA = price of good A
M = average household income
PB = price of related good good B
T = a consumer taste index ranging from 0 to 10
Pe = price consumers expect to pay next month
N = number of buyers in the market next month
a.Interpret the intercept parameter in the generalized demand function
b.Given the value of the slope parameter of the price for good A? Does it have
the correct algebraic sign? Why?
c.Interpret the slope parameter for income. Is good A normal or inferior? Why?
d.Are goods A and B substitutes or complements? Explain. Explain the slope
parameter for the price of good B.
e.Calculate the quantity demanded for good A when PA= $5 , M=$25,000 , PB=
$40 , T=6.5 , Pe = $5.25 and N = 2,000
2-55
Example 1
The generalized demand function for good A
is Qd= 600-4PA – 0.03M – 12PB+15T+6Pe +1.5N
Calculate the quantity demanded for good A
when PA= $5 , M=$25,000 , PB= $40 , T=6.5 ,
Pe = $5.25 and N = 2,000
Qd = 600-4(5)-0.03(25,000)-
12(40)+15(6.5)+6(5.25)+1.5(2,000)
Qd = 600-20-750-480+97.5+31.5+ 3,000
Qd = 2,479
2-56
Example 2
Suppose that the demand and supply functions for good
X are
Qd = 50 – 8P
Qs = -17.5 + 10P
a.What are the equilibrium price and quantity?
b.What is the market outcome if price is $2.75? What do
you expect to happen? Why?
c.What is the market outcome if price is $2.25? What do
you expect to happen? Why?
d.What happens to equilibrium price and quantity if the
demand function becomes Qd= 59-8P?
2-57
Demand & Supply Schedule

PRICE QTY SUPPLIED QTY DEMANDED EXCESS
SUPPLY/DEMAN
D
65 750 0 750
60 700 100 600
50 600 300 300
40 500 500 0
30 400 700 -300
20 300 900 -600
10 200 1,100 -900
2-58
The table shows the demand and

supply schedules for apartments in a
small city.
PRICE QTY DEMANDED QTY SUPPLIED
300 130,000 35,000
350 115,000 37,000
400 100,000 41,000
450 80,000 45,000
500 72,000 52,000
550 60,000 60,000
600 55,000 70,000
650 48,000 75,000
2-59
a. What market situation exist if the

monthly rate is 600
b. What market situation exist if the
monthly rate is 350
c. What is the equilibrium monthly
rental
d. What is the equilibrium number of
apartments
2-60

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Managerial Economics Thomas

ninth edition Maurice

Demand, Supply, &

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

Graphing Demand Curves

A Demand Curve (Figure 2.1)

Graphing Demand Curves

Shifts in Demand (Figure 2.2)

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

Pe Inverse r = Qs/Pe is negative

F Direct s = Qs/F is positive

Direct Supply Function

Inverse Supply Function

Graphing Supply Curves

A Supply Curve (Figure 2.3)

Graphing Supply Curves

Shifts in Supply (Figure 2.4)

Illustration of Derivation of Demand Function

Qd = 1,800 – 20P + 0.6M – 50PR

Illustration of Derivation of Demand Function

Qd = 1,300 – 20P PRICE QTY

A Demand Schedule (or table) shows

Illustration of Derivation of Supply Function

Illustration of Derivation of Supply Function

Qs = 100 + 10P PRICE QTY

Market Equilibrium (Figure 2.5)

Demand and Supply Schedule

Illustration of Market Equilibrium

Excess Demand or Excess Supply

Qs – Qd = 600 – 300 = 300

Suppose the generalized demand function for good X is

Value of Market Exchange

Changes in Market Equilibrium

Simultaneous Shifts: (D, S)

Price may rise or fall; Quantity rises

Simultaneous Shifts: (D, S)

Price falls; Quantity may rise or fall

Simultaneous Shifts: (D, S)

Price rises; Quantity may rise or fall

Simultaneous Shifts: (D, S)

Price may rise or fall; Quantity falls

Ceiling & Floor Prices

Ceiling & Floor Prices (Figure 2.12)

Panel A – Ceiling price Panel B – Floor price

• The Research Department of the Corn Flakes Corporation