Lecture Managerial economics (Ninth edition): Chapter 2 – Thomas, Maurice

Chapter 2 - Demand, supply, and market equilibrium. After reading chapter 2 you should be able to: Work with three different types of demand relations: general, direct, and inverse demand functions; list six principal variables that determine the quantity demanded of a good; derive a direct demand function from a general demand function;...

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Managerial Economics Managerial Economics

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General Demand Function

• Six variables that influence Qd

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• b, c, d, e, f, & g are slope parameters

• Measure effect on Q d of changing one of the variables while holding the others constant

• Sign of parameter shows how variable

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Variable Relation to Q d Sign of Slope Parameter

P

P e N

Direct for normal goods Inverse for inferior goods Direct for substitutes

f = Q d / P e is positive

g = Q d / N is positive Inverse for complements

e = Q d / is positive

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Direct Demand Function

• The direct demand function, or simply

demand, shows how quantity demanded,

Q d , is related to product price, P, when all

other variables are held constant

• Q d = f(P)

• Law of Demand

• Q d increases when P falls & Q d decreases when P rises, all else constant

Q d / P must be negative

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Inverse Demand Function

• Traditionally, price (P) is plotted on

the vertical axis & quantity

horizontal axis

• The equation plotted is the inverse demand function, P = f(Q d )

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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

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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

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General Supply Function

• k, l, m, n, r, & s are slope parameters

• Measure effect on Q s of changing one of the variables while holding the others constant

• Sign of parameter shows how variable

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General Supply Function

Variable Relation to Q s Sign of Slope Parameter

P

P e F

Inverse Inverse for substitutes

k = Q s / P is positive

l = Q s / P I is negative

m = Q s / P r is negative

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Direct Supply Function

• The direct supply function, or

simply supply, shows how quantity

are held constant

• Qs = f(P)

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Inverse Supply Function

• Traditionally, price (P) is plotted on

the vertical axis & quantity

horizontal axis

• The equation plotted is the inverse supply function,

P = f(Q s )

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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

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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

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Market Equilibrium

• Equilibrium price & quantity are

determined by the intersection of demand & supply curves

• At the point of intersection, Q d = Q s

• Consumers can purchase all they want & producers can sell all they want at the “marketclearing” or price

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• Excess supply (surplus)

• Exists when quantity supplied exceeds quantity demanded

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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

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• 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

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Measuring the Value of Market

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• Quantitative forecast

• Predicts both the direction and the magnitude of the change in an economic variable

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(Figure 2.7)

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(Figure 2.8)

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• 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

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• 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

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