The document discusses demand and supply. It defines demand as the total quantity of a good or service that customers are willing and able to purchase under various market conditions. Supply is defined as the total quantity of a good or service that producers are willing and able to sell. The key determinants of demand include price, income, tastes and preferences. The key determinants of supply include price, costs of inputs, technology and weather. The document explains demand curves and how shifts in demand curves occur due to changes in non-price factors. It also discusses market demand and supply functions.

1. Demand and Supply
Lecture 3

2. Demand
This is the total quantity of a good or service that customers
are willing and able to purchase during a specific period
under various market conditions.
The basis of demand is this: goods ad services have ready
markets if they directly satisfy consumer wants or help firms
produce products that satisfy consumer wants (Hirschey,
2012).

3. Specific Periods
hour day
month year

4. Market Conditions
Price of the Good in
Question
• How is the product
priced? Low, high,
or in the middle?
Prices and
Availability of
Related Goods
• Are there
substitutes to the
product?
Expectations of price
changes
• Is the product price
sensitive?
Consumer Incomes
• Can the students
afford the products
offered?
Consumer tastes and
Preferences
• What are the
trends?
Advertising
Expenditures
• How much to
spend to reach
target audience?

5. Demand
For managerial decision making, a prime focus is on
market demand. Market demand is the aggregate of
individual, or personal, demand.
Insight into market demand relations requires an
understanding of the nature of individual demand.

6. Demand
Individual demand is determined by the value
associated with acquiring and using any good or
service and the ability to acquire it. Both are
necessary for effective individual demand.
Desire without purchasing power may lead to want,
but not to demand.

7. Demand
There are two basic models of individual demand.
One, known as the theory of consumer behavior,
relates to the direct demand for personal
consumption products. This model is appropriate for
analyzing individual demand for goods and services
that directly satisfy consumer desires.

8. Demand
The value or worth of a good or service, its utility, is
the prime determinant of direct demand. Individuals
are viewed as attempting to maximize the total utility
or satisfaction provided by the goods and services
they acquire and consume.

9. Demand
This optimization process requires that consumers
focus on marginal utility (gain in satisfaction) of
acquiring additional units of a given product. Product
characteristics, individual preferences (tastes), and
the ability to pay are all important determinants of
direct demand.

10. Demand
Marginal utility is the added satisfaction a consumer
gets from having one more unit of a good or service.
The concept of marginal utility is used by economists
to determine how much of an item consumers are
willing to purchase. Marginal utility can either be
positive, zero, or negative (Bloomenthal, 2023).

11. Demand
Positive Marginal Utility
 This occurs when having more of an item brings additional
happiness.
Zero Marginal Utility
 This occurs when consuming more of an item brings no extra
measure of satisfaction.
Negative Marginal Utility
 This occurs when one have too much of an item, so consuming
more is actually harmful.

12. Demand
There is also something called the law of diminishing
marginal utility that explains that as person consumes an
item or a product, the satisfaction or utility drive from one
product wants as they consume more and more product
(Ross, 2023).

13. Demand
Goods and services are sometimes acquired because
they are inputs in the manufacture and distribution
of products. The outputs of engineers, production
workers, sales staff, managers, lawyers, consultants,
office business machines, production, facilities and
equipment, natural resources, and commercial
airplanes are all examples of goods and services
demanded not for direct consumption but rather for
their use in providing other goods and services.

14. Demand
Their demand is derived from the demand for the
products they are used to provide. Input demand is
called derived demand. The demand for mortgage
money. The quantity of mortgage credit demanded is
not determined directly, it is derived from the more
fundamental demand for housing.

15. Demand
The demand for air transportation to resort areas is
not a direct demand but is derived from the demand
for recreation. The demand for producers’ goods and
services used to manufacture products for final
consumption is derived.

16. Demand
Aggregate demand for consumption goods and
services determines demand for the capital
equipment, materials, labor, and energy used to
manufacture them. Example: Demand for steel,
aluminum, and plastics are all derived demands, as
are the demands for machine tools and labor. None of
these producers’ goods are demanded because of
their direct value to consumers, but because of the
role they play in production.

17. Demand
Demand for producers’ goods and services are
closely related to final products demand. An
examination of final product demand is an important
part of demand analysis for intermediate or
producers’ goods. For product whose demand is
derived rather than direct, demand stems from their
value in the manufacture or sale of other products.

18. Demand
They have value because their employment
has the potential to generate profits. Key
components in the determination of derived
demand are the marginal benefits and
marginal costs associated with using a given
input or factor of production.

19. Demand
The amount of any good or service used rises
when its marginal benefit, measured in terms of
value of resulting output, is greater than the
marginal costs of using the input, measured in
terms of wages, interest, raw material costs, or
related expense.

20. Demand
The amount of any input used in production
falls when resulting marginal benefits are less
than the marginal cost of employment. In short,
derived demand is related to the profitability
of using a good or service.

21. Demand
Regardless of whether a good or service is
demanded by individuals for final consumption
(direct demand) or as an input used in providing
other goods and services (derived demand), the
fundamental of economic analysis offer a basis
for investigating demand characteristics.

22. Demand
For final consumption products, utility
maximization as described by the theory of
consumer behavior explains the basis for direct
demand. For inputs used in the production of other
products, profit maximization provides the
underlying rationale for derived demand. Because
both demand models are based on the optimization
concept, fundamental direct demand and derived
demand relations are essentially the same.

23. Market Demand Function
The market demand function for a product is a
statement of the relation between the
aggregate quantity demanded and all factors
that affect this quantity. In other words, it is the
relation between quantity sold and factors
influencing its level.

24. Determinants of Demand
In function form, a demand function may be
expressed as:
Quantity of Product Y Demanded = f(Price of Y,
Prices of Related Products (X), Income,
Advertising, and so on.)

25. Determinants of Demand
Example: Supposed you are in the automobile
industry. The demand function for the
automobile industry is:
Q = a1P + a2PX + a3I + a4Pop + a5i + a6 A

26. Determinants of Demand
Q = a1P + a2PX + a3I + a4Pop + a5i + a6 A
Translation: This equation states that the quantity of new
domestic automobiles demanded during a given year (in
millions), Q is a linear function of the average price of new
domestic cars (in $), P; the average price of new import luxury
cars, a prime substitute (in $), Px; disposable income per
household (in $), I; population, (in millions; average interest
rate on car loans (in percent), i; and industry advertising
expenditures (in $ millions), A. The terms a1 a2 a3 a4 a5 , a6 are
called the parameters of the demand function.

27. Determinants of Demand
Supposed that the parameters of this demand function are known
with certainty as shown in this equation:
Q = -500P + 250PX + 125I + 20,000Pop - 1,000,000i + 600A
This states that automobile demand falls by 500 for each $1
increase in the average price charged by domestic manufactures; it
rises by 250 with every $1 increase in the average price of new
import luxury cars; it increase by 125 for each $1 increase in the
disposable income per household; it increases by 20,000 with each
additional million persons in the population; it decreases by 1
million for every 1% rise in interest rates; and it increases by 600
with each unit ($1million) spent on advertising.

28. Determinants of Demand
To derive an estimate of industry demand in any given year, each parameter is
multiplied by the value of the related variable and then summed. The table
shows annual demand for new domestic automobiles is 8 million cars, assuming
the state values of each independent variable.

29. Industry Demand versus Firm Demand
Market demand functions can be specified for an
entire industry or for an individual firm, though
somewhat different variables would typically be used
in each case.
Variables representing competitors’ actions would be
stressed in firm demand functions.

30. Industry Demand versus Firm Demand
Example: a firm’s demand function would typically
include competitors’ prices and advertising
expenditures. The quantity demanded for the
firm’s product line is negatively related to its own
prices, but demand is positively related to the prices
charged by competing firms. Demand would
typically increase with the firm’s own advertising
expenditures, but it could increase or decrease with
additional advertising by other firms.

31. Industry Demand versus Firm Demand
The parameters for specific variables ordinarily differ in
industry versus firm demand functions. Consider the
positive influence of population growth on the demand
for Toyota automobiles as opposed to automobiles in
general. Although the effect is positive in each instance,
the parameter value in the Toyota demand function
would be much smaller than that in the industry
demand function. Only if Toyota had 100 percent of the
market—that is, if Toyota were the industry—would the
parameters for firm and industry demand be identical.

32. Industry Demand versus Firm Demand
Because firm and industry demand functions differ,
different models or equations must be estimated for
analyzing these two levels of demand. However,
demand concepts can apply to both firm and industry
demand functions

33. Demand Curve
The demand curve expresses the relation
between the price charged for a product
and the quantity demanded, holding
constant the effects of all other variables.

34. Demand Curve
Demand Curve Determination
- A demand curve is shown in the form of a graph, and all
variables in the demand function except the price and
quantity of the product itself are fixed. In the automobile
example, one must hold income, population, interest rates,
and advertising expenditures constant to identify the demand
curve relation between new domestic automobile prices and
quantity demanded.

35. Demand Curve
Q = -500P + 250PX + 125I + 20,000Pop + 1,000,000i + 600 A
Q = -500P + 250($60,000) + 125($56,000) + 20,000(300) +
1,000,000(8) + 600($5000)
Q = 23,000,000 – 500P
P = $46,000 - $0.002Q

36. Demand Curve
Hypothetical Industry Demand Curve for New Domestic
Automobiles

37. Demand Curve
Following the example, we can assume that 8 million
new domestic automobiles can be sold at an average
price of $30,000, whereas 10 million automobiles can
be sold at an average of $26,000. But at $34,000 only
6 million automobiles can be sold. This variation is
described as a change in the quantity demand.

38. Demand Curve
Change in the quantity demand is defined as a
movement along a single demand curve. As average
price drops from $34,000 to $30,000 to $26,000 along
the demand curve, the quantity demanded rises from
6 million to 8 million to 10 million.
A change in the quantity demand refers to the effect
on sales of a change in price holding constant the
effects of all other demand-determining factor.

39. Demand Curve
A shift in demand or switch from one demand
curve to another demand curve, reflects a
change in one or more non-price variables in
the product demand function.

40. Demand Curve
In our automobile example, a decrease in
interest rates causes an increase in automobile
demand, because the interest rate parameter
of -1 million indicates that demand and interest
rates are inversely related—they change in the
opposite directions.

41. Demand Curve
Hypothetical Industry
Demand Curve for
New Domestic
Automobiles at
Interest Rates of 6
percent, 8 percent,
and 10 percent

42. Demand Curve
Following the graph, a decrease in interest
rates (from 8% to 6%) result in an increase in
demand, therefore it shifts to the right. An
increase in interest rates (from 8% to 10%)
result in a decrease in demand , therefore it
shifts to the left.

43. Demand Curve
The distinction between changes in the quantity demanded,
which reflect movements along a given demand curve, and
changes in demand, which reflect shifts from one demand curve
to another, is extremely important. Failure to understand the
causes of changes in demand for a company’s products can
lead to costly, even disastrous, mistakes in managerial decision
making. The task of demand analysis is made especially difficult
by the fact that under normal circumstances, not only prices but
also prices of other goods, income, population, interest rates,
advertising, and most other demand-related factors vary from
period to period. Sorting out the impact of each factor makes
demand analysis one of the most challenging aspects of
managerial economics (Hirschey, 2012).

44. Supply
The profit motive determines the quantity of a
good or service that producers are willing and
able to sell during a given period.
Total quantity offered for sale under various
market conditions.

45. Supply
How Output Prices Affect Supply
The supply of a product in the market is the
aggregate amount supplied by individual firms.
The supply of products arises from their ability
to enhance the firm’s value maximization
objective.

46. Supply
The amount of any good or service supplied will rise
when the marginal benefit to producers, measured
in terms of the value of output, is greater than the
marginal cost of production. The amount of any
good or service supplied will fall when the marginal
benefit to producers is less than the marginal costs
of production. Thus, individual firms will expand or
reduce the quantity supplied based on the expected
impact on profits.

47. Supply
Among the factors influencing the quantity supplied
of a product, the price of the product itself is often
the most important. Higher prices increase the
quantity of output producers want to ring to
market. When MR > MC, firms increase the quantity
they supplied to earn the greater profits associated
with expanded output. Higher prices allow firms to
pay the higher production that are sometimes
associated with expansion in output. Lower prices
can have the effect of making previous levels of
production unprofitable.

48. Supply
Price of related goods and services can also play an
important role in determining supply of a product. If a
firm uses resources that can be used to produce
several different products, it may switch production
from one product to another, depending on market
conditions. Example: Ore deposits containing lead
often contain silver. An increase in the price of lead
can therefore lead to an expansion in both lead and
silver production.

49. Supply
Technology is another key determinant of product
supply. The current state of technology refers to the
manner in which inputs are transformed into output.
An improvement in the state of technology, including
any product invention or process innovation that
reduces production costs, increases the quantity
and/or quality of products offered for sale at a given
price.

50. Supply
Changes in input prices also affect supply in that an
increase in input prices will raise costs and reduce the
quantity that can be supplied profitably at a given
market price. Alternatively, a decrease in input prices
increases profitability and the quantity supplied at a
given price.

51. Supply
For some products, especially agricultural products,
weather can play an important role in determining
supply. Temperature, rainfall, and wind all influence the
quantity that can be supplied. Heavy rainfall in early
spring, for example, can delay or prevent the planting of
crops, significantly limiting supply. Abundant rain during
the growing season can greatly increase the available
supply at harvest time. An early freeze that prevents full
maturation or heavy snow that limits harvesting activity
can reduce the supply of agricultural products.

52. Supply
Managerial decision making requires understanding
both firm supply and market supply conditions.
Market supply is the aggregate of individual firm
supply, so it is ultimately determined by the factors
affecting firm supply.

53. Market Supply Function
The market supply function for a product is the
relation between the quantity supplied and all
the factors affecting that amount or the level of
supply.

54. Determinants of Supply
In functional form, a supply function can be
expressed as:
Quantity of Product Y Supplied = f(Price of Y, Prices
of Related Products (X), Current State ofTechnology,
Input Prices,Weather, and so on.)

55. Determinants of Supply
Example (continuing the automobile industry):
Q = b 1 P + b 2 PSUV + b 3 W + b 4 S + b 5 E + b 6 i
This equation states that the number of new domestic
automobiles supplied during a given period (in millions), Q, is a
linear function of the average price of new domestic cars in ($),
P; average price of new sport utility vehicles (SUVs) ($); average
hourly price of labor (wages in $ per hour), W; average cost of
steel ($ per ton), S; average cost of energy ($ per mcf natural
gas), E; and average interest rate (cost of capital in percent), i.
Technology is an underlying implicit factor in the supply
function.

56. Determinants of Supply
Example (continuing the automobile industry):
Q = 2,000P - 500 PSUV - 100,000W- 15,000S -125,000E - 1,000,000i
This indicates that the quantity of automobiles supplied increases by
2,000 units for each $1 increase in the average price charged; it
decreases by 500 units for each $1 increase in the average price of new
SUVs; it decreases by 100,000 units for each $1 increase in wage rates,
including fringes; it decreases by 15,000 units with each $1 increase in
the average cost of steel; it decreases by 125,000 units with each $1
increase in the average cost of energy; and it decreases by 1 million
units if interest rates rise 1 percent. Thus, each parameter indicates the
effect of the related factor on supply from domestic manufacturers.

57. Determinants of Supply

58. Industry Supply versus Firm Supply
Like the demand, supply functions can be specified
for an entire industry or an individual firm. Even
though factors affecting supply are often similar in
industry supply versus firm supply functions, the
relative importance of such influences can differ
dramatically (Hirschey, 2012).

59. Industry Supply versus Firm Supply
If all firms used identical production methods and
identical equipment, had salaried and hourly employees
who were equally capable and identically paid, and had
equally skilled management, then individual firm supply
and industry supply functions would be closely related.
Each firm would be similarly affected by the changes in
supply conditions. Each parameter in the individual
firm supply functions would be smaller than in the
industry supply function, however, and would reflect
each firm’s relative share of the market (Hirschey,
2012).

60. Industry Supply versus Firm Supply
More typically, firms within a given industry adopt
somewhat different production methods, use
equipment of different vintage, and employ labor of
varying skill and compensation levels. In such cases,
individual firm supply levels can be affected quite
differently by various factors.(Hirschey, 2012).

61. Industry Supply versus Firm Supply
Individual firms supply output only when doing so is
profitable. When industry prices are high enough to
cover the marginal costs of increased production,
individual firms expand output, thereby increasing total
profits, and the value of the firm. To the extent that the
economic capabilities of industry participants vary, so
too does the scale of output supplied by individual firms
at various prices. Similarly, supply is affected by
production technology. Firms operating with highly
automated facilities incur large fixed costs and
relatively small variable costs.

62. Industry Supply versus Firm Supply
The supply of product from firms who have highly
automated production is likely to be relatively
insensitive to price changes when compared to less
automated firms, for which variable production costs
are higher and thus more closely affected by
production levels. Relatively low-cost producers can
and do supply output at relatively low market prices.
Of course, both relatively low-cost and high-cost
producers are able to supply output profitably when
market prices are high.

63. Supply Curve
The supply curve expresses the relation between the
price charged and the quantity supplied, holding the
effects of all variables.
As is true with demand curves, supply curves are
often shown graphically, and all independent
variables in the supply function except the price of
the product itself are fixed at specified levels.

64. Supply Curve
Going back to the example about automobiles, let us
assume that the price of trucks, the prices of labor,
steel, energy, and interest rates are held constant. We
will use the value in the table on Slide 57.
Q = 2,000P - 500($42,500) - 100,000($100) -
15,000($800) - 125,000($6) - 1,000,000(8)
Q = -52,000,000 + 2,000 P

65. Supply Curve
Q = -52,000,000 + 2,000 P
P = 26,000 + 0.0005Q
When the supply function is pictured with price as a function of
quantity, industry supply will rise by 4 million new domestic
cars if average price rises by $2,000, or by 1/0.0005. Industry
supply increases by 2,000 units with each $1 increase in average
price above the $26,000 level. The $26,000 intercept in this
supply equation implies that the domestic car industry would
not supply any new cars at all if the industry average price fell
below $26,000. At average prices below that level, low-cost
imports would supply the entire industry demand.

66. Relation between Supply Curve and
Supply Function
Like the relation between
the demand curve and the
demand function, the
relation between the supply
curve and the supply
function is very important in
managerial decision making

67. Relation between Supply Curve and
Supply Function
Change in the quantity supplied is the movement
along a given supply curve reflecting a change in
price.
Shift in supply is the movement from one supply
curve to another following a change in a nonprice
determinant of supply.

68. Relation between Supply Curve and
Supply Function
In this example, when
interest rate rises from 8%
to 10%, left shift or upward;
decrease in supply. When
the interest rate is lowers
from 8% to 6% , right shift
or downward; increase in
supply.

69. Market Equilibrium
When quantity demanded and quantity
supplied are in perfect balance at a given
price, the product market is said to be in
equilibrium.

70. Surplus and Shortage
A surplus is created when producers supply
more of a product at a given price than
buyers demand. Surplus describes a
condition of excess supply.

71. Surplus and Shortage
A shortage is created when buyers
demand more of a product at a given price
than producers are willing to supply.
Shortage describes a condition of excess
demand.

72. Surplus and Shortage
When there is market equilibrium, neither
surplus or shortage occurs because it is a
condition in which the quantities
demanded and supplied are exactly
balance at the current market price.

73. Surplus and Shortage
Surplus and shortage describes situations
of market disequilibrium because either
will result in powerful market forces being
exerted to change the prices and
quantities offered in the market.

74. Surplus and Shortage
Let us again use
the example of
the automobile
industry to look
at surplus,
shortage, and
market
equilibrium.

75. Surplus and Shortage
At an industry average price of
$32,000, excess supply creates
a surplus of 5 million units
exerting down ward pressure
on both price and output
levels. Similarly, excess
demand at a price of $28,000
creates a shortage of 5 million
units and upward pressure on
both prices and output. Market
equilibrium is achieved when
demand equals supply at a
price of $30,000 and quantity
of 8 million units.

76. Surplus and Shortage
As you can see in the
graph, only a market
price of $30,000 brings the
quantity demanded and
quantity supplied into
perfect balance. This price
is referred to as the
market equilibrium price
or the market clearing
price.

77. Comparative Statistics
Managers typically control a number of the factors that
affect product demand and supply. To make appropriate
decisions concerning those variables, it is often useful to
know how altering those decisions affect market
conditions. Similarly, the direction and magnitude of
changes in demand and supply that are due to
uncontrollable external factors, such as income or interest
rate changes, need to be understood so that managers
can develop strategies and make decisions that are
consistent with market conditions (Hirschey, 2012).

78. Comparative Statistics
One relatively simple but useful analytical
technique is to examine the effects on market
equilibrium of changes in economic factors
underlying product demand and supply. This is
called comparative statics analysis. In
comparative statics analysis, the role of factors
influencing demand is often analyzed while holding
supply conditions constant.(Hirschey, 2012).

79. Comparative Statistics
Similarly, the role of factors influencing supply can
be analyzed by studying changes in supply while
holding demand conditions constant. Comparing
market equilibrium price and output levels before
and after various hypothetical changes in demand
and supply conditions has the potential to yield
useful predictions of expected changes (Hirschey,
2012).

80. Comparative Statistics
This shows the
changing demand.
Holding supply
conditions constant,
demand will vary with
changing interest rates.
Demand increases with
a fall in interest rates;
demand falls as interest
rates rise.

81. Comparative Statistics
This shows the
changing supply.
Holding demand
conditions constant,
supply will vary with
changing interest rates.
Supply falls with a rise
in interest rates; supply
rises as rule interest
rates decline.

82. Comparative Statistics
This shows the
comparative statistics
of changing demand
and changing supply
conditions. The market
equilibrium price–
output combination
reflects the combined
effects of changing
demand and changing
supply conditions.

83. References:
Bloomenthal,A. (2023). Marginal Utilities: Definition, types, Examples, and history.
Investopedia.
https://www.investopedia.com/terms/m/marginalutility.asp#:~:text=Margin
al%20utility%20is%20the%20added%20satisfaction%20a%20consumer%20
gets%20from,consumers%20are%20willing%20to%20purchase.
Hirschey, M. (2012). Managerial Economics (12th ed.). Cengage LearningAsia Pte Ltd.
Ross, S. (2023).What does the Law of Diminishing Marginal Utility explain?
Investopedia. https://www.investopedia.com/ask/answers/013015/what-
does-law-diminishing-marginal-utility-
explain.asp#:~:text=In%20economics%2C%20the%20law%20of,incrementa
l%20amounts%20of%20a%20good.

84. References:
Bloomenthal,A. (2023). Marginal Utilities: Definition, types, Examples, and history.
Investopedia.
https://www.investopedia.com/terms/m/marginalutility.asp#:~:text=Margin
al%20utility%20is%20the%20added%20satisfaction%20a%20consumer%20
gets%20from,consumers%20are%20willing%20to%20purchase.
Hirschey, M. (2012). Managerial Economics (12th ed.). Cengage LearningAsia Pte Ltd.
Ross, S. (2023).What does the Law of Diminishing Marginal Utility explain?
Investopedia. https://www.investopedia.com/ask/answers/013015/what-
does-law-diminishing-marginal-utility-
explain.asp#:~:text=In%20economics%2C%20the%20law%20of,incrementa
l%20amounts%20of%20a%20good.