Ch 2 Unit1


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Ch 2 Unit1

  1. 1. Managerial Economics & Business Strategy Chapter 2 goes with unit one Demand and Supply
  2. 2. Overview <ul><li>III. Market Equilibrium </li></ul><ul><li>IV. Price Restrictions </li></ul><ul><li>V. Comparative Statics </li></ul><ul><li>II. Market Supply Curve </li></ul><ul><ul><li>The Supply Function </li></ul></ul><ul><ul><li>Supply Shifters </li></ul></ul><ul><li>I. Market Demand Curve </li></ul><ul><ul><li>The Demand Function </li></ul></ul><ul><ul><li>Determinants of Demand </li></ul></ul>
  3. 3. Market Demand Curve <ul><li>Shows the amount of a good that will be purchased at alternative prices, holding other factors constant. </li></ul><ul><li>Law of Demand </li></ul><ul><ul><li>The demand curve is downward sloping. </li></ul></ul>D Price Quantity
  4. 4. Determinants of Demand <ul><li>Income </li></ul><ul><ul><li>Normal good </li></ul></ul><ul><ul><li>Inferior good </li></ul></ul><ul><li>Prices of Related Goods </li></ul><ul><ul><li>Prices of substitutes </li></ul></ul><ul><ul><li>Prices of complements </li></ul></ul><ul><li>Advertising and consumer tastes </li></ul><ul><li>Population </li></ul><ul><li>Consumer expectations </li></ul>
  5. 5. The Demand Function <ul><li>A general equation representing the demand curve </li></ul><ul><li>Q x d = f(P x , P Y , M, H,) </li></ul><ul><ul><li>Q x d = quantity demand of good X. </li></ul></ul><ul><ul><li>P x = price of good X. </li></ul></ul><ul><ul><li>P Y = price of a related good Y. </li></ul></ul><ul><ul><ul><li>Substitute good. </li></ul></ul></ul><ul><ul><ul><li>Complement good. </li></ul></ul></ul><ul><ul><li>M = income. </li></ul></ul><ul><ul><ul><li>Normal good. </li></ul></ul></ul><ul><ul><ul><li>Inferior good. </li></ul></ul></ul><ul><ul><li>H = any other variable affecting demand. </li></ul></ul>
  6. 6. Inverse Demand Function <ul><li>Price as a function of quantity demanded – graph price as a dependent variable in graph – price on the vertical axis </li></ul><ul><li>Example: </li></ul><ul><ul><li>Demand Function </li></ul></ul><ul><ul><ul><li>Q x d = 10 – 2P x </li></ul></ul></ul><ul><ul><li>Inverse Demand Function: </li></ul></ul><ul><ul><ul><li>2P x = 10 – Q x d </li></ul></ul></ul><ul><ul><ul><li>P x = 5 – 0.5Q x d </li></ul></ul></ul>
  7. 7. Change in Quantity Demanded – move along demand curve D 0 B A Price Quantity 4 7 6 A to B : Increase in quantity demanded 10
  8. 8. Change in Demand – shift in function D 0 to D 1 : Increase in Demand Price Quantity D 0 D 1 6 7 13
  9. 9. Market Supply Curve <ul><li>The supply curve shows the amount of a good that will be produced at alternative prices. </li></ul><ul><li>Law of Supply </li></ul><ul><ul><li>The supply curve is upward sloping. </li></ul></ul>Price Quantity S 0
  10. 10. Supply Shifters <ul><li>Input prices </li></ul><ul><li>Technology or government regulations </li></ul><ul><li>Number of firms </li></ul><ul><ul><li>Entry </li></ul></ul><ul><ul><li>Exit </li></ul></ul><ul><li>Substitutes in production </li></ul><ul><li>Taxes </li></ul><ul><ul><li>Excise tax </li></ul></ul><ul><ul><li>Ad valorem tax – property tax </li></ul></ul><ul><li>Producer expectations </li></ul>
  11. 11. The Supply Function <ul><li>An equation representing the supply curve: </li></ul><ul><li>Q x S = f(P x , P R ,W, H,) </li></ul><ul><ul><li>Q x S = quantity supplied of good X. </li></ul></ul><ul><ul><li>P x = price of good X. </li></ul></ul><ul><ul><li>P R = price of a production substitute. </li></ul></ul><ul><ul><li>W = price of inputs (e.g., wages). </li></ul></ul><ul><ul><li>H = other variable affecting supply. </li></ul></ul>
  12. 12. Inverse Supply Function <ul><li>Price as a function of quantity supplied (price is dependent variable in graph) </li></ul><ul><li>Example: </li></ul><ul><ul><li>Supply Function </li></ul></ul><ul><ul><ul><li>Q x s = 10 + 2P x </li></ul></ul></ul><ul><ul><li>Inverse Supply Function: </li></ul></ul><ul><ul><ul><li>2P x = 10 + Q x s </li></ul></ul></ul><ul><ul><ul><li>P x = 5 + 0.5Q x s </li></ul></ul></ul>
  13. 13. Change in Quantity Supplied – move along supply curve B A A to B : Increase in quantity supplied Price Quantity S 0 20 10 5 10
  14. 14. Change in Supply – shift in curve S 0 to S 1 : Increase in supply Price Quantity S 0 S 1 8 7 5 6
  15. 15. Market Equilibrium <ul><li>Balancing supply and demand </li></ul><ul><ul><li>Q x S = Q x d </li></ul></ul>
  16. 16. If price is too low… price ceiling –say at $1/gallon Price Quantity S D 1 6 12 Shortage 12 - 6 = 6 2 3
  17. 17. If price is too high…$15/H min.wage Price Quantity S D 15 14 Surplus 14 - 6 = 8 6 10 8 5
  18. 18. Price Restrictions <ul><li>Price Ceilings </li></ul><ul><ul><li>The maximum legal price that can be charged. </li></ul></ul><ul><ul><li>Examples: </li></ul></ul><ul><ul><ul><li>Gasoline prices in the 1970s. </li></ul></ul></ul><ul><ul><ul><li>Housing in New York City. </li></ul></ul></ul><ul><ul><ul><li>Proposed restrictions on ATM fees. </li></ul></ul></ul><ul><li>Price Floors </li></ul><ul><ul><li>The minimum legal price that can be charged . </li></ul></ul><ul><ul><li>Examples: </li></ul></ul><ul><ul><ul><li>Minimum wage. </li></ul></ul></ul><ul><ul><ul><li>Agricultural price supports. </li></ul></ul></ul>
  19. 19. Impact of a Price Ceiling – creates a shortage Price Quantity S D P* Q* P Ceiling Q s P F Shortage Q d
  20. 20. Impact of a Price Floor – a price above the market clearing price creates a surplus Price Quantity S D P* Q* Surplus P F Q d Q S
  21. 21. Comparative Static Analysis <ul><li>How do the equilibrium price and quantity change when a determinant of supply and/or demand change? </li></ul>
  22. 22. Applications of Demand and Supply Analysis <ul><li>Event: The WSJ reports that the prices of PC components are expected to fall by 5-8 percent over the next six months. </li></ul><ul><li>Scenario 1: You manage a small firm that manufactures PCs. </li></ul><ul><li>Scenario 2: You manage a small software company. </li></ul>
  23. 23. Use Comparative Static Analysis to see the Big Picture! <ul><li>Comparative static analysis shows how the equilibrium price and quantity will change when a determinant of supply or demand changes. </li></ul>
  24. 24. Scenario 1: Implications for a Small PC Maker <ul><li>Step 1: Look for the “Big Picture.” </li></ul><ul><li>Step 2: Organize an action plan (worry about details). </li></ul>
  25. 25. Big Picture: Impact of decline in component prices on PC market Price of PCs Quantity of PC’s S D S* P 0 P* Q 0 Q*
  26. 26. <ul><li>Equilibrium price of PCs will fall, and equilibrium quantity of computers sold will increase. </li></ul><ul><li>Use this to organize an action plan </li></ul><ul><ul><li>contracts/suppliers? </li></ul></ul><ul><ul><li>inventories? </li></ul></ul><ul><ul><li>human resources? </li></ul></ul><ul><ul><li>marketing? </li></ul></ul><ul><ul><li>do I need quantitative estimates? </li></ul></ul>Big Picture Analysis: PC Market
  27. 27. Scenario 2: Software Maker <ul><li>More complicated chain of reasoning to arrive at the “Big Picture.” </li></ul><ul><li>Step 1: Use analysis like that in Scenario 1 to deduce that lower component prices will lead to </li></ul><ul><ul><li>a lower equilibrium price for computers. </li></ul></ul><ul><ul><li>a greater number of computers sold. </li></ul></ul><ul><li>Step 2: How will these changes affect the “Big Picture” in the software market? </li></ul>
  28. 28. Big Picture: Impact of lower PC prices on the software market Price of Software Quantity of Software P 0 S D Q 0 D* P 1 Q 1
  29. 29. <ul><li>Software prices are likely to rise, and more software will be sold. </li></ul><ul><li>Use this to organize an action plan. </li></ul>Big Picture Analysis: Software Market
  30. 30. Conclusion <ul><li>Use supply and demand analysis to </li></ul><ul><ul><li>clarify the “big picture” (the general impact of a current event on equilibrium prices and quantities). </li></ul></ul><ul><ul><li>organize an action plan (needed changes in production, inventories, raw materials, human resources, marketing plans, etc.). </li></ul></ul>