Managerial Economics

ninth edition

Thoma
Mauric

Chapter 2
Demand, Supply, &
Market Equilibrium
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Managerial Economics,
Managerial Economics,

Copyright 2008 by the McGraw-Hill Companies, Inc. All

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

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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

2-3

Qd f ( P, M , PR , , Pe , N )

Managerial Economics

General Demand Function

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

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General Demand Function

Variable

Inverse

Direct for normal goods

Inverse for inferior goods

PR

2-5

Relation to Qd

Sign of Slope Parameter

b = Qd/ P is negative

c = Qd/ M
c = Qd/ M
d = Qd/ PR
Direct for substitutes
Inverse for complements d = Qd/ PR

is positive
is negative
is positive
is negative

Direct

e = Qd/ is positive

Pe

Direct

f = Qd/ Pe is positive

Direct

g = Qd/ N is positive

Managerial Economics

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

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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

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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

2-8

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A Demand Curve (Figure 2.1)

2-9

Managerial Economics

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-

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Shifts in Demand

2-

(Figure 2.2)

Managerial Economics

Supply
Quantity supplied (Qs)
Amount of a good or service offered
for sale during a given period of time

2-

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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

2-

Qs f ( P, PI , Pr , T , Pe , F )

Managerial Economics

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-

Managerial Economics

General Supply Function

Variable

2-

Relation to Qs

Sign of Slope Parameter

Direct

k = Qs/ P is positive

PI

Inverse

l = Qs/ PI is negative

Pr

Inverse for substitutes

Direct for complements

m = Qs/ Pr is negative
m = Qs/ Pr is positive

Direct

n = Qs/ T is positive

Pe

Inverse

r = Qs/ Pe is negative

Direct

s = Qs/ F is positive

Managerial Economics

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-

Managerial Economics

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-

Managerial Economics

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-

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A Supply Curve

2-

(Figure 2.3)

Managerial Economics

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-

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Shifts in Supply

2-

(Figure 2.4)

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Market Equilibrium
Equilibrium price & quantity are
determined by the intersection of
demand & supply curves
At the point of intersection, Qd = Qs
Consumers can purchase all they want
& producers can sell all they want at
the market-clearing or price

2-

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Market Equilibrium

2-

(Figure 2.5)

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Market Equilibrium
Excess demand (shortage)
Exists when quantity demanded
exceeds quantity supplied

Excess supply (surplus)

Exists when quantity supplied exceeds
quantity demanded

2-

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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
2-

Managerial Economics

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-

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Measuring the Value of Market

Exchange (Figure 2.6)

2-

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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-

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Demand Shifts (Supply Constant)

(Figure 2.7)

2-

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Supply Shifts (Demand Constant)

(Figure 2.8)

2-

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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-

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Simultaneous Shifts: ( D, S)
P
S
S
S

P
P
P

C
D
D

Q
Q

Price may rise or fall; Quantity rises

2-

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Simultaneous Shifts: ( D, S)
P
S
S
S
A

D
D

Q Q

Q
Q

Price falls; Quantity may rise or fall

2-

Managerial Economics

Simultaneous Shifts: ( D, S)
P
S
S
P

P
A

D
D
Q Q Q

Price rises; Quantity may rise or fall

2-

Managerial Economics

Simultaneous Shifts: ( D, S)
P
S

P
P
P

D
D
Q

Price may rise or fall; Quantity falls

2-

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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-

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Ceiling & Floor Prices (Figure 2.12)

Px

Sx

2
1

Price (dollars)

Price (dollars)

Px

Sx
3
2

Dx

Dx
22

50 62

Quantity

Panel A Ceiling price

2-

Qx

32 50

84

Quantity

Panel B Floor price

Qx