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ECONOMICS FOR MANAGEMENT Demand

Demand

CODE DEC 5013

• Market demand curve
– Illustrates the relationship between the total
Market Forces: quantity and price per unit of a good all
consumers are willing and able to purchase,
Demand and Supply holding other variables constant.
• Law of demand
– The quantity of a good consumers are willing and
able to purchase increases (decreases) as the
price falls (rises).

McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. 2-2

Demand Demand
Market Demand Curve Changes in Quantity Demanded
• Changing only price leads to changes in
Price ($)
$40
quantity demanded.
– This type of change is graphically represented by a
movement along a given demand curve, holding
$30
other factors that impact demand constant.
$20 • Changing factors other than price lead to
changes in demand.
$10 – These types of changes are graphically
Demand
represented by a shift of the entire demand curve.
0 20 40 60 80 Quantity
(thousands per year)

2-3 2-4

Demand Demand

Changes in Demand Demand Shifters

• Income
Price
– Normal good
– Inferior good
A Increase
in
• Prices of related goods
demand – Substitute goods
– Complement goods
Decrease
in B • Advertising and consumer tastes
demand
– Informative advertising
– Persuasive advertising
D1
D2 D0 • Population
• Consumer expectations
0 Quantity
• Other factors
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Demand Demand
Advertising and the Demand for Clothing The Demand Function
Price of • The demand function for good X is a
high-style
clothing mathematical representation describing how
Due to an many units will be purchased at different
increase in
$50
advertising prices for X, the price of a related good Y,
income and other factors that affect the
$40 demand for good X.

D2
D1
0 50,000 60,000 Quantity of
high-style
clothing
2-7 2-8

Demand Demand
The Linear Demand Function Understanding the Linear Demand Function
• One simple, but useful, representation of a • The signs and magnitude of the 𝛼 coefficients
demand function is the linear demand function: determine the impact of each variable on the
𝑄𝑋 𝑑 = 𝛼0 + 𝛼𝑋 𝑃𝑋 + 𝛼𝑌 𝑃𝑌 + 𝛼𝑀 𝑀 + 𝛼𝐻 𝐻 number of units of X demanded.
, where: 𝑄𝑋 𝑑 = 𝛼0 + 𝛼𝑋 𝑃𝑋 + 𝛼𝑌 𝑃𝑌 + 𝛼𝑀 𝑀
– 𝑄𝑋 𝑑 is the number of units of good X demanded; • For example:
– 𝑃𝑋 is the price of good X; – 𝛼𝑋 < 0 by the law of demand;
– 𝑃𝑌 is the price of a related good Y;
– 𝛼𝑌 > 0 if good Y is a substitute for good X;
– 𝑀 is income;
– 𝛼𝑀 < 0 if good X is an inferior good.
– 𝐻 is the value of any other variable affecting demand.

2-9 2-10

Demand Demand
The Linear Demand Function in Action Inverse Demand Function
• Suppose that an economic consultant for X Corp. recently • By setting 𝑃𝑌 = $15 and 𝑀 = $10,000 and
provided the firm’s marketing manager with this estimate of the
demand function for the firm’s product:
𝐴 = 2,000 the demand function is
𝑄𝑋 𝑑 = 12,000 − 3𝑃𝑋 + 4𝑃𝑌 − 1𝑀 + 2𝐴𝑋 𝑄𝑋 𝑑 = 12,000 − 3𝑃𝑋 + 4 15 − 1 10,000 + 2 2,000
the linear demand function simplifies to
Question: How many of good X will consumers purchase when
𝑃𝑋 = $200 per unit, 𝑃𝑌 = $15 per unit, 𝑀 = $10,000 and 𝑄𝑋 𝑑 = 6,060 − 3𝑃𝑋
𝐴𝑋 = 2,000? Are goods X and Y substitutes or complements? Is Solving this for 𝑃𝑋 in terms of 𝑄𝑋 𝑑 results in
good X a normal or an inferior good?
1
𝑃𝑋 = 2,020 − 𝑄𝑋 𝑑
Answer: 3
𝑄𝑋 𝑑 = 12,000 − 3 200 + 4 15 − 1 10,000 + 2 2000 = , which is called the inverse demand function. This
5,460 units. Goods X and Y are substitutes. Good X is an inferior function is used to construct a market demand
good.
curve.

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Demand Demand
Graphing the Inverse Demand Function in Action Consumer Surplus
Price
• Marketing strategies – like value pricing and
price discrimination – rely on understanding
$2,020 consumer value for products.
– Total consumer value is the sum of the maximum
amount a consumer is willing to pay at different
1 quantities.
𝑃𝑋 = 2,020 − 𝑄𝑋 𝑑
3
– Total expenditure is the per-unit market price
times the number of units consumed.
– Consumer surplus is the extra value that
consumers derive from a good but do not pay
0 6,060
extra for.
Quantity

2-13 2-14

Demand Supply
Market Demand and Consumer Surplus in Action Supply
Consumer Surplus • Market supply curve
Price per – Summarizes the relationship between the total
liter
Consumer Surplus: quantity all producers are willing and able to
0.5($5 - $3)x(2-0) = $2
$5 produce at alternative prices, holding other
Total Consumer Value:
$4
0.5($5 - $3)x2+(3-0)(2-0) = $8 factors affecting supply constant.
$3 Expenditures: • Law of supply
$(3-0) x (2-0) = $6
$2 – As the price of a good rises (falls), the quantity
supplied of the good rises (falls), holding other
$1 Demand factors affecting supply constant.
0 1 2 3 4 5 Quantity
in liters

2-15 2-16

Supply Supply
Changes in Quantity Supplied Change in Supply in Action
• Changing only price leads to changes in Price
quantity supplied. S1 S0

– This type of change is graphically represented by a B S2

Decrease
movement along a given supply curve, holding in supply
other factors that impact supply constant.
Increase
• Changing factors other than price lead to in supply

changes in supply. A

– These types of changes are graphically

represented by a shift of the entire supply curve.
0 Quantity

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Supply Supply
Supply Shifters Change in Supply in Action
Excise tax
• Input prices Price
• Technology or government regulation of
gasoline
S0+t

• Number of firms $1.20 S0

– Entry t = 20¢
t
– Exit
• Substitutes in production $1.00 t = per unit tax of 20¢
• Taxes
– Excise tax
– Ad valorem tax
• Producer expectations 0 Quantity of
gasoline per
week
2-19 2-20

Supply Supply
Change in Supply in Action The Supply Function
Price Ad valorem tax
of • The supply function for good X is a
backpacks
S1 = 1.20 x S0 mathematical representation describing how
$24
many units will be produced at different prices
S0 for X, prices of inputs W, prices of
$20
technologically related goods, and other
$12 factors that affect the supply for good X.
$10

0 1,100 2,450 Quantity of

backpacks per
week
2-21 2-22

Supply Supply
The Linear Supply Function Understanding the Linear Supply Function
• One simple, but useful, representation of a • The signs and magnitude of the 𝛽 coefficients
supply function is the linear supply function: determine the impact of each variable on the
𝑄𝑋 𝑠 = 𝛽0 + 𝛽𝑋 𝑃𝑋 + 𝛽𝑊 𝑊 + 𝛽𝑟 𝑃𝑟 + 𝛽𝐻 𝐻 number of units of X produced.
, where: 𝑄𝑋 𝑠 = 𝛽0 + 𝛽𝑋 𝑃𝑋 + 𝛽𝑊 𝑊 + 𝛽𝑟 𝑃𝑟
– 𝑄𝑋 𝑠 is the number of units of good X produced; • For example:
– 𝑃𝑋 is the price of good X;
– 𝛽𝑋 > 0 by the law of supply.
– 𝑊 is the price of an input;
– 𝛽𝑊 < 0 increasing input price.
– 𝑃𝑟 is price of technologically related goods;
– 𝐻 is the value of any other variable affecting – 𝛽𝑟 > 0 technology lowers the cost of producing
supply. good X.

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Supply Supply
The Linear Supply Function in Action Producer Surplus
• Your research department estimates that the • The amount producers receive in excess of the
supply function for televisions sets is given by: amount necessary to induce them to produce
𝑄𝑋 𝑠 = 2,000 + 3𝑃𝑋 − 4𝑃𝑅 − 1𝑃𝑊 the good.

Question: How many televisions are produced

when 𝑃𝑋 = $400, 𝑃𝑅 = $100 per unit, and
𝑃𝑊 = $2,000?

Answer:
𝑄𝑋 𝑠 = 2,000 + 3 400 − 4 100 − 1 2,000 =
800 television sets.
2-25 2-26

Supply Market Equilibrium

Producer Surplus in Action Market Equilibrium
• Competitive market equilibrium
Price 400 1 𝑆 – Determined by the interactions of the market
𝑃𝑋 = + 𝑄𝑋 Supply
3 3 demand and market supply for the good.
$400
– A price and quantity such that there is no shortage
Producer surplus
or surplus in the market.
– Forces that drive market demand and market
supply are balanced, and there is no pressure on
prices or quantities to change.
$400
3
0 800 Quantity

2-27 2-28

Market Equilibrium Market Equilibrium

Market Equilibrium I Market Equilibrium II
• Consider a market with demand and supply
Price Supply
functions, respectively, as
Surplus 𝑄𝑑 = 10 − 2𝑃 and 𝑄 𝑠 = 2 + 2𝑃
𝑃𝐻
• A competitive market equilibrium exists at a
price, 𝑃𝑒 , such that 𝑄𝑑 𝑃𝑒 = 𝑄 𝑠 𝑃𝑒 . That is,
𝑃𝑒 10 − 2𝑃 = 2 + 2𝑃
8 = 4𝑃
𝑃𝐿
𝑃𝑒 = $2
Shortage
Demand 𝑄𝑒 = 10 − 2 $2 = 10 and 𝑄𝑒 = 2 + 2($4) = 10
0 𝑄0 𝑄𝑒 𝑄1 280 Quantity 𝑄𝑒 = 10 units

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Price Restrictions and Market Equilibrium Price Restrictions and Market Equilibrium

Price Restrictions Price Ceiling in Action I

• In a competitive market equilibrium, price and
quantity freely adjust to the forces of demand Price Supply
and supply.
Lost social welfare
• Sometime government restricts how much

Nonpecuniary price
𝑃𝐹
prices are permitted to rise or fall.
𝑃𝑒
– Price ceiling
– Price floor 𝑃𝑐 Priceceiling

Shortage
Demand

0 𝑄 𝑠
𝑄 𝑒 𝑄𝑑 280 Quantity

2-31 2-32

Price Restrictions and Market Equilibrium Comparative Statics

Price Ceiling in Action II Comparative Statics
• Consider a market with demand and supply • Comparative static analysis
functions, respectively, as – The study of the movement from one equilibrium
𝑄𝑑 = 10 − 2𝑃 and 𝑄 𝑠 = 2 + 2𝑃 to another.
• Suppose a $1.50 price ceiling is imposed on the • Competitive markets, operating free of price
market.
restraints, will be analyzed when:
– 𝑄𝑑 = 10 − 2 $1.50 = 7 units.
– 𝑄 𝑠 = 2 + 2($1.50) = 5 units. – Demand changes;
– Since 𝑄𝑑 > 𝑄 𝑠 a shortage of 7 − 5 = 2 units exists. – Supply changes;
– Full economic price of 5𝑡ℎ unit is 5 = 10 − 2𝑃𝑓𝑢𝑙𝑙 , or – Demand and supply simultaneously change.
𝑃𝑓𝑢𝑙𝑙 = $2.50. Of this,
• $1.50 is the dollar price
• $1 is the nonpecuniary price
2-33 2-34

Comparative Statics Comparative Statics

Changes in Demand Change in Demand in Action

• Increase in demand only
– Increase equilibrium price Demand for Rental Cars
– Increase equilibrium quantity Price Supply

• Decrease in demand only

– Decrease equilibrium price
– Decrease equilibrium quantity $49

• Example of change in demand

– Suppose that consumer incomes are projected to $45
increase 2.5% and the number of individuals over 25 Demand1
years of age will reach an all time high by the end of
next year. What is the impact on the rental car Demand0
market?
0 100 104 108 Quantity
(thousands
rented per day)

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Comparative Statics Comparative Statics

Changes in Supply Change in Supply in Action

• Increase in supply only
– Decrease equilibrium price
Price Supply1
– Increase equilibrium quantity
• Decrease in supply only Supply0
𝑃1
– Increase equilibrium price
– Decrease equilibrium quantity 𝑃0

• Example of change in demand

– Suppose that a bill before Congress would require Demand
all employers to provide health care to their
workers. What is the impact on retail markets?
0 𝑄1 𝑄0 Quantity

2-37 2-38

Comparative Statics Comparative Statics

Simultaneous Shifts in Supply and Demand Simultaneous Shifts in Supply and Demand in Action

• Suppose that simultaneously the following

events occur: Price
Japan’s Sake Market

Supply2
– an earthquake hit Kobe, Japan and decreased the C
𝑃2
supply of fermented rice used to make sake wine. Supply1

– the stress caused by the earthquake led many to B Supply0

𝑃1
increase their demand for sake, and other
alcoholic beverages. A
𝑃0
• What is the combined impact on Japan’s sake Demand1
Demand0
market?
0 𝑄2 𝑄0 𝑄1 Quantity

2-39 2-40

Demand
Conclusion Market Demand Curve
• Demand and supply analysis is useful for Price
(Dollars per Barrel) International Oil Market
– Clarifying the “big picture” (the general impact of
a current event on equilibrium prices and
quantities). $140

– Organizing an action plan (needed changes in $100

production, inventories, raw materials, human
resources, marketing plans, etc.). $60

$20 Demandoil

0 80 160 240 280 Quantity

(Millions of Barrels)

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Demand Demand

Changes in Quantity Demanded Change in Demand

Price
(Dollars per Barrel) International Oil Market International Oil Market
Price
(Dollars per Barrel)

$160

$140 $140

Increase in quantity demanded

$100 $100
$90 $90
Increase in demand

Demandoil2
Demandoil
Demandoil1

0 80 100 280 Quantity 0 80 100 120 140 280 Quantity

(Millions of Barrels) (Millions of Barrels)

2-43 2-44

Supply Supply
Change in Quantity Supplied The Market Supply Curve

International Oil Market International Oil Market

Price Supplyoil Price Supplyoil
(Dollars per Barrel) (Dollars per Barrel)

$140

$100

$65
Increase in quantity supplied
$60 $60

$20 $20

0 80 90 Quantity 0 80 160 240 Quantity

(Millions of Barrels) (Millions of Barrels)

2-45 2-46

Supply Market Equilibrium

Change in Supply in Action Competitive Market Equilibrium I

International Oil Market International Oil Market

Price Supplyoil2 Supplyoil1 Price Supplyoil
(Dollars per Barrel) Decrease in supply (Dollars per Barrel) Surplus
$140 $140 160 million barrels
Forces of demand and supply
$120 put downward
pressure on price.
$100 Pe = $80 Competitive market equilibrium
Q (P ) = Qs(Pe)
d e

Forces of demand and supply

$40 put upward pressure
$50
Shortage on price.
$20 $20 160 million barrels Demandoil

0 100 160 180 240 Quantity 0 40 Qe = 120 200 280 Quantity

(Millions of Barrels) (Millions of Barrels)

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Price Restrictions and Market Equilibrium Comparative Statics

Price Ceiling in Action I Changes in Demand
• Increase in demand only
International Oil Market – Increase equilibrium price
Price Supplyoil
(Dollars per Barrel) – Increase equilibrium quantity
$140 Lost social welfare • Decrease in demand only
Nonpecuniary price

Pf = $120 – Decrease equilibrium price

Pe = $80 Competitive market equilibrium
– Decrease equilibrium quantity
Qd(Pe) = Qs(Pe) • Example of change in demand
Pc = $40 Priceceiling – Suppose that worldwide demand for fuel-efficient
Shortage automobiles is projected to increase by 30% next year.
Demandoil
$20 160 million barrels What is the impact on the international crude oil
0 40 Qe = 120 200 280 Quantity
market?
(Millions of Barrels)

2-49 2-50

Comparative Statics Comparative Statics

Change in Demand in Action Changes in Supply

• Increase in supply only
International Oil Market – Decrease equilibrium price
Price Supplyoil
(Dollars per Barrel) – Increase equilibrium quantity
$140
• Decrease in supply only
– Increase equilibrium price
Pe1 = $80 – Decrease equilibrium quantity
• Example of change in demand
Pe2 = $36
– Suppose that war breaks out in a major oil-
$20 Demandoil2 Demandoil1 producing country in the Middle East. What is the
impact on the international crude oil market?
0 Qe2 = 68 Qe1 = 120 280 Quantity
(Millions of Barrels)

2-51 2-52

Comparative Statics Comparative Statics

Change in Supply in Action Simultaneous Shifts in Supply and Demand
• Suppose that simultaneously the following
International Oil Market
Price Supplyoil2 Supplyoil1
two events occur:
(Dollars per Barrel)
– worldwide demand for fuel-efficient automobiles
$140
is projected to increase by 30% next year.
Pe2 = $100 – war breaks out in a major oil-producing country in
Pe1 = $80 the Middle East.
• What is the combined impact on the
international crude oil market?
$20 Demandoil

0 Qe2 = 80 Qe1 = 120 280 Quantity

(Millions of Barrels)

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Comparative Statics
Simultaneous Shifts in Supply and Demand in Action

International Oil Market

Price Supplyoil2 Supplyoil1
(Dollars per Barrel)

$140

The equilibrium price increases

Pe1 = $80 or decreases depending on the
magnitude of the demand
Pe2 = $65 and supply changes.

$20 Demandoil2 Demandoil1

Qe2 = 10 Qe1 = 120 280 Quantity

(Millions of Barrels)

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