Suma Damodaran

IIM Udaipur

Microeconomics for Managers

Preliminaries,
Market Equilibrium
 Suma Damodaran
IIM Udaipur

Welcome!

 A few things for our online course!

 Since I am TFH (Teaching from Home!) there might
be power/ wifi interruptions. Just hang on, I will be
back in a few minutes
 Put your video on, as far as possible
 Be muted
 However, whenever you want to ask a question, or
interject, unmute and jump in. Need not raise hand;
or send a chat message
 Suma Damodaran
IIM Udaipur

 Tremendous stress on Academic Integrity

 Suma Damodaran
IIM Udaipur

Is economics

 Arcane, incomprehensible?
 Especially for those that are absolutely new
to the subject?
 Suma Damodaran
IIM Udaipur

Seems like!

With all those horrible graphs!

 Suma Damodaran
IIM Udaipur

No. It is not!

 Its basic principles are:

– Logically simple and Commonsensical

And what do you

think of
economists?
 Suma Damodaran
IIM Udaipur

Ed Arno cartoon
 Suma Damodaran
IIM Udaipur

Are you….

 skeptical about the course?

 Do you feel the need for the course at all??!

A candid, frank answer will be appreciated!!

And then my task begins of driving home

the relevance…..in a managerial context.
 Suma Damodaran
IIM Udaipur

Learning Objective

 At the end of this session and the next, you

should be able to:
– Appreciate the relevance of microeconomics for
managers
– Understand how market equilibrium is arrived at,
through the interplay of supply and demand
forces
 Suma Damodaran
IIM Udaipur

Economics.. the two streams

 1. Microeconomics: At the level of the

individual: consumer, or producer
 2. Macroeconomics: At the aggregate level:
Region, or Nation
Concepts/Jargons?

Another Course
 Suma Damodaran
IIM Udaipur

Microeconomics

Demand, Production, Costs,

Prices, Supply, Sensitivity of
Demand

 But, for all the above terms, we need to

fundamentally ask:
– What business are you in? Which is your industry?
– Who is your customer? Who is your competitor?
 Suma Damodaran
IIM Udaipur

Toyota Prius

The world’s first hybrid!

If you were Toyota, what questions would you
desperately seek answers for?
Suma Damodaran
IIM Udaipur
 Suma Damodaran
IIM Udaipur

More deep/dense questions

 What do customers want?....preferences vis-

à-vis other cars, other means of
transportation, other means of mobility
 Consumers also want to know the price so
that they can work out whether they have the
willingness and ability to pay- DEMAND
 In order to provide the price, the firms have to
work out the costs- efficiency cosiderations….
 Suma Damodaran
IIM Udaipur

Toyota Prius

 The world’s first hybrid!

 If you were Toyota, what questions would you
desperately seek answers for?
– Demand, and growth in demand; What do
customers want? Preferences; trade offs
– Pricing, and effect on demand
 What are they willing to pay for specific product
features?
– Production costs
 Effect of quantity produced, experience, and cost of raw
materials/ labor/ capital, technology
 Suma Damodaran
IIM Udaipur

Toyota Prius

 The world’s first hybrid!

 If you were Toyota, what questions would you
desperately seek answers for?
– Profits
 Will it make profits? How can profits be increased?
– What will competitors do? How will they react?
 Strategy!
– Other: incentives for workers and managers,
uncertainty, regulations, public policy, environment
– Other Organisational aspects
 Suma Damodaran
IIM Udaipur

Toyota Prius

Even before all this therefore,…..

What is/are the primary question/s or basic
question/s that you would first seek an
answer/s for?
 Suma Damodaran
IIM Udaipur

Toyota Prius

 For this, we need to ask:

– What business are you in? Which is your industry?
– Who is your customer? Who is your competitor?
 See the basic questions? So, what business
is Toyota in?
 Suma Damodaran
IIM Udaipur

Toyota Prius

 But, for this, we need to ask:

– What business are you in? Which is your industry?
– Who is your customer? Who is your competitor?
 See the basic questions? So, what business is Toyota in?
 Important to understand that though they are in the
automobile industry, they are in the business of mobility
 Therefore, their customers basic ‘want’ is mobility and
therefore Toyota’s competitor could be Uber, Zoomcar etc;
not just another car manufacturer

What business are you in – classic advice from Theodore

Levit
 Suma Damodaran
IIM Udaipur

Another instance…

 Auto 2020: GWM rebranded as Global

Mobility Technology Company

 looks to establish a brand that promises

best of “Technovation”, “Mobility” and
“Sustainability”….GWM Overview
 The latest news??
 Suma Damodaran
IIM Udaipur

Defining Markets: Importance of

Context

 Heard of Salad Days ?

 Read Example 1.1, 1.2

Supplementary reading- Notes on Markets,

business and industry
 Suma Damodaran
IIM Udaipur

What Business are we in?

 Theodore Levitt- That Cos should stop defining

themselves by what they ‘produced’…instead
they should reorient themselves to what
customers ‘need’……….
The railroads industry declined because they
thought they were in the Railroad industry and
NOT in the transportation Business!
They were railroad oriented ..NOT transportation
oriented…They were production oriented and
NOT…..
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Equilibrium Analysis
Interaction of Supply and Demand

Recurring Themes:
1. Markets, and Prices
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

If you were to
plot demand,
how will the
Price

graph look?

Quantity (kgs)
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

Note:

Normally, when we say Y = f(X) we

show Y on Y axis and X on X axis
Price

Here though it is Quantity that is a

function of price, we show Price on
the Y axis and Quantity on the X
axis, as a convention

Quantity
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

DEMAND
Price

Quantity (kgs)
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

If you were to
plot demand,
how will the
graph look?
Price

And supply?

Quantity (kgs)
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

DEMAND

So,
SUPPLY
now?
Price

Quantity (kgs)
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

DEMAND
The equilibrium, market
clearing price ‘discovered’
through the interaction of the SUPPLY
forces of demand and supply
in the market
Price

Quantity (kgs)
 Suma Damodaran
IIM Udaipur

A numerical example
 Demand Equation: P = 300 – Q

 Supply Equation: P = 60 + 2Q
 Suma Damodaran
IIM Udaipur

A numerical example
 Demand Equation: P = 300 – Q or Q= 300 - P

 Supply Equation: P = 60 + 2Q or Q= -30+0.5P

 Equating the two and solving for Q or for P, we have,

 Q = 80; P = 220
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Equilibrium Analysis
Interaction of Supply and Demand

 We will see this in the context of a

hypothetical market: a market for pencils
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Supply Side Analysis

– How many pencils can possibly come to the
‘market’, maximum?
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Supply Side Analysis

– How many pencils can possibly come to the
‘market’, maximum: 7
– How many would ‘suppliers’ be willing to bring to
the market/ want to sell?
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Supply Side Analysis

– How many pencils can possibly come to the
‘market’, maximum: 7
– How many would ‘suppliers’ be willing to bring to
the market/ want to sell: all 7, because unsold
pencils are worth nothing (assumption)
– Therefore, how will the supply curve, ‘supply
schedule’ look like?
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

SS

Interpretation: Note the

notation
Suppliers willing to
sell all 7 pencils at
any price greater
Price

than zero

Quantity 7
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis

– How do we begin?
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis

– How do we begin?
– Unlike the supply side analysis, here we must
look at the demand schedule for each of the three
people on the demand side individually and then
aggregate the demand; because each ‘consumer’
has different ‘preferences’ and thus different
valuations for the number of pencils
– How will you start your analysis? A method?
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = 1, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4

Buyer 1 0

Buyer 2 0

Buyer 3 0
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = 1, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4

Buyer 1 0 1-1 = 0

Buyer 2 0 1-1 = 0

Buyer 3 0 .5-1 = -.5

 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = 1, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4 Now , how
will Buyer
1, Buyer 2
Buyer 1 0 1-1 = 0 1.5-2 = 1.8-3 = 1.85-4 = and Buyer
3 arrive at
-.5 -1.2 -2.15 and their
choice of
so on quantity?

The rule:
Buyer 2 0 1-1 = 0 1.3 – 2 = 1.5 – 3 = 1.6 – 4 = Each
buyer will
-.7 -1.5 -2.4 and choose a
so on quantity
that
maximizes
Buyer 3 0 .5-1 = -.5 1-2 = -1 1.5- 3 = net benefit

-1.5 and
so on
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = 1, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4
And
therefore
Buyer 1 0 1-1 = 0 1.5-2 = 1.8-3 = 1.85-4 = what is the
-.5 -1.2 -2.15 and aggregate
demand at
so on price = 1?

Buyer 2 0 1-1 = 0 1.3 – 2 = 1.5 – 3 = 1.6 – 4 =

-.7 -1.5 -2.4 and
so on
Buyer 3 0 .5-1 = -.5 1-2 = -1 1.5- 3 =
-1.5 and
so on
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis

– At price = 1, quantity demanded can be 0, 1 or 2
(Assumption: indifference between points of equal
net benefit)
– And quantity supplied remains 7
– Therefore, what would happen to the price?
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

SS
1
At price = 1, SS > DD
Note the
notation
Price

2 Quantity 7
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis

– At price = 1, quantity demanded can be 0, 1 or 2
(Assumption: indifference between points of equal
net benefit)
– And quantity supplied remains 7
– Therefore, what would happen to the price?
– The price would fall!
Your first lesson in market dynamics!
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = .9, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4

Buyer 1 0 1-.? = ? 1.5-? = ? 1.8-? = ? 1.85-?

=?

Buyer 2 0 1-.? = ? 1.3 – ? 1.5 – ? 1.6 – ?

=? =? =?
Buyer 3 0 .5-? = 1-? = 1.5- ? = ?
? ?
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = .9, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4

Buyer 1 0 1-.9 = .1 1.5-1.8 = 1.8-2.7 = 1.85-3.6

-.3 -0.9 =-1.75
and so on
Buyer 2 0 1-.9 = .1 1.3 – 1.8 1.5 – 2.7 1.6 – 3.6
= -.5 = -1.2 = -2.0
and so on
Buyer 3 0 .5-.9 = 1-1.8 = 1.5- 2.7 =
-.4 -.8 -1.2 and
so on
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = .9, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4

Buyer 1 0 1-.9 = .1 1.5-1.8 = 1.8-2.7 = 1.85-3.6 And

therefore
-.3 -0.9 =-1.75 what is the
aggregate
and so on demand at
price = .9?
Buyer 2 0 1-.9 = .1 1.3 – 1.8 1.5 – 2.7 1.6 – 3.6
= -.5 = -1.2 = -2.0
and so on
Buyer 3 0 .5-.9 = 1-1.8 = 1.5- 2.7 =
-.4 -.8 -1.2 and
so on
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis

– At price = 0.9, quantity demanded will be 2
(Assumption: indifference between points of equal
net benefit)
– And quantity supplied remains 7
– Therefore, what would happen to the price?
Price would fall again.
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

SS
1
0.9
Note the
At price = .9 also, SS > notation
DD
Price

2 Quantity 7
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = .5, what is

their net benefit (value minus cost)? Now do!
Q 0 1 2 3 >4

Buyer 1

Buyer 2

Buyer 3
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = .5, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4

Buyer 1 0 1-.5 = .5 1.5-1 = .5 1.8-1.5 1.85-2 And

therefore
= .3 =- .15 what is the
aggregate
and so on demand at
price = .5?
Buyer 2 0 1-.5 = .5 1.3 – 1.5 – 1.5 1.6 – 2 =
1= .3 =0 -.4 and
so on
Buyer 3 0 .5-.5 = 0 1-1 = 0 1.5- 1.5 = 1.5- 2 =
0 and so -.5 and
on so on
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

SS
1
0.9
Note the
notation

0.5
At price = .5 also, SS is
Price

slightly more than DD

2 Quantity 6 7
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis; If price = .3, what is

their net benefit (value minus cost)?
Q 0 1 2 3 >4

Buyer 1 0 1-.3 = .7 1.5-.6 1.8-.9 1.85-1.2 And

therefore
= .9 = .9 = .65 and what is the
aggregate
so on demand at
price = .3?
Buyer 2 0 1-.3 = .7 1.3 1.5 – .9 = 1.6 –1.2
–.6= .7 .6 = .4 and
so on
Buyer 3 0 .5-.3 = .2 1-.6 = .4 1.5- .9
= .6 and
so on
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

 Demand Side Analysis

– At price = 0.3, quantity demanded can be 7 or 8
(Assumption: indifference between points of equal
net benefit)
– And quantity supplied remains 7
– Therefore, what would happen to the price?
– Nothing! Equilibrium would be achieved!
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

SS
1
0.9
Note the
notation

DD
Price

0.5

0.3

2 Quantity 6 7
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis

SS
1
0.9

DD
Price

0.5
An equilibrium
price has been
0.3 discovered!

2 Quantity 6 7
 Suma Damodaran
IIM Udaipur

Equilibrium Analysis; Price

Discovery

The equilibrium, market

DEMAND clearing price ‘discovered’
through the interaction of the
forces of demand and supply
in the market. Price discovery SUPPLY
is the basic function of a
market mechanism
Price

Quantity
 Suma Damodaran
IIM Udaipur

 https://www.youtube.com/watch?v=aluuekJIh
WI
 Suma Damodaran
IIM Udaipur

Markets = Supply AND Demand

 Suma Damodaran
IIM Udaipur

After the class …..

 read again-Chapter 1 (except 1.3) of P&R