Chapter 2 - Demand, Supply and Equilibrium

Demand, Supply and Equilibrium
Prices
Chapter 2
Why Should Managers Study
Supply and Demand?
 Managers need to understand supply and
demand to develop their own competitive
strategies and to respond to the actions of their
competitors.
 Managers need to understand how the
structure of the market that their firm operates
in impacts supply and demand.
 Managers need to understand how public
policy will impact supply and demand.
2
Copyright © 2010 Pearson Education, Inc.
Publishing as Prentice Hall
Demand
 The functional 7
relationship between 6
the price of a good or 5
service and the 4
Price
3
quantity demanded 2
by consumers in a 1
given period of time, 0
all else held 0 5 10 15
constant. Quantity
3
Nonprice Factors Influencing
Demand
 Tastes and preferences

 Income
 Prices of goods related in consumption
 Future expectations
 Number of potential consumers
4
Tastes and Preferences
 Tastes and preferences are how potential

consumers feel about a good or service and
how well a good or service meets a
consumer’s desire.
5
Tastes and Preferences in Action
 In the aftermath of the September 11, 2001,
terrorist attacks on New York and Washington,
D.C., the tastes and preferences of U.S.
consumers for airline travel changed
dramatically.
 In spring, 2006, the National Chicken Council
waged a campaign to prevent fears of the
avian flu in Asia from impacting the demand for
chicken in the United States.
6
Income
 The level of a person’s income also affects demand,
because demand incorporates both willingness and
ability to pay for the good.
 If an increase (decrease) in income causes a person to
buy more (less) steak, then for that person, steak is
said to be a normal good.
 If an increase (decrease) in income causes a person to
buy less (more) hamburger, then for that person,
hamburger is said to be an inferior good.
7
Income in Action
 Firms selling normal goods, like, jewelry,

automobiles and clothing experience increases
in sales when the general economy is
booming, like, in the late 1990’s.
 Firms selling inferior goods, like, hamburger,
used clothing and generic bleach experience
increases in sales when the general economy
is in recession, like, in the second half of 2008.
8
Prices of Related Goods
 Prices of related goods will also affect the

demand for a good or service.
 Products or services are substitute goods for
each other if one can be used in place of
another.
 Complementary goods are products or
services that consumers use together.
9
Prices of Related Goods in Action
 By 2006 the abundance and relatively low prices of cell
phones, iPods, and laptop computers resulted in many
teens and young adults no longer purchasing
wristwatches. These all serve as substitutes for
watches.
 As prices of personal computers have dropped over
time, there has been an increased demand for printers
and printer cartridges. Personal computers and
printers are complementary products.
10
Future Expectations
 Expectations about future prices also play a

role in influencing current demand for a
product.
11
Future Expectations in Action
 In summer, 2004, many consumers responded

to high lumber prices by waiting to purchase
until fall when a normal seasonal decline was
expected to occur. One developer in Maryland
bought only as much wood as he needed
week-by-week because the high summer
prices had increased the cost of wood for a
typical apartment by 50 percent.
12
Number of Potential Consumers
 The number of consumers in the marketplace

influences the demand for a product.
13
Number of Potential Consumers in
Action
 The effect of growing populations on demand

and grain prices can be seen as both increases
in the size of the population in Asian and Latin
American economies and growth in the
middleclass segments of these economies had
a stimulating effect on the demand for many
types of grain from US farmers.
14
Expressing Demand Functions
 Qxd = f(Px,T,I,Py,Pz,EXP,N)
7  where
6 – Qxd = quantity of good x
5 demanded
4
Price
– Px = price of good x
3 – T = variables representing
2 tastes and preferences
1 – I = income
0 – Py = price of related good y
0 5 10 15
– Pz = price of related good z
– EXP = expected future prices
Quantity – N = number of consumers
15
Demand
 Demand curves are generally portrayed as

downward sloping, suggesting an inverse or
negative relationship between the price of the
good and the quantity demanded, all else
equal.
 When the price of a good rises the quantity
demanded falls, all else equal.
16
Individual vs. Market Demand
P  Market demand is
the horizontal sum of
individual demand
curves.
D1 D2 D1 + D2
17 Q
Demand Curve Shift vs. Movement
Along a Demand Curve
P P
D2 A to B: change (increase)
in demand D1
A to B: change (increase)
in quantity demanded
D1
P1 A B P1 A
B
P2
Q1 Q2 Q Q1 Q2 Q
18
Supply
 The functional
relationship between
the price of a good or
service and the
Price
quantity supplied by
producers in a given
time period, all else
help constant. Quantity
19
Nonprice Factors Influencing
Supply
 Technology
 Input prices
 Prices of goods related in production
 Future expectations
 Number of producers
20
Technology
 The state of technology, or the body of

knowledge about how to combine the inputs of
production, affects what output producers will
supply because technology influences how the
good or service is actually produced, which, in
turn, affects the costs of production.
21
Technology in Action
 In the nickel industry, most of the world’s production
has come from deposits that were relatively easy to
exploit. However, these deposits comprise only about
40 percent or less of the world’s remaining reserves.
During the 1990s companies tried to develop a process
called “high pressure acid leaching” to remove nickel
from other rock deposits. This new technology could
fundamentally alter the supply of nickel on world
markets.
22
Input Prices
 Input prices are the prices of all the inputs or

factors of production—labor, capital, land, and
raw materials—used to produce the given
product. These input prices affect the costs of
production and, therefore, the prices at which
producers are willing to supply different
amounts of output.
23
Input Prices in Action
 For broiler chickens, feed costs represent 70

to 75 percent of the costs of growing a chicken
to a marketable size. Thus, changes in feed
costs are so important that market analysts
often use them as a proxy to forecast broiler
prices and returns to broiler processors.
24
Prices of Related Goods
 The prices of other goods related in production

can also affect the supply of a particular good.
– Two goods are substitutes in production if the
same inputs can be used to produce either of the
goods, such as land for different agricultural crops.
– Two goods are complementary in production if the
production of one is a by-product of the production
of the other.
25
Prices of Related Goods in Action
 Switching from corn to  As more oil and natural
tobacco, a farmer in Illinois gas are produced, the
netted $1,800 per acre supply of sulfur, which is
from his 150 acres of removed from the
tobacco compared with products, also increases.
$250 per acre for corn and Sixty-foot-high blocks of
that planting tobacco had unwanted sulfur were
increased his annual reported in Alberta,
income by 35 percent over Canada, and Kazakhstan
the previous three years. in 2003.
26
Future Expectations
 If producers expect prices to increase in the

future, they may supply less output now than
without those expectations. The opposite could
happen if producers expect prices to decrease
in the future.
27
Number of Producers
 The number of producers influences the total

supply of a product at any given price. The
number of producers may increase because of
perceived profitability in a given industry or
because of changes in laws or regulations
such as trade barriers.
28
Number of Producers in Action
 For example, the lumber market was reported

to be exceedingly strong in January 1999,
largely due to demand from the booming U.S.
housing market. However, quotas on the
amount of wood that Canada could ship into
the United States also played a role in keeping
the price of lumber high in the United States in
January of that year.
29
Supply
 Supply curves are generally portrayed as

upward sloping, suggesting a direct or positive
relationship between the price of the good and
the quantity supplied, all else equal.
 When the price of a good rises the quantity
supplied rises, all else equal.
30
Expressing Supply Curves
 Qxs=f(Px,TX,Pi,Pa,Pb,EXP,N)
 where
– Qxs = quantity of good x
supplied
– Px = price of good x
Price
– T = variables representing
tastes and preferences
– I = income
– Py = price of related good y
– Pz = price of related good z
– EXP = expected future prices
Quantity
– N = number of consumers
31
Supply Curve Shift vs. Movement
Along a Supply Curve
P P
S1 S2 S1
B
P2
A B
P1 A
P1
A to B: change (increase)
A to B: change (increase) in quantity demanded
in demand
Q1 Q2 Q Q1 Q2 Q
32
Market Equilibrium
 The market equilibrium
Price
price and quantity is that
price for which the
quantity supplied is
equal to the quantity PE
demanded.
QE Quantity
33
Copyright © 2010 Pearson Education,
Inc. Publishing as Prentice Hall
Surplus Disequilibrium
 At prices where the P S
quantity supplied
surplus
exceeds the quantity P1
demanded there exists a
surplus in that market at
that price.
34 Q
Shortage Disequilibrium
 At prices where the P
S
quantity demanded
exceeds the quantity
supplied there exists a
shortage in that market
at that price.
P2
shortage
D
35 Q
Changes in Equilibrium – Demand
Induced
 When nonprice demand P
factors change, the
demand curve shifts and S
produces a change in
P3
the equilibrium price and
quantity. P2
P1
D1 D2 D3
36 Q1 Q2 Q1 Q
Changes in Equilibrium – Supply
Induced
 When nonprice P S1
factors change, the S2
supply curve shifts S3
and produces a P1
change in the P2
equilibrium price and P3
quantity.
D1
37 Q1 Q2 Q3 Q
Changes in Equilibrium – Changes
in Demand and Supply
 When nonprice P S1
factors change, the

supply and demand S2
curves may both shift P1
and produce a P2
change in the
equilibrium price and D2
quantity. D1
38 Q1 Q2 Q

Chapter 2 - Demand, Supply and Equilibrium

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Chapter 2 - Demand, Supply and Equilibrium

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Demand, Supply and Equilibrium

 Tastes and preferences

 Tastes and preferences are how potential

 Firms selling normal goods, like, jewelry,

 Prices of related goods will also affect the

 Expectations about future prices also play a

 In summer, 2004, many consumers responded

 The number of consumers in the marketplace

 The effect of growing populations on demand

 Demand curves are generally portrayed as

 The state of technology, or the body of

 Input prices are the prices of all the inputs or

 For broiler chickens, feed costs represent 70

 The prices of other goods related in production

 If producers expect prices to increase in the

 The number of producers influences the total

 For example, the lumber market was reported

 Supply curves are generally portrayed as

equilibrium price and P3

factors change, the

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