Microeconomics

Demand and Supply

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Market Demand Curve

• Shows the amount of a good that will be

purchased at alternative prices.
• Law of Demand

The demand curve is downward sloping.

Price

Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
Determinants of Demand
• Income
• Prices of substitutes
• Prices of complements
• Advertising
• Population
• Consumer expectations

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 The Demand Function
• An equation representing the demand curve
Qxd = f(Px , PY , M, H,)

 Qxd = quantity demand of good X.

 Px = price of good X.
 PY = price of a substitute good Y.

M = income.

H = any other variable affecting demand

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
Change in Quantity Demanded
Price
A to B: Increase in quantity demanded

A
10

B
6

D0

4 7 Quantity

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Change in Demand
Price
D0 to D1: Increase in Demand

6
D1

D0

7 13 Quantity

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Consumer Surplus:

• The value consumers get from a good but

do not have to pay for.

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Consumer Surplus:

Price

10
Consumer Surplus:
8 The value received but not
paid for
6
4

2
D
1 2 3 4 5 Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Consumer Surplus:

Price $

10 Value
of 4 units
8
Consumer
Surplus 6
4 Total Cost of 4 units

2
D
1 2 3 4 5 Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Market Supply Curve
• The supply curve shows the amount of a good
that will be produced at alternative prices.
• Law of Supply

The supply curve is upward sloping

Price
S0

Quantity

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Supply Shifters
• Input prices
• Technology or
government regulations
• Number of firms
• Substitutes in
production
• Taxes
• Producer expectations

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 The Supply Function
• An equation representing the supply curve:
QxS = f(Px , PR ,W, H,)

 QxS = quantity supplied of good X.

 Px = price of good X.
 PR = price of a related good

W = price of inputs (e.g., wages)

H = other variable affecting supply

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
Change in Quantity Supplied
Price A to B: Increase in quantity supplied

S0
B
20

A
10

5 10 Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Change in Supply
S0 to S1: Increase in supply
Price

S0

S1

5 7 Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Producer Surplus
• The amount producers receive in excess of the amount
necessary to induce them to produce the good.

Price
S0
P*
Producer
Surplus

Q* Quantity

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 Market Equilibrium
• Balancing supply and
demand
 Q S= Q d
x x

• Steady-state

Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 If price is too low…
Price S

7
6

Shortage D
12 - 6 = 6
6 12 Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003
 If price is too high…
Surplus
Price 14 - 6 = 8
S
9

8
7

6 8 14 Quantity
Michael R. Baye, Managerial Economics and Business Strategy, 4e. ©The McGraw-Hill Companies, Inc. , 2003