Managerial Economics
ninth edition
Thomas
Maurice
Chapter 2
Demand, Supply, &
Market Equilibrium
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Managerial Economics, 9e
Managerial Economics, 9e
Copyright © 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
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
Managerial Economics
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
Managerial Economics
General Demand Function
Variable
2-5
Relation to Qd
Sign of Slope Parameter
P
Inverse
b = Qd/P is negative
M
Direct for normal goods
Inverse for inferior goods
c = Qd/M is positive
c = Qd/M is negative
PR
Direct for substitutes
Inverse for complements
d = Qd/PR is positive
d = Qd/PR is negative

Direct
e = Qd/  is positive
Pe
Direct
f = Qd/Pe is positive
N
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 (ceteris paribus)
• Qd/P must be negative
2-6
Managerial Economics
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
Managerial Economics
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
Managerial Economics
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
2-10
Managerial Economics
Shifts in Demand
2-11
(Figure 2.2)
Managerial Economics
Supply
• Quantity supplied (Qs)
• Amount of a good or service offered
for sale during a given period of time
2-12
Managerial Economics
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
•
2-13
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
2-14
Managerial Economics
General Supply Function
Variable
2-15
Relation to Qs
Sign of Slope Parameter
P
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
T
Direct
n = Qs/T is positive
Pe
Inverse
r = Qs/Pe is negative
F
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)
2-16
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)
2-17
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
2-18
Managerial Economics
A Supply Curve
2-19
(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
2-20
Managerial Economics
Shifts in Supply
2-21
(Figure 2.4)
Managerial Economics
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
2-22
Managerial Economics
Market Equilibrium
2-23
(Figure 2.5)
Managerial Economics
Market Equilibrium
• Excess demand (shortage)
• Exists when quantity demanded
exceeds quantity supplied
• Excess supply (surplus)
• Exists when quantity supplied exceeds
quantity demanded
2-24
Managerial Economics
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
2-25
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
2-26
Managerial Economics
Measuring the Value of Market
Exchange (Figure 2.6)
2-27
Managerial Economics
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
2-28
Managerial Economics
Demand Shifts (Supply Constant)
(Figure 2.7)
2-29
Managerial Economics
Supply Shifts (Demand Constant)
(Figure 2.8)
2-30
Managerial Economics
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
2-31
Managerial Economics
Simultaneous Shifts: (D, S)
P
S
S’
S’’
B
P’
P
P’’
A
•
•
•C
D’
D
Q
Q
Q’
Q’’
Price may rise or fall; Quantity rises
2-32
Managerial Economics
Simultaneous Shifts: (D, S)
P
S
S’
S’’
A
•
P
B
P’
•
•C
P’’
D
D’
Q
Q’ Q
Q’’
Price falls; Quantity may rise or fall
2-33
Managerial Economics
Simultaneous Shifts: (D, S)
P
S’’
S’
P’’
•
S
C
B
•
P’
A
•
P
D’
D
Q
Q’’
Q Q’
Price rises; Quantity may rise or fall
2-34
Managerial Economics
Simultaneous Shifts: (D, S)
P
S’’
S’
S
P’’
P
P’
•C
A
•
B
•
D
D’
Q’’
Q
Q’
Q
Price may rise or fall; Quantity falls
2-35
Managerial Economics
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
2-36
Managerial Economics
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
2-37
Qx
32 50
84
Quantity
Panel B – Floor price
Qx