Managerial Economics Week 2
Chapter Three
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Chapter 3
Supply and
Demand
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Chapter Three
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Overview
Market demand
Market supply
Market equilibrium
Comparative statics analysis
short-run analysis, long-run
analysis
Supply, demand, and price
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Chapter Three
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Market demand
- Demand for a good or service is defined
as quantities that people are ready
(willing and able) to buy at various prices
within some given time period
Other factors besides price are held
constant
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Chapter Three
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Market demand
Market demand is the sum of all the individual demands
Example: demand for pizza
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Chapter Three
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Market demand
The inverse relationship between price and the quantity demanded of a good or service is called the Law of Demand
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Chapter Three
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Market demand
- Changes in price result in changes in the quantity demanded
- This is shown as movement along the demand curve
- Changes in non-price factors result in changes in demand
- This is shown as a shift in the demand curve
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Chapter Three
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Market demand
- Nonprice determinants of demand
- tastes and preferences
- income
- prices of related products
- future expectations
- number of buyers
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Chapter Three
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Market supply
- The supply of a good or service is defined as quantities that people are ready to sell at various prices within some given time period
Other factors besides price held constant
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Chapter Three
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Market supply
- Changes in price result in changes in the quantity supplied
shown as movement along the supply curve
- Changes in non-price determinants result in changes in supply
shown as a shift in the supply curve
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Chapter Three
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Market supply
- Nonprice determinants of supply
- costs and technology
- prices of other goods or services offered by the seller
- future expectations
- number of sellers
- weather conditions
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Chapter Three
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Market equilibrium
- Equilibrium price: the price that equates the quantity demanded with the quantity supplied
- Equilibrium quantity: the amount that people are willing to buy and sellers are willing to offer at the equilibrium price level
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Chapter Three
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Market equilibrium
- Shortage: a market situation in which the quantity demanded exceeds the quantity supplied
shortage occurs at a price below the equilibrium level
- Surplus: a market situation in which the quantity supplied exceeds the quantity demanded
surplus occurs at a price above the equilibrium level
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Chapter Three
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Market equilibrium
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Chapter Three
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Comparative statics analysis
- Comparative statics is a form of sensitivity (or what-if) analysis
Commonly used method in economic analysis
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Chapter Three
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Comparative statics analysis
- Process of comparative statics analysis:
- state all the assumptions needed to construct the model
- begin by assuming that the model is in equilibrium
- introduce a change in the model, so a condition of disequilibrium is created
- find the new point of equilibrium
- compare the new equilibrium point with the original one
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Comparative statics: example
Step 1
- assume all factors except the price of pizza are constant
- buyers’ demand and sellers’ supply are represented by lines shown
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Chapter Three
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Comparative statics: example
Step 2
- begin the analysis in equilibrium as shown by Q1 and P1
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Chapter Three
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Comparative statics: example
Step 3
- assume that a new study shows pizza to be the most nutritious of all fast foods
- consumers increase their demand for pizza as a result
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Chapter Three
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Comparative statics: example
Step 4
- the shift in demand results in a new equilibrium price (P2)
- and a new equilibrium quantity (Q2)
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Comparative statics: example
Step 5
- comparing the new equilibrium point with the original one, we see that both equilibrium price and quantity have increased
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Chapter Three
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Comparative statics analysis
- The short run is the period of time in which:
- sellers already in the market respond to a change in equilibrium price by adjusting variable inputs
- buyers already in the market respond to changes in equilibrium price by adjusting the quantity demanded for the good or service
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Chapter Three
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Comparative statics analysis
- Short run changes show the rationing function of price
The rationing function of price is the change in market price to eliminate the imbalance between quantities supplied and demanded is the change in market price to eliminate the imbalance between quantities supplied and demanded
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Chapter Three
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Short-run analysis
- an increase in demand causes equilibrium price and quantity to rise
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Chapter Three
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Short-run analysis
- a decrease in demand causes equilibrium price and quantity to fall
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Chapter Three
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Short-run analysis
- an increase in supply causes equilibrium price to fall and equilibrium quantity to rise
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Chapter Three
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Short-run analysis
- a decrease in supply causes equilibrium price to rise and equilibrium quantity to fall
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Chapter Three
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Long run analysis
- The long run is the period of time in which:
- new sellers may enter a market
- existing sellers may exit from a market
- existing sellers may adjust fixed factors of production
- buyers may react to a change in equilibrium price by changing their tastes and preferences
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Chapter Three
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Long run analysis
- Long run changes show the allocating function of price
- The guiding or allocating function of price is the movement of resources into or out of markets in response to a change in the equilibrium price
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Chapter Three
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Long-run analysis
- initial change: decrease in demand from D1 to D2
- result: reduction in equilibrium price and quantity (to P2,Q2)
- follow-on adjustment:
- movement of resources out of the market
- leftward shift in the supply curve to S2
equilibrium price and quantity (to P3,Q3)
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Chapter Three
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Long-run analysis
- initial change: increase in demand from D1 to D2
- result: increase in equilibrium price and quantity (to P2,Q2)
- follow-on adjustment:
- movement of resources into the market
- rightward shift in the supply curve to S2
equilibrium price and quantity (to P3,Q3)
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Chapter Three
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Supply, demand, and price:
the managerial challenge
- in the extreme case, the forces of supply and demand are the sole determinants of the market price, not any single firm
- this type of market is ‘perfect competition’
- in many cases, individual firms can exert market power over price because of their:
- dominant size
- ability to differentiate their product through advertising, brand name, features, or services
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