READ BEFORE YOU APPLY - 3 Short Papers 3 pages each ----- DUE in 12hours

Instructor – Dr. Gabriel Axarlian

• Chapter 2 Market Forces: Demand and Supply

o Demand

o Supply

Demand

• Suppose a clothing manufacturer desires information about the impact of its pricing decisions on the demand for its jeans in a small foreign market

o To obtain this information, it might engage in market research to determine how many pairs of jeans consumers would purchase each year at alternative prices per unit

o This fundamental economic principle revealed in the data is the law of demand - Price and quantity demanded are inversely related

Market Demand Curve: A curve indicating the total quantity of a good all consumers are willing and able to purchase at each possible price, holding the prices of related goods, income, advertising, and other variables constant • The line is downward

sloping, reflecting the law of demand

Change in Quantity Demanded: Changes in the price of a good lead to a change in the quantity demanded of that good. This corresponds to a movement along a given demand curve

Quantity (thousands per year)

Price ($)

Demand

$40

0

$30

$20

20 40

$10

60 80 • Also, all other factors that

influence demand are held constant at each point on the line

Demand Shifters

Quantity

Price

D1

Increase in

demand

A

B

D0D2

Decrease in

demand

Changes in Demand: Changes in variables other than the price of a good such as income or the price of another good, lead to a change in demand. This corresponds to a shift of the entire demand curve

Don’t be sloppy in terminology:

a “change in demand” a “change in quantity

demanded”

Quantity

P ri

c e

P ri

c e

Change in demand Change in quantity demanded

D1

D2

$1.00

.50

10 14.2

D1

$1.00

10 15

Quantity

Shifts of the Demand Curve

• Predominantly five factors affect demand

o Consumer Income

o Prices of Related Goods

o Advertising and Consumer Tastes

o Population

o Consumer expectations

1. Income

• Whether an increase in income shifts the demand curve to the right or to the left depends on the nature of consumer consumption patterns

Normal Good: The good for which an increase (decrease) in income leads to an increase (decrease) in the demand for a good

Inferior Good: The good for which an increase (decrease) in income leads to an decrease (increase) in the demand for a good

2. Prices of Related Goods

• Changes in the prices of related goods generally shift the demand curve for a good

Substitutes: Goods for which an increase (decrease) in the price of one good leads to an increase (decrease) in the demand for the other good

Compliments: Goods for which an increase (decrease) in the price of one good leads to an decrease (increase) in the demand for the other good

• Another variable that is held constant when drawing a given demand curve is the level of advertising

3. Advertising and Consumer Tastes

Quantity of high-style clothing

0

$50

$40

50,000

Price of high-style clothing

D2

60,000

Due to an increase in advertising

D1

informative advertising: Advertising often provides consumers with information about the existence or quality of a product, which in turn induces more consumers to buy the product; known as

persuasive advertising: Advertising can also influence demand by altering the underlying tastes of consumers

• The demand for a product is also influenced by changes in the size and composition of the population

4. Population

o Generally, as the population rises, more and more individuals wish to buy a given product, and this has the effect of shifting the demand curve to the right

5. Consumer Expectations

• Changes in consumer expectations also can change the position of the demand curve for a product

The Demand Function

Demand Function: A function that describes how much of a good will be purchased at alternative prices of that good and related goods, alternative income levels, and alternative values of other variables affecting demand

o Let 𝑸𝒙 𝒅 represent the quantity demanded of good X

o Let 𝑷𝒙 represent the price of good X

o Let 𝑷𝒚 represent the price of a related good

o Let 𝑴 represent income

o Let 𝑯 represent the value of any other variable that affects demand

o Then the demand function for good X may be written in a general form as

𝐐𝐱 𝐝 = 𝐟(𝐏𝐱,𝐏𝐲,𝐌,𝐇)

• Different products will have demand functions of different forms

o One very simple but useful form is the linear representation of the demand function

𝐐𝐱 𝐝 =∝𝟎 +∝𝐱 𝐏𝐱+∝𝐲 𝐏𝐲+∝𝐌 𝐌+∝𝐇 𝐇

o The ∝ 𝒔 are fixed numbers that the firm's research department or an economic consultant typically provides to the manager

o By the law of demand, an increase in 𝑷𝒙 leads to a decrease in the quantity demanded of good X

▪ This means that ∝𝒙 < 0

o The sign of ∝𝒚 will be positive if X and Y are substitutes

o The sign of ∝𝑴 will be positive if X is a normal good

• The information summarized in a demand function can be used to graph a demand curve o Since a demand curve is the relation between price and quantity, a representative

demand curve holds everything but price constant

o The sign of ∝𝒚 will be negative if X and Y are complements

o The sign of ∝𝑴 will be negative if X is an inferior good

Quantity

Price

𝑃𝑋 = 2,020 − 1

3 𝑄𝑋

𝑑

$2,020

6,060

and plugging in 𝐏𝐲 = $15, 𝐌 = $10,000,

and 𝐇 = 2,000, we get

𝐐𝐱 𝐝 = 𝟏𝟐,𝟎𝟎𝟎 − 𝟑𝐏𝐱 + 𝟒𝐏𝐲 − 𝟏𝐌 + 𝟐𝐇• Using this sample demand function

𝐐𝐱 𝐝 = 𝟔𝟎𝟔𝟎 − 𝟑𝐏𝐱

• We graph this relation with the price of the good on the vertical axis

ഥ𝟑

• This relation is called an inverse demand function

𝐐𝐱 𝐝 = 𝟔𝟎𝟔𝟎 − 𝟑𝐏𝐱 +𝟑𝐏𝐱𝟑𝐏𝐱 +−𝐐𝐱

𝐝 + −𝐐𝐱 𝐝

𝟑𝐏𝐱 = 𝟔𝟎𝟔𝟎 −𝐐𝐱 𝐝

𝟑

𝐏𝐱 = 𝟐𝟎𝟐𝟎 − 𝐐𝐱 𝐝

𝟑

Quantity

Price

Demand

$5

$3

$2

1 2

$1

4 5

Expenditures:

Consumer Surplus:

$4

3

Consumer SurplusConsumer Surplus

• We now show how a manager can use the demand curve to ascertain the value a consumer or group of consumers receives from a product o The concepts developed in

this section are particularly useful in marketing and other disciplines that emphasize strategies such as value pricing and price discrimination

Consumer Surplus: The value consumers get from a good but do not have to pay for

• More generally, consumer surplus is the area above the price paid for a good but below the demand curve

Total Consumer Value:

Quantity

Demand

$5

$3

$2

1 2

$1

4 5

Expenditures:

Choke Price

$4

3

Consumer Surplus

• A typical consumer's demand for the Happy Beverage Company's product looks like that in the figure

Demonstration Problem 2.2

Price

• At the market price of $3, how much revenue will the firm earn and how much consumer surplus will the typical consumer enjoy?

𝐑𝐞𝐯𝐞𝐧𝐮𝐞 = 𝐩𝐫𝐢𝐜𝐞 × 𝐪𝐮𝐚𝐧𝐭𝐢𝐭𝐲

𝐑𝐞𝐯𝐞𝐧𝐮𝐞 = $𝟑 × 𝟐

𝐑𝐞𝐯𝐞𝐧𝐮𝐞 = $𝟔 • The shape of the consumer surplus (CS) with a linear demand

curve is a triangle 𝐀𝐫𝐞𝐚 𝐨𝐟 𝐚 𝐓𝐫𝐢𝐚𝐧𝐠𝐥𝐞 =

𝟏

𝟐 𝐛𝐚𝐬𝐞 × 𝐡𝐞𝐢𝐠𝐡𝐭

𝐀𝐫𝐞𝐚 𝐨𝐟 𝐚 𝐓𝐫𝐢𝐚𝐧𝐠𝐥𝐞 = .𝟓(2) (𝐜𝐡𝐨𝐤𝐞 𝐩𝐫𝐢𝐜𝐞 − 𝐦𝐚𝐫𝐤𝐞𝐭 𝐩𝐫𝐢𝐜𝐞) __ __ __ __ __ __ _

𝐂𝐒 = .𝟓(𝟐)(𝟓 − 𝟑)

𝐂𝐒 = .𝟓(𝟐)(𝟐)

𝐂𝐒 = $𝟐

Consumer Surplus:

=Revenue $(3-0) x (2-0) = $6

(CS) = 0.5($5 - $3)x(2) = $2

Choke Price: The price at which quantity demanded is 0

Quantity of Liters

Demand

$5

$3

$2

1 2

$1

4 5

$4

3

Consumer Surplus

• What is the most a consumer would be willing to pay for a bottle containing exactly 2 liters of the firm's beverage?

Price

Demonstration Problem 2.2 (continued)

• The total value of 2 liters of the firm's beverage to a typical consumer is the sum of expenditure and consumer surplus 𝐓𝐂𝐕 = 𝟐 + 𝟔= $𝟖

• This is also the maximum amount a consumer would be willing to pay for a bottle containing exactly 2 liters of the firm's beverage

• Expressed differently, if the firm sold the product in 2-liter bottles rather than in smaller units, it could sell each bottle for $8 to extract all consumer surplus

Total Consumer Value:

Expenditures:

Consumer Surplus:

=Revenue $(3-0) x (2-0) = $6

(CS) = 0.5($5 - $3)x(2) = $2

Supply

Market Supply Curve: A curve indicating the total quantity of a good that all producers in a competitive market would produce at each price, holding input prices, technology, and other variables affecting supply constant

• In a competitive market there are many producers, each producing a similar product

Quantity

Price

A

B

S0

Change in Quantity Supplied: Changes in the price of a good lead to a change in the quantity supplied of that good. This corresponds to a movement along the supply curve.

Law of supply: As the price of a good rises and other things remain constant, the quantity supplied of the good rises (and vice versa)

Quantity

Price

S2

Decrease in supply

S0S 1

Increase in supply

Supply Shifters

Change in Supply: Changes in variables other than the price of a good, such as input prices or technological advances, lead to a change in supply. This corresponds to a shift of the entire supply curve.

1. Input Prices

2. Technology or Government Regulations

3. Number of Firms

4. Substitutes in Production

• Many firms have technologies that are readily adaptable to several different products

5. Taxes

An excise tax is a tax on each unit of output sold, where the tax revenue is collected from the supplier

Ad valorem literally means “according to the value”

6. Producer Expectations

The Supply Function

Supply Function: A function that describes how much of a good will be produced at alternative prices of that good, alternative input prices, and alternative values of other variables affecting supply

• Let 𝐐𝐱 𝐬 represent the quantity supplied of good x

• Let 𝐏𝐱 represent the price of good x • Let 𝐏𝐫 represent the price of technologically related goods • Let 𝐏𝐰 represent the price of an input (like the wage of labor) • Let 𝐇 represent the value of any other variable that affects supply

o Then the supply function for good x may be written in a general form as

𝐐𝐱 𝐬 = 𝐟(𝐏𝐱,𝐏𝐫,𝐏𝐰,𝐇)

• A particularly useful representation of a supply function is the linear relationship

𝐐𝐱 𝐬 = 𝛃𝟎 + 𝛃𝐱𝐏𝐱 + 𝛃𝐫𝐏𝐫 + 𝛃𝐖𝐏𝐰 + 𝛃𝐇𝐇

• The information summarized in a supply function can be used to graph a supply curve

Quantity

Price Supply

0

and plugging in 𝐏𝐫 = $100,𝐏𝐰= $2,000, we get

𝐐𝐱 𝐬 = 𝟐𝟎𝟎𝟎 + 𝟑𝐏𝐱 − 𝟒𝐏𝐫 − 𝟏𝐏𝐰• Using this sample supply function

𝐐𝐱 𝐬 = 𝟑𝐏𝐱 − 𝟒𝟎𝟎

𝐏𝐱 = 𝟒𝟎𝟎

𝟑 + 𝟏

𝟑 𝐐𝐱 𝐬

This relation is called an inverse supply function

−𝟑

−𝟑𝐏𝐱𝟑𝐏𝐱 +−𝐐𝐱 𝒔 − −𝐐𝐱

𝒔

−𝟑

−𝟑𝐏𝐱 = −𝟒𝟎𝟎 −𝐐𝐱 𝒔

𝑃𝑋 = 400

3 + 1

3 𝑄𝑋

𝑆

Quantity

Price Supply

$400

0 800

𝑃𝑋 = 400

3 + 1

3 𝑄𝑋

𝑆

$400

3

Producer surplus

𝑨𝒓𝒆𝒂 𝒐𝒇 𝒂 𝑻𝒓𝒊𝒂𝒏𝒈𝒍𝒆 = 𝟏

𝟐 𝒃𝒂𝒔𝒆 × 𝒉𝒆𝒊𝒈𝒉𝒕

𝑷𝒓𝒐𝒅𝒖𝒄𝒆𝒓 𝑺𝒖𝒓𝒑𝒍𝒖𝒔 = .𝟓(𝟖𝟎𝟎)(𝟒𝟎𝟎 − 𝟏𝟑𝟑.𝟑)

𝑷𝒓𝒐𝒅𝒖𝒄𝒆𝒓 𝑺𝒖𝒓𝒑𝒍𝒖𝒔 = $𝟏𝟎𝟔,𝟔𝟔𝟖

Producer Surplus: The amount producers receive in excess of the amount necessary to induce them to produce the good

Producer Surplus

• Producer surplus can be a powerful tool for managers

o Suppose the manager of a major fast−food restaurant currently purchases 10,000 pounds of ground beef each week from a supplier at a price of $1.25 per pound

▪ The meat supplier′s producer surplus tells the restaurant manager the dollar amount that the supplier is receiving over what it would be willing to accept for meat