Managerial Economics Thomas

eighth edition Maurice

Chapter 2

Demand, Supply, &

Market Equilibrium
McGraw-Hill/Irwin
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Demand
• Quantity demanded (Qd)
• Amount of a good or service
consumers are willing & able to
purchase during a given period of time

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Demand
• 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)
• Generalized demand function
• Qd  f ( P, M , PR , , Pe , N )
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Generalized 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

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Generalized Demand Function

Variable Relation to Qd Sign of Slope Parameter

P Inverse b = Qd/P is negative

Direct for normal goods
M
Inverse for inferior goods
PR Direct for substitutes
Inverse for complements
c = Qd/M is positive
c = Qd/M is negative
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

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Demand Function
• Demand function, or demand, shows
relation between P & Qd 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
• Qd/P must be negative

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Graphing Demand Curves

• 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)

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Graphing Demand Curves

• A point on a 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

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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
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Shifts in Demand (Figure 2.2)

P

80

D1
70
Demand
60 increase
D0
Price (dollars)

$50, 300
50
• • $50, 600
D2
40
•
$40, 200
• $40, 500
30
Demand
20 decrease

10

Qd
0 100 300 500 700 900 1,100 1,300 1,500

Quantity

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Supply
• Quantity supplied (Qs)
• Amount of a good or service offered
for sale during a given period of time

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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)
• Generalized supply function
• Qs  f ( P, PI , Pr , T , Pe , F )
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Generalized 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

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Generalized Supply Function

Variable Relation to Qs Sign of Slope Parameter

P Direct k = Qs/P is positive

PI Inverse l = Qs/PI is negative

Inverse for substitutes m = Qs/Pr is negative

Pr
Direct for complements 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

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Supply Function
• Supply function, or supply, shows
relation between P & Qs when all
other variables are held constant
• Qs = g(P)

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Graphing Supply Curves

• A point on a 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

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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
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Shifts in Supply (Figure 2.4)

P
S2
80
S0
70 S1
$60, 700
60
$60, 400
• Supply •
Price (dollars)

decrease
50

40 $40, 500 • • $40, 650

30
Supply
20 increase

10

Qs
0 100 300 500 700 900

Quantity

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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” price

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Market Equilibrium (Figure 2.5)

P

80

S0
70

60
Price (dollars)

50 • •
40 •
30

20 • •
10
D0
Qd , Qs
0 100 300 500 700 900 1,100 1,300 1,500

Quantity

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Demand Shifts (Supply Constant)
(Figure 2.6)
P

80
S0
70

60
Price (dollars)

B
50
A
•
40 • C
• •
30 •
20

10 D1
D2 D0
Qd , Qs
0 100 300 500 700 900 1,100 1,300 1,500

Quantity

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Supply Shifts (Demand Constant)
(Figure 2.7)
P
S2
80 S0 S1

70

60
T
Price (dollars)

50 • R
40 • • •
•S
30

20

10 D0
Qd , Qs
0 100 300 500 700 900 1,100 1,300

Quantity

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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
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Simultaneous Shifts: (D, S)

P

S
S’
S’’

B
P’ A •
P •
P’’ •C
D’

Q
Q Q’ Q’’

Price may rise or fall; Quantity rises

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Simultaneous Shifts: (D, S)

P

S
S’
S’’

A
P •
B
P’ •
P’’ •C D

D’
Q
Q’ Q Q’’

Price falls; Quantity may rise or fall

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Simultaneous Shifts: (D, S)

P
S’’
S’
S
P’’ • C

B
P’ •
A
P •
D’

Q
Q’’ Q Q’

Price rises; Quantity may rise or fall

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Simultaneous Shifts: (D, S)

P

S’’
S’
S

P’’ •C A
P •
P’ • B

D
D’
Q
Q’’ Q’ Q

Price may rise or fall; Quantity falls

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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
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Ceiling & Floor Prices (Figure 2.11)

Px Px

Sx Sx

Price (dollars)
Price (dollars)

3
2 2
1

Dx Dx
Qx Qx
22 50 62 32 50 84

Quantity Quantity

Panel A – Ceiling price Panel B – Floor price

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