Managerial Economics

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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 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
• Qd  f ( P, M , PR , , Pe , N )
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 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

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 Managerial Economics

General Demand Function

Variable Relation to Qd Sign of Slope Parameter

P Inverse b = Qd/P is negative

Direct for normal goods c = Qd/M is positive
M
Inverse for inferior goods c = Qd/M is negative
PR Direct for substitutes d = Qd/PR is positive
Inverse for complements 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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 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
• Qd/P must be negative

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 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)

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 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

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 Managerial Economics

A Demand Curve (Figure 2.1)

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 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
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 Managerial Economics

Shifts in Demand (Figure 2.2)

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 Managerial Economics

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

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

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 Managerial Economics

General 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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 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)

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 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)

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 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

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 Managerial Economics

A Supply Curve (Figure 2.3)

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 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
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 Managerial Economics

Shifts in Supply (Figure 2.4)

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 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

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 Managerial Economics

Market Equilibrium (Figure 2.5)

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 Managerial Economics

Market Equilibrium
• Excess demand (shortage)
• Exists when quantity demanded
exceeds quantity supplied
• Excess supply (surplus)
• Exists when quantity supplied exceeds
quantity demanded

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 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

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 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
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 Managerial Economics
Measuring the Value of Market
Exchange (Figure 2.6)

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 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

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 Managerial Economics
Demand Shifts (Supply Constant)
(Figure 2.7)

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 Managerial Economics
Supply Shifts (Demand Constant)
(Figure 2.8)

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 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
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 Managerial Economics

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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 Managerial Economics

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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 Managerial Economics

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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 Managerial Economics

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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 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
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 Managerial Economics

Ceiling & Floor Prices (Figure 2.12)

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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