Demand and Supply Model

And its application

Course outline

Managerial Microeconomics

Basic Model

Managerial perspective

Additional topics
2

Lecture outline
Demand and Supply

Demand

supply

Market equilibrium

Law of demand

Law of supply

Producer surplus

efficiency

Consumer surplus

government

Paying vs. bearing

Comparative Statics analysis 3

What question(s) does D-S model address?

Questions

What is the law of demand? Why do we observe the law of demand?

Simplified version of Consumer Theory:

A consumer will purchase more as long as willingness to pay for the next unit is higher than the price.

A demand curve is also a willingness to pay curve. Willingness to pay measures marginal benefit.
6

1.1 Individual Demand Curve

Price ($ per movie)

100
75

50
25 0 1 2

individual demand curve

Quantity (Movies a month)

Consumer Theory

Price change

1.1 Summing up to get Market Demand

($ per movie)Adam + Bob + Chris = 100 0 0 0 75 1 0 0 50 2 1 0 25 4 2 3 0 7 6 4

Market 0 1 3 9 17

1.1 Market Demand Curve

Shows the amount of a good that will be purchased at alternative prices, holding other factors constant. Law of Demand

The demand curve is downward sloping.

D Quantity
10

1.1 Application

Have you seen any application of the law of demand (diminishing marginal benefit)? Can you give an example of when the law of demand seems to be wrong and explain why it is so?

11

Questions

Whats the difference between change in demand and change in quantity demanded?

12

1.2 Determinants of Demand

Income Normal good Inferior good Prices of Related Goods Prices and availability of substitutes Prices and availability of complements Advertising and consumer tastes Population Consumer expectations

13

1.2 Change in Quantity Demanded

D0 4 7 Quantity
14

1.2 Change in Demand

6 D1 D0 7 13 Quantity
15

1. 2 The Demand Function

A general equation representing the demand curve Qxd = f(Px , PY , M, H,)

Qxd = quantity demand of good X. Px = price of good X. PY = price of a related good Y.

Substitute good. Complement good.

M = income. Normal good. Inferior good. H = any other variable affecting demand.

16

1.2 Inverse Demand Function

Price as a function of quantity demanded. Example:

Demand Function

Qxd = 10 2Px 2Px = 10 Qxd Px = 5 0.5Qxd

Inverse Demand Function:

17

1.2 Normal vs. Inferior

Which one of the following is a normal good?

p
Income=100

p
Income=200

Income=200 Q

Income=100 Q

18

1.2 Normal vs. Inferior

Why the distinction is important?

Strategy when economy is in recession Strategy for high-income / low-income area

19

1.3 Demand Curve: Two Views

for every possible price, shows the quantity shows the maximum price willing to pay for each unit of item (marginal Benefit)
P

P*

Q*

20

1.3 Value vis-a-vis Price

21

1.3 Buyer Surplus the discrete case

Price ($ per movie)

100
individual buyer surplus at $25 price 75 d 50 c 25 0 g 1 a b e f individual demand (marginal benefit) curve h j 2 4 7 Quantity (Movies a month)
22

1.3 Buyer Surplus: The Continuous Case

8
6 4 2

Value of 4 units = $24

Expenditure on 4 units = $2 x 4 = $8

D 1 2 3 4 5 Quantity
23

1.3 I got a great deal!

That company offers a lot of bang for the buck! Dell provides good value. Total value greatly exceeds total amount paid. Consumer surplus is large.

24

1.3 I got a lousy deal!

That car dealer drives a hard bargain! I almost decided not to buy it! They tried to squeeze the very last cent from me! Total amount paid is close to total value. Consumer surplus is low.

25

1.3 Capture Consumer surplus

Monthly service fee

Phone service Cable service

Two part tariff (a fixed fee plus a per unit price)

26

2. Supply

What is the law of supply? Why do we observe the law of supply?

27

2.1 Supply

The law of supply (competitive market)

The higher the price, the larger the quantity supplied, holding everything else constant.

28

2.2 Producer Theory

In a competitive market, the supplier take the price as given and supply more until his marginal cost equals the price.

The supply curve can also be interpreted as marginal cost curve.

29

2.2 Supply Shifters

Input prices Technology or government regulations Number of firms Entry Exit Substitutes in production Taxes Excise tax Ad valorem tax Producer expectations

30

2.2 The Supply Function

An equation representing the supply curve: QxS = f(Px , PR ,W, H,)

QxS = quantity supplied of good X. Px = price of good X. PR = price of a production substitute. W = price of inputs (e.g., wages). H = other variable affecting supply.
31

2.2 Inverse Supply Function

Price as a function of quantity supplied. Example:

Supply Function

Qxs = -10 + 2Px 2Px = 10 + Qxs Px = 5 + 0.5Qxs

Inverse Supply Function:

32

2.2 Change in Quantity Supplied

10

Quantity

33

2.2 Change in Supply

S1

8 6 5

Quantity
34

2.3 Producer Surplus

The amount producers receive in excess of the amount necessary to induce them to produce the good.
Price

S0 P*

Q*

Quantity
35

3. Market Equilibrium
Price
a excess supply 22 20 c b equilibrium supply

demand

10

11

Quantity (Million ton-miles a year)

Question

If in an apple market with 10 buyers and 10 sellers. There are 5 high-value buyers. Each willing to pay $40 for one basket of apples. There are 5 low-value buyers. Each willing to pay $20 for one basket of apples. No one wants to buy more than one basket. There are 4 low-cost sellers whose cost is $10 per basket. There are 6 high-cost sellers whose cost is $30 per basket. Each seller has only one basket of apple to sell. What is the market price of apple? What if there are 6 low-cost sellers and 4 high-cost sellers? What if there are 5 low-cost and 5 high-cost sellers?

37

Preparation for next lecture

Finish reading Baye chapter 2. Discussion questions:

Is competitive market efficient? And why? Why is the D-S model important?

38