Engineering Economics &

Management
Week 2

Prepared by:
Miss. Fatima M. Saleem
MARKETS AND COMPETITION

Buyers determine demand.

Sellers determine supply

 DEMAND
 Quantity demanded: is the amount of
a good that buyers are willing and able
to purchase.
 Law of Demand: The negative
relationship between price and quantity
demanded, as price Rises quantity
demanded decreases as price Falls
quantity demanded increases
 Demand Schedule: The demand
schedule is a table that shows the
relationship between the price of
. the good and the quantity
demanded.
Catherine’s Demand
Schedule
The Demand Curve: The Relationship
between Price and Quantity Demanded

 Demand Curve: The demand curve is a graph of the

relationship between the price of a good and the
quantity demanded.
Demand
Schedule
Market Demand versus Individual
Demand

 Market demand refers to the sum of all

individual demands for a particular good or service.
 Graphically, individual demand curves are summed
horizontally to obtain the market demand curve.
Changes in Quantity Demanded
 Movement along the demand curve.
 Caused by a change in the price of the product.
DEMAND IN PRODUCT/OUTPUT
MARKETS

 OTHER DETERMINANTS OF HOUSEHOLD DEMAND

 Income and Wealth

 Income: The sum of all a household’s wages, salaries,

profits, interest payments, rents, and other forms of
earnings in a given period of time. It is a flow measure.
 Wealth or net worth: The total value of what a household
owns minus what it owes. It is a stock measure.
Shifts in the Demand
Curve
 Consumer income

 Prices of related goods

 Tastes

 Expectations

 Number of buyers
Shifts in the Demand Curve
 A shift in the demand curve, either to the left or right is
caused by any change that alters the quantity demanded
at every price.
Shifts in the Demand Curve
 Consumer Income:

 As income increases the demand for a normal good

will increase.

 As income increases the demand for an inferior good

will decrease.

 Inferiority, in this sense, is an observable fact relating to

affordability rather than a statement about the quality of
the good.
DEMAND IN PRODUCT/OUTPUT
MARKETS

 Normal goods are those for which demand goes up when

income is higher and for which demand goes down when
income is lower

 Inferior goods are those for which the demand falls when
income Rises
Consumer Income Normal Good

Price of Ice-
Cream Cone
$3.00 An increase in
income...
2.50
Increase
2.00 in demand

1.50

1.00

0.50
D2
D1 Quantity of
Ice-Cream
0 1 2 3 4 5 6 7 8 9 10 11 12 Cones
Consumer Income Inferior Good

Price of Ice-Cream
Cone
$3.00

2.50 An increase in
income...
2.00
Decrease
1.50 in demand

1.00

0.50

D2 D1 Quantity of
Ice-Cream
0 1 2 3 4 5 6 7 8 9 10 11 12 Cones
Question?
??
 Incomes increase. In a graph of the market for bus rides (an
inferior good) we would expect:

 The demand curve to shift to the left

 The demand curve to shift to the right.

 The supply curve to shift upwards.

 The supply curve to shift downwards.

 Neither the supply nor the demand curve shifts.

Question?
??
 The price of computer memory chips increases. In the market
for computers, we would expect to see:

 The demand curve to shift to the left

 The demand curve to shift to the right.

 The supply curve to shift upwards.

 The supply curve to shift downwards.

 Neither the supply nor the demand curve shifts.

Shifts in the Demand
Curve

 Prices of Related Goods:

 When a fall in the price of one good reduces the demand for
another good, the two goods are called substitutes.
Example: Pepsi & coke.

 When a fall in the price of one good increases the demand

for another good, the two goods are called complements.
Example: Bread & Butter.
DEMAND IN PRODUCT/OUTPUT
MARKETS

 Prices of Other Goods and Services:

 substitutes Goods that can serve as replacements for one

another: when the price of one increases, demand for the other
goes up.

 complements, complementary goods Goods that “go together”: a

decrease in the price of one results in an increase in demand for
the other, and vice versa.
Variables That Shifts
Demand Curve
 TASK:
 For each of the following, determine the potential impact on the demand
curve. Your answer should include why you believe this is the case. Note that
it's possible that there may be no impact on the demand curve.
 In the market for beach chairs, there is an increase in the price.
 In the market for food truck products, there is an increase in the
population of the surrounding area.
 In the market for notebooks, the cost of the paper used in the notebook
rises, making them more expensive to produce.
 Apples and oranges are substitutes. What will be the impact on the
demand for apples if the price of oranges increases?
 A news report comes out that states that eating an apple a day doesn't
actually keep the doctor away. What will be the impact on the demand for
apples?
 In the market for pizzas, what will be the impact on demand if a new pizza
shop opens in your town?
 Peanut butter and jelly are complements. What will be the impact on the
demand for peanut butter if the price of jelly rises.
 The government imposes a price floor (a minimum price that can be
charged) in the market for wheat. What impact will this have on the
demand for wheat?
SUPPLY
 Quantity supplied is the amount of a good that sellers are
willing and able to sell.

 Law of Supply: The law of supply states that, other things

equal, the quantity supplied of a good rises when the price
of the good rises.

 Supply Schedule: The supply schedule is a table that shows

the relationship between the price of the good and the
quantity supplied.
Ben’s Supply
Schedule
The Supply Curve: The Relationship
between Price and Quantity Supplied
 Supply Curve: The supply curve is the graph of the relationship
between the price of a good and the quantity supplied.
Market Supply versus
Individual Supply

 Market supply refers to the sum of all individual supplies for all
sellers of a particular good or service.

 Graphically, individual supply curves are summed horizontally to

obtain the market supply curve.
Market Supply versus
Individual Supply
Shifts in the Supply
Curve

 Input prices

 Technology

 Expectations

 Number of sellers
Shifts in the Supply
Curve

 Change in Quantity Supplied

 Movement along the supply curve: caused by

a change in anything that alters the quantity
supplied at each price.
 Change in Quantity
Supplied
Price of Ice-
Cream S
Cone
C
$3.00
A rise in the price
of ice cream
cones results in a
movement along
A the supply curve.
1.00

Quantity of
Ice-Cream
0 1 5 Cones
Shifts in the Supply Curve
 Change in Supply: A shift in the supply curve,
either to the left or right.

 Caused by a change in a determinant other

than price.
Table 2 Variables That Influence
Sellers
 Equilibrium

A situation in which various forces are in balance

SUPPLY AND DEMAND TOGETHER

 Equilibrium refers to a situation in which the price has

reached the level where quantity supplied equals
quantity demanded.
SUPPLY AND DEMAND TOGETHER
 Equilibrium Price: The price that balances quantity
supplied and quantity demanded.
 On a graph, it is the price at which the supply and
demand curves intersect.

 Equilibrium Quantity: The quantity supplied and the

quantity demanded at the equilibrium price.
 On a graph it is the quantity at which the supply and
demand curves intersect.
SUPPLY AND DEMAND TOGETHER
Demand Schedule Supply Schedule

At $2.00, the quantity demanded

is equal to the quantity
supplied!
 Surplus

 When price > equilibrium price, then quantity

supplied > quantity demanded.

 There is excess supply or a surplus.

 Suppliers will lower the price to increase sales,

thereby moving toward equilibrium.
 Shortage

 When price < equilibrium price, then quantity

demanded > the quantity supplied.

 There is excess demand or a shortage.

 Suppliers will raise the price due to too many buyers

chasing too few goods, thereby moving toward
equilibrium.
 Increases in Demand and
Supply

• Higher demand leads to • Higher supply leads to

higher equilibrium price and lower equilibrium price
higher equilibrium quantity. and higher equilibrium
quantity.
Decreases in Demand and
Supply

• Lower demand • Lower supply leads

leads to lower price to higher price and
and lower quantity lower quantity
exchanged. exchanged.
 Relative Magnitudes of
Change

• The relative magnitudes of change in supply and

demand determine the outcome of market equilibrium.
Relative Magnitudes of
Change

• When supply and demand both increase, quantity

will increase, but price may go up or down.
MARKET EQUILIBRIUM

Examples of Supply and Demand Shifts for Product X

DEMAND AND SUPPLY IN
PRODUCT MARKETS: A REVIEW
Here are some important points to remember about the mechanics
of supply and demand in product markets:
1. A demand curve shows how much of a product a household would buy if it could buy
all it wanted at the given price. A supply curve shows how much of a product a firm
would supply if it could sell all it wanted at the given price.

2. Quantity demanded and quantity supplied are always per time period—that is, per day,
per month, or per year.

3. The demand for a good is determined by price, household income and wealth, prices
of other goods and services, tastes and preferences, and expectations.

4. The supply of a good is determined by price, costs of production, and prices of

related products. Costs of production are determined by available technologies of
production and input prices.

5. Be careful to distinguish between movements along supply and demand curves and
shifts of these curves. When the price of a good changes, the quantity of that good
demanded or supplied changes—that is, a movement occurs along the curve. When
any other factor changes, the curve shifts, or changes position.

6. Market equilibrium exists only when quantity supplied equals quantity demanded at
the current price.
LOOKING AHEAD: MARKETS AND THE
ALLOCATION OF RESOURCES
You can already begin to see how markets answer the basic economic
questions of what is produced, how it is produced, and who gets what
is produced.
 Demand curves reflect what people are willing and able to pay for
products; they are influenced by incomes, wealth, preferences,
prices of other goods, and expectations.

 Firms in business to make a profit have a good reason to choose

the best available technology—lower costs mean higher profits.

 When a good is in short supply, price rises. As it does, those who

are willing and able to continue buying do so; others stop buying.
Problem:

 “An increase in the demand for notebooks raises the quantity of

notebooks demanded but not the quantity supplied.” Is this
statement true or false? Explain.

 Over the past 30 years, technological advances have reduced

the cost of computer chips. How do you think this has affected
the market for computers? For computer software?
 Elasticity

 It is a measure of how much buyers and sellers respond to

changes in market conditions.

 A measure of the responsiveness of quantity demanded or

quantity supplied to a change in one of its determinants.
THE ELASTICITY OF DEMAND
 Price elasticity of demand is a measure of how much the
quantity demanded of a good responds to a change in
the price of that good.

Price Elasticity of Demand and

Its Determinants
 Availability of Close Substitutes Demand tends to be more elastic:
– The larger the number of close
 Necessities versus Luxuries substitutes.
– If the good is a luxury.
 Definition of the market.
– The more narrowly defined the
 Time Horizon. market.
– The longer the time period
 Computing PED:
 The price elasticity of demand is computed as the
percentage change in the quantity demanded divided by
the percentage change in price.

𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅

𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒅𝒆𝒎𝒂𝒏𝒅 =
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆

 Example: If the price of an ice cream cone increases from $2.00

to $2.20 and the amount you buy falls from 10 to 8 cones, then
your elasticity of demand would be calculated as:

10 − 8
∗ 100 20%
𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 = 10 = =2
2.0 − 2.2 10%
∗ 100
2.0
The Midpoint Method:
 A Better Way to Calculate Percentage Changes and
Elasticity

 The midpoint formula is preferable when calculating the

price elasticity of demand because it gives the same
answer regardless of the direction of the change.
𝑄2 − 𝑄1
(𝑄2 + 𝑄1)/2
𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 =
𝑃2 − 𝑃1
(𝑃2 + 𝑃1)/2

10 − 8
(10 + 8)/2 22%
𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 = = = 2.32
2.0 − 2.2 9.5%
(2.0 + 2.2)/2
The Variety of Demand Curves
 Inelastic Demand

 Quantity demanded does not respond strongly to price

changes.

 Price elasticity of demand is less than one.

 Elastic Demand

 Quantity demanded responds strongly to changes in

price.

 Price elasticity of demand is greater than one.

 Because the price elasticity of demand measures how

much quantity demanded responds to the price, it is
closely related to the slope of the demand curve
Summary

 If equals to 0, then Demand is perfectly inelastic.

 If greater then 1, then Demand is elastic

 If less then 1, then Demand is inelastic.

 If equals to 1, then Demand have unitary elastic.

 If equals to infinity, then Demand is perfectly elastic.

Computing PED
Total revenue
 The amount paid by buyers and received by sellers of a good,
computed as the price of the good times the quantity sold.
i.e. P x Q
 Income elasticity of demand

 Income elasticity of demand a measure of how much the

quantity demanded of a good responds to a change in
consumers’ income, computed as the percentage change in
quantity demanded divided by the percentage change in
income.

𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅

𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒅𝒆𝒎𝒂𝒏𝒅 =
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒊𝒏𝒄𝒐𝒎𝒆
Cross-price elasticity of demand

 Cross-price elasticity of demand a measure of how much the

quantity demanded of one good responds to a change in the
price of another good, computed as the percentage change
in quantity demanded of the first good divided by the
percentage change in the price of the second good

𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅 𝒐𝒇 𝒈𝒐𝒐𝒅𝟏

𝑪𝒓𝒐𝒔𝒔 − 𝑷𝑬𝑫 =
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆 𝒐𝒇 𝒈𝒐𝒐𝒅 𝟐
 THE ELASTICITY OF SUPPLY
 Price elasticity of supply is a measure of how much the
quantity supplied of a good responds to a change in the price
of that good.

Computing PES:
 Price elasticity of supply is the percentage change in quantity
supplied resulting from a percent change in price.

𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒔𝒖𝒑𝒑𝒍𝒊𝒆𝒅

𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒔𝒖𝒑𝒑𝒍𝒚 =
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆

𝑸𝟐 − 𝑸𝟏
(𝑸𝟐 + 𝑸𝟏)/𝟐
𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 𝒐𝒇 𝒔𝒖𝒑𝒑𝒍𝒚 =
𝑷𝟐 − 𝑷𝟏
(𝑷𝟐 + 𝑷𝟏)/𝟐
Numerical

• If the price of a good increases by 8% and the

quantity demanded decreases by 12%, what is the
price elasticity of demand?
• Is it elastic, inelastic or unitary elastic?
• -12%/8% = -.12/.08 = -1.5.
• Drop the negative sign, so the elasticity is 1.5.
• This means it is elastic (greater than one).
 Numerical
• Anna owns the Sweet Alps Chocolate store. She charges
$10 per pound for her hand made chocolate. You, the
economist, have calculated the elasticity of demand for
chocolate in her town to be 2.5. If she wants to increase
her total revenue, what advice will you give her and
why? Be able to explain your answer.
• Anna should lower her price. Her price elasticity of
demand for chocolate is elastic (greater than one) and
therefore, when she lowers her price she will sell a lot
more chocolate. The greater quantity sold will make up
for her lower price, increasing her total revenue. In other
words, she is selling at a lower price but making up for it
in volume of sales.
Numerical
Solution
Numerical
• You are given market data that says when the price of
pizza is $4, the quantity demanded of pizza is 60
slices and the quantity demanded of cheese bread is
100 pieces. When the price of pizza is $2, the quantity
demanded of pizza is 80 slices and the quantity
demanded of cheese bread is 70 pieces.
• Can the Price-Elasticity of Demand be calculated for
either good?
• If so, calculate the PED?
Numerical