Managerial Economics

Demand and Supply

Analysis
Managerial Economics

Demand

 Quantity demanded (Qd)

 Amount of a good or service consumers are

willing & able to purchase during a given
period of time
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 Pattern of Consumers (T)
 Expected future prices of the product/service
(PE)
 Number of Consumers in the market (N)

• General demand function

Qd = f (P, M, PR, T, PE,
N)
Managerial Economics
Qd a  bP Demand
General  cM  dPR  e   fPe  gN
Function
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
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
c = Qd/M
Inverse for inferior goods is negative

PR Direct for substitutes d = Qd/PR is positive

Inverse
Inversefor complements d = Q /P
forcomplements is negative
d R

 Direct e = Qd/  is positive

Pe Direct f = Qd/Pe is positive

N Direct g = Qd/N is positive

Managerial Economics
Practice Problem:
Consider this demand Equation:
Qd = 600 – 4PA - 0.03M – 12PB + 15 T +
6PE + 1.5N

where, Qd is quantity demanded of Good A each

month, PA is price of Good A, M is average
household income, price of related good, T is
consumer taste index ranging in value from 0 till
10 (highest rating), price consumers expect to
pay next month for Good A, and N is no. of
buyers n the market for Good A.
1.Interpret the intercept parameter in the general
demand function
2.Value of the slope parameter for the price of
Good A? Does it have correct algebraic sign?
Why?
3.Interpret the slope parameter for income. Is
good A normal or inferior? Explain.
Managerial Economics
Practice Problem:
Consider this demand Equation:

Qd = 600 – 4PA - 0.03M – 12PB + 15 T + 6PE

+ 1.5N

where, Qd is quantity demanded of Good A each month,

PA is price of Good A, M is average household income,
price of related good, T is consumer taste index
ranging in value from 0 till 10 (highest rating), price
consumers expect to pay next month for Good A, and
N is no. of buyers n the market for Good A.
4. Are goods A & B substitutes or complements?
Explain. Interpret the slope parameter for the price of
Good B.
5. Are the algebraic signs on the slope parameters for
T, PE and N correct?, Explain.
6. Calculate the quantity demanded of Good A when
PA = $ 5, M = $25, 000, PB = $ 40, T = 6.5, PE = $ 5.25,
and N = 2,000
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
Managerial Economics

A Demand Curve
Managerial Economics

Law of Demand

 Q increases when P falls & Q decreases

d d
when P rises, all else constant (ceteris
paribus)

 Q /P must be negative

d

 Or, we can say keeping other factors

constant, there exists an inverse
relationship between prices and quantity
demanded.
Managerial Economics
Reasons why a Demand
curve slopes downwards?

January 22, 2025

Law of Diminishing
Marginal Utility
Income Effect
Addition of new customers
Substitution Effect
Managerial Economics

Market Demand

January 22, 2025

 Market demand is the summation
of the individual quantities that
consumers are willing to purchase
at a given price.

 It is the horizontal summation of

demand curves of all the
consumers in the market and is
downward sloping.
Managerial Economics
 Q: The demand for good X is given by

 Qdx = 1200 – 0.5Px + 0.25Py – 8Pz + 0.10M

January 22, 2025

 Research shows that the prices of related goods are given
by Py = $ 5,900 and Pz = $ 90, while the average income of
individuals consuming this product is M= $ 55,000.


 a. Indicate whether goods Y and Z are substitutes or

complements for good X, respectively.
 b. Is X an inferior or a normal good?
 c. How many units of good X will be purchased when Px = $
4,910?
 d. Determine the demand function and inverse demand
function for good X.
Managerial Economics

Changes in Demand
Curves

January 22, 2025

 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
Managerial Economics

Shifts in Demand
Managerial Economics

Exceptions to Law of
Demand:

January 22, 2025

Network Externalities:
Up to this point we have assumed that people’s
demands for a good are independent of one
another.
If fact, a person’s demand may be affected by
the number of other people who have
purchased the good.

If this is the case, a network externality

exists. It can be positive as well as negative!
Managerial Economics

Network Externalities:

January 22, 2025

 A positive network externality exists if the quantity of
a good demanded by a consumer increases in
response to an increase in purchases by other
consumers.
 Negative network externalities are just the opposite.

 The Bandwagon Effect (Positive Network

Externality)
 This is the desire to be in style, to have a good
because almost everyone else has it, or to indulge
in a fad.
 This is the major objective of marketing and
advertising campaigns (e.g. toys, clothing).
Managerial Economics
Exception: Negative Network
Externality
The Snob Effect (Negative Network

January 22, 2025

Externality)
 If the network externality is negative, a snob effect exists.
 The snob effect refers to the desire to own exclusive or unique
goods.
 The quantity demanded of a “snob” good is higher, the fewer
the people who own it.

The Veblen Goods: Examples:

Luxurious cars, antique items etc.
When a consumer's demand (or consumption) of a certain
good is increased when the price also is increased. This is
against traditional theory of rationality. However, the
consumer perceives that the good brings a higher utility at
a higher price.
Managerial Economics

Exceptions
Continued…
 Giffen Goods:

January 22, 2025

 A rare type of “inferior good”, where
an increase in price causes an increase
in demand.

 The reason is that the income effect of a rise

in the price causes you to buy more of this
cheap good because you can’t afford more
expensive goods.

 For
example, if the price of wheat rises, a
poor peasant may not be able to afford meat
any more, so has to buy more wheat only
Managerial Economics

Exceptions
Continued…

January 22, 2025

Conspicuous necessities: Examples -
TVs, Refrigerators etc.

Ignorance

Emergencies
Managerial Economics

Direct Demand
Function

January 22, 2025

 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)
Managerial Economics

Inverse Demand
Function

January 22, 2025

 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)
Managerial Economics

Supply

January 22, 2025

 Quantity supplied (Qs)
 Amount of a good or service offered
for sale during a given period of time
Managerial Economics

Supply

January 22, 2025

 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)

 Q Supply
General
sf ( P, PFunction
, P ,T , P
I r e , F)

Managerial Economics
General
Qs h  kP Supply Function
lPI  mPr  nT  rPe  sF

January 22, 2025

 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
Managerial Economics

General Supply Function

January 22, 2025

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 Directfor
Direct forcomplements
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

Managerial Economics

Direct Supply Function

January 22, 2025

 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)
Managerial Economics

Inverse Supply Function

January 22, 2025

 Traditionally, price (P) is plotted on
the vertical axis & quantity supplied
(Qs) is plotted on the horizontal axis

 Theequation plotted is the inverse

supply function, P = f(Qs)
Managerial Economics

Graphing Supply Curves

January 22, 2025

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
Managerial Economics

A Supply Curve
Managerial Economics

Graphing Supply Curves

January 22, 2025

 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
Managerial Economics

Shifts in Supply
Managerial Economics

Market Equilibrium

January 22, 2025

 Equilibriumprice & 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
Managerial Economics

Market Equilibrium
Managerial Economics

Market Equilibrium

January 22, 2025

 Excess demand (Shortage)
 Existswhen quantity demanded exceeds
quantity supplied
 Excess supply (Surplus)
 Existswhen quantity supplied exceeds
quantity demanded
Managerial Economics

Value of Market Exchange

January 22, 2025

 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
Managerial Economics
Measuring the Value of Market
Exchange

January 22, 2025

 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
Managerial Economics

Measuring the Value of Market

Exchange

January 22, 2025

Managerial Economics

Changes in Market
Equilibrium

January 22, 2025

 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
Managerial Economics

Demand Shifts (Supply Constant)

January 22, 2025

Managerial Economics

Supply Shifts (Demand Constant)

January 22, 2025

Managerial Economics

Simultaneous Shifts

January 22, 2025

 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
Managerial Economics

Simultaneous Shifts: (D,

S)

January 22, 2025

P
S
S’
S’’

B
P’ A •
P •
P’’ •C
D’

Q
Q Q’ Q’’

Price may rise or fall; Quantity rises

Managerial Economics

Simultaneous Shifts: (D,

S)

January 22, 2025

P

S
S’
S’’

A
P •
B
P’ •
P’’ •C D

D’
Q
Q’ Q Q’’

Price falls; Quantity may rise or fall

Managerial Economics

Simultaneous Shifts: (D,

S)

January 22, 2025

P
S’’
S’
S
P’’ • C

B
P’ •
A
P •
D’

Q
Q’’ Q Q’

Price rises; Quantity may rise or fall

Managerial Economics

Simultaneous Shifts: (D, S)

January 22, 2025

P
S’’
S’
S

P’’ •C A
P •
P’ • B

D
D’
Q
Q’’ Q’ Q

Price may rise or fall; Quantity falls

Managerial Economics

Ceiling & Floor Prices

January 22, 2025

 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
 Managerial Economics

Ceiling & Floor Prices

January 22, 2025

Px Px

Price (dollars)
Price (dollars)

Sx Sx

3
2 2
1

Dx Dx
Qx Qx
22 50 62 32 50 84

Quantity Quantity

Panel A – Ceiling price Panel B – Floor price

Managerial Economics

Demand of Various
Goods in Industry

January 22, 2025

 Consumer Goods Vs. Producer
Goods
 Concept of Derived Demand
 Demand of Consumer Durable Vs.
Non-Durables