Managerial Economics & Business Strategy

Chapter 2 Market Forces: Demand and Supply

Market Equilibrium

• Balancing supply and demand Qx

S = Qxd

• Interaction of supply and demand determines the equilibrium price

Price

Quantity

S

D

5

6 12

Shortage12 - 6 = 6

6

If price is too low…

7

8

Price

Quantity

S

D

9

14

Surplus14 - 6 = 8

6

8

8

If price is too high…

7

Price Restrictions

• Price Ceilings The maximum legal price that can be charged. Examples:

• Gasoline prices in the 1970s.

• Housing in New York City.

• Proposed restrictions on ATM fees.

Price

Quantity

S

D

P*

Q*

P Ceiling

Q s

PF

Impact of a Price Ceiling

Shortage

Q d

Price Restrictions cont.

• Price Floors The minimum legal price that can be charged. Examples:

• Minimum wage.– Current PA minimum wage $6.25

» Increased from $5.15 January 1, 2007

– Increase to $7.15 by July, 1 2007

• Agricultural price supports.

Impact of a Price Floor

Price

Quantity

S

D

P*

Q*

Surplus

PF

Qd QS

Do we understand? (number 6)

• Suppose demand and supply are given by Qd=50-P and Qs=1/2P-10.

• What are the equilibrium quantity and price in this market?• Determine the quantity demanded, the quantity supplied and

the magnitude of the surplus if a price floor of $42 is imposed in this market.

• Determine the quantity demanded, the quantity supplied and the magnitude of the shortage if a price ceiling of $30 is imposed in this market.

• Determine the Full Economic Price paid by the consumers

Comparative Static Analysis

• How do the equilibrium price and quantity change when a determinant of supply and/or demand change?

Applications of Demand and Supply Analysis

• Event: The WSJ reports that the prices of PC components are expected to fall by 5-8 percent over the next six months.

• Scenario 1: You manage a small firm that manufactures PCs.

• Scenario 2: You manage a small software company.

Use Comparative Static Analysis to see the Big Picture!

• Comparative static analysis shows how the equilibrium price and quantity will change when a determinant of supply or demand changes.

Scenario 1: Implications for a Small PC Maker

• Computers are now going to be cheaper to produce

• What curve is impacted?? supply

Priceof

PCs

Quantity of PC’s

S

D

S*

P0

P*

Q0 Q*

Big Picture: Impact of decline in component prices on PC market

Scenario 2: Software Maker• More people buying computers means

consumers will want more software

• Which curve is impacted??

Priceof Software

Quantity ofSoftware

S

D

Q0

D*

P1

Q1

Big Picture: Impact of lower PC prices on the software market

P0

Is this really used?? (number 12)

• You are the manager of an organization in America that distributes blood to hospitals in all 50 states and the District of Columbia. A recent report indicates that nearly 50 Americans contract HIV each year through blood transfusions. Although every pint of blood donated in the US undergoes a battery of nine different tests, existing screening methods can detect only the antibodies produced by the body’s immune system, not foreign agents in the blood. Since it takes weeks or even months for these antibodies to build up in the blood, newly infected HIV donors can pass along the virus through blood that has passed existing screening tests. Happily researchers have

• Developed a series of new tests aimed at detecting

and removing infections from donated blood before it is used in transfusions. The obvious benefit of these tests is the reduced incidence of infections through blood transfusions. The report indicates that the current price of decontaminated blood is $80 per pint. However, if the new screening methods are adopted, the demand and supply for decontaminated blood will change to Qd=175-P and Qs=2P-200.

What price do you expect to prevail if the new screening methods are adopted?

How many units of blood will be used in the US? What is the level of Consumer Surplus and Producer Surplus?

Illustrate your findings in a graph

What if BOTH supply and demand shift?

• Depends on the magnitudes and directions of the shifts

• Examples….

Chapter 2 homework

Numbers 7, 10, and 13