MANAGERIAL ECONOMICS

PGP I, Term I, June - August 2016

LECTURE 3
DEMAND & SUPPLY
Prof. D. Tripati Rao
Indian Institute of Management Lucknow
tripati@iiml.ac.in, June 28, 2016

Review QEUSTIONS !
What is:
a Market?
Invisible Hand?
Scarcity?
Opportunity Cost?
People take decisions at the margin
Productive- vs. Allocative- Efficiency?
Comparative Statics Analysis?
Positive vs. Normative Economics?
Accounting vs. Economic Profit?

Deriving the Market Demand Curve

from the Demand Function
Consider a Linear DD Function
Qx = a + B1Px + B2Py + B3Ax + B4Ay + B5Yc + B6Tc +
B7Ec + B8N + B9W
let all other independent variables remain constant
aggregate them into a single term : A
DD Function: Qx = A + B1Px (Sign of B1???)
Transformation to a DD curve
DD Curve
a special sub-case of the DD function
ceteris paribus: all independent variables; except for
the price of the product under investigation

Deriving the Market Demand Curve

from the Demand Function
Conventional Usage
dependent variable along Y-axis & independent
variable along X-axis
DD curve => P in Y axis & Qx in X axis???
Let Px = a + bQx
DD curve: Qx= A + B1Px
Or, Px = A/B1 + 1/B1 Qx
Or, a = A/B1, & b = 1/B1
Inverse relationship between Qx & Px, hence,
the sign of a = Positive (a > 0)
the sign of b = Negative (b < 0)

Non-Price Determinants
price of related products
tastes & preferences
income & wealth
future expectations
number of buyers

Short-Run

Changes

Constant

Deriving the Demand Curve

The Rationale ..!

Long-Run

Movement Along vs. Shifts

in the Demand Curve
Movement Along the Demand Curve
a up(down) movement along the DD curve is due to a
change in rise (decrease) in the price only, and it is
called as change in quantity demand
Shifts in the Demand Curve
a rightward/leftward shift in the DD Curve is due to
change (increase/decrease) in DD at a given price
Reasons for the Shifts
shifts in parameters: a & b ???
change in income/wealth
change in price of substitute/complement
change in tastes & preferences

Change in Quantity Demanded

Movement Along the DD Curve
Price of Pizza

A Service Tax on Sellers of Pizzas

- Raises the Price of Pizza
- Movement Along the DD Curve

INR200

Px

= a + bQx

INR100

D
0

Quantity of Pizzas

Price of Pizza

Change in Demand
Shifts in the DD Curve

Increase
in Demand

Change in Income
Increase
Decrease

Decrease
in Demand
Demand Curve, D2
Demand Curve, D1
Demand Curve, D3
0

Quantity of Pizza

The Supply Schedule/Curve

The Supply Schedule/Curve
for a good shows the relationship between its market
price & the amount of that commodity that producers are
willing to produce & sell, ceteris paribus
the qty of goods that producers are willing to sell at a
price
Factors Influence Supply
own price
cost of production
input prices, wages & interest rate charges
technological know-how
government policy
other variables: weather, expectations

The Law of Supply

Supply Function
QD = f (P0, P1, P2, P3.Pm ,T)
Law of Supply
at higher(lower) price, the more(less) that firms are able
& willing to produce & sell; ceteris paribus
the qty supplied positively related to goods price
Note:
firms expand production at a higher cost
Market Supply Curve
sum of all individual supply curves
horizontal aggregation of SS curves

Karims Supply Schedule & Supply Curve

Price of Pizza

Price of
Pizza
(INR)

Qty of
Pizza DD
(000)

0
50
100
150
200
250
300

0
0
1
2
3
4
5

300
250

An Increase
in Price 200
150
100
50

1 2
0

9 10 11 12 Quantity of

Pizza

Increases Quantity of Pizzas Supplied

Shifts in the Supply Curve

Movement Along the Supply Curve
A up(down) movement along the SS curve is due to a
change in rise (decrease) in the price only, and it is
called as change in quantity supplied
Shifts in the Supply Curve
A rightward/leftward shift in the SS Curve is due to
change (increase/decrease) in SS at a given price
Reasons for the Shifts (other than Price)
change in the price of inputs
improvement in technology
expectations
number of sellers

Shifts in the Supply Curve

Price
of Pizza

Supply Curve, S 3

Supply
Curve, S 1

Shifts in the Supply Curve

Decrease
in Supply

Supply
Curve, S 2

Increase
in supply

Quantity of Pizza

Supply & Demand Together

Equilibrium or Market Clearing Prices
Equilibrium Price (P*)
the price that equates/balances QS = QD
on a graph, it is the price at which the supply &
demand curves intersect

Equilibrium Quantity (Q*)

the quantity supplied & the quantity demanded at
the equilibrium price
on a graph it is the quantity at which the supply &
demand curves intersect

Rationing Function of Price

Equilibrium or Market Clearing Prices
Surplus
If Price > P*, then QS > QD
a case of excess supply at that price
price will fall to adjust to equilibrium QS = QD

Shortage
Price < P*, then QD > QS
a case of excess demand at that price
price will rise to adjust to equilibrium QD = QS

Law of Supply & Demand

Market mechanism has the tendency in a free market
for the price to adjust until market clears, i.e., QS = QD

The Supply & Demand Equilibrium

Price of
Pizza

Supply

Equilibrium Price

Equilibrium

200

Equilibrium
Quantity
0 1

Demand

2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Pizza

Market NOT in Equilibrium

(a) Excess Supply
Price of
Pizza

Supply

Surplus
250
200

Demand
0

10

Quantity
Demanded

Quantity
Supplied

Quantity of Pizza

Markets NOT in Equilibrium

(b) Excess Demand

Price of
Pizza

Supply

200
150
Shortage
Demand
0

4
Quantity
Supplied

10
Quantity of Pizza
Quantity
Demanded

Understanding Changes in
Supply & Demand Forces
Steps
1. Identify whether the event shifted supply or
demand or both
2. Identify in which direction the curve shifts
3. Use the SS-DD curves to analyse how the
shift changes in P & Q

What Happens to Price & Quantity

When Demand & Supply Shifts?
No Change An Increase
in SS
in SS
P down
Q up

A Decrease
in SS

No Change
in DD

P same
Q same

P up
Q down

An Increase
in DD

P up
Q up

P ambiguous
P up
Q up
Q ambiguous

A Decrease
in DD

P down
Q down

P down
P ambiguous
Q ambiguous
Q down

10

Comparative Statics Analysis

Short Run
SR is the period of time in which:
buyers already in the market respond to
changes in equilibrium price by adjusting the
quantity demanded for the good or service

Rationing Function of Price

the increase or decrease in price to clear
the market of any shortage or surplus
rationing is a short run function of price
SR adjustments are represented as
movement along the SS or DD curve

11

Rationing Function of Price

D2

D1

increase in DD causes
P & Q to rise

P1

Q1

S
h
o
rt
a
g
e

P2

Q2

Rationing Function of Price

D1
D2

P1

S
u
r
p
l
u
s

decrease in DD causes
P & Q to fall

P2

Q2

Q1

12

Comparative Statics Analysis

Long Run
LR is the period of time in which:

new sellers may enter a market

existing sellers may exit from a market
existing sellers may adjust fixed inputs
buyers may react to a change in equilibrium
price by changing their tastes and preferences

Comparative Statics Analysis

Long Run
Guiding or allocating function of price is:
the movement of resources into or out of
markets as a result of changes in the
equilibrium market price
long run adjustments are represented as shifts
in given SS or DD curves

13

Allocation Function of Price

D2

increase in DD causes
P & Q to rise

D1

P2
P1=P3

Q1

Q2

Q3

14