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MANAGERIAL ECONOMICS

Demand and Supply Analysis Larry Davidson

OVERVIEW

Intro Determinants of Demand & Supply Market Equilibrium Using supply and demand as a qualitative forecasting tool Price floors and ceilings Using supply and demand to manage: a. Raw Materials b. Human Resources c. Inventories

OVERVIEW

Intro
Determinants of Demand & Supply Market Equilibrium Using supply and demand as a qualitative forecasting tool Price floors and ceilings Using supply and demand to manage: a. Raw Materials b. Human Resources c. Inventories

S&D: Several Perspectives

Philosophy: Used to extol capitalism Macro : Understand what causes inflation and business cycles

Industry: What factors are causing change?


Firm: Tools of the trade How do I increase revenues? How do I control costs? What is my best price? How much should I produce?

OVERVIEW

Intro

Determinants of Demand & Supply


Market Equilibrium Using supply and demand as a qualitative forecasting tool Price floors and ceilings Using supply and demand to manage: a. Raw Materials b. Human Resources c. Inventories

MARKET EQUILIBRIUM: DEMAND & SUPPLY ANALYSIS

Price

Quantity

MARKET EQUILIBRIUM: DEMAND & SUPPLY ANALYSIS

Price

$5.00

5,000 units

Quantity

Bam Something
Changes

SOMETHING CAUSES THE D CURVE TO SHIFT AND LEADS TO A NEW EQUILIBRIUM PRICE AND QUANTITY HAVE PRESSURE TO CHANGE

S
Price

D
Quantity

GENERAL POINT
Many

factors can change This causes changes in supply and/or demand This leads to pressures for industry price and output to change.

EXAMPLE D-RAM CHIPMAKERS RATTLED BY 70% FALL IN PRICES FT JULY 22, 2011

driven by global economic woes stifling consumer demand coupled with bloated inventory levels in the wake of the March Japanese earthquake. Computers are a highly cyclical product Samsung has done okay since they are more diversified but Hynix has suffered a 34.2% drop in second quarter net profit. Nanya and Inotera are moving away from commoditized chips to more specialized chips for mobile devices and servers

THE DEMAND CURVE

Price

D
Quantity

DETERMINANTS OF DEMAND

Quantity of goods households/persons want to buy Goal is to maximize satisfaction subject to constraints on income and prices Quantity demanded depends on:

Own price Income after taxes (inferior and normal goods) Net worth Advertising expenditures Tastes and preferences Price of substitutes Price of complements Weather Stuff

DEMAND SCHEDULE

Example: FJR 1300 (Yamaha-Sport Touring)

Price of FJR1300

D for FJR 1300 Quantity of FJR1300

LAW OF DEMAND

Price of FJR1300

Downward slope reveals Law of Demand: shows the effect of changes in own price.

D for FJR1300 Quantity of FJR1300

MOVEMENT ALONG A DEMAND CURVE

Price of FJR1300

Higher price of FJR1300 lower quantity demanded of FJR1300

D for FJR1300 Quantity of FJR1300

MOVEMENT ALONG A DEMAND CURVE

Price of FJR1300

Lower price of FJR1300 higher quantity demanded of FJR1300

D for FJR1300 Quantity of FJR1300

DEMAND SCHEDULE AND SHIFTERS

Increase in demand for FJR1300


Tax

cut raises after tax income Green revolution pushes demand for motorcycles People just love the looks of the new model FJR1300 Prices of BMWs K1200GT increase significantly Yamaha advertises in Bloomington Herald Times Price of Leather clothing falls (complementary good)

DEMAND SCHEDULE AND SHIFTERS

Price of FJR1300

Increase in demand For FJR1300

D for FJR1300 Quantity of FJR1300

DEMAND SCHEDULE AND SHIFTERS

Decrease in demand for FJR1300


Economy

slows down and generates less

income People expect price of FJR1300 to decline next year Honda goes on very aggressive advertising campaign Safety report details rising deaths from motorcycle riding

DEMAND SCHEDULE AND SHIFTERS

Decrease in Demand for FJR1300 Price of FJR1300

D for FJR1300 Quantity of FJR1300

RECENT APPLICATIONS
What is causing recent changes in demand for? Nokia phones? Palm Oil? Kia/Hyundai cars in the USA? Government bonds of EU countries? Oil?

THE SUPPLY CURVE OR SCHEDULE


S
Price

Quantity

DETERMINANTS OF MARKET SUPPLY


Quantity of goods producers want to supply Objective: Maximize Profits Marginal Analysis: MB & MC Marginal Costs and Unit Costs: Business Costs & Productivity

DETERMINANTS OF MARKET SUPPLY

Quantity of goods producers want to supply:


Own price law of supply Price of labor, energy, other inputs Technological change Quality of labor Government regulations/infrastructure Number of firms Taxes paid by firms (labor taxes, profit taxes, excise and ad valorem) Producer expectations Stuff

SUPPLY SCHEDULE AND PRICE


Law of supply: Price goes up: MB>MC .. quantity Supply supplied up

Price

Quantity

SUPPLY SCHEDULE AND PRICE


Law of supply: Price goes down MB<MC quantity Supply supplied goes down

Price

Quantity

SUPPLY SCHEDULE AND SHIFTERS: INCREASE IN SUPPLY: MC FALLS RELATIVE TO MB

Workers receive more training that improves output per day Energy costs fall Firm shifts health care cost to thirdparty Excise (or sales) tax cut

SUPPLY SCHEDULE AND SHIFTERS


Increase in supply more output at any given price Supply
Price

Quantity

SUPPLY SCHEDULE AND SHIFTERS DECREASE IN SUPPLY: MC RISES RELATIVE TO MB

Government puts new higher tariff on imported raw materials Workers demand large wage increase Government passes new pollution/safety regulation that adds cost to production Intellectual property protection

SUPPLY SCHEDULE AND SHIFTERS


Decrease in supply less output Supply at any given price

Price

Quantity

OVERVIEW

Intro Determinants of Demand & Supply

Market Equilibrium
Using supply and demand as a qualitative forecasting tool Price floors and ceilings Using supply and demand to manage: a. Raw Materials b. Human Resources c. Inventories

MARKET EQUILIBRIUM: THE PRICE AT WHICH S=D

Price

Pe

Qe

Quantity

MARKET EQUILIBRIUM: IF PRICE TOO HIGH, A SURPLUS EXISTS

Surplus
Price

At Ph, S>D

Ph

D
Quantity

Surplus!

Too many goods. Have a big Sale! Cut Prices!

MARKET EQUILIBRIUM: IF PRICE TOO HIGH, THEN TENDENCY FOR IT TO FALL


Surplus Price Ph At Ph, S>D So P falls

D
Quantity

MARKET EQUILIBRIUM: IF PRICE TOO LOW, THEN TENDENCY FOR A SHORTAGE

Price

PL At PL, S<D

D
Quantity

Shortage

Shortage!

Too many customers for too few items Raise Prices

MARKET EQUILIBRIUM: IF PRICE TOO LOW, THEN TENDENCY FOR IT TO RISE

Price

PL At PL, S<D So P rise Shortage

D
Quantity

OVERVIEW

Intro Determinants of Demand & Supply Market Equilibrium

Using supply and demand as a qualitative forecasting tool


Price floors and ceilings Using supply and demand to manage: a. Raw Materials b. Human Resources c. Inventories

Experiment #1: Input cost increases wage cost, capital cost, energy cost, benefits cost, etc
At any given price, profits are lower.
MC > MB

Firms can improve profits by producing less.


S curve shifts left

Of course, they could improve profits also if they raise price

S curve shifts up/left

EXPERIMENT 1: INPUT COST


Note: the supply curve shifted left (up) Price

Result: P

D Quantity

EXPERIMENT 1: INPUT COST


Interim stage: Shortage Price S

D If price does not immediately rise, a Shortage exists creating upward price pressure Quantity

EXPERIMENT 1: INPUT COST


Shortage causes Price to rise Price

D Quantity

Experiment #2 : An event reduces demand


price of substitute falls, price of complement rises, new model is introduced by a competitor, advertising is less effective People buying less of the product: orders decrease inventories rise Picture: Demand curve shifts left/down

EXPERIMENT 2: DEMAND

Price

Result: P

D Quantity

Interim step
What if price did not fall right away? At original price.. D<S So Surplus exits

Pressure for P to fall

EXPERIMENT 2: DEMAND

Price

If price does not immediately fall a Surplus exists causing downward pressure on price S

P D P D Quantity S

EXPERIMENT 2: DEMAND

Price

As P falls we move along both curves S D rises and S falls until surplus disappears

P P

D Quantity

Comparing Demand and Supply Shocks:


Shock Demand decreases P decreases Q decreases

Supply decreases
Demand Increases Supply increases

increases
? ?

decreases
? ?

OVERVIEW

Intro Determinants of Demand & Supply Market Equilibrium Using supply and demand as a qualitative forecasting tool

Price floors and ceilings


Using supply and demand to manage: a. Raw Materials b. Human Resources c. Inventories

Price floors and ceilings are forms of government intervention A floor prevents price from falling too low floors are intended to help producers A ceiling prevents price from rising too highceilings are intended to help consumers All government regulations have both intended and unintended effects

Price floors
Regulation that says that the price cannot go lower than a specified price, called the price floor Canada has price floors on telephone companies to prevent below cost pricing in competitive situations When a government raises a tariff on an imported good (US, steel, 2003) it effectively creates a price floor for the imported item The Minimum wage is a wage floor. It prevents a wage from falling to a level that is deemed too low.

PRICE FLOOR KEEPS PRICE HIGH TO HELP PRODUCER: PROTECT US STEEL WITH TARIFF ON IMPORTED STEEL

S
Pf Price P* Price floor

P* would exist if government did not put a floor on this product. P* is so low D that it might injure this industry Quantity

FIRMS WOULD LIKE TO PRODUCE THIS AMOUNT AT THE HIGH PRICE

Price floor Pf Price P*

D
Qsf Quantity

BUYERS WANT TO PURCHASE THIS AMOUNT AT THE HIGH PRICE

Price floor Pf Price P*

D
Qdf Quantity

PRICE FLOOR LEADS TO LOWER SALES BECAUSE THE HIGHER PRICE (PF>P*) REDUCES DEMAND**
Even though firms want to sell Qsf they will only produce Qdf! S So this point is irrelevant

Price floor Pf Price P*

D
Qdf ** Unless the government buys the surplus Qsf

Quantity

Price ceiling keeps a lid on prices.

Prevents price from rising to a level that might injure the consumer Some countries put ceilings on necessities like milk, gasoline, eggs, bread. Rent controls in New York are infamous. We have usury laws to prevent financial firms from charging high interest rates

VENEZUELA EXAMPLE
Article in WSJ July 18, 2011 A survey of the of major supermarkets found that 10 out of 16 price regulated products were scarce. Could not find cooking oil, cuts of meat, cheeses, corn flour, aspirin, pharma drugs, etc Producers explained that inflation of their inputs prices meant they lose money producing products with price ceilings.

A LOW PRICE, CONSUMERS HAVE HIGHER QUANTITY DEMAND

S
Price P*

Pc

Price Ceiling

D
Qdc Quantity

A LOW PRICE, PRODUCERS HAVE LOW SUPPLY

S
Price P*

Pc

Price Ceiling

D
Qsc Quantity

PRICE CEILING INTENDED TO HELP CONSUMER, BUT LEADS TO LOWER OUTPUT BECAUSE IT REDUCES SUPPLY

Price P*

S Buyers want Qdc at the low price but firms are not at profit maximizing point. They wont produce this much at Pc
So this point is irrelevant Price Ceiling

Pc

D
Qsc Qdc Quantity

Upshot:

Price floors and ceilings interfere with efficiency They may solve a social goal but they always lead to economic waste since resources are not fully utilized.

OVERVIEW

Intro Determinants of Demand & Supply Market Equilibrium Using supply and demand as a qualitative forecasting tool Price floors and ceilings Using supply and demand to manage: a. Raw Materials b. Human Resources c. Inventories

Market for Raw Materials

S
Price Of Raw Mats.

Quantity of raw materials

Market for Inventories

S
Price Of inventories

Quantity of inventories

Market for Human Resources

S
Compensation

Employment

SEE YOU LATER, ALLIGATOR

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