PPA 723: Managerial Economics

1. PPA 723: Managerial Economics Lecture 3: Market Equilibrium

2. Managerial Economics, Lecture 3: Market Equilibrium Outline • Review Supply and Demand • Market Equilibrium • Applications

3. Managerial Economics, Lecture 3: Market Equilibrium Demand Curves • Demand Curve: relationship between quantity demanded and price, other factors fixed • Law of Demand: demand curves slope down • Change in price causes movement along the demand curve • Change in income or other background factor causes shift of demand curve • A demand curve is hypothetical

4. Managerial Economics, Lecture 3: Market Equilibrium Supply Curves • Supply Curve: relationship between quantity supplied and price, other factors constant • Market supply curve need not slope up but frequently does • Change in price causes movement along the supply curve • Change in input price or other background factor causes shift of the supply curve • Supply curve is hypothetical

5. Managerial Economics, Lecture 3: Market Equilibrium Market Equilibrium • The intersection of demand and supply curves determines market equilibrium price and quantity. • An equilibrium is a situation, perhaps temporary, in which nobody has an incentive to change behavior.

6. Managerial Economics, Lecture 3: Market Equilibrium Figure 2.6 Market Equilibrium P ($ per kg) Excess supply = 39 S 3.95 e 3.30 2.65 Excess demand = 39 D 0 176 194 207 220 233 246 Q (Million kg of pork per year)

7. Managerial Economics, Lecture 3: Market Equilibrium Reaching Equilibrium • When P > P *, there is a surplus, inventories build up, suppliers get the message and lower price • When P < P *, there are shortages, every store sells out by noon, suppliers get the message and raise price. • A market sends signals and people respond to them; it’s not just because the curves cross!

8. Managerial Economics, Lecture 3: Market Equilibrium Shocking the Equilibrium • Once an equilibrium is achieved, it may persist indefinitely because no one applies pressure to change the price • An equilibrium changes if • The demand curve shifts • The supply curve shifts • The government intervenes

9. Managerial Economics, Lecture 3: Market Equilibrium Figure 2.7a Effects of a Shift of the Pork Demand Curve Effect of a $0.60 Increase in the Price of Beef P ($ per kg) e 2 S 3.50 3.30 2 e D 1 1 D 0 176 220 228 232 Q (Mil. kg of pork/year) Excess demand = 12

10. Managerial Economics, Lecture 3: Market Equilibrium Figure 2.7b Effects of a Shift of the Pork Demand Curve Effect of $0.25 Increase in the Price of Hogs P ($ per kg) 2 S e 2 1 S 3.55 3.30 e 1 D Q (Mil. kg of pork/year) 0 176 205 215 220 Excess demand = 15

11. Managerial Economics, Lecture 3: Market Equilibrium Direction and Magnitude • Theory alone often gives the direction of an effect: Does a given change lead to an increase in price? • Sometimes this is enough. • But sometimes the magnitude of the effect also matters: Is the effect large enough to be significant? • Calculating the magnitude generally requires more information.

12. Managerial Economics, Lecture 3: Market Equilibrium Limits of Supply and Demand Model • Supply and demand model directly applies only in competitive markets • Competitive markets: homogeneous goods, many buyers and sellers (price takers)

13. Managerial Economics, Lecture 3: Market Equilibrium Applications of Supply and Demand Model • Supply and demand model can help to understand: • Price ceilings • Price floors

14. Managerial Economics, Lecture 3: Market Equilibrium Price Ceiling P, price S e p Price ceiling p* D Q Q, Quantity per year Q Q d s Excess demand

15. Managerial Economics, Lecture 3: Market Equilibrium Usury Law’s Effect on Interest Rate i, Interest rate per $ S e i i* Usury law D Q, Money loaned per year Q Q Q s d Excess demand

16. Managerial Economics, Lecture 3: Market Equilibrium Minimum Wage w, wage S w* Minimum wage e w D H H H, Hours worked H d s Excess supply: Unemployment

17. Managerial Economics, Lecture 3: Market Equilibrium Supply Need not Equal Demand • Price ceilings or price floors  quantity supplied does not necessarily equal quantity demanded • Quantity supplied = amount firms want to sell at a given price, holding constant other factors that affect supply • Quantity demanded = amount consumers want to buy at a given price, holding constant other factors

18. Managerial Economics, Lecture 3: Market Equilibrium Summing Demand and Supply Curves • Market curves equal horizontal summation of individual curves • They show total quantity demanded or supplied at each possible price

19. Managerial Economics, Lecture 3: Market Equilibrium Total Supply with and without a Ban on Imports (a) Japanese Domestic Supply (b) Foreign Supply (c) Total Supply p , Price p , Price p , Price per ton d per ton f f per ton S S (ban) S (no ban) S (ban) S (no ban) p * p * p * p p p * * = * * = * * Q Q Q Q Q Q + Q d f d d f Q , Tons per year Q , Tons per year Q , Tons per year d f

20. Managerial Economics, Lecture 3: Market Equilibrium Figure 2.8 A Ban on Rice Imports Raises The Price in Japan – S (ban) S (no ban) e p p, Price of rice per pound 2 2 p e 1 1 D Q Q Q , Tons of rice per year 2 1

21. Managerial Economics, Lecture 3: Market Equilibrium Total Supply with an Quota on Imports (a) U.S. Domestic Supply (b) Foreign Supply (c) Total Supply p , Price p , Price p , Price f S S per ton per ton per ton d f S S S p * p * p * p p p Q Q * Q Q * Q + Q Q * + Q Q * + Q * d d f f d f d f d f Q , Tons per year Q , Tons per year Q , Tons per year d f

22. Managerial Economics, Lecture 3: Market Equilibrium Page 34 Solved Problem 2.3 – S (quota) S (no quota) p (Price of steel per ton) e 3 p e 3 2 p 2 – p p e 1 1 h D (high) l D (low) Q Q Q Q (Tons of steel per year) 1 3 2