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CHAPTER2MarketForces:DemandandSupplyChapterOutline•Demand–Factorsthatchangequantitydemandedandfactorsthatchangedemand–Thedemandfunction–Consumersurplus•Supply–Factorsthatchangequantitysuppliedandfactorsthatchangesupply–Thesupplyfunction–Producersurplus•Marketequilibrium•Pricerestrictionsandmarketequilibrium–Priceceilings–Pricefloors•Comparativestatics–Changesindemand–Changesinsupply–Simultaneousshiftsinsupplyanddemand2-2ChapterOverview•Marketdemandcurve–Illustratestherelationshipbetweenthetotalquantityandpriceperunitofagoodallconsumersarewillingandabletopurchase,holdingothervariablesconstant.•Lawofdemand–Thequantityofagoodconsumersarewillingandabletopurchaseincreases(decreases)asthepricefalls(rises).2-3DemandDemandMarketDemandCurve2-4Quantity(thousandsperyear)Price($)Demand$400$30$202040$106080Demand•Changingonlypriceleadstochangesinquantitydemanded.–Thistypeofchangeisgraphicallyrepresentedbyamovementalongagivendemandcurve,holdingotherfactorsthatimpactdemandconstant.•Changingfactorsotherthanpriceleadtochangesindemand.–Thesetypesofchangesaregraphicallyrepresentedbyashiftoftheentiredemandcurve.2-5DemandChangesinQuantityDemandedChangesinDemand2-6Quantity0PriceD1IncreaseindemandDemandABD0D2DecreaseindemandDemandShifters•Income–Normalgood–Inferiorgood•Pricesofrelatedgoods–Substitutegoods–Complementgoods•Advertisingandconsumertastes–Informativeadvertising–Persuasiveadvertising•Population•Consumerexpectations•Otherfactors2-7DemandAdvertisingandtheDemandforClothing2-8Quantityofhigh-styleclothing0$50$4050,000Priceofhigh-styleclothingD260,000DuetoanincreaseinadvertisingDemandD1•ThedemandfunctionforgoodXisamathematicalrepresentationdescribinghowmanyunitswillbepurchasedatdifferentpricesforgoodX,differentpricesofarelatedgoodY,differentlevelsofincome,andotherfactorsthataffectthedemandforgoodX.2-9DemandTheDemandFunction•Onesimple,butuseful,representationofademandfunctionisthelineardemandfunction:𝑄𝑋𝑑=𝛼0+𝛼𝑋𝑃𝑋+𝛼𝑌𝑃𝑌+𝛼𝑀𝑀+𝛼𝐻𝐻,where:–𝑄𝑋𝑑isthenumberofunitsofgoodXdemanded;–𝑃𝑋isthepriceofgoodX;–𝑃𝑌isthepriceofarelatedgoodY;–𝑀isincome;–𝐻isthevalueofanyothervariableaffectingdemand.2-10DemandTheLinearDemandFunction•Thesignsandmagnitudeofthe𝛼coefficientsdeterminetheimpactofeachvariableonthenumberofunitsofXdemanded.𝑄𝑋𝑑=𝛼0+𝛼𝑋𝑃𝑋+𝛼𝑌𝑃𝑌+𝛼𝑀𝑀•Forexample:–𝛼𝑋0bythelawofdemand;–𝛼𝑌0ifgoodYisasubstituteforgoodX;–𝛼𝑀0ifgoodXisaninferiorgood.2-11DemandUnderstandingtheLinearDemandFunction•SupposethataneconomicconsultantforXCorp.recentlyprovidedthefirm’smarketingmanagerwiththisestimateofthedemandfunctionforthefirm’sproduct:𝑄𝑋𝑑=12,000−3𝑃𝑋+4𝑃𝑌−1𝑀+2𝐴𝑋Question:HowmanyofgoodXwillconsumerspurchasewhen𝑃𝑋=$200perunit,𝑃𝑌=$15perunit,𝑀=$10,000and𝐴𝑋=2,000?AregoodsXandYsubstitutesorcomplements?IsgoodXanormaloraninferiorgood?Answer:𝑄𝑋𝑑=12,000−3200+415−110,000+22000=5,460units.GoodsXandYaresubstitutes.GoodXisaninferiorgood.2-12DemandTheLinearDemandFunctioninActionInverseDemandFunction•Bysetting𝑃𝑌=$15and𝑀=$10,000and𝐴=2,000thedemandfunctionis𝑄𝑋𝑑=12,000−3𝑃𝑋+415−110,000+22,000thelineardemandfunctionsimplifiesto𝑄𝑋𝑑=6,060−3𝑃𝑋Solvingthisfor𝑃𝑋intermsof𝑄𝑋𝑑resultsin𝑃𝑋=2,020−13𝑄𝑋𝑑,whichiscalledtheinversedemandfunction.Thisfunctionisusedtoconstructamarketdemandcurve.2-13DemandGraphingtheInverseDemandFunctioninAction2-14QuantityPrice𝑃𝑋=2,020−13𝑄𝑋𝑑$2,02006,060Demand•Marketingstrategies–likevaluepricingandpricediscrimination–relyonunderstandingconsumervalueforproducts.–Totalconsumervalueisthesumofthemaximumamountaconsumeriswillingtopayatdifferentquantities.–Totalexpenditureistheper-unitmarketpricetimesthenumberofunitsconsumed.–Consumersurplusistheextravaluethatconsumersderivefromagoodbutdonotpayfor.2-15ConsumerSurplusDemandQuantityinlitersPriceperliterDemand$50$3$212$1452-16TotalConsumerValue:0.5($5-$3)x2+(3-0)(2-0)=$8Expenditures:$(3-0)x(2-0)=$6ConsumerSurplus:0.5($5-$3)x(2-0)=$2DemandMarketDemandandConsumerSurplusinAction$43ConsumerSurplus•Marketsupplycurve–Summarizestherelationshipbetweenthetotalquantityallproducersarewillingandabletoproduceatalternativeprices,holdingotherfactorsaffectingsupplyconstant.•Lawofsupply–Asthepriceofagoodrises(falls),thequantitysuppliedofthegoodrises(falls),holdingotherfactorsaffectingsupplyconstant.2-17SupplySupply•Changingonlypriceleadstochangesinquantitysupplied.–Thistypeofchangeisgraphicallyrepresentedbyamovementalongagivensupplycurve,holdingotherfactorsthatimpactsupplyconstant.•Changingfactorsotherthanpriceleadtochangesinsupply.–Thesetypesofchangesaregraphicallyrepresentedbyashiftoftheentiresupplycurve.2-18SupplyChangesinQuantitySupplied2-19ChangeinSupplyinActionQuantityPriceS20DecreaseinsupplySupplyABS0S1Increaseinsupply•Inputprices•Technologyorgovernmentregulation•Numberoffirms–Entry–Exit•Substitutesinproduction•Taxes–Excisetax–Advaloremtax•Producerexpectations2-20SupplySupplyShifters2-21ChangeinSupplyinActionQuantityofgasolineperweekPriceofgasoline0t=perunittaxof20¢SupplyS0S0+tt=20¢$1.20$1.00tExcisetax2-22ChangeinSupplyinActionQuantityofbackpacks