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ECO 610-401

Monday, September 8

Course Outline Review of Supply and Demand

Readings:

Brickley et. al, Chapters 1-2,4:96-114;

Hoyt, Lectures 1:1-10Next Class (Monday, September 15)

Demand and Supply; Market Equilibrium (continued);

Pricing with Market Power

Readings

Brickley et. al, Chapters 4 & 7;Hoyt, Lectures 1:11-16-2:1-6

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Course Description

From the University Bulletin, 2001-2002(p. 216) "Analysis of

applications of economic theory to management decision

making. Such problems as demand and cost determination,

pricing, and capital budgeting are treated."

Narrow goal: Using the tools of economics, a number ofbusiness practices and strategies including pricing, cost

determination, compensation, entry and exit, and output

decisions.

Broader goal: Acquaint the student with and help the studentlearn to use economic analysis in his or her professional,

business pursuits.

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Use of Tools of Economic AnalysisMost of you have been exposed to the use of graphical analysis in economics.

Some of you might also have taken courses in which calculus and algebraic equations havebeen used extensively.

In this course, some graphical analysis is used as are algebra and calculus but much less thanmost intermediate economics courses.

My view: very unlikely that most of you will ever use these tools (graphs and calculus) tosolve any problems you face in business, there is not a good reason to train youextensively in their use.

Use graphical analysis and algebra examples only when I think they add to yourunderstanding of an economic concept or principal.

Use numerical examples and cases as an opportunity to see how an economic principal ortool can be applied to business decision-making.

Exams and assignments will also be much more heavily weighted towards solving simplenumerical examples or analyzing actual or hypothetical cases.

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Readingand Text

The required text for the course is: Brickley, James; Smith, Clifford; and Zimmerman, Jerold, Managerial

Economics and Organizational Architecture, McGraw Hill Irwin, 2007, 4thEdition.

Additionally chapters from:Hoyt, William H. Lectures in Managerial Economics, 2008.

Lectures in Managerial Economicsis an unpublished manuscript that will be

available (by lecture) at the website.

Material used in a number of sections of the course and

complements the material in your text. Not a substitute for the lecture nor are they a verbatim summary of

the lecture.

Do not use them as a substitute for class or taking notes in

class.

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Grading and Assignments

Exams 2 during semester and 1 during Finals week Each exam is 20% of grade

Extended Assignments: 3 during the semester 20% of grade

Applying the economic concepts and principles discussed in thecourse to make a business decision. Frequently, the assignmentsare based on reading and analyzing a specific case.

Homework: Several Problem solving

20% of grade Specific dates have not yet been determined.

Participation: Important component of the course At the end of the term, I award bonuses for class participation. The maximum bonus is small, but can matter for your grade in

borderline cases.

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Exam and Assignment Schedule

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Absences and Attendance

No explicit attendance policy for the course, but good attendance is important for doing wellin the course.

If you miss a class, it is your responsibility to obtain notes and other material from that classperiod (from some source other than me).

Most of this material will be on the website.

Make-up Exams

Students who have a University-excused absence for missing an exam may take a make-up. Arrangements for a make-up must be made with the instructor as soon as possible.

Make-up for missed homework is allowed only in extraordinary circumstances.Information on Grades

After the first 2 exams I shall calculate a grade distribution based on the scores of gradedmaterial up to that point

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Grievance Procedure

Incorrectly added your points or have appeared not to see some material on theexam, simply bring it to my attention sometime outside of class.

If you believe that your answer is correct and I have incorrectly interpreted ormisunderstood it or my answer is incorrect, then I will ask you to make a writtenappeal.

Homework assignments will not be regraded other than errors in totaling scores.

Cheating

Dont Cheat.Tardiness

Tardiness is discouraged

Try as much as possible to arrive on or before the class starts.

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Classroom Behavior

No cellular telephones should be on or on vibrate

Limit entrances and exits from room

Extended discussions between students during lecture are very disruptive to therest of the class

No Classroom Computer UseOffice Hours

Encourage you to come to my office during office hours.

If office hours are not convenient and you would like to talk to me, please makean appointment (e-mail is probably best) to schedule a meeting at a moreconvenient time.

If you are having difficulty in the course, please come to see me as early as

possible rather than waiting until a few days before the exam or, worse, after theexam.

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The Determinants of DemandDemandThe relationship between the quantity of a good

desired by people in a market and the factors that affect that

the quantity desired is referred to as the demand for the

product. We can express the demand for a product in the

formWe have some precise definitions related to how income and

prices of other goods affect the demand for a good.

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Factors that we expect to affect the demand for the good include:

Population (n)

Price of the good (pi)

Price of other goods (pj)

Income (y) Expectations of future prices

Tastes (T)

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Substitutes and Complements

Two goods, x and y, are said to be substitutesif an increase in the price of x

(y) increases the demand for good y (x) and a decrease in the price of x

(y) decreases the demand for y (x).

Two goods, x and y, are said to be complementsif an increase in the price

of x (y) decreases the demand for good y (x) and a decrease in the priceof x (y) decreases the demand for y (x).

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Income and Demand

A good is said to be normal if an increase (decrease) inincome increases (decreases) the demand for the good. A

good is said to be inferior if an increase (decrease) in income

decreases (increases) the demand for a good.

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The Demand Curve

The relationship between the quantity demanded of a good and the price of that

good is referred to as the demand curve.

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Figure 5

0

1

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7

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0 10 20 30 40 50 60 70 80 90 100

Quantity

Price

($)

D

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The demand curve gives the relationship between price and

the quantity consumers will desire to purchase at that price.

Note the demand curve is drawn given that no other

factors affecting the demand for the product, such as

income, population, or tastes, change.

Demand for the product is based on specific,

unchanging values for the other factors that affect

demand.

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The Law of Demand As the price of a good decreases (increases), more (less) of it

will be purchased.

That is, the demand curve is downward sloping.

There are two factors that explain this relationship:

As the price of a good increases, consumers will substitute into othergoods (substitution effect);

.As the price of a good increases, consumers will have less real income to

purchase all goods (income effect).

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Changes in Demand versus Changes in Quantity

Demanded

A movement along a demand curve is referred to as a change in quantity

demanded. The quantity demanded changes because of a price change.

A shift in the demand curve is referred to as a change in demand.

Demand changes (the demand curve shifts) because of a change in one ofthe factors affecting demand other than price (income, price of othergoods, tastes, population) changes.

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Demand for steaks

D1represents the demand for steaks (lbs/day) given the price of

chicken is $3.50; the number of customers is 1,500 a day; and theaverage annual household income is $40 thousand.

Then we might expect the following:

A decrease in demand for steak if the price of chicken, a substitutefor steak, fell from

$3.50 to $2.00.

This is shown by a shift in of the demand curve from D1 to D2

An increase in demand for steak if the annual income increases from $40 to $60

thousand, since steak is a normalgood.

This is shown by a shift out of the demand curve from D1 to D3

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Figure 6

0

1

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3

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5

6

0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 2000

Quantity (lbs of Steak/Day)

Price

($/lb)

D1

D2

D3

D4

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Figure 1

0

1

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0 10 20 30 40 50 60 70 80 90 100

Quantity

Price

($)

D

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Algebraic Representation

The preceding figure that follows is given byQD = 100 - 10P

Linear relationshipwe can graph by choosing two points.

Easiest points:

Q = 0 0 = 100 - 10P or P = 10, Q = 0

P = 0 implying Q = 100 - 10(0) = 100 and therefore P =

0, Q = 100

Slope, dQ/dP = -10

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The Determinants of Supply

Number of Firms

Price of Product

Cost of inputs

Wages Capital

Materials

Price of other goods

Expectations of Future Prices

Technology

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The Supply Curve

The relationship between the quantity supplied of a good and the price ofthat good is referred to as the supplycurve.

The supply curve gives the relationship between price and thequantity produces will wish to sell at that price

Note the supply curve is drawn given that no other factors affecting the

supply for the product. Supply of the product is based on specific, unchanging values for the

other factors that affect supply.

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Figure 3

0

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0 10 20 30 40 50 60 70 80

Q

$

S

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The Law of Supply

As the price of a good increases (decreases), more (less) of it will be produced

and offered for sale.

The supply curve is upward sloping.

This is explained by the assumption that marginal (incremental) cost increases

as output increases.

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Changes in Supply versus Changes in

Quantity Supplied

A movement along a supply curve is referred to as a change in

quantity supplied.

The quantity supplied changes because of a price change.

A shift in the supply curve is referred to as a change in supply.

Supply changes (the supply curve shifts) because of a change

in one of the factors affecting supply other than price

changes.

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Supply of Steaks

The supply curve represents the supply (lbs/day) given that there

are 5 grocery stores and butchers are paid $12 an hour.

Then we might expect the following:

An increase in supply if another grocery store opens. This is

shown by a shift in supply from S1 to S2.

A decrease in supply if the wage rate for butchers increases

from $12 an hour to $14 an hour. This is shown by a shift

from S1 to S3.

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Figure 4

0

0.5

1

1.5

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2.5

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3.5

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4.5

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5.5

0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600

Q

$ S1

S2

S3

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Algebraic Representation of Supply

The algebraic representation of supply is analogous to that of

demand.

The supply curve depicted in Figure 3 is given by the

equation

Qs= -50 + 10P

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Equilibrium

What do we mean by equilibrium price and quantity?

At the equilibrium price, the quantity demanded by consumers is exactly

equal to the quantity supplied by producers.

Why do we care about equilibrium?

Expected Prices

Predictable Prices (can be modeled)

Stable Prices

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Figure 5

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0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80

Q

P

S=-50+10P

D=100-10P

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Algebraic Determination of Equilibrium

QD = 100 - 10P (Demand)

QS = -50 + 10P (Supply)

Equating QD = QS gives

100 - 10P = -50 + 10P

20P = 150 P = 7.50Using the Demand equation we find Q

Q = 100 10(7.50) = 25

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Comparative Statics

What happens to Price & Quantity when:

Incomes increase

Wages fall

Prices of other goods change

Making predictions of the impact on the market of these types of changes isreferred to as Comparative Statics

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Comparative Statics (continued)

These changes are all changes in demand or changes in supply

Shifts in demand or supply curve

4 possibilities:

Increase in demand (shift out demand curve) Decrease in demand (shift in demand curve)

Increase in supply (shift out supply curve)

Decrease in supply (shift in supply curve)

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Table 1: The Impact of Market Condition Changes on EquilibriumPrice and Quantity

MarketChange

Impact onEquilibrium

Price

Impact onEquilibrium

Quantity

Examples

Increase inDemand

+ + Increase in Income (normalgood); increase in price ofsubstitute; decrease inprice of complements;increase in population

Decreasein Demand

- - Opposite of increase indemand

Increase inSupply

- + Technological innovation;increase in suppliers;decreases in costs

Decreasein Supply + - Increase in costs or wages;increase in price ofalternative productproduced by firms

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Figure 6b: A Decrease in Demand

-4

-2

0

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0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100

Q

P

S

Do

D'

P'

Po

QoQ'

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Figure 6c: An Increase in Supply

0

2

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0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100

Q

P

S'

DoP'

Po

QoQ'

So

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Figure 6d: A Decrease in Supply

0

2

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10

12

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18

20

0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90

Q

P

S'

Do

P'

Po

QoQ'

So