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Managerial Economics

1. Managerial Economics (ECON 231) Instructor: Dr. Ronil Barua (Assistant Professor – Finance) Email: [email protected] Essential reading: Keat P. G., P. K. Y. Young and S. Banerjee - Managerial Economics, Pearson Unit II: Demand, Supply and Equilibrium

2. Demand Demand for an item = willingness to buy + ability to pay Desire without purchasing power may lead to want, but not to demand. The demand for a good or service is defined as quantities of a good or service that people are ready to buy at various prices within some given time period, other factors besides price held constant. Direct Demand: Demand for consumption products. This is concerned with individual demand for goods and services that directly satisfy consumer desires. E.g. When customers purchase a cup of coffee, the coffee itself is the final product being consumed, representing direct demand. Derived Demand: Demand for inputs used in production. Their demand is derived from the demand for the products they are used to provide. E.g. The demand for coffee beans by Café Coffee Day.

3. Law of Demand A decrease in the price of a good, all other things held constant, will cause an increase in the quantity demanded of the good. An increase in the price of a good, all other things held constant, will cause a decrease in the quantity demanded of the good. The price (willingness to pay) of a product, service, or activity is inversely related to the quantity demanded, ceteris paribus.

4. The Demand Schedule 4 Demand schedule is a table that shows the relationship between the price of a good and the quantity demanded Example: Sam’s demand for ice-cream. Notice that Sam’s preferences obey the law of demand. Price of ice cream ($) Quantity demanded 0.00 16 1.00 14 2.00 12 3.00 10 4.00 8 5.00 6 6.00 4

5. Demand Curve is a graph of the demand schedule showing the relationship between the price of a good and the quantity demanded per period of time, ceteris paribus. The Demand Curve

6. Price of ice-cream Quantity of ice-cream Sam’s Demand Curve Price of ice-cream ($) Quantity demanded 0.00 16 1.00 14 2.00 12 3.00 10 4.00 8 5.00 6 6.00 4 6

7. Market Demand Vs Individual Demand The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price. Suppose Sam and John are the only two buyers in the ice-cream market. ( Q d = quantity demanded) 4 6 8 10 12 14 16 Sam’s Q d 2 3 4 5 6 7 8 John’s Q d + + + + = = = = 6 9 12 15 + = 18 + = 21 + = 24 Market Q d 0.00 6.00 5.00 4.00 3.00 2.00 1.00 Price ($) 7

8. P Q The Market Demand Curve for Ice-Cream P ($) Q d (Market) 0.00 24 1.00 21 2.00 18 3.00 15 4.00 12 5.00 9 6.00 6 8

9. Quantity Price P Q P 1 Q 1 An increase in price causes a decrease in quantity demanded. Change in Quantity Demanded (movements along the demand curve) A A*

10. Quantity Price P Q P 1 Q 1 A decrease in price causes an increase in quantity demanded. B B*

11. Change in Demand (shifts in the demand curve) The demand curve shows how price affects quantity demanded, other things being equal . These “other things” are non-price determinants of demand (i.e. , things that determine buyers’ demand for a good, other than the good’s price). Changes in them shift the D curve… An increase in demand means that, at each price, more is demanded; a decrease in demand means that, at each price, less is demanded.

12. Quantity Price P Q Q 1 An increase in demand refers to a rightward shift in the market demand curve.

13. Quantity Price P Q 1 Q A decrease in demand refers to a leftward shift in the market demand curve.

14. Change in tastes and preferences of buyers Change in buyers’ income Change in price of related goods Change in future expectations of buyers Change in number of buyers Non-Price Determinants of Demand

15. "Café Delights" is a popular coffee shop located in a bustling city center. Known for its cozy atmosphere and high-quality coffee, the café has a loyal customer base. The café offers a variety of beverages, with its signature product being the "Hazelnut Mocha," priced at $5 per cup. As the café navigates through various market changes, the management observes the impact on the demand for their Hazelnut Mocha. Initial Situation : Product: Hazelnut Mocha Original Price: $5 per cup Quantity Demanded: 300 cups per day Case Study: "Café Delights" and the Dynamics of Demand

16. Situation I: Change in tastes and preferences of buyers Scenario: Over time, there has been a noticeable shift in consumer preferences toward healthier, low-calorie, and plant-based options. This change in tastes and preferences is driven by increasing awareness of health and wellness, as well as environmental concerns. Impact on Demand: As consumers become more health-conscious, the demand for Café Delights' Hazelnut Mocha and other sweet, creamy beverages may decline. This results in a leftward shift in the demand curve for these products, meaning that at every price point, the quantity demanded is lower than before.

17. Quantity Price $5 200 300 Result : The café previously sold 300 cups of Hazelnut Mocha per day at $5 each. After the shift in preferences, the café now sells only 200 cups per day at the same price. This decrease in quantity demanded, without any change in price, indicates a change in demand.

18. Situation II: Change in buyers’ income Normal goods are goods for which demand increases as consumer income increases, and demand decreases as consumer income decreases. In other words, there is a positive relationship between income and the demand for normal goods. E.g. organic foods, electronics, dining at high-end restaurants, etc. Inferior goods are goods for which demand decreases as consumer income increases, and demand increases as consumer income decreases. There is an inverse relationship between income and the demand for inferior goods. E.g. public transportation, used cars, discount clothing, etc.

19. Scenario: A tech company in the area gives its employees significant bonuses, resulting in more frequent visits to Café Delights. Impact on Demand : At Café Delights, most products, such as the Hazelnut Mocha are considered normal goods. With higher incomes, customers may buy more of these items, purchase larger sizes, or choose higher-priced options on the menu. This increase in income leads to a rightward shift in the demand curve for Café Delights’ products. At every price point, customers are now willing to purchase more.

20. Result: Café Delights previously sold 300 cups of Hazelnut Mocha per day at $5 each, a rise in income boosts sales to 400 cups per day at the same price. Quantity Price $5 300 400

21. Situation III: Change in price of related goods Substitute Goods : A substitute good is a product that consumers can choose instead of another similar product. If two goods are substitutes, an increase in the price of one good will increase the demand for the other good. For Café Delights, substitute goods could include coffee from a nearby coffee shop or instant coffee available at grocery stores. Complementary Goods : A complementary good is a product that is typically consumed together with another product. Two goods are complements if an increase in the price of one of the goods causes consumers to demand less of the other good. For Café Delights, complementary goods might include items like pastries, sandwiches, or even milk used in coffee.

22. Scenario A: A nearby competitor called "Bean Bliss," lowers the price of their specialty lattes from $5 to $3. Impact on Demand at Café Delights : If the price of a substitute decreases, the demand for Café Delights' products, such as their Hazelnut Mocha, is likely to decrease. This occurs because consumers can get a similar product for less elsewhere. This scenario would cause a leftward shift in the demand curve for Café Delights' coffee. Even if Café Delights keeps its prices the same, fewer people will buy their coffee because they can purchase a similar product at a lower price nearby.

23. Result: Café Delights sees a drop in sales from 300 to 200 cups of Hazelnut Mocha per day. This indicates a decrease in demand due to the lower price of a substitute good. Quantity Price $5 200 300

24. Scenario B: Café Delights significantly raises the prices of pastries, which customers often buy along with their coffee. Impact on Demand at Café Delights : If the price of a complementary good increases, the demand for Café Delights' products may decrease. Customers might see the overall cost of their café experience as too high and reduce their consumption. This would also cause a leftward shift in the demand curve for Café Delights' coffee. The higher price of the complement discourages the purchase of both the complement and the associated coffee.

25. Result: Café Delights sees a drop in sales from 300 to 250 cups of Hazelnut Mocha per day. This suggests that the increased price of the complementary goods (pastries) has led to a decrease in demand for their coffee. Quantity Price $5 250 300

26. Situation IV: Change in future expectations of buyers Scenario A : There have recently been widespread reports and rumors that coffee prices are expected to rise significantly in the near future due to a poor coffee harvest or an increase in global coffee bean prices. Impact on Demand at Café Delights : If consumers expect that the price of coffee at Café Delights will increase soon, they may decide to buy more coffee now while the prices are still low. This is a classic example of "buying ahead" to avoid higher costs later. This behavior would cause a rightward shift in the demand curve . Even though the current price of coffee at Café Delights has not changed, the quantity demanded increases because consumers are trying to take advantage of current prices before they rise.

27. Result: Café Delights typically sells 300 cups of coffee per day at $5 each, but due to expectations of future price increases, sales jump to 400 cups per day, indicating that consumer expectations are driving an increase in current demand. Quantity Price $5 300 400

28. Scenario B : Café Delights operates in a city where the economic and social environment can influence consumer expectations about the future. There have recently been concerns about potential job losses, wage cuts, and a recession, as three companies in the area have announced layoffs due to which consumers expect their income to decrease in the near future. Impact on Demand at Café Delights : In anticipation of tighter budgets, consumers might cut back on discretionary spending, including visits to Café Delights. This would result in a decrease in current demand and a leftward shift in the demand curve , as consumers become more cautious with their spending due to fears of reduced future income.

29. Result: Café Delights sees a drop in sales from 300 to 200 cups of Hazelnut Mocha per day, as customers start cutting back on their daily coffee purchases, leading to a drop in demand even before the layoffs actually happen. Quantity Price $5 200 300

30. Situation V: Change in number of buyers Scenario : The neighborhood around Café Delights experiences a surge in population due to the opening of a new apartment complex and an influx of students to a new university campus. Impact on Demand : As the number of residents increases, the number of potential customers for Café Delights also rises. More people living or working in the area means more potential customers who might stop by for coffee or a snack. This increase in the number of buyers leads to a rightward shift in the demand curve . At any given price, Café Delights can now expect higher sales because there are more customers in the area.

31. Result: Café Delights typically serves around 500 customers per day, and a new apartment complex and university complex brings 200 more regular customers, due to which, the café sees its daily customer count increase to 700. This growth reflects an increase in demand from 300 cups to 400 cups due to the higher number of buyers. Price Quantity $5 300 400

32. Summary: Variables That Influence Buyers Variable A change in this variable… Price …causes a movement along the D curve No. of buyers …shifts the D curve Income …shifts the D curve Price of related goods …shifts the D curve Tastes …shifts the D curve Expectations …shifts the D curve 32

33. The relation between quantity demanded and these six factors is referred to as the general demand function and is expressed as follows: where, means “is a function of” or “depends on”, and = quantity demanded of the good or service = price of the good or service = consumers’ income = price of related goods or services = tastes and preferences of consumers = expected price of the good in some future period = number of consumers in the market  

34. The linear form of the general demand function is given as: where, a, b, c, d, e, f, and g are parameters. The intercept parameter shows the value of when the variables , , , , and are all simultaneously equal to zero. The other parameters, b, c, d, e, f, and g, are called slope parameters . They measure the effect on quantity demanded of changing one of the variables , , , , , or while holding the rest of these variables constant. The slope parameter b, for example, measures the change in quantity demanded per unit change in price.  

35. Problem 1: The following function describes the demand condition for a company that makes caps featuring names of college and professional teams in a variety of sports: Q = 2,000 - 100 P where, Q is cap sales and P is price. a) How many caps could be sold at $12 each b) What should the price be in order for the company to sell 1,000 caps c) At what price would cap sales equal zero

36. Solution: The number of caps that could be sold at a price of $12 each as per the demand equation is: 2,000 – 100(12) = 800 caps. b) The price that should be in order for the company to sell 1000 caps is: 1,000 = 2000 – 100P ⇒100P = 2,000 – 1,000 ⇒100P = 1,000 ⇒P = 10 So, the price should be $10 per cap. c) The price at which cap sales would equal zero is: 0 = 2,000 – 100P ⇒100P = 2,000 ⇒P = 20 So, at a price of $20 per cap, the sales will be zero.

37. Problem 2: You are a manager at Cadence Brisk, a vegetarian restaurant chain. Your supervisor asks you to determine the quantity of food to buy for the chain’s Brisk Feast, an annual month-long promotion when Cadence Brisk features a variety of vegetarian dinners, including its signature truffled mushroom casserole. Your research department reports that the demand for vegetarian dinners is: where, is the quantity of dinners demanded per week, is the price of a dinner, and is the average family income of Cadence Brisk customers. If the average family income of Cadence Brisk customers is $40,000 and you set the price of a dinner at $18 per dinner, what is the quantity of dinners demanded? If you raise the price of a dinner from $18 to $20 and the average family income remains equal to $40,000, what is the change in the quantity of dinners demanded? Is there a movement along the demand curve or a shift of the curve? With the price of a dinner set at $20, what is the change in the quantity of dinners demanded if your advertising brings in families with an average income of $42,000 rather than $40,000? Is there a movement along the demand curve, or does the curve shift?  

38. Solution: a) The demand function shows that the quantity of dinners demanded equals: 13,00,000 dinners – (1,00,000 dinners $18) + (32 dinners $40,000) = 7,80,000 dinners. b) The coefficient for the price variable, 1,00,000 dinners per dollar, shows that a $2 increase in the price of a dinner decreases the quantity demanded by: 1,00,000 dinners 2 = 2,00,000 dinners per week. The increase in price leads to an upward movement along the demand curve. c) The coefficient for the income variable, 32 dinners per dollar, shows that a $2,000 increase in the customers’ average income increases the quantity demanded by: 32 dinners $2,000 = 64,000 dinners per week. The increase in income leads to a rightward shift of the demand curve equal to 64,000 dinners.  

39. Supply The supply for a good or service is defined as quantities of a good or service that people are ready to sell at various prices within some given time period, other factors besides price held constant. Notice that the only difference between the above definition and that of demand is that in this case, the word sell is used instead of buy.

40. Law of Supply A decrease in the price of a good, all other things held constant, will cause a decrease in the quantity supplied of the good. An increase in the price of a good, all other things held constant, will cause an increase in the quantity supplied of the good. The price of a product, service, or activity is positively related to the quantity supplied, ceteris paribus.

41. The Supply Schedule Supply schedule is table that shows the relationship between the price of a good and the quantity supplied. Example: Baskin Robbins’ supply of ice-cream. Notice that Baskin Robbins’ supply schedule of ice-cream obeys the law of supply. Price of ice-cream ($) Quantity of ice-cream supplied 0.00 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18

42. The Supply Curve Supply Curve is a graph of the supply schedule showing the relationship between the price of a good and the quantity supplied per period of time, ceteris paribus.

43. Baskin Robbins’ Supply Schedule & Curve Price of eateries ($) Quantity of ice-cream supplied 0.00 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18 P Q 43

44. Market Supply Vs Individual Supply The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. Suppose Baskin Robbins and Kwality Walls are the only two sellers in this market. ( Q s = quantity supplied) 18 15 12 9 6 3 Baskin Robbins 12 10 8 6 4 2 Kwality Walls + + + + = = = = 30 25 20 15 + = 10 + = 5 + = Market Q s 0.00 6.00 5.00 4.00 3.00 2.00 1.00 Price ($) 44

45. P Q P ($) Q S (Market) 0.00 1.00 5 2.00 10 3.00 15 4.00 20 5.00 25 6.00 30 The Market Supply Curve 45

46. Change in Quantity Supplied (movements along the supply curve) Quantity Price P 1 Q 1 P Q A decrease in price causes a decrease in quantity supplied.

47. Quantity Price P Q P 1 Q 1 An increase in price causes an increase in quantity supplied.

48. The supply curve shows how price affects quantity supplied, other things being equal . These “other things” are non-price determinants of supply. Changes in them shift the S curve… “Non-price determinants of supply” simply means the things—other than the price of a good—that determine sellers’ supply of the good. 48 Change in Supply (shifts in the supply curve)

49. Quantity Price P Q 1 Q An increase in supply refers to a rightward shift in the market supply curve.

50. Quantity Price P Q 1 Q A decrease in supply refers to a leftward shift in the market supply curve.

51. Costs and Technology Prices of other goods or services offered by the seller Future expectations Number of sellers Weather conditions Non-Price Determinants of Supply

52. Case Study: Indigo Airlines and the Dynamics of Supply IndiGo Airlines, one of India’s leading low-cost carriers, operates a vast network of domestic and international flights. As a major player in the aviation industry, IndiGo faces various market forces that impact its supply of flights. This case study explores how the law of supply, changes in quantity supplied, and changes in supply affect IndiGo Airlines in response to different market conditions. Initial Situation : Ticket Price: ₹5,000 per flight on a popular domestic route (Delhi to Mumbai). Quantity Supplied: 20 flights per day on this route.

53. Situation I: Change in costs and technology Scenario A: There’s a significant increase in global oil prices, leading to a 30% rise in jet fuel costs. This increases the overall operating expenses for IndiGo, making each flight more expensive to operate. Impact on Supply: Due to the higher fuel costs, to maintain profitability, they might reduce the number of flights or raise ticket prices. Assuming they keep the same ticket price, the quantity of flights supplied will decrease. The increase in fuel costs causes a leftward shift in the supply curve .

54. Result: IndiGo can no longer afford to operate 20 flights per day at the same price of ₹5,000. At the original price of ₹5,000, the new supply curve shows that IndiGo now only supplies 15 flights per day instead of 20, reflecting a reduction in supply due to higher input costs. Quantity Price Rs. 5000 15 20

55. Scenario B: IndiGo invests in a new fleet of more fuel-efficient aircraft, reducing fuel consumption by 15% per flight. This technological improvement lowers the cost of operating each flight. Impact on Supply: The new, more fuel-efficient aircraft reduce operational costs, allowing IndiGo to increase the number of flights without raising prices. As a result, the quantity supplied might increase per day at the same ticket price. This technological improvement leads to a rightward shift in the supply curve .

56. Result: IndiGo can now supply more flights at the same price, increasing the quantity supplied from 20 to 28 flights per day. Quantity Price Rs. 5000 28 20

57. Situation II: Prices of other goods or services offered by Indigo Scenario: IndiGo offers various ancillary services such as checked baggage, onboard meals, extra legroom seats, and priority boarding. The airline initially charged ₹500 for checked baggage. Suppose, IndiGo increases the price of checked baggage from ₹500 to ₹800 due to higher handling costs or to improve profitability from ancillary services. Impact on Supply: The increase in ancillary service prices boosts IndiGo's overall revenue per passenger. This additional revenue can be used to cover higher costs, invest in fleet expansion, or improve service quality. With increased revenue from ancillary services, IndiGo might decide to offer more flights, expand its routes, or increase flight frequencies. This is because the additional revenue supports the airline’s operational and expansion efforts. Thus, the supply curve shifts rightward , indicating an increase in the quantity of flights supplied at each price level.

58. Result: If IndiGo initially supplied 20 flights per day on a route at ₹5,000 per ticket, the additional revenue from the increase in ancillary service prices might enable IndiGo to increase the number of flights to 22 per day at the same ticket price, reflecting an increase in supply. Quantity Price Rs. 5000 22 20

59. Situation III: Future expectations Scenario: IndiGo expects that global oil prices will rise significantly in the next six months due to geopolitical tensions or other factors. Impact on Supply: In anticipation of higher fuel prices, IndiGo might adjust its current supply decisions to mitigate future costs. They could reduce the number of flights or slow down expansion plans to avoid operating with higher future costs. Anticipating higher future costs may lead IndiGo to reduce its current supply as a precaution. The supply curve shifts leftward , reflecting a decrease in the quantity of flights supplied at each current price level due to expected increased future costs.

60. Result: If IndiGo initially planned 20 flights per day, the expectation of higher fuel costs prompts a reduction to 18 flights per day, reflecting a decrease in supply. Quantity Price Rs. 5000 18 20

61. Situation IV: Number of sellers Scenario: IndiGo is one of the key players in a market with a certain number of airlines operating on popular routes, such as the Delhi-Mumbai route. Two new airlines have now entered the market, increasing the total number of airlines offering flights on the same routes. This increase in competition can alter the dynamics of supply and pricing. Impact on Supply: With more airlines offering similar routes, IndiGo faces higher competition. The increase in the number of sellers can lead IndiGo to expand its flight offerings to compete effectively. This results in a rightward shift in the supply curve , indicating an increase in the quantity of flights supplied at each price level due to the heightened competition and market pressure.

62. Result: If IndiGo initially operated 20 flights per day on a route and new competitors enter the market, IndiGo increases its flights to 25 per day to capture a larger market share, reflecting an increase in supply. Quantity Price Rs. 5000 25 20

63. Situation V: Weather conditions Scenario: Weather conditions have a direct impact on airline operations and can cause shifts in the supply curve for IndiGo Airlines. IndiGo operates a certain number of flights on various routes under normal weather conditions. Now, major storms have been affecting key airports that IndiGo uses for a while. Impact on Supply: Severe weather can lead to airport closures, flight cancellations, and delays. This disrupts IndiGo’s flight schedules and reduces the number of flights that can be operated safely. Due to operational disruptions, IndiGo may reduce the number of flights it offers temporarily or adjust its schedule to deal with the adverse weather. This results in a leftward shift in the supply curve , indicating a decrease in the quantity of flights supplied at each price level due to the weather-related disruptions.

64. Result: If IndiGo originally operated 20 flights per day on a route, severe weather conditions forces a reduction to 12 flights per day due to airport closures or safety concerns, reflecting a decrease in supply. Quantity Price Rs. 5000 12 20

65. The relation between quantity supplied and these six factors is referred to as the general supply function and is expressed as follows: where, means “is a function of” or “depends on”, and = quantity of a good or service offered for sale = price of inputs used in production = price of goods or services related in production = level of available technology = expectations of producers concerning the future price of the good = number of firms or amount of productive capacity in the industry  

66. The linear form of the general supply function is given as: where, , , , , , , and are parameters. is the intercept parameter. The other parameters, , , , , , and , are called slope parameters .  

67. Problem 3: The market supply of a good is given by the following equation: Q = 30 + 2P where, Q = quantity supplied per period P = price of the good Determine the quantity of the good supplied at a price of ₹25. Calculate the price at which the quantity supplied would be 90 units. If the price increases from ₹30 to ₹40, find the change in the quantity supplied.

68. Solution: The quantity of goods supplied at a price of ₹25 is given as: 30 + 2(25) = 80 b) The price at which quantity supplied would equal 90 units is: 90 = 30 + 2P ⇒2P = 60 ⇒P = 30 So, price should be ₹30. c) Quantity supplied at ₹40 is given as: 30 + 2(40) = 110 So, increase in quantity supplied if price increases from ₹30 to ₹40 is: 110 – 90 = 20 units.

69. Problem 4: Renewza Corp. is a company that produces two types of solar panels: Panel X and Panel Y . The supply of these panels is influenced by the price of the panels, labor costs, and production capacity constraints. The supply equations for the two types of panels are given by: Panel X : Panel Y : where, and represent the quantity of Panel X and Panel Y supplied per month, respectively. and are the prices of Panel X and Panel Y, respectively, in ₹. represents the labor cost of production in ₹. and represent the production capacity constraints for Panel X and Panel Y, respectively, in units. Given that: = ₹600, = ₹800, = ₹100, = 200 and = 300. Determine the initial quantity supplied for both Panel X and Panel Y. If labor costs increase by ₹50, how does this affect the quantity supplied for both Panel X and Panel Y, assuming all other factors remain constant? Renewza Corp. decides to expand production capacity, reducing the constraints by 50 units for each panel. Determine the new quantity supplied after the capacity expansion, keeping labor costs at the increased level. If the market price of Panel X drops by ₹100 and Panel Y by ₹150, calculate the resulting quantity supplied for each panel, assuming the expanded capacity and increased labor costs.  

70. Solution: a) For Panel X: units. For Panel Y: units. b) If labor costs increase by ₹50, the new labor cost becomes ₹150. Keep all other factors constant. For Panel X: units. For Panel Y: units. After the labor cost increases, the quantity supplied of Panel X decreases by 15 units to 5,235 units , and the quantity supplied of Panel Y decreases by 25 units to 8,565 units .  

71. c) Renewza Corp. expands production capacity, reducing the constraints by 50 units for each panel. The new constraints are =150 and =250. Keep labor costs at ₹150. For Panel X: units. For Panel Y: units. After the production capacity expansion, the quantity supplied of Panel X increases slightly to 5,240 units , and Panel Y increases slightly to 8,575 units . d) The market price of Panel X drops by ₹100 (new price = ₹500) and Panel Y by ₹150 (new price = ₹650). Consider the expanded capacity and increased labor costs. For Panel X: units. For Panel Y: units. After the price drop, the quantity supplied of Panel X decreases to 4,440 units , and Panel Y decreases to 7,075 units .