Lecture - 1 (1), Basics of Engineering Economics

8/20/2019 Lecture - 1 (1), Basics of Engineering Economics

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The Market Forces of

Supply andDemand◆ Supply and demand are the two words

that economists use most often.◆ Supply and demand are the forces that

make market economies work.

◆Modern microeconomics is aboutsupply, demand, and market

equilibrium.


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Markets

◆A market is a group of buyers and

sellers of a particular good or service.◆The terms supply and demand refer

to the behavior of people . . . as theyinteract with one another in markets .

Harcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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Markets◆ Buyers determine demand .

◆ Sellers determine supply .



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Market Type:

A CompetitiveMarket


A competitive market is a market. . .

… with many buyers and sellers.

… that is not controlled by any one person.

… in which a narrow range of prices areestablished that buyers and sellers actupon.


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Competition:

Perfect and Otherwise


erfect !ompetition

◆ roducts are the same◆ "umerous buyers and sellers so that each

has no influence over price◆ Buyers and Sellers are price takers


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Competition:

Perfect and Otherwise


◆Monopoly

◆One seller, and seller controls price◆#ligopoly

◆Few sellers◆ Not always aggressive competition


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Demand


$uantity demanded

is the amountof a good that buyers are

willing and ableto purchase.


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Law of Demand


The law of demand states

that there is an inverserelationship between price

and quantity demanded.


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Demand Schedule


The demand schedule is a table

that shows the relationshipbetween the price of the goodand the quantity demanded.


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Demand Schedule

Price Quantity

$0.00

12

0.50 10

1.00 81.50 62.00 4

2.50 2Harcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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Determinants of Demand

◆Market price◆!onsumer income◆ rices of related goods◆Tastes

◆%&pectations



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Demand Curve


The demand curve is the downward'

sloping line relating price toquantity demanded.


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Demand CurvePrice of

Ice-CreamCone

$3.00

2.50

2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 1112

P r ic e$0 . 0 0

Q ua n tity1 2

0 . 50 101 . 00 81 . 50 62 . 00 42 . 50 23 . 00 0

Quantity

of Ice-CreamConeHarcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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Market Demand


◆Market demand refers to the sum ofall individual demands for a

particular good or service.◆(raphically, individual demand

curves are summed horizontally toobtain the market demand curve.


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Determinants of Demand


◆Market price◆!onsumer income◆ rices of related goods◆Tastes

◆%&pectations


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Chan ein!uantity Demanded

versus Chan e in Demand


!hange in $uantity )emanded◆ Movement along the demand curve.◆ !aused by a change in the price

of the product.


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Chan es in !uantityDemandedPrice of

Ci arettes!erPac"

) *0

#um er ofCi arettes

% ta& t'at raisest'e !rice of

ci arettes resu(tsin a mo)ement

a(on t'e *eman*cur)e.

%

C

20

2.00

$4.0

0

12 +mo"e* !erHarcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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Chan ein!uantity Demanded

versus Chan e in Demand

!hange in )emand◆ A shift in the demand curve,

either to the left or right.◆

!aused by a change in adeterminant other than theprice.



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Chan es in DemandPrice of

Ice-CreamCone

0

) *Quantity

of Ice-Cream

) +

Increasein*eman*

,ecreasein*eman*

)

ConeHarcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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Consumer "ncome


◆As income increases the demand

for a normal good will increase .◆As income increases the demand

for an inferior good will decrease .


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Consumer "ncome#ormal $ood

2.502.001.501.000.50

Price of

Ice-CreamCone$3.00

Increasein*eman*

) *9 10 11 12

Quantity

of Ice-0 1 2 3 4 5 6 7 8Harcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.

%nincrease

inincome...

)


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Consumer "ncome"nferior $ood

1.501.00

0.50

Price of

Ice-CreamCone

$3.00

2.50

2.00 ,ecrease in*eman*

%n

increaseinincome...

) ) *9 10 11 12

Quantity

of Ice-0 1 2 3 4 5 6 7 8Harcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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Prices of %elated $oods


Su&stitutes ' Complements

◆-hen a fall in the price of one goodreduces the demand for another good,

the two goods are called substitutes .◆-hen a fall in the price of one good

increases the demand for another

good, the two goods are calledcomplements .


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Supply


$uantity supplied is the amount of a

good that sellers are willing and ableto sell.


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Law of Supply


The law of supply states that there is a

direct (positive) relationship betweenprice and quantity supplied.


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Determinants of Supply

◆Market price◆ nput prices◆Technology◆%&pectations◆"umber of producers



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Supply Schedule

The supply schedule is a table that

shows the relationship between theprice of the good and the quantity

supplied.



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Supply Schedule

Price Quantity

$0.00 0

0.50 01.00 11.50 22.00 32.50 43.00 5Harcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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Supply Curve


The supply curve is the upward'sloping line relating price to

quantity supplied.


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Supply CurvePrice ofIce-CreamCone

$3.00

2.50

2.00

1.50

1.00

0.50Quantityof Ice-Cream

Price Quantity$0.00 00.50 0

1.00 11.50 22.00 32.50 4

3.00 5

0 1 2 3 4 5 6 7 8 9 10 1112 ConeHarcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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Market Supply


◆Market supply refers to the sum ofall individual supplies for all sellersof a particular good or service.

◆(raphically, individual supplycurves are summed horizontally toobtain the market supply curve.


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Determinants of Supply


◆Market price◆ nput prices◆Technology◆%&pectations

◆"umber of producers


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Chan e in !uantity Suppliedversus Chan e in Supply


!hange in $uantity Supplied◆ Movement along the supply curve.◆ !aused by a change in the market price

of the product.

Chan e in !uantity Supplied


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Chan e in !uantity Supplied

1 50

Price ofIce-CreamCone

S

1.00

Quantityof Ice-Cream

%

C$3.00

A rise in the price

of ice cream conesresults in amovement alongthe supply curve .



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Chan e in !uantity Suppliedversus Chan e in Supply

!hange in Supply◆ A shift in the supply curve, either to the

left or right.◆ !aused by a change in a

determinant other than price.


Chan e in Supply


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Chan e in SupplyPrice of

Ice-CreamCone


0

S* SS+

Increasein+u!!(y

,ecreasein+u!!(y


Supply and Demand To ether


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%quilibrium rice◆ The price that balances supply and

demand. #n a graph, it is the price

at which the supply and demandcurves intersect.

%quilibrium $uantity

◆ The quantity that balances supply anddemand. #n a graph it is the quantity atwhich the supply and demand curves

intersect.



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Supply and Demand To ether ,eman* +c'e*u(e +u!!(y

+c'e*u(e

1.502.0

02.503.0

0

471

013

Price$0.00

Quantity19

Price$0.00

Quantity 0

0.50 16 0.50 01.00 13 1.00 11.50 102.00 72.50 43.00 1

(t )*+,,- the .uantity demanded ise.ual to the .uantity supplied/


0 uili&rium of


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0.uili&rium ofSupply and DemandPrice of

Ice-CreamCone

$3.0

0

2.5

0

2.00

1.50

1.00

+u!!(y

ui(i rium

,eman*Quantityof Ice-Cream

0.50

0 1 2 3 4 56

7 8 9 10 1112Harcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.


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01cess Supply

+u!!(y+ur!(u

s

,eman*Quantityof Ice-Cream

0.50

0 1 2 3 4 56

7 8 9 10 1112Harcourt Inc. items and derived items co ri ht © 2001 b Harcourt Inc.

Price of

Ice-CreamCone

$3.002.502.001.501.00


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Surplus

-hen the price is above the equilibriumprice, the quantity supplied e&ceeds thequantity demanded. There is e&cesssupply or a surplus. Suppliers willlower the price to increase sales, thereby

moving toward equilibrium.



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01cess Demand


, 2 *3

4 5 6 7 8 9 2, 22 2*23

,eman*

Priceof Ice-Cream

Cone

+u!!(y

$2 .00

$1.50


+'ortae


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Shorta e


-hen the price is below the equilibriumprice, the quantity demanded e&ceeds the

quantity supplied. There is e&cessdemand or a shortage. Suppliers willraise the price due to too many buyers

chasing too few goods, thereby movingtoward equilibrium.


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hat ;appens to Price and !uantityhen Supply or Demand Shifts<


#o C'an eIn +u!!(y

%n IncreaseIn +u!!(y

% ,ecreaseIn +u!!(y

#o C'an eIn ,eman*

P. sameQ. same

P. downQ. up

P. upQ. down

%nIncreaseIn ,eman*

P. upQ. up

Pam i!uousQ up

P. upQ. am i!uous

% ,ecreaseIn ,eman*

P. downQ. down

P. downQ. am i!uous

P. am i!uousQ. down


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Summary


◆%conomists use the model of supplyand demand to analy/e

competitive markets.◆The demand curve shows how the

quantity of a good depends upon theprice.


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Summary


◆According to the law of demand, asthe price of a good rises, the quantitydemanded falls.

◆ n addition to price, otherdeterminants of quantity demanded

include income, tastes, e&pectations,and the prices of complements andsubstitutes.


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Summary


◆The supply curve shows how thequantity of a good supplied depends

upon the price.◆According to the law of supply, as

the price of a good rises, the quantitysupplied rises.


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Summary


◆ n addition to price, otherdeterminants of quantity supplied

include input prices, technology, ande&pectations.◆Market equilibrium is determined

by the intersection of the supply anddemand curves.


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Summary


◆Supply and demand togetherdetermine the prices of the

economy0s goods and services.◆ n market economies, prices are the

signals that guide the allocation of

resources.


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The Costs of Production

The 1aw of Supply2◆3irms are willing to produce andsell a greater quantity of a good whenthe price of the good is high.◆This results in a supply curve thatslopes upward.


Th Fi O& i


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The Firm=s O&>ective

The economic oal of the firmis to ma1imi?e profits+


( Firm=s Total %evenue and


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(Total Cost


◆Total 4evenue◆ The amount that the firm receives for

the sale of its output.◆Total !ost

◆ The amount that the firm pays to buy

inputs.

( Fi P fit


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( Firm=s Profit


rofit is the firm0s total revenue minusits total cost.

Profit @ Total revenue A Total cost


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Costs as Opportunity Costs


A firm0s cost of productionincludes all the opportunitycosts of making its output of

goods and services.


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01plicit and "mplicit Costs


A firm0s cost of production includee&plicit costs and implicit costs.◆%&plicit costs involve a direct moneyoutlay for factors of production.◆ mplicit costs do not involve a directmoney outlay.

0conomic Profit versus


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(ccountin Profit


◆ %conomists measure a firm0s economicprofit as total revenue minus all the

opportunity costs 5e&plicit andimplicit6.◆ Accountants measure the accounting

profit as the firm0s total revenue minusonly the firm0s e&plicit costs. n other

words, they ignore the implicit costs.

f


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(ccountin Profit

◆-hen total revenue e&ceeds bothe&plicit and implicit costs, thefirm earns economic profit.◆ %conomic profit is smaller than

accounting profit.




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(ccountin Profit

&!(icitcosts

%ccountin

!ro/t

o an%ccountant

ie s a irm

e)enue

e)enue ota(

o!!ortunity costs

o anconomistie s a irm


conomic

!ro/t

Im!(icitcosts

&!(icitcosts

( Production Function and


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Total Cost


#um erof

or"ers

ut!ut ar ina(Pro*uct

of a or

Costof

actory

Costof

or"ers

ota( CostofIn!uts

0 0 $30 $0 $30

1 50 50 30 10 40

2 90 40 30 20 50

3 120 30 30 30 60

4 140 20 30 40 70

5 150 10 30 50 80


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The Production Function

The production function showsthe relationship between quantityof inputs used to make a good

and the quantity of output of thatgood.



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Mar inal Product

The marginal product of any input

in the production process is theincrease in the quantity of outputobtained from an additional unit

of that input.



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Mar inal Product


(dditional output

(dditionalinput

@Mar inal

product

Diminishin Mar inal Product


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◆)iminishing marginal product is theproperty whereby the marginal product of aninput declines as the quantity of the input

increases.◆%&ample2 As more and more workers arehired at a firm, each additional worker

contributes less and less to productionbecause the firm has a limited amount ofequipment.

A Production Function


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A Production Function...

Quantity of ut!u

t:coo"ies

!er'our;

25,

24,23,2*,22,2,,

9,

8,7,6,5,4,3,*,2,

2 * 3 45 #um er of or"ers

Pro*uctionfunction




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◆The slope of the productionfunction measures the marginal

product of an input, such as aworker.

◆-hen the marginal productdeclines, the production functionbecomes flatter.

From the Production Function toh T lAC C


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the TotalACost Curve


◆The relationship between thequantity a firm can produce and itscosts determines pricing decisions.

◆The total-cost curve shows thisrelationship graphically.

( Production Function andl C


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Total Cost


#um erof

or"ers

ut!ut ar ina(Pro*uct

of a or

Costof

actory

Costof

or"ers

ota( CostofIn!uts

0 0 $30 $0 $30

1 50 50 30 10 40

2 90 40 30 20 50

3 120 30 30 30 60

4 140 20 30 40 70

5 150 10 30 50 80

;un ry ;elen=s Cookie Factory

Total-Cost Curve...


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ota(Cost

$8070

60

50

40

30

20

Quantity of

ut!ut

0 20 40 60 80 100 120

140

ota(-costcur)e

:coo"ies !erHarcourt Inc. items and derived ite ms co ri ht © 2001 b Harcourt Inc.


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The Barious Measures of Cost


!osts of production may bedivided into fi&ed costs andvariable costs.

Fi1ed and Baria&le Costs


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◆3i&ed costs are those costs that donot vary with the quantity of output

produced.◆7ariable costs are those costs that do

change as the firm alters thequantity of output produced.

Family of Total Costs


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y

◆Total 3i&ed !osts 5T3!6◆Total 7ariable !osts 5T7!6◆Total !osts 5T!6

TC @ TFC TBC


Family of Total Costs


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Quantity

"ota# ost %i&edost

'aria #eost

0 $ 3.00 $3.00 $ 0.001 3.30 3.00 0.30

2 3.80 3.00 0.803 4.50 3.00 1.504 5.40 3.00 2.405 6.50 3.00 3.50

6 7.80 3.00 4.807 9.30 3.00 6.308 11.00 3.00 8.009 12.90 3.00 9.90

(vera e Costs


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(


◆Average costs can be determined bydividing the firm0s costs by the

quantity of output produced.◆The average cost is the cost of each

typical unit of product.

Family of (vera e Costs


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y (

◆Average 3i&ed !osts 5A3!6◆Average 7ariable !osts 5A7!6◆Average Total !osts 5AT!6

(TC @ (FC (BC


Family of (vera e Costs


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Quantity (% (' ("0 ) ) )1 $3.00 $0.30 $3.302

3

1.50

1.00

0.40

0.50

1.90

1.5045

0.750.60

0.600.70

1.351.30

6 0.50 0.80 1.30

78 0.430.38 0.901.00 1.331.389

100.330.30

1.101.20

1.431.50

Mar inal Cost


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◆Marginal cost 5M!6 measures theamount total cost rises when the firmincreases production by one unit.

◆Marginal cost helps answer thefollowing question2◆ 8ow much does it cost to produce an

additional unit of output9

Mar inal Cost


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:C'ane


in tota(cost;

inuantity;

C <:C'an e

<∆ C

∆ Q

Mar inal Cost


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Quantity

"ota#

ost

*ar!ina#

ost

Quantity

"ota#

ost

*ar!ina#

ost

0 $3.00 )1 3.30 $0.30 6 $7.80 $1.302 3.80 0.50 7 9.30 1.50

3 4.50 0.70 8 11.00 1.704 5.40 0.90 9 12.90 1.905 6.50 1.10 10 15.00 2.10

Total-Cost Curve...$16 0


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$12.00

$10.0

0

$8.00

$6.00

$4.00

$2.00

$14.00

$16.00

0 2 10

12

5 o

t a (

C o s

t

ota(-

cost


cur)e

4 6 8

!uantity of Outputlasses of lemonade per hourE

Average-Cost and Marginal-CostCurves


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%C%C

Curves...

$0.00

$0.50

$1.00

$1.50

$3.50

$3.00

$2.50

C$2.00

0 2 10

12

C o s

t

s

%C


4 6 8

Quantity of ut!ut: (asses of (emona*e !er

C t C d Th i Sh


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Cost Curves and Their Shapes

Harcourt Inc items and derived items co ri ht © 2001 b Harcourt Inc

Marginal cost rises with the

amount of output produced.◆This reflects the propertyof diminishing marginal

product .



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$0.00

$0.5

0

$1.00

$1.5

0

0 2 10

12

4 6 8


C o s

t

s

$2.50

C$2.00




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The average total'cost curve is :'shaped.◆ At very low levels of output average total cost is

high because fi&ed cost is spread over only a fewunits.

◆ Average total cost declines as output increases.◆ Average total cost starts rising because average

variable cost rises substantially.


C t C d Th i Sh


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The bottom of the :'shape occurs at

the quantity that minimizes averagetotal cost . This quantity issometimes called the efficient scale

of the firm.



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$1.00

$0.50

$0.00

$1.50

$3.5

0

$3.00

$2.5

0

$2.00

0 2 10

12

5 o

t a

(

C o s

t s

%C


4 6 8


%elationship etween Mar inalCost and (vera e Total Cost


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(

◆-henever marginal cost is less thanaverage total cost, average total

cost is falling.◆-henever marginal cost is greater

than average total cost, average

total cost is rising.


%elationship etween Mar inalC t d ( T t l C t


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Cost and (vera e Total Cost


The marginal'cost curve crosses

the average'total'cost curve atthe efficient scale.◆%fficient scale is the quantity

that minimi/es average total cost.

%elationship etween Mar inalCost and (vera e Total Cost


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%C

(

$1.00

$0.50

$0.00


$1.50

$2.00

$3.50

$3.00

$2.50

C

0 2 10

12

C o s

t

s

4 6 8



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The Barious Measures of Cost


t is now time to e&amine therelationships that e&ist between the

different measures of cost.

The Barious Measures of Costi o&=s a el in


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Quantity of=a e(s

ota(Cost

i&e*Cost

aria (eCost

%)era ei&e*

Cost

%)erae

aria (eCost

%)era eota(

Cost

ar ina(Cost

0 $2.00 $2.00 $0.00

1 $3.00 $2.00 $1.00 $2.00 $1.00 $3.00 $1.002 $3.80 $2.00 $1.80 $1.00 $0.90 $1.90 $0.803 $4.40 $2.00 $2.40 $0.67 $0.80 $1.47 $0.604 $4.80 $2.00 $2.80 $0.50 $0.70 $1.20 $0.405 $5.20 $2.00 $3.20 $0.40 $0.64 $1.04 $0.406 $5.80 $2.00 $3.80 $0.33 $0.63 $0.97 $0.607 $6.60 $2.00 $4.60 $0.29 $0.66 $0.94 $0.808 $7.60 $2.00 $5.60 $0.25 $0.70 $0.95 $1.009 $8.80 $2.00 $6.80 $0.22 $0.76 $0.98 $1.20

10 $10.20 $2.00 $8.20 $0.20 $0.82 $1.02 $1.4011 $11.80 $2.00 $9.80 $0.18 $0.89 $1.07 $1.6012 $13.60 $2.00 $11.60 $0.17 $0.97 $1.13 $1.8013 $15.60 $2.00 $13.60 $0.15 $1.05 $1.20 $2.00

Big Bo !s Cost Curves...


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$14.00

$12.00

$10.00

$8.00

$6.00

$4.00

$2.00


$16.00

$20.00

$18.00

0 2 4 12

14

16

6 8 10

Quantity ofut!ut : a e(s

! '

T o

t a l C o s

t

ota( CostCur)e

Big Bo !s Cost Curves...3.5


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AFC

MC

0

0.5

1

1.5

2

2.5

3

5

0 2 4 6 10

12

14

16

8!uantity of Output

C o s

t s

AT C

AV

C


Three "mportant Properties ofCost Curves


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H t I it d d i d it i ht © 2001 b H t I

◆Marginal cost eventually rises withthe quantity of output.

◆The average'total'cost curve is :'shaped.◆The marginal'cost curve crosses

the average'total'cost curve at theminimum of average total cost.

Lecture - 1 (1), Basics of Engineering Economics

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Transcript of Lecture - 1 (1), Basics of Engineering Economics