AE12 – Economic Development

Module 2: Basic Concepts in Economics

Ian Dave B. Custodio

Instructor
 AE 12

Lesson 5: Demand, Supply, and Market Equilibrium

Learning objectives:
a. Define demand and law of demand
b. Define supply and law of supply
c. Distinguish the various determinants of demand and supply
d. Differentiate change in demand and change in quantity demanded
e. Differentiate change in supply and change in quantity supplied
f. Define market equilibrium.
 AE 12

Outline
5.1 Demand and the Law of Demand
5.2 Determinants of Demand
5.3 General, Direct, and Inverse Demand Function
5.4 Exemptions to the Law of Demand
5.5 Supply and the Law of Supply
5.6 Determinants of Supply
5.7 Supply Function
5.8 The Market Equilibrium
 AE 12

5.1 Demand and the

Law of Demand
 AE 12

Demand
- is an economic principle that describes a consumer's desire and willingness to pay a
price for a specific good or service.
- is the amount of a product that people are willing and able to purchase at each
possible price during a given period of time.
- willingness and ability of the consumer to purchase goods and services

Quantity Demanded
-is the amount of a product that people are willing and able to purchase at one,
specific price.
 AE 12

Law of Demand
- there is an inverse relationship between price and quantity demanded, ceteris
paribus.

- As price falls, quantity demanded rises, ceteris paribus.

- As price rises, quantity demanded falls, ceteris paribus.

 AE 12

Demand Schedule
- a table of the quantity demanded of a good at different price levels. Given the price
level, it is easy to determine the expected quantity demanded.

Quantity Demanded
Price/kg (Php)
(𝑸𝒅𝒑𝐨𝐫𝒌 )
0 286
200 240
250 220
280 200
300 0
 AE 12

Demand Curve
- a graph showing how the demand for a commodity or service varies with changes in
its price, ceteris paribus.
300

D1, Demand curve for pork

Php per kg
280

250

200

0 200 220 240 286

Qd, kg of pork
 AE 12

5.2 Determinants of Demand

 AE 12

Determinants of Demand
1. Price of the good or service (P)
2. Consumer’s income (I)
3. Price of related goods or services (Pr)
4. Taste pattern/preference of the consumers (T)
5. Price expectations (Pe)
6. Number of consumers or population (N)
 AE 12

1. Price (P)
Increase in price of the product, decreases quantity demanded. Decrease in price,
increases quantity demanded.
 AE 12

2. Consumer’s Income (I)

1. Normal Goods
-demand increases as income rises and decreases as income falls.

2. Inferior Goods
-demand decreases as income rises and increases as income falls.
 AE 12

Normal Goods
Increase in income, increase in demand. Decrease in income, decrease in demand.
 AE 12

Inferior Goods
Increase in income, decrease in demand. Decrease in income, increase in demand.
 AE 12

3. Price of Related Goods (Pr)

The change in the price of a particular good can affect the demand of its related
good.
 AE 12

Types of Goods
1. Substitute Goods
-a good's demand is increased when the price of another (substitute) good is
increased.

2. Complementary Goods
-a good's demand is decreased when there’s an increase in the price of another
(complementary) good.
 AE 12

4. Taste and Preference (T)

When people prefers the product, there is an increase in the demand for such
product.
 AE 12

5. Price Expectations (Pe)

When people expects an increase in the price of the product, then current demand
increases.
 AE 12

6. Number of Consumers or Population (N)

The more consumers are there in the market, the higher is the demand for
products/goods/services.
 AE 12

Change in Demand vs. Change in Quantity Demanded

Change in demand
- occurs when one of the other variables or determinants of demand changes,
other than price
- demand curve shifts rightward or leftward

Change in quantity demanded

- occurs when price alone changes
- movement along the demand curve
 AE 12

A shift in the demand curve

Price (per kg) is a change in demand

A C
Php175

Php150 B

A movement
along the D2
demand curve
is a change in D1
quantity
demanded 0 50 000 60 000 70 000 Quantity (kg/month)
 AE 12

5.3 General, Direct, and

Inverse Demand Function
 AE 12

General Demand Function

𝑸𝒅=𝒇(𝑷, 𝑰, 𝑷𝒓,𝑻,𝑷𝒆, 𝑵)
𝑸𝒅 = quantity demanded of the good or services
𝑷 = price of the good or service
𝑰 = consumer’s income
𝑷𝒓 = price of related goods or services
𝑻 = taste pattern of the consumers
𝑷𝒆 = price expectations
𝑵 = number of consumers or population
 AE 12

𝑸𝒅 = 𝒂 + 𝒃𝑷 + 𝒄𝑰 + 𝒅𝑷𝒓 + 𝒆𝑻 + 𝒇𝑷𝒆 + 𝒈𝑵
a is the intercept or autonomous demand
- the quantity being demanded when price and other determinants are equals zero

b, c, d, e, f and g are the slope parameters

- measure effect on Qd of changing one of the variables while holding the others
constant

Slope =  Qd / X where X is the parameter

 AE 12

Sign of a parameter shows how variable is related to Qd

- Positive sign (+) indicates direct relationship

- Negative sign (-) indicates inverse relationship

 AE 12

Variable relationships to Qd
Variable Relation to Qd Slope Sign of Slope
𝑷 Inverse b -
𝑰 Direct for Normal Goods c +
(lechon, lasagna) -
Inverse for Inferior Goods
(dried fish)
𝑷𝒓 Direct for Substitute d +
Inverse for Complements -
𝑻 Direct e +
𝑷𝒆 Direct f +
𝑵 Direct g +
 AE 12

Example:
𝑸𝒅𝑨 = 500−2𝑷−0.25𝑰−20𝑷𝒓+10𝑻+8𝑷𝒆+2.2𝑵
1. Interpret the intercept of the demand function.
2. What is the value of the slope parameter of the Price for good A. Does it have the
correct sign? Why?
3. Interpret the slope parameter of income. Is it a normal good or an inferior good?
Why?
4. Interpret the slope parameter of price of related goods. Is it a substitute good or a
complementary good? Why?
 AE 12

Direct Demand Function

The direct demand function, or simply demand function, shows how quantity
demanded, 𝑄𝑑 is related to product price P, when all other variables are held constant.

𝑸𝒅 = 𝒇(𝑷)
𝑸𝒅 = 𝒂 − 𝒃𝑷
Law of Demand:
- Qd increases when P falls & Qd decreases when P rises, all else constant

- The slope: Change in Qd / Change in P = (-b) must be negative

 AE 12

Inverse Demand Function

- express price as a function of quantity demanded:

From Direct Demand: 𝑸𝒅 = 𝒇 𝑷

𝑸𝒅 = 𝒂 − 𝒃𝑷

To: 𝑷 = 𝒇(𝑸𝒅 )

𝒂 − 𝑸𝒅
𝑷=
𝒃
 AE 12

5.4 Exemptions to the

Law of Demand
 AE 12

Exceptional cases against the Law of Demand

Giffen Goods
- a concept introduced by the Scottish Economist and
Statistician, Robert Giffen.

- are non-luxury items which generate higher demand

even when prices rise.

Examples include essential goods such as rice, bread,

water, etc.
Image source: https://www.hetwebsite.net/het/profiles/image/giffen.jpg
 AE 12

Luxury Brand Goods (Veblen Goods)

- a concept introduced by an American Economist
and Sociologist Thorstein Bunde Veblen.

- superior and luxury goods which generates

higher demand when the product’s price
is high.

Examples include branded goods like Armani,

Chanel, Christian Dior, Michael Kors, Gucci, Lamborghini, Ferrari, etc.
Image source: https://en.wikipedia.org/wiki/Thorstein_Veblen#/media/File:Veblen3a.jpg
 AE 12

5.5 Supply and the

Law of Supply
 AE 12

Supply
- the relationship that exists between the price of a good and the quantity supplied in
a given time period, ceteris paribus.
- defined as quantities of a good or service that people (firms, consumers) are willing
and able to sell at various prices within some given time period, cet. par.
- the quantity of a good or service available in a market at a specific time

Quantity Supplied
-is the amount of a product that producers are willing and able to supply at one,
specific price.
 AE 12

Law of Supply
- there is a direct (positive) relationship exists between the price of a good and the
quantity supplied in a given time period, ceteris paribus.

- As price rises, quantity supplied rises, ceteris paribus.

- As price decreases, quantity supplied falls, ceteris paribus.

 AE 12

Supply Schedule
- a table of the quantity supplied of a good at different price levels. Given the price
level, it is easy to determine the expected quantity supplied.

Quantity Supplied
Price/kg (Php)
(𝑸𝒔𝒑𝒌 )
0 0
200 200
250 220
280 240
300 286
 AE 12

Supply Curve
- a graph showing how the supply for a commodity or service varies with changes in
its price, ceteris paribus.
300
Php per kg

S1, Supply curve for pork

280

250

200

0 200 220 240 286

Q, Million kg of pork per year

 AE 12

5.6 Determinants of Supply

 AE 12

Determinants of Supply
1. Price of good or service (P)
2. Input prices (Pi)
3. Prices of goods related in production (Pr)
4. Technological advances (T)
5. Expected future price of product (Pe)
6. Number of firms producing product (Nf)
 AE 12

1. Price (P)
Increase in the price of the product increases quantity supply, decrease in the price of
the product decreases quantity supply.
 AE 12

2. Price of Resource / Inputs (Pi)

As the price of a resource rises, profitability declines, leading to a reduction in the
supply at any price.
 AE 12

3. Price of goods related in the Production (Pr)

When the price of a good increases, it affects the supply of the other good related in
the production.
Rice Corn
 AE 12

4. Technological Improvements (T)

Technological improvements (and any changes that raise the productivity of labor)
lower production costs and increase profitability.
 AE 12

5. Price Expectations (Pe)

An increase in the expected future price of a good or service results in a reduction in
current supply.
 AE 12

6. Increase in Number of Sellers (Nf )

An increase in the number of seller/producer of goods or services results in an
increase in supply.
 AE 12

Change in Supply vs. Change in Quantity Supplied

Change in supply
- occurs when one of the other variables, or determinants of supply, changes
- supply curve shifts rightward or leftward

Change in quantity supplied

- occurs when price alone changes
- movement along the supply curve
 AE 12

Change in Supply vs. Change in Quantity Supplied

Price (dollars A shift in the supply curve is S1

per printer) a change in supply S2

A movement $175 C
B
along the
supply curve $150 A
is a change
in quantity
supplied

0 50 000 60 000 70 000 Quantity (printers/month)

 AE 12

5.7 Supply Function

 AE 12

General Supply Function

𝑸𝑠=𝒇(𝑷, 𝑃𝑖, 𝑷𝒓,𝑻,𝑷𝒆, 𝑵𝑓)
𝑸𝑠 = quantity supplied of the good or services
𝑷 = price of the good or service
𝑃𝑖 = input prices
𝑷𝒓 = price of related goods in production
𝑻 = Technological advances
𝑷𝒆 = Expected future price of product
𝑵f = Number of firms producing product
 AE 12

𝑸𝒔 = 𝒉 + 𝒊𝑷 + 𝒋𝑷𝒊 + 𝒌𝑷𝒓 + 𝒍𝑻 + 𝒎𝑷𝒆 + 𝒏𝑵𝒇

h is the intercept or autonomous supply
- the quantity being supplied when price and other determinants is equals zero.

i, j, k, l, m and n are the slope parameters

- measure effect on Qs of changing one of the variables while holding the others
constant

Slope =  Qs / X where X is the parameter

 AE 12

Sign of a parameter shows how variable is related to Qs

- Positive sign (+) indicates direct relationship

- Negative sign (-) indicates inverse relationship

 AE 12

Variable relationships

Variable Relation to Qs Slope Sign of Slope

𝑷 Direct i +
𝑷𝒊 Inverse j -
𝑷𝒓 Inverse for Substitutes k -
(rice and corn)
Direct for Complements +
(pen and ink)
𝑻 Direct l +
𝑷𝒆 Inverse m -
𝑵f Direct n +
 AE 12

Supply Function
The supply function, or simply supply function, shows how quantity supplied, 𝑄s is
related to product price P, when all other variables are held constant.

𝑸𝒔 = 𝒇(𝑷)
𝑸𝒔 = 𝒂 + 𝒃𝑷
Law of Supply:
- Qs increases when P increases & Qs falls when P also falls, all else constant

- The slope: Change in Qs / Change in P = (b) must be positive

 AE 12

5.8 The Market Equilibrium

 AE 12
The point at which
Market Equilibrium Qd=Qs is called the
equilibrium point
- happens when the supply and
demand curves intersect
- this is also where the quantity
demanded and quantity supplied
are equal

Qd = Qs
 AE 12

If the price exceeds the equilibrium

price, a surplus occurs.
 AE 12

If the price is below the

equilibrium price, a shortage occurs.
 AE 12

When demand rises:

 AE 12

When demand falls:

 AE 12

When supply rises:

 AE 12

When supply falls:

 AE 12

References:
Baye, M. and Prince, J. (2022). Managerial Economics and Business Strategy 10th Edition. McGraw Hill
Greenlaw, S. A., Shapiro D., (2017). Principles of Economics, 2nd Edition. OpenStax – Rice University
Nafziger, E. W. (2006). Economic Development 4th Edition. Cambridge University Press
Todaro, M. P., Smith, S. C. (2012). Economic Development 11th Edition). Addison-Wesley
 THANK YOU!

Ian Dave B. Custodio, LPT, MSc Western Leyte College

Part-time Instructor College of Accountancy and Business
Western Leyte College A. Bonifacio St., Ormoc City, Leyte
E-mail: iandave.custodio@wlcormoc.edu.ph E-mail: info@wlcormoc.edu.ph
Website: iandavecustodio.github.io Website: wlcormoc.edu.ph
Telephone (Office): (053) 563 7064 local 1121 Telephone: (053) 561 5310 / 255-8549