Demand and Supply

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 The Concept of DEMAND
Demand - refers to the various quantities of a
good or service that consumers are willing and
able to purchase at alternative prices, ceteris
paribus.

Conveys both the elements of desire for the commodity

and capacity to pay (must be willing and able).

Emphasizes the relationship between quantity bought

and its price, although there may be other factors that
determine how much a consumer wants to purchase.

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 The Law of Demand
“There is an inverse relationship between price
and quantity demanded”.

When the price increases, less of the good or service will

be bought
When the price decreases, more of the commodity will
be purchased.

WHY ?
3
 Two Reasons for the Inverse
Relationship
Substitution effect
When price of a good decreases, the consumer
substitutes the lower priced good for the more expensive
ones.
Income effect
When price decreases, the consumer’s real income (or
purchasing power) increases, so he tends to buy more.

P Q
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 Two Reasons for the Inverse
Relationship
1. Substitution effect
 When price of a good increases, the consumer tends
to substitute it with the lower priced goods.
2. Income effect
 When price increases, the consumer’s purchasing
power (or real income) decreases, so he tends to buy
less.

P Q
5
 Ways of presenting
the demand relationship

The relationship between quantity purchased and

alternative prices may be presented in 3 ways:

 Demand schedule –in tabular form.

 Demand curve – in graphical form
 Demand function – in equation form

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 Demand Schedule
TABLE 3.1. Demand Schedule for Denim Pants

Price of Denim Pants Quantity Demanded per month

(in pesos) (No. of pairs)
0 8
50 7
100 6
150 5
200 4
250 3
300 2
350 1
400 0
7
 Demand Curve
P

400
Price (in pesos)

300

200

100
D

0 2 4 6 8
Q

Quantity

Figure 1. Demand Curve. The negative slope of the

demand curve depicts the inverse relationship between
8 price and quantity demanded.
 Demand Function
Quantity demanded (Q) is expressed as a
mathematical function of price (P). The demand
function may thus be written as:

Qd = a - bP
where
a is the horizontal intercept of the equation or the
quantity demanded when price is zero
(-b) is the slope of the function.
Example: Qd = 8 - 0.02P

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 Factors Affecting Demand

1. Price of the commodity

2. Prices of related commodities (substitutes and
complements)
3. Consumer incomes
4. Tastes and preferences
5. Number of consumers
6. Price expectations

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 Change in Quantity Demanded
vs.
Change in Demand
Change in quantity demanded – is a movement along the
same demand curve, due solely to a change in price, i.e.,
all other factors held constant.

Change in demand – is a shift in the entire demand curve

(either to the left or to the right) as a result of changes in
other factors affecting demand.

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 Change in quantity demanded
Price
•A decrease in price from p1
to p2 brings about an
p1 increase in quantity
demanded from q1 to q2
•It is shown as a movement
p2 along the same demand
curve

Quantity
q1 q2
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 Change in demand
•An increase in demand
Price means that at the same price
such as p1 more will be
brought, due to other factors
such as increased incomes,
p1 increase in number of
consumers, etc.
•It is shown as a shift in the
entire demand curve

This is a
decrease in
demand D1

D0
D2
Quantity
q1 q2
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 Change in Demand
P P

D’ D
D’
D

Q Q

Increase in Demand Decrease in Demand

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 Change in Quantity Demanded
versus Change in Demand
Variables that A Change in
Affect Quantity This Variable . . .
Demanded
Price Represents a movement
along the demand curve
Income Shifts the demand curve
Prices of related Shifts the demand curve
goods
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number of Shifts the demand curve
15 buyers
 Other factors affecting demand

Income: as income changes, demand of a commodity

usually changes

Normal goods – are goods whose demand respond positively

to changes in income.
 Most goods are normal goods. As income increases, more of shoes,
TVs, clothes, are bought.

Inferior goods – are goods whose demand respond

negatively to change in income
 Few but existent. Examples are firewood, bicycles, etc.

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 Consumer Income
Normal Good
Price of
Ice-Cream
Cone
$3.00 An increase
2.50 in income...
Increase
2.00 in demand

1.50

1.00

0.50
D2
D1 Quantity of
17 0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 Consumer Income
Inferior Good
Price of
Ice-Cream
Cone
$3.00

2.50 An increase
2.00
in income...
Decrease
1.50 in demand
1.00

0.50

D2 D1 Quantity of
18 0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 Other factors affecting demand
Prices of related commodities in consumption:

Substitutes – are goods that are substitutable with each other

(not necessarily perfect).
 Examples are coffee and tea, Coke and Pepsi
 When the price of a substitute increases, quantity bought of a good
increases. --- Py Qx  (direct relationship)

Complements – are goods that are used or consumed

together.
 Examples are coffee and sugar, bread and butter, tennis rackets and
tennis balls.
 When the price of a complement increases, quantity bought of a good
decreases. --- Py Qx (inverse relationship)

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 Other factors affecting demand
Consumer tastes and preferences:

When consumer tastes shift towards a particular good,

greater amounts of goods are demanded at each price.
 Example: consumers preference for drinking mineral water
increases so its demand curve will shift rightward.

If consumer preferences change away from a good, its

demand will decrease; at every possible price, less of the
good is demanded than before.
 Example: the demand for VCDs and VHS tapes decreases due to
preference for DVDs.

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 Other factors affecting demand
Number of Consumers: affects the total demand
for a good.
Total demand is also known as market demand. It is the
summation of the individual demand of all consumers
An increase in the number of consumers shifts the
market demand curve to the right
Example: demand for housing and transportation
increases with an increase in population.
On the other hand, less consumers will cause the
market demand to decrease, resulting in a shift to
the left of the entire demand curve.

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 Other factors affecting demand
Consumer expectations: Expectations about
future prices and income affect our current demand
for many goods and services.
If we expect prices of dried fish to increase with coming
of the rainy season, we might stock up on the good to
avoid the expected price increase. Thus, current demand
for dried fish might increase
those who expect to lose their jobs due to bad economic
conditions, will reduce their demand for a variety of
goods in the current period.

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 Market Demand
 Market demand refers to the sum of all individual
demands for a particular good or service.

 Graphically, individual demand curves are summed

horizontally to obtain the market demand curve.

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 Demand
Aggregating Demand

Market Demand
B’s Demand
A’s Demand

P1

P2

Q3 Q4

Q1 Q2
Q1+Q2

24 Q3+Q4
 The Concept of SUPPLY
Supply - refers to the various quantities of a good
or service that producers are willing and able to sell
at alternative prices, ceteris paribus.

Obviously, firms are motivated to produce and sell more

at higher prices.

Emphasizes the relationship between quantity sold of a

commodity and its price. However, there are other
factors that determine how much a producer would like
to produce and sell.

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 The Law of Supply
“The quantity sold of a good or service is
positively or directly related to its own price”.
When the price increases, more of the good or service will
be sold
When the price decreases, less of the commodity will be
purchased.

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 3 Ways of presenting
the supply relationship
The relationship between quantity supplied and
alternative prices may be presented in 3 ways:

 Supply schedule –in tabular form.

 Supply curve – in graphical form
 Supply function – in equation form

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 Supply Schedule
TABLE : Supply Schedule for Denim Pants

Price of Denim Pants Quantity Supplied per month

(in pesos) (No. of pairs)
0 0
50 1
100 2
150 3
200 4
250 5
300 6
350 7
400 8
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 Supply Curve
P

400
S
Price (in pesos)

300

200

100

0 2 4 6 8
Q

Quantity

Figure 3.2. Supply Curve. The positive slope of the supply

curve depicts the direct relationship between price and
29 quantity supplied.
 Supply Function
Quantity supplied (Qs) is expressed as a
mathematical function of price (P). The supply
function may thus be written as:

Qs = c + dP
where
c is the horizontal intercept of the equation or the
quantity demanded when price is zero
d is the slope of the function.
Example: Qs = 0 + 0.02P

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 Change in Quantity Supplied
vs.
Change in Supply

Change in quantity supplied – is a movement along the

same supply curve, due solely to a change in price, i.e., all
other factors held constant.
Change in supply – is a shift in the entire supply curve
(either to the left or to the right) as a result of changes in
other factors affecting supply.

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 Change in quantity supplied
S
Price
•An increase in price from p1
to p2 results in an increase in
p2 quantity supplied from q1 to
q2
•It is shown as a movement
p1 along the same supply curve

Quantity
q1 q2
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 Change in supply S0
S2
S1
Price

•An increase in supply

p1 means that at the same
price such as p1 more will be
sold, due to other factors
such as improvement in
technology, increase in
number of producers, etc.
This is a
decrease in •It is shown as a shift in the
supply entire supply curve

Quantity
q1 q2
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 Change in Supply
S’
P S P
S
S’

D’ D

Q Q

Increase in Supply Decrease in Supply

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 Change in Quantity Supplied versus
Change in Supply

Variables that
Affect Quantity Supplied A Change in This Variable . . .
Price Represents a movement along
the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve
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 Other factors affecting supply
 There are other factors aside from price that affect the
supply schedule. These are

1. resource prices
2. prices of related goods in production
3. technology
4. expectations
5. number of sellers.

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 Other factors affecting supply
 Resource prices:

 When prices of inputs to production

increase, the supply of the firm's product
decreases.
 Decreases in resource prices, however,
translate to an increase in supply. The
entire supply curve shifts to the right.

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 Other factors affecting supply
 Prices of related goods in production:
 Resources can be employed to produce several alternative
goods and services.

 Examples from agriculture:

 a piece of farmland can be use to grow rice, corn, or
sugarcane. An increase in price of sugarcane may
result in decreased supply of rice and corn.
 farmers can use their land and labor to produce
ornamental flowers instead of vegetables. If vegetable
prices decrease, the supply of ornamental flowers may
increase.
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 Other factors affecting supply
 Technology:
 A change in production techniques can lower
or raise production costs and affect supply.
 Improvements in technology shift the supply
curve to the right.
 A cost-saving invention will enable firms to
produce and sell more goods than before at
any given price.
 New high yielding crop varieties will
increase production on the same amount of
39 land.
 Other factors affecting supply
 Producer expectations:
 When producers expect the price of their product to
increase in the future, they may hoard their output
for later sale, thus reducing supply in the present
period. Thus the supply curve shifts to the left.

 If firms expect that the price of their product will

fall in the near future, supply may increase in the
current period as firms try to increase production as
well as to dispose of their inventory.

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 Other factors affecting supply
 Number of sellers: As the number of sellers
increases, so will total supply.

 The market supply is the horizontal summation of

the supply schedules of individual producers.
 As more firms enter the market, more will offered
for sale at each possible price, thus shifting the
supply curve to the right.
 Similarly, the supply curve shifts to the left when
firms exit the market.
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 Market Equilibrium
Market equilibrium is that state in which the quantity that
firms want to supply equals the quantity that consumers want
to buy.
or
Market Equilibrium is arrived at when the quantity demanded by
consumers is exactly equal to the quantity supplied by producers.
Market clearing price - at this price everyone is satisfied

The price that clears the market is called the equilibrium price and
the quantity (sold and bought) is called the equilibrium quantity.
The market is said to be "at rest" since the equilibrium price and
equilibrium quantity will stay at those levels until either demand or
supply changes.
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 Market Equilibrium
TABLE : Market for Denim Pants
Quantity Demanded Quantity Supplied
Price of Denim Pants per month per month
(in pesos) (No. of pairs) (No. of pairs)
0 8 0
Equilibrium 50 7 1
Price=200 100 6 2
150 5 3
200 4 4
250 3 5
300 2 6
350 1 7
400 0 8

43 Equilibrium Quantity=4
 Market Equilibrium
At prices above the equilibrium price, quantity supplied is
greater than quantity demanded, resulting in a temporary
surplus.
In a surplus situation, producers will try to reduce price
to entice consumers to buy more denim pants. Actions
by both producers and the public will wipe out the
temporary surplus
At prices below the equilibrium price, consumers desire to
buy more denim pants than are available, creating a
temporary shortage.
Consumers will try to outbid each other, thus pushing up
the price. As price rises, firms increase their production
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while some consumers reduce their purchases.
 Market Equilibrium

400
S
Surplus
Price (in pesos)

300

200

100
Shortage

0 2 4 6 8
Q

Quantity

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 Market Equilibrium
Algebraic solution: equate the demand and supply
equations (Qd=Qs).
Qd = 8 - 0.02P
Qs = 0 + 0.02 P
Step by step solution:
8 - 0.02P = 0 + 0.02 P
0.04P = 8
P* = 8/0.04 = 200
Qd = 8 – 0.02(200) = 8 – 4 = 4
P* =200 per unit, Q* = 4 per month

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 .

How an Increase in Demand Affects

the Equilibrium
Price of 1. Hot weather increases
Ice-Cream the demand for ice cream...
Cone

Supply

$2.50 New equilibrium

2.00
2. ...resulting Initial
in a higher equilibrium
price...
D2

D1

47
0 3. ...and a higher 7 10 Quantity of
quantity sold. Ice-Cream Cones
 How a Decrease in Supply Affects the
Equilibrium
Price of 1. Shortage of Ice cream reduces
Ice-Cream the supply of ice cream...
Cone S2
S1

New
$2.50 equilibrium

2.00 Initial equilibrium

2. ...resulting
in a higher
price...
Demand

0 1 2 3 4 7 8 9 10 11 12 13 Quantity of
48 3. ...and a lower Ice-Cream Cones
quantity sold.
 Thank You

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