demand and supply
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Chapter 3
Demand and Supply Analysis
Demand
Need to satisfy human wants Willingness to buy a particular commodity
backed by purchasing power. Amount of the commodity which will consumers
are willing to buy per unit of time, at that price, factors other than price remaining constant.
3 things necessary for demand: Time Price of the commodity Amount (or quantity) of the commodity consumers are
willing to purchase
Basics
Want: having a strong desire for something Need: lack of means of subsistence Desire: an aspiration to acquire something Demand: effective desire, as it is backed by
willingness to pay and ability to pay
Determinants of Demand
Price of the product Negative effect on demand
Income of the consumer Normal goods: demand increases with increase in
consumer’s income Inferior goods: demand falls as income rises
Tastes and preferences Expectation of future price changes Population Advertising
More…
Price of related goods Substitutes
Goods that can be used as replacement of one another and satisfy a similar need
If the price of a commodity increases, quantity demanded of its substitute rises.
Complements Goods that are consumed together. If the price of a commodity increases, quantity
demanded of its complement falls.
Demand Function
Functional form Interdependence between individual demand and
its determinants Dx = f(Px, T, Py, Y, Pe, N, A) Px, T, Py, Y, Pe: independent variables, Dx:
dependent variable If all the variables except the own price of the
commodity remain unchanged (ceteris paribus), demand function: Dx = f(Px)
Ceteris paribus is a Latin phrase, literally translated in English as “with other things (being) the same” or “all other things being equal”.
Demand Schedule
Point Price [Rs per unit]Quantity demanded of X
[kg. per month]
abcdef
0.501.00
2.002.50
1.50
7.0
3.52.5
3.00
5.0
1.01.5
1 2 3
0.50
1.00
2.00
Quantity of X
Pric
e o
f X
3.00
2.50
654 7
Demand Curve
a
b
c
e
d
f
1.50
Demand Schedule and Individual Demand Curve
Market Demand and Market Demand Curve
Market: interaction between sellers and buyers of a good (or service) at a mutually agreed upon price.
Market demand Aggregate of individual demands for a commodity at a
particular price per unit of time. Sum total of the quantities of a commodity that all buyers in
the market are willing to buy at a given price and at a particular point of time (ceteris paribus)
Market demand curve: horizontal summation of individual demand curves
2 4 6 8 10 12
2 4 6
1.00
2.00
3.00
1.00
2.00
3.00
8
14
Quantity of X
Quantity of X
Pric
e o
f X
Pric
e o
f X
Individual and Market Demand Curves
Consumer I
Consumer II
Total Demand: Consumer I+II
2 4 6
1.00
2.00
3.00
Quantity of X
Pric
e o
f X
8
Market Demand Schedule
Reference Letter Price [Rs per kg] Quantity demanded [kg per month]
U
V
W
X
Y
Z
0.50
1.00
2.00
2.50
1.50
110.0
77.5
67.5
3.00
90.0
60.0
62.5
Quantity of X
20 40 60 80 100 120
1.00
2.00
3.00
140
Pric
e o f
X [
Rs
per
kg]
Market Demand Curve
2.50
1.50
3.50
0.50
Z
D
Y
X
W
V
U
Law of Demand
Other things remaining constant, when the price of a commodity rises, the demand for that commodity falls or when the price of a commodity falls, the demand for that commodity rises.
Reasons: Substitution Effect Income Effect Law of Diminishing Marginal Utility
Exceptions to the Law of Demand
Giffen Goods Snob appeal Demonstration effect Consumer Bias Fashion Future expectation of prices Insignificant portion of income spent Goods without any substitutes
D0P
rice
Quantity0
Change in Quantity Demanded
P0
Q0
P1
Q1
D2
D0
Quantity0
Pric
e
Change in DemandD1
Shift in demand curve from D0 to D1
more is demanded at each price.
Increase in demand caused by: A rise in the price of a substitute A fall in the price of a complement A rise in income A redistribution of income towards those who favour
the commodity A change in tastes that favours the commodity
Shift in demand curve from from D0 to D2
less is demanded at each price.
Market Supply Schedule
Reference Letter Price [Rs per kg] Quantity demanded [kg per month]
w
y
u
v
z
x
0.50
1.00
2.00
2.50
1.50
5.0
77.5
100.0
3.00
46.0
122.5
115.0
20 40 60 80 100 120
1.00
2.00
3.00
140
Quantity of X
Pric
e o f
X [
Rs
per
kg]
Supply Curve For X
2.50
1.50
3.50
0.50
Z
S
Y
X
W
V
U
Quantity
Pric
e
Changes in Quantity Supplied
S0
Quantity
Pric
e S2 S0
S1
Shifts in the Supply Curve
Shift in the supply curve from S0 to S1 more is supplied at each price.
Increase in supply caused by: Improvements in the technology of producing the commodity A fall in the price of inputs that are important in producing the
commodity Shift in the supply curve from S0 to S2
less is supplied at each price. Decrease in supply caused by:
A rise in the price of inputs that are important in producing the commodity
Changes in technology that increase the costs of producing the commodity (rare)
Demand and Supply Schedules for X and Equilibrium Price
Price [Rs per kg]
Quantity supplied [kg
per month]
0.50
1.00
2.00
2.50
1.50
110.0
77.5
67.5
3.00
90.0
60.0
Quantity demanded
[kgper month]
62.5
5.0
46.0
77.5
100.0
115.0
122.5
105.0
44.0
0.0
-32.5
-52.5
-62.5
Excess Demand [quantity demanded minus quantity supplied]
[kg per month]
Equilibrium occurs where the quantity demanded and the quantity supplied are equal.
In the table the equilibrium price is Rs.1.50 The equilibrium quantity bought and sold is 77.5 kg
per month. For prices below the equilibrium, such as Re. 0.50,
quantity demanded (110) exceeds quantity supplied (5)
For prices above the equilibrium, such as Rs 3.00, quantity demanded (60) is less than quantity supplied (122.5)
20 40 60 80 100 120
1.00
2.00
3.00
140
Quantity of X
Pric
e o f
X [
Rs
per
kg]
Determination of Equilibrium Price of X
2.50
1.50
3.50
0.50
D
Z
Y
X
W
V
U
20 40 60 80 100 120
1.00
2.00
3.00
140
Quantity of X
Pric
e o f
X [
Rs
per
kg]
2.50
1.50
3.50
0.50
Z
S
Y
X
W
V
U
D
U
V
W
X
Y
Z
Determination of the Equilibrium Price of X
E
Equilibrium Price of X
Equilibrium price is where the demand and supply curves intersect, point E in the figure.
At all prices above equilibrium there is excess supply and downward pressure on price.
At all prices below equilibrium there is excess demand and upward pressure on price
[i]. The effects of shifts in the demand curve
[ii]. The effects of shifts in the supply curve
q0 q1
p1
p0
Pric
e
D1
D0
S
Quantity
E1
E0
q1q0
p0
p1
Pric
e
E0
S0
S1
Quantity
E1
D
Changes in Demand and Supply
Shifts in Demand
The original curves are D0 and S, which intersect to produce equilibrium at E0.
Price is p0, and quantity q0.
An increase in demand shifts the demand curve to D1 .
Price rises to p1 and quantity rises to q1 taking the new equilibrium to E1 .
A decrease in demand now shifts the demand curve to D0.
Price falls to p0 and quantity falls to q0 taking the new equilibrium to E0.
Thus, an increase in demand raises both price and quantity while a decrease in demand lowers both price and quantity
Shifts in Supply
The original demand and supply curves are D and S0, which intersect to produce an equilibrium at E0, price p0 and quantity q0.
An increase in supply shifts the supply curve to S1. Price falls to p1 and quantity rises to q1, taking the new equilibrium to E1 .
A decrease in supply shifts the supply curve back to S0. Price rises to p0 and quantity falls to q0 taking the new equilibrium to E0.
Thus an increase in supply raises quantity but lowers prices while a decrease in supply lowers quantity but raises price.
Changes in Both Demand and Supply
q1q0
p0
p1
Pric
e
E0
S0
S1
Quantity
E1
D0
D1
Let Us Have a RECAP!!
Demand An individual consumer’s demand curve shows the relation between the
price of a product and the quantity of that product the customer wishes to purchase per period of time.
It is drawn on the assumption that all other prices, income, and tastes remain constant.
Its negative slope indicates that the lower the price of the product, the more the consumer wishes to purchase.
The market demand curve is the horizontal sum of all the individual consumers.
The demand curve for a normal good shifts to the right when the price of a substitute rises, when the price of a complement falls, when total income rises, when the distribution of income changes in favour of those with large demands for the product, and when tastes change in favour of the product.
It shifts to the left with the opposite changes.
A movement along a demand curve indicates a change in quantity demanded in response to a change in the product’s own price; a shift in a demand curve indicates a change in the quantity demanded at each price in response to a change in one of the conditions held constant along a demand curve.
Supply The supply curve for a product shows the relationship between its
price and the quantity that producers wish to produce and offer for sale per period of time.
It is drawn on the assumption that all other forces that influence quantity supplied remain constant, and its positive slope indicates that the higher price, the more producers wish to sell.
Determination of Price At the equilibrium price the quantity demanded equals the
quantity supplied. Graphically, equilibrium occurs where the demand and supply
curves intersect. At any price below equilibrium there will be excess demand and
price will tend to rise; at any price above equilibrium there will be excess supply and price will tend to fall.
A rise in demand raises both equilibrium price and quantity; a fall in demand lowers both.
A rise in supply raises equilibrium quantity but lowers equilibrium price; a fall in supply lowers equilibrium quantity but raises equilibrium price.
These are those so-called ‘laws’ of supply and demand.
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