Demand & Supply

Scarcity

Arises due to limited resources and unlimited wants

Factors of Production

• Land

• Labour

• Capital e.g factories, machineries, infrastructure

• Entrepreneurship

Opportunity Cost

Refers to the value of the next best alternative foregone when a choice is made

Factors affecting demand

• Price

• EGYPT

EGYPT

• Expectation to future changes of price or income

• Government policies

• Income change

• Price of related goods

• Taste and Preferences

Normal goods

Goods or services which consumers will demand more of when their income increases.

Inferior goods

Goods or services which consumers will demand less of when their income increases and demand more when their income falls

Factors affecting supply

• Price

• WETPIGS

Non-price determinant of supply

• Weather and natural conditions

• Expectation of price changes

• Technology

• Price of related goods Taste

• Cost of FOP

• Government policies

• Suppliers

Price Adjustment Process (shortage)

• Upward pressure on price as consumers compete among themselves for the good by bidding up the price. As the price increases, the quantity demanded decreases. At the same time, the higher prices will signal to producer to increase their quantity supplied.

• Process will continue until an equilibrium is achieved

Price Adjustment Process (Surplus)

• There is a downward pressure on prices as producers lower the prices to clear stocks of unsold goods

• The lower prices will also signal to producers to reduce their quantity supplied.

• As the price decreases, consumers will increase their quantity demanded.

• process repeats until market equilibrium is achieved.

PED

Price elasticity of demand measures the degree of responsiveness of the quantity demanded for a good or service to a given change in its price ceteris paribus.

Price Elastic Demand

• |PED|>1

• Increase in price leads to a more than proportionate decrease in quantity demanded ceteris paribus

Price Inelastic Demand

• |PED|<1

• An change in price leads to a less than proportionate change in quantity demanded ceteris paribus

Price Unitary Elastic

• |PED|=1

• A change in price leads to an equal proportionate change in quantity demanded ceteris paribus.

Determinants of PED

• Availability of substitutes

• Closeness of substitutes

• Proportion of income spent on good or service

• Time period

• Degree of necessity of a good

Availability of substitutes

The greater the availability of substitutes, the more price elastic the demand for the good or service.

Closeness of substitutes

• The presence of close susbtitutes for a good or service makes the demand for that good more price elastic

• The greater the number of close substitutes, the more price elastic the demand for the good.

Proportion of income spent on the good or service

• When the proportion of income spent on the good or service is small, demand for the good or service tends to be price inelastic.

• The higher the proportion of income spent on the good, the higher the price elasticity of the demand.

Time Period

With a longer period of time, consumers will have more time to change their consumption pattern or habits. At the same time, they are able to find more substitutes given the longer time period.

The price elasticity of demand for a good or service may be higher when the time period is longer.

Degree of necessity

High necessity → |PED|<1

Addictive goods e.g cigarettes → |PED|<1

Luxury Goods |PED|>1.

Income Elasticity of Demand

Measures the degree of responsives of the demand for a good or service to a given change in income of the consumers ceteris paribus.

Inferior Good YED

YED<0

When income increases, demand for such a good falls

Normal Good e.g necessities YED

0 < YED < 1

Increase in income leads to a less than proportionate increase in demand

Luxury Goods YED

YED>1.

Increase in income leads to a more than proportionate increase in demand for goods and services.

YED determinants

• Nature of good

• Income level of consumers

• Stages of development of an economy.

Nature of the good or service

• The more basic or staple a good or service is, the lower the YED value.

• An increase in income can lead to a more than proportionate increase in demand for luxury goods or services

Income Level of Consumers

This is because an initial increase in the income of the poor is more likely to be spent than saved. Hence, for a given increase in income, the demand for certain essentials will increase more for the poor than the rich.

Stages of development of an economy

Thus, when income in a developing country rises, ceteris paribus, it leads to a more than proportionate increase in the demand for television sets as household can now afford to buy a television set. On the other hand, because most households in the developed country would already own a television set, there is likely to be a less than proportionate increase in demand for television sets in the developed country when income increases.

XED

Measures the degree of responsiveness of the demand of a good to a given change in price of related good or service, ceteris paribus,

XED<0

Complements

When the price of complement increases, ceteris paribus, consumers will buy less of the good

e.g shuttlecocks and badminton racquets

XED>0

Substitutes

When price of substitute increases ceteris paribus, consumers will buy more of a good.

e.g margarine and butter

Relationship between absolute value and closeness of goods

• When the absolute value is bigger than 1, it indicates that the two goods have very close relationship

• When the absolute value is smaller than 1, it indicates that the two goods do not have a close relationship.

Determinants of XED.

• Substitutes

• Complements

Substitutes

• If the XED is highly positive (XED>1), it indicates that the two goods or services are close substitutes.

• The demand for a good will fall more than proportionately when the price of substitute falls ceteris paribus.

Complements

• If the value of XED is negative (XED<0) and its absolute value is larger than one (|XED|>1), this indicates that the two goods are close complement.

• The demand for a good or service will fall more than proportionately when the price of its complement increases.

Price Elasticity of Supply

The price elasticity of supply measures the degree of responsiveness of quantity supplied of a good or service to a given change in its price ceteris paribus.

Factors affecting PES

• Length of production period

• Existence of spare capacity

• Existence of inventory stock

• Short run vs Long Run

• Mobility of FOP