Demand and Supply
DEMAND AND SUPPLY
DEFINITION OF DEMAND
Demand is defined as the ability and willingness to buy specific quantities of goods in a given period of time at a particular price, ceteris paribus (all other factors being equal).
LAW OF DEMAND
The law of demand states that the higher the price of a good, the lower the quantity demanded for that good, and vice versa. This can be summarized as:
If price ($P$) increases ($P ↑$), quantity demanded ($Q{dd}$) decreases ($Q{dd} ↓$)
If price decreases ($P ↓$), quantity demanded increases ($Q_{dd} ↑$)
This illustrates a negative relationship between price and quantity demanded.
DEMAND SCHEDULE AND CURVE
Demand Schedule: A table showing the relationship between price and quantity demanded. Example:
Price: 5 → Quantity: 2
Price: 4 → Quantity: 4
Price: 3 → Quantity: 6
Price: 2 → Quantity: 8
Price: 1 → Quantity: 10
Demand Curve: Graphical representation of the demand schedule.
Typically slopes downward from left to right, indicating the law of demand.
INDIVIDUAL AND MARKET DEMAND
Individual Demand: The relationship between the quantity of a good demanded by a single individual and its price.
Market Demand: The relationship between the total quantity of a good demanded by all consumers in the market and its price.
DETERMINANTS OF DEMAND
Factors that influence demand include:
Price of related goods
Consumers’ income
Tastes and trends
Population or number of buyers
Supply of money in circulation
Expectation about future prices
Advertisement
Level of taxation
Festive seasons and climate
CHANGES IN QUANTITY DEMANDED VS. CHANGES IN DEMAND
Changes in Quantity Demanded:
Occur with a movement along the demand curve due to price changes (ceteris paribus).
Upward movement indicates a decrease in quantity demanded (contraction).
Downward movement indicates an increase in quantity demanded (expansion).
Changes in Demand:
Refers to a shift in the entire demand curve.
Increase in Demand: Shift from $D0$ to $D1$.
Decrease in Demand: Shift from $D1$ to $D0$.
GIFFEN GOODS
Exceptional demand phenomenon where the demand for a good increases as its price increases (contrary to the law of demand). Examples include:
Status symbol goods
Speculation goods
Emergency situations
Highly-priced goods.
DEFINITION OF SUPPLY
Supply is defined as the ability and willingness to sell or produce a particular product or service in a given period of time at a particular price, ceteris paribus.
LAW OF SUPPLY
The law of supply states that the higher the price of a good, the greater the quantity supplied for that good, and vice versa:
If price increases ($P ↑$), quantity supplied ($Q{ss}$) increases ($Q{ss} ↑$).
If price decreases ($P ↓$), quantity supplied decreases ($Q_{ss} ↓$).
This illustrates a positive relationship between price and quantity supplied.
SUPPLY SCHEDULE AND CURVE
Supply Schedule: A table showing the relationship between price and quantity supplied. Example:
Price: 5 → Quantity: 10
Price: 4 → Quantity: 8
Price: 3 → Quantity: 6
Price: 2 → Quantity: 4
Price: 1 → Quantity: 2
Supply Curve: Graphical representation of the supply schedule.
Typically slopes upward from left to right, illustrating the law of supply.
INDIVIDUAL AND MARKET SUPPLY
Individual Supply: The relationship between the quantity of a product supplied by a single seller and its price.
Market Supply: The relationship between the total quantity of a product supplied by all sellers in the market and its price.
DETERMINANTS OF SUPPLY
Factors that influence supply include:
Price of related goods
Cost of production
Expected future price
Technological advancement
Number of sellers
Government policies
Improvement in infrastructure
CHANGE IN QUANTITY SUPPLIED VS. CHANGE IN SUPPLY
Changes in Quantity Supplied:
Occur with a movement along the supply curve due to price changes (ceteris paribus).
Downward movement indicates a decrease in quantity supplied (contraction).
Upward movement indicates an increase in quantity supplied (expansion).
Changes in Supply:
Refers to a shift in the entire supply curve.
Increase in Supply: Shift from $S0$ to $S1$.
Decrease in Supply: Shift from $S1$ to $S0$.
EXCEPTIONAL SUPPLY
Exceptional supply is the opposite of the law of supply where an increase in price leads to a decrease in quantity supplied and vice versa. Factors include wage rates and labor costs.
MARKET EQUILIBRIUM
Definition of Market Equilibrium:
Market equilibrium is the situation when quantity demanded ($Q{DD}$) and quantity supplied ($Q{SS}$) are equal, resulting in no tendency for price or quantity to change.
Mathematically represented as: Q{DD} = Q{SS}
EQUILIBRIUM PRICE AND OUTPUT
Graphical representation of market equilibrium indicated by intersections of the demand and supply curves showing:
Surplus occurs when $Q{SS} > Q{DD}$.
Shortage occurs when $Q{DD} > Q{SS}$.
CHANGES IN DEMAND
Increase in Demand:
Demand curve shifts to the right ($DD$ curve shifts right).
Results in an increase in equilibrium price and quantity.
Decrease in Demand:
Demand curve shifts to the left.
Results in a decrease in equilibrium price and quantity.
CHANGES IN SUPPLY
Increase in Supply:
Supply curve shifts to the right.
Results in a decrease in equilibrium price and an increase in quantity.
Decrease in Supply:
Supply curve shifts to the left.
Results in an increase in equilibrium price and a decrease in quantity.
CHANGES IN BOTH DEMAND AND SUPPLY
Case 1: Same Magnitude
Simultaneous increases in demand and supply lead to a constant equilibrium price with an increase in quantity.
Case 2: Different Magnitude
If demand increases more than supply, the equilibrium price increases while quantity also increases.
Case 3: Different Magnitude (Opposite Direction)
If supply increases more than demand, equilibrium price decreases while quantity increases. Whether the price increases or decreases remains uncertain in cases of different magnitudes.
GOVERNMENT INTERVENTION IN THE MARKET
Maximum Price (Ceiling Price):
Regulations preventing prices from rising above a specified level.
Causes shortages since demand exceeds supply at the capped price.
Advantages: Consumers benefit from lower prices.
Disadvantages: Emergence of a black market, reduction in production, illegal payments to producers.
Minimum Price (Floor Price):
Regulations preventing prices from falling below a specified level.
Causes surpluses since supply exceeds demand at the imposed price.
Advantages: Protects producer income, stabilized higher wage rates.
Disadvantages: Higher consumer prices, resource wastage, unemployment.
ELASTICITY
Price Elasticity of Demand
Definition: Measures the sensitivity/responsiveness of the quantity demanded due to a change in price.
Formula: ext{ε}d = rac{ ext{%} ΔQd}{ ext{%} ΔP} or ext{ε}d = rac{Q2 - Q1}{Q1} imes rac{P1}{P2 - P_1}
Degree of Elasticity
Unit Elastic Demand: The percentage change in price equals the percentage change in quantity demanded.
Inelastic Demand: A large percentage change in price affects only a small percentage change in quantity demanded.
Elastic Demand: A small percentage change in price leads to a larger percentage change in quantity demanded.
Perfectly Inelastic Demand: Quantity demanded does not change as price changes ($ε_d = 0$).
Perfectly Elastic Demand: A small percentage change in price results in an infinite percentage change in quantity demanded ($ε_d = ∞$).
Determinants of Price Elasticity of Demand
Factors that determine elasticity include:
Availability of substitutes
The proportion of expenditure on the good
The nature of the goods
Income levels
Frequency of purchases
Time dimension.
Relationship to Total Revenue
Total Revenue (TR) formula: TR = Price (P) imes Quantity (Q)
For elastic demand, increasing price decreases total revenue.
For inelastic demand, increasing price increases total revenue.
For unitary elastic demand, total revenue remains unchanged when the price changes.
Income Elasticity of Demand
Definition: Measures the sensitivity/responsiveness of quantity demanded due to a change in income.
Formula: ext{ε}Y = rac{ ext{%} ΔQd}{ ext{%} ΔY}
Responses of Income Elasticity:
Normal goods: Elastic if income elasticity $> 0$
Necessity goods: Inelastic if $0 < ε_Y < 1$
Giffen/inferior goods: Negative elasticity if $ε_Y < 0$
Luxury goods: Elastic $ε_Y > 1$.
Cross Elasticity of Demand
Definition: Measures the sensitivity/responsiveness of the quantity demanded of one product due to a change in the price of a related product.
Formula: ext{ε}X = rac{ ext{%} ΔQd ext{(Good X)}}{ ext{%} ΔP ext{(Good Y)}}
Responses of Cross Elasticity:
Substitute goods yield positive cross elasticity ($ ext{ε}_x > 0$).
Complementary goods yield negative cross elasticity ($ ext{ε}_x < 0$).
Zero cross elasticity signifies no relationship between goods.
Price Elasticity of Supply
Definition: Measures the sensitivity/responsiveness of quantity supplied due to a change in price.
Formula: ext{ε}{ss} = rac{ ext{%} ΔQs}{ ext{%} ΔP}
Degree of Elasticity:
Unitary elastic supply where the percentage change in price equals the percentage change in quantity supplied.
Inelastic supply: Large price changes result in small quantity changes.
Elastic supply: Small price changes lead to larger quantity changes.
Perfectly inelastic supply: No change in quantity with price changes ($ε_{ss} = 0$).
Perfectly elastic supply: Very small price changes lead to large supply changes ($ε_{ss} = ∞$).
Determinants of Price Elasticity of Supply
Factors influencing elasticity of supply include:
Availability and mobility of production factors
Time period analyzed
Nature of the market
Perishability of goods.