Price Theory, Demand and Supply

Price Theory

  • Analysis of how price affects customer and supplier.
  • A business needs to assess what consumers need and want, but also what consumers are willing to pay.

Demand

  • Demand: the quantity of goods and services that a customer/consumer is willing to buy at a specific price.

    • Focuses only on price.

  • The Law of Demand:

    • When the price of a product increases, the demand for the product will decrease.
    • When the price of a product decreases, the demand for the product will increase.

  • Demand Schedule: Shows the wants and needs of consumers at specific prices.

  • Demand Curve: A graphical illustration of the information found in the demand schedule.

    • Y-axis: Price.
    • X-axis: Quantity demanded.
    • The graph has a negative gradient.

  • Example: Peter's demand for cold drinks.

    • Illustrates how to plot a demand curve from a demand schedule.

Change (Shift) In Quantity Demanded

  • Changes in demand can occur when there are changes in the market.
  • Factors influencing a shift in quantity demanded:
    • Consumer Income: If a consumer's income is high, they buy more. If a consumer's income is low, they buy less.
    • Advertising: If a product is advertised effectively, consumers will buy more of the product.
    • Fashion Trends: When products are out of fashion, consumers do not want to purchase them. When items are fashionable, there will be a high demand.
    • Competition: Competitor's products (better quality or better prices) will affect the demand a consumer has for products.
    • Price of Complementary Items: If the price of complementary products increases, consumers will buy less.
      • Example: If the fuel price increases, the demand for cars will decrease.
    • Price of Substitute Items: The price of substitute products can affect the demand for certain items.
      • Example: If the price of "pure butter" increases, the demand for "margarine" will increase as people prefer the cheaper substitute.
    • Weather Conditions/Seasons: In summer, people buy very few raincoats and rain boots. In winter, the demand for swimwear is very low.
    • Consumer Preferences: If the taste of customers changes, it will cause a change in the demand.
  • A Shift in Demand:
    • Caused by factors other than price.
    • A new curve has to be drawn to show the shift.
      • Example: If cold weather causes a decrease in the demand for ice cream at every price level, the curve will shift to the left (D1). Hot weather will cause an increase in the demand for ice cream and the curve will shift to the right (D2).

Increase/Decrease in Demand

  • When demand increases, the demand curve shifts to the right.
  • When demand decreases, the demand curve shifts to the left.
  • Example: Shift in demand for chicken pieces, illustrating how changes in income affect the demand curve.
    • Quantity demanded after an increase/decrease in income.

Supply

  • Definition: The units producers are willing to provide at specific prices.
  • Businesses need to determine the quantity of a product they are willing to supply at different prices.
  • Businesses will need to assess the capabilities of the business and the production department on what they are able to produce, how much it would cost, and how much they expect consumers to pay.
  • The Law of Supply:
    • When the price of a product increases, the supply of the product will increase.
    • When the price of a product decreases, the supply of the product will decrease.
  • Supply Schedule: Shows in a table the amount of goods that can be supplied at specific prices.
  • Supply Curve: A graphical illustration of the information found in the Supply Schedule.
    • The supply curve has a positive gradient.
    • Y-axis = the price.
    • X-axis = the quantity supplied.
  • Example: Supply of cold drinks by Coco Drinks, illustrating how to plot a supply curve from a supply schedule.

Change (Shift) In Quantity Supplied

  • Changes in supply can occur when there are changes in the market.
  • Factors influencing the supply:
    • Price of Joint Products/Resources: If the price of the resources used to make products is high, the supply might decrease. E.g., if the price of a sheep increases, it affects the supply of lamb or wool used to make jerseys.
    • Cost of Production: If the product is cheap to produce, suppliers will supply a greater quantity of the product. If the cost of production is high, they will supply less of the item.
    • Production Technology: If there is a technological innovation that allows a product to be produced faster, there will be an increase in supply. Example: Manufacturing sweets using machines is quicker than making them by hand.
    • Number of Producers: If there are a large number of businesses producing a particular product/service, there will be large supply. If some businesses close down and stop producing, the supply of the product will decrease.
    • Weather Conditions: A natural disaster such as floods or droughts might affect the supply of a product or service.
  • Shift In Supply:
    • Changes in the cost of production, technology, or weather conditions can cause the supply curve to shift to the LEFT or RIGHT.
      • Example: An increase in the price of any of the factors of production causes a shift to the left (S2). A decrease in the price of any of the factors of production causes a shift to the right (S1).

Increase/Decrease in Supply

  • When supply increases, the supply curve shifts to the right.
  • When supply decreases, the supply curve shifts to the left.
  • Example: Shift in supply for chicken pieces, illustrating how changes in production costs affect the supply curve.
    • Quantity supplied after an increase/decrease in the production costs.

Equilibrium Price and Quantity

  • Market equilibrium: When the quantity demanded and the quantity supplied are equal at a specific price.
    • Example: At a price of R4, the tuck shop supplies 50 muffins, and the consumer demands 50 muffins.
  • A market is very seldom in perfect equilibrium. There is often a surplus or shortage of goods and services.
  • The point where demand and supply are equal.
  • POINT E - Market Equilibrium: Demand equals supply at a price of R25 and a quantity of 20 loaves of bread.
  • POINT A - B - The surplus: If the price of bread were to increase to a price of R35, the market would be in disequilibrium. At a price of R35, the quantity supplied will exceed the demand, and there will be a surplus of bread.
  • POINT C - D - The shortage: If the price of bread were to decrease to a price of R15, the market would be in disequilibrium. At a price of R15, the quantity demanded will exceed the supply, and there will be a shortage of bread.
  • Example: Equilibrium graph for loaves of bread, illustrating how to find the equilibrium point from demand and supply schedules.