Theory of demand and supply

Unit 2: Theory of Demand and Supply

Page 1

  • Title: Theory of Demand and Supply

Page 2

Concept of Demand

  • Definition: Demand refers to the desire or will for a commodity along with the ability to pay for it.

  • Key Definitions:

    • Prof. Benham: "The demand for anything, at a given price, is the amount that will be bought per unit of time at that price."

    • Mankiw: "When the price of a good rises, the quantity demanded falls, and when the price falls, the quantity demanded rises."

Page 3

Types of Demand

  • Categories: Several types of demand based on influencing factors:

    • Direct Demand

    • Price Demand

    • Income Demand

    • Cross Demand

    • Indirect / Derived Demand

    • Joint Demand

    • Composite Demand

    • Competitive Demand

Page 4

Direct Demand and Price Demand

  • Direct Demand: Demand for final goods only.

  • Price Demand: Quantities demanded at various prices; shows an inverse relationship with normal goods. Example:

    • Price rises from OP to OP1, quantity demanded decreases from OQ to OQ1.

Page 5

Income Demand

  • Income Demand: Quantities demanded vary with consumer income levels.

  • Negative relationship with inferior goods; positive for normal goods.

  • Example:

    • Income increases from OY to OY1, demand increases from OQ to OQ1.

Page 6

Cross Demand

  • Definition: Change in demand for one good due to changes in price of another. Categories:

    • Substitute Goods: Positive relationship; e.g., Fanta and Mirinda.

    • Complementary Goods: Negative relationship; e.g., Printers and ink cartridges.

Page 7

Complementary Goods

  • Description: Goods used together. Price increase of one good results in lower demand for the other.

Page 8

Determinants of Demand

  • Key Factors:

    1. Price of the Commodity

    2. Price of Related Goods (substitutes/complementary)

    3. Income of Consumers

    4. Distribution of National Income

    5. Size of Population

Page 9

Demand Function

  • Definition: Shows the relationship between demand (dependent) and its determinants (independent).

  • Example Function: QX = f(PX, Y, T, PY, E, A, SP,...)

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Types of Demand Function

  • Linear Demand Function: Changes occur at a constant rate. Function represented as QX = a - bPX.

  • Linear Demand Curve: Slope remains constant.

Page 11

Non-linear Demand Function

  • Definition: Changes occur at different rates; slope changes along the curve. Represented as QX = a(PX)–b.

Page 12

Law of Demand

  • Definition: According to Alfred Marshall, quantity demanded increases as price falls, and decreases as price rises.

  • Assumptions: Constant income, consumer preferences, population size, etc.

Page 13

Demand Schedule

  • Example: Inverse relationship seen in table. As price decreases, quantity demanded increases.

Page 14

Demand Curve

  • Definition: Graphical representation of the demand schedule; negatively sloped indicating inverse relationship.

Page 15

Limitations/Exceptions to the Law of Demand

  • Exceptions Include:

    1. Giffen Goods

    2. Change in Consumer Income

    3. Ignorance of Market Prices

    4. Fear of Shortage

    5. Prestigious Goods

    6. Essential Goods

Page 16

Reasons for Downward Sloping Demand Curve

  • Key Factors:

    1. Law of Diminishing Marginal Utility

    2. Income Effect

    3. Substitution Effect

    4. Multiple Uses

Page 17

Movement along Demand Curve

  • Concept: Change in quantity demanded due to price change. Types:

    • Expansion in Demand: Increase due to price decrease.

    • Contraction in Demand: Decrease due to price increase.

Page 18

Shift in Demand Curve

  • Definition: Change in demand at the same price due to factors other than the commodity's price.

  • Types of shifts: Rightward (increase) and leftward (decrease).

Page 19

Illustration of Shift in Demand Curve

  • Explanation: Shift examples and impact on demand quantity.

Page 20

Factors Causing Shift in Demand Curve

  • Key Influencers:

    1. Change in Income

    2. Change in Price of Related Goods

    3. Change in Taste and Preferences

    4. Size of Population

    5. Distribution of National Income

Page 21

Difference between Movement along and Shift in Demand Curve

  • Highlights the distinctions between the two concepts.

Page 22

Theory of Supply

  • Definition: Quantity supplied refers to the amount sellers are willing to sell at various prices.

Page 23

Determinants of Supply

  • Key Factors:

    1. Price of the Commodity

    2. Number of Firms

    3. Price of Production Factors

    4. Change in Technology

    5. Goals of Firms

    6. Government Policy

    7. Change in Size of Population

Page 24

Supply Function

  • Definition: Relationship between supply and its determinants. Key focus on price's impact.

Page 25

Types of Supply Function

  • Linear Supply Function: Constant rate of change; expressed as QX = a + b(PX).

Page 26

Illustration of Linear Supply Curve

  • Slope remains constant throughout curve.

Page 27

Non-linear Supply Function

  • Definition: Changes at varying rates; slope changes along curve.

Page 28

Illustration of Non-linear Supply Curve

  • Shows variable slope.

Page 29

Law of Supply

  • Definition: Higher prices lead to higher supply; lower prices lead to lower supply.

Page 30

Supply Schedule

  • Example: Table showing positive relationship between price and quantity supplied.

Page 31

Supply Curve

  • Definition: Graph of supply schedule showing positive relationship.

Page 32

Movement along a Supply Curve

  • Concept: Changes in quantity supplied due to price level changes. Types:

    • Extension in Supply

    • Contraction in Supply

Page 33

Shift in Supply Curve

  • Definition: Change in supply due to factors other than price. Types: Rightward (increase) and leftward (decrease).

Page 34

Factors Causing Shift in Supply Curve

  • Key Influencers:

    • Change in Cost of Production

    • Change in Technology

    • Goals of Firms

    • Taxation Policy

    • Change in Size of Population

Page 35

Difference between Movement along and Shift in Supply Curve

  • Differences highlighted for better understanding.

Page 36

Interaction between Demand and Supply

  • Market Equilibrium: State where demand and supply are equal.

Page 37

Graphical Representation of Market Equilibrium

  • Illustrates intersections of demand and supply curves.

Page 38

Change in Equilibrium due to Shifts

  • Impacts of demand and supply shifts on equilibrium price and quantity.

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Graphical Representation of Changes in Equilibrium

  • Visual representation of shifts in demand/supply affecting equilibrium.

Page 40

Assignment Questions

  1. Define demand and explain its types.

  2. Discuss factors affecting (determinants) demand.

  3. Explain the law of demand with limitations/exceptions.

  4. Define demand functions and explain types.

  5. Show differences between shifts and movements along the demand curve.

  6. Explain factors causing shifts in demand.

  7. Discuss factors affecting (determinants) supply.

  8. Explain the law of supply with limitations/exceptions.

  9. Define supply functions and explain types.

  10. Show differences between shifts and movements along the supply curve.

  11. Discuss factors causing shifts in supply.

  12. Explain market equilibrium with a table and diagram.

  13. Discuss Market Equilibrium Condition.

  14. Discuss causes of simultaneous changes in demand and supply.

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  • Questions: Open floor for clarification and inquiries.

Page 42

  • Closure: Thank you note.