All Rights Reserved PRINCIPLES OF ECONOMICS Third Edition © Oxford Fajar Sdn. Bhd. (008974-T), 2013 2– 1

All Rights ReservedPRINCIPLES OF ECONOMICS Third Edition

© Oxford Fajar Sdn. Bhd. (008974-T), 2013 2– 1



CHAPTER 2DEMAND 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.



CLASSIFICATION OF GOODS AND SERVICES

Free goods are goods that have no production cost.

Public goods are goods that are for common use and will benefit everyone.

Economic goods are goods of value that can be seen and touched. Economic services are intangible things (with value) that cannot be seen or touched.



LAW OF DEMAND

Law of demand states that the higher the price

of a good, the lower is the quantity demanded

for that good and the lower the price, the higher is the quantity demanded, ceteris paribus.

P Qdd P Qdd

NEGATIVE RELATIONSHIP



DEMAND SCHEDULE AND CURVE

Price Quantity

5 2

4 4

3 6

2 8

1 10

Demand Schedule Demand Curve

5

4

3

2

1

0

6

2 4 6 8 10

DD

Quantity (units)

Price (RM)



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 adding all the quantities demanded by all consumers in the market and its price.



Level of taxationLevel of taxationFestive seasons and climate

Festive seasons and climate

Price of related goodsPrice of related goods

Consumers’ incomeConsumers’ income

Tastes and trendsTastes and trends

Population or number of buyers

Population or number of buyers

Supply of money in circulation

Supply of money in circulation

Expectation about future prices

Expectation about future prices

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CHANGES IN QUANTITY DEMANDED VS. CHANGES IN DEMAND

CHANGES IN QUANTITY DEMANDED CHANGES IN DEMAND Price

DDQuantity

Movement along DD curve Price changes and other factors are

constant Upward movement Decrease in

quantity demanded (Contraction) Downward movement Increase in

quantity demanded (Expansion)

Price

D1

D0

Quantity

Shift in the demand curve Occurs when there are changes in

other factors but price remains constant

Increase in Demand (D0 D1)

Decrease in Demand (D1 D0)



EXCEPTIONAL DEMAND

Exceptional Demand is the opposite of the Law of Demand where as price increases, demand will also increase and vice versa.

STATUS SYMBOL GOODS

SPECULATION

EMERGENCIES

HIGHLY-PRICED GOODS



INTER-RELATED DEMAND

The demand for a good is also affected by the price ofits substitute or complementary goods. Cross demand can be divided into two: Joint demand and competitive demand.



CROSS DEMAND: JOINT DEMAND VS. COMPETITIVE DEMAND

Price of pizza

Q2 Q1

P2

P1

Negative relationship exists between complement goods

Quantity of soft drinks Q1 Q2 Quantity of spaghetti

P1

P2

DD

Positive relationship exists between substitute goods

Cross Demand

Price of pizza

a) Joint Demand b) Competitive Demand

DD



Derived demand is the demand for a good which is derived from other goods.

INTER-RELATED DEMAND



DERIVED DEMAND

Derived Demand

Price (RM)

Q0 Q1

P1

P0

D0

Quantity of houses Q0 Q1 Quantity of

workers

WR0

WR1

Wage rate (RM per hour)

Demand and supply for houses Demand and supply for carpenters

D1

S0

D0

D1

S0



INTERRELATED DEMAND

Composite demand is demand for a good that has multiple uses

For example: oil can be used for petrol, kerosene and diesel



COMPOSITE DEMAND

Price

Q0 Q1

P1

P0

D0

Quantity of petrol Q1 Q0 Quantity of diesel

P0

P1

Demand and supply for petrol Demand and supply for diesel

D1

S0

D0

S1Price

S0



PRICE ELASTICITY OF DEMAND

DEFINITION:

Measures the sensitivity/responsiveness of the quantity demanded due to a change in its price.



PRICE ELASTICITY OF DEMAND (cont.)

d = Q2 – Q1 x P1

Q1 P2 – P1

FORMULA:

d = % Quantity Demanded % Price



Perfectly Inelastic DemandA condition in which the quantity demanded does not change as the price changes.

Inelastic DemandA large percentage of change in the price of a good will only affect a small percentage of change in the quantity demanded.

Elastic Demand A small percentage of change in the price of a good will lead to larger percentage of change in quantity demanded.

Unitary Elastic DemandA condition in which percentage changes in price equals to percentage changes in quantity demanded.

Perfectly Elastic DemandA condition in which a small percentage of change in price leads to an infinite percentage of change in the quantity demanded.

d > 1

d < 1

d =0

d =

d = 1

DEGREE OF ELASTICITY




Price (RM)

Quantity Demanded

d > 1

d < 1

d = 1

d =0

d =



Existence of substitutesExistence of substitutes

Frequently purchased products

Frequently purchased products

Time dimension

Time dimensionComplementary

goodsComplementary

goods HabitsHabits

Proportion of the expenditure on a product


Nature of goods

Nature of goods

Income levelIncome level

Existence of substitutesExistence of substitutes

Proportion of the expenditure on a

product

Proportion of the expenditure on a

product



RELATIONSHIP TO TOTAL REVENUE

Price

D

RM30

10

DEMAND IS ELASTIC

Total Revenue

RM20 x 10 = RM200

If seller increases price to RM30

New Total Revenue

= RM30 x 5 = RM150

TR = RM50

RM20

5 Quantity Demanded

The information on price elasticity of demand will be useful for the seller to adjust their selling price since it will affect the total revenue.

Total Revenue (TR) = Price (P) x Quantity (Q)



RELATIONSHIP TO TOTAL REVENUE (cont.)

Price

D

RM2

15

DEMAND IS INELASTIC

Total Revenue

RM1 x 15 = RM15


New Total Revenue

= RM2 x 10 = RM20

TR = RM5

RM1

10Quantity Demanded




RELATIONSHIP TO TOTAL REVENUE (cont.)

Price

D

RM2

20

DEMAND IS UNITARY ELASTIC

Total Revenue

RM1 x 20 = RM20


New Total Revenue

= RM2 x 10 = RM20

TR = 0

RM1

10 Quantity Demanded




INCOME ELASTICITY OF DEMAND

DEFINITION:

Measures the sensitivity/responsiveness of the quantity demanded due to a change in income.



INCOME ELASTICITY OF DEMAND (cont.)

Y = Q2 – Q1 x Y1

Q1 Y2 – Y1

FORMULA:

Y = % Quantity Demanded

% Income



RESPONSES OF INCOME ELASTICITY

Negative Income Elasticity-Type of good: Giffen/ Inferior goods such as

used car and low grade potatoes

Income

Quantity Demanded

y< 0y > 1

y =0Inelastic Income

-Type of good: Normal goods such as food and clothing

Elastic Income-Type of good: Luxury goods such as antique

furniture and diamonds

0 < y < 1 Zero Income Elasticity-Type of good: Necessity Goods such as rice

and vegetables



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.



CROSS ELASTICITY OF DEMAND

X = QX2 – QX1 x PY1

QX1 PY2 – PY1

FORMULA:

X = % Quantity Demanded of good X

% Price of good Y



RESPONSES OF CROSS ELASTICITY

Price of Good X

Quantity Demanded of Good Y

x < 0x > 0

x =0

Zero Cross Elasticity-Good X and Y have no relationship

Positive Cross Elasticity-Good X and Y are substitute goods

Negative Cross Elasticity-Good X and Y are complementary goods



DEFINITION OF SUPPLY

Supply is defined as the ability and willingness to sell or produce a particular product and services in a given period of time at a particular price, ceteris paribus.



LAW OF SUPPLY

P Qss P Qss

POSITIVE RELATIONSHIP

Law of supply states that the higher the price of a good, the greater is the quantity supplied for that good and the lower the price of a good,

the lower is the quantity supplied, ceteris paribus.



SUPPLY SCHEDULE AND CURVE

Price Quantity

5 10

4 8

3 6

2 4

1 2

Supply Schedule Supply Curve

10

8

6

4

2

0

12

1 2 3 4 5

Supply



INDIVIDUAL AND MARKET SUPPLY

INDIVIDUAL SUPPLYThe relationship between the quantity of a product

supplied by a single seller and its price.

MARKET SUPPLYThe relationship between the total quantity

of a product supplied by adding all the quantities supplied by all sellers

in the market and its price.



Price of related goods

Price of related goods

Number of sellers

Number of sellers

Improvement in infrastructure

Improvement in infrastructure

Government Policies

Government Policies



Expected future priceExpected

future price

Technological advancementTechnological advancement

Cost of productionCost of production



CHANGE IN QUANTITY SUPPLIED VS. CHANGE IN SUPPLY

CHANGE IN QUANTITY SUPPLIED CHANGE IN SUPPLY

Price

SS

Quantity

Movement along supply curve Price changes and other factors are

constant Downward movement Decrease in

quantity supplied (Contraction) Upward movement Increase in

quantity supplied (Expansion)

Price

s0

s1

Quantity

Shift in the supply curve Occurs when there are changes in

other factors but the price remains constant

Increase in Supply (S0 S1)

Decrease in Supply (S1 S0)



EXCEPTIONAL SUPPLY

Wage Rate

Labour

15

4 5

5

10

20

0 1 2 3

Income Effect

(Exceptional Supply Curve)

Substitution Effect

Exceptional Supply is the opposite of the Law of Supply where as price increases, the quantity supplied decreases and vice versa

6



INTERRELATED SUPPLY

Increase in the supply of one good brings to an increase in the supply

of another related goods.



PRICE ELASTICITY OF SUPPLY

DEFINITION:

Measures the sensitivity/responsiveness of the quantity supplied due to a change

in the price of a product or service.



PRICE ELASTICITY OF SUPPLY (cont.)

SS = Q2 – Q1 x P1

Q1 P2 – P1

FORMULA:

ss = % Quantity Supplied % Price




Price (RM)

Quantity Supplied

Unitary Elastic SupplyPercentage change in price equals the percentage change in the quantity supplied.

Inelastic SupplyA large percentage of change in the price of a good will only affect a small percentage of change of the quantity supplied.

Elastic SupplyA small percentage of change in the price of a good will lead to larger percentage of change in the quantity supplied.

Perfectly Inelastic Supply A percentage of change in price has no effect on the percentage of change in the quantity supplied.

Perfectly Elastic SupplyAn almost zero percentage of change in price brings a very large percentage of change in the quantity supplied.

ss > 1

ss < 1

ss = 1ss =0

ss =

ss > 1

ss < 1

ss = 1

ss =0

ss =



Technology improvements

Technology improvements

PerishabilityPerishabilityAvailability and mobility of

factors of productionAvailability and mobility of

factors of production

Nature of the market

Nature of the market

Time PeriodTime Period

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All Rights Reserved PRINCIPLES OF ECONOMICS Third Edition © Oxford Fajar Sdn. Bhd. (008974-T), 2013 2– 1