STUDY UNIT 4

DEMAND, SUPPLY AND PRICES

7.2: Demand

When we talk about demand we are referring to the quantities of a good or service that the potential buyers are willing and able to buy.

Figure 7.1: The interaction between households and firms

The law of demand states that other things being equal (i.e. ceteris paribus), the higher the price of a good, the lower is the quantity demanded.

A demand schedule is a table which lists the quantities demanded at different prices when all other influences on planned purchases are held constant.

Figure 7.3: The market demand curve

You only need to draw in figure (b), but note that the market demand curve is the “horizontal summation” of the individual demand curves.

Qd = number of tomatoes demanded in the market

Px = price of tomatoesPg = prices of related goodsY = total income of all prospective purchasers

of tomatoesT = tastes of all prospective purchasers of

tomatoesN = total number of potential consumers of

tomatoes. . . . = allowance for any other possible

influences

A movement along a curve relates to the slope of the curve, while the shift of a curve relates to its position.

An increase in the price of a substitute will cause an increase in demand for the product in question.

An increase in the price of butter will increase the demand for margerine, ceteris paribus.

Figure 7.5: Two substitutes: Butter and Margerine(Adapted)

Complements are goods that tend to be used jointly to satisfy a certain want, e.g. VCRs and cassettes, or cars and petrol.

A fall in the price of a complementary product (VCRs) increases demand for the product (video cassettes, and this is illustrated by a rightward shift of the demand curve.

An increase in the price of the complement (VCRs) will lead to a decrease in demand for the product (video cassettes).

Demand curve for video cassettes will shift to the left.

Figure 7.6: Two complements: video cassette recorders and video cassettes (Adapted)

The increased quantity of VCRs demanded (as a result of the lower price) leads to an increase in the demand for video cassettes.

If demand increases when income increases, the goods are normal goods.If demand decreases when income increases, the goods are inferior goods.

Increase in demand for apples, the demand curve will shift to the right.

An increase in the population will shift the curve to the right, ceteris paribus.

If price of the good is expected to fall, consumers will reduce current demand.A common example: petrol

Demand by low income households will increase, and

Demand by high income households will decrease.

7.3: Supply

Supply can be defined as the quantities of a good or service that producers plan to sell at each possible price during a certain period.

The higher the price, the greater the quantity that the producer will plan to grow and sell, ceteris paribus.

Quantities that the producer plans to sell at different prices will also depend on the cost of production.

New technologies that enable producers to produce at lower costs will increase the quantity supplied at each price.

Qs = number of tomatoes supplied in a particular period

Px = price of the product (tomatoes)Pg = prices of alternative outputsPf = prices of factors of production and other

inputsPe = expected future prices of the productTy = technologyN = number of firms supplying the product. . . . = allowance for any other possible

influences

Subsidies on particular goods and services tend to raise their supply, while taxes tend to reduce their supply.

Some products are produced jointly, e.g. beef and leather.

If productivity falls, production costs increase (ceteris paribus), and supply decreases.

Figure 7.8: Annual market supply of tomatoes (Adapted)

Figure 7.9: Movement along a supply curve: A change in the quantity supplied

A A change in the price of the product leads to a movement along the supply curve SS. For example, when the price of the product increases from P1 to P2 the quantity supplied increases from Q1 to Q2. In other words, there is a movement along SS from a to b.

Figure 7.10: Shifts of the supply curve: Changes in supply

A Original supply curve is SS. A change in any of the determinants of the quantity supplied other than the price of the product will lead to a change in supply, illustrated by a leftward shift of the supply curve. Any factor which reduces supply will shift the supply curve to the left, to S1S1. Any factor which increases supply will shift the supply curve to the right, to S2S2.

The market is in equilibrium when the quantity demanded is equal to the quantity supplied.

Excess demand (or a market shortage)

Excess supply (or a market surplus)

The demand and supply of tomatoes in a market on a particular day

Price of tomatoes (R/kg)

Quantity demanded (kg)

Quantity supplied (kg)

Excess supply or demand (kg)

Pressure on price

1 350 50 300 ED Upward

2 300 100 200 ED Upward

3 250 150 100 ED Upward

4 200 200 0 (equilibrium)

None

5 150 250 100 ES Downward

6 100 300 200 ES Downward

7 50 350 300 ES Downward

Figure 7.11: Demand, supply and market equilibrium(Adapted)

• DD intersects supply curve at a price of R4 per kg.

• Equilibrium quantity is 200 kg per week.

• At price of R2, Qd is 300 kg and Qs is 100 kg. Excess demand is indicated by points bc.

• At price of R7, Qd is 50 kg and Qs is 350 kg. Excess supply of 300 kg is indicated by points df.

When there is EXCESS DEMAND:• As the price increases, the quantity supplied increases

along the supply curve (existing firms produce more), while the quantity demanded falls along the demand curve.

When there is EXCESS SUPPLY:• They cut their production and compete with each other

to find buyers for their products by reducing the price.

• This process continues until equilibrium is reached where Qd = Qs.

• Market equilibrium occurs at the intersection of the demand and supply curves.

• This is the point where buyers and sellers agree on quantity of goods to be exchanges and the price at which they will be exchanged.