8/8/2019 Demand, Supply and Price 1
1/104
8/8/2019 Demand, Supply and Price 1
2/104
DEMAND
Individuals and Motives
In formulating demand theory, the agents areall assumed to be adult individuals who earn
income,
and They spend this income purchasing various
goods and services.
8/8/2019 Demand, Supply and Price 1
3/104
In economics, it is generally assumed that
each individual consumer seeks maximum
satisfaction, orutility.
The consumer maximizes utility within thelimits set by his or her available resources.
8/8/2019 Demand, Supply and Price 1
4/104
The nature of demand
Quantity demanded : The amount of aproduct that consumers wish to purchase.
Quantity actually purchased: Actual
purchase of a commodity.
8/8/2019 Demand, Supply and Price 1
5/104
Quantity demanded is a desiredquantity.
Quantity demanded is a flow.
8/8/2019 Demand, Supply and Price 1
6/104
Stocks and Flows
Aflow variable has a time dimension: it is so
much per unit of time.
Astock variable has no time dimension: it isjust so much.
8/8/2019 Demand, Supply and Price 1
7/104
The determinants of quantity
demanded: the demand function
The quantity of each product demanded byeach individual consumer is influenced byfive main variables:
1. The price of the product
2. The prices of other products
3. The consumers income and wealth 4. The consumers tastes
5. Various individual-specific or
environmental factors
8/8/2019 Demand, Supply and Price 1
8/104
This can be conveniently summarized in a
demand function:
qdn = D (pn, p1, .,pn-1,Y,S)
8/8/2019 Demand, Supply and Price 1
9/104
The term qdn stands for the quantity that the
consumer demands of some product, which
we call product n. The term pn stands for the price of this
product.
p1, .,pn-1 is a short hand notation for the
prices of all other products.
Y denotes consumers income.
8/8/2019 Demand, Supply and Price 1
10/104
8/8/2019 Demand, Supply and Price 1
11/104
There are also some environmental factors
affecting demand patterns, such as
The state of weather and
The time of the year.
8/8/2019 Demand, Supply and Price 1
12/104
Demand and Price
A basic economic hypothesis is that the lower
the price of a product, the larger the quantity
that will be demanded, other things beingequal.
This negative relationship between the price
of a product and the quantity demanded issometimes referred to as the law of
demand.
8/8/2019 Demand, Supply and Price 1
13/104
This law might be true.
A major reason for this is that there is usually
more than one product that will satisfy anygiven desire or need.
It can be determined what happens when
income, tastes, population, and the prices ofall other products are held constant and the
price of only one product is varied.
8/8/2019 Demand, Supply and Price 1
14/104
First, let the price of the product rise.
The product then becomes a more expensiveway of satisfying a want.
Some consumers will stop buying italtogether.
8/8/2019 Demand, Supply and Price 1
15/104
Others will buy smaller amounts.
Still others may continue to buy the sameamount.
But no rational consumer will buy more of it.
8/8/2019 Demand, Supply and Price 1
16/104
As many consumers will switch wholly, orpartially, to other products to satisfy the samewant, less will be bought of the product
whose price has risen.
Second, let the price of the product fall.
This makes the product a cheaper method ofsatisfying any given want.
8/8/2019 Demand, Supply and Price 1
17/104
Consumers will buy more of it and less of
other similar products whose prices have not
fallen.
These other products have become
expensive relative to the product in question.
8/8/2019 Demand, Supply and Price 1
18/104
The demand schedule and the
demand curve
An individuals demand
Ademand sch
edule is one way of showingthe relationship between quantity demandedand price.
It is a numerical tabulation that shows thequantity that will be demanded at someselected prices.
8/8/2019 Demand, Supply and Price 1
19/104
The data from the demand schedule of an
individual consumer can be plotted with price
on the vertical axis and quantity on thehorizontal axis.
The smooth curve drawn through these
points is called the demand curve.
8/8/2019 Demand, Supply and Price 1
20/104
It shows the quantity that a consumer would
like to buy at every possible price.
Its negative slope indicates that the quantity
demanded increases as the price falls.
A single point on thedemandcurve indicates
a single price-quantity relationship.
8/8/2019 Demand, Supply and Price 1
21/104
The wholedemandcurve shows the
complete relationship between quantity
deman
dedan
dpric
e.
Economists often speak of the conditions of
demand in a particular market as given or as
known.
8/8/2019 Demand, Supply and Price 1
22/104
When they do so they are referring not just to
the particularquantity that is being demanded
at the moment but to the whole demand
curve.
The whole demand curve remains in one
place so long as all variables other than theprice of the product itself remain unchanged.
8/8/2019 Demand, Supply and Price 1
23/104
The market demand curve
To explain market behaviour, the total
demand of all consumers has to be known.
To obtain a market demand schedule, the
quantities demanded by each consumer at a
particular price are summed to obtain the
total quantity demanded at that price.
8/8/2019 Demand, Supply and Price 1
24/104
The process is repeated for each price to
obtain a schedule of total, or market, demand
at all possible prices.
A graph of this schedule is called the market
demandcurve.
8/8/2019 Demand, Supply and Price 1
25/104
The market demand curve is thus the
horizontal sum of the demand curves ofall
the individuals who buy in the market.
In practice, knowledge of market demand is
usually derived by observing total quantities
of sales directly.
8/8/2019 Demand, Supply and Price 1
26/104
The derivation of market demand curves by
summing individual curves is a theoretical
operation.
It is done to understand the relation between
curves for individual consumers and market
curves.
8/8/2019 Demand, Supply and Price 1
27/104
The total quantity demanded depends on the
price of the product being sold,
the prices of all other products,
the incomes of the individuals buying in that
market,
and
on their tastes.
8/8/2019 Demand, Supply and Price 1
28/104
The market demand curve relates the total
quantity demanded to the products own
price, on the assumption that
all other prices,
total income,
and
all other environmental factors
are held constant.
8/8/2019 Demand, Supply and Price 1
29/104
Shifts in the demand curve
The demand schedule and the demand curve
are constructed on the assumption ofceteris
paribus (other things held constant).
A demand curve shifts to a new position
in response to a change in any of the
variables that were held constant whenthe original curve was drawn.
8/8/2019 Demand, Supply and Price 1
30/104
Any change that increases the quantity of a
product that consumers wish to buy at each
price will shift the demand curve to the right.
Any change that decreases the quantity that
consumers wish to buy at each price will shift
the demand curve to the left.
8/8/2019 Demand, Supply and Price 1
31/104
Changes in other prices
The demand curves have negative slopes
because the lower a products price, the
cheaper it becomes relative to other products
that can satisfy the same needs.
Those other products are called substitutes.
8/8/2019 Demand, Supply and Price 1
32/104
A product becomes cheaper relative to its
substitutes if its own price falls.
This also happens if the substitutes pricerises.
A rise in the price of a products substituteshifts the demand curve for the product to the
right.
More will be purchased at each price.
8/8/2019 Demand, Supply and Price 1
33/104
Products that tend to be used jointly with
each other are called complements.
For example:
Cars and petrol
Electric cookers and electricity etc.
8/8/2019 Demand, Supply and Price 1
34/104
Complements tend to be consumed together.
Hence, a fall in the price of either willincrease the demand for both.
A fall in the price of one product that iscomplementary to a second product will shiftthe second products demand curve to the
right.
More will be purchased at each price.
8/8/2019 Demand, Supply and Price 1
35/104
Change in total income
If consumers receive more income, they can
be expected to purchase more of most
products even though product prices remain
the same.
A product whose demand increases when
income increases is called a normal good.
8/8/2019 Demand, Supply and Price 1
36/104
A rise in consumers incomes shifts the
demand curves for normal products to theright.
This indicates that more will be demanded at
each possible price.
8/8/2019 Demand, Supply and Price 1
37/104
For a few products, called inferior goods, a
rise in consumers income leads them to
reduce their purchases.
This is because, they can switch to a more
expensive, but superior, substitute.
8/8/2019 Demand, Supply and Price 1
38/104
A rise in income will shift the demand for
inferior goods to the left.
This indicates that less will be demanded at
each price.
8/8/2019 Demand, Supply and Price 1
39/104
The distribution of income
Suppose total income and all other
determinants of demand are held constant
while the distribution of income changes.
Then the demand for normal goods
will rise for consumers gaining income
and
fall for consumers losing income.
8/8/2019 Demand, Supply and Price 1
40/104
If both gainers and losers buy a good in
similar proportions, these changes will tend to
cancel out.
However, this will not always be the case.
8/8/2019 Demand, Supply and Price 1
41/104
When the distribution of income changes,
demands will rise for those goods favoured
by those gaining income
and
fall for those goods favoured by those losing
income.
8/8/2019 Demand, Supply and Price 1
42/104
Individual characteristics
Changes in the characteristics of theindividuals who make up the market will
cause demand curves to shift.
8/8/2019 Demand, Supply and Price 1
43/104
Environmental factors
Demand for some products is different at
different times of the year.
Some of this is due to weather.
Other variations may be due to traditionsassociated with annual festivals.
8/8/2019 Demand, Supply and Price 1
44/104
From the point of view of theory of demand,
these are exogenous forces.
In other words, these are things that lie
outside the theory, affecting demand,
sometimes greatly, but not themselves being
explained by the theory.
8/8/2019 Demand, Supply and Price 1
45/104
Changes in tastes
If there is a change in tastes in favour of a
product, more will be demanded at each
price.
This will cause the demand curve to shift to
the right.
8/8/2019 Demand, Supply and Price 1
46/104
In contrast, if there is a change in tastes
away from a product, less will be demanded
at each price.
This will cause the entire demand curve to
shift to the left.
8/8/2019 Demand, Supply and Price 1
47/104
Quantity
Price
D0 D1D2
SHIFTS IN DEMAND CURVE
8/8/2019 Demand, Supply and Price 1
48/104
A shift in the demand curve from D0 to D1indicates an increase in demand.
A shift from D0 to D2 indicates a decrease in
demand.
8/8/2019 Demand, Supply and Price 1
49/104
Movements along demand
curves versus shifts
Shifts of curves are different from movements
along curves.
Demand refers to one whole demand curve.
Change in demand refers to a shiftin the
whole curve, that is, a change in the amount
that will be bought at everyprice.
8/8/2019 Demand, Supply and Price 1
50/104
An increase in demand means that the
whole demand curve has shifted to the
right .
A decrease in demand means that the
whole demand curve has shifted to the
left.
8/8/2019 Demand, Supply and Price 1
51/104
Any one point on a demand curve representsa specific amount being bought at a specifiedprice.
It represents, therefore, a particularquantitydemanded.
A movement along a demand curve isreferred to as a change in the quantitydemanded.
8/8/2019 Demand, Supply and Price 1
52/104
A movement down a demand curve is
called an increase (or a rise) in the
quantity demanded.
A movement up the demand curve is
called a decrease (or a fall) in the quantity
demanded.
8/8/2019 Demand, Supply and Price 1
53/104
Supply
The suppliers in a market are the firms.
The firms are in business to make the goodsand services that consumers want to buy.
8/8/2019 Demand, Supply and Price 1
54/104
Firms motives
According to economic theory, firms haveseveral attributes.
First, each firm is assumed to makeconsistent decisions.
Second, firms hire workers and invest capitaland entrepreneurial talent to produce goodsand services that consumers wish to buy.
8/8/2019 Demand, Supply and Price 1
55/104
Third, firms are assumed to make their
decisions with a single goal in mind: to make
as much profit as possible.
In other words, they are driven by the goal of
profit maximization.
8/8/2019 Demand, Supply and Price 1
56/104
The nature of supply
The amount of a product that firms are able
and willing to offer for sale is called the
quantity supplied.
Supply is a desired flow: how much firms are
willingto sell per period of time, not how
much they actually sell.
8/8/2019 Demand, Supply and Price 1
57/104
The determinants of quantity
supplied: the supply function
Three major determinants of the quantity
supplied in a particular market are:
1. The price of the product
2. The prices of inputs to production
3. The state of technology
8/8/2019 Demand, Supply and Price 1
58/104
This list can be summarized in a supplyfunction:
qs
n = S (pn, F1,.,Fm), where qsn is the quantity supplied of product
n;
pn is the price of that product;
F1,.,Fm represent prices of all inputs intoproduction;
and the state of technology determines theform of the function S.
8/8/2019 Demand, Supply and Price 1
59/104
Supply and price
It has to be known how quantity supplied
varies with a products own price, all other
things being held constant.
The focus is therefore, only on the ceteris
paribus relation,
qsn = S (pn)
8/8/2019 Demand, Supply and Price 1
60/104
Ceteris paribus, the quantity of any product
that firms will produce and offer for sale is
positively related to the products own price,
rising when price rises and falling when price
falls.
The basic reason behind this relationship isthe way in which costs behave as output
changes.
8/8/2019 Demand, Supply and Price 1
61/104
The cost of increasing output by another one
unit tends to be higher the higher is the
existing rate of output.
The firm will not find it profitable to increase
output if it cannot at least cover the additional
costs that are incurred.
8/8/2019 Demand, Supply and Price 1
62/104
As the price of the product rises, the firm can
cover the rising costs of more and more
additional units of output.
As a result, higher and higher prices are
needed to induce firms to make successive
increases in output.
8/8/2019 Demand, Supply and Price 1
63/104
The result is a positive association between
market price and the firms output.
The supplyschedule records the quantity all
producers wish to produce and sell at a
number of alternative prices, rather than the
quantities consumers wish to buy.
8/8/2019 Demand, Supply and Price 1
64/104
The supplycurve relates the quantity of acommodity supplied to the price of thecommodity.
In other words, it shows the quantityproduced and offered for sale at each price.
Its positive slope indicates that quantitysupplied increases as price increases.
8/8/2019 Demand, Supply and Price 1
65/104
O
SPrice
QuantityA supply curve
8/8/2019 Demand, Supply and Price 1
66/104
Shifts in the supply curve
A shift in the supply curve means that, at
each price, a different quantity is supplied.
If there is an increase in quantity supplied,
there is a rightward shift in the supply curve.
A decrease in the quantity supplied at each
price causes a leftward shift.
8/8/2019 Demand, Supply and Price 1
67/104
When there is a change in any of the
variables (other than the products own
price) that affect the amount of a product
that firms are willing to produce and sell,
the whole supply curve for that product
will shift.
8/8/2019 Demand, Supply and Price 1
68/104
The major possible causes of such shift areas follows:
Prices of inputs
All things that a firm uses to produce itsoutputs are called the firms inputs.
Other things being equal, the higher the priceof any input used to make a product, the lesswill be the profit from making that product.
8/8/2019 Demand, Supply and Price 1
69/104
Thus, the higher the price of any input used
by a firm, the lower will be the amount thatthe firm will produce and offer for sale at any
given price of the product.
A rise in the price of any input shifts the
supply curve to the left.
This indicates that less will be supplied at any
given price.
8/8/2019 Demand, Supply and Price 1
70/104
A fall in the price of inputs shifts the supplycurve to the right.
8/8/2019 Demand, Supply and Price 1
71/104
Technology
At any time, what is produced and how it isproduced depend on the technologies in use.
Over time, knowledge and productiontechnologies change.
The quantities of individual products that canbe supplied also change.
8/8/2019 Demand, Supply and Price 1
72/104
A technological change that decreases costs will
increase the profits earned at any given price of
the product.
Increased profitability leads to increased
production.
This change shifts the supply curve to the right,
indicating an increased willingness to produce the
product and offer it for sale at each possible price.
M t l l
8/8/2019 Demand, Supply and Price 1
73/104
Movements along supply
curve versus shifts
Quantity supplied refers to a particular
quantity actually supplied at a particular price
of the product.
Supply refers to the whole relation between
price and quantity supplied.
8/8/2019 Demand, Supply and Price 1
74/104
Thus, increase ordecrease in supply
refers to shifts in the supply curve.
Change in the quantitysuppliedmeans a
movement from one point on the supply
curve to another point on the same curve.
8/8/2019 Demand, Supply and Price 1
75/104
The Determination of Price The concept of a market
A market may be defined as an area over
which buyers and sellers negotiate theexchange of some product or related group ofproducts.
Therefore, it must be possible for buyers andsellers to communicate with each other andto make meaningful deals over the wholemarket.
The graphical analysis of
8/8/2019 Demand, Supply and Price 1
76/104
The graphical analysis of
market
Both the demand and supply curves can be
shown on a single graph.
Let us consider the following diagram.
D i i f h ilib i
8/8/2019 Demand, Supply and Price 1
77/104
Price
Quantity
E
DS
O
Determination of the equilibrium
price of a commodity
8/8/2019 Demand, Supply and Price 1
78/104
The equilibrium price corresponds to the
intersection of the demand and supply
curves.
Point E indicates the equilibrium.
8/8/2019 Demand, Supply and Price 1
79/104
At prices above equilibrium there is excess
supply and downward pressure on price.
At prices below equilibrium there is excess
demand and upward pressure on price.
The pressures on price are represented by
the vertical arrows.
8/8/2019 Demand, Supply and Price 1
80/104
The amount by which the quantity demanded
exceeds the quantity supplied is called the
excess demand.
It is defined as quantity demanded minus
quantity supplied (qd qs).
8/8/2019 Demand, Supply and Price 1
81/104
When quantity supplied exceeds the quantity
demanded, there is negative excess demand
(qd qs)
8/8/2019 Demand, Supply and Price 1
82/104
Changes in price when quantity
demanded does not equal quantity
supplied Whenever there is excess demand,
consumers are unable to buy all they wish tobuy.
Whenever there is excess supply, firms areunable to sell all they wish to sell.
In both cases, some agents will not be able todo what they would like to do.
8/8/2019 Demand, Supply and Price 1
83/104
There is a key driving force in markets which
may be referred to as the law of price
adjustment.
This law predicts what will happen to the
market price when there is either excess
demand or excess supply.
8/8/2019 Demand, Supply and Price 1
84/104
When supply exceeds demand, the market
price will fall.
When demand exceeds supply, the market
price will rise.
8/8/2019 Demand, Supply and Price 1
85/104
If there is excess supply, it means that
producers cannot sell all that they wish to sell
at the current price.
They may then begin to offer to sell at lower
prices, for example, through clearance sales
or discounts.
8/8/2019 Demand, Supply and Price 1
86/104
If purchasers observe the glut of unsold
output they may begin to offer lower prices.
For either or both of these reasons, the price
in the market will fall.
8/8/2019 Demand, Supply and Price 1
87/104
If, at the current price, consumers are unable
to buy as much as they would like to buy,they may offer higher prices in an effort to get
more of the available supply for themselves.
Suppliers are unable to produce a greater
quantity of the product in the short run.
But they can ask higher prices for the
quantities that they are producing.
8/8/2019 Demand, Supply and Price 1
88/104
8/8/2019 Demand, Supply and Price 1
89/104
This law of price adjustment makes
considerable sense and conforms with the
common experiences of how markets work.
Shortages of any product tend to lead to price
rises
while
gluts tend to lead to price falls.
8/8/2019 Demand, Supply and Price 1
90/104
This means that the market will exhibit
stability.
Whenever the current price is not the one
that equates demand and supply, the law of
price adjustment ensures that the price will
move towards the market-clearing pricerather than away from it.
8/8/2019 Demand, Supply and Price 1
91/104
Thus, it is not enough that there exists a price
for which demand is equal to supply.
Stability of the market also requires some
mechanism to return the price to the market-
clearing level whenever it is away from that
point.
8/8/2019 Demand, Supply and Price 1
92/104
The combination of a negatively slopeddemand curve and a positively sloped supply
curve with the law of price adjustment will
guarantee a stable market, so long as any
market in this product exists.
8/8/2019 Demand, Supply and Price 1
93/104
The equilibrium price
Once supply and demand are equal, there isno tendency for the price to change becausesuppliers are just able to sell all that they
want And demanders are just able to buy all that
they want.
Nobody has any incentive to change theprice.
8/8/2019 Demand, Supply and Price 1
94/104
The price where the supply and demand
curves intersect, is the price towards which
the actual market price will tend.
It is called the equilibrium price: the price at
which quantity demanded equals quantity
supplied.
8/8/2019 Demand, Supply and Price 1
95/104
The amount that is bought and sold at theequilibrium price is called the equilibriumquantity.
The term equilibrium means a state ofbalance.
It occurs when desired purchases equaldesired sales and
there are no forces tending to make anythingchange.
8/8/2019 Demand, Supply and Price 1
96/104
When quantity demanded equals quantity
supplied, we say that the market is in
equilibrium.
When quantity demanded does not equal
quantity supplied, we say that the market is in
disequilibrium.
The predictions of demand
8/8/2019 Demand, Supply and Price 1
97/104
The predictions of demand
and supply analysis
Aquestion arises how a shift in either
demand or supply curve affects price and
quantity.
The answers to this question constitute the
predictions of supply and demand theory.
8/8/2019 Demand, Supply and Price 1
98/104
The purpose is to see what happens when an
initial position of equilibrium is upset by some
shift in either the demand or supply curve,
and a new equilibrium position is then
established.
8/8/2019 Demand, Supply and Price 1
99/104
To discover the effects of the demand andsupply shifts, the method that is used, isknown as comparative statics.
After starting from a position of equilibrium,the change to be studied is introduced.
The new equilibrium position is determinedand compared with the original one.
8/8/2019 Demand, Supply and Price 1
100/104
The differences between the two positions of
equilibrium must result from the change that
was introduced, for everything else has been
held constant.
8/8/2019 Demand, Supply and Price 1
101/104
The predictions of supply and demand theory
are:
1. A rise in the demand for a product (a
rightward shift of the demand curve)
causes an increase in both the
equilibrium price and the equilibriumquantity bought and sold.
8/8/2019 Demand, Supply and Price 1
102/104
2. A fall in the demand for a product (a leftward
shift of the demand curve) causes a decrease in
both the equilibrium price and the equilibrium
quantity bough
t and sold.
3. A rise in the supply of a product (a rightward
shift of the supply curve) causes a decrease in
the equilibrium price and an increase in theequilibrium quantity bought and sold.
8/8/2019 Demand, Supply and Price 1
103/104
4. A fall in the supply of a product (a
leftward shift of the supply curve) causes
an increase in the equilibrium price and a
decrease in the equilibrium quantity
bought and sold.
References:
8/8/2019 Demand, Supply and Price 1
104/104
1. Lipsey & Chrystal. Economics, Oxford
University Press.
2. Dominick Salvatore. Managerial
Economics in a GlobalEconomy, McGraw-
Hill, Inc.