MODULE BASIC MICROECONOMICS

CHAPTER 2: DEMAND AND SUPPLY

Objectives:
1. Familiarized with the concepts of demand and supply.
2. State the Law of Demand and the Law of Supply.
3. Identify the determinants of demand and supply.
4. Explain how the forces of demand and supply interact to attain
equilibrium in the market.
5. Apply the Law of Demand and the Law of Supply to different
economic situation.

The Law of Supply and Demand, as explained by Calvin:

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INTRODUCTION
In a market economy, the forces of demand and supply play a significant role in the
determination of what goods to produce and at what prices they should be sold. In an attempt to
show how they work together in a market system.

The Market Mechanism

A market is a mechanism through which buyers and sellers interact in order to determine
the price and quantity of a good or a service. In the market system, prices seves as signal to both
the producers and the consumers. If the consumer wants more goods, this will cause the price of
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that good to increase. Rising prices encourage producers to increase the supply of good.High
prices are therefore a green light to producers since they normally mean higher profit margins.
However, if a good is overstocked, suppliers of this good will lower their prices so they can dispose
of their excess supply. These low prices will attract consumers to buy the goods. What will ensue
is the restoration of balance or equilibrium between the buyers and sellers.

Price – is the value of a good in terms of money.

DEMAND
Demand Schedule and Demand Curve

The demand for a product is defined as the quantity that buyers are willing to buy.

Demand Schedule – shows the quantity of the product demanded by a consumer or an

aggregate of consumers at any given price.

Demand Functions – shows how the quantity demanded of a prticular good responds to price
change.

In addition, the demand schedule must specify the time period during which the quantities
will be bought. This is the best illustrated in Table 2.

Table 2: Hypothetical Demand Schedule for

Price of X Quantity Demanded Good X per week.
( per kilo) (in kilo)
The quantity demanded values are rates
₱45 of purchases at alternative prices. It can be seen
100 from Table 2 that at lower prices of X, people get
40 150 attracted to buy more.

The demand curve is a graphical

35 200 representation of the demand schedule and
therefore contains the same prices and quantities
30 250 presented in the demand schedule. Plotting the
data from Table 2, we arrive at Figure 3. The
normal demand curve slopes downward from left
25 300 to right. Any point on the demand curve reflects
the quantity that will be bought at a given time.
20 350

THE LAW OF DEMAND

After analysing the above relationship, we can now state that as price increases, the
quantity demanded of the product decreases, the quantity purchased will increase.
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Changes in Quality Demanded and Movements along the Demand Curve

Figure 3: Hypothetical market Demand Curve for One Week

Looking back at
Figure 3, the 50
consumers are willing 45
to buy 250 kilos of X
when price is at ₱30. A 40
drop in the price to ₱5 35
will attract the 30
consumers to increase
their purchase to 300 25
kilos. This movement 20
point D to point E along 15
the demand curve is
described as a change 10
in quantity demanded. 5
0
100 150 200 250 300 350

Quantity Demanded (in kilo)

Ceteris Paribus Assumption – as defined by J. Bruce Linderman, is a Latin for “all else being
equal.” The ceteris paribus assumption says that none of the independent variables changes.
They (all else) are equal (unchanging). The economic “real word” is very complex; ceteris paribus
simplifies such study by letting us ignore other real world details while we look at specific factors.
Let us now restate the Law of Demand by taking into account that there are factors other
than price which also influence the quantity of demand, namely:
1. income;
2. expectation on future prices;
3. prices of related goods like substitutes and complements;
4. size of the population
5. quality of the product
6. taste and preferences
7. promotion and/or advertisement;
8. religion;
9. customs/traditions; and
10. fad or fashion

Therefore, the functional relationship between price and quantity demanded is essential
since these non-price factors are assumed as constant. The Law of Demand now states,
“Assuming other things constant, price and quantity demanded are inversely proportional”.
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Changes in Demand and Shifts in the Demand Curve

If the ceteris paribus assumption is dropped, then the changes in the non-price factor shall
take place. This will result in a change in the position or slope of the demand curve and a change
in the entire demand schedule.

Table 3: hypothetical Increase in Demand

The graph shows a shift of the
Price of X Initial Demand Initial Demand demand curve from d1 to d2. This is
(per kilo) (d1) (d2)
a rightward shift and reflects an
₱45 100 150 increase in actual demand at every
price level. At a price of ₱40, the
40 150 200 original demand amounted to 150
35 200 250 kilos per week; whereas with the
increase in consumer income, the
30 250 300 new demand corresponds to 200
25 300 350 kilos per week.

20 350 400

Figure 4: Hypothetical Shift in the Demand Curve

The curve shifts to the right if the

determinant causes demand to increase.
This means more of the good or services
are demanded at every price. When the
economy is booming, buyers' incomes will
rise. They'll buy more of everything, even
though the price hasn't changed.

The following changes in the non-price factors may cause the corresponding shift in the
demand curve.

• increase in income - shift to the right

• decrease in income - shift to the left
• greater taste/preference - shift to the right
• less taste/preference - shift to the left
• increase in population - shift to the right
• decrease in population - shift to the left
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• greater speculation - shift to the right
• less speculation - shift to the left

SUPPLY
The concept of supply shows the seller’s side of the market.

Supply Schedule and Supply Curve

The supply of a product is defined as the quantity that the sellers are willing to sell. The
supply schedule shows the quantities that are offered for sale at various prices. If the quantities
offered are only of one seller, then it is an individual supply schedule. The aggregate supply
quantities of a group of sellers are presented as a market supply schedule.

From the given schedule, we can see that

Price of X Quantity Supplied higher prices serve as incentive for the sellers
( per kilo) (in kilo) to offer more goods (x) for sale, while low
prices discourage them from offering more
₱45 180
quantities to sell. The market schedule can be
40 150 depicted as a supply curve. The supply curve
35 120 contains the exact prices quantities in the
supply schedule. In effect it is the graphical
30 90
representation of the supply schedule. (see
25 60 Figure 5.)
20 30

Figure 5: Hypothetical Market Supply Curve for One Week

The supply curve is

upward sloping from left to 50
right. It shows a direct 45
relationship between price 40
and quantity supplied. Any
point on the supply curve 35
reflects the quantity that will 30
be supplied at a given price. 25

After analyzing the 20

relationship between price 15
and quantity supplied, we can 10
now state that as price
5
increases, the quantity
supplied of a product tends to 0
increase; and as price 30 60 90 120 150 180 210
decreases, quantity supplied
decreases.

Quantity Supplied (in kilo)

Changes in Quantity Supplied and Movements along the Supplt Curve

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Let us study a point from Figure 5. Consider the price of X (good) at ₱25 per kilo. At this
price, the sellers will offer for sale 60 kilos of X. Should there be an increase in price to ₱30,
quantity supplied will increase to 90 kilos. This is reflected as a movement along the supply curve
and is caused by a change in the price of the good.

THE LAW OF SUPPLY

As in the theory of demand, there are also non-price determinants that influence supply.
These include:

1. cost of production;
2. availability of economic resources;
3. number of firms in the market;
4. technology applied;
5. producer’s goals;
6. taxes and subsidiaries;
7. price of the product; and
8. price expectation.

Under the ceteris paribus assumption, these factors are again assumed constant to enable
us to analyze the effect of a change in price on quantity supplied.

The Law of Supply now states, “Other things assumed as constant, price and quantity
supplied are directly proportional”.

Changes in Supply and Shifts in the Supply Curve

Once again, let’s drop the ceteris paribus assumption, which means changes in non-price
factors shall now take place. This will likewise result in a change in the position or slope of the
supply curve and a change in the entire supply schedule. The increase or decrease in the entire
supply is also shown through a shift of the entire supply curve. Factors include the use of improved
technology, increase in the number of sellers in the market, and decrease in the cost of
production.

Figure 6: Hypothetical Shift in the Supply Curve

In Figure. 6, let us suppose that SS is the

original supply curve where Q amount of
commodity has been supplied at price P. Due to
favorable changes in non-price factors, the
production of the commodity has increased and its
supply has been increased by Q2 – Q amount, at
the same price. This has caused the supply curve
rightwards and new supply curve S2S2 has
formed.

In the same, due to unfavorable changes in

non-price factors of the commodity, the production
and supply have fallen to Q1 amount. Accordingly,
the supply curve has shifted leftwards and new
supply curve S1S1 has formed.
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Market Equilibrium

Demand and Supply should eventually be analysed as one since the market operates
within the forces of both demand and supply. Combining the demand and supply curves will show
the point of market equilibrium. This equilibrium is attained at the point where demand is equal to
supply. We can identify this graphically in Figure 7

Figure 7: Hypothetical Market Demand and Supply Curves

When we put the demand and
supply graphs together, the curves will
intersect. This intersection is used to
determine the equilibrium price. The
equilibrium price represents the point
where the supply of a product is equal to
the demand for that product.

The example supply and demand

equilibrium graph below identifies the
price point where product supply at a
price consumers are willing to pay are
equal, keeping supply and demand
steady.

Shifts to Both the Demand and Supply Curves

The point of equilibrium is subject to change. Shifts in either the demand curve alone, or
the supply curve alone, or in both the demand and supply curves at the same time can cause a
change in the equilibrium point. For example, a rightward shift of the supply curve with the original
demand curve maintained will result in a decrease in the equilibrium price as shown in Figure 8.

Figure 8: Hypothetical Shift in the Market Supply Curve with Demand Curve

In Figure 8, the rightward shift of the

supply curve has caused the equilibrium
price to drop. In like manner, a shift of
demand curve with the original supply
curve maintained will cause a change in
the equilibrium point as shown in Figure
9.
 MODULE BASIC MICROECONOMICS

Figure 9: Hypothetical Shift of the Market Demand Curve with Supply Curve

In this graph (Figure 9), a rightward shift of the demand curve with supply curve maintained
has caused the equilibrium price to increase.

THE DYNAMICS OF DEMAND AND

SUPPLY

We shall illustrate several examples on how we

move from original equilibrium to a new equilibrium
position over time as a result of a shift of either the
demand curve or the supply curve in the commodity.

Shifts in Demand

We can see in figure 10 that at the price of ₱30, the quantity that consumers are willing
to buy, which is 1000, is equal position.

At a price higher than equilibrium, demand will be less than 1000, but supply will be more
than 1000 and there will be an excess of supply in the short run. Graphically, we say that
demand contracts inwards along the curve and
supply extend outwards along the curve. Both of
these changes are called movements along the
demand or supply curve in response to a price
change.

Figure 10: Equilibrium Situation

Demand contracts because at the higher price,

the income effect and substitution effect combine
to discourage demand, and demand extends at
lower prices because the income and substitution
effect combine to encourage demand. In terms of
supply, higher prices encourage supply, given the
supplier’s expectation of higher revenue and
profits, and hence higher prices reduce the
opportunity cost of supplying more. Lower prices discourage supply because of the increased
opportunity cost of supplying more.
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Figure 11: Shift of Demand to the Left Figure 12: Shift of Demand to the Right

Demand Shift to the Right: An increase in demand shifts the demand curve to the right, and
raises price and output.

Demand Shift to the Left: A decrease in demand shifts the demand curve to the left and reduces
price and output.

SHIFTS IN SUPPLY

In Figure 11 and 12, we saw a shift of the demand curve while the supply curve remained
unchanged. Let us illustrate what happens when the supply curve shifts.

Figure 13: Shift of Supply to the Left Figure 14: Shift of Supply to the Right

Supply Shift to the Right: An increase in supply shifts the supply curve to the right, which
reduces price and increase output.
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Supply Shift to the Left: A decrease in supply shifts the supply curve to the left, which raises
price but reduces output.

SUMMARY

Market – a mechanism through which buyers and sellers interact in order to determine the price
and quantity of a good or a service; its mechanisms is best described by the law of demand and
supply.

Law of Demand – as price increases, the quantity demanded of the product decreases, but as
price decreases, the quantity purchased increases.

Law of Supply – as price increases, the quantity supplied of product tends to increase, and as
price decreases, quantity supplied decreases.

Factors that Affect the Law of Demand

1. Income
2. Expectation on future prises
3. Prices of related goods like substitutes and complements
4. Size of the population
5. Quality of the product
6. Taste and preferences
7. Promotion and/or advertisement
8. Religion
9. Customs/tradition
10. Fad of fashion

Factors that Affect the Law of Supply

1. Cost of production
2. Availability of economic resources
3. Number of firms in the market
4. Technology applied
5. Producer’s goals
6. Price of the product
7. Taxes and subsidiaries
8. Price of the product
9. Price expectation

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