MODULE 2

BASIC MICROECONOMICS

Session Topic: Basic Analysis of Demand and Supply

1. Supply and demand in microeconomics

2. Ceteris Peribus
3. Supply and demand curves, price ceilings and floors, elasticity of supply
4. Price determination

Learning Objectives

1. Familiarize one selves with the concepts of demand and supply.

2. State the Law of Demand and 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 supply to different economic situations.

Key Points

Market Demand Supply Equilibrium Price ceiling

Price floor Surplus Shortage Demand Supply function
function

Core Content

Introduction

In an economy where prices are continuously rising, people have always wondered what
factors cause prices to fluctuate. This chapter aims to show the demand and supply are the main
forces that cause prices to increase or decrease. The chapter also tries to explain why an
increase in the price of a commodity will make consumers want to sell more and why a price
decrease will cause the opposite reaction.

In-text Activities

DEMAND AND SUPPLY

Part I: DEMAND

A. Basic Concepts in Demand

Demand(D) refers to the behaviour of people with regard to their willingness and
ability to buy products at given prices. Without the willingness or their ability to buy (called
purchasing power), the needs and wants of consumers cannot be considered their
demand. The amount of goods and services people are willing to buy and consumer refer
to the quantity demanded (Qd).

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 The tabular presentation of Qd at given Prices (P) is called demand schedule.

DEMAND
Table 2.1
Hypothethical Market Demand for X Per Week
Price of X (per kilo) Quantity demand POINT

P45 100 A

40 150 B

35 200 C

30 250 D

25 300 E

20 350 F

15 400 G

The graphical presentation of a demand schedule is called demand curve.

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 DEMAND CURVE
50
A
40 B
C
30 D

PRICE
E
20 F
10
0
0 100 200 300 400
Quantity Demand

Figure 2.1 Hypothetical Market Demand Curve for One Week

The Law of Demand states that when the price of the commodity increases,
quantity demand decreases, and as the price of commodity decreases, quantity demand
increases. This is simply understood to be that “when prices of products increase, the
tendency of consumers is to buy less of a product, and when prices of products
decrease, the normal tendency of consumers is to buy more of a product.” This law, like
all other laws, only applies when all other things that might affect the relationship
between the price and quantity demanded are held constant (ceteris paribus). Note
however, the use of the word “tendency”.

This tendency of people with respect to changes in prices may be traced to the
concept and influence of scarcity. Assuming that people have fixed (finite) budgets,
prices determine their behaviour towards buying products. If prices of products increase,
consumers will have less money to buy the same quantity of products they used to buy.
However, if the prices of products decrease, they may acquire more quantity than the
amount they are used to.

B. Changes in Demand and the Movement Along the demand Curve

Looking back at Figure 2.1, the consumers are willing to buy 250 kilos of X when
price is at ₱30. A drop in the price to ₱5 will, however, attract the consumers to increase
their purchases to 300 kilos. This is what we called movement along the curve, in our
example this is the movement from point D to point E along demand curve and is
described as a change in quantity demanded.

C. Changes in Demand and the Shifts of the Demand Curve

If the ceteris paribus assumption is dropped, then 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.

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 DEMAND
Table 2.2
Hypothethical Increas e in Demand
Price of X (per kilo) Quantity demand Increase in Demand

P45 100 150

40 150 200

35 200 250

30 250 300

25 300 350

20 350 400

The increase or decrease in the entire demand is shown through a shift of the
entire demand curve and referred to as a change in demand.
For an example, if an increase in consumer incomes results in an increase of
consumer’s purchase of X, the effect will now be reflected, as seen in Figure 2.2.

SHIFT OF DEMAND
50
40
30
20
PRICE

10 d2
d1

0
100 150 200 250 300 350 400 450 500 550
Quantity Demand

Figure 2.2 Hypothetical Shift of the Demand Schedule

The above graph shows a shift of demand curve from d1 to d2. This is a
rightward shift and reflects an increase in actual demand at every price level. At a price of
₱40, original demand amounted to 150 kilos per week, whereas with the increase in the
consumer income, the new demand now corresponds to 250 kilos per week.

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 The demand curve may also shift to the left. Decrease in consumer incomes, in
the price of a substitute good, may all cause actual demand to decrease. This will be
shown in a leftward shift in the demand curve.

D. Non-Price Determinants in Demand

Although price is the main determinant of the behaviour of people in the Law of
Demand, reality dictates that not all other factors that affect demand for products. They
are collectively called Non-Price Determinants of Demand.
The following changes in the non-price factors may cause the corresponding
shifts 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
 Greater speculation - shift to the right
 Less speculation - shift to the left

PART II: SUPPLY

A. Basic Concepts in Supply

Supply(S) refers to the behaviour suppliers (or producers) on their willingness and
ability to make products available at given prices. Quantity supplied (Qs) pertains to the
amount of goods and services suppliers (or producers) is able to make available at given
prices. A Supply Schedule refers to the tabular presentation of prices and their
corresponding quantities supplied by suppliers. A Supply curve is a graphical depiction
of a supply schedule. The general appearance of this curve is an upward sloping curve
from left to right.

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 SUPPLY CURVE
50
F
40 E
D
30 C
B
PRICE 20 A
10
0
0 20 40 60 80 100 120 140 160 180 200

Quantity Supply
Figure 2.3 Hypothetical Market Supply Curve for One
Week

The Law of Supply states that as the price of the commodity increases, quantity
supply increases and vice versa. In simple words “when price of the commodities tend to
increase, the quantity being supplied by producers also tend to increase; while the
opposite also holds true, such that when prices of commodities in consideration tends to
decrease.” These observations though, only hold true when all other things are held
constant (ceteris paribus).

B. Changes in Demand and the Movement Along the Demand Curve

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

C. Changes in Supply and Shifts of the Supply Curve

Once again, let us 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 entire supply is also known shown through a shift of the entire supply curve.
Factors, like the use of improved technology, increase in the number of sellers in the
market, and decrease in the cost of production, may all cause an increase in the actual
supply curve shown in Figure 2.4.

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 SHIFT OF SUPPLY
50
40
30
20
s1 s2

PRICE
10
0
0 50 100 150 200 250 300
Quantity Supply

Figure 2.4 Hypothetical Shift of the Market Supply Schedule

for One Week

This graph shows a rightward shift of the supply curve from s1 to s2. AT the price
of ₱40, whereas quantity supplied used to be 150 kilos, the new supply at that price is
now 250 kilos which is on a point on the supply curve. Thus, the rightward shift of the
supply curve is the effect on an increase in supply caused by a change in the non-price
factor. In the same manner, a leftward shift of the supply curve will reflect the decrease in
supply.

D. Changes in Supply and Shifts of the Supply Curve

The following changes in the non-price factors may cause the corresponding shift
in the demand curve:
 Increase in the number of sellers - shift to the right
 Decrease in the number of sellers - shift to the left
 Better technology - shift to the right
 Decrease in the cost of production - shift to the right
 Goals of the firm - it depends

Part III: Market Equilibrium

After studying demand and supply concepts and their graphs, it is now time for us to
learn about their greater significance in their respective roles at the heart of microeconomics: the
market.

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 A market is generally composed of buyers (consumers) and sellers (producers or
suppliers). These buyers are represented in microeconomics as the demand side of the market,
while all sellers and producers are collectively represented by the supply side of the market.

Demand and Supply should eventually be analyzed as one since the market operates
within the forces of both demand and supply. This is exactly what a British economist, Alfred
Marshall, has in mind when he combined the Law of Supply and Demand into one law.

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 2.5.

There is only one point in the graph where demand is exactly equal to supply. This point
of equality is the equilibrium point. It corresponds to the price of ₱40, which is the equilibrium
price. At this price, the quantity supplied is also 150 kilos. All the quantity that is offered for sale
will be bought by the consumers, and all of the demand of the consumers will be met by the
quantity offered by the sellers. This is the ideal situation. Any price above or below ₱40 will be
temporary because prices will revert to equilibrium level.

Considering the price of ₱45 in Figure 2.5, it is above the equilibrium price where the
quantity demanded is only 100 kilos while the sellers will be attracted to offer a bigger quantity
and this is 180 kilos. There is a difference of 80 kilos representing surplus of goods that will be
unsold if the sellers maintained their price at that level. To dispose of these unsold goods, sellers
have to lower their prices and the price level will ultimately settle at equilibrium point.

EQUILIBRIUM
50 Surplus
s
40

30
Excess
Demand
20 d
PRICE

10

0
0 100 200 300 400
Quantity

Figure 2.5Hypothetical Market Demand and Supply Curve

for One week

In the other side, at the price ₱35, which is lower than equilibrium price, buyers will be
attracted to demand for more. In the figure above, the quantity demand corresponds to 200 kilos.
On the other hand lower price will discourage the sellers from offering more. Quantity supplied is
down to 120 kilos. The difference of 80 kilos represents a shortage of the product. The

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consumers will demand for more but it will not be completely met. To fully exploit the demand,
consumers should be willing to pay more and revert price level to ₱40 where supply meets
demand.

More than the reason than an agreed price between buyers and sellers may lead to
transaction, students studying economics have to see the broader picture as to why equilibrium is
important. To understand this better, let us consider another example in the following equations.

Suppose that the determined equation of demand is Qd=250 - 10P and the determined
equation of supply is Qs= 50 + 10P.This would mean that if we generate a schedule for both
equations we have the following values:

DEMAND SUPPLY GAPS

Quantity demanded Quantity supplied
Price (₱) (Qd)-(in units) Price (₱) (Qs)-(in units) (in units) EFFECT
6 190 6 110 80 shortage
10 150 10 150 0 equilibrium
14 110 14 190 80 surplus

Shifts to Both Demand and Supply Curves

The point of equilibrium is subject to change. Shifts in either the demand alone, or the
supply curve alone, or in both the demand and supply curve 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 will result in a decrease in the equilibrium price as shown in Figure 2.6.

MARKET EQUILIBRIUM

Figure 2 .6
A Hypothetical
A
Price (p e r kg)

P3 Shift in the
B Market Supply
P2
Curve with
De mand Curve
Kept Constant

Q1 Q2
Qua ntity (kg)

In the above graph, the original equilibrium price is at P3 per kilo. The rightward shift of
the supply curve has caused the equilibrium price to drop at P2 per kilo.

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 In the like manner, a shift of the demand curve with the original supply curve maintained
will cause a change in the equilibrium point as shown in Figure 2.7. In the preceding graph, a
rightward shift of the demand curve with the supply curve held constant has cause the equilibrium
price to increase from P3 to P4 per kilo.

MARKET EQUILIBRIUM

B
Price (per kg)

P4
A Excess demand (Q3 -Q1)
P3

d2 Figure 2..7
d1 A Hypothetical
Shift of the Market
Q1 Q2 Q3
Demand Curve
Quantity (kg) with the Market
Supply Curve Kept
Constant

Let us now consider a simultaneous shift of the demand curve with the supply curves as
shown in Figure 2.8. Both the demand and supply curves show a rightward shift. Since the
increase in demand is proportionate to the increase in supply, the equilibrium is maintained at ₱3
per kilo. However, the new equilibrium point corresponds to a bigger quantity which is now Q3.

MARKET EQUILIBRIUM

s1
s2
Price (pe r kg)

P4 B
A

d2 Figure 2 ..8
d1 A Hypothetical
Shift in the
Q1 Q2 Q3
Market Demand
Quantity (I kg) and Market Supply
Curves

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What happens when there is market disequilibrium?

When there is market diequilibrium, two conditions may happen:

Surplus

Surplus is a condition in the market where the quantity supplies is more than the quantity
demanded. When there is a surplus, the tendency is for sellers to lower market prices in order for
the goods and services to be easily disposed from the market.

Generally, a surplus happens when there are more products sold in the market by sellers
but few products are bought by consumers. This is because the quantity of goods that buyers are
willing to buy at a given price is less than the quantity of goods that sellers are willing to sell at the
same price.

Shortage

The reverse happens when shortage occurs in the market. Shortage is basically a
condition in the market in which quantity demanded is higher than quantity supplied at a given
price. Shortage happens when quantity demanded is greater than quantity supplied at a given
price.

So what happens when there is a shortage of goods and services in the market? When
this happens, there is an upward pressure on prices to restore equilibrium in the market. In this
particular situation, it is the consumers who will influence the price to go up since they will bid up
prices in order for them to acquire the goods or services that are in short supply.

Price Controls

When the market is experiencing a surplus there is a possibility that producers will lose.
Conversely, when market is encountering shortage, there is likelihood that consumers will be
abused.

Price control is a specification by the government of minimum or maximum prices for

certain goods and services. The price may be fixed at a level below the market equilibrium price
or above it depending on the objective in mind.

Floor Price

A floor price is the legal minimum price imposed by the government on certain goods and
services. A price at or above the price floor is legal; a price below it is not. The setting of a floor
price is undertaken by the government if a surplus in the economy persist.

Generally, the policy is resorted to in order to prevent bigger losses on the part of
the producers. Floor price is a form of assistance to producers by the government for
them to survive in their business.

Price Ceiling

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 A ceiling price is the legal maximum price imposed by the government. A price eciling is
usualy below the equilibrium price. A Price eciling is therefore imposed by the government to
protect the consumers from abusive producers or sellers who take advantage of the situation.
This is usually done by the government after the occurrence of a clamity like typhoon or severe
flooding.

Summary

A market is a mechanism through which buyers and sellers interact in order to determine
the price and quantity of a good or service. In a market economy, the forces of demand and
supply play a very significant role in the determination of what goods to produce and at what
prices they should be sold. The meeting of demand and supply results to market equilibrium
which is generally understood as state of balance. While two conditions may happen when there
is a market disequilibrium; a surplus or a shortage.

LEARNING ASSESSMENT : Demand and Supply

Name:_______________________________ Professor:____________________

Year and Section:_____________________ Rating:_______________________

Exercise 1

True or False. Write TRUE in the space provided if the statement is correct, hence FALSE.

_____1. A market is a mechanism of interaction between buyers and sellers for trade or
exchange. The seller sells and the consumer buys.

_____2. The demand for a product is the quantity of a good that the buyers are willing to buy at
certain prices. A demand schedule shows the different quantities that will be sold by sellers given
various prices.

_____3. A demand function shows the quantity demanded of a good is dependent on its
determinants, the most important of which is the price of the good itself.

_____4. One of the non-price determinants of demand is taste. Taste of preference may vary
from person to person.

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_____5. The consumers’ income does not influence the demand for goods and services. The
increase in demand due to an increase in income is not experienced in the economy.

_____6. An increase in the population results in greater demand since there will be more
consumers as population increases.

_____7. The supply of a product is the quantity of goods and sellers are willing to sell. The supply
schedule shows the different quantities that will be sold.

_____8. The demand curve is an upward sloping to the right while supply curve is downward
sloping.

_____9. When the income of the consumer increases it can shift the demand curve upward to the
right representing the increase in demand.

_____10. Expectations as to future incomes and prices may cause a shift of demand curve.

Exercise 2. Graph Plotting. Plot the following data in a graph in the graphical space provided
below and indicate if there is a shortage, surplus or equilibrium.

Price Qd Qs Shortages/Surplus

P2 80 20

4 70 40

6 60 60

8 50 80

10 40 100

12 30 120

14 20 140

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Exercise 3 Identify whether the curve will shift to the right or to the left. Write R in the blank if it
shifts to the right and L if it shifts to the left.

I Demand II Supply

____1. increase in population ____6. Increase in total cost of production

____2. Decrease in income ____7. Increase in technology

____3. Increase in income ____8. Decrease in total cost of production

____4. Increase in taste ____9. Increase in the number of sellers

____5. Decrease in population ____10. Decrease in the number of sellers

Exercise 5 State what happens to the Philippine market demand and supply curves for oil under
the following conditions: (Decrease, Increase, Same)

Conditions On On
demand supply

Electricity-run cars are introduced and used in the country

The oil fields of Iraq, a major supplier of the country are burned.

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OPEC decides to decrease the price of oil.

An increase in the price of the dollars causes oil to be more expensive in

other country.

Carless days are made compulsory by the government.

Oil mines are discovered in Palawan.

Saudi Arabia increases its quotas in oil sales to the Philippines

A substitute for oil is discovered by Filipino inventors.

Exercise 6. Demand and Supply Scheduling

I Assume that the demand function is equal to:

Qd=5,000-1000P

Where price range is ₱1 to ₱5, derive the demand schedule economies.

Price Qd

II Based on the following functions for demand and supply, compute the demand and supply
schedules

A. Qd=500-20p Qs=50+10p

Price Qd Qs

₱5.00

10.00

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15.00

20.00

25.00

B. Plot the above schedules on a single graph. Identify the equilibrium price and
equilibrium quantity.

Price

Quantity
C. Based on your schedules, indicate if a surplus or shortages exists and so as the
quantity of the surplus or the shortage.

Price Surplus Shortage Quantity

₱5.00

10.00

15.00

20.00

25.00

References

Refer to the references listed in the syllabus of the subject

For instructional use only

For instructional use only