Demand and Supply

What is a market?

A market is any situation where two parties gather to facilitate the exchange of goods and
services. The parties involved are usually buyers and sellers.

A market can also be a group of buyers and sellers of a particular good or service.

The elements of a market are as follows:

 Buyer/producers
 Seller/consumers
 Goods
 Services
 Price
The market forces

The market forces are supply and demand

The term supply and demand refer to the behavior of people as they interact with one another
in markets.
What is demand & supply

Demand is an economic principle referring to a consumer’s desire to purchase goods and

services. The consumer is also willing to pay a price for a specific good or service.

Supply is a fundamental economic concept that describes the total amount of a specific good or
service that is available to consumers.

There are determinants/factors that affect both demand and supply.

The non-price determinants of demand are as follows:

 Consumer income
 Prices of related goods
 Tastes
 Expectations
 Number of buyers

The non-price determinants of supply are as follows:

 Number of sellers
 Input Prices
 Technology
 Expectations
The price determinant of demand is as follows:
 Price

The price determinant of supply is as follows:

 Price
Rules of Supply and Demand

The first two laws of supply are demand are as follows:

Price and Supply

If price increases, then in turn, supply will increase.

If price decreases, then in turn, supply will decrease.

Price and Demand

If price increases, then in turn, demand will decrease.

If price decreases, then in turn, demand will increase.

Price, Demand and Supply

If demand is help constant and supply increases, then in turn, price will decrease.
If demand is help constant and supply decreases, then in turn, price will increase.

If supply is held constant and demand increases, then in turn, price will increase.
If supply is held constant and demand decreases, then in turn, price will decrease.
Supply Curve

The Supply Curve is a graphic representation of the correlation between the cost of a good or
service and the quantity supplied for a given period.

Quantity supplied - the amount of a good or service that sellers are willing to sell at a specific
price.

The supply curve is upward sloping. This is due to price and supply having positive/direct
relationship. As seen in the two rules, if supply is increased, price will increase and
subsequently, if supply decreases, price will decrease.
Change in quantity supplied – a movement along a supply curve resulting from a change in a
good’s price. (PRICE CAUSES MOVEMENT)

Change in supply – a shift in an entire supply curve resulting from a change in one of the non-
price determinants of supply.

Supply Curves are usually drawn from Supply Schedules.

A supply schedule is a table that shows the relationship between the price of a good and the
quantity supplied.

The following image is an example of a supply schedule.

The following image shows the movement along the supply curve.
The following image shows the inward shift along the supply curve

The inward shift is a drawback. It states that the produces cannot supply as much at each price
level.
The following image shows the outward shift in the supply curve.

The outward shift is a positive. It means that more can be supplied at each price level.
Law of Supply

The law of supply states, other things are equal, the quantity supplied of a good, rises when the
price of a good rises.
Demand Curve

The Demand Curve it is a graph depicting the relationship between the price of an item and its
quantity demanded.

Quantity demanded – is the quantity of an item that people are willing and able to purchase at
a particular price at a particular point in time. (PRICE CAUSES MOVEMENT)

Change in demand – A change in demand describes a shift in the entire curve resulting from a
change in the non-price determinants.
The demand curve is downward sloping. This is due to price and demand having an inverse
relationship. As seen in the two rules, if demand increases, price will decrease and if demand
decreases, price will increase.

Demand Curves are usually drawn from Demand Schedules.

Demand Schedule – It is a table that shows the quantity demanded of a good or service at
different price levels.

The following image shows a demand schedule.

The following image shows a movement along the demand curve.
The following image shows a shift along the demand curve. An inward and outward shift is
illustrated.

An inward shift is a drawback. Less is demanded at each market price.

An outward shift is a positive. More is demanded at each market price.
Law of demand

The law of demand states that, other things are equal, the quantity demanded of a good, falls
when the price of a good rises.
Ceteris Paribus

It is a Latin phrase meaning holding all things or other things constant. It also could mean
holding all other things equal.

The Ceteris Paribus assumption.

A demand and or supply curve is a relationship between two and only two variables. Quantity
and Price. The assumption behind these curves is that no relevant economic factors, other than
the product’s price, are changing. Economists calls this assumption ceteris paribus. If all else is
not equal, then the laws of supply and demand would not hold.
Equilibrium

Equilibrium is a state in a market-based economy in which economic forces, such as supply are
demand are balanced.

Equilibrium refers to a situation in which the price has reached the level where quantity
supplied equals quantity demanded.

The Supply and Demand Curve once connected create an equilibrium point. This is shown in the
following image.

The point at which both graphs intersect is called the equilibrium point. At this point, the
quantity supplied equals the quantity demanded.

Now, there are points and quantities that go beyond and below this point. The governments of
specific countries have developed a way to label these sections under and over the point.

This is termed as government intervention.

Government intervention is any action carried out by the government that affects the market
with the objective of changing the free market equilibrium/outcome.
AN UPSIDE-DOWN HOUSE

A price ceiling and a price floor.

A price ceiling is a government-imposed price control or price limit on how high a price is
charged for a product or service.

A price floor is a government-imposed price control or price limit on how low a price is charged
for a product or service.

Anything below the equilibrium point is termed excess demand (Price ceiling)
Anything above the equilibrium point is termed excess supply (Price floor)

Draw an upside-down house over both supply and demand curve.

Changes in market equilibrium result from shifts/movements in both supply and demand
curves.

The following image depicts the above statement.

Disequilibrium

It is where the quantity demanded is not equal to the quantity demanded. Essentially, any point
below or above the equilibrium point.
Elasticity

Elasticity is a measure of how much buyers and sellers respond to changes in market conditions.

Elasticity refers to the degree to which individuals, consumers or producers change their
demand or the amount supplied in response to price or income changes.

Elasticity allows people to analyze supply and demand with greater precision.
Price Elasticity of Demand

Price elasticity of demand (PED) is a measure of how much the quantity demanded of a good,
responds to a change in the price of a good. Price elasticity of demand is the percentage change
in quantity demanded given a percent change in the price.

Elasticity of demand attempts to predict the amount by which the quantity demanded will rise.

To calculate price elasticity of demand:

Percentage change in Quantity demanded/ Percentage change in price

percentage change in quantity demanded = (New Qd – Old Qd/ Old Qd) x 100

percentage change in price = (New price – Old price/ Old price) x 100

Notes:
 Qd stands for quantity demanded
 The concept of new-old/old is utilized here.

Price Elasticity can be caused by an increase in the quantity demanded of a good or a decrease
in the price of a good.
When a person has finished computing Price elasticity of demand, they will be given a number.
For example, -1.25%
This number is termed as the price elasticity of demand coefficient.

The price elasticity of demand coefficient will always be negative once there is a negative or
inverse relationship between price and quantity demanded. (The law of demand) It will also be
negative; price and demand have a negative/inverse relationship.

Notes:
 If either the percentage change quantity demanded or price is positive, it represents an
increase in either one.

 If either the percentage change in quantity demanded or price is negative, it represents

a decrease in either one.
Degrees of Elasticity

The degree of elasticity describes how responsive quantity demanded is to changes in price. It is
the range of possible elasticity of demand coefficients.

 For example, if the quantity demanded is very responsive to a change in price, then the
quantity demanded is elastic.

 For example, if the quantity demanded is very unresponsive to changes in price, then
the quantity demanded is inelastic.

The degrees range from perfectly inelastic to perfectly elastic

The following image shows the degrees for elasticity of demand.
The Variety of Demand Curves

Since price elasticity of demand measures how much quantity demanded responds to the price,
it is closely related to the demand curve.
The following image shows a perfectly inelastic demand curve.

Perfect inelastic simply means that are buyers are willing and able to pay any price for a
product.
The following image shows an inelastic demand curve.
The following image shows a unitary elastic demand curve.

This graph shows that a 10% decrease in price would lead to a 10% increase in quantity
demanded.
This graph could also that a 10% increase in price would lead to 10% decrease in quantity
demanded.
The following image shows an elastic demand curve.
The following image shows a perfectly elastic demand curve.

At any price above (P), the quantity demanded is equal to 0.

At price (P), consumers will buy any quantity.
At a price below (P), quantity demanded is infinite.
Factors Affecting Price Elasticity of Demand

The following factors affect the value of the elasticity coefficient:

 Price of the good
 Number and closeness of substitutes for the commodity
 Price of the commodity as a percentage of total expenditure
 Adjustment time
 Habit
 The degree of necessity of the good
 The number of uses of the good
 The definition of the good

Price of the good -> If the price of a good is high, the price elasticity of demand will be more
elastic than if the price is low. Cars will have a more elastic demand than bicycles. If the price of
a new car increases by 50%, quantity demanded will fall by a larger percentage as the car now
becomes unaffordable for many consumers. If the price of a bicycle increases by 50%, quantity
demanded will also fall, but by less than 50%. This is because the price of a bicycle is low
relative to that of a car.

Number of closeness of substitutes for the commodity -> The more and better the available
substitutes for a commodity, the greater is the price elasticity. If a good has many substitutes,
and the price raises, the elasticity would be high. If a good has no substitutes and the price
raises, the good would be inelastic.

Price of the commodity as a percentage of total expenditure -> The lower the percentage of
income spent on a good, the more inelastic demand is expected to be. The larger the
percentage of income spent on the good, the greater the price elasticity of demand. For
example, the demand for newspapers is likely to be more inelastic than the demand for
television sets. Expenditure on newspapers forms a small percentage of total monthly income.
Adjustment time -> The longer the period allowed for adjustments in quantity and price, the
more elastic demand will be. This is so because it takes time for consumers to learn of new
prices and new products. For example, the price of your contact lenses increases. It might take
some time for you to become aware of the price change. You might continue to purchase the
expensive brands as you learn about other brands and their prices.

Habit -> Goods that are habit-forming generally have a lower elasticity of demand. Consumers
continue to buy similar quantities of the good even when price increases because the consumer
cannot do without the good. Examples of habit-forming goods are as follows:
 Alcohol
 Cigarettes

It might also be a brand of a consumer good, such as toothpaste. The consumer is in a habit of
buying a specific brand of toothpaste. The consumer is loyal to that brand.

The degree of necessity of the good -> The more necessary a good, the more inelastic demand
will be. Demand is not very responsive to price increases if the consumer needs the good, the
consumer will continue to buy similar amounts. When price decreases, the consumer will again
buy similar amounts, as there is only so much of the good the consumer can use. Salt is a good
example of this. Another example can be incline, if the price of incline increases, people who
need it would continue to buy it. They need it to survive.

The number of uses of the good -> If the commodity has a large number if uses, such as
aluminum, the greater will be the elasticity of demand. As price falls, a more than proportionate
amount will be bought for all its different uses. If aluminum foil drops in price, consumers would
purchase more aluminum foil because it can be used for a variety of different things. For
example, wrapping and baking. If price increases, you will buy less and would use the good for a
smaller number of tasks.

The definition of the good -> The more narrowly defined a good is, the more elastic demand
will be. The broader the definition, the more inelastic demand will be. For example, Sony CDs
will have an elastic demand because, as the price increases users might switch to another
brand. These users switch to a Maxwell Brand. However, if the price of compact disks goes up in
general, demand will remain the same, as there are no close substitutes for compact disk
products. Pens could also be a good example.
Income Elasticity of Demand

Income elasticity of demand (YED) measures the responsiveness of the quantity demanded to a
change in income.

The formula for income elasticity of demand:

Percentage change in Qd/ Percentage change in income

To calculate percentage change in quantity demanded = (NewQd – OldQd/ Old Qd) x 100
To calculate percentage change in income = (New income – Old income/ Old income) x 100
As income changes, demand will change. Income elasticity of demand measures whether
demand is responsive or not responsive to changes in income. If a person’s income increases,
they would demand more goods. Assuming Ceteris Paribus.

Goods with a positive income elasticity of demand coefficients are termed as normal goods.
Goods with a negative income elasticity of demand coefficients are termed as luxury goods.

Normal goods are goods the demand for which increases as income increases. Inferior goods
are goods the demand for which decreases as income decreases.

Income and Demand have a positive relationship.

As income increases, price increases. As income decreases, price decreases
Factors affect Income Elasticity of Demand

The main factor affecting income elasticity of demand is whether goods are necessities or
luxuries.
Cross Elasticity of Demand

Cross elasticity of demand (XED) measures the responsiveness of quantity demanded of one
good to a change in the price of another good.

Assume one good is called good x and another good is called good y.

The formula for cross elasticity of demand is:

XED = Percentage change in Qd for Good x/Percentage change in price for Good y

To calculate percentage change in Qd for Good x = (NewQd – OldQd/ OldQd) x 100

With respect to the quantity demanded for good x

To calculate percentage change in price for Good y = (New price – Old price/ Old price) x 100
With respect to the price for good y
Sometimes demand for a good might change not because of change in the price of the good,
but because there are changes in the price of another good.

For example:
The demand for butter might increase even though the price for butter is constant. It might be
that the price of a substitute – such as margarine or jam increased. This made butter relatively
cheaper.

As the price of one good increases, the quantity demanded for a substitute good also
increases.
The cross elasticity of demand for substitutes is positive. If you receive a positive answer, the
good is said to be a substitute good.

The cross elasticity of demand for compliments is negative. If you receive a negative answer, the
good is said to be a compliment good.

Examples of compliment goods:

 Bread & Butter
 Cereal & Milk

Another example:
The price of bread increases from $5 to $6, a 20% increase. The demand for butter falls from 10
tubs per week, a 10% decrease. Since all other factors remain constant, we can conclude that
the fall in the demand for butter is due to the increased price of bread.
Factors affecting Cross Elasticity of Demand

The following are factors that affect cross Elasticity of Demand:

 Income effect
 Substitution effect
 Complementary effects

Assume there are two goods. A and B

Income effect -> A finite or specific income imposes a budget constraint. An increase in the
price of B changes the quantity consumed and hence the total money spent on B. This in turn
changes the effective available income for other purposes, including the consumption of A.

Substitution effect -> Both A and B are substitute goods. A change in the price of B will affect
the quantity demanded for B. By the law of demand, the quantity demanded decreases with an
increase in price. This in turn affects the utility function of A, and hence, the quantity demanded
at a given price.

Complementary effect -> A change in the price of B affects the quantity of B demanded. By the
law of demand, the quantity demanded decreases with an increase in price. This in turn affects
the utility function of A, and hence, the quantity demanded at a given price.
Elasticity of Supply

Price elasticity of supply measures the responsiveness of quantity supplied to a change in the
price of a good. (PES)

To calculate PES:

PES = Percentage change in quantity supplied/ Percentage change in price

When the price of a good increases, ceteris paribus, quantity supplied will increase.
When the price of a good decreases, ceteris paribus, quantity supplied will decrease.

The above is a direct/positive relationship between price and supply.

Degrees of Elasticity of Supply

It is like that of the elasticity of demand. It also includes perfectly inelastic and perfectly elastic.
Perfectly inelastic means when elasticity of supply = 0

Perfectly elastic means when elasticity of supply = ∞

The Variety of the Supply Curve

It like the variety of the demand curves. It simply removes quantity demanded and includes quantity
supplied.
Factors Affecting Price Elasticity of Supply

The following are factors that affect the price elasticity of supply:
 Number of producers
 Spare capacity
 Ease of switching
 Ease of storage
 Length of production period
 Time
 How cost react