Demand and

Supply

AS Economics
 Demand

• Is the willingness and the

ability to buy certain
quantities of the product
at certain price level
during certain time period.

• Consumers demand good

and services which they
need for consumption like
car, house, cell-phone etc.
 Demand Schedule

• A table that shows information

about Price and Quantity
Demanded for a product. This
information is used to make
the product’s Demand Curve.

Price Per Unit Quantity Demanded

100 750
105 710
112 685
118 655
125 630
132 590
135 575
 Supply

•Supply is the willingness

and the ability to produce
a product in certain
quantities at certain price
level during certain time
period.

•Producers of the product

determine its supply.
 Supply Schedule

• A table that shows

information about Price and
Quantity Supplied for a
product. This information is
used to make the product’s
Supply Curve.
Price Per Unit Quantity Supplied
100 460
105 510
112 575
118 655
125 690
132 725
135 735
 Demand Curve

• Demand curve is a graph that

shows the relationship between
price and quantity demanded.

• Demand curve will always be

downward sloping.

• Keeping other factors constant,

Demand Curve shows how much
will be the quantity demanded, by
any consumer, at different price
levels.
 Law of Demand

•The law of Demand states

that other factors being
constant the price of the
product and quantity
demanded will have inverse
relationship; meaning
higher the prices lower the
quantity demanded and
vice versa.
 Movement along the
Demand Curve

• Change in price of the

product cause a movement
along the demand curve.

• Decrease in price results in

extension in quantity
demanded and increase in
price results in contraction in
quantity demanded.
 Movement along the
Demand Curve
Movement along a demand curve occurs
when there’s a change in relevant
variable measured on either axis

Increase in Qty demanded

of goods due to decrease in
price of that good is termed
as Extension of Demand
 Market Demand Curve

• Since there are number of

consumers who buy any product, the
market demand curve is horizontal
summation of individual demand
curves.

• Assuming that there are only two

consumers namely A and B in the
market for product X, then addition
of quantities demanded of X by A
and B at different prices will give us
the market demand curve for
product X.
Market Demand Curve
 Supply Curve

•Supply curve shows the

relationship between price
and quantity supplied.

•Higher the price, higher

the quantity supplied.
Therefore the supply curve
is always upward sloping.
Movement along the
Supply Curve
 Market Supply Curve

• Since multiple firms produce any

product, market supply will be
horizontal summation of
individual firms supply curves.

• Assuming that for product X

there are only three firms in the
market namely A, B and C, then
addition of quantities supplied by
these 3 firms at different price
levels will give us our market
supply curve.
 Market Supply
As with market demand,
market supply is the horizontal
summation of individual firms’
supply curves

Market
Supply
 Difference between Movement
along the curve and Shift in
the Demand Curve
• Movement along demand curve
occurs due to changes in the product
prices.

• The movement along the curve is

termed as extension in demand
if price is falling and contraction
in demand if price is rising.

• Any factor that affects demand

apart from the price of the product
results in shift in entire demand
curve.
Shifts in Demand
Curve
 Shifts in Demand
Curve
Is price the only factor that affect demand?
NO

1. Population: higher the population higher

the demand; hence rightward shift in
demand curve.

2. Income: higher the income higher the

demand; hence rightward shift in
demand curve.

3. Income Tax: higher the income tax lower

the demand – leftward shift in demand

4. Seasonal Effect- more ice-cream will

be demanded in summers meaning a
rightward shift in demand curve

5. Invention of more substitutes- demand

curve shifts left - for instance Netflix has
significantly reduced the demand for movie
cinemas
 Shifts in Demand
Curve
1.Price of Substitute Goods: higher the
price of your substitute good, higher
the demand for your product. Increase
/ decrease in the price of substitute
products will shift the demand curve
to right / left
2.Price of Complementary Good: higher the
price of complementary good lower the
demand for other good. For instance if
fuel gets expensive less people will
demand cars. Increase / decrease in the
price of complementary products will
shift the demand curve to left / right
 Difference between
movement along the curve
and shift in Supply Curve
• Movement along supply curve
occurs due to changes in the
product prices.

• The movement along the curve is

termed as extension in supply if
price is increasing and contraction
in supply if price is decreasing.

• Any factor that affects supply

apart from the price of the
product results in shift in
entire supply curve.
Shifts in Supply Curve
 Shifts in Supply Curve

• Costs: lower the cost of producing a

product higher the supply. Decrease
/ increase in the cost of production
will shift the supply curve right / left

• Technology: advancement in
technology shifts the supply curve to
right

• Subsidies: are financial payments

made by government to producers.
Provision of subsidies shift the
supply curve to right.

• Indirect Taxes: higher the amount of

indirect tax lower the supply.

 Shifts in Supply Curve

• Expectations of higher / lower future

profits- will shift the supply curve
rightward / leftwards

• Increase in the production of by-

product - will shift the supply curve
rightwards. For instance production
of buttermilk due to manufacture of
butter. Hence more the production of
butter greater the supply of butter
milk.
 Direct Versus Indirect
Taxes

• Direct Taxes: any tax imposed

on income, wealth or property
example income tax, wealth tax,
property tax. Direct Taxes only
affect demand.

• Indirect Tax: any tax imposed on

consumption of the product like
GST (General Sales Tax), VAT
(Value Added tax). Indirect taxes
only affect supply.
 Market Equilibrium

• A situation in which market

demand for a product is equal to
its market supply. The price of a
product in a market is
determined by its market
demand and market supply
curve.

• To show Market Equilibrium we

need to draw market demand
and market supply curve on the
same graph.
 Market Equilibrium

•The equilibrium point

shows the Equilibrium
Price at which each unit of
the good is being sold and
Equilibrium Quantity which
is the total quantity of the
good that is being traded
in the market.
Market Equilibrium
 Changes in Market
Equilibrium
• Shifts in supply and demand curves
cause market equilibrium to change.

1.Increase in Demand: increase in

equilibrium quantity and increase
in equilibrium price

2.Decrease in Demand: decrease in

equilibrium quantity and decrease
in equilibrium price
3.Increase in Supply: increase in
equilibrium quantity and decrease
in equilibrium price

4.Decrease in Supply: decrease in

equilibrium quantity and increase in
equilibrium price
Increase in Demand
Decrease in Demand
Increase in Supply
Decrease in Supply
 Price Elasticity of
Demand

•A formula that captures

the extent of change in
quantity demanded of a
product due to given
change in product price.
 Formula of PED

Percentage Change in Quantity

PED = demanded

Percentage Change in Price

PED = Q2 – Q1 x P1
Q1 P2–P1
 More Elastic Demand
vs Less Elastic Demand
• If the change in quantity demanded
compared to change in price is more
than proportionate then it is known
as more elastic. Therefore the overall
value of more elastic products will
always be greater than 1.

• If the change in quantity demanded

compared to change in price is less
than proportionate then it is
known as less elastic. Therefore the
overall value of less elastic products
will always be less than 1.
 Types of PED

As can be seen through the diagram, D1

being more responsive in terms of quantity
demanded for any change in price has
higher price elasticity of demand.
 How to know if
product demand will
be more of less elastic?

• Rule of Thumb: if a product

is a necessity like food item
then it would be less elastic
and if it is a luxury like
expensive phone or watch
then it will be more elastic.
 Factors that affect
PED

1.Necessity or a Luxury: if
something is a necessity it
will be less elastic and if it is
a luxury then it would have
more elastic PED.
 Factors that affect
PED

Since necessities are needed in

relatively stable quantities,
decrease in price does not cause
too much increase in quantity
demanded. Similarly when price
of the product increases the
quantity demanded does not
decrease substantially. Like food
whether the prices are rising or
falling we all demand relatively
stable quantities of food items.
 Factors that affect
PED
2. Number of Substitutes: if there are more
substitutes then people will be more sensitive
to change in price and so the product will
have more elastic demand and vice versa.

3. Proportion of Income Spent on the Good:

if something takes a large proportion of
consumers’ income like a cellphone or a car
then the demand is expected to change
much more due to given change in price as
compared to something that takes a small
proportion of consumers’ income like a pen
or a chocolate bar.
 Factors that affect
PED

4. The urgency of the product:

If there is urgent demand /
need of something then people
would not mind paying a
higher price and so on. Hence
urgent things have price
inelastic demand and vice
versa.
 More Elastic Less Elastic

Luxury Necessity

More Substitutes Less Substitutes

Higher Proportion Less Proportion of

of Income Income

Not Urgent / No Urgent /

Emergency Emergency
Other Types of PED
 Other Types of PED

• Perfectly Inelastic demand has PED

value of zero. This is because any change
in price yields absolutely no change in
quantity demanded. Eg life saving drug
– no matter what the price is people
will buy the needed quantities.

• Perfectly Elastic demand has PED value

of infinity. This is because at certain
price level the change in quantity
demanded is infinite. Eg when there are
a lot of firms producing the same
product like in perfect competition

• Unitary Elastic is when certain change

in price yields proportionate change in
quantity demanded.
 Values of PED

Type Values

More Elastic Greater than 1

Less Elastic Less than 1

Unitary Elastic Equal to 1

Perfectly Inelastic Has a value of 0

Perfectly Elastic Has a value of

Infinity
 Price Elasticity of
Supply

• A formula that captures the

extent of change in quantity
supplied of a product due to
given change in product price.

% Change in Quantity
Price Supplied
Elasticity of =
Supply % Change in Price
 Formulas of PES

PES = Q2–Q1 x P1

Q1 P2–P1
 Types of PES

• If the change in quantity supplied

compared to change in price is more
than proportionate then it is known
as more elastic. Therefore the overall
value of more elastic products will
be greater than 1.

• If the change in quantity supplied

compared to change in price is less
than proportionate then it is known
as less elastic. Therefore the overall
value of less elastic products will be
less than 1.
Note: more than proportionate means that for 2% change
in price the percentage change in quantity demanded is
more than 2%.
Types of PES
 How to know if a product
will be more or less elastic

• Rule of Thumb: Easier and

less complex it is to produce a
good or service more elastic
would be its supply and the
more difficult or complex a
product’s production process
is like commercial plane, tank
etc the more inelastic the
supply.
 Factors affecting PES
• Availability of Resources: more the
resources available to produce a
product more elastic the supply and
vice versa. In the case of Pakistan we
have more resources to produce
agricultural products so more elastic
supply compared to manufactured
goods.

• Locally manufactured versus

imported goods: things produced
locally take relatively less time and
have more resources available and so

have more elastic supply compared

to imported goods
 Factors affecting PES

• The complexity of production

process: the more complex the
product is the more inelastic the
supply for instance producing a
car is much more complex than
a bicycle therefore the PES of
cars is expected to be inelastic
in relation to PES of
bicycles.
 Factors affecting PES

• Number of Firms producing the

product: greater the number of
firms producing a product
more elastic the supply and vice
versa

• Storage Possibility: if the products

are perishable and so hard to store
the more inelastic the supply and
vice versa. Perishable items like food
items cannot be stored unlike
manufactured goods like books or
cell phones etc.
 Other Types of PES
• Perfectly Elastic: is when for a given
price level the change in quantity
supplied is infinite. The value of PES
in this case is infinity.

• Perfectly Inelastic: is when for any

price level a fixed quantity is being
supplied. Eg no matter how high or
low the price is the number of seats in
movie theater or stadium are fixed.
The value of PES in this case is 0.

• Unitary Elastic: is when for certain

change in price there is proportionate
change in quantity supplied. The value
of PES in this case is 1.
Other Types of PES
 Income Elasticity of
Demand
• A formula that captures the
percentage change in quantity
demanded of the product due
to certain change in consumers’
income.

YED = % CHANGE IN
QUANTITY DEMANDED / %
CHANGE IN INCOME
 Normal vs Inferior
Goods

• Normal: direct relationship with

income; higher the income
higher the product demand. Ex
usual products like restaurants,
movie tickets etc.

• Inferior: inverse relationship with

income, higher the incomes
lower the demand. Ex fast food,
cheaper brands for any product.
 Normal Goods:
More and Less
Elastic

• Luxury items are more elastic

because a certain change in
income will result in big
change in quantity demanded

• Basic Items: are less elastic

because a certain change in
income will result in small
change in quantity demanded.
 Cross Elasticityr of
Demand
• XED is a formula that calculates
the percentage change in quantity
demanded for one product due to
percentage change in price of the
other product.

• These product are either

substitute goods or
complementary goods.

• Substitute goods will always have

a positive value for XED and
Complementary goods will
always have a negative value of
XED.
 Cross Elasticity of
Demand

• If the relationship between 2

products is strong like Coke
and Pepsi or Car and Fuel
then the value of XED will be
more elastic (greater than 1)
and vice versa.
 Consumer Surplus
• The economic benefit that consumers gain
from their participation in the market is
known as consumer surplus

• The difference between consumers’

willingness to pay for a product and the
actual price paid is known as consumer
surplus.
CS = Willingness to Pay – Market Price

• If, for instance, my willingness to pay for a

product is Rs 10 and that product is
priced at Rs 5, then my consumer surplus
is Rs 5.

• In the absence of markets, I would have

paid Rs 10 to acquire the product hence I
would not have experienced any consumer
surplus.
 Producer Surplus
• The economic benefit that
producers gain from their
participation in the market is
known as producer surplus.

• The difference between market

price of the product and
producers’ minimum willingness
to sell the product for is known
as producer surplus.

PS = Market Price – Minimum

Willingness to Sell
 Consumer and
Producer Surplus
 Consumer and
Producer Surplus

• The area below the demand curve

and above equilibrium price is
consumer surplus because it
calculates the difference between
consumers’ willingness to pay and
what they actually pay.

• Similarly area above the supply

curve and below equilibrium price
calculates the difference between
price actually received by producers
and minimum compensation to sell
the product for.
 Consumer and
Producer Surplus
• Consumer and producer
surplus are indicator of
consumers’ and
producers’ well-being.

• Therefore, impact of
government intervention in
markets like taxes and
subsidies etc is evaluated
through changes in consumers
and producer surplus.
 Consumer and
Producer Surplus

• Increase in consumer and

producer surplus is indicator
of higher consumers’ and
producers’ well-being and vice
versa.
 Price as Allocative
Mechanism

• Prices of products play an

important role when it comes
to allocation of resources.

• Relative profits that are

determined through
changes in prices of goods /
services help producers to
determine their best possible
allocation of resources.
 Price as Allocative
Mechanism

• Increase in price of any one

product while prices of
other products have stayed
constant are a signal of
higher profits in production
of that product and
therefore producers will
allocate more resources
towards production of that
product and vice versa.
 Price as Rationing
Mechanism

• Prices help ration the

products. Higher prices
reduce demand since
less people can afford
the products and vice
versa.
Hence prices really help
reach a balance between
demand and supply.
 Prices as
Allocative
and Rationing
Mechanism
• In free market economy
prices play the crucial role of
resource allocation and
distribution of goods/services.

•
•
• In absence of market forces
these functions are performed
by central decision making
body as in command /
planned economies.
 Prices as Allocative
and Rationing
Mechanism
• Though equity (fair
distribution) is often
compromised when prices
undertake these functions
but the process is fast and
efficient without resulting in
over or under production of
goods because markets are
always expected to reach
equilibrium.
 Changes in
Consumer and
Producer Surplus

AS Economics
 Consumer and
Producer Surplus
 Graphical
Representation of
Consumer & Producer
Surplus
• Consumer Surplus is total
area below the market
demand curve and above
prevailing market price.

• Similarly Producer Surplus

is total area above the
market supply curve and
below the prevailing
market price.
 Consumer and
Producer Surplus
Consumer and producer surplus
are indicators of consumers’ and
producers’ well-being.

• Therefore, impact of
government intervention in
markets like taxes and
subsidies etc is evaluated
through changes in consumers
and producer surplus.
 Consumer and
Producer
Surplus

• Increase in consumer
and producer surplus is
indicator of higher
consumers’ and
producers’ well-being
and vice versa.
Indirect Tax & Changes in
Consumer and Producer
Surplus
• Now we will see with the help of a
graph how an indirect tax reduces
both consumer and producer surplus.

• However because indirect tax provides

revenue for the government hence it is
not entirely bad.

• Lastly since indirect tax reduces

equilibrium quantity - it is loss of
economic output which is known as
deadweight loss.
 Indirect Tax

D1 is the original demand curve

S1 is the original Supply Curve.

 Indirect Tax

D1 is the original demand curve

S1 is the original Supply Curve.

S2 is the new supply curve after the

imposition of tax.
 Indirect Tax

At the original equilibrium point,

P1 is the original equilibrium
price and Q1 is original
equilibrium quantity
 Indirect Tax

Pc is the new price paid by

consumers.

Pp is the new price received by

Producers.

And Q2 is the new equilibrium quantity.

 Indirect Tax

Pc is the new price paid by consumers which is

higher than the previous equilibrium price of Rs
150.

Pp is the new price received by Producers which is

lower than previous equilibrium price of
Rs 150.
 Indirect Tax

The blue shaded trapezium shows

loss of consumer surplus.

The red shaded trapezium
represents the loss of producer
surplus.
 Indirect Tax

The red shaded region represents the total

tax revenue received by the government
by the imposition of tax.
Total amount of tax is calculated as Per
unit tax which in our example is Rs 20
multiplied by new equilibrium quantity
which is Q2.
 Indirect Tax

The red shaded region represents the total

tax revenue received by the government
by the imposition of tax.
Calculated as Per unit tax which in our
example is The blue shaded triangle shows
deadweight loss.
Subsidy & Consumer and
Producer Surplus
• Now with the help of graphs we
will see how subsidy increases both
consumer and producer surplus.

• However this increase in consumer

and producer surplus comes at the
expense of government
expenditure.

• Because government spends more

amount on the subsidy compared
to the combined gain of consumer
and producer surplus the
difference is shown as deadweight
loss.
 Subsidy

D1 is the original demand curve and

S1 is the original supply curve.
 Subsidy

D1 is the original demand curve and

S1 is the original supply curve.
P1 is the original equilibrium price
and Q1 is the original equilibrium
quantity.
 Subsidy

S2 is the new supply curve after

the provision of subsidy.
 Subsidy

Pp is the price received by producers

after the provision of subsidy which
is higher than the price previously
received by producers which was Rs
100.
 Subsidy

Pc is the new price paid by

consumers which is lower than the
price previously paid by
consumers. Hence it shows that
consumers benefitted from the
provision of subsidies.
 Subsidy

The blue shaded region represents the

gain of consumer surplus.
 Subsidy

The red shaded region represents the

gain of producer surplus.
 Subsidy

Now we will show the deadweight

loss that arises from subsidies.
 Subsidy

The red shaded triangle shows

the deadweight loss that arises
from provision of subsidies.
 Subsidy

The red shaded rectangle shows the cost

incurred by the government from the
provision of subsidies.
This is calculated by multiplying the per
unit amount of subsidy with the new
equilibrium quantity