SUPPLY AND DEMAND

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2 Direct and Derived Demand Supply Curve

Demand, Supply
23
Market Demand Function

6
Law of Demand 40
Market Supply
Function
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30 End of Report
Demand Curve

MARIA TANIA MAE S.ROSARIO

Demand is the quantity of a good service
that consumers are willing and able to
purchase during a specific period under a
given set of economic conditions.
Conditions to be considered include the
price of good in question, prices and
availability of related goods, expectations
of price changes, consumer incomes,
consumer taste and preferences,
advertising expenditures, and so on.
The amount of the product that
consumers are prepared to purchase, its
demand, depends on all these factors.
According to the law of demand, the
lower the price of a good, the larger the
quantity consumers wish to purchase, all
other things held constant.
What is the Law of Demand?
In microeconomics, the law of demand
 states that, "conditional on all else being
equal, as the price of
a good increases (↑), quantity demanded
decreases (↓); conversely, as the price of
a good decreases (↓), quantity
demanded increases (↑)".
In other words, the law of demand
describes an inverse relationship between
price and quantity demanded of a good.
Alternatively, other things being constant,
quantity demanded of a commodity is
inversely related to the price of the
commodity. 
This operational description intentionally
ignores both known and unknown factors
that may also influence the relationship
between price and quantity demanded,
and thus to assume ceteris paribus is to
assume away any interference.
For managerial decision-making, a prime
focus is on market demand. Market
demand is the aggregate of individual or
personal demand. Insight into market
demand relations requires an
understanding of the nature of individual
demand.
Individual demand is determined by the
value associated with acquiring and using
any good or service and the ability to
acquire it.
Direct Demand
There are two basic models of individual
demand. One, known as the theory of
consumer behavior, relates to the direct
demand for personal consumption
products. 
Theory of Consumer Behavior
In recent years, study of consumer
behavior has emerged as a specialty of
growing concern to marketing scholars.
Knowledge of consumer behavior can
provide useful input to marketing
strategies like segmentation, target
market selection and positioning.
Concept of Consumer Behavior
Who buy the products?
How do they buy the product?
Where do they buy them?
How often do they buy them?
When do they buy them?
Why do they buy them?
How often do they use them?
Individuals are viewed as attempting to maximize
the total utility or satisfaction provided by the
goods and services they acquire and consume.
This optimization process requires that consumers
focus on the marginal utility (gain in satisfaction)
of acquiring additional units of a given product.
Product characteristics, individual preferences
(tastes), and the ability to pay are all important
determinants of direct demand.
Derived Demand
Goods and services are sometimes
acquired because they are important
inputs in the manufacture and
distribution of other products. Their
demand is derived from the demand for
the products they are used to provide.
Examples of Derived Demand
Demand for producers’ goods and services is
closely related to final products demand. For
products whose demand is derived rather
than direct, demand stems from their value in
the manufacture and sale of other products. 
They have value because their employment
has the potential to generate profits.
Key components in the determination of
derived demand are the marginal benefits
and marginal costs associated with using
a given input or factor of production.
Factors That Shift The Resource Demand
Curve
 Regardless of whether a good or service is demanded by
individuals for final consumption or as an input used in
providing other goods and services, the fundamentals of
economic analysis offer a basis for investigating demand
characteristics. For final consumption products, utility
maximization as described by the theory of consumer
behavior explains the basis for direct demand. For
inputs used in the production of other products, profit
maximization provides the underlying rationale for
derived demand. Because both demand models are
based on the optimization concept, fundamental direct
and derived demand relations are essentially the same.
MARKET DEMAND FUNCTION
The market demand function for a
product is a statement of the relation
between the aggregate quantity
demanded and all factors that affect this
quantity.
Determinants of Demand
In functional form, a demand function
may be expressed as:

Quantity of Product Y Demanded = f (Price

of Y, Prices of Related Products (X),
Income, Advertising and so on.) (3.1)
The generalized function expressed in
(3.1) lists variables that commonly
influence demand. For use in managerial
decision-making, the relation between
quantity and each demand-determining
variable must be specified. To illustrate,
assume that the demand function for the
automobile industry is

Equation 3.2
 This equation states that the quantity of new domestic
automobiles demanded during a given year (in
millions) Q,
 is a linear function of the average price of new
domestic cars (in $), P
 the average price for new import luxury cars, a prime
substitute (in $), Px
 disposable income per household (in $), I
 population, (in millions), Pop
 average interest rate on car loans (in percent), i
 And industry advertising expenditures (in $ millions),
A
 The terms a1, a2,…, a6 are called the parameters of
demand function.
Let’sassume that the parameters of this
demand function are known with certainty as
shown in the following equation:

 Equation 3.3 states that automobile demand falls by

500 for each $1 increase in the average price charged
by domestic manufacturers; it rises by 250 with every
$1 increase in the average price of new import luxury
cars (Px); it increases by 125 for each increase in
disposable income per household (I); it increases by
20,000 with each additional million persons in the
population (Pop); it decreases by 1 million for every 1
percent rise in interest rates (i); and it increases by
600 with each unit ($1 million) spent on advertising
(A).
Table 3.1 Estimating Industry Demand for New Automobiles
Estimated Value for
Independent Variable Independent Estimated Demand
Parameter Estimate 2
(1) Variable During the (4) = (2) x (3)
Coming Year (3)
Average Price for
New Cars (P)($) -500 30 000 -15,000,000
Average Price for
New Import Luxury
Cars (Px)($) 250 60 000 15,000,000
Disposable Income,
Per Household (I)($) 125 56 000 7,000,000
Population (pop)
(millions) 20 000 300 6,000,000
Average Interest Rate
(i)(%) -1,000,000 8 -8,000,000
Industry Advertising
Expenditures (A)($
million) 600 5000 3,000,000
       
Total Demand for
New Cars     8,000,000
Industry Demand Versus Firm
Demand
Market Demand functions can be
specified for an entire industry or for an
individual firm, though somewhat
different variable would typically be used
in each case. /
The parameters for specific variables
ordinarily differ in industry versus firm
demand functions. /
Demand Curve

The demand curve expresses the relation

between price charged for a product and
the quantity demanded., holding constant
effects of all other variables.
Demand Curve Determination
A demand curve is shown in the form of a graph,
and all variables in the demand function except
the price for the price and quantity of the
product itself are held fixed.
In the automobile demand function given in
Equation (3.3), for example, one must hold
income, population, interest rates, and
advertising expenditures constant to identify the
demand curve relation between new domestic
automobile prices and quantity demanded.
/ Assuming that import luxury cars prices, income,
population,
= interest rates, and advertising expenditures
are held constant at their Table 3.1 values, the relation
between the quantity demanded of new domestic cars
and price is expressed as (Fig. 3.4)

Q = -500P + 250($60 000) + 125($56 000) + 20,000(300) –1 000 000(8) + 600($5000)

P Px Inc Pop int adv.exp.

Q = 23 000 000 – 5000P
• Alternatively, when price is expressed as a function of
output, the industry demand curve [Equation 3.4] can be
written (Fig. 3.5)
P = $46,000 - $0.0002Q /
ERRATUM:
DEMAND CURVE
Q = 23 000 000 – 5000P
P = $46,000 - $0.0002Q
Supply
Total quantity offered for sale under
various market condition.
The supply of a product in the market is
the aggregate amount supplied by
individual firms. The supply of product
arises from the ability to enhance the
firm’s value maximization objective. The
amount of any good or service will rise
when the marginal benefit to producers is
less than the marginal costs of
production.
Among the factors influencing the
quantity supplied of a product, the price
of the product itself is often the most
important. Higher prices increase the
quantity of output producers want to
bring to market. When marginal revenue
exceeds marginal cost, firms increase the
quantity supplied to earn the greater
profits associated with expanded output.
Higher prices allow firms to pay the
higher production costs that are
sometimes associated with expansions in
output.
Conversely, lower prices typically cause
producers to reduce the quantity
supplied. At the margin lower prices can
have the effect on making previous levels
of production profitable.
The prices of related goods and services
can also play an important role in
determining supply of a product. If a firm
uses resources that can be used to
produce several different products, it may
switch to production from one product to
another, depending on market conditions.
• Managerial decision-making requires
understanding both individual firm supply and
market supply conditions.
• Market supply is the aggregate of individual
firm supply, so it is ultimately determined by
the factors affecting the firm supply.
MARKET SUPPLY FUNCTION
The market supply function for a product
is the relation between the quantity
supplied and all factors affecting that
amount.
Determinants of Supply
In functional form, a supply function can
be expressed as Figure 3.6

Quantity of Product Y Supplied= f(Price of Y,

Prices of Related Products (X), Current
State of Technology, Input Prices,
Weather, and so on.)
To illustrate, consider the automobile
industry example discussed previously
and assume that the supply function has
been specified as follows:
 This equation states that the number of new domestic
automobiles supplied during a given period (in millions), Q
 is a linear function of the average price of new domestic
cars (in $), P;
 average price of new sport utility vehicles (SUVs) (in
$), PSUV;
 average hourly price of labor (wages in $ per hour), W;
 average cost of steel ($ per ton), S;
 average cost of energy ($ per mcf natural gas), E;
 and average interest rate (cost of capital in percent), i.
 The terms b1, b2, . . . , b6 are the parameters of the supply
function. Note that no explicit term describes technology,
or the method by which inputs are combined to produce
output. The current state of technology is an underlying or
implicit factor in the industry supply function.
Substituting a set of assumed parameter
values into Equation 3.7 gives the
following supply function for the
automobile industry:
Table 3.2 Estimating Industry Supply for New Automobiles
Estimated Value for
Independent Variable Parameter Estimate 2 Independent Variable Estimated Demand (4)
(1) During the Coming = (2) x (3)
Year (3)
Average Price for New
Cars (P)($) 2000 25,000 50,000,000
Average Price for Sport
Utility Vehicles (Psuv)
($) -400 35,000 -14,000,000
Average Hourly Wage
Rate, Including Fringe
Benefits (W)($) -100,000 $85 -8,500,000
Average Cost of Stee,
per ton (S)($) -13,750 $800 -11,000,000
Average Cost of Energy
Input, per mcf natural
gas (E)($) -125,000 $4 -500,000
Average Interest Rate
(i) (in%) -1,000,000 8% -8,000,000
       
Total Supply Cars     8,000,000
SUPPLY CURVE
The supply curve expresses the relation
between the price charged and the
quantity supplied, holding constant the
effects of all other variables.
SUPPLY CURVE DETERMINATION
As is true with demand curves, supply curves
are often shown graphically, and all
independent variables in the supply function
except the price of the product itself are fixed
at specified levels. In the automobile supply
function given in Equation 3.8, for example, it is
important to hold constant the price of SUVs
and the prices of labor, steel, energy, and other
inputs to examine the relation between
automobile price and the quantity supplied.
To illustrate the supply determination
process, consider the relation depicted in
Equation. Assuming that the price of
trucks, the prices of labor, steel, energy,
and interest rates are all held constant at
their Table 3.2 values, the relation
between the quantity supplied and price
is:
Alternatively,when price is expressed as
a function of output, the industry supply
curve (Equation 3.9) can be written