2. demand and supply

1. Demand and Supply
Chapter 3

2. Learning outcomes
 The participants in markets and what motivates
them.
 The main factors that influence how much of a
product consumers wish to buy.
 The main influences on how much producers wish
to sell.
 How consumers and producers interact to
determine the market price.
 While demand and supply forces are present in
all markets, many different institutional
structures also affect market outcomes.

3. Demand
 An individual consumer’s demand curve shows the relation
between the price of a product and the quantity of that
product the customer wishes to purchase per period of
time.
 It is drawn on the assumption that all other prices,
income, and tastes remain constant.

 Its negative slope indicates that the lower the price of the
product, the more the consumer wishes to purchase.
 The market demand curve is the horizontal sum of all the
individual consumers.
DEMAND, SUPPLY AND PRICE

4. Demand
 In formulating our demand theory, the
agents are all assumed to be adult
individuals who earn income, and they
spend this income purchasing various
goods and services.
 The consumer ‘is assumed to ‘maximize
utility’ within the limits set by his or her
available resources.

5. The nature of demand
 The amount of a product that consumers
wish to purchase is called the quantity
demanded.
 Note there are two important things about
this concept.
 First, quantity demanded is a desired quantity ie
how much consumers wish to purchase given the
resources at their command.
 Secondly, quantity demanded is a flow.

6. Demand Function
Determinants of Demand / Demand Function:
Qd =f(Pn, Pr, Y, T, U)
 Price of the commodity.
 Price of related commodities i.e. substitutes or
complementary goods.
 Level of Income and Wealth
 Tastes and preferences of consumers
 Size and composition of population
 Distribution of income
 Wealth conditions
 Credit Availability
 Other factors

7. Alice’s Demand Schedule
Reference Letter Price [£ per dozen] Quantity demanded
[dozen per month]
a
b
c
d
e
f
Alice’s Demand Curve
1 2 3
0.50
1.00
2.00
Quantity of Eggs [dozen per month]
3.00
2.50
6
5
4 7
a
b
c
e
d
f
1.50
DEMAND
0.50
1.00
1.50
2.00
2.50
3.00
7.0
5.0
3.5
2.5
1.5
1.0

8. Alice’s demand schedule for
eggs
The table shows the quantity of eggs that Alice
will demand at each selected price, other things
being equal.
For example, at a price of £1.00, Alice demands
5 dozen eggs per month.
The data is plotted in the figure ‘Alice’s demand
curve’.

9. Alice’s demand curve
Each point on the figure relates to a row on Table
Demand Schedule.
For example, when price is £3.00, 1 dozen are
brought per month (point f ).
When the price is £0.50, 7 dozen are brought
(point a).
The resulting curve relates the price of a
commodity to the amount that Alice wishes to
purchase.

10. 2 4 6 8 10 12
2 4 6
1.00
2.00
3.00
1.00
2.00
3.00
8
14
Quantity of Eggs
[dozen per month]
Quantity of Eggs
[dozen per month]
The Relation Between Individual and Market Demand Curves
[i]. William
[ii]. Sarah
[iii]. Total Demand William & Sarah
2 4 6
1.00
2.00
3.00
Quantity of Eggs
[dozen per month]
8

11. The relation between individual
and market demand curves
The figure illustrates aggregation over two
individuals, William and Sarah.
For example, at a price of £2.00 per dozen
William purchases 2.4 dozen and Sarah
purchases 3.6 dozen.
Together they purchase 6 dozen.
In general the market demand curve is the
horizontal sum of the demand curves of all
consumers in the market.

12. A Market Demand Schedule for Eggs
Reference Letter Price [£ per dozen]
Quantity demanded
[000 dozen per month]
0.50
1.00
1.50
2.00
2.50
3.00
110.0
90.0
77.5
67.5
62.5
60.0
U
V
W
X
Y
Z

13. The table shows the quantity of eggs that would
be demanded by all consumers at selected
prices, ceteris paribus.
For example, row W indicates that if the price of
eggs were £1.50 per dozen, consumers would
want to purchase 77,500 dozen per month.
The data in this table are plotted in the following
figure.
A Market Demand Schedule for Eggs

14. Quantity of Eggs (000/month)
20 40 60 80 100 120
1.00
2.00
3.00
140
A Market Demand Curve for Eggs
2.50
1.50
3.50
0.50
Z
D
Y
X
W
V
U

15.  The negative slope of the curve indicates
that quantity demanded increases as price
falls.
 The six points correspond to the six price–
quantity combinations shown in the table.
 The curve drawn through all of the points
and labelled D is the demand curve.
A Market Demand Curve for Eggs

16. 20 40 60 80 100 120
1.00
2.00
3.00
140
Quantity of Eggs (000/month)
Two Demand Curves for Eggs
2.50
1.50
3.50
0.50
Z
D0
Y
X
W
V
U

17. A Market Demand Schedule for Eggs
when income rises
Reference Letter Price [£ per dozen]
Quantity demanded
[000 dozen per month]
0.50
1.00
1.50
2.00
2.50
3.00
140.0
116.0
100.0
90.0
81.3
78.0
Quantity demanded
[000 dozen per month]
when income rises
110.0
90.0
77.5
67.5
62.5
60.0
U’
V’
W’
X’
Y’
Z’
U
V
W
X
Y
Z

18. 20 40 60 80 100 120
1.00
2.00
3.00
140
2.50
1.50
3.50
0.50
Z
D0
Y
X
W
V
U
D1
Z’
Y’
X’
W’
V’
U’
Two Demand Curves for Eggs
Quantity of Eggs (000/month)

19. Two demand curves for eggs
When the curve shifts from D0 to D1, more is
demanded at each price and a higher price is paid
for each quantity.
At price £1.50, quantity demanded rises from
77.5 thousand dozen (point W) to 100 (point W’).
The quantity of 90 thousand dozen, which was
formerly bought at a price of £1.00 (point V), will
be brought at a price of £2.00 after the shift
(point X’).

20. D0
Price
Quantity
0
Shifts in the Demand Curve

21. D0
Quantity
0
Price
Shifts in the Demand Curve
An increase in demand
D1

22. D0
Quantity
0
Price
Shifts in the Demand Curve
A decrease in demand
D2

23. D2 D0 D1
Quantity
0
Price Shifts in the Demand Curve

24. Note
 A rise in the price of a product’s substitute
shifts the demand curve for the product to
the right. More will be purchased at each
price.
 A fall in the price of one product that is
complementary to a second product will
shift the second product’s demand curve
to the right. More will be purchased at
each price.

25. Movements along demand
curves versus shifts
 Demand refers to one whole demand
curve.
 Change in demand refers to a shift in
the whole curve, that is, a change in the
amount that will be bought at every price.

26. Note
An increase in demand means that the
whole demand curve has shifted to the
right; a decrease in demand means that
the whole demand curve has shifted to
the left.
 Any one point on a demand curve represents
a specific amount being bought at a specified
price. It represents, therefore, a particular
quantity demanded.

27. Note
A movement down a demand curve is
called an extension in the quantity
demanded; a movement up the
demand curve is called a contraction in
the quantity demanded.
 A movement along a demand curve is
referred to as a change in the quantity
demanded.

28. Shifts in the demand curve
When the demand curve shifts from D0 to D1,
more is demanded at each price.
Such an increase in demand can be caused by:
A rise in the price of a substitute
A fall in the price of a complement
A rise in income
A redistribution of income towards those who
favour the commodity
A change in tastes that favours the commodity.

29. Shifts in the demand curve
When the demand curve shifts from D0 to D2,
less is demanded at each price.
Such a decrease in demand can be caused by:
a fall in the price of a substitute
a rise in the price of a complement, a fall in
income
a redistribution of income away from groups
that favour the commodity
a change in tastes that dis-favours the
commodity.

30. Demand and price
 We are interested in developing a
theory of how products get priced.
 To do this, we hold all other influences
constant and ask the following
question:
‘How will the quantity of a product
demanded vary as its own price
varies?’

31. Note
A basic economic hypothesis is that
the lower the price of a product, the
larger the quantity that will be
demanded, other things being equal.

32. Exception to Law of Demand
 Giffen goods : According to Sir Giffen, when the price of cheap
foodstuff like bread increased, people bought more and consumed
more and not less of it. Eg: A rise in the price of bread caused a
decline in the purchasing power of the poor such that they were
forced to cut down the consumption of other items like meat,
vegetables etc as bread even though its price had increased was
cheaper than other items.
 Conspicuous Necessities : Commodities like TV, fridge as through
their constant use they have become necessities of life.
 Conspicuous consumption : Goods like diamond etc. where with an
increase in price of the good, Quantity demanded increases.
 Future changes in price : Households act as speculators. Eg: Realty
prices etc.
 Emergencies : Like war, flood negate the operation of law of demand.
 Change in fashion
 Ignorance

33. Note
Substitution effect : When price falls,
quantity demanded of the commodity by
the individual increases as the individual
substitutes in consumption commodity X for
other commodities. This is called the
substitution effect.
Income Effect: When the price of a
commodity falls, a consumer can purchase
more of the commodity with a given money
income, (ie real income in the hands of
consumer increases) This is called the
income effect

34. Note
Derived Demand: The demand faced by a firm
will determine the type and quantity of inputs or
resources that the firm will purchase or hire in
order to produce or meet the demand for goods
and services that it sells.
Since the demand for the inputs or resources
that a firm uses depends on the demand for the
goods and services that it sells, the firm’s
demand for inputs is derived demand.
Rather, the firms demand for producer goods ie
capital equipment and raw materials that can be
stored, is even more volatile and unstable than
the firms demand for perishable raw materials.

35. Supply
 We now look at the supply side of
markets. The suppliers are firms, which
are in business to make the goods and
services that consumers want to buy.

36. Firms’ motives
 Economic theory gives firms several
attributes.
 Firstly, each firm is assumed to make consistent
decisions, as though it was run by a single
individual decision-maker.
 Secondly, firms hire workers and invest capital
and entrepreneurial talent in order to produce
goods and services that consumers wish to buy.
 Thirdly, firms are assumed to make their decisions
with a single goal in mind: to make as much profit
as possible.

37. The nature of supply
 The amount of a product that firms are
able and willing to offer for sale is called
the quantity supplied.
 Supply is a desired flow: how much firms
are willing to sell per period of time, not
how much they actually sell.

38. The determinants of quantity
supply
 Major determinants of the quantity
supplied in a particular market are:
◦ the price of the product;
◦ the prices of inputs to production;
◦ the state of technology
◦ Availability of credit
◦ Joint supply
◦ Expectation of future prices
◦ Number of producers

39. Supply and price
 For a simple theory of price, we need to
know how quantity supplied varies with a
product’s own price, all other things being
held constant.
‘The quantity of any product that firms
will produce and offer for sale is
positively related to the product’s own
price, rising when the price rises and
falling when the price falls.’

40. A Market Supply schedule for Eggs
Reference Letter Price [£ per dozen] Quantity demanded
[000 dozen per month]
w
y
u
v
z
x
0.50
1.00
2.00
2.50
1.50
5.0
77.5
100.0
3.00
46.0
122.5
115.0

41. A market supply schedule for
eggs
The table shows the quantities that
producers wish to sell at various prices,
ceteris paribus.
For example, row y indicates that if the
price were £2.50, producers would wish
to sell 115,000 dozen eggs per month.
The data in this table are plotted in the
following figure.

42. 20 40 60 80 100 120
1.00
2.00
3.00
140
Quantity of Eggs[thousand dozen per month]
A Supply Curve For Eggs
2.50
1.50
3.50
0.50
Z
S
Y
X
W
V
U

43. A supply curve for eggs
The six points correspond to the price-quantity
combinations shown in Table ‘A Market Supply
Schedule for Eggs’.
The curve drawn through these points, labeled
S, is the supply curve showing the quantity of
eggs that will be supplied at each price of
eggs.
The supply curve’s positive slope indicates that
quantity supplied increases as price increases.

44. Two Alternative Market Supply Schedule for Eggs
[1]
Price of Eggs
[£ per dozen]
New quantity
supplied [‘000
dozen per month]
w
y
u
v
z
x
0.50
1.00
2.00
2.50
1.50
5.0
77.5
100.0
3.00
46.0
122.5
Original quantity
supplied [‘000
dozen per month]
115.0
28.0
76.0
102.0
120.0
132.0
140.0
U’
V’
W’
X’
Y’
Z’
[2] [3] [4] [5]

45. 20 40 60 80 100 120
1.00
2.00
3.00
140
Quantity of Eggs [thousand dozen per month]
Two Supply Curves for Eggs
2.50
1.50
3.50
0.50
Z
S0
Y
X
W
V
U

46. 20 40 60 80 100 120
1.00
2.00
3.00
140
Quantity of Eggs [thousand dozen per month]
2.50
1.50
3.50
0.50
Z
S0
Y
X
W
V
U
S1
Two Supply Curves for Eggs

47. Two supply curves for eggs
The rightward shift in the supply curve
from S0 to S1 indicates an increase in the
quantity supplied at each price.
For example, at the price of £1.00 the
quantity supplied rises from 46 to 76
thousand dozen per month.

48. Quantity
Shifts in the Supply Curve
S0

49. Quantity
S0 S1
Shifts in the Supply Curve – increase in supply

50. Quantity
S2
S0
Shifts in the Supply Curve – decrease in supply

51. Quantity
S2 S0
S1
Shifts in the Supply Curve

52. Shifts in the supply curve
 A shift in the supply curve from S0 to S1 indicates
more is supplied at each price.
 Such an increase in supply can be caused by:
 Improvements in the technology of producing the
commodity
 A fall in the price of inputs that are important in
producing the commodity
 A shift in the supply curve from S0 to S2 indicates less
is supplied at each price.
 Such a decrease in supply can be caused by:
 A rise in the price of inputs that are important in
producing the commodity.
 Changes in technology that increase the costs of
producing the commodity (rare).

53. The determination of price
 So far we have considered demand and
supply separately.
 We now outline how demand and supply
interact to determine price.

54. The concept of a market
 A market may be defined as an area over
which buyers and sellers negotiate the
exchange of some product or related
group of products.
 It must be possible, therefore, for buyers
and sellers to communicate with each
other and to make meaningful
transactions over the whole market.

55. Demand and Supply Schedules for Eggs and Equilibrium Price
Price
[£ per dozen]
Quantity supplied
[‘000 dozen
per month]
0.50
1.00
2.00
2.50
1.50
110.0
77.5
67.5
3.00
90.0
60.0
Quantity
demanded
[‘000 dozen
per month]
62.5
5.0
46.0
77.5
100.0
115.0
122.5
105.0
44.0
0.0
-32.5
-52.5
-62.5
Excess Demand [quantity
demanded minus
quantity supplied]
[‘000 dozen per month]

56. Demand and supply schedules for
eggs and equilibrium price
 Equilibrium occurs where the quantity demanded and the
quantity supplied are equal.
 In the table the equilibrium price is £1.50.
 The equilibrium quantity bought and sold is 77.5
thousand dozen per month.
 For prices below the equilibrium, such as £0.50, quantity
demanded (110) exceeds quantity supplied (5).
 For prices above the equilibrium, such as £3.00, quantity
demanded (60) is less than quantity supplied (122.5).
 The data in this table are plotted in the following figure.

57. 20 40 60 80 100 120
1.00
2.00
3.00
140
Quantity of Eggs [thousand dozen per month]
2.50
1.50
3.50
0.50
Z
S
Y
X
W
V
U
D
U
V
W
X
Y
Z
Determination of the Equilibrium Price of Eggs

58. Determination of the equilibrium
price of eggs
Equilibrium price is where the demand and
supply curves intersect, point E in the
figure.
At all prices above equilibrium there is
excess supply and downward pressure on
price.
At all prices below equilibrium there is
excess demand and upward pressure on
price.

59. The ‘Laws’ of Demand and Supply
D
S
[ii]. The effects of shifts in the supply curve
Quantity
Quantity
[i]. The effects of shifts in the demand curve
S0
q0
E0
p0
p0
E0
q0
p1
p1
q1
q1
E1
E1
D1
D0
S1

60. The laws of demand and supply
(i) shifts in demand
 The original curves are D0 and S, which intersect to
produce equilibrium at E0.
 Price is p0, and quantity q0.
 An increase in demand shifts the demand curve to D1.
 Price rises to p1 and quantity rises to q1 taking the new
equilibrium to E1.
 A decrease in demand now shifts the demand curve to D0.
 Price falls to p0 and quantity falls to q0 taking the new
equilibrium to E0.
 Thus, an increase in demand raises both price and
quantity while a decrease in demand lowers both price and
quantity.
 Fall in demand brings down the equilibrium price and
quantity sold and purchased also declines.

61. The laws of demand and supply
(ii) shifts in supply
 The original demand and supply curves are D and S0,
which intersect to produce an equilibrium at E0, price p0
and quantity q0.
 An increase in supply shifts the supply curve to S1. Price
falls to p1 and quantity rises to q1, taking the new
equilibrium to E1.
 A decrease in supply shifts the supply curve back to S0.
Price rises to p0 and quantity falls to q0 taking the new
equilibrium to E0.
 Thus an increase in supply raises quantity but lowers
prices while a decrease in supply lowers quantity but
raises price.
Joint Demand:
 When the two commodities are complimentary to one
another, they maybe jointly demanded. A change in
demand for one commodity will bring about a similar
change in demand for the other commodity.

62. Assumption concerning a competitive
market
 The law of demand: demand curves have
negative slopes throughout their entire
ranges
 The theory of supply: supply curves have
positive slopes throughout their entire
ranges
 The law of price adjustment: prices rise
when demand exceeds supply, and fall if
supply exceeds demand.

63. Implications
 There is no more than one price at which
quantity demanded equals quantity
supplied; equilibrium is unique.
 Only at the equilibrium price will the
market price remain constant.
 When the demand or supply curve shifts,
the equilibrium price and quantity will
change.
 The market is stable in the sense that
forces exist to move the price towards its
market clearing level.