1464

1. Demand, Supply
& Elasticity
Mahmood-ur-Rahman
Lecturer, BIBM

2. Outline
• Market
• Market Demand
• Market Supply
• Market Equilibrium
• Price Adjustment Process
• Shifts in Market Demand (increase,
decrease)
• Shifts in Market Supply (increase, decrease)
• Interaction of Market Forces

3. Markets
• In a market economy, the price of a good is
determined through the interaction between
demand and supply side forces
• Market is some institutional framework in
which price of a product as well as the quantity
which is going to be transacted are determined
through the interaction between demand and
supply , coming up from the buyers and the
sellers of the product

4. Markets
• Constituents of a market-
product
consumers/buyers-creating the demand side
force in the market
suppliers/sellers/manufacturers-generating
the supply side force in the market

5. Demand
• The desire to purchase a product (either a
commodity or service) at a given market
price to satisfy a need/want, backed up by
purchasing capacity as well as the willingness
to spend for that specific purpose

6. Demand
• Constituents of demand-
desire
financial capability
willingness to spend for that purpose

7. Law of Demand
• an inverse relationship exists between the price of
a good and the quantity demanded in a given time
period, ceteris paribus
• the higher the price the lower the quantity
demanded & vice versa
• Reasons:
– substitution effect
– income effect

8. Demand Schedule-a tabular presentation of
Law of Demand

9. Demand Curve- a graphical presentation of Law of
Demand

10. Determinants of Demand
• price of the product
• tastes and preferences
• prices of related goods and services (complements
& substitutes)
• income
• wealth
• number of consumers/population
• expectations of future prices and income
• currency depreciation/appreciation
• special influences

11. Change in Quantity Demanded vs. Change
in Demand (Shift)
Change in quantity demanded Change in demand

12. Shift Factors

13. Prices of Related Goods
• substitute goods – an increase in the price of
one results in an increase in the demand for
the other.
• complementary goods – an increase in the
price of one results in a decrease in the
demand for the other.

14. Change in the price of a substitute good
• Price of coffee rises:

15. Change in the price of a complementary
good
• Price of DVDs rises:

16. Income and Demand: normal goods
• A good is a normal good if an increase in income
results in an increase in the demand for the good

17. Income and Demand: inferior goods
• A good is an inferior good if an increase in
income results in a reduction in the demand
for the good

18. Market Demand Curve
• Market demand is the horizontal summation
of individual consumer demand curves

19. Supply
• The desire to supply/sell a product
(either a commodity or service) at a
given market price
• The is something different than Stock
• Constituents of supply-
Desire to sell
stock at disposal
willingness to sell at ongoing market
price

20. Law of Supply
• A positive relationship exists between the
price of a good and the quantity supplied in a
given time period, ceteris paribus.
Reasons for Law of Supply
• The law of supply is the result of the law of
increasing cost.
• As the quantity of a good produced rises, the
marginal opportunity cost rises.

21. Reasons for Law of Supply
• Sellers will only produce and sell an
additional unit of a good if the price rises
above the marginal opportunity cost of
producing the additional unit.
• To produce more, the producers require
hiring more factors of production at higher
prices (usually), which raises cost of
production if the factor supply is fixed
• So, the suppliers will only supply at higher
prices (usually)

22. The Law of Supply
• The law of supply holds that other things
equal, as the price of a good rises, its
quantity supplied will rise, and vice
versa.
• Reasons
–they seek higher profits
–they must cover higher marginal costs
of production

23. Supply Schedule

24. Supply Curve
The supply curve has a positive slope, consistent
with the law of supply.

25. Determinants of Supply
• price of the product
• price of resources
• technology and productivity
• expectations of producers
• number of producers/suppliers
• prices of related goods and services
(complements, substitutes)
• goverment policy (tax, subsidy)
• special influences

26. Change/Shift in Supply vs. Change in
Quantity Supplied
Change in supply Change in quantity supplied

27. Price of Resources
• As the price of a resource rises, profitability
declines, leading to a reduction in the quantity
supplied at any price.

28. Technological Improvements
• Technological improvements (and any changes that
raise the productivity of labor) lower production
costs and increase profitability.

29. Expectations and Supply
• An increase in the expected future price of a
good or service results in a reduction in
current supply.
Prices of Other Goods
• Firms produce and sell more than one
commodity.
• Firms respond to the relative profitability of
the different items that they sell

30. Prices of Other Goods
• The supply decision for a particular
good is affected not only by the good’s
own price but also by the prices of
other goods and services the firm may
produce

31. International Effects
• firms import raw materials (and often the
final product) from foreign countries, the
cost of these imports varies with the
exchange rate.
• appreciation/depreciation of currency
affects the supply

32. Market Supply Curve
• Market supply is the horizontal summation of
individual producer supply curves

33. Equilibrium
• In economics, an equilibrium is a
situation in which:
–there is no inherent tendency to
change,
–quantity demanded equals quantity
supplied, and
–the market just clears

34. Equilibrium, Surplus & Deficits
Equilibrium occurs at a price of $3 and a quantity
of 30 units

35. Shortages and Surpluses
• a shortage occurs when quantity
demanded exceeds quantity supplied
–a shortage implies the market price is
too low
• a surplus occurs when quantity supplied
exceeds quantity demanded
–a surplus implies the market price is
too high

36. Price Ceilings & Floors
• a price ceiling is a legal maximum that can be
charged for a good
– results in a shortage of a product
– common examples include sugarcane
price, apartment rentals in public sector
• a price floor is a legal minimum that can be
charged for a good
– results in a surplus of a product
– common examples include soybeans, milk,
minimum wage

37. Price Ceiling
a price ceiling is set at tk. 2 resulting in a shortage
of 20 units

38. Price Floor
a price floor is set at tk. 4 resulting in a surplus of
20 units

39. Shift in the Demand Curve
• A change in any variable other than price that
influences quantity demanded produces a shift in
the demand curve or a change in demand
• Factors that shift the demand curve include:
– Change in consumer incomes
– Population change
– Consumer preferences
– Prices of related goods:
• Substitutes: goods consumed in place of one
another
• Complements: goods consumed jointly

40. Shift in the Demand Curve
This demand curve has shifted to the right.
Quantity demanded is now higher at any given
price.

41. Equilibrium After a Demand Shift
The shift in the demand curve moves the
market equilibrium from point A to point B,
resulting in a higher price and higher quantity.

42. Shift in the Supply Curve
• A change in any variable other than price
that influences quantity supplied produces a
shift in the supply curve or a change in
supply.
• Factors that shift the supply curve include:
– Change in input costs
– Increase in technology
– Change in size of the industry
© OnlineTexts.com p. 42

43. Shift in the Supply Curve
For an given rental price, quantity supplied
is now lower than before.

44. Equilibrium After a Supply Shift
The shift in the supply curve moves the market
equilibrium from point A to point B, resulting in
a higher price and lower quantity.

45. Elasticity
• The percentage (%) change in dependent
variable (demand, supply) due to one percent
(1%) change in independent variable (price,
income).

46. Price Elasticity of Demand
Demand
P The percentage change in
the quantity demanded
A given. . .
. . . a one percent change
B in the price.
Q

47. Ranges of Elasticity
• Perfectly Inelastic Consumers are “completely
unresponsive” to price changes.
• Perfectly Elastic Consumers are “extremely
responsive” to price changes.
• Unit Elastic Response is “equal to” change in price.

48. Elasticity of Demand
Perfectly Inelastic
P2
Even if price
increases a lot
P1 quantity demanded
stays the same.

49. Elasticity of Demand
A small increase
in price will cause
demand to drop off
P1 completely.
Perfectly Elastic

50. Computing Elasticity Coefficient
Percentage Change in
Price Elasticity Quantity Demanded
=
of Demand Percentage Change
in Price
• Computed as the percentage change in
the quantity demanded divided by the
percentage change in price.

51. Computing Elasticity Coefficient
Demand for
Ice Cream E D
=
2.20
(8 - 10) / 10
2.00 ($2.20 - $2.00) / $2.00
8 10

52. Elasticity and Total Revenue
E > 1 then
D
P Q and TR

53. Elasticity and Total Revenue
E < 1 then
D
P Q and TR

54. Income Elasticity of Demand
• The percentage change in the quantity
demanded given a one percent change in
income.

55. Computing Income Elasticity
Percentage Change in
Income Elasticity Demand
=
of Demand Percentage Change
in Income
• Computed as the percentage change in demand
divided by the percentage change in Income.

56. Income Elasticity... Types
YD > 0 Normal Goods
YD < 0 Inferior Goods
YD = 0 Income-neutral Goods

57. Cross-Price Elasticity of Demand
• Cross-price elasticity of demand measures
percentage change in quantity demanded of
one good caused by a 1% change in price of
another good
• While all other influences on demand remain
unchanged
• While the sign of the cross-price elasticity
helps us distinguish substitutes (positive) and
complements (negative) among related goods
57

58. Cross-Price Elasticity of Demand
 Its size tells us how closely the two goods are
related
 A large absolute value for EXZ suggests that the
two goods are close substitutes or
complements
 While a small value suggests a weaker
relationship
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59. Price Elasticity of Supply
Price
• The percentage change
in quantity supplied B
resulting from a one (1)
percent change in price. A
Quantity

60. Determinants of
Elasticity of Supply
• Flexibility or ability of sellers to change the
amount of the good they produce.
– land vs manufactured goods
– more elastic in the long run

61. Computing Elasticity Coefficient
Percentage Change in
Elasticity Quantity Supplied
=
of Supply Percentage Change
in Price
• Computed as the percentage change in the
quantity supplied divided by the percentage
change in price.