1. Chapter 3
Demand and Supply Analysis

2. Demand




Need to satisfy human wants
Willingness to buy a particular commodity
backed by purchasing power.
Amount of the commodity which will consumers
are willing to buy per unit of time, at that price,
factors other than price remaining constant.
3 things necessary for demand:



Time
Price of the commodity
Amount (or quantity) of the commodity consumers are
willing to purchase

3. Basics




Want: having a strong desire for something
Need: lack of means of subsistence
Desire: an aspiration to acquire something
Demand: effective desire, as it is backed by
willingness to pay and ability to pay

4. Determinants of Demand

Price of the product
 Negative effect on demand

Income of the consumer
 Normal goods: demand increases with increase in
consumer’s income
 Inferior goods: demand falls as income rises
Tastes and preferences
Expectation of future price changes
Population




Advertising

5. More…

Price of related goods
 Substitutes



Goods that can be used as replacement of one another
and satisfy a similar need
If the price of a commodity increases, quantity
demanded of its substitute rises.
Complements


Goods that are consumed together.
If the price of a commodity increases, quantity
demanded of its complement falls.

6. Demand Function






Functional form
Interdependence between individual demand and
its determinants
Dx = f(Px, T, Py, Y, Pe, N, A)
Px, T, Py, Y, Pe: independent variables, Dx:
dependent variable
If all the variables except the own price of the
commodity remain unchanged (ceteris paribus),
demand function: Dx = f(Px)
Ceteris paribus is a Latin phrase, literally
translated in English as “with other things (being)
the same” or “all other things being equal”.

7. Demand Schedule and Individual Demand
Curve
Demand Schedule
a
b
c
d
e
f
Price [Rs per unit]
Quantity demanded of X
[kg. per month]
0.50
1.00
1.50
2.00
2.50
3.00
7.0
5.0
3.5
2.5
1.5
1.0
3.00
f
e
2.50
d
Price of X
Point
Demand Curve
2.00
c
1.50
b
1.00
a
0.50
1
2
3
4
5
6
7
Quantity of X

8. Market Demand and Market Demand Curve


Market: interaction between sellers and buyers of a
good (or service) at a mutually agreed upon price.
Market demand



Aggregate of individual demands for a commodity at a
particular price per unit of time.
Sum total of the quantities of a commodity that all buyers in
the market are willing to buy at a given price and at a
particular point of time (ceteris paribus)
Market demand curve: horizontal summation of
individual demand curves

9. Price of X
Individual and Market Demand Curves
3.00
2.00
1.00
2
4
6
8
Quantity of X
Consumer I
Price of X
3.00
2.00
Price of X
1.00
3.00
2
2.00
4
6
8
10
12
14
Quantity of X
1.00
Total Demand: Consumer I+II
2
Consumer II
4
6
8
Quantity of X

10. Market Demand Schedule
Reference Letter
Price [Rs per kg]
Quantity demanded
[kg per month]
U
0.50
110.0
V
1.00
90.0
W
1.50
77.5
X
2.00
67.5
Y
2.50
62.5
Z
3.00
60.0

11. Market Demand Curve
3.50
Price of X [Rs per kg]
D
Z
3.00
Y
2.50
X
2.00
W
1.50
V
1.00
U
0.50
20
40
60
80
100
120
140
Quantity of X

12. Law of Demand


Other things remaining constant, when the price of
a commodity rises, the demand for that commodity
falls or when the price of a commodity falls, the
demand for that commodity rises.
Reasons:



Substitution Effect
Income Effect
Law of Diminishing Marginal Utility

13. Exceptions to the Law of Demand

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Giffen Goods
Snob appeal
Demonstration effect
Consumer Bias
Fashion
Future expectation of prices
Insignificant portion of income spent
Goods without any substitutes

14. Change in Quantity Demanded
Price
D0
P0
P1
0
Q0
Q1
Quantity

15. Change in Demand
D1
Price
D2
D0
0
Quantity

16. •
Shift in demand curve from D0 to D1
•
•
Increase in demand caused by:
•
•
•
•
•
•
more is demanded at each price.
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
Shift in demand curve from from D0 to D2
•
less is demanded at each price.

17. Market Supply Schedule
Reference Letter
Price [Rs per kg]
Quantity demanded
[kg per month]
u
0.50
5.0
v
1.00
46.0
w
1.50
77.5
x
2.00
100.0
y
2.50
115.0
z
3.00
122.5

18. Supply Curve For X
3.50
S
Z
Price of X [Rs per kg]
3.00
Y
2.50
X
2.00
W
1.50
V
1.00
U
0.50
20
40
60
80
100
120
140
Quantity of X

19. Changes in Quantity Supplied
Price
S0
Quantity

20. Shifts in the Supply Curve
S2
S0
Price
S1
Quantity

21. •
Shift in the supply curve from S0 to S1
•
•
Increase in supply caused by:
•
•
•
Improvements in the technology of producing the
commodity
A fall in the price of inputs that are important in
producing the commodity
Shift in the supply curve from S0 to S2
•
•
more is supplied at each price.
less is supplied at each price.
Decrease in supply 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)

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

23. •
•
•
•
•
Equilibrium occurs where the quantity demanded and
the quantity supplied are equal.
In the table the equilibrium price is Rs.1.50
The equilibrium quantity bought and sold is 77.5 kg
per month.
For prices below the equilibrium, such as Re. 0.50,
quantity demanded (110) exceeds quantity supplied
(5)
For prices above the equilibrium, such as Rs 3.00,
quantity demanded (60) is less than quantity supplied
(122.5)

24. Determination of Equilibrium Price of X
3.50
D
Z
Price of X [Rs per kg]
3.00
Y
2.50
X
2.00
1.50
W
V
1.00
U
0.50
20
40
60
80
100
120
Quantity of X
140

25. Determination of the Equilibrium Price of X
3.50
S
Price of X [Rs per kg]
D
Z
3.00
Z
Y
Y
2.50
X
2.00
1.50
W
X
W
V
E
V
1.00
U
U
0.50
20
40
60
80
100
120
Quantity of X
140

26. Equilibrium Price of X
•
•
•
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

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

28. 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

29. 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.

30. Changes in Both Demand and Supply
S0
D1
S1
Price
D0
p0
E0
E1
p1
q0
q1
Quantity

31. Let Us Have a RECAP!!

32. 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.
 The demand curve for a normal good shifts to the right when the
price of a substitute rises, when the price of a complement falls,
when total income rises, when the distribution of income
changes in favour of those with large demands for the product,
and when tastes change in favour of the product.
 It shifts to the left with the opposite changes.

33. 
A movement along a demand curve indicates a change in
quantity demanded in response to a change in the product’s
own price; a shift in a demand curve indicates a change in the
quantity demanded at each price in response to a change in
one of the conditions held constant along a demand curve.
Supply
 The supply curve for a product shows the relationship between
its price and the quantity that producers wish to produce and
offer for sale per period of time.
 It is drawn on the assumption that all other forces that
influence quantity supplied remain constant, and its positive
slope indicates that the higher price, the more producers wish
to sell.

34. Determination of Price
 At the equilibrium price the quantity demanded equals the
quantity supplied.
 Graphically, equilibrium occurs where the demand and supply
curves intersect.
 At any price below equilibrium there will be excess demand and
price will tend to rise; at any price above equilibrium there will be
excess supply and price will tend to fall.
 A rise in demand raises both equilibrium price and quantity; a fall
in demand lowers both.
 A rise in supply raises equilibrium quantity but lowers equilibrium
price; a fall in supply lowers equilibrium quantity but raises
equilibrium price.
 These are those so-called ‘laws’ of supply and demand.