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CHAPTER 2

DEMAND AND SUPPLY

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Demand (DD) & Supply (SS)

Concept of DD & SS based on workings of a freemkt economy.

In a mkt economy, resources are allocated via the

price mechanism (invisible hand) where dd & sschanges bring abt price changes to bring abt mktequilibrium.

Consumers have freedom to decide & choosewhat gds to buy to maximise satisfaction basedon their ability & willingness to pay.

Producers have freedom to engage in any prod tomaximise profits.

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THEORYOF DEMAND

Demand behavior of buyers in the mkt.

DD defined as total amount of g&s bought

(Qd) by consumers at various price (P) levelsat given time period.

Effective dd dd measured by willingess to

buy & ability to pay by consumers

DD shows the relationship bet. P & Qd = DD

curve.

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LAWOF DEMAND

Law of DD states that ceterius paribus (cp) i.e.

other things remain constant/unchanged, the

P, Qd; P, Qd.

P & Qd shows inverse/negative relationship.

DD curve is downward sloping from left to

right.

Draw dd curve to show Law of DD

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LAWOF DEMAND

Why downward sloping? 2 effects to explain that

a lower price, consumers demand buy more.

1. Substitution effect (SE) when Px relative to other

gds, consumers switch or substitute with cheaper

gds (Gd X), Qdx.

2. Law of Diminishing Marginal Utility (LDMU) as

more of Gd X is consumed, less & less satisfaction is

derived, consumers Qdx, thus to get consumers to

buy more of Gd X, Px must be .

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DETERMINANTS OF DEMAND

1. Movement along dd curve caused by changes

in the price of good X. C.p., when

Px, Qdx = movt upwards along dd curve =contraction of dd (pt A to B)

Px, Qdx = movt downwards along dd curve =

extension of dd (pt A to C)

Draw dd curve movt.

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DETERMINANTS OF DEMAND

2. DDx is a function of Px and other factors (c.p.

factors)

Dx = (Px, Pr, Ps, Y, T, anticipated P & Y) Change in c.p. factors bring abt shifts in DD

curve

Increase in DD = shift in dd curve to the right Decrease in DD = shift in dd curve to the left

Draw shift in dd curve

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Changes in DD = shifts in DD

Dx = (Px, Pc, Ps, Y, T, anticipated P & Y)

1. Change in price of related gds:

Pc = change in price of complementary gds Ps = change in price of substitutes

2. Change in income level

3. Change in taste & preferences4. Anticipated change in future price and

income

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Changes in DD = shifts in DD

1. Change in price of related gds:

a. Ps = change in price of substitutes

Substitutes are gds that can replace thefunctions of another gd e.g. butter & margarine

(close substitutes) or meat & fish

Pbutter Dmargarine (consumers subsitute

butter with margarine increase in DD) Pbeef Dchicken (decrease in DD)

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Changes in DD = shifts in DD

b. Pc = change in price of complementary gds

Complementary gds are gds that are demanded

together or jointly used or joint demand e.g. car

with petrol, pen with ink, tea with sugar

Ppetrol D car (increase in DD)

Psugar D coffee (decrease in DD)

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Changes in DD = shifts in DD

2. Change in income (Y) level

c.p. generally as Y, DD (increase in DD)

Y DD depends on type of gds: Y, DD = Normal gds

Y, DD = inferior gds

Y

, no DD = common gds Y, largeDD = luxury gds

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Changes in DD = shifts in DD

3. Change in taste & preferences

Consumer taste & preferences change over time

E

.g. change in preference towards organic food increase in DD

E.g. change in preference influenced by

advertisement increase in DD for beauty

products

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Changes in DD = shifts in DD

4. Anticipated change in future price and income

Consumers anticipate future changes in price

and income E.g. consumers predict price of sugar to

increase in the future such as during festive

season, bring forward current purchases

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Individual DD and Market DD

Mkt DD = sum or aggregate of dd of individual

buyers in the mkt

E.g. mkt dd for cars = sum of each car sold &bought (sum of Qd) at different price levels in

the mkt

Draw mkt dd curve

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THEORYOF SUPPLY

Behavior of producers/sellers in the market

Definition of Supply (SS):

Various quantities of goods sold/offered for sale at

various price levels at a given time period C.p. supply shows the relationship between quantity

supplied (Qs) and price (P)

Law of Supply:

P, Qs & vice versa

Direct/positive relationship between P & Qs

Draw SS curve

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DETERMINANTS OF SS

Why P leads toQs ? Or Why ss curve is

upward sloping?

3 reasons:

Increase price means higher revenue, leads to higher

profits, firms are motivated to increase prod - Qs

P means profits long run new firms are attracted

to enter the industry to compete leads to Qs

Increase prod leads to increase cost of prod due to Law

of Diminishing Returns

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Determinants of SS

Change in Qs caused by change in price of gd

itself, c.p. = movement along ss curve

P, Qs = extension of ss (pt A to B)

P, Qs = contraction of ss (pt A to C)

Draw movt of SS curve

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Determinants of SS

Change in Supply caused by change in c.p. factors =shift of ss curve to the right or left

C.p. factors e.g. change in cost of prod, priceprediction, number of producers & change in price of

related goods e.g. Cost of prod, ss & vice versa

number of producers, SS vice versa. cost of prod, SS = decrease in ss (ss curve shifts to the

left) number of producers, SS = increase in ss (ss curve

shifts to the right)

Draw shifts in ss curve

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Determinants of SS

SSx = {Priceof Gd X itself, cost of prod (C), Price of relatedgds (Pr), number of producers (Pd), anticipated pricechanges (Pa)}

Change in cost of prod (cop) due to:

increase in cost of resources e.g. in wage cost, increase inrental or increase in cost of raw materials

Change in technology e.g. technological progress lowerscop

Taxation by govt increase cop

Subsidies lower copLeads to changes in ss shift of ss to the right/left

Draw diagrams

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Determinants of SS

Change in price of related goods:

1. Substitutes in ss prod of chillies vs prod ofgreen vegetables

E.g. price of chillies producers prod green vegeswitch to prod of chillies

2. Complements in ss (joint ss) two gds jointlyprod e.g. petroleum & natural gas

E.g. price of oil producers prod pump outmore oil and prod of crude oil & at the sametime, more natural gas is prod because jointly ss

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Determinants of SS

3. Anticipated price changes:

e.g. if producers predict P of gds in the future,

increase prod & vice versa

4. Number of producers in the mkt

e.g. new entrants into the mkt will increase ss &

vice versa

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Individual SS & Mkt SS

Mkt ss = sum of Qs by all sellers at various

price levels in the mkt

Draw derivation of mkt ss