Ch03 - Demand and Supply -Part 1

8/6/2019 Ch03 - Demand and Supply -Part 1

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Chapter 3. DEMAND, SUPPLY, ANDChapter 3. DEMAND, SUPPLY, AND

MARKET EQUILIBRIUMMARKET EQUILIBRIUM

Economics 11- UPLBEconomics 11- UPLBPrepared by T.B.Paris, Jr. 11/25/07Prepared by T.B.Paris, Jr. 11/25/07


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SignificanceSignificance

The tools ofThe tools ofdemanddemand andand supplysupply can be appliedcan be applied

to a range of important topics such as:to a range of important topics such as: evaluating how global weather conditions will affectevaluating how global weather conditions will affect

agricultural production and market prices ofagricultural production and market prices ofagricultural commodities;agricultural commodities;

assessing the impact of government rent control onassessing the impact of government rent control on

dormitory space;dormitory space;

understanding how taxes, subsidies, and otherunderstanding how taxes, subsidies, and othergovernment policies affect both consumers andgovernment policies affect both consumers and

producers.producers.


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The Concept of DEMANDThe Concept of DEMAND

DDemand -emand - refers to the various quantities of arefers to the various quantities of a

good or service that consumers are willing togood or service that consumers are willing to

purchase at alternative prices,purchase at alternative prices, ceteris paribusceteris paribus..

Conveys both the elements of desire for theConveys both the elements of desire for the

commodity and capacity to pay (must be willing andcommodity and capacity to pay (must be willing and

able).able).

Emphasizes the relationship between quantity boughtEmphasizes the relationship between quantity boughtand its price, although there may be other factors thatand its price, although there may be other factors that

determine how much a consumer wants to purchase.determine how much a consumer wants to purchase.


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The Law of DemandThe Law of Demand

Asserts that the quantity demanded of aAsserts that the quantity demanded of a

good or service is negatively or inverselygood or service is negatively or inversely

related to its own price.related to its own price. When the price increases, less of the good orWhen the price increases, less of the good or

service will be boughtservice will be bought

When the price decreases, more of theWhen the price decreases, more of the

commodity will be purchased.commodity will be purchased.

WHY SO?


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Two Reasons for the InverseTwo Reasons for the Inverse

RelationshipRelationship

Substitution effectSubstitution effect When price of a good decreases, theWhen price of a good decreases, the

consumerconsumersubstitutessubstitutes the lower priced goodthe lower priced good

for the more expensive ones.for the more expensive ones.

Income effectIncome effect When price decreases, the consumersWhen price decreases, the consumers realreal

incomeincome (or purchasing power) increases, so(or purchasing power) increases, sohe tends to buy more.he tends to buy more.

P Q


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Two Reasons for the InverseTwo Reasons for the Inverse

RelationshipRelationship

1.1. Substitution effectSubstitution effect When price of a good increases, theWhen price of a good increases, the

consumer tends toconsumer tends to substitutesubstitute it with theit with the

lower priced goods.lower priced goods.

1.1. Income effectIncome effect When price increases, the consumersWhen price increases, the consumers

purchasing power (orpurchasing power (orreal incomereal income))decreases, so he tends to buy less.decreases, so he tends to buy less.

P Q


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3 Ways of presenting3 Ways of presenting

the demand relationshipthe demand relationship

The relationship betweenThe relationship between quantityquantity

purchasedpurchasedand alternativeand alternativepricesprices maymay

be presented in 3 ways:be presented in 3 ways:

Demand schedule in tabular form.Demand schedule in tabular form.

Demand curve in graphical formDemand curve in graphical form

Demand function in equation formDemand function in equation form


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Demand ScheduleDemand ScheduleTABLE 3.1. Demand Schedule for Denim Pants

Price of Denim Pants(in pesos)

Quantity Demanded per month(No. of pairs)

0 8

50 7

100 6

150 5

200 4

250 3

300 2

350 1

400 0


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Demand FunctionDemand Function

Quantity demandedQuantity demanded (Q)(Q) is expressed as ais expressed as a

mathematical function of pricemathematical function of price (P).(P). The demandThe demand

function may thus be written as:function may thus be written as:

Qd = a - bPQd = a - bP

wherewhere aa is the horizontal intercept of the equation or theis the horizontal intercept of the equation or the

quantity demanded when price is zeroquantity demanded when price is zero (-b)(-b) is the slope of the function.is the slope of the function.

Example:Example: Qd = 8 - 0.02PQd = 8 - 0.02P


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Factors Affecting DemandFactors Affecting Demand

1.1. Price of the commodityPrice of the commodity

2.2. Prices of related commoditiesPrices of related commodities

(substitutes and complements)(substitutes and complements)

3.3. Consumer incomesConsumer incomes

4.4. Tastes and preferencesTastes and preferences

5.5. Number of consumersNumber of consumers6.6. Price expectationsPrice expectations


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Change in Quantity Demanded vs.Change in Quantity Demanded vs.

Change in DemandChange in Demand

Change in quantity demandedChange in quantity demanded is a is a

movement along the same demand curve,movement along the same demand curve,

due solely to a change in price, i.e., alldue solely to a change in price, i.e., all

other factors held constant.other factors held constant.

Change in demandChange in demand is a shift in the entire is a shift in the entire

demand curve (either to the left or to thedemand curve (either to the left or to the

right) as a result of changes in otherright) as a result of changes in otherfactors affecting demand.factors affecting demand.


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Change in quantity demandedChange in quantity demanded

Price

Quantity

p1

p2

q1 q2

D

A decrease in price from p1

to p2 brings about an

increase in quantity

demanded from q1 to q2

It is shown as a movement

along the same demand

curve


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Change in demandChange in demand

Price

Quantity

p1

q1

An increase in demandmeans that at the same price

such as p1 more will be

brought, due to other factors

such as increased incomes,

increase in number of

consumers, etc.

It is shown as a shift in the

entire demand curve

D0

D1

q2

This is a

decrease in

demand

D2


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Change in DemandChange in Demand

P

Q

D

D

Increase in Demand

P

Q

DD

Decrease in Demand


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Other factors affecting demandOther factors affecting demand

Income:Income: as income changes, demand aas income changes, demand acommodity usually changescommodity usually changes Normal goodsNormal goods are goods whose demand are goods whose demand

respond positively to changes in income.respond positively to changes in income. Most goods are normal goods. As income increases,Most goods are normal goods. As income increases,

more of shoes, TVs, clothes, are bought.more of shoes, TVs, clothes, are bought.

Inferior goodsInferior goods are goods whose demand are goods whose demand

respond negatively to change in incomerespond negatively to change in income

Few but existent. Examples are firewood, tuyo,Few but existent. Examples are firewood, tuyo,adidas or chicken feet, bicycles, etc.adidas or chicken feet, bicycles, etc.


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Prices of related commodities in consumption:Prices of related commodities in consumption: SubstitutesSubstitutes are goods that are substitutable with each other are goods that are substitutable with each other

(not necessarily perfect).(not necessarily perfect). Examples are coffee and tea, Coke and Pepsi, beer and ginebra.Examples are coffee and tea, Coke and Pepsi, beer and ginebra.

When the price of a substitute increases, quantity bought of a goodWhen the price of a substitute increases, quantity bought of a goodincreases. --- Pincreases. --- P

yy QQ

xx (direct relationship)(direct relationship)

ComplementsComplements are goods that are used or consumed together. are goods that are used or consumed together. Examples are coffee and sugar, bread and butter, tennis rackets andExamples are coffee and sugar, bread and butter, tennis rackets and

tennis balls.tennis balls.

When the price of a complement increases, quantity bought of a goodWhen the price of a complement increases, quantity bought of a gooddecreases. --- Pdecreases. --- Pyy QQxx (inverse relationship)(inverse relationship)


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Consumer tastes and preferences:Consumer tastes and preferences: When consumer tastes shift towards a particularWhen consumer tastes shift towards a particular

good, greater amounts of a good are demanded atgood, greater amounts of a good are demanded at

each price.each price. Example: consumers preference for drinking mineral waterExample: consumers preference for drinking mineral waterincreases so its demand curve will shift rightward.increases so its demand curve will shift rightward.

If consumer preferences change away from a good,If consumer preferences change away from a good,

its demand will decrease; at every possible price, lessits demand will decrease; at every possible price, less

of the good is demanded than before.of the good is demanded than before. Example: the demand for VCDs and VHS tapes decreasesExample: the demand for VCDs and VHS tapes decreases

due to preference for DVDs.due to preference for DVDs.


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Consumer expectations:Consumer expectations: Expectations aboutExpectations about

future prices and income affect our currentfuture prices and income affect our current

demand for many goods and services.demand for many goods and services.

If we expect prices of dried fish to increase withIf we expect prices of dried fish to increase withcoming of the rainy season, we might stock up on thecoming of the rainy season, we might stock up on the

good to avoid the expected price increase. Thus,good to avoid the expected price increase. Thus,

current demand for dried fish might increasecurrent demand for dried fish might increase

those who expect to lose their jobs due to badthose who expect to lose their jobs due to badeconomic conditions, will reduce their demand for aeconomic conditions, will reduce their demand for a

variety of goods in the current period.variety of goods in the current period.


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Number of Consumers:Number of Consumers: affects the totalaffects the totaldemand for a good.demand for a good. Total demand is also known as market demand. It isTotal demand is also known as market demand. It is

the summation of the individual demand of allthe summation of the individual demand of all

consumersconsumers An increase in the number of consumers shiftsAn increase in the number of consumers shifts

the market demand curve to the rightthe market demand curve to the right Example: demand for housing and transportationExample: demand for housing and transportation

increases with an increase in population.increases with an increase in population.

On the other hand, less consumers will causeOn the other hand, less consumers will causethe market demand to decrease, resulting in athe market demand to decrease, resulting in ashift to the left of the entire demand curve.shift to the left of the entire demand curve.


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The Concept of SUPPLYThe Concept of SUPPLY

Supply -Supply - refers to the various quantities of arefers to the various quantities of a

good or service that producers are willing to sellgood or service that producers are willing to sell

at alternative prices,at alternative prices, ceteris paribusceteris paribus..

Obviously, firms are motivated to produce and sellObviously, firms are motivated to produce and sell

more at higher prices.more at higher prices.

Emphasizes the relationship between quantity sold ofEmphasizes the relationship between quantity sold ofa commodity and its price. However, there are othera commodity and its price. However, there are other

factors that determine how much a producer wouldfactors that determine how much a producer would

like to produce and sell.like to produce and sell.


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The Law of SupplyThe Law of Supply

States that the quantity sold of a good orStates that the quantity sold of a good or

service is positively or directly related to itsservice is positively or directly related to its

own price.own price. When the price increases, more of the goodWhen the price increases, more of the good

or service will be soldor service will be sold

When the price decreases, less of theWhen the price decreases, less of the

commodity will be purchased.commodity will be purchased.


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Supply ScheduleSupply ScheduleTABLE 3.2. Supply Schedule for Denim Pants


Quantity Supplied per month(No. of pairs)

0 0

50 1100 2

150 3

200 4

250 5300 6

350 7

400 8


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Supply CurveSupply Curve

Quantity

Price

(in

pesos)

P

Q0 2 4 6 8

100

200

300

400S

Figure 3.2. Supply Curve. The positive slope of the supply

curve depicts the direct relationship between price and

quantity supplied.


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Supply FunctionSupply Function

Quantity suppliedQuantity supplied (Qs)(Qs) is expressed as ais expressed as a

mathematical function of pricemathematical function of price (P).(P). The supplyThe supply

function may thus be written as:function may thus be written as:

Qs = c + dPQs = c + dP

wherewhere ccis the horizontal intercept of the equation or theis the horizontal intercept of the equation or the

quantity demanded when price is zeroquantity demanded when price is zero dd is the slope of the function.is the slope of the function.

Example:Example: Qs = 0 + 0.02PQs = 0 + 0.02P


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Change in Quantity Supplied vs.Change in Quantity Supplied vs.

Change in SupplyChange in Supply

Change in quantity suppliedChange in quantity supplied is a is a

movement along the same supply curve,movement along the same supply curve,

due solely to a change in price, i.e., alldue solely to a change in price, i.e., all

other factors held constant.other factors held constant.

Change in supplyChange in supply is a shift in the entire is a shift in the entire

supply curve (either to the left or to thesupply curve (either to the left or to the

right) as a result of changes in otherright) as a result of changes in otherfactors affecting supply.factors affecting supply.


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Change in quantity suppliedChange in quantity supplied

Price

Quantity

p1

p2

q1 q2

S

An increase in price from p1

to p2 results in an increase in

quantity supplied from q1 to

q2

It is shown as a movement

along the same supply curve


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Change in supplyChange in supply

Price

Quantity

p1

q1

An increase in supply

means that at the same

price such as p1 more will be

sold, due to other factors

such as improvement in

technology, increase in

number of producers, etc.

It is shown as a shift in the

entire supply curve

S0

S1

q2

This is a

decrease in

supply

S2


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Change in SupplyChange in Supply

P

Q

S

S

Increase in Supply

P

Q

DD

Decrease in Supply

S

S


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Other factors affecting supplyOther factors affecting supply

There are other factors aside from priceThere are other factors aside from price

that affect the supply schedule. Thesethat affect the supply schedule. These

areare

1.1. resource pricesresource prices

2.2. prices of related goods in productionprices of related goods in production

3.3. technologytechnology

4.4. expectationsexpectations

5.5. number of sellers.number of sellers.


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Resource prices:Resource prices: When prices of inputs to productionWhen prices of inputs to production

increase, the supply of the firm's productincrease, the supply of the firm's product

decreases.decreases. Decreases in resource prices, however,Decreases in resource prices, however,

translate to an increase in supply. The entiretranslate to an increase in supply. The entire

supply curve shifts to the right.supply curve shifts to the right.


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Prices of related goods in production:Prices of related goods in production: Resources can be employed to produce severalResources can be employed to produce several

alternative goods and services.alternative goods and services.

Examples from agriculture:Examples from agriculture: a piece of farmland can be use to grow rice, corn, ora piece of farmland can be use to grow rice, corn, or

sugarcane. An increase in price of sugarcane may result insugarcane. An increase in price of sugarcane may result in

decreased supply of rice and corn.decreased supply of rice and corn.

farmers can use their land and labor to producefarmers can use their land and labor to produce

ornamental flowers instead of vegetables. If vegetableornamental flowers instead of vegetables. If vegetableprices decrease, the supply of ornamental flowers mayprices decrease, the supply of ornamental flowers may

increase.increase.


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Technology:Technology: A change in productionA change in productiontechniques can lower or raise production coststechniques can lower or raise production costsand affect supply.and affect supply.

Improvements in technology shift the supplyImprovements in technology shift the supplycurve to the right.curve to the right. A cost-saving invention will enable firms to produceA cost-saving invention will enable firms to produce

and sell more goods than before at any given price.and sell more goods than before at any given price. New high yielding crop varieties will increaseNew high yielding crop varieties will increase

production on the same amount of land.production on the same amount of land.


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Producer expectations:Producer expectations: When producers expect the price of their product toWhen producers expect the price of their product to

increase in the future, they may hoard their outputincrease in the future, they may hoard their output

for later sale, thus reducing supply in the presentfor later sale, thus reducing supply in the presentperiod. Thus the supply curve shifts to the left.period. Thus the supply curve shifts to the left.

If firms expect that the price of their product will fallIf firms expect that the price of their product will fall

in the near future, supply may increase in thein the near future, supply may increase in the

current period as firms try to increase production ascurrent period as firms try to increase production as

well as to dispose of their inventory.well as to dispose of their inventory.


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Number of sellers:Number of sellers: As the number ofAs the number of

sellers increases, so will total supply.sellers increases, so will total supply. The market supply is the horizontal summation ofThe market supply is the horizontal summation of

the supply schedules of individual producers.the supply schedules of individual producers. As more firms enter the market, more will offered forAs more firms enter the market, more will offered for

sale at each possible price, thus shifting the supplysale at each possible price, thus shifting the supply

curve to the right.curve to the right.

Similarly, the supply curve shifts to the left whenSimilarly, the supply curve shifts to the left whenfirms exit the market.firms exit the market.


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Market EquilibriumMarket Equilibrium

Market equilibriumMarket equilibrium is that state in which theis that state in which the

quantity that firms want to supply equals thequantity that firms want to supply equals the

quantity that consumers want to buy.quantity that consumers want to buy.

The price that clears the market is called theThe price that clears the market is called theequilibrium priceequilibrium priceand the quantity (sold and bought)and the quantity (sold and bought)

is called theis called the equilibrium quantity.equilibrium quantity.

The market is said to be "at rest" since the equilibriumThe market is said to be "at rest" since the equilibrium

price and equilibrium quantity will stay at those levelsprice and equilibrium quantity will stay at those levelsuntil either demand or supply changes.until either demand or supply changes.


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Market EquilibriumMarket EquilibriumTABLE 3.3. Market for Denim Pants


Quantity Demanded permonth

(No. of pairs)

Quantity Suppliedper month

(No. of pairs)

0 8 0

50 7 1

100 6 2

150 5 3

200 4 4

250 3 5

300 2 6

350 1 7

400 0 8

Equilibrium Quantity=4

Equilibrium

Price=200


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Market EquilbriumMarket Equilbrium

At pricesAt prices aboveabovethe equilibrium price, quantity supplied isthe equilibrium price, quantity supplied isgreater than quantity demanded, resulting in a temporarygreater than quantity demanded, resulting in a temporarysurplussurplus.. In a surplus situation, producers will try to reduce price to enticeIn a surplus situation, producers will try to reduce price to entice

consumers to buy more denim pants. Actions by both producersconsumers to buy more denim pants. Actions by both producersand the public will wipe out the temporary surplusand the public will wipe out the temporary surplus

At pricesAt prices belowbelowthe equilibrium price, consumers desirethe equilibrium price, consumers desireto buy more denim pants than are available, creating ato buy more denim pants than are available, creating atemporarytemporary shortageshortage..

Consumers will try to outbid each other, thus pushing up theConsumers will try to outbid each other, thus pushing up theprice. As price rises, firms increase their production while someprice. As price rises, firms increase their production while someconsumers reduce their purchases.consumers reduce their purchases.


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Quantity

Price

(in

peso

s)

P

Q0 2 4 6 8

100

200

300

400S

Shortage

Surplus


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Algebraic solution: equate the demand andAlgebraic solution: equate the demand and

supply equations (Qd=Qs).supply equations (Qd=Qs).

Qd = 8 - 0.02PQd = 8 - 0.02P

QsQs == 0 + 0.02 P0 + 0.02 P Step by step solution:Step by step solution:

8 - 0.02P = 0 + 0.02 P8 - 0.02P = 0 + 0.02 P

0.04P = 80.04P = 8

P* = 8/0.04 = 200P* = 8/0.04 = 200

Qd = 8 0.02(200) = 8 4 = 4Qd = 8 0.02(200) = 8 4 = 4

P*P*=200 per unit,=200 per unit, Q* =Q* = 4 per month4 per month


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End Part 1End Part 1

Ch03 - Demand and Supply -Part 1

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