Demand and Supply

Demand

Exam definition: Demand is the quantity demanded of a good. It is the amount of a good a

person (consumer) is willing and able to buy at a given price. Definition in general terms: It

basically shows the relationship between prices and the number of people that are willing to buy

a product/service at that given price.

BRAINSTORM

So let’s think about customers and even yourself… If the price of coffee increases people would

certainly demand less…WHY? Because of 2 reasons:

(1) People will feel poorer. They will not be able to afford to buy so much of the good with their

money. The purchasing power of their income (their real income) has fallen. In other words

people cannot buy as much as before. This is called the income effect of a price rise.

(2) The good will now cost more than alternative or ‘substitute’ goods, for example people

would switch to lipton tea, herb tea, hot chocolate etc. This is called the substitution effect of a

price rise. General Terms: when the price increase quantity demanded falls because we

can’t buy as much as before because it too expensive (_______________ effect) and we will

find some other good to buy (____________________ effect).

Similarly, when the price of a good falls, the quantity demanded will rise. People can afford to

buy more (the income effect), and they will switch away from consuming alternative goods (the

substitution effect). Therefore, returning to our example of the increase in the price of coffee, we

will not be able to afford to buy as much as before, and we will probably drink more tea,cocoa,

fruit juices or even water instead.

So now, you know that when price increase, quantity demanded decreases and when price

decrease, quantity demanded increases. NOW THIS IS CALLED THE LAW OF

DEMAND….TADAHHHHH. Remember it!!!

Key terms to remember:

Quantity demanded The amount of a good that a consumer is willing and able to buy at a given price over a given period of time.

Law of Demand: Price increase, quantity demanded decrease: Price decrease quantity demanded increase while other things being equal or other factors don’t change (ceterus paribus)

Substitution Effect: Income Effect:

Now we can draw a demand curve…we have two axis (horizontal axis is the quantity demanded

and the vertical axis is the price) and we plot the data. Observe that the graph is downward

sloping meaning it has a negative slope. WHY? Because when price fall, quantity demanded

goes in other direction (upwards) and vice versa (CAN YOU TELL?) *wink*. We can have an

individual demand schedule or market demand schedule.

OTHER DETERMINANTS OF DEMAND

We realise that the price of a product can cause people to buy more or buy less. Can you think of

any another reasons that will cause people to buy more or buy less? Let’s Brainstorm…

Taste/preference: If people really like it they will buy it. Advertising, fashion, health,

experiences can affect taste.

Income: As people’s incomes rise, their demand for most goods will rise.

Expectations of future price: If people think that prices are going to rise in the future, they are

likely to buy more now before the price does go up.

The number and price of substitute goods: The higher the price of substitute goods,

the higher will be the demand for this good as people switch from the substitutes. For example,

the demand for coffee will depend on the price of tea. If tea goes up in price, the demand for

coffee will rise.

The number and price of complementary goods: Complementary goods are those

that are consumed together: cars and petrol, shoes and polish, fish and chips. The higher the price

of complementary goods, the fewer of them will be bought and hence the less will be the demand

for the good under consideration. For example, the demand for batteries will depend on the price

of handheld games. If the price of handheld games comes down, so that more are bought, the

demand for batteries will rise.

DIFFERENCE BETWEEN CHANGE IN DEMAND AND CHANGE IN QUANTITY

DEMANDED

In economics there are two terms we need to remember when dealing with demand. These are a

change in demand and a change in quantity demanded.

Change in demand is the term used for a shift in the demand curve. It occurs when a

determinant of demand other than price changes. When we say determinants we mean those

determinants above. In other words, it means others factors that cause demand to change other

than price, hence price remains constant.

Change in the quantity demanded is the term used for a movement along the

demand curve to a new point (up and down the current demand curve). It occurs when ONLY

price changes.

DON’T GET MIX UP WITH THESE TERMS.

I will show you a graphical representation of

change in demand and change in quantity

demanded.

Change in demand – see the price remains at $4. A new demand curve was drawn to show an

increase in demand and you would see that demand increase from 20-40 at $4 may be due to

taste, income or some other factor. So note, an increase in demand will be shown by drawing a

new demand curve to the right and a decrease will be noted be a shift to the left.

Change in quantity demanded – You will see this term is illustrated by movement up and

down the current demand curve.

SUPPLY

Now if you can understand demand you can understand supply. WHY? Because…

Demand refers to buyers

Supply refers to Sellers.

Supply curve is a graph showing the relationship between the price of a good and the

quantity of the good supplied over a given period of time.

Law of Supply

When price increase producers produce more, when price falls producers produce less. Meaning

the supply curve is positive sloped or upwards sloping. WHY?

1. The higher the price of the good, the more profitable it becomes to produce. Firms will thus

be encouraged to produce more of it by switching from producing less profitable goods.

2. Given time, if the price of a good remains high new producers will be encouraged to set up in

production. Total market supply thus rises.

3. As firms produce more and more it comes to a point that it becomes really expensive to

produce so the price would increase. Hence when you supply more it is possible that price

would increase.

Picture of a Supply Curve

Other determinants of Supply – These factors will cause the whole supply curve to change.

(Change in supply)

Technology: Improvement in technology enables sellers or producers to supply the good or service easier and quicker. Then the market supply curve increases.

Costs of factors of production: If labor, capital or materials cost of production decreases the supply curve increases and shifts to the right because of increased profitability.

Prices of related goods: If other jobs or business offer better prices than web-design, sellers of web-design will offer less web design services. The entire supply curve for web-design services decreases.

Taxes: An increase in taxes decreases the supply curve which shifts to the left. Expectation of a price change: The supply curve may increase or decrease if the price is

expected to increase in the future. It depends on storability of the good. Storable: (e.g., Oil) an expected increase in price of oil decreases the supply curve

because oil is storable and extraction can be reduced. Non-Storable: (e.g., Milk) an expected increase in price, increases the supply

curve. Here the producers can increase output easily and they want to maintain market share. This is the standard case.

Number of individual suppliers: The market supply is also an aggregate supply in the sense that it is the sum of individual quantities supplied at each price during a given time period, Ceteris Paribus. If this number increases then the aggregate will increase, which means an increase in the aggregate supply.

Change in Supply and Change in quantity supply….its the same as demand but from the

seller side. See below

Change in Supply

Change in Quantity Supplied

EQUILIBRIUM – Price and Output Determination

We can now combine our analysis of demand and supply. This will show how the actual price of

a product and the actual quantity bought and sold are determined in a free and competitive

market.

The equilibrium price and quantity is the only price and quantity at which producers’ and

consumers’ wishes are mutually reconciled: where the producers’ plans to supply exactly match

the consumers’ plans to buy. This is known as the market it clear. A market clears when supply

matches demand, leaving no shortage or surplus. Market equilibrium occurs at the intersection of

market supply and demand (QS = QD). Let me show you.

If QS > QD , there is a market surplus

If QS < QD , there is a market shortage

If QS = QD , there is a market equilibrium

Changes in Equilibrium (within Supply/Demand framework):

If there is a change in one of the “other determinants” of supply or demand, there will be a

change in market equilibrium.

Suppose there is an increase in taste, or income, or prices of substitutes or expected price. Then

the market demand will shift up, leading to a new intersection or equilibrium with the given

supply.

Fig: Changes in Equilibrium

Both equilibrium quantity and price increase.

Exercise

Graphing Tutorial

Drawing and interpreting demand and supply diagrams below

Price Quantity Demanded Quantity Supplied($ per broom) (per month) (per month)

6 10 705 20 604 30 503 40 402 50 301 60 20

True-False Questions — If a statement is false, explain why.

1. The law of demand states that as price decreases, quantity demanded decreases. (T/F)

2. A demand schedule shows people's willingness to buy specific quantities of a good at different prices. (T/F)

3. The market demand for a good is the sum of individual demands for the good. (T/F)

4. An increase in the number of suppliers in a market will cause the supply curve to shift to the left. (T/F)

5. An increase in the price of a good will cause the supply curve to shift to the right. (T/F)

6. An increase in supply causes an excess demand at the original price, and competition between sellers leads to a lower equilibrium price. (T/F)

7. An increase in demand causes an excess demand at the original price, and competition between demanders leads to a higher equilibrium price. (T/F)

8. The expectation that the price of a good will increase can cause the demand for that good to increase. (T/F)

9. If two goods are complements, then one can replace the other in consumption.. (T/F)

10. If income increases and the demand for a good increases, then it is a normal good. (T/F)

11. A change in demand refers to a movement along a demand curve due to a price change, but a change in quantity demanded refers to a shift in the entire demand curve. (T/F)

a. Plot the demand and supply curve using the above data.

b. What is the equilibrium price and equilibrium quantity?

c. If the price of bicycles is 100euros, is there a shortage or surplus? How many units of a shortage or surplus are there? Will this cause the price of bicycles to rise or fall?

d. If the price of bicycles were €400, is there a surplus or a shortage? How many units of surplus or shortage are there? Will this cause the price to rise or fall?

e. Suppose that the bicycle maker's labour union bargains for an increase in its wages. Further, suppose this event raises the cost of production, makes bicycle manufacturing less profitable, and reduces the quantity supplied of bicycles by 20 units at each price of bicycles. Plot the new supply curve and the original supply and demand curves. What is the new equilibrium price and quantity in the market for bicycles?

2. Each of the events listed below has an impact on the market for bicycles. For each event, which curve is affected (supply or demand for bicycles), what direction is it shifted, and what is the resulting impact on equilibrium price and quantity of bicycles?

a. The price of cars increases.b. The price of steel used to make bicycle frames increases.c. An environmental movement shifts tastes toward bicyclingd. Consumers expect the price of bicycles to fall in the future.e. A technological advance in the manufacture of bicycles occursf. The price of bicycle helmets and shoes is reduced.

3. Draw an equilibrium point and illustrate an increase in demand, what will happen to the new equilibrium price and quantity?

4. Draw an equilibrium point and illustrate an increase in supply, what will happen to the new equilibrium point?

5. Draw an equilibrium point and illustrate a decrease in demand, what will happen to the new equilibrium point?

6. Draw an equilibrium point and illustrate a decrease in supply, what will happen to the new equilibrium point?

7. What will cause demand to increase? What will cause supply to decrease?

8. What will cause the quantity demanded and quantity supplied to increase?