The Market Forces of Supply and Demand

The Market Forces of Supply and Demand

Supply and demand are the two words that economists use most often.

Supply and demand are the forces that make market economies work.

Modern microeconomics is about supply, demand, and market equilibrium.

Markets

A market is a group of buyers and sellers of a particular good or service.

The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.

Markets Buyers determine demand.

Sellers determine supply.

Demand

Quantity demanded is the amount

of a good that buyers are willing and able

to purchase.

Law of Demand

The law of demand states that, ceteris paribus, there is an

inverse relationship between price and quantity demanded.

Demand Schedule

The demand schedule is a table that shows the relationship

between the price of the good and the quantity demanded.

Demand Schedule

Price Quantity 0.00 12 0.50 10 1.00 8 1.50 6 2.00 4 2.50 2 3.00 0

Demand Curve

The demand curve is the downward-sloping line relating price to quantity

demanded.

Demand Curve

Rs.32.502.001.501.000.50

21 3 4 5 6 7 8 9 10

12

11

Price

Quantity of Ice-Creams

0

Price Quantity 0.00 12 0.50 10 1.00 8 1.50 6 2.00 4 2.50 2 3.00 0

Ceteris ParibusCeteris paribus is a Latin phrase that

means all variables other than the ones being studied are assumed to be

constant. Literally, ceteris paribus means “other things being equal.”

The demand curve slopes downward because, ceteris paribus, lower prices

imply a greater quantity demanded!

Ceteris Paribus Ceteris Paribus means “other things being

equal”. What other things? Consumer income. Consumer preferences. Fashion. Population. Price of related goods. Government policies. Weather conditions.

Market Demand

Market demand refers to the sum of all individual demands for a particular good or service.

Determinants of Demand Market price : A larger quantity is demanded at a

lower price & vice versa. Tastes, habits and preferences : Demand depends

upon a persons tastes, habits and preferences. Demand for ice – creams, bhel – puri etc depends upon an individual’s tastes. Tea, betal leafs, tobacco etc is a matter of habits. People with different tastes & habits have different preferences. A strict veg. will have no demand for fish and a person who likes non – veg will purchase fish even at a high price.

Determinants of Demand

Expectations : If a consumer expects that the prices of a product are going to rise in future, the demand may increase and vice – versa.

Consumer income : A rich consumer demands more goods than a poor consumer.

Determinants of Demand Prices of related goods ( substitutes and

complementary ) : When a desire or a want can be satisfied by alternative similar goods, they are called as substitutes. Eg. Peas and beans, groundnut oil and mustard oil, tea or coffee, jowar or bajra etc.

Demand for a commodity depends on the relative prices of the substitutes. There will be more demand for a commodity if it’s substitutes are highly priced.

Determinants of Demand Complementary products : When, in order to

satisfy a given want, two or more goods are needed in combination, these goods are referred to as complementary goods. Eg. car and petrol, pen and ink, shoes and socks, guns and bullets.

Complementary goods are always in Joint Demand. Thus, when the price of a complementary product will fall, the demand for its complementary product will increase.

Change in Quantity Demanded versus Change in Demand

Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of

the product.

Changes in Quantity Demanded

0

D1

Price of Cigarettes

Number of Cigarettes

A tax that raises the price of cigarettes

results in a movement along the

demand curve.

A

C

20

2.00

Rs.4.00

12

Change in Quantity Demanded versus Change in Demand

Change in Demand A shift in the demand curve, either to

the left or right. Caused by a change in a

determinant other than the price.

Changes in Demand

0

D1

Price

Quantity of Ice-Cream Cones

D3

D2

Increase in demand

Decrease in demand

Change in Quantity Demanded versus Change in Demand

Variables that Affect Quantity

DemandedA Change in

This Variable . . .Price Represents a movement

along the demand curveIncome Shifts the demand curve

Prices of relatedgoods

Shifts the demand curve

Tastes Shifts the demand curveExpectations Shifts the demand curveNumber ofbuyers

Shifts the demand curve

Consumer IncomeNormal Good

Rs.3.00

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12

11

Price

Quantity of Ice-Cream Cones

0

Increasein demand

An increase

in income...

D1

D2

Consumer IncomeInferior Good

Rs.3.00

2.502.001.501.000.50

21 3 4 5 6 7 8 9 10

12

11

Price

Quantity of Ice-Cream Cones

0

Decreasein demand

An increase

in income...

D1D2

Exceptions to the law of Demand Law of Demand is a universal

phenomenon. Very rarely, it is so observed that with a fall in price, demand also falls and a increase in price increases demand.

The demand curve in such cases is upward sloping.

Exceptions to the law of Demand

A few such exceptions are seen in case of: Giffen Goods : In cases of some inferior goods,

as observed by Scottish economist Robert Giffen, when price decreases, there is a decrease in the demand for these products.

E.g. This was observed by Giffen in Italy when the poor & labour class people purchased less of potatoes even after the decrease in their price.

With whatever savings they did by purchasing less of potatoes, they purchased more of meat which was a preferred good.

Exceptions to the law of Demand

Snob Appeal : Goods that are used as “Status Symbol” e.g.. Rolls Royce cars, Johnnie Walker Scotch Whisky, Diamonds etc.

The demand for these goods increases even if the price is increased because these goods are purchased for their “exclusiveness” which increases with an increase in price.

Exceptions to the law of Demand

Speculation : When the consumers understand that there is a increase in price of a product and they are expecting a further rise, they will not mind purchasing more of that product even if it’s price is increased.

Consumer’s psychology : Many consumers do not purchase products at the time of “discount sales” etc assuming that the quality of the products may have been compromised.

Law of Supply

The law of supply states that, ceteris paribus, there is a direct (positive)

relationship between price and quantity supplied.

Supply

Quantity supplied is the amount of a good that sellers are willing and able

to sell.

Supply Schedule

The supply schedule is a table that shows the relationship between the price of the good and the quantity

supplied.

Supply Schedule

Price Quantity Rs.0.0 0

0.50 0 1.00 1 1.50 2 2.00 3 2.50 4 3.00 5

Supply Curve

The supply curve is the upward-sloping line relating price to quantity

supplied.

Supply Curve

Rs.3.00

2.502.001.501.000.50

21 3 4 5 6 7 8 9 10

12

11

Price

Quantity of Ice-Cream Cones

0

Price Quantity 0.00 0 0.50 0 1.00 1 1.50 2 2.00 3 2.50 4 3.00 5

Market Supply

Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.

Determinants of Supply Market price : The single largest factor that

affects supply is the price. More commodities will be supplied at a higher price and vice versa.

Input prices : When the factors of production are available at low price, more investment is encouraged. This increases supply.

Technology : The improvement in the technique of production leads to increased supply.

Natural conditions : The supply of agricultural commodities depends upon the natural conditions. Whenever there is good monsoon, conductive temperature, the supply of such products increases.

Transport conditions : Difficulties in transport may cause a temporary decrease in supply. So, even at rising price, quantity supplied may decrease.

Expectations : When a seller expects a further rise in the price, he may withhold the supply and hence the supply may decrease.

Prices of other products : The prices of substitutes or related products can influence the supply. If the prices of wheat are increasing, farmers may grow more of wheat and less of rice. If the price of sugar rises, the price of jaggary will also rise.

Govt. policy : If the policies of the govt. are liberalized, more firms may tend to enter the market and hence supply may rise.

Change in Quantity Supplied versus Change in Supply

Change in Quantity Supplied Movement along the supply curve. Caused by a change in the market price

of the product.

Change in Quantity Supplied

1 5

Price

Quantity of Ice-Cream Cones

0

S

1.00 A

C Rs.3.00

A rise in the price of ice cream cones

results in a movement along the supply curve.

Change in Quantity Supplied versus Change in Supply

Change in Supply A shift in the supply curve, either to the

left or right. Caused by a change in a determinant

other than price.

Change in Supply

Price

Quantity of Ice-Cream Cones

0

S1 S2

S3

Increase in Supply

Decrease in Supply

Change in Quantity Supplied versus Change in Supply

Variables that Affect Quantity Supplied

A Change in This Variable . . .

Price Represents a movement along the supply curve

Input prices Shifts the supply curve

Technology Shifts the supply curve

Expectations Shifts the supply curve

Number of sellers Shifts the supply curve

Shifts in Curves versus Movements along Curves

A shift in the supply curve is called a change in supply.

A movement along a fixed supply curve is called a change in quantity supplied.

A shift in the demand curve is called a change in demand.

A movement along a fixed demand curve is called a change in quantity demanded.

Supply and Demand Together

Equilibrium Price The price that balances supply and

demand. On a graph, it is the price at which the supply and demand curves intersect.

Equilibrium Quantity The quantity that balances supply and

demand. On a graph it is the quantity at which the supply and demand curves intersect.

Supply and Demand Together

Price Quantity Rs 0 0 0.50 0 1.00 1 1.50 4 2.00 7 2.50 10 3.00 13

Price Quantity Rs 0 19 0.50 16 1.00 13 1.50 10 2.00 7 2.50 4 3.00 1

Demand Schedule

Supply Schedule

At Rs.2.00, the quantity demanded is equal to the quantity supplied!

Supply

Demand

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

Equilibrium of Supply and Demand

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Rs.3.00

2.502.001.501.000.50

Equilibrium

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

21 3 4 5 6 7 8 9 10

12110

Rs.3.00

2.502.001.501.000.50

Supply

Demand

Surplus

Excess Supply

Surplus

When the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

Excess Demand

Quantity ofIce-Cream Cones

Price ofIce-Cream

Cone

Rs.2.00

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Supply

Demand

Rs.1.50

Shortage

Shortage

When the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

Three Steps To Analyzing Changes in Equilibrium

Decide whether the event shifts the supply or demand curve (or both).

Decide whether the curve(s) shift(s) to the left or to the right.

Examine how the shift affects equilibrium price and quantity.

How an Increase in Demand Affects the Equilibrium

Price ofIce-Cream

Cone

2.00

0 7 Quantity ofIce-Cream Cones

Supply

Initialequilibrium

D1

1. Hot weather increasesthe demand for ice cream...

D2

2. ...resultingin a higherprice...

Rs.2.50

103. ...and a higherquantity sold.

New equilibrium

S2

How a Decrease in Supply Affects the Equilibrium

Price ofIce-Cream

Cone

2.00

0 1 2 3 4 7 8 9 11 12 Quantity ofIce-Cream Cones

13

Demand

Initial equilibrium

S1

10

1. Shortage of milk reducesthe supply of ice cream...

Newequilibrium

2. ...resultingin a higherprice...

Rs.2.50

3. ...and a lowerquantity sold.