BASIC ELEMENTS OF SUPPLY BASIC ELEMENTS OF SUPPLY AND DEMAND # 3AND DEMAND # 3

THEORY OF DEMANDTHEORY OF DEMAND Theory of demand establishes relationship Theory of demand establishes relationship

between the quantity demanded of a between the quantity demanded of a commodity and its price.commodity and its price.

CONSUMER`S BEHAVIOURCONSUMER`S BEHAVIOUR Two theoriesTwo theories 1)Marshallian utility approach1)Marshallian utility approach 2)Hicksian indifference curve analysis2)Hicksian indifference curve analysis

MARGINAL UTILITYMARGINAL UTILITY

The change in the total utility resulting from a one-The change in the total utility resulting from a one-unit change in the consumption of a commodity per unit change in the consumption of a commodity per unit of time.unit of time.

OROR The addition made to the total utility by the The addition made to the total utility by the

consumption of the last unit considered just consumption of the last unit considered just worthwhile.worthwhile.

Marginal utility Marginal utility (MU) = Change in the total (MU) = Change in the total utility utility

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Change in quantity Change in quantity consumedconsumed

MARGINAL UTILITIES OF MARGINAL UTILITIES OF RELATED GOODSRELATED GOODS

Substitutes Substitutes : : They are capable of They are capable of satisfying same want, e.g., tea satisfying same want, e.g., tea and coffeeand coffee

ComplementaryComplementary : : They are such They are such goods which are wanted together goods which are wanted together for the satisfaction of a for the satisfaction of a want,e.g.paper, pen and ink for want,e.g.paper, pen and ink for writing. writing.

DEMANDDEMAND

LAW OF DEMANDLAW OF DEMAND

ELASTICITY OF DEMAND

MEANING OF DEMANDMEANING OF DEMAND

Power to purchase a product Power to purchase a product andand Willingness to Willingness to purchase itpurchase it

LAW OF DEMANDLAW OF DEMAND

Price( per egg)Price( per egg) Quantity demandedQuantity demanded

8080 22

7070 33

6060 44

5050 55

4040 66

40

60

50

70

80

2 3 4 5 6

Qd (Eggs)

Price

D

D

ASSUMPTIONS OF THE ASSUMPTIONS OF THE LAW OF DEMANDLAW OF DEMAND

1- INCOME REMAINS CONSTANT1- INCOME REMAINS CONSTANT

2- HABITS AND FASHION SHOULD NOT2- HABITS AND FASHION SHOULD NOT CHANGECHANGE

3- PRICE OF RELATED GOODS SHOULD REMAIN 3- PRICE OF RELATED GOODS SHOULD REMAIN CONSTANTCONSTANT

4- NO CHANGE IN FUTURE CIRCUMSTANCES4- NO CHANGE IN FUTURE CIRCUMSTANCES

5- WEATHER AND POPULATION SHOULD REMAIN 5- WEATHER AND POPULATION SHOULD REMAIN CONSTANTCONSTANT

6- DISREGARDING NEW SUBSTITUTES6- DISREGARDING NEW SUBSTITUTES

LIMITATIONSLIMITATIONS 1) VERY HIGH- PRICED PRODUCTS1) VERY HIGH- PRICED PRODUCTS

2) VERY LOW- PRICED PRODUCTS 2) VERY LOW- PRICED PRODUCTS (INFERIOR GOODS)(INFERIOR GOODS)

3) IGNORENCE OF THE CONSUMER3) IGNORENCE OF THE CONSUMER

4) INCREASE IN THE MARGENAL 4) INCREASE IN THE MARGENAL UTILITY OF THE CONSUMER UTILITY OF THE CONSUMER

FACTORS AFFECTING FACTORS AFFECTING THE DEMAND CURVETHE DEMAND CURVE

1) Average income1) Average income 2)Size of the market2)Size of the market 3)Prices and availability of related 3)Prices and availability of related

goods.goods. 4)Tastes and preferences.4)Tastes and preferences. 5)Special influences(umberallas)5)Special influences(umberallas)

CHANGES IN DEMANDCHANGES IN DEMAND

1) EXTENSION AND 1) EXTENSION AND CONTRACTION OF DEMANDCONTRACTION OF DEMAND

2) RISE AND FALL OF DEMAND2) RISE AND FALL OF DEMAND

EXTENSION AND EXTENSION AND CONTRACTION OF CONTRACTION OF

DEMANDDEMAND

P P QdQd

AA 1010 55

BB 55 1010

PP QdQd

BB 55 1010

AA 1010 55

0

5

5 10

10

D

D

PRICE

Qd

RISE OF DEMANDRISE OF DEMAND

P P QdQd

AA 1010 55

CC 1010 88

PP QdQd

AA 1010 55

AA 1212 55

OR

05 8

10

D

PRICE

Qd

12D

D/

D/

B

CA

Rise of Demand

FALL OF DEMANDFALL OF DEMAND

PP QdQd

AA 1010 55

BB 1010 22

PP QdQd

AA 1010 55

CC 88 55

OR

02 5

10PRICE

Qd

D

D

A

Fall of Demand

5

D/

D/

CAUSES OF RISE AND FALL CAUSES OF RISE AND FALL OF DEMANDOF DEMAND

1) CHANGES IN INCOME1) CHANGES IN INCOME 2) CHANGES IN TASTE AND FASHION2) CHANGES IN TASTE AND FASHION 3) CHANGES IN WEATHER3) CHANGES IN WEATHER 4) CHANGES IN POPULATION4) CHANGES IN POPULATION 5) CHANGES IN THE QUANTITY OF MONEY5) CHANGES IN THE QUANTITY OF MONEY 6) CHANGES IN DISTRIBUTION OF INCOME6) CHANGES IN DISTRIBUTION OF INCOME 7) RATE OF ECONOMIC GROWTH7) RATE OF ECONOMIC GROWTH 8) DISCOVERY OF A SUBSTITUTE8) DISCOVERY OF A SUBSTITUTE 9) CHANGES IN THE PRICE OF SUBSTITUTE9) CHANGES IN THE PRICE OF SUBSTITUTE 10) CHANGE OF TASTE10) CHANGE OF TASTE

THE SUPPLY SCHEDULETHE SUPPLY SCHEDULE The supply schedule relates the quantity The supply schedule relates the quantity

supplied of a good to its market price, supplied of a good to its market price, other things constant. input prices, other things constant. input prices, prices of related goods, and government prices of related goods, and government policies)policies)

SUPPLY CURVESUPPLY CURVE It shows the relationship between It shows the relationship between

quantity supplied and prices. There quantity supplied and prices. There exists a positive relationship between exists a positive relationship between these two. (table, diagram)these two. (table, diagram)

EQUILIBRIUM OF SUPPLY EQUILIBRIUM OF SUPPLY AND DEMANDAND DEMAND

A market equilibrium comes at the price A market equilibrium comes at the price at which quantity demanded equals at which quantity demanded equals quantity supplied. At that equilibrium, quantity supplied. At that equilibrium, there is no tendency for the price to rise there is no tendency for the price to rise and fall .The equilibrium price is also and fall .The equilibrium price is also called the called the market –clearing pricemarket –clearing price..

EFFECT OF A SHIFT IN EFFECT OF A SHIFT IN SUPPLY AND DEMANDSUPPLY AND DEMAND

If Demand rises…. D curve shift right…PriceIf Demand rises…. D curve shift right…Price QuantityQuantity

If demand falls….D curve shift left….PriceIf demand falls….D curve shift left….Price QuantityQuantity

If supply rises….S curve shift right….PriceIf supply rises….S curve shift right….Price QuantityQuantity If supply falls…. S curve shift left….PriceIf supply falls…. S curve shift left….Price Quantity Quantity