DEMAND AND SUPPLY

Meaning of Demand
In economic terminology the term demand conveys a wider and definite meaning than in the ordinary usage. Ordinarily demand means a desire, whereas in economic sense it is something more than a mere desire. It is interpreted as a want backed up by the purchasing power. Further demand is per unit of time such as per day, per week etc. moreover it is meaningless to mention demand without reference to price. Considering all these aspects the term demand can be defined in the following words, Demand for anything means the quantity of that commodity, which is bought, at a given price, per unit of time. In other words, demand in economics implies three things: (a) Desire for the commodity; (b) Willingness to pay its price; and (c) Ability to pay, i.e. the person should have the necessary and adequate purchasing power (money).

Law of Demand
This law explains the functional relationship between price of a commodity and the quantity demanded of the same. It is observed that the price and the demand are inversely related which means that the two move in the opposite direction. An increase in the price leads to a fall in the demand and vice versa. This relationship can be stated as Other things being equal, the demand for a commodity varies inversely as the price. Therefore D = f(p), Where:'D' represents demand, 'f' is the functional relationship and 'p' is the price.

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A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the negative relationship between price and quantity demanded. The higher the price of a good the lower the quantity demanded (A), and the lower the price, the more the good will be in demand (C).

Demand Schedule
Demand schedule is a tabular statement showing quantities of a commodity demanded at different prices. It represents functional relationship between price and amount demanded. Demand schedules are of two types: Individual Demand schedule Market demand schedule 1) Individual Demand Schedule: individual demand schedule shows the quantities of a commodity that a person will buy at different prices; in other words, it shows the relationship between the price and quantity demand by an individual. For example, if we study the different quantities of an article which an individual demands at different prices, we will get an individual demand schedule. Individual Demand Schedule Prices 5 4 3 2 1
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Quantity Demanded by an Individual 5 units 7 units 10 units 13 units 15 units

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The individual demand curve slopes down from left to right indicating that lower the price, greater is the quantity demanded. 2) Market Demand Schedule: In any market, there is a large number of buyers each one having his own demand schedule. The sum of these demand schedules constitutes market demand schedule. Thus, market demand schedule can be defined as a schedule indicating various amounts of a commodity that can be purchased by all the buyers at various amounts of a commodity that would be purchased by all the buyers at various prices during a period of time. Suppose there are three buyers in the market and their demand schedules are as follows; Price per units (in Rs.) 3 2 1 Units purchased by Mr. X 0 2 4 Units purchased by Mr. Y 2 4 6 Units purchased by Mr. Z 4 6 8 Total market demand 6 12 18

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Since individual demand curves slope down from right, market demand curve also slopes down from left to right showing that quantity demanded increases with the fall in price.

Assumptions Of The Law Of Demand

The assumptions refer to the conditions under which the law will hold goods. These assumptions are contained in the phrase "other things remain equal". They are explained in detail as follows:
1)

Income: It is assumed that there is no change in the size and distribution of individual income. If there is a change, the law will not operate. If income increases, consumer's purchasing power increases and so demand may increase even if there is a rise in price. Tastes and Preferences: It is assumed that taste and preferences for a commodity remains unchanged and do not move in favor of new products. Population: The size and composition of the total population in the country is assumed to be constant. If population increases, demand for commodities would increase even when prices are rising. Price of substitutes and complementary: The price of substitutes and complimentary are assumed to be constant. If they fall in greater proportion consumer's demand for the substitute will increase and that of the commodity will decrease. Speculation or Expectation regarding future prices: If consumers expect a further fall in the price of the commodity the demand for it would be low in the present even though its price falls. Hence, it is assumed that there should be no change in the expectations regarding future changes in prices. Government policy: The level of taxation and fiscal policy of the government remains the same throughout the operation of the law, otherwise changes in income tax for example may cause changes in consumer's income and as a result demand will change. Range of goods available to the Consumers: The innovation or arrival of new variety of a product in the market may change consumer's preference, so it is assumed to be a constant one. Weather conditions: In case of seasonal goods, a study of demand and price is made during a particular season only, for example: demand for sugarcane juice, and ice creams are made during summer season only. Advertisements: Advertisement and publicity attracts the attention of the consumers. Due to this, there are might be changes in the consumption pattern/ So it is assumed that there is no new product introduced in the market or any new advertisement for the existing product.
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Exceptions To The Law Of Demand

1) Giffen goods: These goods came to be known as Giffen goods after the name of Sir Robert Giffen, a notable English Economist. These goods constitute very inferior goods which are essential for a minimum living. Law of Demand does not hold well in case of giffen goods. Robert Giffen found that bread and meat were two important items of consumption of the workers in early 19th century England. As meat is superior to bread they can't afford to pay for meat. With the fall in price of bread in the market they bought the same quantity at fewer prices. The money income so saved was spent on the meat instead of bread. Thus with a fall in price quantity of bread falls and with a rise in price quantity of bread rises. This is contrary to the operation of Law of Demand. The demand curve of giffen goods rises upward from left to right. 2) Prestigious goods: There are certain goods having prestige value. These goods are mainly consumed by the richer sections of the society for the gain of pride and social distinction. According to Veblen some rich people measure the utility of a commodity entirely by price. The greater the price of a commodity, the greater its utility. Diamond has got a very little value in use but has got a very great prestige value as its price is extremely high. Poor people can't dream of its use. The richer people buy diamond so long as its price is high. The moment its use comes to the income ability of the common people diamond ceases to be an article of distinction. The greater the price of diamond, the greater its utility because of its higher prestige value. The consumer will buy less of diamonds at a low price because of the fall in prestige value. Thus prestigious goods constitute another exception to the Law of Demand. 3) Speculation: There are some commodities whose prices are expected to change in future. People demand more when price of the commodity continues rising. People apprehend a further rise in price in the future. To escape the further rise in price, they hurry to buy more even at a high price. The fear of price rise in future makes him buy more at a higher price. On the other hand they buy less at fewer prices with a hope of further fall in future. Thus this expectation or speculation constitutes another exception to the Law of Demand.

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Determinants (Factors Affecting) of Demand

The law of demand, while explaining the price-demand relationship assumes other factors to be constant. In reality however, these factors such as income, population, tastes, habits, preferences etc., do not remain constant and keep on affecting the demand. As a result the demand changes i.e. rises or falls, without any change in price. 1. Income: The relationship between income and the demand is a direct one. It means the demand changes in the same direction as the income. An increase in income leads to rise in demand and vice versa. 2. Population: The size of population also affects the demand. The relationship is a direct one. The higher the size of population, the higher is the demand and vice versa. 3. Tastes and Habits: The tastes, habits, likes, dislikes, prejudices and preference etc. of the consumer have a profound effect on the demand for a commodity. If a consumers dislikes a commodity, he will not buy it despite a fall in price. On the other hand a very high price also may not stop him from buying a good if he likes it very much. 4. Other Prices: This is another important determinant of demand for a commodity. The effects depend upon the relationship between the commodities in question. If the price of a complimentary commodity rises, the demand for the commodity in reference falls. E.g. the demand for petrol will decline due to rise in the price of cars and the consequent decline in their demand. Opposite effect will be experienced incase of substitutes. 5. Advertisement: This factor has gained tremendous importance in the modern days. When a product is aggressively advertised through all the possible media, the consumers buy the advertised commodity even at a high price and many times even if they dont need it. 6. Fashions: Hardly anyone has the courage and the desire to go against the prevailing fashions as well as social customs and the traditions. This factor has a great impact on the demand. 7. Imitation: This tendency is commonly experienced everywhere. This is known as the demonstration effects, due to which the low income groups imitate the consumption patterns of the rich ones. This operates even at international levels when the poor countries try to copy the consumption patterns of rich countries.

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Variation & Changes In Demand

The law of demand explains the effect of only-one factor viz., price, on the demand for a commodity, under the assumption of constancy of other determinants. In practice, other factors such as, income, population etc. cause the rise or fall in demand without any change in the price. These effects are different from the law of demand. They are termed as changes in demand in contrast to variations in demand which occur due to changes in the price of a commodity. In economic theory a distinction is made between Variations i.e. extension and contraction in demand due to price and Changes i.e. increase and decrease in demand due to other factors.

(a) Variations in demand refer to those which occur due to changes in the price of a commodity. These are two types. 1. Extension of Demand: This refers to rise in demand due to a fall in price of the commodity. It is shown by a downwards movement on a given demand curve.

2. Contraction of Demand: This means fall in demand due to increase in price and can be shown by an upwards movement on a given demand curve.

The original price is OP and the Quantity demanded is OQ. With a rise in price from OP to OP1 the demand contracts from OQ to OQ1 and as a result of fall in price from OP to OP2, the demand extends from OQ to OQ2.
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(b) Changes in demand imply the rise and fall due to factors other than price. It means they occur without any change in price. They are of two types. 1. Increase in Demand: This refers to higher demand at the same price and results from rise in income, population etc., this is shown on a new demand curve lying above the original one. 2. Decrease in demand: It means less quantity demanded at the same price. This is the result
of factors like fall in income, population etc. this is shown on a new demand lying below the original one.

In figure, B an increase in demand is shown by a new demand curve, D1 while the decrease in demand is expressed by the new demand curve D2, lying above and below the original demand curve D respectively. On D1 more is demand (OQ1) at the same price while on D2 less is demanded (OQ2) at the same price OP.

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Meaning Of Supply
Economists have a very precise definition of supply. Economists describe supply as the relationship between the quantity of a good or service consumers will offer for sale and the price charged for that good. More precisely and formally supply can be thought of as "the total quantity of a good or service that is available for purchase at a given price."

Law of Supply
The law of supply demonstrates the quantities that will be sold at a certain price. The supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue. All other factors being equal, as the price of a good or service increases, the quantity of goods or services offered by suppliers increases and vice versa.

A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation between quantity supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and the price will be P2, and so on.

Supply Schedule
Supply schedule represents the relationship between prices and the quantities that the firms are willing to produce and supply. In other words, at what price, how much quantity a firm wants to produce and supply. Supply schedule is a table which lists the possible prices for a good and service and the associated quantity supplied. It represents a functional relationship between the price and the quantity supplied.

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Price of wheat (per quintal) 1000 1100 1150 1200 1250

Quantity of wheat Supplied (in quintals) 125 150 180 220 250

Market Supply Curve The summation of supply curves of all the firms in the industry gives us the market supply curve. Price (in $) 4 6 8 10 12 Quantity offered by Supplier A 5 7 9 11 13 Quantity offered by Supplier B 6 7 8 9 10 Market Supply 5 + 6 = 11 7 + 7 = 14 9 + 8 = 17 11 + 9 = 20 13 + 10 = 23

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Assumptions Of The Law Of Supply

1. Cost of production: It is assumed that the price of the product changes without any change in the cost of production. If the cost of production rises along with the rise in the price of the product, it is not profitable for the sellers and they will not sell more quantity. 2. No change in the techniques of production: The techniques used in production process should remain constant. This is an important condition to maintain constancy of the cost of production s constant one.

3. Scale of production: During the production process, there should not be any change in the scale of production. If there is any change in the scale of production, there will be change in supply, irrespective of the change in the price of the commodity. 4. No changes in Government policy: Government policies like taxation, trade policy etc. are assumed to be constant. For example if there is any change in levy tax or change in quota for raw materials or change in the policies regarding export or import of a commodity, then in that case supply cannot be increased with a rise in price. 5. No change in transport cost: It is assumed that transport costs are unchanged. Any reduction or increase in transport cost will affect the supply of the commodity without any change in price.

6. No speculation: It is assumed that the sellers do not speculate about the future changes in the price of the product. If they expect a rise in price in future, they will not supply more today even if the present price is high. 7. Constancy of price of related goods: It is assumed that there are no change in the price of related goods. If the price of other commodity rises much faster than this commodity then the sellers will start producing that commodity by shifting the raw-materials towards the production of that commodity which is a profitable one.

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Exceptions To The Law Of Supply

The law of supply states that other things being equal, the supply of a commodity extends with a rise in price and contracts with a fall in price. There are however a few exceptions to the law of supply. 1. Exceptions of a fall in price: If the firms anticipate that the price of the product will fall further in future, in order to clear their stocks they may dispose it off at a price that is even lower than the current market price. 2. Sellers who are in need of cash: If the seller is in need of hard cash, he may sell his product at a price which may even be below the market price. 3. When leaving the industry: If the firms want to shut down or close down their business, they may sell their products at a price below their average cost of production. 4. Agricultural output: In agricultural production, natural and seasonal factors play a dominant role. Due to the influence of these constraints supply may not be responsive to price changes. 5. Backward sloping supply curve of labor: The rise in the price of a good or service sometimes leads to a fall in its supply. The best example is the supply of labor. A higher wage rate enables the worker to maintain his existing material standard of living with less work, and he may prefer extra leisure to more wages. The supply curve in such a situation will be backward sloping SS1 as illustrated in figure 3.

At WN wage rate, the supply of labor is ON. But beyond NW wage rate the worker will reduce rather than increase his working hours. At MW1 wage rate the supply of labor is reduced to OM.
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Determinants (Factors Affecting) of Supply

1. Prices of other factors of production. An increase in the price of, say, hops, will increase the costs of a brewing firm and so for any given price the firm will not be able to brew as much beer. Hence, the firm's supply curve will shift to the left. The same would be true for changes in wage costs or fuel costs.

2. Technology. The supply curve drawn above assumes a 'constant' state of technology. But as we know, there can be improvements in technology that tend to reduce firms' unit costs. These reduced costs mean that more can be produced at a given price, so the supply curve would shift to the right.

3. Indirect taxes and subsidies. When the chancellor announces an increase in petrol tax (again!), it is the firm who actually pays the tax. Granted, we end up paying the tax indirectly when the price of petrol goes up, but the actual tax bill goes to the firm. This again, therefore, represents an increase in the cost to the firm and the supply curve will shift to the left. The opposite is true for subsidies as they are handouts by the government to firms. Now the firm can make more units of output at any given price, so the supply curve shifts to the right.

4. Labour productivity. This is defined as the output per worker (or per man-hour). If labour productivity rises, then output per worker rises. If you assume that the workers have not been given a pay rise then the firm's unit costs must have fallen. Again, this will lead to a shift to the right of the supply curve.

5. Price expectations. Just as consumers delay purchases if they think the price will fall in the future, firms will delay supply in they think prices will rise in the future. It's the same point but the other way round.

6. Entry and exit of firms to and from an industry. If new entrants are attracted into an industry, perhaps because of high profit levels (much more on this in the topic 'Market structure'), then the supply in that industry will rise at all price levels and the supply curve will shift to the right. If firms leave the industry then the supply curve will shift to the left.
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Extension and Contraction of Supply

Extension and contraction of supply refer to movements on the same supply curve. If with a rise in price, the supply rises, it is called an extension of supply; if, with a fall in price, the supply declines it is called a contraction of supply. The extension and contraction of supply are illustrated in figure 4. In figure 4, the movement from point E to E1 on the same supply curve shows an extension of supply and E1 to E shows a contraction of supply.

Increase and Decrease in Supply

Increase and decrease in supply causes shifts in the supply curve. A shift in the supply curve due to a change in some factor other than the price of the commodity is referred to as a change in supply. Supply is said to increase when more is offered in the market without a change in price. Supply is said to decrease when less is offered in the market without a change in the price of the commodity.

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In figure 5, at price EM, the supply is OM. SS is the supply curve before the change. S 1S1 shows an increase in supply because at the same price ME = M1E1 more is offered for sale, i.e., OM1 instead of OM. S2S2 shows the decrease in supply because at the same price ME = M2E2 less is offered for sale, i.e., OM2 instead of OM.

Equilibrium Price Interaction Of Demand And Supply.

(a) Equilibrium
When supply and demand are equal (i.e. when the supply function and demand function intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the current economic condition. At the given price, suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are demanding.

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As you can see on the chart, equilibrium occurs at the intersection of the demand and supply curve, which indicates no allocative inefficiency. At this point, the price of the goods will be P* and the quantity will be Q*. These figures are referred to as equilibrium price and quantity. In the real market place equilibrium can only ever be reached in theory, so the prices of goods and services are constantly changing in relation to fluctuations in demand and supply. (b) Disequilibrium Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*. 1. Excess Supply: If the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency.

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At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At P1, however, the quantity that the consumers want to consume is at Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much is being produced and too little is being consumed. The suppliers are trying to produce more goods, which they hope to sell to increase profits, but those consuming the goods will find the product less attractive and purchase less because the price is too high.

2. Excess Demand: Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it.

In this situation, at price P1, the quantity of goods demanded by consumers at this price is Q2. Conversely, the quantity of goods that producers are willing to produce at this price is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of the consumers. However, as consumers have to compete with one other to buy the good at this price, the demand will push the price up, making suppliers want to supply more and bringing the price closer to its equilibrium.

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Change in Equilibrium Price

When supply and demand curves shift, this results in changes to the equilibrium price and quantity. For example, if there is an increase in demand (a shift to the right of the demand curve, as might occur with higher incomes, higher prices for a substitute good, or stronger tastes for the product in question), both the equilibrium price and equilibrium quantity will increase. A decrease in demand will entail reductions in the equilibrium price and quantity. If there is an increase in supply (a shift to the right of the supply curve, as might occur with improved technology or reduction in the prices of inputs), this will result in a decline in the equilibrium price and an increase in the equilibrium quantity. Conversely, a decrease in supply will raise the equilibrium price and lower the equilibrium quantity. You can see these changes by starting with a simple supply and demand graph showing an initial equilibrium, and then drawing the new demand or supply curve and observing the new equilibrium point. In order to do well in this course, you will need to become proficient at drawing supply and demand graphs and using them to determine the consequences of changes in demand, supply, or both. The four basic changes (increase in demand, decline in demand, increase in supply, reduction in supply) are illustrated in the diagrams below. Note that in each case, there is a movement along the curve for the aspect that does not change. That is, when demand increases, there is an increase in the quantity supplied (movement along the supply curve) as the market moves from the initial equilibrium price to the new equilibrium price. Likewise, when there is an increase in supply, there is an increase in the quantity demanded (downward movement along the demand curve).

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1. An increase in demand

2. A decline in demand

3. An increase in supply

4. A decline in supply

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Time Element In The Determination Of Price

Time plays an important role in the theory of volume, i.e., price determination because supply and demand conditions are affected by time. Price during the short-period can be higher or lower than the cost of production, but in the longperiod price will have a tendency to be equal to the cost of production. The relative importance of supply on demand in the determination of price depends upon the time given to supply to adjust itself to demand. To study the relative importance of supply or demand in price determination, Prof. Marshall has divided time element-into three categories: Very short period or market period. Short period. Long period. Very long period

Now we shall discuss the price determinant in different period. 1. Very short period (determination of market price): In an extremely short period, say a day the supply is completely fixed. It cannot be increased at short notice. The supply of fresh vegetables or milk is an example. Since the supply is fixed, demand is the sole factor that determines the price. If the demand rises, supply remaining fixed, price rises much.

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(b) Price determination is short period:

There is a tendency for supply to adjust to a change in demand. If demand has increased, manufactures well try to produce more and hence supply will increase. During short period supply might increase but not sufficiently. Here the supply factor might assume importance but still demand side is predominant.

(c) Price determination in long period (Normal Price):

Long period is a period sufficient for supply to adjust to a change in demand. The scale of production of individual firms will be adjusted. The fixed costs well be spread over the increased output, hence average cost will fall. The price therefore will come down in the long run and may be equal to or slightly higher than the previous price. During long period, marginal cost of production will influence the price. The supply curve in the long run will have less slope than in the short run. The long run equilibrium price is known as normal price. There is a tendency for the market price to fluctuate around the normal price. The market price is influenced by changing conditions in demand; but it tends to settle at the level of normal price.

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(d) Very long (secular) Period Price:

In the very long period the basic conditions of supply changes. New inventions and their applications have far reaching effects on costs of production. Hence it is the supply side i.e. the cost of production which is predominant in the determination of price. It is possible that price might fall despite rise in demand.

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