BF1207

PRINCIPLES OF
ISLAMIC
ECONOMICS
LECTURE 5

DR ABDUL NASIR BIN HAJI ABDUL RANI

Dean / Senior Lecturer
Faculty of Islamic Economics and Finance
 SUPPLY AND DEMAND
 In economics, economists use the terms supply and demand;
 Supply refers to sellers’ / producers’ willingness and ability to provide goods
for sale in a market;
 Demand refers to buyers’ / consumers’ willingness and ability to purchase
goods;

Law of Demand
 The Law of Demand can be stated formally as follows: in any market, other
things being equal, an inverse relationship exists between the price of a good and
the quantity of the good that buyers demand . Thus, the quantity demanded
tends to rise as the price falls and to fall as the price rises.
 DEMAND CURVE
 Demand curve is a graphical representation of the relationship between the price of a
good and the quantity of that good that buyers demand.
 The negatively sloped curve is called a demand curve. A negative slope represents an
inverse relationship; a relationship in which an increase in the value of one variable is
associated with a decrease in the value of the other variable.
• The effect of a change in the price of A Demand Curve for Chicken
chicken, other things being equal, can $80.00
be shown as a movement from one A Demand Curve
$70.00 for Chicken
point to another along the demand
curve for chicken. $60.00
Change in
• Economists speak a movement along a $50.00 quantity
demand curve as a change in
A demanded
$40.00
quantity demanded. Such a $30.00
movement represents buyers’ reaction
$20.00
to a change in the price of the good in B
question, other things being equal. $10.00
$0.00

Quantity of chicken (per pound PA)

 SHIFTS IN THE DEMAND CURVE
 The changes in other variables effect the demand curve to shift to a point on the new demand
curve. The corresponding term for a shift in demand curve is called a change in demand;
 A rightward shift (D1) of demand curve indicates the increment of demand. In contrast, a leftward
shift (D2) indicate the decrement of demand.

A Demand Curve for Chicken

$80.00
D2 D D1 A Demand Curve
• A change in quantity demanded is $70.00 for Chicken
caused by a change in the price of the $60.00 Change in
good in question; demand
• A change in demand is caused by a $50.00
change in some variable other than $40.00
the price of the good in question.
$30.00

$20.00

$10.00

$0.00
SHIFTS IN THE DEMAND CURVE (CONT.)
 Changes in other variables can affect people’s purchases of good;
 Changes in other variables can be listed as follows:
1) Changes in the price of another good: In the case of chicken, people bought more chicken when the
price of beef went up, replacing one meat with the other in their dinners. Economists call such pairs of
good substitutes;
2) Changes in consumer income: When people’s income rise, they intend to buy larger quantities of many
goods, assuming that the prices of those goods do not change;
3) Changes in population size: Changes in the size of the population can affect the demand of many goods.
A society with relatively more children will have greater demand for goods and services.
4) Price changes for complement goods: If the price of golf clubs rises, the quantity demanded of golf
clubs falls because of the law of demand, and demand for a complement good like golf balls decreases
along with it.
5) Changes in expectations: If people expect the price of particular good to rise relative to the prices of
other goods, or expect something than a price increase to rise the opportunity cost of acquiring the
good, they will step up their rate of purchase before the change takes place;
6) Changes in tastes: changes in tastes take longer to occur but are more permanent, such as increasing
preference for foods with a low saturated fat content.
SHIFTS IN THE DEMAND CURVE (CONT.)
SUPPLY CURVE
 Supply Curve: a graphical representation of the relationship between the
price of a good and the quantity of that good that sellers are willing to supply;
 The positively sloped curve is called a supply curve. A positively sloped line
represents direct relationship between two variables (on the “x axis” and
“y axis”) in which an increase of one variable is associated with an increase in
the value of the other; 9
8
B
Law of supply: 7
A rise in price almost always leads to an
6
increase in the quantity supplied of that good
or service, while a fall in price will decrease 5
the quantity supplied. The law of supply 4
assumes that all other variables that affect
3
supply are held constant.
2
A
1
0
 SHIFTS IN THE SUPPLY CURVE
 A movement along the supply curve is called a change in quantity supplied;
 A shift in supply curve is called a change in supply;

A Supply Curve for Chicken A Supply Curve for Chicken

$80.00 $80.00
S2 S S1
$70.00 $70.00
Change in Change in
supply B
$60.00 quantity
$60.00 supplied
$50.00
$50.00
$40.00 A
$40.00
$30.00
$30.00
$20.00
$20.00
$10.00
$10.00
$0.00
$0.00
 SHIFT IN THE SUPPLY CURVE (CONT.)
 There are reasons for a change of supply, among others are:
1) Natural conditions: A drought decreases the supply of agricultural products, which
means that at any given price, a lower quantity will be supplied. Conversely, especially
good weather would shift the supply curve to the right.

2) Changes in production cost: It can cause an entire supply curve to shift right or left.
This causes a higher or lower quantity to be supplied at a given price.

3) Changes in technology: A technological improvement that reduces costs of

production will shift supply to the right, causing a greater quantity to be produced at
any given price.

4) Government policies: Government policies can affect the cost of production and the
supply curve through taxes, regulations, and subsidies. Taxes or regulations are an
additional cost of production that shifts supply to the left, leading the firm to
produce a lower quantity at every given price. Government subsidies, however,
reduce the cost of production and increase supply at every given price, shifting
supply to the right.
SHIFT IN THE SUPPLY CURVE (CONT.)
THE INTERSACTION OF SUPPLY AND DEMAND
 Market equilibrium: a condition in which buyers’ and sellers’ plans exactly match in the marketplace, so that the
quantity supplied exactly equals the quantity demanded at a given price;
 The equilibrium price is the only price where the plans of consumers and the plans of producers agree—that is, where the
amount consumers want to buy of the product (quantity demanded) is equal to the amount producers want to sell
(quantity supplied);
 The word equilibrium means balance. If a market is at its equilibrium price and quantity, then it has no reason to move
away from that point. However, if a market is not at equilibrium, then economic pressures arise to move the market
toward the equilibrium price and the equilibrium quantity.
9
Excess quantity supplied (surplus): 8 Surplus
• A condition in which the quantity of a good D S
supplied at a given price exceeds the quantity 7
demanded. A higher price cause a surplus of a 6
Equilibrium
good and puts downward pressure on price. price
5
Excess quantity demanded (shortage):
4
• A condition in which the quantity of a good
demanded at a given price exceeds the quantity 3
supplied. A lower price causes a shortage and
2
puts upward pressure on price. Shortage
1
0
CHANGES IN MARKET CONDITIONS
Apple Market
9 Scenario A:
New disease resistant for apple
8 D
S S1 invented
7
6 Effects:
5 E 1) Price went down;
Price

2) Quantity supplied went up;

4
E1 3) New equilibrium price
3 created at E1
2
1
0

Quantity
CHANGES IN MARKET CONDITIONS (CONT.)

Apple Market
9 Scenario B:
8 New study released on how
D D1
7
S apples prevent cancer
6 E1 Effects:
5 E 1) Price went up;
Price

4 2) Quantity supplied went up;

3 3) New equilibrium price
2 created at E1
1
0

Quantity
CHANGES IN MARKET CONDITIONS (CONT.)

Apple Market
9 Scenario C:
a) Pear cider industry launches ad
8 S1
D1 D S campaign
7
Effects:
6
E2 1) Price went down;
5 E 2) Quantity supplied went down;
Price

3) New equilibrium price created at E1

4 E1
3
b) Apple supplier also grows pear
2
1 Effects:
1) Price went up;
0 2) Quantity supplied went down;
3) New equilibrium price created at E2
Quantity
CHANGES IN MARKET CONDITIONS (CONT.)

Apple Market
9
8 D Scenario D:
S1 S
7 Apple pickers unionize:
6 E1 demand wage increases
5 E
Price

4 Effects:
3 1) Price went up;
2
2) Quantity supplied went
down;
1
3) New equilibrium price
0
created at E1
Quantity
What markets do?
 Markets coordinate the self interest of many different people
who ultimately have different goals, different preferences,
different insights, different knowledge, different circumstances to
produce extensive cooperation and mutual gain. In other words,
markets link the world.
 E.g. Iphone is designed in California, but parts are from USA
(Kentucky, Texas, and New York), inner Mongolia, Korea, Taiwan,
France, and Italy. But assembled in China. Therefore, to produce
an Iphone, all things were brought together, and all people were
gathered cooperating to produce one product.

THE PRICE SYSTEM

Other than link the world, markets also solve the
great economic problem, i.e. to arrange limited
resources to satisfy many wants as possible.
Resources are not equally valuable in all uses, so they
must be properly allocated in order to get the most
value out of those resources. There are a couple of
possible methods to do so, by using a central planner
or using the price system.

THE PRICE SYSTEM (CONT.)

Price system:
 A price is a signal wrapped up in an incentive. A change in the price
of one resource ripples out throughout the world economy. Changing
the consumption pattern, production decisions, incentives, and choices of
many different goods.
 E.g. When the price of oil increase, it signal that the oil become more
scarce. It gives everyone an incentive to listen to that signal.
 The users respond to the signal by finding ways to economize on oil
(using less oil) or develop substitutes (to lower cost alternatives) to gain
profit. The suppliers respond to the signal by investing more in
exploration, to look for alternatives sources, to build more and so forth.
These responds are intended to try and find the best way of responding
to this reduced amount of the resource.

THE PRICE SYSTEM (CONT.)

 Price ceiling is a maximum price allowed by law. It is illegal to
buy or sell above that price.
 Amongst the effects of imposing the price ceiling are:
1) It creates shortage:
With a price ceiling, buyers are unable to signal their increased
demand by bidding prices up. Suppliers in turn have no
incentive to increase the quantity supplied because they cannot
raise the price. The result is a shortage; the quantity demanded
exceeds the quantity supplied. Normally, when shortage
occurred in the market, it will push the price up till it reaches
the equilibrium price. But in this case, it is illegal to push up the
price. So, shortage does not go away.

THE PRICE CEILING

2) Reductions in product / service quality:
When Qd > Qs, sellers have more customers than goods.
Sellers can cut quality, cut cost and still sell the goods at the
controlled price. Therefore, with a surplus of buyers, sellers
have less of an incentive to give good service.

3) A misallocation of resources:
With price control, prices no longer serve their signaling and
incentive function and as a result resources are misallocated, i.e.
resources no longer flow from their high valued uses to their
low valued uses, and as a result of that less use out resources.

THE PRICE CEILING (CONT.)

 Price floors is a minimum price allowed by law. It is illegal to buy
or sell below that price.
 Amongst the effects of imposing the price floor are:
1) It creates surpluses:
A good example of a price floor is the minimum wage, i.e. a
price below which one cannot sell labour, and the suppliers of
labour exceed the buyers of labours. Workers with very low
productivity and low-skilled teenagers are most affected by the
minimum wage. A surplus of labour is called unemployment. A
large increase in the minimum wage will cause serious
unemployment problem.

THE PRICE FLOORS

2) Wasteful increases in quality:
It is illegal to lower a price below the price floor. In this case,
the only effort can be done to attract more customers is by
increasing the quality of products or services. As a result, it
cause raising to the costs greater than the value to the
customers.

3) A misallocation of resources:
Price floor prevented competition. In other words, price floor is
a restriction on entry in the industry which may lead to the
misallocation of resources.

THE PRICE FLOORS (CONT.)

 BF1207
PRINCIPLES OF
ISLAMIC
ECONOMICS
LECTURE 5

DR ABDUL NASIR BIN HAJI ABDUL RANI

Dean / Senior Lecturer
Faculty of Islamic Economics and Finance