MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 1

DEMAND, SUPPLY AND MARKET EQUILIBRIUM

DEMAND, SUPPLY AND MARKET

EQUILIBRIUM 2
LEARNING OUTCOMES
After completing this topic, student should be able to understand:
1. The concept of demand and the law of demand.
3. The concept of supply and the law of supply.
4. The factors determine demand and supply for a good.
5. How demand and supply interact in the market to determine prices and quantities
6. The government intervention in determining prices in the market.

1. DEMAND
1.1 Definition of Demand
I. Demand is defined as the ability and willingness to buy specific quantities
of good in a given period of time at a particular price, by holding other factors
constant.
II. The Quantity demanded of any good is the quantity of a particular good that
buyers are willing and able to purchase at a given price during some specified
period of time.

1.2 Law of Demand

I. A fundamental characteristic of demand is: Other things equal (ceteris
paribus), as price falls, the quantity demanded rises, and as price rises,
the quantity demanded fall - Law of Demand.
II. There is an inverse relationship between price and quantity demanded.

III. Demand Schedule and Demand Curve

Demand schedule – table of numbers showing the relationship between the

price of a particular good and the quantity demanded, holding constant other
factors (ceteris paribus).
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 2
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

Nina’s Demand for Ice cream

Point Price per Ice cream Quantity Demanded for
(RM) Ice cream
a 6 0
b 5 2
c 4 4
d 3 6
e 2 8
f 1 10
g 0 12

Demand Schedule

Demand curve – a graph of the relationship between the price of a good and
the quantity demanded.
I. Price is represented on vertical axis
II. Quantity demanded drawn on the horizontal axis

Figure 2.1
According to the law of demand,
the higher the price, the smaller
the quantity demanded,
everything else being equal.
Because price and quantity
demanded are inversely related,
therefore, the individual demand
curve is downward-sloping.

IV. Individual Demand and Market demand

Individual Demand Market demand

The ability and willingness of a single The sum of all individual demand for
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 3
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

individual to purchase a particular a particular product in the market.

product

Figure 2.2

 We assumed that the market consists of two individual buyers, 1 and 2. By

adding the individual demands, we obtain the market demand. The market
demand curve is a horizontal summation of individual demand curves.

1.3 Changes in Quantity Demanded

I. Change in quantity demanded results in movement along the demand
curve, as shown in figure (a), due a change in price of product while other
factors remain constant.
a) When price increases, let say from RM30 to RM40, quantity demanded will
decrease from 10 to 5 units, as shown by an upward movement along the
demand curve, from point b to a.
b) When price decreases, let say from RM20 to RM10, quantity demanded
will rises from 15 to 20 units, as shown by a downward movement along
the demand curve, from point c to d.
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 4
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

Figure 2.3
1.4 Changes in Demand
I. A change in one or more of the determinants of demand will change the
underlying demand data (the demand schedule in the table) and therefore the
location of the demand curve.
II. If any of these factors change, as shown in figure (b), the demand curve will
shift:
a) An increase in demand is represented by a shift of demand curve to the
right (D-D1) ;
b) An decrease in demand is represented by a shift of demand curve to the
left (D-D2).

III. Causes of Change in Demand (Determinant of Demand)

a) Income
i. A good is a normal good if an increase in income results an
increase in the demand for the good, such as cars, shirts or
books.
ii. A good is an inferior good if an increase in income results a
reduction in the demand for the good, such as second hand
phone, used cars, and low grade rice.

b) Price of related goods

Goods are related to other goods in two ways; a) substitute goods; and b)
complementary goods.
i. Substitute goods are goods that can be used in place of
another product service. An increase in the price of one results
in an increase in the demand for the other. E.g: coffee and tea,
Pepsi and Coca Cola, and so on.
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 5
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

P coffee Qdd coffee DD tea

ii. Complementary goods are the goods that are used together
such as, petrol and cars, software and computers, bread and
butter, and so on. An increase in the price of one results in a
decrease in the demand for other.

P car Qdd car DD petrol

c) Taste
Consumer’s taste and fashion change significantly. As taste or fashions
change, demand for a particular product will also change. If a product
becomes trending or more fashionable, the demand for it will increase and
vice versa.

d) Expectations
i. The higher expected future price of a product, the higher the
current demand for that product, and vice versa.
ii. The higher expected future income, the higher demand for all
normal goods, and vice versa.

e) Number of buyers
An increase in the number of buyers of a commodity in the market is most
likely to increase the demand for that commodity and vice versa.

2. SUPPLY

2.1 Definition of Supply

I. Supply is defined as the ability and willingness to sell or produce a
particular good or service.
II. The quantity supplied of any good is the amount that seller are willing and
able to sell.

2.2 Law of Supply

I. The Law of Supply states that other things being equal (ceteris paribus), the
quantity supplied of a good rises as the price that good rises, and vice
versa.
II. Based on the law, a positive relationship exists between price and quantity
supplied.
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 6
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

III. Supply Schedule and Supply Curve

Supply schedule – a list of quantity supplied at different level of price,

holding constant other factors (ceteris paribus).

Supply for Ice cream

Point Price per Ice Quantity of Ice
cream (RM) cream Supplied
a 6 12
b 5 10
c 4 8 Supply Schedule
d 3 6
e 2 4
f 1 2
g 0 0

Supply curve – a graph of the relationship between the price of a good and
the quantity supplied.

I. Price is represented on vertical axis

II. Quantity supplied drawn on the horizontal axis

Figure 2.4

IV. Individual Supply and Market supply

Individual Supply Market Supply

The ability and willingness to sell a The sum of all individual supplies for
particular product by a single seller a particular product in the market.
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 7
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

Figure 2.5

 We assumed that the market consists of only two sellers, 1 and 2. By adding
the individual supply, we obtain the market supply. The market supply curve is
a horizontal summation of individual supply curves.

2.3 Change in Quantity Supplied

I. Change in quantity supplied results in movement along the supply
curve, as shown in figure 2.6 (a), due a change in price of product while
other factors remain constant.
a) When price increases, let say from RM20 to RM43, quantity supplied
will increase from 15 to 20 units, as shown by an upward movement
along the supply curve, from point c to d.
b) When price decreases, let say from RM10 to RM5, quantity supplied
will falls from 10 to 5 units, as shown by a downward movement along
the supply curve, from point b to a.

Figure 2.6
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 8
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

2.4 Change in Supply

I. There are numbers of factors that can shift the supply curve. If any of these
factors change, as shown in the figure 2.6 (b) the supply curve will shift:

a) An increase in supply is represented by a shift of supply curve to the

right (S-S1)
b) An decrease in supply is represented by a shift of supply curve to the
left (S-S2)

II. Causes of Change in Supply (Determinant of Supply)

a) Input Prices
i. Producers use resources or inputs for producing output or product. As
cost of production change, the willingness of producers to produce
output at a given price changes.
ii. As the price of an input rises, cost of production increase and lead
producers to produce less output at each given price. This decrease in
supply shifts the supply curve to the left. Vice versa.

b) Price of Related Goods

The supply of a product can be influenced by the price of related goods:
i. Substitute goods: Supply of a product will decrease when there is an
increase in the price of a substitute product. E.g; Coffee and Tea.

P coffee Qss coffee SS tea

If the price of coffee increases, the Qs for coffee will increase and the
supply of tea in the market will decrease.
ii. Complementary goods: An increase in the price of a product will
increase the supply of its complementary product. E.g: computers and
software.

P computer Qss computer SS software

c) Technology Advancement
The improvement and advancement in technology enable producers to use
fewer resources to produce a product, as well as lower the cost of production
than before or they can produce more of a product with the same resources.
E.g, the invention of machine reduced the amount of labour necessary to the
production

d) Government Policies
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 9
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

i. Taxes: an excise tax is a tax on each units of output sold, where the
tax revenue is collected from the supplier/sellers. Taxes will decreases
supply of a product because taxes discourage producers from
producing extra which increase the cost of production.
ii. Subsidies: Subsidies granted to the producers intended to reduce
prices for the targeted sections of population to meet some social
objectives. Subsidies will increase supply as subsidies encourage
producers to produce more.

e) Number of Sellers
The larger the number of firms supplying a product, the larger the quantity
supplied for the product, and vice versa. For example, increasing in the
number of cafe in the college campus will increase the supply of food and
drinks. This is reflected by a rightward shift in the supply curve.

3. MARKET EQUILIBRIUM

3.1 Definition
I. Market Equilibrium is a situation when quantity demanded and quantity
supplied are equal and there is no tendency for price or quantity to rise or to
fall.
II. The equilibrium price is the price that equates quantity demanded with
quantity supplied.
III. Equilibrium quantity is the quantity supplied and the quantity demanded at
the equilibrium price.

3.2 Equilibrium Price and Quantity

I. Market equilibrium is determined by the intersection of both the demand curve
and supply curve. Let see how it established:

Price Quantity Quantity Market Condition (Surplus(+) or

Demanded Supplied Shortage(-))
5 2 10 10-2=8 Surplus
4 4 8 8-4=4 Surplus
3 6 6 6-6=0 Equilibrium
2 8 4 4-8=-4 Shortage
1 10 2 2-10=-8 Shortage
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 10
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

Figure 2.7

II. Figure 2.7 shows the condition when market reached equilibrium. Equilibrium
occurs where the demand curve and supply curve intersect at point E.
III. Point E indicates the equilibrium price and equilibrium quantity.

Surplus is the difference between the quantity demanded and quantity

supplied in a market, where Qs>Qd

Since sellers have excess supply of product that they would like to sell but
cannot, they will have an incentive to lower the price in order to sell off the
surplus.

This downward pressure on the price will continue until the price reaches the
equilibrium price where the surplus no longer exists.

Shortage is the difference between the quantity demanded and quantity

supplied in a market, where the quantity demanded is greater than the
quantity supplied. (Qd>Qs)

At the price RM1, buyers will compete amongst themselves for a limited
quantity.

Because of high demand, sellers can respond to the shortage by raising their
price. This upward pressure on the price will continue until the price reaches
the equilibrium price where shortage no longer exists.

3.3 Government Intervention in the Market

 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 11
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

I. There are several types of government interventions on market equilibrium.

II. The government may intervene and mandate a maximum price (price ceiling)
and minimum price (price floor) for a good or service in the market and this
can be explained using the demand and supply analysis.
III. Basically there are two price controls – Price ceiling and Price floor

3.3.1 Price Ceiling

i. Price ceiling is referred as a maximum price sellers are allowed to

charge for a good or services.
ii. This is a government intervenes to regulate price to prevent certain
prices from rising above maximum level as set by the government.
iii. The price of product is set below the equilibrium price and sellers are
not allowed to increase them.
iv. Examples of commodities with government imposed price ceiling in
Malaysia; sugar, cooking oil, chicken, petrol and diesel, etc.

Figure 2.8

v. As shown in figure 2.8, the imposition of the price ceiling below the
equilibrium level creates an excess in demand or shortage.

3.3.2 Floor Price

i. Sometime government intervene to push market price up instead of

down, by the imposition of price floor or minimum price.
ii. Floor price is a government-imposed regulation that prevents the prices
from falling below a minimum price level as set by the government.
iii. Price floor widely legislated in the agriculture sectors, as a way to
support the incomes of farmers.
 MBB2303: MICROECONOMICSMBB1303: MICROECONOMICS 12
DEMAND, SUPPLY AND MARKET EQUILIBRIUM

Figure 2.9

iv. As shown in figure 2.9, fixing the price above the equilibrium price level
creates a surplus of product (quantity demanded is less than quantity
supplied)

Ceiling Price Floor Price

 Price is not allowed to rise  Price is not allowed to set below
 Shortage occurs equilibrium price
 Surplus occurs
Advantages
 Consumers can buy products at  Producers’ income protected
lower price
Disadvantages
 Shortages of demand lead to the  Consumers have to pay more since
black market or illegal transactions. prices are higher than the equilibrium
 Producers will reduce production due price.
to lower price

REFERENCE

1. Deviga.V, Karunagaran M., (2013) Principles of Economics. Oxford Fajar Malaysia.

2. Deviga.V, Karunagaran M., Rohana Kamaruddin (2008) Microeconomics. Oxford
Fajar Malaysia.
3. Mankiw, N.G., Khoon, G.S, Boon,O.H., Hwa,Y.S., Yu, C.M.,Muszafarshah, M.M. &
Yvonne, L.L.E (2012). Principles of Economics, (Malaysia Edition). Cengage
Learning Asia.
4. Parkin, M. (2014) Microeconomics (Eleventh Edition). Person.