Topic Outline

DEMAND, Topic 2(a)

SUPPLY & 2.1 Introduction: Market and the Circular Flow
MARKET 2.2 Demand (DD)
2.3 Supply (SS)
EQUILIBRIUM
2.4 Market Equilibrium
2.5 Change in Equilibrium (SS & DD)
2.6 SS/DD Analysis: Example

2.1 INTRODUCTION
Markets
Market & the circulation flow
• A market is a group of buyers and sellers
of a particular goods and services.
• A market may be local, national or
international in scope.
• This chapter concern purely competitive
market with a large number of
independent buyers and sellers.

2.2 DEMAND
An economic principle that describes
a consumer’s desire and willingness
to pay a price for a specific good or
service, other factors const ant.
Law of Demand
• Says that quantity demanded varies inversely, or
negatively, to the price, other things constant.
• Negative relationship between price and quantity
demanded.
• The higher the price, the smaller the quantity
demanded.

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 Demand Schedule & Demand Curve: May’s Demand Schedule and Demand Curve:
Price of
Ice-Cream Cone

• The demand schedule is a table that $3.00

shows the relationship between the 2.50

price of the good and the quantity 1. A decrease

2.00
in price ...
demanded. 1.50

• The demand curve is a graph of the 1.00

relationship between the price of a 0.50

D
good and the quantity demanded.
0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.

Example
The market demand curve is the horizontal
sum of the individual demand curves!
Individual Demand & Market demand: When the price is RM2.00, When the price is RM2.00, The market demand at
Ali will demand 4 ice- Abu will demand 3 ice- RM2.00 will be 7 ice-
cream cones.
• The individual demand is the
cream cones. cream cones.
Ali’s Demand + Abu’s Demand = Market Demand
relationship between the quantity Price of Ice-
Cream Cone
Price of Ice-
Cream Cone
Price of Ice-

demanded by a single buyer and its

Cream Cone

price.
2.00 2.00 2.00

• The market demand is the 1.00 1.00 1.00

relationship between the total quantity 4 8 3 5 7 13

demanded by all consumers in the Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

The market demand at

market and its price.
When the price is RM1.00, When the price is RM1.00,
Ali will demand 8 ice- Abu will demand 5 ice- RM1.00, will be 13 ice-
cream cones. cream cones. cream cones.

Changes in Quantity Demanded (Qd)& Changes in Quantity Demanded

Change in Demand (DD): (movement along):
Price of Ice-
Price of ice-cream
• Changes in quantity demanded result in Cream
Cones
con es i nc re as e a nd
movement along the demand curve due a
results in a movement
change in price of that particular good B
RM2 along the demand
while other factors remain constant. curve.
(upward/downward movement)

• Change in demand is the shift of the

A
demand curve due a change in other RM1

factors while price remains constant.

(leftward/ rightward shift) D
0
4 8 Quantity of Ice-Cream Cones

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 Change in Demand (shift):
Change in Demand (shift):
A shift in the demand curve either to the left Price of
Ice-Cream
or right caused by any changes that alters Cone

the quantity demanded at every price. Such Increase

as: in demand

1. Prices of related goods – substitutes goods or

complements goods
2. Changes in consumer income – normal goods Decrease
in demand
or inferior goods Demand
curve, D2
3. Tastes and preferences Demand
curve, D1
4. Population or number of buyers Demand curve, D3
5. Expectations about the future price 0 Quantity of
Ice-Cream Cones

1. Prices of Related Goods: Prices of Related Goods (cont.)

(i) Substitutes Goods (ii) Complements Goods

- A product that can be used in place of
another product (similar satisfaction).
- A change in the price of substitute
products affect the demand for the
product in the same direction in which
the price change.
- E.g. tea vs. coffee
- A product that is used in conjunction with
another product (use together).
- The change in the price of a
c o m p le m e n ta r y p r od u ct a ffe c ts th e
demand for the product in the opposite
direction to the change price.
- E.g. pen and ink.

(Pcoffee ↑ ; Qd coffee↓ ; Dtea↑ ) ( Ppen↑ ; Qd pen ↓ ; Dink↓ )

2. Changes in Consumer Income: 3. Tastes & Preferences:

Goods can be classified into two broad
categories: • Tastes and preferences of consumers change
§ Normal goods: the demand increases when significantly.
income increases and demand decreases
when income decrease. • If a product become more fashionable, the
§ (Income ↑; Demand↑) demand for it will increase and if the same
product becomes outdated, the demand for it
will fall.
§ Inferior goods: the demand decreases when
income increases and demand increases when
income decreases • E.g. Changes in music.
§ (Income ↑; Demand↓)

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 4. Population or Number of Buyers: 5. Expectations about the future price:

• A larger population with a high rate of growth
c re a t e s g r e a t er d e m a n d f o r g o od s a n d
services.
• E.g. An increase in the population of UTAR
would increase the demand for houses and
other goods and services.
• Expectation of price in the future could either
increase or decrease current demand.
• E.g: If consumers currently expect that the price
will be lower later, they will demand less now.
Demand curve will shift to the left.
• E.g: If consumers currently expect that the price
will be higher later, they will demand more now.
Demand curve will shift to the right.

2.3 SUPPLY Law of Supply

Supply indicates how much • Law of supply states that the

of a good producers are quantity supplied is usually directly
related to its price, other things
willing and able to offer for constant
sale per period at each
possible price, other things § The lower the price, the smaller the
constant. quantity supplied
§ The higher the price, the greater the
quantity supplied

Supply Schedule & Supply Curve Ben’s Supply Schedule and Supply Curve
Price of
Ice-Cream
• The supply schedule is a table that Cone
$3.00
S

showing how much of a product 2.50

firms will set at different prices. 1. An
increase
in price ... 2.00

• The supply curve is a graph 1.50

illustrating how much of a product 1.00

a firm will set at different prices. 0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.

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 Individual Supply & Market Supply Market Supply Curve

• The individual supply is the

relationship between price of good
and the quantity an individual
producer is willing and able to sell
per period, other things constant.
• The market supply is the sum of all
that is supplied each period by all
producers of a single product.

Changes in Quantity Supplied (Qs) &

Change in Supply (SS)
Changes in Quantity Supplied
• A changes in quantity supplied result Price of Ice-
in the movement along the supply Cream S
Cone
curve due a change in price while B
other factors remain constant. $3.00
A rise in the price
of ice cream
• Change in supply is shift of supply cones results in a
curve resulting from a change in one movement along
of the determinants of supply other A the supply curve.
1.00
than price of the goods.

Quantity of
Ice-Cream
0 1 5 Cones

Change in Supply Shifts in The Supply Curve

Price of
• A shift of the supply curve, either to the left or Ice-Cream Supply
right. Cone curve, S 3

• Determinants of supply other than the price of Supply

curve, S 1
Decrease
the good in supply Supply
curve, S2
1. Input prices
2. Government regulation Increase
3. Technology in supply

4. Prices of related products

5. Number of sellers
6. Expectations
0 Quantity of
Ice-Cream Cones

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 1. Input prices
• Response to the factor of production (labor, land and
capital).
• E.g: To produce ice-cream, sellers use various inputs
such as cream, sugar, flavoring, ice-cream machines.
• When price of one or more of these inputs ri ses,
producing ice-cream is less profitable (higher cost).
Supply curve will shift to the left.
• When pri ce of one or m ore of th ese i nputs fal ls,
producing ice-cream is more profitable (lower cost).
Supply curve will shift to the right.
3. Technology
• Represents the economy’s knowledge about how to
combine resources efficiently.
• If a better technology is discovered, production costs
will fall.
• Thus, suppliers will be more willing and able to supply
the good at each price.
• E.g: When new technology are introduced in the
production of ice cream. Supply of ice cream will
increase. Supply curve will shift to the right.
5. Number of Sellers
• Affect the supply curve in the market either to the
right or left.
• E.g: More Sellers: If there is an increase in the
number of sellers in the market, then the supply of
the good increases. Supply curve will shift right.
• Fewer Sellers: If there is a decrease in the number
of sellers in the market, then the supply of the good
decreases. Supply curve will shift left.
2. Government Regulation
• Supply may also change because of changes in the
legal and regulatory environment in which firms
operate.
• E.g.: Taxes - will increase the firms cost and
decrease the supply. Supply curve will shift to the
left.
• Subsidi es - w il l decrease th e fi rms cost an d
increase the supply. Supply curve will shift to the
right.
4. Price of Related Goods
Substitutes Goods:
• If there is an increase in the price of substitute goods in
production, supply of a good will decrease.
• Example: Big Mac Hamburger (BM) and Double Cheese (DC)
Burger
( PBM ↑; QSS BM↑; SSDC↓ )
Complementary Goods
• An increase in the price of complementary goods will increase
the supply of a good & vice versa.
• Example: Pen and Ink
( Ppen ↑; QSS pen↑; SSink ↑ )
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6. Expectations
• Expectation of price in the future could either
increase or decrease current supply.
• E.g: If producers currently expect that the price
will be lower later they will supply more now.
Supply curve will shift to the right.
• If producers currently expect that the price will
be higher later they will supply less now.
Supply curve will shift to the left.
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 2.4 MARKET EQUILIBRIUM
Equilibrium:
Output (Product) Market
Price of
DD & SS Interaction Ice-Cream
Cone Supply
3 set of market condition / effect:

Equilibrium price Equilibrium

Equilibrium: Shortage Surplus $2.00
(Excess Demand): (Excess Supply):
The quantity
demanded equal The quantity The quantity
the quantity demanded exceeds supplied exceeds Equilibrium Demand
supplied (Qd=Qs) the quantity the quantity quantity
at the current price. supplied (Qd>Qs) demanded (Qs>Qd)
at the current price. at the current price. 0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones

Market Equilibrium: Surplus (Excess Supply):

• The condition that exists in a market when the
plans of buyers match those of sellers. Price of
Ice-Cream Supply
• So quantity demanded equals quantity supplied Cone Surplus
and the market clears. $2.50
• There is no tendency for price to change. 2.00
• Equilibrium price:
The price that balances quantity supplied and
quantity demanded.
Demand
• Equilibrium quantity:
The quantity supplied and the quantity demanded 0 4 7 10 Quantity of
at the equilibrium price. Quantity Quantity Ice-Cream
demanded supplied Cones

Shortage (Excess Demand):

Surplus (Excess Supply):

• Current price ($2.50) > Equilibrium price ($2), Price of

Ice-Cream Supply
then; Cone

• What: There is surplus or excess supply. $2.00

• Why: Qs > Qd
1.50
• Size: (Qs–Qd) = (10–4) = 6 units Shortage
• Adjustment: Price tends to drop ($2.50 $2) Demand
and reach back at equilibrium.
0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
supplied demanded Cones

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 2.5 CHANGE IN EQUILIBRIUM:
Shortage (Excess Demand):
• The market equilibrium will change when there
• Current price ($1.50) < Equilibrium price ($2), is a shift in the demand or supply curve.
then;

• We will see what happens when:

• What: There is shortage or excess demand.
• Why: Qd > Qs (i) The demand curve shifts and supply
remains constant.
• Size: (Qd–Qs) = (10–4) = 6 units
• Adjustment: Price tends to rise ($1.50 $2) (ii) The supply curve shifts and demand
and reach back at equilibrium. remains constant.
(iii) Both the demand and supply curves shift.

Three Steps for Analyzing Changes in Effect of Change in Demand:

Equilibrium:
• Change in DD can arise from a number of
factors; change in income, tastes, etc.
1. Decide whether the events shifts the supply
or demand curve (or both).
• E.g: Suppose there is an increase in the income
2. Decide in which direction the curve shifts. level; demand for pens will increases and the
demand curve will shift rightwards.
3. Use the supply-and-demand diagram to see
how the shift changes the equilibrium price
and quantity.

(a) Increases in the income level: Effect of Change in Supply:

Price of pen D2 • Change in SS can arise from a number of

Increase in the income level: D1 S factors; change in cost, technology, etc.
• Demand will increases.
E2
• Demand curve shift to the P2 • S up po se t he re is a de cr eas e in c o st o f
right from D1 to D2.
E1 production, thus supply for pens will decreases.
• Equilibrium price will P1
The supply curve will shift rightwards, to S1.
increase from P1 to P2.
• Equilibrium quantity will
increase from Q1 to Q2

Q1 Q2
Quantity of pen

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 (b) Decreases in the cost of production: (b) Decreases in the cost of production:
S1

• _______ will ______ P D Decrease in the cost of P D

S production: S2
• _______ curve shift to
______ from ___ • Supply will increases.
to_____. E1
• Supply curve shift to the P1
• Equilibrium price will right from S1 to S2.
________ from P1 to E2
P1 P2
____. • Equilibrium price will
decrease from P1 to P2.
• Equilibrium quantity will
________ from Q1 to____. • Equilibrium quantity will
increase from Q1 to Q2

Q1 Q Q1 Q2 Q
49 50

Effect of Changes in Both Demand and Supply:

• As long as only one curve shifts, equilibrium
price and quantity will change.
• If both curve shift, the outcome is obvious.
Effect of Changes in Both Demand and
Supply:
E.g: Price of chicken is expected to fall.

i. Changes in SS = Changes in DD
Thus; supply (for today) will increases and
ii. Changes in SS < Changes in DD
iii. Changes in SS > Changes in DD
demand (for today) will decreases.
(i)↑ SS < ↓ DD
(ii)↑ SS > ↓ DD
(iii)↑ SS = ↓ DD

Effect of Changes in Both Demand and Supply: Effect of Changes in Both Demand and Supply:

(i) Change (↑) in SS < Change (↓) in DD: (ii) Change (↑) in SS > Change (↓) in DD:

Price • SS↑; SS curve shift right. Price • SS↑; SS curve shift right.
S1 S1
• DD↓; DD curve shift left. • DD↓; DD curve shift left.
E1 S2
• As ↑SS < ↓DD; • As ↑SS > ↓DD;
P1
ü Equilibrium price ↓ E1 ü Equilibrium price ↓
P1 S2
ü Equilibrium quantity ↓ ü Equilibrium quantity ↑
E2
P2
E2
P2
D1 D1
D2 D2
Quantity Quantity
0 Q2 Q1 0 Q1 Q2

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Effect of Changes in Both Demand and Supply: 2.6 Supply and Demand Analysis:
(iii) Change (↑) in SS = Change (↓) in DD:
Question (i):

Price S1
• SS↑; SS curve shift right. Proton Berhad increases the price of its car
• DD↓; DD curve shift left.
• As ↑SS < ↓DD; model, Proton Exora from P0 to P1. Explain
P1
E1 ü Equilibrium price ?? the law of demand and based on it, explain
ü Equilibrium quantity ??
what will happen to the quantity demanded
for Proton Exora car. Sketch a graph to
D1 illustrate your explanation.
Quantity
0 Q1
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Question (iii):
Question (ii):
Assume that Proton Exora cars need
What will happen to Perodua Aruz a specific regular maintenance
(substitutes) when the price of service to bring out the performance
Proton Exora car rise? Sketch a of the car. Based on situation in (i),
graph to illustrate your explanation. what will happen to the demand of
that specific regular maintenance
service?
57 58

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