Lecture #2.

SUPPLY, DEMAND, AND ELASTICITY

In a market economy or capitalists economy, the interaction of demand and supply of goods and
services determine the prices of goods and services. This explains the law of demand and supply
and determination of price.
Demand
Demand is the schedule of various quantities of goods and services which buyers are
willing and able to purchase at a given price, time and place, all other factors are held constant
(ceteris paribus).
The law of demand states that as the price increases, the quantity demanded decreases;
and as the price decreases, the quantity demanded increases, ceteris paribus.
Various factors affecting demand include the following:
1. Price of the product 7. Tastes and preferences
2. Income of the buyers 8. Promotion and Advertisement
3. Quality of the product 9. Religion
4. Season 10. Price of related products
5. Price expectation 1. Fashion/Fad
6. Number of consumers/Population 12. Customs and tradition
A demand schedule is a listing of the different quantities of goods and services that
buyers will purchase given the various alternative prices.
Example:
Table 1. Demand schedule for commodity X
Price of X ( Px) Quantity demanded for
commodity X (Qdx)
10 9
20 8
30 7
40 6
50 5
60 4
70 3
80 2
 A demand curve is a plotted demand schedule as in Figure 2.

Figure 2. Demand Curve

100

80

60
Price 40

20

0
1 2 3 4 5 6 7 8 9 10
Demand
Quantity Demanded

A demand function is expressed in this form:

Qdx = f (Px)
Where: Qdx – quantity demanded for commodity X
Px – price of commodity X
While a demand equation is presented as follows:
Qdx = a - bPx
Where: a – intercept
b – slope (the formula: DQ /DP)
Example: Qdx = 20 - 0.4 Px
Interpretation of the intercept and the slope
a = 20 The intercept means that if the price of commodity X is zero,
the buyer will purchase 20 units of the commodity.
 b = 0.4 The slope means that for every one unit change (either an
increase or decrease) in the price of X, the quantity
demanded will change by 0.4 unit.
The negative sign indicates a negative (inverse) relationship
between the price of X and the quantity demanded.

Calculate the quantity demanded assuming the following prices:

1. P = 20 2. P = 30 3. P = 40

Answer:
1. If P = 20, then 2. If P = 30, then 3. If P = 40, then
Qx = 20 - 0.4 (20) Qx = 20 - 0.4 (30) Qx = 20 - 0.4 (40)
= 12 =8 =4

Plot the demand curve.

45 Figure 3. Demand Curve

Price Qd
40
2035 12
3030 8
25
40
Price 4
20
15 Demand
10
5
0
2 4 6 8 10 12 14

Quantity Demanded
 A change (or shift) in the demand refers to the shift in the entire demand schedule due to
the changes in some factors that were held constant like income, price of related products,
population and others.
Table 2. Demand schedule
45 Figure 5. Change in the Demand Curve
40 Price Qd1 Qd2
35
5 18 36
30
25 10 16 32
Price
20
15 14 28
15
10 20 12 24
5
0
25 10 20 D1 D2
0 30 4 8 812 161620 24 28 32 36 40
Market demand curve is the total demand
35 Quantity
6 12Demanded obtained by taking the horizontal
summation of all individual demand
40 4 8 curves of the consumers in the market.

Table 3. Demand schedule

Prices Consumer Consumer Consumer Total
A B C Demand
15 5 10 2 17
14 8 13 4 25
13 11 16 6 33
12 14 19 8 41
11 17 22 10 49
10 20 25 12 57

Figure 6. Total Demand Curve

16
Supply
15
14 Supply is the schedule of various
13 quantities of goods and services which
12
Price
11
10
9 Total
8 C A B
0 10 20 30 40 50 60
Quantity Demanded
sellers are willing and able to sell at a given price, time and place, all other factors are held
constant (ceteris paribus).
The law of supply states that as the price increases, the quantity supplied also increases,
and as the price decreases, the quantity supplied also decreases, ceteris paribus.
Some factors affecting supply:
1. Price of the product
2. Cost of production
3. Availability of raw materials
4. Technology
5. Number of sellers
6. Price expectation
7. Taxes and subsidies
8. Prices of other products

A supply schedule is a listing of the different quantities of goods and services that sellers
will sell given the various alternative prices.

Example:
Table 4. Supply schedule for commodity X
Price of X Quantity supplied for
(Px) commodity X (Qsx)
10 1
20 2
30 3
40 4
50 5
60 6
70 7
 80 8

A supply curve is a plotted supply schedule (Figure 7).

Figure 7. Supply Curve

90

80 Supply
70

60

50
Price 40

30

20

10

0
0 1 2 3 4 5 6 7 8 9

Quantity Supplied

Supply function: Qsx = f (Px)

Where: Qsx – quantity supplied for commodity X
Px – price of commodity X

Supply equation: Qsx = a + bPx

Where: a – intercept
b – slope (the formula: DQ /DP)
example: Qsx = - 10 + 0.6 Px

Interpretation of the intercept and the slope

 a = -10 The intercept means that if the price of commodity X is zero,
the seller will sell -10 units of the commodity. A negative
quantity is nothing. This only emphasizes that if there is no
price, the seller will sell nothing.
b = 0.6 The slope means that for every one unit change in the price
of X, the quantity supplied will change by 0.6 unit.
The positive sign signifies a positive relationship between
the price and the quantity supplied.

Calculate the quantity supplied assuming the following prices:

1. P = 20 2. P = 30 3. P = 40

Answer:
1. If P = 20, then 2. If P = 30, then 3. If P = 40, then
Qx = - 10 + 0.6 (20) Qx = - 10 + 0.6 (30) Qx = - 10 + 0.6 (40)
= 2 = 8 = 14

Price Qs
20 2
30 8
40 14

Figure 8. Supply Curve Supply

45
40
35
30
25
Price
20
15
10 Change in the supply refers to shift in
5 the entire supply schedule due to
0
0 2 4 6 8 10 12 14 16

Quantity Supplied
changes in some factors that were held constant like the cost of production, availability of raw
materials, price expectation and others.

Table 5. Supply schedule

Price Qs1 Qs2

28 4 2
Fig 10. Change in the Supply Curve
24 S2

20
S1
16
Price

12
8
4
0
0 2 4 6 8 10 12 14 16 18 20 22 24
Quantity Supplied

10
12 8 4
14 12 6
16 16 8
18 20 10
20 24 12
22 28 14
24 32 16
 Market supply curve is the horizontal summation of all individual supply of the sellers in
the market.

Table 6. Supply schedule

Prices Seller A Seller B Seller C Total Supply
1 11 5 1 17
2 15 9 4 28
3 19 14 7 40
4 23 18 10 51
5 27 22 13 62
6 31 27 16 74

7 Figure 11. Total Supply

6 B Total
A C
5
4
Price3
2
1
0
0 10 20 30 40 50 60 70 80
Quantity Supplied

Market Equilibrium

The condition when quantity demanded is equal to quantity supplied is said to be market
equilibrium.
 Quantity Demanded = Quantity Supplied
Price

Supply

Equilibrium Price
Demand
Quantity
EquilibriumQuantity
Figure 12. Market Equilibrium

When there is no equilibrium, there is no balance between the demand and supply.
Shortage is a condition when the quantity demanded exceeds the quantity supplied. This happens
when the price gets lower than the equilibrium price.
Surplus is a condition when the quantity supplied is greater than the quantity demanded.
This occurs when the price is above the equilibrium price.
Numerical example using data on Tables 1 and 4.
Table 7. Demand and supply schedule
Price of X Quantity demanded for Quantity supplied for
(Px) commodity X (Qdx) commodity X (Qsx)
10 9 1
20 8 2
30 7 3
40 6 4
50 5 5
60 4 6
70 3 7
80 2 8
 Market Equilibrium
Figure 13. Market Equilibrium in Mathematical
90 Language
80
70
60 Su
ppl
50
y
Price 40
30
20 Assume the
10 Dem
0 and
1 2 3 4 5 6 7 8 9 10
Quantity previous demand
and supply
equations:
Demand: Qdx = 20 - 0.4 Px
Supply: Qsx = - 10 + 0.6 Px
Find the equilibrium price and quantity.
Demand = Supply
Qdx = Qsx
20 - 0.4Px = - 10 + 0.6Px
20 + 10 = 0.6Px + 0.4Px
30 = 1Px
30 = Px
The equilibrium price is P30.
The equilibrium quantity can be obtained using either the demand or supply equations.
Demand Supply
Qdx = 20 – 0.4Px Qsx = - 10 + 0.6 Px
= 20 - 0.4(30) = - 10 + 0.6 (30)
= 8 = 8
Therefore, the equilibrium quantity is 8 units.