APPLIED ECONOMICS

Module 2
Demand and Supply
Prepared by: Mr. Roel Dumaboc
Lesson 1. Demand
Objectives
The learner will be able to;
 Understand the law of demand;
 to know and explain the factors that affect demand;
 interpret current situation based on the law of demand;
 Graph the law of demand and interpret demand curves.

What is demand?

Demand is the schedule of various quantities of commodities which buyer are willing and able
to purchase at given price, time and place.
Various quantities of commodities is refers to the quantity demanded. How much commodities
you are going to buy? It is very important to remember that, in economics, the term demand
refer to the entire relationship between the price and the quantity demanded. The term
quantity demanded refers to a given quantity chosen by buyers at a particular price.

What are the Factors that affects the demand?

The factors are;

1. income
2. population
3. taste and preferences
4. price expectation
5. price of related goods

How these factors affects the demand?

1. Income. People buy more goods and services when their income increase. Poor people
who become rich naturally purchase more basic goods. On the other hand, if their
income decrease, demand for such goods and services also declines.
A change in income brings about a change in the demand for goods and services; either
an increase or decrease which is directly related to change in income.

2. Population. More people means more demand for goods and services.
There are more consumers in an urban community than in a rural community. That is
why we can observe that there are more buyers in city stores than in barrio stores.
Conversely, less population means less demand for goods and services.

3. Tastes and Preferences. Demand goods and services increases when people like or
prefer them. Such taste or preferences are greatly influenced by advertisement or
fashion. On the other hand, if a certain product is out of fashion, the demand for it falls.
 4. Price Expectations. When people expect the price of goods, especially in basic
commodities, they buy more of these goods. In the same manner, they decrease their
demand for such products if they expect prices to decline. The reason for such
consumers’ behavior is to economize.

5. Prices of related goods. When the price of certain product increases people tend to buy
a substitute product. If the price of a certain product increases, consumer buy less of the
said product and buy more of the other close substitute. This means demand of first
product decreases while the demand of the substitute increases. If complementary
goods, the price of the one good and the demand of the other goods are directly
opposite. This means if the price of one good increases, the demand of the other
decreases.

Law of demand

Consumers are most likely to buy more goods and services as price decrease, and buy
less goods and services as price rises. (As price increases, quantity demanded decreases, and as
the price decreases, quantity demanded increases)

This theory will be only true if the assumption of ceteris paribus is applied. It means all other
thing are equal. For example, if the price of a radio increases by 20 percent then the quantity
demanded for such goods decreases. This true if the income of the buyer is the same. But
supposing the income of the buyer has increase by 100 percent. Would quantity demanded for
the radio fall since there is an increase of price? Certainly not, because the income of the
consumer has increased. This means that buyer has more purchasing power.

Another example, reducing the price of a product which is out of fashion does not
increase the quantity demanded for such product. This appears to contradict the law of
demand. It shows that the behavior of consumers is not affected by price reduction. This is true
because taste and preferences determine the demand of a product. If people do not like the
product, their tendency is not to buy it even if the price is reduced. Thus, to make the law of
demand valid, we always assume that taste and preferences do not change.
 Income effect. At lower prices, an individual has a greater purchasing power. This means
he can buy more goods and services.
Substitution effect. Consumers tend to buy goods with lower prices. In case the price of
a product that they are buying increase, they look for substitute whose price are lower.

Changes in demand vs. Changes in Quantity demanded

Changes in demand refers to the changes in the determinants of demand like income,
population, price expectation and so forth. For instance, an increase in population also
increases demand for goods and services, or decrease in population decreases the demand of
goods and services. It also true to income.

The in the graph, an increase in demand shifts the demand curve to the right, while a
decrease in demand shifts the demand curve to the left.

Change in quantity demanded indicate the movement from one point another point (from
price-quantity combination to another price-quantity combination on a fixed demand curve).
This means the demand curve does not change its position like that of the demand curve in the
change of demand. The changes in quantity demanded is brought about by change in price.
Whenever there is changes in price (increase or decrease), there is a corresponding change in
quantity demanded. For example, lower price results to more unit of goods. In the case of
change in demand, it caused by changes in determinants of demand.

Activity 1.
1. Give your examples of demand schedule and graph it.
 2. Aside from number 1, give two example of demand schedule and graph it make sure
that this two schedule shows the demand curves (increase and decrease).

3. Why is it important to have an understanding of demand, law of demands and it curves?

4. As a student or a citizen, what are the determinants in demand that you observed in the
society? Explain your answer why you say so?

Lesson 2. Supply
Objectives
The learner will be able to;
 Understand the law of supply;
 to know and explain the factors that affect supply;
 interpret current situation based on the law of supply;
 Graph the law of supply and interpret demand curves.

What is supply?
Supply is the schedule of various quantities of commodities which producers are willing and
able to produce and offer at a given price and time.
Table 1-Suppy schedule showing direct relationship between price and quantity supplied.
When the price is high the supply increases, when price is low supply decreases.
Price Quantity supplied
1 1
2 2
3 3
4 4
5 5

Determinants of Supply
 Technology
 Cost of production
 Number of seller
 Price of other goods
 Price expectations
 Taxes and subsidies

Technology
This refers to the techniques or method of production.
Modern technology increases supply of goods. It also reduces the cost of production and
encourage producer or sellers to increase their supply. Lower cost results in an increase in
profit.

Cost of Production
In producing goods, raw materials are needed, together with laborers. If the price of raw
materials or the salaries of the laborers increase, it means higher cost of production. The higher
cost of production decreases supply.

Number of sellers
More seller or more factories mean an increase in supply. Conversely, less seller or factories
means less in supply.

Prices of other goods

Changes in price of goods affects the supply of goods and services.

Price Expectations
If producers expect prices to rise very soon, they usually keep goods and then release them in
the market when price is already high. This can creates artificial shortage due to hoarding.
Factories increase number of production due to expected price increase. They cut also their
production when there is an expected decrease in price.
Taxes and Subsidies
Certain taxes increase cost of production. Higher taxes encourage production because it
reduces the earnings of businessmen.
Subsidies, which are financial grants or financial assistance are likewise given to producers.
Example is the fertilizer subsidy granted by the Philippine government to small farmers. Clearly
subsidies reduce the cost of production.

Law of Supply
As price increases, quantity supply also increases, and as price decreases, quantity supply also
decreases. This direct relationship between price and quantity supplied is the law of supply.
Producers are willing and able to produce and offer more goods at a higher price than at a
lower price. No businessmen is willing to produce goods if he make no profit.
Same to law of demand, this law of supply is only valid if assumption of ceteris paribus is
applied.

Changes in Supply vs. Changes in Quantity Supplied

Changes in supply pertain to changes in the determinants of supply. An increase in
supply shifts the supply curve to the right while a decrease in supply shifts the supply curve to
the left.

In the figure, S2 represents the decrease while S1 on the other hand represents the increase in
supply.

The Law of Supply and Demand

In the market, supply and demand interact freely. Supply is represented by producers or seller
while the demand is represented by buyers. Producers are willing and able to offer more goods
at a higher prices. This is the law of supply. On the other hand, buyers are willing and able to
purchase at lower prices. This is the law of demand. There is therefore contradiction between
two parties. One likes high price while the other likes low price. At high price, seller offers more
goods because they are encouraged. But buyers are able to purchase less goods. The result is a
surplus of goods. This means quantity supplied is greater than quantity demanded. To sell the
surplus goods, sellers compete with one another in decreasing their price. Buyer can take more
goods at a lower price. But producers are discouraged to produce and offer goods and services
at very low price. The result is shortage of goods. This means quantity demanded is greater
than the quantity supplied. Such situation compels many buyer to pay a higher price to get the
available goods. In the process of interaction between buyers and seller, an equilibrium price is
established.

Table 1.1 Supply and demand schedule indicating the equilibrium price or market price. At a
higher price, there is surplus, while at a lower price, there is shortage.
Quantity supplied Price Quantity demanded
1 1 5
shortage
2 2 4

3 3 3 equilibrium price

4 4 2
surplus
5 5 1

The law of supply and demand states that when supply is greater than demand, prices
decreases. When demand is greater than supply, price increases. When supply is equal to
demand, price is constant. This is the market price or equilibrium price. It means both sellers
and buyer have mutual agreement. That is, producers are able and willing to offer the same
quantity of goods which buyers are willing and able to purchase at a given price. In table 1.1 the
equilibrium is P3, the market price in which both seller and buyers decision are mutually
consistent.
Figure 1.1
Equilibrium price established by interaction
between demand and supply. Above
equilibrium price is surplus, below the
equilibrium price is shortage. In the process
of interaction between buyer and sellers
prices tends to move towards the
equilibrium price.

Activity 2.
1. Give your examples of supply schedule and graph it.

2. Graph you demand schedule and supply schedule. Put some markers of the following;
 Surplus, Shortage, Equilibrium price.

3. Demand and supply reacts when there is a change in the prices of goods and services.
What do you think is the role of the price system in our economy?

Who do you think determined the prices of goods and services?

4. Hoarding of basic goods by producers creates an artificial shortage. What happens to
the price, demand and supply in the case of hoarding?

5. Gives the meaning and examples of the following;

1. Price

2. Relative price

3. Normal goods
4. Inferior goods