Unit 2 – DEMAND, SUPPLY AND MARKET EQUILIBRIUM

OVERVIEW:
In a market economy or a capitalist economy, the interaction of demand and supply of goods
and services determine the price of good and services. This unit will explain the law of demand
and supply and determination of price.

LEARNING OUTCOME: After the completion of this unit, the students will be able to:
1. To define the theories of demand and supply.
2. To solve simple demand and supply equation.
3. To identify the conditions affecting the demand and supply of goods in the market.
4. To analyze and solve simple case study problems,
5. To determine the validity of theories in the past in relation to the current situation.

COURSE MATERIAL:
The Coca Leaves Production

“What does Mother’s Day flowers have to do with cocaine? Very little, most people would
think. But as an economist, I often explain to my students that the world is economically
connected, often in strange ways. The flower business is one of those strange economic
connections.
Mother’s Day, which this year falls on May 10, is typically big for the American floral industry,
which depends on it for over a quarter of all holiday flower sales. It’s especially important to
flower vendors this year as the coronavirus has ravaged the industry, affecting both supply and
demand. About a third of cut flowers purchased in the U.S. come from California, while the rest
are imported. About 80% of those come from Colombia or Ecuador. The story of how both
countries became such an important source of flowers for the U.S. can be traced back to the
U.S. war on drugs.
In the late 2000s, the U.S. and Colombian government were looking for new ways to stem
the flow of cocaine into the U.S. Part of the strategy involved law enforcement: increasing
interdictions to stop drugs before they crossed the border and ramping up arrests of people
selling drugs in the U.S.
Another part of this strategy, however, was to convince farmers in Colombia to stop growing
coca leaves, a traditional Andean plant that provides the raw ingredient for making cocaine, by
giving them preferential access to U.S. markets if they grow something else. The goal of the
program was to give these subsistence farmers a legal crop that would be roughly as profitable
as growing coca leaves - whether flowers, honey or coffee. This is formally called crop
substitution.
In theory, by cutting back the supply of coca leaves, the price of the key raw material in
cocaine rises. This cost increase is passed along the supply chain, raising the price of cocaine
at every point. Why is raising the price of cocaine important? A basic idea in economics is the
“law of demand,” which says the higher the price of a product the less people buy, holding
everything else constant. Pushing up the price of cocaine should reduce the amount Americans
consume.
Not just Colombia but also Ecuador, Bolivia and Peru – all coca-producing countries – get
dutyfree access to U.S. markets in exchange for clamping down on illegal drugs, under the
Andean Trade Promotion and Drug Eradication Act.
Has crop substitution worked?

Well, not to eradicate the cocaine market. Only last year Colombia had a record coca crop,
and the street price of cocaine hasn’t budged. There are complicated reasons for this, including
the persistence of U.S. demand for drugs, regardless of source, the ingenuity of drug trafficking
organizations, and the cultural significance of coca leaf in the Andean region.

But this failed U.S. drug policy did lead to a surge in cut flower exports to the U.S. from both
Colombia and Ecuador. Colombia exported US$800 million worth of flowers to the U.S. in 2019,
up from $350 million in 2000. Ecuador’s exports tripled from $90 million in 2000 to $270 million
in 2019. As a result of the increased supply, flower prices in the U.S. rose less than average
inflation. (Please click bit.ly/33Ua71O)

The students may group themselves into 5 and discuss among themselves the effect of huge
demand for Coca leaves in the life of the people. Find who are the people behind it and why
the government had stick in this far product.

LEARNING ACTIVITY:

1. The students may group themselves into 5 and discuss among themselves the effect of
huge demand for Coca leaves in the life of the people. Find who are the people behind
it and why the government has not stop the sale of this product despite the on-going war.
2. Make a positon paper about this material which may be submitted in two weeks time. By
watching the video below

The student may watch the video and write a position paper about this topic.

REFERENCES:
Understanding Economics by Payumo,
bit.ly/33Ua71O
ME https://youtu.be/FJzdrdVOfW0ASUREMENT:

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Lesson 4 - Demand Market and its Determinants
Display the Slide 1 and discuss the coverage of the discussion for a week. Tell the class that the
discussion for the week will focus on the concept of demand economics. Here is the Circular Flow of
Economy

Fig. 4.1

Ask the class to share their understanding on the concept of circular flow of sconomy based
on their research assignment from last week. Call on at least 3 students to answer. Display
Slide 2 and discuss the definition of the circular flow model. Refer to the information below for
explanation.
Circular Flow of Economy Model – refers to a visual model of the economy that shows
how money flows through the markets among households and firms.
Explain to the class that in this model, there are two kinds of decision makers – households
and firms. Explain to the class that in this model. Display slide 3 and discuss the following:
• Firms – are the ones that produce goods and services using inputs, such as
labor, land and capital. These inputs are called the factors of production.
Furthermore, the following are the definition of the factors of production.
1. Labor - refers to the human input into the production process. Each
individual has a different level of skills, qualities and qualifications. This is
known as the human capital.
2. Land - refers to the natural resources on the planet. It includes space on
the ground, hills, seas, oceans, etc.
3. Capital – refers to the man –made physical goods that are used to
produce other goods and services. It includes tools such as machines,
computers etc.
• Households - refers to the ones who own the factors of production and
consume all the goods and services that firms produce.

Furthermore, discuss to the class that households and firms interact in two types of markets
Display Slide 4 and discuss the following:
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 • Market for goods and services - households are buyers and firms are sellers.
In particular, households buy the output of goods and services that firms
produce.

Market for the factors of production – households are sellers and firms are buyers. In these
markets, household provide firmss the inputs that the firms use to produce goods and services.

The circular flow diagram is a simple way of organizing all the economic transactions
that occur between hoseholds and firms in the economy.

The Circular Flow – this diagram is a schematic is a schematic representation of the

organization of the economy. Decisions are made by households and firms.
Households and firms interact in markets for goods and services and in the markets for
factors of production. The outer set of arrows shows the flow of money, and the inner
set of arrows shows the flow of money, and the inner set of arrows show the flow of
goods and services.
The Inner loop of the circular flow diagram - represents the flow of goods and
services between households and firms. The households sell the use of their labor, land
and capital to the firms in the markets for the factors of production. The firms then use
these factors to produce goods and services, which in turn are sold to households in the
markets for goods and services. Hence, the factors of production flow from households
to firms, and the goods and services from firms to households.
The outer loop of the circular flow diagram – represents the corresponding flow of
money. The households spend money to buy goods and services from the firms. The
firms use some of the revenue from these sales to pay for the factors of production, such
as the wages of their workers. What’s left is the profit of the firm owners, who
themselves are members of the households. Hence, spending on goods and services
flows from households to firm, and income in the form of wages, rent and profit flows
from the firms to households.
Afterwards, explain to the students that the circular flow of economy above is only a simple
model of the economy. There are more complex circular flow model that includes the roles
of the government and international trade. Yet these details are not crucial for basic
understanding of how the economy is organized.
Demand and Supply are two words that an economist use most often and for good reasons.
The two refers to the behavior of the people as they interact with one another in markets.
Indeed, the law of supply and demand is the core of economics. First the next slide will
elaborate on the definition of market as the arena from which demand and supply works its
functions in the economy.

Market – is a group of buyers and sellers of a

particular good or service. The buyer as a group
determine the demand for the product and the
sellers as a group determine the supply of the
product. It is a place where buyers and sellers
interact together.

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 Demand refers to the quantity of a product or service that the buyer is willing and able to
purchase at various possible prices at any given time. Emphasize to the class that demand is
the amount of a good that buyers are willing and able to purchase. Ask then the students what
factor/s s/he will consider before buying his/her desired item. Expect that the students might
give answers such as the price, or the quality or the amount of money that s/he have.
Display the next slide, and explain to the class that these factors are known as the
determinants of demand.

The Determinants of Demand

• Price of good - refers to how much is the wanted product or service
• Income of the buyer - this determinant answers the question, “for whom?”
• Population or number of buyers - the number of buyers has a direct effect on the
quantity of goods and services being purchased.
• Tastes and Preferences – this is influence mostly by advertisements.
• Prices of related goods o Substitute products - these refers to goods that directly
compete with the good based on the opinion of the buyer. For instance, orange juice
can be a substitute to apple juice.
o Complementary products - use of the good based on the opinion of the buyer.
For instance, MP3 players and headsets are complements as the use of the
first product will also require the use of the second product.
• Future expectations - a person’s expectations about the future may affect her
demand for a good or service today.
Ceteris Paribus of demand - refers to the Latin phrase which literally means, “all other
things being equal.” Economist use the term ceteris paribus to signify that all the
relevant variables are held constant, except for the price. Afterwards, show the next slide
to the class to show the Demand schedule

The Demand Function, Demand Schedule and Demand Curve

Display the slide on the Law of Demand which shows the inverse relationship
between price and quantity which can be illustrated in three different ways through a
demand function, demand schedule and a demand curve.
Demand function is expressed in term of mathematical equation Qd = 80-4P
this shows that the slope of coefficient of the price is -4 which means that for every
peso increase in price quantity demanded decreases by 4 units. The constant term 80 is
the maximum quantity the market can absorb, and that is when the price is free or has a
zero price.
Demand schedule is a list or table that shows the inverse relation between price and
quantity demanded, all other things constant.

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 Figure 4.2

The table shows that as price goes up from P10 to P15, quantity demanded
decreases from 40 to 20 units.
Demand curve is a locus of points that shows the inverse relation between price
and quantity demanded, all other things constant.

Figure 4.3
Demand Curve

Change in Quantity Demanded versus Change in Demand

A. Change in Quantity Demanded (ΔD)

 Display this slide to show that “a change in quantity demanded” occurs when there is
a change in the price of the good itself all other things constant.

Figure 4.4

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 Demand Curve showing the change in Price
 The above figure shows that increasing the price from 10 to 15 results to a decrease in
quantity demanded as shown by point A to point B. A change in quantity demanded
is reflected by movement from one point to another point along a given demand
curve and this movement is due to a change in price of the good itself.

B. Change in Demand
 Display another slide to show that “a change in demand” occurs whenever any of the
other determinants of supply changes. An increase in demand is represented by
either a shift from D1 to D2 (increase) or a shift from D2 to d1 (decrease).

Fig. 4.5

The illustration above shows a shift of the demand curve from D1 to D2 (increase) or
D2 to D1 (which means decrease in the demand). The students must examine
closely the effect of every determinant in the market.

LEARNING ACTIVITY:
To do a seatwork by plotting the Demand and Supply Schedule in one (1) piece of graphing
paper. (Display the slide)

(See answer on page 24, Introduction to Microeconomics by Mutya)

MEASUREMENT:

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A thirty (30) point analysis quiz via Google Form.

Lesson 5 – Supply, Firm and its Determinants

From the assignment of the students, ask at least two students to give the meaning of the
law of supply. Afterwards, display Slide and discuss the following:
Law of supply – states that, the higher the price, the larger the quantity supplied and all
other things held constant (ceteris paribus).
Supply shows the different quantities of commodities which producers are willing and able to
produce and make available for sale in the market at each specific price in a set of various
prices during some specified time period. This means that the higher the price, the higher the
quantity supplied. Producers supply more at a higher price because it will mean higher
revenue.

Supply Function, Supply Schedule and Supply Curve

Supply function is expressed in term of mathematical equation
Qs = -10 + 5P shows the coefficient or the slope of the price is 5 and a constant
term -10. The coefficient is interpreted that for every peso increase in price, quantity supplied
will increase by 5 units while the constant term -10 implies that if price is zero, no one will ever
supply the good and is tantamount that no one will supply if price is below P2.
Supply Schedule below shows various combination of prices and quantity supplied by the
firm. It also shows that at higher prices the firm is inspired to supply more.

Fig 2.6

Fig. 5.1

Supply curve as shown in the Display slide, has an upward slope to the right reflecting
that as price increases the quantity supplied also increases.

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 Fig. 5.2

Explain to the students that the dots along the line shows the proportional increase in
quantity as the price of good increase successively.

The Determinants of Supply (This will be presented by the next slide)

• Resource price - has an inverse relation to supply. It is characterized with high
payment for land, labor, capital and entrepreneur which discourages seller’s hence
there will be a decrease in supply.
• Technology - has a direct relationship to supply because an improved technology
encourages producers creating increase in the supply of goods.
• The price of related goods or price of competing products - it has an inverse relation
to supply. Palay and corn to farmers are competing products, so if the price of Palay
increases farmers will plant Palay rather than corn to take advantage of higher Palay
price.
• Firm’s expectations about future prices – it has an inverse relation to supply. If the
price of rice is expected to increase, traders tend to hoard, hence, there will be a
decrease in supply.
• Number of suppliers – has a direct relation to supply. The more the number of
sellers, the higher the supply.
• Taxes and subsidy - has a direct relation to supply, respectively. Subsidy - has an
inverse and direct relation to supply respectively.

• Calamities - has a direct negative effect once typhoon, flooding and earthquake
affect the supply of goods.

Change in Quantity Supplied versus Change in Supply

C. Change in Quantity Supplied (ΔS)

 Display this slide to show that “a change in quantity supplied” occurs when there is a
change in the price of the good itself all other things constant.

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 Fig.
5.3

 The above figure shows that increasing the price from 5 to 10 from point A to point B
increases quantity supplied from 15 to 40 units. A change in quantity supplied is
reflected by movement from one point to another point along a given supply curve
and this movement is due to a change in price of the good itself.

D. Change in Quantity Supply

• Display another slide to show that “a change in supply” occurs whenever any of
the other determinants of supply changes. An increase in supply is represented by a
shift of the supply curve to the right. Alternatively, a decrease in supply is
represented by a shift of the supply curve to the left.

Increase in Supply Decrease in Supply

Fig. 5.4

• The illustration above shows a shift to the right of the supply curve, S1 to S2,
represents an increase in supply, while a shift to the left, S1 to S2, represents a
decrease in supply.

LEARNING ACTIVITY:

The student can group themselves into three (3) and choose a determinant to talk about.
Every group shall make a hypothetical supply curve on a piece of paper with their explanation
supporting their answer.

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MEASUREMENT:

A ten (10) point hypothetical supply analysis via Google form

A.
B.
C
D.

REFERENCES:

Payumo, page 35-51. Understanding Economics, 2014

Paraiso. Larano and Cuevas, page 15-25. Introduction to Microeconomics, 2011

Lesson 6 - Market Equilibrium and Demand Supply Equation

COURSE MATERIAL:

The students has to understand that demand and supply interact freely. Supply is
represented by producers or sellers, while demand is represented by buyers or consumers. The
law of supply describes that producers are willing and able to offer more goods at higher prices
while the law of supply describes that the buyers or consumers are willing and able to buy at
lower prices. Clearly, it shows that there is a conflict between the two parties. One favors high
price while the Other favors low price.

Display the slide, and explain that demand and supply should eventually be analyzed as one
since the market operates within the forces of both demand and supply. Combining the demand
and supply curves will show the point of market equilibrium. The equilibrium is attained at the
point when demand is equal to supply.

Fig 6.1
The Equilibrium Equation:

On this slide, the students will learn to combine their demand and supply analysis as
Qd = Qs
Solution:

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 Qd = 80-4P Qs = -10 + 5P
-4P- 5P = - 80 - 10
-9P = -90
P = -90/-9
P = 10
Is the price of P10 really the equilibrium price? Let the student substitute the price of
P10.00 on the demand and supply function.
Therefore:
80 - 4(10) = -10 + 5 (10)
80 - 40 = -10 + 50
40 = 40

Then we can conclude that Pe = 10 and Qe = 40 units

This means that any price above P10 will result to surplus in the market while any price
below P10 will result to shortage.
Violations of the Law of Supply and Demand

A common way of attempting to go against the law is the use of price controls, where price
ceilings are set by the government normally on basic goods. Basically some of the commodities
from which price ceilings were set included laundry soap, milk, poultry, rice, chicken and pork.

LEARNING ACTIVITY:
1. Research on price control and price flow
2. Seatwork on equation, copy the equation on the slide and answer in 20 minutes.

MEASUREMENT:
A short quiz on equilibrium equation with time limit will be given on-line with under time pressure
A solution will be submitted using a cam photo shot and will be uploaded in the group page.

REFERENCES:
https://bit.ly/2DcNQkZ https://bit.ly/2QCdF0Z

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