CHAPTER B Tue Basic ANALYsis OF DEMAND AND SupPLy supply is usually affected by the conduct of producers. The interplay between these two is the foundation of economic activity. Thus, the consumer identifies his/her needs, wants, and demands, while producers address these by accordingly producing goods and services. In the end, the consumer gains satisfaction while the producer gains profit. D emand is generally affected by the behavior of consumers, wt As the economy cannot operate without this interaction =p between the consumer and the producer, it is essen- tial, therefore, that students understand the different movements of the demand and supply curve, as well as the concept of market equilibrium. This chapter provides an introduction of the basic ele- ments of demand and supply. An understanding of these concepts is essential in the study of economics. ‘Amarketis where buyers and sellers meet. tis the place where they both trade or exchange goods or services—in other words, it is where their transac- tion takes place. There are different kinds of mar- kets, such as wet and dry. Wet market is where people usually buy vegetables, meat etc. On the other hand, dry market is where people buy shoes, clothes, or other dry goods. However, in economic parlance, the term market does not neces- sarily refer to a tangible area where buyers and sellers could be seen trans- acting. It can represent an intangible domain where goods and services are traded, such as the stock market, real estate market,-or labor market— where workers offer their services, and employers look for workers to hire.Principles of Econ, 32 Demand that people f a good or service D to the quantity of @ 90 yen other ready to buy agen pes win given tie pai, whe pede besides price are held conta. Simpy put the dorane Te Peet te uanity ofa good or service that buyers are willing to uy “ Particular time. Demand therefore implies three things: + desire to possess a thing; ae the ability to pay for itor means of purchasing it; and * willingness in utilizing it Law of Demand ‘The Law of Demand states that price goes UP, the quantity demanded wit ‘90 DOWN. Conversely, i price goes DOWN, the quantity demanded will go UP ceteris paribus. The reason for this is because consumers always tend to MAXIMIZE SATISFACTION. Demand Schedule ‘A demand schedule is a table that shows the relationship of prices and the ‘Specific quantities demanded at each of these prices. The information pro- ed to construct a demand curve lationship in graphical form. Table 'edule for rice per month, vided by a demand schedule can be us showing the price-quantity demanded rel 2.1 presents a hypothetical demand sche Table 2.1 Hypothetical Demand Schedule for Rice Per Month Situation Price (P) Quantity (kg) A 5 3 . 4 13 c 3 20 D 2 o = 1 6 ei month For tan ees and quantities for the demand for rice er mont instance, at a given price ppurchase only 8 kilograms ofc (stuns, ates waver is wing t0 he is willing to buy 45 kilogy sora er, ic , rams of rice (situation £) -” ** @ Price of Pt,Chapter 2: The Basic Analysis of Demand and Supply a3 Chapter 2: The Basic Analysis of Demand and Supply SD Demand Curve Itis a graphical representation showing the relationship between price and quantities demanded per time period. A demand curve has negative slope thus it slopes downward from left to right, The downward slope indicates the inverse relationship between price and quantity demanded. Most demand curves slope downwards because (a) as the price of the prod- uct falls, consumers will tend to substitute this (now relatively cheaper) product for others in their purchases; (b) as the price of the product fas, this serves to increase their real income allowing them to buy more products (Pass & Lowes 1993). Figure 2.1 illustrates a typical demand curve. Figure 2.1: Demand Curve P, This figure illustrates a typical demand curve. The Y-axis represents price (P), while the X-axis represents the quantity demanded (Q,). The de- mand curve is negatively sloped or downward sloping. The (negative) slope measures the change in quantity demanded for a unit change in price. This indicates that as the price of commodities decreases, more goods will be bought by the consumer. Demand Function ‘A demand function shows the relationship between demand for a commod- ity and the factors that determine or influence this demand. These factors ‘are—the price of the commodity itself, prices of other related commodities, ‘consumers’ level of incomes, taste and preferences, size and composition of level of population, distribution of income etc. Demand function is expressed as a mathematical function. Thus,Q, = (own price, income, price of related goods, etc.) Change in Quantity Demanded vs. Change in Demand Change in Quantity Demanded There is change in quantity demanded if the movement is along the same demand curve. A change in quantity demanded is brought about by an in- crease (decrease) in the product's price. The direction of the movement however is inverse considering the Law of Demand. Figure 2.2 illustrates the concept of change in quantity demanded. We can see in this figure that the original price is at P, and the corresponding quan. tity demanded is at Q, The point of interaction between P, and Q, is at Point (a) along the demand curve. Now let us assume that price decreases to P,. As a result quantity demanded will increase to Q,,. Quantity demanded wil ‘move to Point (b) along the same demand curve because of the decrease in price. The reverse however will happen if price will increase. Change in quantity demanded therefore happen if the price of the good changes and this is illustrated by movement from one point to another point along the same demand curve. Figure 2.2: Change in Quantity Demanded This figure illustrates the concept of change in quantity demanded. Change Trauantity demanded occurs when price of the product changes, thus, Te Suiting to a change in quantity demanded. This is ilustrated in the graph 78 where P, declines to P. resulting to change in Q, to Q, and a move- abent along the demand curvé from Point (@) to Point (6). *Chapter 2: The Basic Analysis of Demand and Supply 5 Chapter Se Rae Anenn i Remandand Supply Change in Demand There is a change in demand if the entire demand curve shifts to the right side resulting to an increase in demand, At the same price, therefore, more amounts of a good or service are demanded by consumers. Figure 2.3a illustrates an increase in demand, In the figure, we can observe that the entire demand curve shifts upward or to the right (indicated by the arrow) from D to D’. We can also observe that at the same price P, more goods will be demanded by consumers (from Q,, to Q,). Conversely demand decreases or falls if the entire demand curve shifts downward or to the left. At the same pric, less amounts of a good or ser- vice are demanded by consumers. A decrease in demand is illustrated in ‘igure 2.3b. We can observe in the figure that the entire demand curve shifts downward or to the left (indicated by the arrow) from D to D’. If price remains the same, demand for the product or service will decrease (from Q, to Q,). Increase (decrease) in demand is brought by factors other than the price of the good itself such as tastes and preferences, price of substitute goods, etc. resulting in the shift of the entire demand curve either upward or down- ward. Figure 2.3: Change in Demand a. Increase in Demand b, Decrease in Demand i id curve. Figure This figure shows the two different movements of the demant 2 3a ehows an ncreaso in demand, while Figure 2.3bilustrates a decrease or fall in demand. baceihisaticnianipeneees se neanaieaet Siew aeprinciples of Economie, nd curve to change es and thus CAUSE the gp, re general 22S0NS for thy al Forces that cause the de™ d chang' There are soveral reasons Why Cor ag Mand curve to change. The follow! change in demand. Taste or preferences . al likes or dislikes of consumers ferences change S0 that people then an increase in de. Tastes or preferences pertain to the aa for certain goods and senioes. tastes 0° PRE price, want to buy more of a commodity at @ 9! ‘Mand will result or vice versa. As an illustration: Flemember the craze for |Pods? Tae boa hee Philippines sometime in 206, and everyone just wanted 10 Note ofA hat time, there were quite a number of MP3 player brands Delng market. However, for some reasons, consumers were just So engrossed with the thought of having an IPod MP3 player, to the point that some shops had all their stocks sold out. This is a clear example of consumer prefer- ences when it came to MP3 players during that time. Consumers preferred a certain brand because at that time, it was “in” to have an IPod. Consumer preference towards a certain product increases the demand for that prod- uct. However, products which consumers do not prefer, suffer a decrease in demand. Changing incomes : Increasing incomes of households raise the demand for certain goods or services or vice versa. This is because an increase in one’s income gener- ally raises his or her capacity or power to demand for goods or services which (s)he is not able to purchase at lower income. On the other hand, a decrease in one’s income reduces his or her purchasing power, and consequently, his (her) demand for some goods or services ultimate declines. Take for example Juan who is receiving a monthly sal he loves to buy shirts during payday. Se Coen shirts per month. After a year, how With his income, he could only buy 3 ‘ever, he was promoted to a higher posi- goods or services for that matter) monthly income.Chapter 2: The Basic Analysis of Demand and Supply 7 Occasional or seasonal products, The various events or seasons in a given year also result to a movement the demand curve with reference to coer goods. For example: iene Christmas season, demand for Christmas trees, parols, and other Christ- ‘mas decors increase. Moreover, demand for food items like ham and quezo de bola also increases. Similarly, as Valentine's Day approaches, the de- mand for red roses and chocolates also rises. It should be noted, however, that after these events, demand for these products retums back o the orig level Population change ‘An increasing population leads to an increase in the demand for some types ‘of goods or services, and vice-versa, More people simply mean that more goods or services are to be demanded. In particular, Increase in population generally results to an increase in demand for basic goods, such as food and medicines. On the other hand, a decrease in population results in a decline in demand. Substitute goods Substitute goods are goods that are interchanged with another good. In a situation where the price of a particular good increases a consumer will tend to look for closely related commodities. Substitute goods are generally of- fered at cheaper price, consequently making it more attractive for buyers to purchase. For instance, if Juan wants to buys a pair of Nike rubber shoes. but the price of the shoes that he wanted was worth Pph5,000. Considering the price and his lower budget of Pph3000, he can opt for an alternative brand of shoes with lower price, say Converse shoes. In this situation, Nike and Converse shoes are substitutes. Expectations of future prices buyers expect the price of a good or service to rise (or fall) in the future, it may cause the current demand to increase (or decrease). Also, expecta tions about the future may alter demand for a specific commodity. Take for example the fluctuating prices of rice. If households expect that a drastic increase in the price of rice will happen after week, their natural be- havior is to purchase and stock-up rice before the price goes up. Thus, at that given point in time there will be an increase in demand for rice due to consumers stock pilling because of the expected increase in price.principles of Economie, i iia Supply (FirmesSellr's s4¢) services tat rs ae ready and wing ot s being held const Suppys tho quanto seid of time, athe facing tosellata ove sell at a given price Wi ices which a fir I t made available j te mY a Thos, SUPP ay ormally Sell Ore at» , ered that sae by firms, Ht shld “This is because higher PrIC® FeSults tg her price than al higher profits. yr servi Law of Supply su The Law of Suply tates hati the pric of g008 a the price goes quantity supplied for such good or service wil also G0 UP; down the quantity supplied also goes down, ceteris paribus The law of supply implies that higher price is an incentive for busines firms to produce more goods or services as this will maximize their profits. Supply Schedule Asupply schedule is schedule listing the various prices of a product and the specific quantities supplied at each of these prices. Generally, the informa tion provided by a supply schedule can be used to construct a supply curve showing the price/quantity supplied relationship in graphical form. Table 2.2 Presents a hypothetical supply schedule for rice per month, Table 2.2 Hypothetical Supply Schedule for Rice Per Month Situation Price (P) Quantity (kg) > 48 4‘Chapter 2: The Basic Analysis of Demand and Supply 2 Chapter 2: The Basie Analysis of Demandand Supply 3 ‘Supply Curve {tis a graphical representation showing the relationship between the price of the product or factor of production (e.g, labor) and the quantity supplied per time period. The typical market supply curve for a product slopes upward {rom left to right indicating that as price rises (falls) more (less) is supplied. The upward slope indicates the positive relationship between price and quan- tity supplied. Consistent with the Law of Supply, as prices increase (decrease) the quan- tities of commodities offered by producers also increase (decrease). This is illustrated in Figure 2.4. Given the higher price, producers or sellers normally increase their supply of goods or services to increase their profits thus they always want that prices are high. On the other hand, at a lower price only those producers or sellers who are more efficient in their operations survive. These producers or sellers are those who are able to maximize their resources, who handle their budget well, and who know how to handle these kinds of situations. ‘While other producers or sellers who are less-efficient and with bad budget- ing system run the risk of losing profits, or may even be removed in the market (Sicat 2003). This is what we mean by the Law of Supply: higher prices entice producers or sellers to supply more goods or services be- cause of their profit motive while lower prices diminish their goal of putting additional investment because of the possibility of incurring a loss. Figure 2.4: Supply Curve ‘ s Q This figure ilustrates a typical supply curve. The Y-axis represents the price (P) and the X-axis represents the quantity supplied (Q,). The supply Curve is positively sloped or upward sloping. This positive siope indicates that as the price of commodities increases (decreases), more (ess) ‘goods willbe offered for sale by the producers.40 ‘Supply Function ‘of mathematical notation i ine a enon A supply function isa form wh vais independent varabes whey data cuantty supp rong the factors that infence the quan determine quantity Sipe umber of sles in the ma ica eer tae Seen business goals, importation, we tions, and government policies. Thus, Q, = £ (own price, number of sellers, price of factor inputs, techno), Ns , Ogy, etc.) Supply Change in Quantity Supplied vs. Chang Change in Quantity Supplied it ong the same There is change in quantity supplied if the movement is al supply curve. change in quantity supplied is brought about by an increase (decrease) in the product's own price. The direction of the movement however 's positive considering the Law of Supply. Figure 2.5 illustrates the concept of change in quantity supplied. We can $29 inthis figure that the original price is at P, and the corresponding quan. tity supplied is at Q,, The point of interaction between P, and Q, is point A along the supply curve. Now let us assume that price increases io P..Asa result quantity supplied will increase to Q,, Quantity ‘Supplied will thereforeThis igure ilustrates change in quantity supplied. Change in quantity sup- plied happens when price of the product changes, thus, resulting to a ‘change in quantity supplied. This is illustrated in the graph above where P, increases to P, resulting to a change in Q, to Q, and a movement along the same supply curve from Point (a) to Point (b). Change in Supply There is change in supply when the entire supply curve shifts rightward or leftward. At the same price, therefore, more amounts of a good or service fare supplied by producers or sellers. Figure 2.6a illustrates an increase in supply. In the figure, we can see that the entire supply curve moves rightward (indicated by the arrow) from S to S'. We can also observe that at the same price P, ‘more goods will be offered for sale by producers (from Q, to Q,) (On the other hand, supply decreases if the entire supply curve shifts to * the left. At the same price, fewer amounts of a good or service are sold by producers. A decrease in supply is illustrated in Figure 2.6, We can see in the figure that the entire supply curve shifted leftward (indicated by the arrow) from S to S'. We can also see that at the same price P,, supply for the product will decrease (from Q,, to Q,) Increase (decrease) in supply is caused by factors other than the price of the good itseif such as change in technology, business, goals. etc. resulting to the movement of the entire supply curve rightward (leftward)principles of Economy Qa, a in Supply ja. Increase in Supply b. Decrease This figura shows the two ofrent movements of the supply curve. Fi ure 2.3a shows an increase in supply, while Figure 2.3b illustrates a de- crease or fall in supply. Forces that cause the supply curve to change just like demand, there are also forces that cause the supply curve to change. Below are some of the reasons that cause the supply curve to change: Optimization in the use of factors of production ‘An optimization in the utilization of resources will in failure to achieve such will re Thus, the optimization of the various i resus oS °F Production (ie., land, labor, ts to an increase in Supply, and vice versa Capital and entrepreneurship) resu (Sicat 2003).Technological change The introduction of cost-teducing innovations in produc- tion technology increases supply on one hand. On the other hand, this can also decrease supply by means of freezing the production through the problems that the new technology might encounter, such as technical trouble (Samuelson and Nordhaus 2004), Take for example AST Motors Corporation, which uses Machine “A” in the production of its cars. Machine “A” can produce 20 cars per week, However, after 3 years (of production, AST Motors Corporation decided to replace Machine “A” with the newer and faster Machine “B", which can fully produce 80 cars per week. Because of the introduction of this new technology (Ma- chine “B’), the quantity of cars supplied by AST Motors Corporation increased from 20 cars per week to 80 cars per week. However, if Machine “B” mal- functions and such was not fixed immediately, AST Corporation's produc- tion of cars would decrease and thus not meet the optimum level of produc- tion using Machine “B”. Future expectations This factor impacts sellers as much as buyers. I sellers anticipate a rise in prices, they may choose to hold back the current supply to take advantage of the future increase in price, thus decreasing market supply. If sellers how- ever expect a decline in the price for their products, they willincrease present supply. For example: If MVB Meat Company expects a drastic increase in prices of meat within the following week, it may opt to hold its supply of meat for the meantime and sellit only upon application ofthe price increase; thus, reduc- ing the present supply of meat in the market Conversely, if NKR Company, a producer of pagers, expects that its product will be rendered obsolete after 2 years due to the introduction of cellular phones in the market, it may decide to sell all ts stock of pagers in order to presently eam profit from their sale, rather than have them unsold in the following years, considering its apparent obsoleteness in the near future.principles ot Econom “4 Number of sellers supplied. Simp) lumbe sectimpact 0 quentty suPeiy of ood The number of sellers aa the market the e oe Christmas Season, my the more sellers ther® 27 example, during Nr increase in the ay, services willbe avaiable FO ary ruling 02 mers will lan fangge stores salts 2, Moreove more et willincrease ge able shirts and RTWS in Me Te ply of rice int ‘ciamties Wil Stka he instead of other crops, 00 that no destructive to more production asst country. Weather conditions: nn ther natural disasters, reduces Jnoons, drought or o Baden ch i at enh 2 PFS pact. For instance, it a typhoon destroys the vagelab® ‘arr ng et Province, the supply of vegetables particularly in marke . will decline, Government policy Removing quotas and tariffs on imported products also attect supply. Lower trade restrictions and lower quotas or tariffs boost imports, thereby adding more supply of goods in the market. In order for imported products to be accepted in a country, there is need for importers to ay the government the required tariffs or duties and taxes. Im | or local produets.Chapter 2: The Basic Analysis of Demand Market Equilibrium From a separate discussion of demand and supply, we now proceed with reconciling the two. The meeting of supply and demand results to what is referred to as ‘market equilibrium’. As earlier said the market referred to here isa situation ‘where buyers and sellers meet’, while equllibrium is generally understood as a ‘state of balance’. Equilibrium Equilibrium generally pertains to a balance that exists when quantity de- manded equals quantity supplied. Equilibrium is the general agreement of the buyer and the seller at a particular price and at a particular quantity. At equilibrium point, there are always two sides of the story, the side of buyer and that of the seller, For instance, given the price of P10.00 the buyeris wil S ing to purchase 20 units. On the seller side, he is will ing to sell the quantity of 20 units ata price of P10.00. It simply shows that the buyer and seller agree at one particular price and quantity. This is the main concept an of equilibrium: there is a balance between price and Quantity of goods bought by consumers and sold by | sellers in the market. Equilibrium Market Price Equilibrium market price is the price agreed by the seller to offer its good or service for sale and for the buyer to pay for it. Specifically, it is the price at which quantity demanded of a good is exactly equal to the quantity supplied. The equilibrium market price and quantity can best be depicted in a graph. As illustrated in Figure 2.7, the demand curve depicts the quantity that consumers are willing to buy at particular prices; the supply curve depicts the quantity that producers are prepared to sell at particular price. The equilibrium market price is generated by the intersec- tion of the demand and supply curves. A higher initial price (say at P40.00) results in excess supply (Q, = 200 units and Q, = 100 units). The excess ‘supply is depicted by the area abe. In this case, ‘the oversupply of 100 units forces price down in order to eliminate the excess supply. At lower initialee ms wn ce sar ‘nocd by the Se ony al prea Paoaoe ee 13s deal 2, = 200 uns). Ts is deren an {foe uo oreo ema ses oo demand and supply in Price (say at P20.00) results ang jum? there is market disequilibri What happens when happen: a su disequilibrium, two conditions may happe mi When there is market na ©F @ shortage as shown in Figur Surplus lied is more he quantity supp! ir market where t! cy is For sand Surplus is a Sonaon ne Scart ie ns ryt stony fewer m cape in order for the goods to ain Price when ther uilibriu S dope Fae Sry nena seus eat ‘equilibrium pars t Figure 2.7: Equilibrium Market Price and Quantity P 50 40 30 20 f- 10 This figure shows the quiliorium between Guantity demanded and Guantty supplied (X-axis are the prices and Yeaxig are the quantities). As we, serve in the ‘gfaph, the market equilibrium is the point of intersection, tween the Supply (S) ang ‘demand (D) Curves, that is, at P= 30 ang Q= 150,Chapter 2: The Basic Analysis of Demand and Supply a7 Chapter 2 The Rene Ate yen Remendand Supply ‘As we can observe in the graph, surplus is a situation above the equilibrium point. This is because quantity supplied (say at P = P40.00, Q, = 200 units) |s greater than quantity demanded (at p = P40,00, Q,, = 100 units) resulting to 100 units more goods being supplied in the market. Shortage Shortage is a condition in the market in which quantity demanded is higher than supplied, When the markets experiencing shortage, there isa possibility of consumers being abused, while the producers are enjoying imposing higher prices for their own interest. ‘Shortage exists below the equilibrium point, When there is a shortage, there is an upward pressure to prices to restore equilibrium in the market. This is due to the fact that consumers bid up prices in order for them to acquire the goods or services that are in short supply. This is depicted by the arrow ‘going up from point dto the equilibrium point. ‘As we can see in Figure 2.7, shortage happens when quantity demanded is greater than quantity supplied. For instance, at price P20.00 quantity demanded Q, = 200 units while quantity supplied Q, = 100 units, This is because sellers are not willing to sell at the lower price but, consumers demand for more at this price. What happens if disequilibrium in the market persists at longer period of time? If this happens, the government may intervene by imposing price con- trols. Price control is the specification by the government of minimum and/ cor maximum prices for goods and services. The price may be fixed at a level below the market equilibrium price or above it depending on the objective in mind. In the former case, for instance, the government may wish to keep the price of some goods (e.g. food) down as a means of assisting poor con- sumers. In the latter case, the aim may be to ensure that producers receive an adequate return (price suppor to farmers, for instance). More generally, price controls may be applied across a wide range of goods and services as. part of prices and incomes policy aimed at combating inflation.a Pile of Eon 48 sified into two types: floor price ad Price controls are clas: price ceiling. Floor price a “ ed by the government. This is unde Itis the legal minimum price ae in this case, the government may in, if a surplus inthe economy ars commodities. This NOW & Mores Bose a minimum pice season the part ofthe proce (29. Floor pce ‘a form of assistance t9 producers byt il eae a for then Hae par busines. ganraly, oor pices 87@ IPROT Y He Gow fernment on agricultural products especially when harvest, Price ceiling Itis the legal maximum price imposed by the government. Price ceiling ig utilized om ant if there is a persistent shortage of goods (e.g, basic commodities like food items and oil products) in the economy. The government monitors the market and imposes a maximum price on com. modities, which is to be strictly followed by producers and sellers. Price ceiling is generally imposed by government to protect consumers from abu- sive producers or sellers who take advantage of the situation. This is usually done by government after the occurrence of a calamity like typhoon or se- vere flooding. Could you think of concrete examples of price ceilings and floor prices im- posed by government? What do you think are the reasons why government imposes such price controls? noe = z gi