Demand and Supply

Module 2
(text: Pindyck and Rubinfeld , Chapter 2)
Boishampayan Chatterjee
School of Commerce
NMIMS
Demand Analysis
• As a businessman, you are interested in profit of your company
• Profit=Total Revenue – Total Cost
• To maximize profit, you have to maximize revenue and minimize cost.
• To increase revenue you have to increase sales. Sales is an indication
of demand
• Start with demand analysis

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Demand Data
You are in a company that manufactures and distributes tea. Your
company is diversifying the product and is coming up with organic tea,
especially for export purpose. You are appointed as the head of their
export market in North America. You have to study the demand
conditions of organic tea in that market. You have the data on price and
quantity demanded of a similar organic tea exported by a Chinese
company.

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What is your first observation looking at the price and quantity
demanded?
Plot the relation between price and demand
Demand Curve
35
Year Price/100 gms Tea Demand (in millions) 30,0
30
2018.01 0 12
25,2
25
2018.02 5 10
20,4
2018.03 10 8 20

Price
15,6
2018.04 15 6 15

10,8
2019.01 20 4 10

2019.02 25 2 5
5,10

2019.03 30 0 0,12
0
0 2 4 6 8 10 12 14
Quantity Demanded

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Demand Curve and law of Demand
• The demand curve is the relationship between Price and Quantity
Demanded

• Law of demand: Other things equal, the quantity demanded of the

good falls when price of the good rises.

• Law of demand implies that the demand curve is downward sloping

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Market Demand Function
• Now that we have a relation between price and quantity in form a
curve, can this relation be represented in form of an equation?
• Yes….and we call it a market demand function
Market Demand Function
Qd=12-0.4P

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 Market Demand Function(Q in terms of P)
What is the slope of this market demand function?
-0.4
14
Qd=12-0.4P What is the meaning of slope? How do we interpret -0.4?
12 If Price increase by 1 unit, then quantity demanded
falls by 0.4 units
10
Tea Demand

b=(Y2-Y1)/(X2-X1), where Y is Qd and X is price

8

b=(10-12)/(5-0)=-2/5=-0.4
6
What is the intercept of this market demand function?
4
12
2

What is the meaning of intercept? How do we interpret 12?

0
0 5 10 15 20 25 30 35

Price If Price is zero, then quantity demanded is 12 units

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 Market demand curve (P in terms of Q)
Now if the axes of the graph is reversed, what will
be the equation of this line?
Demand Curve
35
30,0
If the axes are reversed, the equation also needs to be
30
P=30-2.5Qd reversed. Thus this line is represented by the equation
25
25,2
P=30-2.5Qd. [Qd=12-0.4P0.4P=12-QdP=12/0.4-1/0.4Qd
20,4 P=30-2.5Qd]
20
Price

15,6
15 This is the equation of the market demand
10
10,8
Curve and the line is called market demand curve.
5,10
5
A demand curve is always drawn with Price on the vertical axis
0,12
0 And quantity demanded on the horizontal axis, and its equation
0 2 4 6 8 10 12 14
is represented as P in terms of Qd.
Quantity Demanded

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 Example
Viking Interworks is one of many manufacturers that supplies memory
products to original equipment manufacturers (OEMs) of laptop
computers. The CEO recently read an article in a trade publication that
reported the market demand function for laptops to be Qd=2900000-
700P.
Derive the equation of the market demand curve for laptops

What is the slope of the equation of the demand curve?

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 Example
Viking Interworks is one of many manufacturers that supplies memory
products to original equipment manufacturers (OEMs) of laptop computers.
The CEO recently read an article in a trade publication that reported the
market demand function for laptops to be Qd=2900000-700P.
Derive the equation of the market demand curve for laptops
Qd=2900000-700P
700P=2900000-Qd
P=2900000/700-Qd/700
P=4142.85-0.001429Qd
P=4143-0.00143Qd
What is the slope of the equation of the demand curve?
-0.00143
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Slope=-0.001429
Market Demand Schedule for Laptops
P=4143-0.001429Qd
3500

800, 3000
3000
975, 2750

1150, 2500
2500
1325, 2250

2000 1500, 2000

Price(P)

1500

1000

500

0
800 975 1150 1325 1500
Quantity Demanded(Qd)

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The CEO believes that the given demand function is a relation between price of
laptops and its demand, given many other things/factors held constant. But how
might the demand for laptops change if there is a change in other factors?
For instance the other factors may be average income(I), average price of software(S),
amount spent on advertising by laptop producers(A).
So the market demand function might be:
Qd=b1P+b2I+b3S+b4A
Qd= -700P+200I-500S+0.01A (i)
But, the market demand function that we have just plotted shows the relationship
between Qd and P, given all other relevant variables held constant. So if I=$13000, S=$400
and A=$50 million, then putting these values in equation (i) we get the market demand
function as: Qd=2900000-700P
Putting values in the above equation, the resulting market demand function is:
Qd= -700P+200I-500S+0.01A
Qd= -700P+200(13000)-500(400)+0.01(50000000)
Qd=-700P+2900000
Qd=2900000-700P
P=4143-0.001429Qd (equation of the market demand curve)
Therefore, intercept in the market demand function represents all other factors. If other
factors change, then the intercept will change, and that’s how it will change the market
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What would happen to the market demand curve
if average price of software falls?
Let now S be equal to $200 instead $400. Values of I and A are same as
before.

What would be the market demand curve now

Graphically, what would happen to the market demand curve?

Qd= -700P+200I-500S+0.01A I=$13000, S=$400 and A=$50 million P=4143-0.00143Qd

Qd= -700P+200I-500S+0.01A I=$13000, S=$200 and A=$50 million P=4285.71-0.00143Qd

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The market demand curve shifts parallel rightward/upward due to fall in Average Software Price

Market Demand Schedule for Laptops

P=4286-0.001429Qd
3500

3000

2500

2000
Price(P)

1500

P=4143-0.001429Qd
1000

500

0
800 975 1150 1325 1500
Quantity Demanded(Qd)

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What would happen if Average Income (I) falls from $13000 to
$10000 (Consider S=$400)?
• Market Demand function?
Qd= -700P+200I-500S+0.01A
Qd=-700P+200(10000)-500(400)+0.01(50000000)
Qd=-700P+2000000-200000+500000
Qd=-700P+2300000
Qd=2300000-700P Market Demand Schedule for Laptops
3500
• Market Demand Curve?
P=3285.71-0.001429Qd 3000 P=4143-0.001429Qd

2500

2000
Price(P)

1500

1000 P=3285.71-0.001429Qd

500

0
800 975 1150 1325 1500
Quantity Demanded(Qd)
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Market demand curve is the sum of Individual
demand curves
Catherine's Nicholas Market
Price of Ice-cream cone Demand
(dollars)
0 12 7 19
0.5 10 6 16
1 8 5 13
1.5 6 4 10
2 4 3 7
2.5 2 2 4
3 0 1 1

Nicholas's Demand Market Demand

Catherine's Demand + =
3
3
Price of Ice-cream Cones

Price of Ice-cream Cones

3

Price of Ice-cream Cones

2.5
2.5 2.5
2 2
2 1.5
1.5 1.5
1 1
1 0.5
0.5
0.5 0
0
0 0 2 4 6 8 10 12 14 16 18
0 1 2 3 4 5 6 7 8 9 10 11 12
0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-cream cones Quantity of Ice-cream Cones
Quantity of Ice-cream Cones

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Consider the market for ice-cream with only two consumers, Catherine and
Nicholas. The individual demand curves for Catherine and Nicholas and the market
demand is given as per the earlier slide. Let the current market price of ice-cream is
$1.5. The market demand for ice-cream at this price is 10 units (Catherine 6 units
and Nicholas 4 units).
Now because of extreme hot summer, Catherine and Nicholas each wants to have
two more ice-creams. What will happen to the market demand curve?
Market Demand
3
Price of Ice-cream Cones

2.5

1.5

0.5

0
0 2 4 6 8 10 12 14 16 18
Quantity of Ice-cream Cones

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Consider the market for ice-cream with only two consumers, Catherine and
Nicholas. The individual demand curves for Catherine and Nicholas and the market
demand is given as per the earlier slide. Let the current market price of ice-cream is
$1.5. The market demand for ice-cream at this price is 10 units (Catherine 6 units
and Nicholas 4 units).
Now the market price of ice-cream is 2.5 dollar. What is the number of ice-cream
sold in the market now?
Market Demand
3
Price of Ice-cream Cones

2.5

1.5

0.5

0
0 2 4 6 8 10 12 14 16 18
Quantity of Ice-cream Cones

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Consider the market for ice-cream with only two consumers, Catherine
and Nicholas. The individual demand curves for Catherine and Nicholas
and the market demand is given as per the earlier slide. Let the current
market price of ice-cream is $1.5. The market demand for ice-cream at
this price is 10 units (Catherine 6 units and Nicholas 4 units).
What will happen to market demand curve if Catherine looses her
summer job and only consumes 3 units of ice-cream?
Market Demand
3
Price of Ice-cream Cones

2.5

1.5

0.5

0
0 2 4 6 8 10 12 14 16 18
Quantity of Ice-cream Cones

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Consider the market for ice-cream with only two consumers, Catherine and
Nicholas. The individual demand curves for Catherine and Nicholas and the market
demand is given as per the earlier slide. Let the current market price of ice-cream is
$1.5. The market demand for ice-cream at this price is 10 units (Catherine 6 units
and Nicholas 4 units).
Suppose that the price of frozen yogurt falls. Given that both Catherine and
Nicholas like frozen yogurt, what will happen to the market demand curve of ice-
cream?
Market Demand
3
Price of Ice-cream Cones

2.5

1.5

0.5

0
0 2 4 6 8 10 12 14 16 18
Quantity of Ice-cream Cones

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Consider the market for ice-cream with only two consumers, Catherine and
Nicholas. The individual demand curves for Catherine and Nicholas and the market
demand is given as per the earlier slide. Let the current market price of ice-cream is
$1.5. The market demand for ice-cream at this price is 10 units (Catherine 6 units
and Nicholas 4 units).
Assume that American medical association declares that people who regularly eat
ice-cream may develop adverse health conditions in the future. What would
happen to market demand curve?
Market Demand
3
Price of Ice-cream Cones

2.5

1.5

0.5

0
0 2 4 6 8 10 12 14 16 18
Quantity of Ice-cream Cones

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 FACTORS AFFECTING DEMAND

Price Other Factors

• There are many other factors that may

• Inverse relation between Price and Demand influence demand for a product other than
price.
• Demand Curve
• Following are some of the factors:
• Any change in Price leads to movement -Income
along the demand curve -Taste and Preference
-Price of related commodities
-Season
-Number of buyers, demography of buyers
-Future expectations
- Government regulation and policy

• When there is a change in other factors,

market demand curve shifts.
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Exceptions to law of Demand
• Consumer expectations
speculation at stock exchange-when prices of shares of company are expected to rise then investors
purchase larger quantities of that particular share, they demand more as the price rises because
they feel that the price will rise further and they will enjoy good profit in the near future.

• Veblen Effect
Economist Thorstien Veblen observed that most consumers were ignorant and demanded goods
solely because they thought that a highly priced product must be of a good quality. Hence if the
price increased then the consumers demand also increases.

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Exceptions to law of Demand
• Bandwagon Effect/demonstration effect
This is a very normal occurrence which happens on a regular basis whereby a consumer
copies the behaviour and consumption pattern of neighbours, relatives and friends. If a
certain type of product is being used by a group then peer pressure encourages members
of a group to demand a specific product because it is widely used in the group. For instance
if Apple's iPhone is used by majority of the members in a group then the consumer will
also demand for iPhone even if the price rises.

• Giffen Effect
In late 18th century Sir Robert Giffen observed the strange phenomenon amongst the poor
mining community in England. The miners had to work in unhygienic conditions and were
paid very low wages. They had a staple diet which contain large quantity of bread and
small quantity of meat. Once the government intervene and brought the prices of bread
down then the workers demanded less bread and substituted bread with meat with was
far more nourishing. This happened because the fall in price of bread increased the
purchasing power of the workers who opted for a better product. All this time price of
meat was constant.

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 ANALYSIS OF SUPPLY
(text: Pindyck and Rubinfeld, 8th Edition, Chapter 2)

Boishampayan Chatterjee
School of Commerce
NMIMS
 Due to recent slowdown of the Chinese economy, global demand for oil has fallen.
This has been reflected in a continuing fall in global oil prices. Given is the data on
oil prices and the global supply of oil during the last few quarters. What is the
relation between oil price and market supply of oil? Plot the relation. MARKET SUPPLY
CURVE (P in terms
Price per Quantity of Q)
gallon of oil supplied (in P=-6+0.75Qs
Market Supply Curve
(in dollars) millions) 16

15 28
14
12 24
9 20 12

6 16 10

3 12

Price
8

Market Supply Function: 2

Qs=a+bP, b>0 0
Market Supply Function: 0 5 10 15 20 25 30
Quantity Supplied
Qs=8+1.33P (Q in terms of P) to be used only for lecture purpose at NMIMS SOC
• slope: b=(Q2-Q1)/(P2-P1)
=((24-28)/(12-15))
=1.33
Qs=a+1.33*P
28=a+1.33*15
a=8.05
1.33: If price increases by 1 unit, then supply increases by 1.33 units
8: If price is zero, then what is the amount of supply in the market. The
intercept also captures the influence of other factors on supply. If other
factors change, then the intercept will change.

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Supply
Just as demand is a relation between price and quantity demanded,
supply is the relation between price and quantity supplied.

Law of Supply states that other things equal, the quantity supplied of a
good rises when the price of the good rises.

Market Supply Curve shows the quantity that suppliers are willing to
supply at each price level.

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 Market supply sum of individual supply
Price of Ice cream Cone Ben Jerry Market Consider the market for ice-creams.
0 0 0 0 There are two suppliers of ice-cream, Ben and Jerry.
0.5 0 0 0
The individual supply schedules of Ben and Jerry are given.
1 1 0 1
1.5 2 2 4
What will be the market supply curve at each price level?
2 3 4 7
2.5 4 6 10
3 5 8 13

Ben's Supply + Jerry's Supply = Market Supply

3.5 3.5 3.5

3 3 3

2.5 2.5 2.5

2 2

Price
2
Price

Price

1.5 1.5 1.5

1 1 1

0.5 0.5 0.5

0 0 0
0 1 2 3 4 5 6 0 2 4 6 8 10 0 2 4 6 8 10 12 14

Quantity Supplied Quantity Supplied

Quantity Supplied

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Consider the market for ice-creams. There are two suppliers of ice-cream, Ben and Jerry. The
individual supply curves for Ben and Jerry and the market supply is given as per the earlier slide. Let
the current market price of ice-cream be $1.5. The market supply for ice-cream at this price is 4
units (Ben 2 units and Jerry 2 units).
Suppose, price of sugar, which is an ingredient in ice-cream production, rises. This makes ice-cream
production less profitable for Ben and Jerry. Ben now produces 1 unit of ice-cream and Jerry
stopped production. What will happen to market supply?

Market Supply

3.5

2.5

2
Price

1.5

0.5

0
0 2 4 6 8 10 12 14
Quantity Supplied

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Consider the market for ice-creams. There are two suppliers of ice-cream, Ben and Jerry. The
individual supply curves for Ben and Jerry and the market supply is given as per the earlier slide. Let
the current market price of ice-cream is $1.5. The market supply for ice-cream at this price is 4 units
(Ben 2 units and Jerry 2 units).
Suppose there is an invention of new mechanized machine which reduced the amount of labor
necessary to make ice-cream and makes ice-cream production faster. What will happen to market
supply curve.
Market Supply
3.5

2.5

2
Price

1.5

0.5

0
0 2 4 6 8 10 12 14
Quantity Supplied

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Consider the market for ice-creams. There are two suppliers of ice-cream, Ben and Jerry. The
individual supply curves for Ben and Jerry and the market supply is given as per the earlier slide. Let
the current market price of ice-cream is $1.5. The market supply for ice-cream at this price is 4 units
(Ben 2 units and Jerry 2 units).
Suppose market price of ice-cream increased from $1.5 to $2. How many ice-cream will be sold in
the market. How would this be represented in the diagram?

Market Supply
3.5

2.5

2
Price

1.5

0.5

0
0 2 4 6 8 10 12 14
Quantity Supplied

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Consider the market for ice-creams. There are two suppliers of ice-cream, Ben and Jerry. The
individual supply curves for Ben and Jerry and the market supply is given as per the earlier slide. Let
the current market price of ice-cream is $1.5. The market supply for ice-cream at this price is 4 units
(Ben 2 units and Jerry 2 units).
Suppose, both Ben and Jerry expect that the price of ice-cream to rise in the upcoming months.
What will happen to market supply?

Market Supply
3.5

2.5

2
Price

1.5

0.5

0
0 2 4 6 8 10 12 14
Quantity Supplied
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Other Factors affecting supply

• Technology

• Input Prices

• Producer Expectations

• Number of sellers

• Prices of Alternative goods

• Taxes and subsidies

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Market Equilibrium
(text: Pindyck and Rubinfeld chapter 2)

Boishampayan Chatterjee
School of Commerce
NMIMS
Market Equilibrium
You are an assistant to a senator who chairs an ad hoc committee on
reforming taxes on telecommunication services. Based on your
research, AT&T has spent over $15 million on related paperwork and
compliance costs. Moreover, depending on the locality, telecom taxes
can amount to 25 percent of a consumer’s phone bill. These high tax
rates on telecom services have become quite controversial, due to the
fact that the deregulation of the telecom industry has led to a highly
competitive market. Based upon the data on the monthly market
demand and supply of telecommunication services, the market
demand and supply functions are as follows: Qd=300-4P and Qs=3P-
120.
What is the equilibrium market price and quantity demanded/supplied
of telecommunication services?

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 Equilibrium Price and Quantity
Market demand for telecom services Market Supply of Telecom Services
80 80
P=75-0.25Qd P=40+0.33Qs
70 70

60 60

50 50
Price

Price
40 40

30 30

20 20

10 10

0 0
0 20 40 60 80 100 120 140 160 0 20 40 60 80 100 120
Quantity Demanded Quantity Supplied

Market Equilibrium of Telecom Services Equilibrium is a situation where market demand and supply forces are at a balance, i.e.
80
quantity demanded is equal to quantity supplied. At the equilibrium, the quantity of
70 goods
E1 that the buyers are willing and able to buy exactly balances the quantity that sellers are
60
willing to sell. The equilibrium price is called the market clearing price because at this
50 price everyone in the market has been satisfied.
At a price greater than 60, there will be excess supply. That means sellers are unable to
Price

40
sell their product and would thus mean that price would adjust and come down to 60.
30 Similarly, if price is below 60, there will excess demand, which would push the price up
to 60 so that the market clears.
20 Price acts as an invisible hand which guides the demand and supply from a
10 disequilibrium situation to return to the equilibrium and clear the market.

0
0 20 40 60 80 100 120 140 160
Quantity demanded/Supplied
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The senator is considering tax reform that would cut taxes and benefit the suppliers.
How would this impact the market supply/demand curves and the equilibrium?
Explain your answer with a suitable diagram.
The market supply function after the tax reduction is Qs=-90+3P
Equation of the market supply curve: P=30+0.33Qs
1. Due to tax cut, supply curve shifts
Market Equilibrium of Telecom Services 2. At the initial price, this creates
80
an excess supply(E3E1)
P=40+0.33Qs 3. With excess supply in the market, price
70
will start falling
4. When price falls, demand starts
E1 E3
60
P=30+0.33Qs increasing. As per the law of
E2
demand(movement along the demand
50 curve from E1 to E2). As per the law of
supply, supply starts falling (movement
along the supply curve from E3 to E2)
Price

40
E2: (77.14,55.71)
5. The market settles down at an
P=75-0.25Qd equilibrium
30
Price at E2, where Qd=Qs.
20

10

0
0 20 40 60 80 100 120 140 160
Quantity demanded/Supplied

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Solve the new equilibrium price and quantity
• Supply equation: P=30+0.33Qs
• Demand Equation P=75-0.25Qd
• Solve the above two equations:
• At equilibrium, Qd=Qs=Q
30+0.33Q= 75-0.25Q
Q=77.14
Put the value of Q in any of the equations:
P=75-0.25Qd
75-0.25(77.14)=55.71

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What if the income of the consumers increase?
The market demand function after increase in income is Qd=400-4P

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What if the income of the consumers increase?
The market demand function after increase in income is Qd=400-4P
Equation of the market demand curve is: P=100-0.25Qd
1. Due to increase in income,
Market Equilibrium of Telecom after change in Demand demand curve shifts to the
right
80
E2: (102.85, 74.28)
2. At the initial price, this
creates an excess
70 P=100-0.25Qd demand(E3E1)
E1 E3 3. With excess demand in the
60 market, price will start rising
P=75-0.25Qd
4. When price rises, demand starts
50
falling. As per the law of
P=40+0.33Qs demand(movement along the
Price

40
demand curve from E3 to E2). As
per the law of supply, supply starts
30
increasing (movement along the
supply curve from E1 to E2)
20
5. The market settles down at an
equilibrium Price at E2, where
10
Qd=Qs.
0
0 50 100 150 200 250 300
Quantity Supplied/Demanded

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What if both happens simultaneously? A reduction in tax and
an increase in income?
The market demand and supply functions are:
Qd=400-4P; Qs=-90+3P

Earlier Equation before any changes:

Qd=300-4P and Qs=3P-120

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What if both happens simultaneously? A reduction in tax and
an increase in income?
The market demand and supply functions are:
Qd=400-4P; Qs=-90+3P
P=100-0.25Qd, P=30+0.33Qs
Market Equilibrium of Telecom Services
100-0.25Q=30+0.33Q 80 P=100-0.25Qd

Q=120 70

Substitute Q=120 in either 60

P=30+0.33Qs
demand and supply equation 50

Price
P=70 40

New equilibrium price and quantity? 30

Q=120; P=70 20

10

0
0 20 40 60 80 100 120 140 160
Quantity demanded/Supplied

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 What if both happens simultaneously? A reduction in tax and
an increase in income?

NOTE: there can be 3 possible cases here: Market Equilibrium of Telecom Services
80 P=100-0.25Qd
Case1: Price and Quantity Rises (shift in demand curve
Is more than shift in supply curve) 70

60
Case 2: Price falls and quantity rises (shift in supply curve P=30+0.33Qs
is more than shift in demand curve) 50

Price
Case 3: Price remains unchanged, quantity increases (shift in 40
demand curve is equal to the shift in supply curve)
30

20

10

0
0 20 40 60 80 100 120 140 160
Quantity demanded/Supplied

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