ECON 11 (INTRODUCTORY ECONOMICS)

STUDY GUIDE: MODULE 2

MARKET FORCES OF SUPPLY AND DEMAND

PART I
Supply and Demand
This week’s topic introduces you to the concepts of supply and demand. Discussion commences with
explaining the laws of demand and supply, constructing the demand and supply curves using the demand
and supply schedules, analysing how price and quantity sold in markets are determined, and identifying
factors that affect both demand and supply.
At the end of this module, you should be able to
L01 Explain the laws of demand and supply
L02 Identify and examine the determinants of demand and supply
L03Analyze how demand and supply interact to achieve market equilibrium

Think!
In studying supply and demand, here are some questions to guide you
o Why is there an inverse (positive) relationship between price and quantity demanded (quantity
supplied)?
o What is the difference between demand and quantity demanded, and supply and quantity
supplied?
o What are the possible ways of presenting the inverse (positive) relationship between price and
quantity demanded (quantity supplied)?
o What are the factors that shift demand and supply?
o What is the difference between a change in demand or supply to a change in quantity demanded
or quantity supplied?

Read and Watch

 (WATCH)An introductory video clip on supply and demand is available for viewing in MIT’s
OpenCourseWare. This can be accessed through this link:
https://ocw.mit.edu/courses/economics/14-01-principles-of-microeconomics-fall-2018/lecture-
videos/lec1-intro/
 (READ) The main reference material for this topic can be accessed through this link
https://openstax.org/books/principles-economics/pages/3-1-demand-supply-and-equilibrium-in-
markets-for-goods-and-services

1.1 Demand, Supply, and Equilibrium in Markets for Goods and Services

As you go through the material, you are strongly encouraged to answer all the sample problems/
exercises you encounter.

 (SUPPLEMENTAL READING) You may use the following references for supplemental
reading:
  CHAPTER 3, Basic Elements of Supply and Demand by Samuelson and Nordhaus’
Economics (19th Edition).
 CHAPER 4, Market Forces of Supply and Demand by N.G. Mankiw’s Principles of
Economics (8th Edition or Older Editions)
DEMAND: Law, Schedule, Curve and Determinants
This section provides a detailed discussion on demand, emphasizing how quantity bought by a consumer
tends to decrease as the price os such commodity increases. It further presents various means to illustrate
the negative relationship through the demand schedule, demand curve, and demand function. We will also
differentiate between individual demand and market demand. Lastly, we will identitfy and discuss factors
that affect the quantity demanded and influence the demand curve to shift.
The Law of Demand
The Law of Demand describes the inverse relationship between quantity demanded and price. In other
words, when price rises quantity demanded falls, and vice versa. Note that other factors that may affect
quantity demanded are being held constant that is why the law of demand should always include the
ceteris paribus assumption. Ceteris paribus is a Latin phrase which translates to “other things equal”. So
here, when we talk about the law of demand, we assume that other things such as income is constant.
“When price rises quantity demanded falls, ceteris paribus.”
There are three ways to present the inverse relationship between price and quantity demanded:Demand
Schedule, Demand Curve, and Demand Function.
Example
Suppose we have a demand function 𝑄𝑑 = 10 − 2𝑃 for a certain good, 𝑄𝑑. Let us try to derive the
demand schedule for this demand function:

Price (P) Quantity

Demanded (𝑄𝑑)
0 10
1 8
2 6
3 4
4 2
5 0

𝑄𝑑 = 10 − 2𝑃; 𝑄𝑑 = 10 – 2(0) = 10
Try this!
Deriving the demand curve from the demand schedule. To derive the demand curve, simply plot the
points corresponding to P and 𝑄𝑑.
(READ) Why does the demand curve slope downward? Read this article to learn why:
https://www.economicsdiscussion.net/demand-curve/downward-sloping-demand-curve-7-reasons/21798
 Downward Sloping Demand Curve: 7 Reasons
A general form of the demand function is written as 𝑄𝑑 = 𝑎 − 𝑏𝑃, where 𝑄𝑑represents quantity
demanded, 𝑃is the price of the good, 𝑏is the slope of the demand curve, and 𝑎takes into account all
factors affecting demand other than the price (i.e. price of related goods, income, taste, etc.). The negative
sign in the slope (−𝑏) illustrate the negative relationship of quantity demanded to price as stated by the
law of demand.

Individual Demand vs. Market Demand

The above-mentioned example pertains to an individual demand for a particular commodity. To be able to
analyse how the market for such good works, we need to determine the market demand. We obtain such
by adding all the individual demand for a particular good or service.

Example

Presented in the table below are individual demands for a certain commodity:

Price 𝑄𝑑1 𝑄𝑑2 Market

0 10 11
1 8 9
2 6 7
3 4 5
4 2 3
5 0 1

Try this!

Compute for the market demand and graph the demand curves for 𝑄𝑑1, 𝑄𝑑2, and the market. (Hint: You
should have three demand curves)

Shifters of Demand

Our demand for goods is not only dependent on price. There are other factors that affect our demand, and
these “other things” were held constant when we examined the law of demand.

1) Income (Normal and Inferior Goods)

2) Price of Related Goods (Substitutes and Complements)
3) Taste
4) Expectations
5) Number of Buyers

These actors are called shifters of demand since changes in these factors will result in a shift in the
demand curve. The movement of the shift depends on the direction of the change of these variables.
Demand Shifters are further explained in the reference provided below:

(READ) 3.2Shift in Demand (and Supply) for Goods and Services:

https://openstax.org/books/principles-economics/pages/3-2-shifts-in-demand-and-supply-for-goods-and-
services

SUPPLY: Law, Schedule, Curve and Determinants

In contrast to demand, supply emphasizes how quantity produced by a producer increases as the price of
such commodity increases. Under supply, we also introduce the supply schedule, curve, and function to
illustrate the positive relationship of P and 𝑄s. Lastly, we determine the different factors that affect the
quantity supplied thus causing the supply curve to shift.

Law of Supply

The Law of Supply describes the positive relationship between price and quantity supplied. Here, same
with the law of demand, we also assume that other things that may affect supply are held constant.

“When price rises quantity supplied also rises, ceteris paribus.”

We can also illustrate the positive relationship between price and quantity supplied using the supply
schedule, supply function, and supply curve.

(READ) Why does the supply curve slope upward? Read this article to learn why:
https://www.economicsonline.co.uk/Competitive_markets/Producer_supply.html

Another means of presenting the relationship between price and quantity supplied is through the supply
function written as 𝑄𝑠 = 𝑐 + 𝑑𝑃. 𝑄𝑠represents quantity supplied, 𝑃is the price of the good, 𝑑is the slope of
the supply curve, and 𝑐takes into account all factors affecting supply other than the price (i.e. input prices,
technology, etc.). The positive sign in the slope (+𝑑) illustrate the positive relationship of quantity
supplied to price as stated by the law of supply.

Shifter of Supply

Price is not the sole determinant of supply, just like with demand. These “other things” that affect
quantity supplied were assumed to be constant when we examined the law of supply are:

1) Input Prices
2) Technology
3) Expectations
4) Number of Sellers

These are referred to as shifters of supplysince changes in these factors trigger a shift in the supply curve.
The movement of the shift depends on the direction of the change of these variables. Supply shifters are
further explained in the reference material whose link is provided below:

(READ) 3.2 Shifts in (Demand and) Supply for Goods and Services:
https://openstax.org/books/principles-economics/pages/3-2-shifts-in-demand-and-supply-for-goods-and-
services

EQUILIBRIUM: Putting Supply and Demand Together

Market equilibrium is attained when quantity supplied is equal to quantity demanded (𝑄𝑠 = Qd).
Graphically, it is where the supply and demand curve intersect. It is at this point where equilibrium price
and quantity are produced.

At the equilibrium, the amount that buyers want to buy is equal to the amount that sellers want to sell.
Given this balance in demand and supply, there is no reason for price to rise or fall, as long as other things
remain unchanged. Therefore, the equilibrium price is also referred to as the market-clearing price. Such
is also what Adam Smith meant with his popular claim on the invisible hand guiding the buyers and
sellers in a free market.

Something to ponder upon: Is there an incentive for price to be set not equal to the equilibrium price? If
such is true, what happens to quantity demanded and quantity supplied?

 Surplus
 Shortage

Evaluating Changes in the Equilibrium

Changing market forces caused by either shifting demand, supply, or shifting both supply and demand
disrupts the market equilibrium. The reference provided below explicitly discusses the step-by-step
process of analyzing the changes in market equilibrium.

(READ) 3.3 Changes in Equilibrium Price and Quantity: The Four Step Process:
https://openstax.org/books/principles-economics/pages/3-3-changes-in-equilibrium-price-and-quantity-
the-four-step-process

Dig Deeper

We take our discussion of supply and demand further by going through the listed references below. It
tackles the application of supply and demand to issues we face today:
Is it immoral to increase the price of goods during a crisis?
https://www.nytimes.com/2020/03/16/learning/is-it-immoral-to-increase-the-price-of-goods-during-a-
crisis.html
The Price of Gouging During COVID-19 Pandemic
https://www.arnoldporter.com/en/perspectives/blogs/enforcement-edge/2020/07/the-price-of-price-
gouging-during-covid
 PART II

Elasticty and Its Application

This section will introduce you to the concept of elasticity. After learning how buyers and sellers interact
in the market, it is only important that you also understand how buyers and sellers respond to changes in
prices and other variables such as income and prices of related goods. Elasticity is used as a gauge in
measuring these changes and can be extended into analyzing how prices affect market outcomes.
At the end of this module, you are expected to:

L01 Explain the concept of elasticity

L02 Demonstrate understanding of the different types of elasticity: price elasticity, income
elasticity, and cross-price elasticity
L03 Discuss different varieties of demand and supply based on the price elasticity
L04 Apply the concept of elasticity in explaining pricing decisions
Think!
Here are some guide questions:
o What is elasticity?
o How do we compute for elasticity? How do we interpret the resulting elasticity value?
o What are the different varieties of demand and supply based on price elasticity?
o What are the other types of elasticity?
o How do we apply the concept of elasticity in understanding how certain policies affect a market?
Read and Watch
 (READ) The main reference assigned for this section may be accessed through the provided link.
Unit 5. Elasticity, Principles of Economics by OpenStax College:
https://openstax.org/books/principles-economics/pages/5-introduction-to-elasticity
Each subsection will direct you to specific subtopics of elasticity. While going through the reference,
you are strongly encouraged to answer all the sample problems and exercises you encounter.
 (WATCH) After finishing the main reference material, here’s an interesting video clip you may
watch to help you fully understand the topic. Elasticity by Jacob Clifford:
https://www.youtube.com/watch?v=nAT_shQGlIk
 (SUPPLEMENTAL READING) You can use the following references as supplemental
readings:
o CHAPTER 4, Supply and Demand: Elasticity and Application by Samuelson and
Nordhaus’ Economics (9th Edition).
o CHAPTER 5, Elasticity and Its Application by N.G. Mankiw’s Principles of Economics
(8th or older Editions)
Elasticity, defined
We begin our discussion by defining elasticity as an economic concept that measures the responsiveness
of one variable to change in another variable. Specifically, it serves as gauge on how much quantity
demanded or quantity supplied changes following a change in price. Preliminary example and application
of elasticity to public policy ir provided in the reference assigned.
Price Elasticity of Demand and Supply
The Price Elasticity of Demand measures the responsiveness of quantity demanded to changes in price.
The Price Elasticity of Supply measures the responsivess of quantity supplied to changes in price.
Elasticity can be measured through the midpoint formula. Depending on the price elasticity, the demand
curve can either be Perfectly Inelastic, Inelastic, Unit Elastic, or Perfectly Elastic. The same is true with
the supply curve. There are factors that determine whether demand or supply is elastic or inelastic.
(READ) 5.1 Price Elasticity of Demand and Price Elasticity of Supply:
https://openstax.org/books/principles-economics/pages/5-1-price-elasticity-of-demand-and-price-
elasticity-of-supply
(READ) 5. 2 Polar Cases of Elasticity and Constant Elasticity: https://openstax.org/books/principles-
economics/pages/5-2-polar-cases-of-elasticity-and-constant-elasticity

Pricing and Elasticity

How do we use the concept of elasticity in helping us make economic decisions such as what price to
charge? Imagine that you own a coffee shop and your goal is to maximize profit. The question is, to
increase your profit, should you increase the price of your coffee or lower it? The answer depends on the
Price Elasticity of Demand.
Learn more about the relationship between elasticity and pricing by reading this section of principles of
economics:
(READ) 5.3 Elasticity and Pricing: https://openstax.org/books/principles-economics/pages/5-3-elasticity-
and-pricing
Other Types of Elasticity
We can also measure the responsiveness of quantity demanded to a change in other variables such as
income ans prices of related goods. The Income Elasticity of Demand measures the sensitivity of quantity
demanded to a change in income. This measure of elasticity can indicate whether a good is inferior or
normal depending on the sign of the elasticity. On the other hand, the response of quantity demanded to a
change in the prices of related goods is measured by the Cross-Price Elasticity. The latter can indicate
whether two goods are susbstitutes or complements depending on the sign of the elasticity.
An explicit discussion on this topic can be accessed through the link:
(READ) 5.4 Elasticity in Areas Other than Price: https://openstax.org/books/principles-
economics/pages/5-4-elasticity-in-areas-other-than-price
Application of Supply, Demand, and Elasticity

We now proceed into studying how certain policies affect market outcomes. This section highlights the
effects of farming technology, maintaining oil prices at a certain level, and drug interdiction program to
its respective markets.

(READ) A detailed discussion on the topic. Section 5-3, Chapter 5 (Elasticity and It’s Applications) of
N.G. Mankiw’s Principles of Economics.

Dig Deeper
We broaden our discussion on the application of elasticity by reviewing an actual research work that
employs elasticity as its methodology.

 Guerrero-López, C.M., Unar-Munguía, M. &Colchero, M.A. Price elasticity of the demand for
soft drinks, other sugar-sweetened beverages and energy dense food in Chile. BMC Public Health
17, 180 (2017). https://bmcpublichealth.biomedcentral.com/articles/10.1186/s12889-017-4098-x

Another interesting aspect to investigate is that elasticity tend to differ depending on the time horizon in
question. That is, consumer and producers tend respond to a price change differently in the short run and
long run. Read this article from Khan Academy to understand elasticity in the long run and short run:
 https://www.khanacademy.org/economics-finance-domain/microeconomics/elasticity-
tutorial/price-elasticity-tutorial/a/elasticity-in-the-long-run-and-short-run
 PART III

Supply, Demand, and Government Policies

The previous topics on supply and demand tackled the model’s building blocks, how various events cause
both supply and demand to shift, and developed a gauge to measure the size of these changes. This
section will extend the previous discussion on the application of supply, demand, and elasticity to existing
government policies such as price control and taxes.

Learning Outcomes

At the end of this module, you are expected to:

L01 Identify and explain what price controls are
L02 Cite and discuss examples of price control
L03 Examine how burden of a tax is shared among participants in a market
L04 Analyze how price control and taxes affect market outcomes

Think!
Here are some study questions that can aid you as you study price controls and taxes:
o What are price controls? Why is there a need for such?
o When implemented, how does it disrupt the prevailing market equilibrium?
o How is the burden of a tax shared among participants in a market?
o How do we apply the concept of supply, demand, and elasticity in understanding how
certain policies affect market outcomes?

Price Control

Policymakers implement price controls in the event when the prevailing market price for a particular good
or service tends to be discriminatory to either the consumers or producers. Two types of control are
introduced in this section: price ceiling and price floor. Also discussed thoroughly in this section are
specific examples of these types and how each influence market outcomes.

Learn more on price control and how supply and demand is applied to better analyze its effect to market
outcomes in the link below: 3.4 Ceilings and Price Floors https://openstax.org/books/principles-
economics/pages/3-4-price-ceilings-and-price-floors

Specific case studies on rent control and minimum wage are also available in N.G. Mankiw’s Principles
of Economics, section 6-1, Chapter 6 (Supply, Demand, and Government Policies).

Taxes

After the application of supply and demand to government-enacted price control, we extend our
discussion into including elasticity in the analysis, specifically applied to taxes. Government revenues
where funds for public projects are obtained basically comes from the taxes collected from different
sources. What happens when taxes are raised? Does a higher tax automatically mean higher revenue for
the government, thus more public projects? When a tax is levied, who shoulders the burden of the tax
more heavily? We will try to answer these questions in this section by applying the concept of supply,
demand, and elasticity. A step-by-step procedure is presented on how to analyze the effect of taxes when
levied either with the buyer or the seller. Lastly, we use the concept of elasticity in examining how much
revenue and deadweight loss is created when tax is levied.

A comprehensive discussion on the application of supply, demand, and elasticity to taxes is available in
section 6-2, Chapter 6 (Supply, Demand, and Government Policies) of N.G. Mankiw’s Principles of
Economics.

Dig Deeper

Please read the article from the link provided below to learn more on price control as applied to a well-
timed concern on consumption of face mask:

Price controls don’t work-but mask rationing is the exception that proves the rule:
https://theconversation.com/price-controls-dont-work-but-mask-rationing-is-the-exception-that-proves-
the-rule-136595

- End of Module 2 –

An Important Note

Before proceeding to the quiz, please be reminded of this:

ACADEMIC INTEGRITY

As a student of the University of the Philippines, I pledge to act ethically and uphold the value of honor
and excellence.

I understand that suspected misconduct on given assignments/examinations will be reported to the

appropriate office and if established, will result in disciplinary action in accordance with University
rules, policies and procedures. I may work with others only to the extent allowed by the Instructor.

Study well and Stay Safe. 