Module 3

Demand and
Supply Analysis

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 • Supply and demand
– Words economists use most often
– The forces that make market economies
work
– Refer to the behavior of people as they
interact with one another in competitive
markets

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 • Market
– A group of buyers and sellers of a
particular good or service
– Buyers as a group
• Determine the demand for the product
– Sellers as a group
• Determine the supply of the product

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 • Competitive market
– Market in which there are many buyers
and many sellers
– Each has a negligible impact on market
price
– Price and quantity are determined by all
buyers and sellers
• As they interact in the marketplace

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 • Perfectly competitive market
– Goods offered for sale are all exactly the same
– Buyers and sellers are so numerous
• No single buyer or seller has any influence over the
market price
• Price takers
– At the market price
• Buyers can buy all they want
• Sellers can sell all they want

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 • Monopoly
– The only seller in the market
– Sets the price
• Oligopoly
• Monopolistic Competition

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 • Quantity demanded
– Amount of a good that buyers are willing
and able to purchase
• Law of demand
– When the price of a good rises, the
quantity demanded of the good falls
– When the price falls, the quantity
demanded rises

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 Demand, Part 2
• Demand
– Relationship between the price of a good
and quantity demanded
– Demand schedule: a table
– Demand curve: a graph
• Price on the vertical axis
• Quantity on the horizontal axis
• Individual demand
– An individual’s demand for a product
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 Figure 1 Catherine’s Demand Schedule and
Demand Curve
Price of Quantity of
Ice-Cream Cones
Cone Demanded
$0.00 12 cones
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.00 0

The demand schedule is a table that shows the quantity demanded at each price.
The demand curve, which graphs the demand schedule, illustrates how the quantity
demanded of the good changes as its price varies. Because a lower price increases the
quantity demanded, the demand curve slopes downward.

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The Demand Schedule for Bread

Price in
Point Quantity
PHP
A 4 0
B 3 10
C 2 20
D 1 30
E 0 40
 Demand
• Market demand
– Sum of all individual demands for a good
or service
• Market demand curve
– Sum the individual demand curves
horizontally
– Total quantity demanded of a good varies
• As the price of the good varies

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 Market Demand as the Sum of Individual Demands
Price of Ice- Catherine Nicholas Market
Cream Cone
0.00 dollar 12 7 19 cones

0.5 dollar 10 6 16 cones

1.00 dollar 8 5 13 cones

1.50 dollars 6 4 10 cones

2.00 dollars 4 3 7 cones

2.50 dollars 2 2 4 cones

3.00 dollars 0 1 1 cone

The quantity demanded in a market is the sum of the quantities demanded by all the buyers at
each price. Thus, the market demand curve is found by adding horizontally the individual
demand curves. At a price of $2.00, Catherine demands 4 ice-cream cones and Nicholas
demands 3 ice-cream cones. The quantity demanded in the market at this price is 7 cones.

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 Figure 2 Market Demand as the Sum of Individual
Demands, Part 2

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14
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 Demand
• Shifts in the demand curve
– Increase in demand
• Any change that increases the quantity
demanded at every price
• Demand curve shifts right
– Decrease in demand
• Any change that decreases the quantity
demanded at every price
• Demand curve shifts left

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 Figure 3 Shifts in the Demand Curve

Any change that raises the quantity that buyers wish to purchase at any given price shifts the
demand curve to the right.
Any change that lowers the quantity that buyers wish to purchase at any given price shifts the
demand curve to the left.
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 Demand
• Variables that can shift the demand curve
– Income
– Prices of related goods
– Tastes
– Expectations
– Number of buyers

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 Supply
• Quantity supplied
– Amount of a good
– Sellers are willing and able to sell
• Law of supply
– Other things equal
– When the price of a good rises, the
quantity supplied of the good also rises
– When the price falls, the quantity supplied
falls as well
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 Supply
• Supply
– Relationship between the price of a good
and the quantity supplied
– Supply schedule: a table
– Supply curve: a graph
• Price on the vertical axis
• Quantity on the horizontal axis
• Individual supply
– A seller’s individual supply
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 Figure 5 Ben’s Supply Schedule and Supply Curve

Price of Quantity
Ice-cream Of Cones
Cone Supplied
$0.00 0 cones
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5

The supply schedule is a table that shows the quantity supplied at each price.
This supply curve, which graphs the supply schedule, illustrates how the quantity supplied of
the good changes as its price varies.
Because a higher price increases the quantity supplied, the supply curve slopes upward.

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 Supply, Part 3
• Market supply
– Sum of the supplies of all sellers for a good
or service
• Market supply curve
– Sum of individual supply curves horizontally
– Total quantity supplied of a good varies
• As the price of the good varies
• All other factors that affect how much suppliers
want to sell are hold constant
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 Figure 6 Market Supply as the Sum of Individual
Supplies, Part 1
Price of ice- Ben Jerry Market
cream cone
0.00 dollar 0 0 0 cone
0.50 dollar 0 0 0 cone
1.00 dollar 1 0 1 cone
1.50 dollars 2 2 4 cones
2.00 dollars 3 4 7 cones
2.50 dollars 4 6 10 cones
3.00 dollars 5 8 13 cones

The quantity supplied in a market is the sum of the quantities supplied by all the sellers at
each price. Thus, the market supply curve is found by adding horizontally the individual
supply curves. At a price of $2.00, Ben supplies 3 ice-cream cones and Jerry supplies 4 ice-
cream cones. The quantity supplied in the market at this price is 7 cones.

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 Figure 6 Market Supply as the Sum of Individual
Supplies, Part 2

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 Supply
• Shifts in supply
– Increase in supply
• Any change that increases the quantity
supplied at every price
• Supply curve shifts right
– Decrease in supply
• Any change that decreases the quantity
supplied at every price
• Supply curve shifts left

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 Exhibit 7 Shifts in the Supply Curve

Any change that raises the quantity that sellers wish to produce at any given price shifts the
supply curve to the right.
Any change that lowers the quantity that sellers wish to produce at any given price shifts the
supply curve to the left.
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 Supply, Part 5
• Variables that can shift the supply curve
– Input prices
– Technology
– Expectations about future
– Number of sellers

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 Supply, Part 6
• Input prices
– Supply is negatively related to prices of
inputs
– Higher input prices: decrease in supply
• Technology
– Advance in technology: reduces firms’
costs: increase in supply

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 Supply, Part 7
• Expectations about future
– Affect current supply
– Expected higher prices
• Decrease in current supply
• Number of sellers, increases
– Market supply increases

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 Supply and Demand Together, Part 1
• Equilibrium
– Various forces are in balance
– A situation in which market price has
reached the level where
• Quantity supplied = Quantity demanded
– Supply and demand curves intersect

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 Supply and Demand Together, Part 2
• Equilibrium price
– Balances quantity supplied and quantity
demanded
• Equilibrium quantity
– Quantity supplied and quantity demanded
at the equilibrium price

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The Demand and Supply Schedule
for Bread
Price in Quantity Quantity
Point
PHP Demanded Supplied
A 4 0 40
B 3 10 30
C 2 20 20
D 1 30 10
E 0 40 0
 Figure 8 The Equilibrium of Supply and Demand

The equilibrium is found where the supply and demand curves intersect. At the equilibrium
price, the quantity supplied equals the quantity demanded.
Here the equilibrium price is $2.00: At this price, 7 ice-cream cones are supplied and 7 ice-
cream cones are demanded.
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 Supply and Demand Together, Part 3
• Surplus
– Quantity supplied > Quantity demanded
– Excess supply

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 Supply and Demand Together, Part 4
• Shortage
– Quantity demanded > Quantity supplied
– Excess demand

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 Figure 9 Markets Not in Equilibrium

In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price, the
quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to increase
sales by cutting the price of a cone, and this moves the price toward its equilibrium level.
In panel (b), there is a shortage. Because the market price of $1.50 is below the equilibrium price,
the quantity demanded (10 cones) exceeds the quantity supplied (4 cones). With too many buyers
chasing too few goods, suppliers can take advantage of the shortage by raising the price. Hence, in
both cases, the price adjustment moves the market toward the equilibrium of supply and demand.
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 Pricing Strategies

Factors that affects pricing decision:

1. The degree of competitive pressure
2. Availability of sufficient supply
3. Seasonal or cyclical changes in demand
4. Distribution cost
5. Prevailing economic conditions
6. Customer services provided by the seller
7. The amount of promotion done, and
8. The market buying power
Pricing Strategies
Pricing strategies refer to the
processes and methodologies
businesses use to set prices for their
products and services
Pricing Strategies
Penetration Pricing
 Penetration Pricing

Price set to ‘penetrate the market’

‘Low’ price to secure high volumes
Typical in mass market products –
chocolate bars, food stuffs, household
goods, etc.
May be useful if launching into a new
market
Market Skimming
 Market Skimming
 High price, Low volumes
 Skim the profit from the
market
 Suitable for products that
have short life cycles or
which will face competition at
some point in the future (e.g.
after a patent runs out)
 Examples include:
Playstation, jewellery, digital
technology, new DVDs, etc.
Many are predicting a firesale in
laptops as supply exceeds
demand.
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Value Pricing
 Value Pricing
 Price set in accordance
with customer
perceptions about the
value of the
product/service
 Examples include
status
products/exclusive Companies may be able to set prices
products according to perceived value.

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Loss Leader
 Loss Leader

Goods/services deliberately sold below cost

to encourage sales elsewhere
Purchases of other items more than covers
‘loss’ on item sold
Psychological Pricing
 Psychological Pricing

Used to play on consumer

perceptions
Classic example - £9.99 instead of
£10.99!
Links with value pricing – high value
goods priced according to what
consumers THINK should be the
price
Going Rate (Price Leadership)
 Going Rate (Price Leadership)

 In case of price leader, rivals have difficulty in

competing on price – too high and they lose market
share, too low and the price leader would match
price and force smaller rival out of market
 May follow pricing leads of rivals especially where
those rivals have a clear dominance of market
share
 Where competition is limited, ‘going rate’ pricing
may be applicable – banks, petrol, supermarkets,
electrical goods – find very similar prices in all
outlets
Tender Pricing
 Tender Pricing
 Many contracts awarded on a tender basis
 Firm (or firms) submit their price for carrying out the
work
 Purchaser then chooses which represents best value
 Mostly done in secret
Price Discrimination
 Price Discrimination
 Charging a different
price for the same
good/service in different
markets
 Requires each market
to be impenetrable
 Requires different price
elasticity of demand in
Prices for rail travel differ for the same each market
journey at different times of the day

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Destroyer Pricing/Predatory Pricing
 Destroyer/Predatory Pricing
Deliberate price cutting or offer of ‘free
gifts/products’ to force rivals (normally
smaller and weaker) out of business or
prevent new entrants
Anti-competitive and illegal if it can be
proved
Absorption/Full Cost Pricing
 Absorption/Full Cost Pricing

Full Cost Pricing – attempting to set

price to cover both fixed and
variable costs
Absorption Cost Pricing – Price set
to ‘absorb’ some of the fixed costs
of production
Marginal Cost Pricing
 Marginal Cost Pricing

 marginal-cost pricing, in economics, the practice of

setting the price of a product to equal the extra cost
of producing an extra unit of output.
Contribution Pricing
 Contribution Pricing

 Contribution = Selling Price – Variable (direct

costs)
Prices set to ensure coverage of variable
costs
Similar in principle to marginal cost pricing
Break-even analysis might be useful in such
circumstances
Target Pricing
 Target Pricing

Target Pricing is a pricing strategy

in which the selling price of the
product or service is determined first
and then the cost is calculated by
reducing the profit margin.
Cost-Plus Pricing
 Cost-Plus Pricing

Calculation of the average cost (AC)

plus a mark up
AC = Total Cost/Output
Influence of Elasticity
 Influence of Elasticity

Any pricing decision must be mindful of the

impact of price elasticity
The degree of price elasticity impacts on the
level of sales and hence revenue
Elasticity focuses on proportionate
(percentage) changes
PED = % Change in Quantity demanded/%
Change in Price
 Price Elasticity of Demand

is the degree of responsiveness of quantity

demanded to a change on price.
 Problem Solving:
Cecilia sells bangus for P100 and her Q1 =
500. when she decides to sell it for P125,
her Q2 becomes 450. Is Quantity
demanded elastic or inelastic? Compute for
TR1 and TR2. Should Cecilia sell her
bangus at P100 or P125.
 Price Elasticity of Supply

is the degree of responsiveness of

quantity supplied to a change on price.
Summary of Price Elasticity of Demand

Price Elasticity of Interpretation

Demand
=1 Unitary Elastic
>1 Elastic
<1 Inelastic
 Problem Solving:
Cecilia sells bangus for P100 and her Q1 =
500. when she decides to sell it for P125,
her Q2 becomes 450. Is Quantity
demanded elastic or inelastic? Compute for
TR1 and TR2. Should Cecilia sell her
bangus at P100 or P125.
 Problem Solving:
The old price of sardines is P10. At P10, a
producer can supply 100 cans of them.
When the selling price changes to P12, the
producer was able to increase its
production to 120 units. Solve for the price
elasticity of supply.