Chapter 2:

Theory of Demand and Supply

• Definition of demand, law of demand, individual
and market demand
• Determinants of demand
• Exceptional demand (not tested)
• Change in quantity demand vs Change in demand
• Definition of supply, law of supply, individual and
market supply
• Determinants of supply
• Exceptional supply (not tested)
• Change in quantity supply vs Change in supply
 THEORY OF DEMAND
 DEFINATION OF DEMAND
Demand can be defined as the desire to buy goods and
Services with the ability to pay, and the consumer must
have the purchasing power. Simply, demand implies the
willingness and the ability to pay for good and services

• THE LAW OF DEMAND

The law of demand states that when price
increases, the quantity demanded fall and when
price decreases, the quantity demanded will
rise, ceteris paribus. There is an inverse negative
relationship between the quantity demanded and
the price of the product concerned
 DEMAND SCHEDULE AND DEMAND CURVE

• Demand schedule shows the quantity demanded of a

product at various price levels.
• Table below shows the quantity demanded for good
A at different pice level.
Price per unit of good A Quantity demanded
(RM) (unit)
1 10
2 8
3 6
4 4
5 2
• Due to the negative relationship between the quantities
demanded of a product and its price. The demand curve
is downward –sloping.
 INDIVIDUAL DEMAND AND MARKET DEMAND
• Individual demand refers to the demand of an individual or a buyer.
• Market demand refers to the total quantity demanded by all buyers in the market.
The market demand derived by sum up horizontally the quantity demanded at each
and every price level.
• Market Demand=∑ Individual Demand
Table 2.2: Market demand schedule for good A
Figure 2.2:Individual and Market demand Curves
 DETERMINANTS OF DEMAND (FACTORS AFFECTING
DEMAND)
1.Fashion, taste.
 The affect of fashion on demand can be clearly seen in the changing demand
for ladies fashion apparel.
 Taste refers to the general preference of a population or a particular individual.
 If a product becomes more favorable or fashionable, the demand will increase
for that product and vice versa.
2. Changes in income.
 This affects both the individual as well as national levels.
 Generally, the higher the individual income, the higher would be the demand
for goods and services.
3. Changes in size and structure population
 In terms of size, an increase in total population would generally lead to an
increase in demand.
 In terms of population structure, the different age groups influence demand
differently.
 The young will demand more education toys, books, etc, while the older
population will demand a different list of goods and services.
 Cont’…
4.Changes in the price of related goods. There are good groups:
 Complementary goods.
Complementary goods are goods which are needed to be used together
with other goods. E.g VCD and VCD player, pen and ink, car and petrol and
the like.
Thus, an increase in the price of one good effectively decreases the
demand of the other. Take for instance, pen and ink. If the price of pen
decreases, more pen will be demanded and demand ink will also increase.
The effect of change in price for complementary goods is negative. When
the price of a good falls, the demand for another good increases.

 Substitute goods.
These are goods and services that can be replaced with other goods. E.g
coffee and tea, Pepsi-Cola and Cola-Cola, Foreign and Domestic Cars.
The demand for a good rises when the price of the other good rises.
 Cont’…
5. Expectation of future price.
• If people learn that the price of good will rise substantially, they may
decide to increase demand now.

6.Advertisements.
• Advertised goods generally have higher demand.

7. Festive seasons
• During festive seasons, certain products will be in high demand
 CHANGES IN QUANTITY DEMANDED VERSUS
CHANGES IN DEMANDED
CHANGES IN QUANTITY DEMANDED CHANGES IN DEMANDED

Changes in quantity demanded refer to
the movement along the same demand
curve due to the changes in the price to the
product itself.
It is movement from one point to another
point i.e from one price and quantity to
another quantity.
Change in demand refer to the shift of the
demand curve to the left or right due to
other factors that determine demand(price
of the product remain constant).
It is a shift in the entire demand curve
either to the right or to the left.

The cause of change is due to a change in The cause of change is not due to
price either to P2 or P1. price(price is fixed) but when one or more
of the non – price factors, such as income,
taste and preferences or population
changed.
A movement from quantity a to b is called  when the demand curve shift from D0D0
contraction of demand and a movement to D1D1,leftwards,it is known as decrease
from A to C is called expansion of demand. in demand and when demand curve moves
upwards to the right from D0D0 to D2D2 is
known as increase in demand.
• Contraction
Means a decrease in quantity demanded as
goes up.
• Expansion
Means an increase in quantity demanded as
price goes down.
 EXCEPTIONAL DEMAND
Demand does not follow the law of demand (its goes against
the law of demand).

• Where the price of the product increases, the

demand for it will also increase.
• The demand curve is positively sloped.
• Exceptional demand occurs in the following
instances:
 a) For Giffen goods.
 b) speculation- Expectation prices to fall or increases.
 c) For luxury goods.
 d) Emergencies.
THEORY OF SUPPLY
• Definition of supply
Supply is the amount of particular product
or service that a firm would be willing and
able to offer for sale at a particular price
during a period of time.
LAW OF SUPPLY
•The law of supply states that as price
increase, the quantity supplied will also
increase and conversely, when price falls,
the quantity supplied will fall , ceteris paribus.
• SUPPLY SCHEDULE AND SUPPLY CURVE
• Supply schedule shows the quantity supplied of a
product at various price levels.
• Table below shows the quantity supplied of good A at
different price level.

• Table 2.1 individual supply schedule for good A

Price per unit of good A(RM) Quantity supplied(unit)

1 2
2 4
3 6
4 8
5 10
 Figure 2.1 : An Individual Supply Curve

Due to the positive relationship between the quantities

supplied of a product and its price. The supply curve is
upward-sloping.
 Individual supply and market supply

• Individual supply refers to the supply of an individual or a seller.

• Market supply refers to the total quantity supplied by all sellers in
the market supply derived by sum up horizontally the quantity
supplied at each and every price level.
• Market Supply = ∑ Individual Supply
• Table 2.2:Market supply schedule for good A
Figure 2.2:Individual and Market supply Curve
 Determinants of supply (factors affecting
supply
Cost of production.
The supply decisions is likely to change in
response to changes in the cost of
production. When the cost of production
increases, the supply will decrease and
when the cost of production decreases,
supply will increase. The cost of
production is affected directly to the price
of raw material used to produce those
goods and services, wages of workers.
Price of related goods
a) Substitute goods- supply of a good will
decrease if there is an increase in the price of
substitute good, example Pepsi and coke.
When the price of Pepsi increases, the quantity
supplied will increase. And quantity Coke will
decrease.
b) Complementary goods- An increase in the price
of a good will increase the supply of a
complementary good. Example pen and ink.
When the price of pens increases, the quantity
of pens supplied will increase and the supply of
ink will also increase since both are
complementary goods.
 Technological advancement.
If there is a more advanced technology, the ability to produce
output will increase even when using a fixed amount of
resources. As a result supply increases.

 Expectation of future price changes.

If the producer speculates that there will be an increase in the
price later on, they will reduce the supply now and will only
increase the supply when the price increase.

 The number of seller

The larger the number of firms supplying a goods, the larger
the quantity supplied of the good and vice versa. Example, if
there is an increase in the number of cafeterias in a university
campus, the supply of food and drink will increase.
Government policy.
The two policies which have a large affect on the
supply are:
i. Taxes . When goods are taxed, the supply will
fall. Tax act as disincentives to producers
because part of their profit are eroded.
ii. Subsidies. When the government subsidizes
production, supply of that good will increase.
With subsidies, cost of production will be
cheaper and this in turn will generate more
profits. Being motivated by profits, the
producer will supply more good and services.
 CHANGE IN QUANTITY SUPPLIED VS CHANGE IN SUPPY

CHANGE IN QUANTITY SUPPLY VS CHANGE IN SUPPLY

 EXCEPTIONAL SUPPLY
• the exception occurs when the price of a
product increase and the supply decrease.
• supply curve negative sloped
• normally happens in the supply of labour and
also known as the backward bending lobour
supply curve