Leidenschaft

fürs Leben.

Fundamentals of Economics
and Management
Ekaterina Aleshchenko, PhD, MBA
Course Structure

01 13. October
Introduction to the Economic Theory. Fundamentals of the Theory of Consumer
Behavior.

02 17. October
Fundamentals of the Theory of Demand and Supply.

03 26. October
Theory of Company Behavior. The Company Under Imperfect Competition.

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Lecture 2. Fundamentals of the Theory of Demand
and Supply

1. Demand
2. Supply
3. Market equilibrium
4. Elasticity

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1. Demand

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How would you define „demand“?

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Demand

• The term demand refers to the number of units of a particular good or

service that consumers (households) are willing to purchase at a particular
period.
• This is a solvent need for any product or service.
• The need for a certain good implies a desire to possess goods. Demand
implies not only a desire, but also the possibility of acquiring it at current
market prices. The term demand refers to the number of units of a
particular good or service that consumers (households) are willing to
purchase at a particular period.
• This is a solvent need for any product or service.

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Law of Demand

• If the prices for any product increase, and at the same time all other
parameters remain unchanged, then the demand will be presented for the
smaller quantity of this product.
• Two interrelated effects:
- income effect
- substitution effect

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The income effect

• The income effect refers to the change in the demand for a product or
service caused by a change in consumers’ disposable income, which is the
portion of somebody’s income that is available for spending on non-
essentials or saving.

key word: disposable income

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The substitution effect

• An effect caused by a rise in price that induces a consumer (whose income

has remained the same) to buy more of a relatively lower-priced good and
less of a higher-priced one.

to buy the same product from another supplier for

lower price to SUBSTITUTE for the higher priced
product.

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Model of demand

• Qx = f (Px) – the quantity of commodity X demanded is a function of the

price of X.
• The relationship between price and quantity is negative. This is due to a
substitution and an income effect.

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Individual demand curve

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Market demand curve

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Determinants of demand

• Price of the commodity Price is inversely proportional to demand.

• Price of other goods and services because of substitution effect, consumer will choose a product that provides
same or similar purpose but for lower price.
• Average household disposable income this is for non-essential items which can be either substituted or not
necessarily bought.
• Wealth
• Taste and preferences
• Size of population the size of target population determines how much of the product will be distributed amongst the
population.

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Exceptions of the law of demand

Giffen’s Paradox Veblen’s Effect

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Giffens’ paradox
• a situation where a decrease in prices for certain types of
goods leads to a decrease in demand for them. The reverse is
also true: the increase in prices for certain types of goods leads
to an increase in demand for them.
• The Giffen effect refers to the reaction of buyers to the
economic or political situation and applies to the goods of first
necessity. The different behavior of buyers in relation to the
goods allowed to formulate the division of goods into two
groups: ordinary goods and "Giffen goods".
• This particular economic paradox was propounded by Scottish
economist, Sir Robert Giffen in Victorian England
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Giffen goods
Characteristics of Giffen goods:
• low-value goods; necessary goods.

• occupy a significant place in the consumer budget;

• there is no equivalent substitute product;
• consumers of the goods, to a large extent, people with low and
middle incomes.
Examples: bread, food grain, rice, vegetables, etc.
Short-term effect is observed when petrol prices rise.

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Veblens‘ effect
• This is a situation where buyers perceive a decrease in the price
of a product as a signal of a decrease in its quality or prestige,
and a price increase, on the contrary, makes the product more
attractive.
• All Veblen goods belong to the premium segment, and as their
prices rise, the desire of the target audience to possess them
increases.
• The paradox was discovered by the American sociologist
Torstein Veblen, and is described in the book Theory of the
Leisure Class.

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2. Supply

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How would you define „supply“?

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Supply
• The quantity of a commodity that producers wish to sell at
various prices is the quantity supplied. The supply schedule
specifies the units of good or service that producer is willing to
supply at alternative prices.
• The supply curve shows the amount of a product or service
that a producer is ready to offer at a different price at a given
point in time.
• Graphic representation of the supply - the curve of the supply.
The curve has a positive slope, indicating that manufacturers
must raise the price in order to produce more.

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An individual supply curve

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A market supply curve

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Determinants of Supply
• The commodity’s own price.
• Number / size of producers.
• Factor prices (wages, interest or rent paid to economic
resources).
• Cost of factors of production.
• Technological progress.
• Government subsidy / taxes on output.

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3. Market equilibrium

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Market Equilibrium

• To consider how prices are determined in a competitive market

by the forces of supply and demand, we assume first that other
factors except the commodity’s own price are held constant.
• Equilibrium price is the price at which quantity demanded
equals quantity supplied.
• It is a situation in which there is no tendency for price or
quantity to change.

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Market Equilibrium

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Deficit and Surplus

• At prices below the equilibrium there will be shortages and

rising prices. Deficit - a situation in the market in which the
volume of demand is greater than the volume of supply at a
given price level.
• And at points above the equilibrium there will be surpluses and
falling prices. Surplus (glut) - a situation in the market in which
the volume of supply is greater than the volume of demand at
a given price level.

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Market Equilibrium

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Market Equilibrium

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4. Elacticity

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Elasticity

• … Is a measure of how much buyers and sellers respond to

changes in market conditions.
• … It is helpful to describe the relative responsiveness of
consumers and suppliers to price changes.
• … Elasticities allow economists to quantify the differences
among markets without standardizing the units of
measurement, because it is unit-free.

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Elasticity

There are different types of elasticity. Let’s discuss two main of

them – price elasticity of demand and price elasticity of supply.

• Price elasticity of demand: how sensitive is the quantity

demanded to a change in the price of the good.
• Price elasticity of supply: how sensitive is the quantity
supplied to a change in the price of the good.
Often referred to as “own” price elasticities.

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Elasticity of demand: examples

When the price of gasoline rises by 1% the quantity demanded

falls by 0.2%, so gasoline demand is not very price sensitive.
• Price elasticity of demand is -0.2.

When the price of gold jewelry rises by 1% the quantity

demanded falls by 2.6%, so jewelry demand is very price
sensitive.
• Price elasticity of demand is -2.6.

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Elasticity of supply: examples

When the price of DaVinci paintings increases by 1% the quantity

supplied doesn’t change at all, so the quantity supplied of
DaVinci paintings is completely insensitive to the price.
• Price elasticity of supply is 0.

When the price of beef increases by 1% the quantity supplied

increases by 5%, so beef supply is very price sensitive.
• Price elasticity of supply is 5.

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Price elasticity can be

Unit elastic
Inelastic Elastic

0 1 2 3 4 5 6

• Unit elastic: own price elasticity equal to 1

• Inelastic: own price elasticity less than 1
• Elastic: own price elasticity more than 1

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Determinants of elasticity
What is a major determinant of the own price elasticity of
demand?
• Availability of substitutes in consumption.

What is a major determinant of the own price elasticity of

supply?
• Availability of alternatives in production.

As a general rule, the more substitutes a good has, the more

elastic is its supply and demand.
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Substitution and demand
• The larger the time interval considered, or the longer the run,
the more elastic is the good’s demand curve.
• The less a good is a necessity, the more elastic its demand
curve: Necessities tend to have fewer substitutes than do
luxuries.
• Demand for goods that represent a large proportion of one's
budget are more elastic than demand for goods that represent
a small proportion of one's budget: Goods that cost very little
relative to your total expenditures are not worth spending a lot
of time figuring out if there is a good substitute.

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Substitution and supply

The longer the time period considered, the more elastic the
supply.
• In the long run there are more options for change so it is easier (less
costly) for suppliers to change into the production of another good.

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Substitution and supply

The longer the time period considered, the more elastic the
supply.
• In the long run there are more options for change so it is easier (less
costly) for suppliers to change into the production of another good.

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