BACC 1- BASIC MICROECONOMICS

CHAPTER II

THE BASIC ANALYSIS OF

DEMAND AND SUPPLY
 LEARNING OBJECTIVES
Ater reading and studying this chapter, you should be able to:
•Define market
•Know the difference between demand and supply
•Identify the ways forces of demand and supply affect its curve
•Categorize the forces or factors that affect the level of demand and supply
•Explain how the law of demand and supply affect the market
•Define equilibrium
•Explain how equilibrium occur in the market
• Differentiate surplus from shortage
•Describe how the government utilize price control
 INTRODUCTION
This chapter will help you gain understanding on how prices are
set and markets operate. As markets exist to facilitate exchanges
of goods, services, and resources, the forces that make the
markets move are the operations of demand and supply.

Demand is generally affected by the behavior of consumers, while

supply is usually affected by the conduct of producers. The
interplay between these two is the foundation of economic activity.
Thus, the consumer identifies his or her needs, wants, and
demands, while producers address these by accordingly producing
goods and services. In the end, the consumer gains satisfaction
while the producer gains profit.
 INTRODUCTION
As the economy cannot operate without this
interaction between the producer, it is essential,
therefore, that students understand the different
movements of the the demand and supply curves, as
well as the concept of market equilibrium.
 MARKET
Take note that when there is demand for a good or
service, there is a market. A market is where buyers
and sellers meet. It is the place where they both
0-14
trade or exchange goods or services-in other words,
33%
it is where their transaction takes place. There are
30-44
different kinds of markets, such as wet and dry. Wet
20%
market is where people 15-29usually buy vegetables,
meat, etc. On the other hand,28% dry market is where
people buy shoes, clothes, or other dry goods.
 MARKET
However, in economic parlance, the term
market does not necessarily refer to a tangible a
where buyers and sellers could be seen
transacting. It can represent an intangible
domain where goods and services are traded,
such as the stock market, real estate market, or
labor market-where workers offer their services,
and employers look for workers to hire.
 DEMAND
Demand pertains to the quantity of a good or
service that people are ready to buy at given
prices within a given time period, when other
factors besides price are held constant.
Simply put, the demand for a product is the
quantity of a good or service that buyers are
willing to buy given its price at a particular
time.
 DEMAND
Demand therefore implies three things:
• Desire to possess a thing (good or service);
• The ability to pay for it or means of purchasing it
(price), and
• Willingness in utilizing it.
METHODS OF
DEMAND ANALYSIS
Demand can be analyzed in several ways.
However, the most common way of
analyzing demand is through demand
schedule, demand curve, and demand
function.
 DEMAND SCHEDULE
A demand schedule is a table that shows the
relationship of prices and the specific quantities
demanded at each of these prices. Generally, the
information provided by a demand schedule can
be used to construct a demand curve showing the
price-quantity demanded relationship in graphical
form. Table 2.1 presents a hypothetical demand
schedule for rice per month.
DEMAND SCHEDULE
TABLE 2.1
 DEMAND SCHEDULE
Take note that as the price goes up (down) the
quantity of rice being purchased by the consumer
goes down (up). This implies that quantity
demanded is inversely related with price. In other
words, consumers are not willing to purchase
more rice at higher prices but will consume more if
prices are low.
 DEMAND CURVE
As we have said earlier, the demand curve is a
graphical representation showing the
relationship between price and quantities
demanded per time period. A demand curve has
negative slope, thus it slopes downward from
left to right. The downward slope indicates the
inverse relationship between price and quantity
demanded.
 DEMAND CURVE
Take note that most demand curves slope
downwards because (a) as the price of the
product falls, consumers will tend to substitute
this (now relatively cheaper) product for others
in their purchases; (b) as the price of the
product falls, this serves to increase their real
income allowing them to buy more products
(Pass & Lowes 1993). Figure 2.1 illustrates a
normal demand curve.
FIGURE 2.1: Demand Curve
 DEMAND FUNCTION
Demand can also be analyzed mathematically through a
demand function. A demand function also shows the
relationship between demand for a commodity and the
factors that determine or influence this demand. These
factors are-the price of the commodity itself, prices of other
related commodities, level of incomes, taste and preferences,
size and composition of level of population, distribution of
income etc. Demand function is expressed as a mathematical
function.
 DEMAND FUNCTION
We can therefore come up with the
demand equation as:
QD = a-bp
where:
QD = quantity demanded at a particular
price
a = intercept of the demand curve
b = slope of the demand curve
p = price of the good at a particular time
period
CHANGE IN QUANTITY
DEMANDED VS. CHANGE IN
DEMAND
Before we go further with our discussion of the
concept of demand, let us first distinguish change
in quantity demanded and change in demand. This
is important since a change in quantity demanded
must not be confused with a change in demand.
 CHANGE IN QUANTITY DEMANDED
We can say that there is change in quantity
demanded (symbolized as rQD) if there is a
movement from one point to another point-or
from one price-quantity combination to another-
along the same demand curve. A change in
quantity demanded is mainly brought about by
an increase (a decrease) in the product's own
price. The direction of the movement however is
inverse considering the Law of Demand.
 CHANGE IN QUANTITY DEMANDED
We can explain change in quantity demanded through a
demand curve. Figure 2.2 illustrates the concept of
change in quantity demanded. We can see in this figure
that the original price is at P0, and at this price level
quantity demanded is at Q0 The point of interaction
between P0, and Q0, is at point a along the demand
curve. Now let us assume that price decreases to P1. As
a result quantity demanded will increase to Q1 because
of the change in the product's price.
 CHANGE IN QUANTITY DEMANDED
As a result, quantity demanded will move to point b
along the same demand curve because of the
decrease in price as shown by the arrow. The reverse
however will happen if price will increase. We can
therefore say that there is change in quantity
demanded if the price of the good being sold changes.
This is shown by a movement from one point to
another point along the same demand curve.
FIGURE 2.2: Change in Quantity Demanded
CHANGE IN DEMAND
There is a change in demand if the entire demand
curve shifts to the right (left) resulting to an increase
(decrease) in demand due to other factors other than
the price of the good sold. At the same price,
therefore, more amounts of a good or service are
demanded by consumers.
CHANGE IN DEMAND
Increase (decrease) in demand is
brought by factors other than the
price of the good itself such as tastes
and preferences, price of substitute
goods, etc. resulting in the shift of the
entire demand curve either upward or
downward.
FIGURE 2.3: Change in Demand
FORCES THAT CAUSE THE
DEMAND CURVE TO CHANGE
There are several reasons why demand changes
and thus cause the demand curve to move either
upwards or downwards. The following are the more
general reasons for the change in demand.
 TASTE OR PREFERENCES

Tastes or preferences pertain to personal likes

or dislikes of consumers for certain goods and
services. If tastes or preferences change so
that people want to buy more of a commodity at
a given price, then an increase in demand will
result or vice versa.
 CHANGING INCOMES

Increasing incomes of households raise the

demand for certain goods or services or vice
versa. This is because an increase in one's
income generally raises his or her capacity or
power to demand for goods or services which
he or she is not able to purchase at lower
income. On the other hand, a decrease in one's
income reduces his or her purchasing power,
and consequently, his or her demand for some
goods or services ultimately declines,
 OCCAIONAL OR SEASONAL
PRODUCTS
The various events or seasons in a given year also result to
a movement of the deman curve with reference to particular
goods. For example: During Christmas season, demand for
Christmas trees, parols, and other Christmas decors
increase. Moreover, demand for food items like ham and
quezo de bola also increase. Similarly, as Valentine's Day
approaches, the demand for red roses and chocolates also
rises. It should be noted, however, that after the events,
demand for these products returns back to the original level.
 POPULATION CHANGE

An increasing population leads to an increase in the demand

for some types of good a service, and vice-versa. This
simply means that more goods or services are to be
demande because of rising population. In particular,
increase in population generally results to a increase in
demand for basic goods, such as food and medicines. On
the other hand, a decrease in population results in a decline
in demand
 SUBSTITUTE AND
COMPLEMENTARY GOODS
Substitute goods are goods that are interchanged with another
good. In a situation where the price of a particular good
increases, a consumer will tend to look for closely related
commodities. Substitute goods are generally offered at cheaper
price, consequently making it more attractive for buyers to
purchase. For instance, Juan wants to buys a pair of Nike rubber
shoes. But the price of the shoes that he wants isworth
P5,000.00. Considering the price and his lower budget of
P3000.00, he will opt for an alternative brand of shoes with a
lower price, say, Converse shoes. In this situation, Nike and
Converse shoes are substitutes.
 NOMINAL GOOD AND INFERIOR

Normal goods can be defined as those goods for which demand

increases when the income of the consumer increases, and
those goods that decline when income of the consumer
decreases, price of the goods remaining constant. Examples of
normal goods are demand for LED TVs, demand for more
expensive iPhones, cars, and houses. With an increase in
income, there would be more spending, leading consumers to
buy normal goods.
On the other hand, inferior goods are goods for which the
demand decreases when the income of the consumer increases.
A good becomes inferior simply when the capacity of the
consumers has favorably increased, for instance, increase in
income, leading him or her to buy better alternatives.
FIGURE 2.4: Normal and Inferior Goods
 EXPECTATIONS OF FUTURE
PRICES
If buyers expect the price of a good or service to rise (or fall) in
the future, it may cause the current demand to increase (or
decrease). Also, expectations about the future may alter demand
for a specific commodity.
Take for example the fluctuating prices of rice. If households
expect that a drastic increase in the price of rice will happen after
a week, their natural behavior is to purchase and stock-up rice
before the price goes up. Thus, at that given point in time there
will be an increase in demand for rice due to consumer stock
piling because of the expected increase in its future price.
 SUPPLY (FIRMS/SELLER'S SIDE)
We now go to the other side of the coin which is
supply. Simply defined, supply is the quantity of
goods and services that firms are ready and willing to
sell at a given price within a period of time, other
factors being held constant. It is the quantity of goods
and services which a firm is willing to sell at a given
price, at a given point in time. Thus, supply is a
product made available for sale by firms. It should be
remembered that sellers normally sell more at a
higher price than at a lower price. This is because
higher price results to higher profits.
METHODS IN SUPPLY
ANALYSIS

Just like demand, supply can also be analyzed

through a supply schedule, supply curve, and
supply function.
 SUPPLY SCHEDULE

A supply schedule is a table listing the various prices

of a product and the specific quantities supplied at
each of these prices at a given point in time.
Generally, the information provided by a supply
schedule can be used to construct a supply curve
showing the price quantity supply relationship in
graphical form. Table 2.2 presents a hypothetical
supply schedule for rice per month.
TABLE 2.2:
Observe that as price increases quantity supplied
also increases. For instance, if the price of rice per
kilo is P5.00, sellers will be willing to sell 48 kilos of
rice in the market. However, if the price of rice will
decrease to P1.00, sellers will only be willing to sell 5
kilos of rice. As we have noted earlier, high prices
provide incentives to sellers to sell more because of
the expected increase in their profits. However, when
prices decline, these become a disincentive on the
sellers to sell more goods and services in the market
since their profits will be low.
 SUPPLY CURVE

A supply curve is a graphical representation showing

the relationship between the price of the product sold
or factor of production (e.g., labor) and the quantity
supplied per time period. The typical market supply
curve for a product slopes upward from left to right
indicating that as price rises (falls) more (less) is
supplied. The upward slope indicates the positive
relationship between price and quantity supplied.
This is illustrated in Figure 2.5.
FIGURE 2.5: Supply Curve
 SUPPLY FUNCTION

A supply function is a form of mathematical notation

that links the dependen variable, quantity supplied
(Qs), with various independent variables which
determine quantity supplied. Among the factors that
influence the quantity supplied are price of the
product, number of sellers in the market, price of
factor inputs, technology, business goals
importations, weather conditions, and government
policies.
 SUPPLY FUNCTION
Qs= f (product's own price, number of sellers, price of factor inputs,
technology, etc.)
Given our supply function, we can now derive our supply equation:

Qs = c+dp
Where:
Qs = Quantity supplied at a particular price
c = intercept of the supply curve
d = slope of the supply curve
p = price of the good sold
CHANGE IN QUANTITY
SUPPLIED VS. CHANGE IN
SUPPLY
Before we go further with our discussion of
the concept of supply, let us first distinguish
change in quantity supplied and change in
supply. This is important since a change in
quantity supplied must not be confused with
a change in supply
 CHANGE IN QUANTITY
SUPPLIED

A change in quantity supplied occurs if there is a

movement from one point to another point along
the same supply curve. A change in quantity
supplied is brought about by an increase
(decrease) in the product's own price. The direction
of the movement however is positive considering
the Law of Supply.
FIGURE 2.6: Change in Quantity Supplied
 CHANGE IN SUPPLY

A change in supply happens when the

entire supply curve shifts leftward or
rightward. At the same price, therefore, less
(more) amounts of a good or service is
supplied by producers or sellers.
FIGURE 2.7: CHANGE IN SUPPLY
 FORCES THAT CAUSE THE
SUPPLY CURVE TO CHANGE

Just like demand, there are also other factors that

cause the supply curve to change. Below are some of
the factors that cause the supply curve to change.
 OPTIMIZATION IN THE USE OF
FACTORS OF PRODUCTION
An optimization in the utilization of resources will increase
supply, while a failure to achieve such will result to a
decrease in supply. Optimization, in this sense, refers to the
process or methodology of making or creating something
as fully perfect, functional, or effective as possible. Simply
put, it is the efficient use of resources. In business
parlance, it can mean maximum production of output at
minimum cost.
Thus, the optimization of the various factors of production
(i.e., land, labor, capital and entrepreneurship) results to an
increase in supply, and vice versa (Sicat 2003).
 TECHNOLOGICAL CHANGE

The introduction of cost-reducing innovations in

the production technology increases supply on
one hand. On the other hand, this can also
decrease supply by means of freezing the
production through the problems that the new
technology might encounter, such as technical
trouble (Samuelson and Nordhaus 2004).
 FUTURE EXPECTATION
This factor impacts sellers as much as
buyers. If sellers anticipate a rise in
prices, they may choose to hold back
the current supply to take advantage of
the future increase in price, thus
decreasing market supply. If sellers
however expect a decline in the price
for their products, they will increase
present supply.
 NUMBER OF SELLERS

The number of sellers has a direct impact on quantity

supplied. Simply put, the more sellers there are in the
market the greater supply of goods and services will be
available.
WEATHER CONDITION

Bad weather, such as typhoons, drought or other natural

disasters, reduces supply agricultural commodities while good
weather has an opposite impact
 GOVERNMENT POLICY
Removing quotas and tariffs on imported products
also affect supply. Lower trade restrictions and lower
quotas or tariffs boost imports, thereby adding more
supply of good in the market.
In order for imported products to be accepted in a
country, there is a need for importen to pay the
government the required tariffs or duties and taxes.
Importers must also abid by the quota required by the
government on certain products. Quotas are limitation
on the number or quantities of imported goods which
could enter a country. This is used in order to protect
domestic or local products.
 MARKET EQUILIBRIUM

From a separate discussion of demand and

supply, we now proceed with reconciling the
two. The meeting of supply and demand
results to what is referred to as 'market
equilibrium As earlier said, the market
referred to here is a situation 'where buyers
and sellers meet while equilibrium is generally
understood as a 'state of balance'.
WHAT HAPPENS WHEN THERE
IS MARKET DISEQUILIBRIUM?

When there is market disequilibrium, two

conditions may happen: a surplus or a
shortage
 SURPLUS
Surplus is a condition in the market where the quantity
supplied is more the quantity demanded.

SHORTAGE
The reverse happens when shortage occurs in the
market. Shortage is basically a condition in the market
in which quantity demanded is higher than quantity
supplied at a given price.