Module 1: Unit 3- Demand, Supply, and Equilibrium

Unit learning outcomes

1. Understand demand, supply and equilibrium.
2. Explain the effect of non-price determinants to demand and supply and equilibrium.
3. Use demand and supply to explain how equilibrium price and quantity are
determined in a market.
4. Understand the concepts of surpluses and shortages and the pressures on
price they generate.
5. Explain the impact of a change in demand or supply on equilibrium price and
quantity.
6. Apply the principles of demand and supply to illustrate how prices of commodities
are determined.

In preparation for the next topic let us recall the previous discussion on efficient allocation,
limited or scarce resource.

You walked into a typical market (any type of market) answer the question that follows.
What happens in a market?
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What is a market?
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Who are the parties that compose the market?
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What are you going to do if you have a limited budget and you want to buy something?
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‘No vaccine, no ride’: Limits imposed on Manila public transport

Source: ALJAZEERA News - 12 Jan 2022
The Philippine government has banned unvaccinated residents of the capital Manila and
surrounding districts from public transport amid a new surge of COVID-19 cases due to the
Omicron variant.

In an order published on Wednesday, the country’s transport secretary, Arthur Tugade, said the
“no vaccination, no ride” policy covers all domestic public transport to, from and within Metro
Manila
Operators of public transport, including land, air and sea, “shall allow access or issue tickets
only to fully vaccinated persons”, and passengers are required to show proof of their
identification and vaccination status.

The order added that people are considered fully vaccinated two weeks after receiving their
second dose of the COVID-19 vaccine, or two weeks after getting a single-dose vaccine.

Learning insights from the news:

The mandatory imposition of the “no vaccine, no ride to the public can lead to an increase in the
demand for covid-19 vaccine.

What is a market?
Market, a means by which the exchange of goods and services takes place as a result of
buyers and sellers being in contact with one another, either directly or through mediating agents
or institutions.
As long as there are buyers and sellers, that is a market. No matter whether trading happens or
not.
Buyers as a group determine the demand, to purchase this good or service.
Sellers as a group determine the supply of the product, to provide this good or service.

Demand and Supply Analysis

Price determination is one of the most crucial aspects in economics. Business managers are
expected to make perfect decisions based on their knowledge and judgment. Since every
economic activity in the market is measured as per price, it is important to know the concepts
and theories related to pricing. Demand and supply analysis help us understand assumptions
behind pricing decisions.

Demand concept
Demand- refers to the behavior of people with regard to their ability and willingness to buy
products at a given prices. Therefore, when we say demand both the ability and willingness to
pay should be present.
Quantity demand- refers to the amount of goods and services people are willing to buy and
consume.
Demand schedule- is the tabular presentation of quantity demanded at a given prices (P).
Demand curve- graphical presentation of the demand schedule. Graphically, demand is
depicted as a downward sloping line on a graph with Price on the Y axis and Quantity on the X
axis. The downward slope indicates the inverse relationship between price and quantity
purchased.

Law of demand- is a simple explanation of consumer behavior.

⮚ States that as the price of a good goes up, the quantity demanded of that good goes
down when other factors are held constant (ceteris paribus assumption).
⮚ This means that consumers tend to buy more of a certain good at a lower price.
Conversely, as this good becomes more expensive, consumers will tend to buy less.
⮚ Take note of the word “tendency”.
Assuming people have a fixed budget, prices will determine their behavior towards
buying products. If the price of the product will increase, the effect of this increase in price
to the fixed budget of people is they tend to have less money to buy the same quantity of
products they used to buy. This means that if the need or want the product, they have to
buy lesser quantity. The reverse is also true. If the price of the commodities decreases,
given a fixed budget, it means that more money is available to buy more quantity of the
same product. Thus, this factual tendency is the basis of the law of demand.

Exceptions to the Law of Demand

Some goods do not show an inverse relationship between the price and the quantity. Therefore,
the demand curve for these goods is upward-sloping. These goods are classified as:
1. Giffen goods
These are inferior goods that lack close substitutes that represent the large portion of the
consumer’s income. The existence of such goods was proposed by Scottish
economist Sir Robert Giffen in the 19th century. Giffen goods violate the law of demand
because the prices of these goods increase with the increase in the quantity demanded.
However, Giffen goods remain mostly a theoretical concept as there is limited empirical
evidence of their existence in the real world.

2. Veblen goods
There are certain types of luxury goods that violate the law of demand. Veblen goods are
named after American economist, Thorstein Veblen. Generally, they are luxury goods
that indicate the economic and social status of the owner. Therefore, consumers are
willing to consume Veblen goods even more when the price increases. Some examples
of Veblen goods include luxury cars, expensive wines, and designer clothes.

Aside from price which is the main determinant of the behavior of people in the Law of Demand.
There are other factors that affects the demand for products. They are collectively called the
Non-Price Determinant of Demand.
1. Income-
When income rises, so will the quantity demand. When income falls, so will the demand.
Usually as income rises the demand for normal good increases and the demand for
inferior goods decreases.
Normal good - can be defined as those goods for which demand increases when the income of
the consumer increases and falls when income of the consumer decreases, price of the goods
remaining constant. Examples of normal goods are demand of smart television, demand for
more expensive cars, branded clothes, expensive houses, diamonds etc… increases when the
income of the consumers increases.

Inferior good- the opposite side of normal goods. It is defined as those goods the demand for
which decreases when the income of the consumer increases. Examples of inferior goods are
consumption of breads or cereals and since the income of the consumer increases, he moved
towards consumption of more nutritious foods and hence demand for low priced product like
bread or cereal decreases. Another example can be of use of public transportation, when
income is low people use more of public transportation which is not the case when their income
increases.

2. Prices of related goods or services

Complementary goods or service- these are goods service that must (or at least are
meant) to be used together, like car and fuel, printer and ink.
The price of complementary goods or services raises the cost of using the product you
demand, so you'll want less.

Besides influencing the price of one another, these goods also influence greatly the
demand of each other. This is very exploited in marketing campaigns. That’s why you find
packages bringing together example a car seller offering x kilometers worth of fuel: by
buying a car it is implied that you’ll have to buy eventually the other element of the pair,
and thus this type of deals is very appealing to the consumer.

Substitute goods- are two alternative goods that could be used for same purpose.
An increase in the price of good A will lead to an increase in the demand for good B and
vice versa.

That's why Apple continually innovates with its iPhones and iPods. As soon as a
substitute, such as a new Android phone, appears at a lower price, Apple comes out with
a better product. Then the Android is no longer a substitute.

3. Tastes and preferences

When the public’s desires, emotions, or preferences change in favor of a product, so does
the quantity demand. Likewise, when tastes go against it, that depresses the amount
demanded. Brand advertising tries to increase the desire for consumer goods.

4. Expectations
When people expect that the value of something will rise, they demand more of it. That
helps explains the housing asset bubble of 2005. Housing prices rose, but people kept
buying houses because they expected the price to continue to increase.

5. Number of buyers in the market

The number of consumers affects overall, or “aggregate,” demand. As more buyers enter
the market, demand rises. That's true even if prices don't change the total number of
buyers in the market expanded. Example: as population increases demand for housing
increases.
The Law of Demand in the Real World
The law of demand comes with important applications in the real world. It is an economic
principle that guides the actions of politicians and policymakers. The law of demand is
quintessential for the fiscal and monetary policies that are undertaken by governments around
the world. The policies generally intend to increase or decrease demand to influence the
country’s economy.

Supply concept
Supply- refers to the behavior of the suppliers or the producers on their ability and willingness to
make products available at a given prices.
Quantity supply- refers to the amount of goods and services suppliers or producers are able to
make available at a given prices.
Supply schedule- is the tabular presentation of prices and their corresponding quantities
supplied by suppliers.
Supply curve- Graphically, supply is depicted as an upward sloping line on the same graph
with price and quantity on the axes, indicating the positive relationship between price and
quantity. The reason for this relationship is simple: the higher the price of a product, the more
rewarding it is to sell.

Concept of Supply and Stock

The concept of supply is often confused with stock of the commodity. However, these terms
have different meanings in economics.
Stock is the total quantity of the commodity that is held by the firm at a particular point of time.
On the other hand, supply is that portion of the stock of the commodity that the producer is
willing to bring to the market for sale. Stock can never be less than supply.
For example, if a seller has 50 tons sugar in his warehouse and he is willing to sell 30 tons @
Php 37/kg, then the supply is 30 tons and the stock is 50 tons.
The concept of supply in economics is complex and has many mathematical formulas, practical
applications and various factors affecting supply.
Supply can refer to anything in demand that is sold in a competitive marketplace, but supply is
most used to refer to goods, services, or labor
Law of Supply-
⮚ Given the ceteris paribus assumption, when price of commodities tends to increase the
quantity being supplied by suppliers/ producers also tend to increase. Likewise, if the
price of commodities tends to decrease, the corresponding quantities being supplied
also tend to decrease.
⮚ Take note of the word “tend”.
The driving force behind the behavior of the suppliers / producers is simply of the “profit
motive”.
Common sense would tell us that no producer or supplier would offer his/her products or
services without a corresponding economic benefit (in this case profit). Because of this
motive if the producers see that they can make more money by offering more products
they tend to offer more at higher prices. But if there is less money to be made, they tend
to offer fewer products to cut their losses and offer these at a lower price to entice
customers to buy their products. Take note that this law of supply applies when all other
things are held constant.

Just like in the demand concept in reality aside from price as the main determinant in the
law of supply there are also other factors that usually affect the availability of supply of
products in the markets. There are also collectively termed as non-price determinant in
supply.
Non-price determinant in supply
1. Number of sellers in the market (competition)- more firms producing the same or very
similar product means more supply overall.
2. Technology- as technology improves more supply being produced at a cheaper price.
3. Cost of inputs- changes in costs of factors of production (land, labor, capital
entrepreneurship). As there is an increase in costs of production you would have to pay
more for the same quantity.
4. Price of related goods- an increase in the price of related goods can influence the supply
of the original good.
5. Producer’s expectation of future prices- if the demand for a product is likely to rise,
companies increase their supply (in order to be ready to supply more in the future and
gain higher profit for example prior to this upcoming Christmas there would be an
increase in the production of Christmas decorations.
6. Legal provisions- pertains to government intervention for example;
provision on indirect taxes will lead to an increase in the cost of production which result
to less supply and increase in price.
Rules regulations, policies are among them.
7. Natural phenomenon- affecting mostly the agricultural sector. For example, what had
recently happened in some parts of Luzon where rice production is engrained. It is
expected that if there is a decrease in the supply of rice it is because of the devastation
brought about by typhoon Ulysses.

Equilibrium
The point at which the supply and demand curves intersect.
The price at this intersection is called the equilibrium price, and the quantity is called the
equilibrium quantity.
The equilibrium price is the only price where the plans of consumers and the plans of
producers agree—that is, where the amount of the product consumers want to buy (quantity
demanded) is equal to the amount producers want to sell (quantity supplied). Economists call
this common quantity the equilibrium quantity.
At any other price, the quantity demanded does not equal the quantity supplied, so the market is
not in equilibrium at that price so disequilibrium happens.

Disequilibrium
If the market price is above or below the equilibrium price, the market is in disequilibrium.
Disequilibrium occurs when the quantity supplied does not equal the quantity demanded. There
are two conditions that are a direct result of disequilibrium: a shortage and a surplus.
A shortage occurs when the quantity demanded is greater than the quantity supplied.
Shortage = Quantity demanded (Qd) > Quantity supplied (Qs)
Because of the excess demand, there will be competition among buyers to have their
wants reserved. They compete for the limited supply and this is done through a price
increase. As the price of the commodity increase, the quantity demand will decline and
the quantity supplied will increase thus eliminating the excess demand.

A surplus occurs when the quantity supplied is greater than the quantity demanded.
Surplus = Quantity supplied (Qs) > Quantity demanded (Qd).
If the quantity demand is lower than the quantity supplied there is excess supply at the
prevailing price. Suppliers are then motivated to remove excess supply through price
competition. Suppliers will compete to dispose their excess supply by lowering their
prices and this will encourage the consumers to increase quantity demand thus
adjustment from both supplier and buyers will eliminate excess supply.
John Maynard Keynes, an economist was the first to study market disequilibrium. He theorized
that markets will usually be in a state of disequilibrium as a result of various factors that
influence market stability.

How to solve for demand, supply equation and equilibrium?

Given below is a demand and supply schedule for ABC Company.

Price quantity demand quantity supply

3 600 200
4 500 300

a. Solve for the demand equation

Step1: solve for the slope
Formula: slope = Qd2-Qd1 500-600 =-100
P2-P1 4-3
Interpret the slope: for every 1 peso increase in the price there will be 100 units
decrease in quantity demand. Remember the concept of budget constraint.

Step 2: Determine the demand equation: Qd = a – b(P)

● Q = quantity demand
● a = all factors affecting price other than price (e.g. income, fashion)
● b = slope of the demand curve
● P = Price of the good.
Solve for the value of a= (the y intercept) the value of Qd when price is zero
From the above equation we can derive the formula to compute for the
value of a.
600= a-100P 600= a-300 answer: 600+300= a
 Demand equation: Qd= 900-100P

b. Solve for the supply equation.

Step 1: solve for the slope (m)
Formula: slope = Qs2-Qs1 300-200 =100
P2-P1 4-3
Interpret the slope: for every 1 peso increase in the price there will be 100 units
increase in quantity supply. Remember the profit motive of every supplier
Step 2. Determine the supply equation: Qs = a + b(P)
● Q = quantity supply
● a = all factors affecting price other than price (e.g. income, fashion)
● b = slope of the supply curve
● P = Price of the good.
Solve for the value of a= (the y intercept) the value of Qs when price is zero
From the above equation we can derive the formula to compute for the
value of a.
200= a=100P 200= a+300 answer: 200-300 = a
Supply equation: Qs= -100+100P

c. Solve for the equilibrium price and equilibrium quantity

Equilibrium is Qd= Qs at an agreeable price
(Qd) 900-100P = (Qs) -100+100P
900+100= 100P+100P
1000= 200P P= 5 equilibrium (price the price agreeable to both
200 200 party)
Equilibrium quantity: substitute the computed equilibrium price to the demand and
supply equation. 900-100(5) = -100+100(5)
400 = 400 equilibrium quantity
d. What will happen if the price will increase by 2 pesos?
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e. What is the market situation?
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Types of elasticity:
1. Price elasticity- is the responsiveness of demand to change in price;
2. Income elasticity- income elasticity means a change in demand in response to a change
in the consumer’s income;
3. Cross elasticity- cross elasticity means a change in the demand for a commodity owing
to change in the price of another commodity.

Price elasticity of demand and supply

A. Price elasticity of demand- refers to the degree of responsiveness of the consumers for
every change in price. In other words, it shows how many products customers are willing to
purchase as the price of these products increases or decreases.
 The elasticity of demand formula is calculated by dividing the percentage that quantity
changes by the percentage price changes in a given period.

Elasticity = % change in quantity / % change in price

Q2-Q1 / P2-P1
Q1 P1
✔ Types of price elasticity of demand.
a. Elastic- The demand is elastic when with a small change in price there is a great
change in demand
b. Inelastic- it is inelastic or less elastic when even a big change in price induces only a
slight change in demand.
c. Unitary elastic- changes in the same proportion to its price; this means that the
percentage change in demand is exactly equal to the percentage change in price

✔ Types of price elasticity of supply

a. Elastic- when with a small change in price there is a great change in supply
b. Inelastic- it is inelastic or less elastic when even a big change in price induces only a
slight change in supply
c. Unitary elastic- which changes in the same proportion to its price; this means that the
percentage change in supply is exactly equal to the percentage change in price.

Using the given demand and supply schedule of ABM compute for the elasticity of demand and
elasticity of supply.

To enrich your understanding on the topic demand, supply and equilibrium. Carefully understand
the effect of price and non-price determinant of demand and supply illustrated graphically.
Supply shift or change in supply: the shifting/ changing of the supply curve to either inward
(to the left) or outward (to the right) is caused by the non-price determinant of supply such as
illustrated below.

Equilibrium= the state where the quantity demanded and the quantity supplied is equal
at a given price.
The steps to analyzing changes in equilibrium
1. Step 1. Draw a demand and supply model representing the situation before the
economic event took place.
2. Step 2. Decide whether the economic event being analyzed affects demand or supply
3. Step 3. Decide whether the effect on demand or supply causes the curve to shift to the
right or to the left, and sketch the new demand or supply curve on the diagram.
4. Step 4. Identify the new equilibrium and then compare the original equilibrium price and
quantity to the new equilibrium price and quantity.

Example:
Effect of change in demand or the shifting of the demand curve to equilibrium.
What if the demand curve moves either shift to the left or shift to the right? (we got a new
demand curve)
What will happen to equilibrium?
Notice that if the demand curve will shift upward (D1 to D2) a supply remains
unchanged, the equilibrium price is higher and there is an increase in the equilibrium
quantity. Why? Consumers are willing to pay more, leading producers to make more so
they can earn money.

If the demand curve will shift inward (D3 to D4) assuming supply remains unchanged,
equilibrium price is lower and equilibrium quantity decreases. Why? If the consumers
aren’t buying, producers lower their prices to move product. They will not produce more
of the goods and services that aren’t selling.

Effect of change in Supply or the shifting of the supply curve to equilibrium.

What if the supply curve moves either shift to the left or shift to the right? (We got a new
supply curve)
What will happen to equilibrium?

Notice that if the supply curve will shift to the right or upward (S1 to S2) assuming
demand remains unchanged, equilibrium price is lower and equilibrium quantity
 increases. Why? When goods or services are plentiful and easy to obtain, consumers
will shop for the lowest prices and still not deplete an oversupply.

If the supply curve will shift to the left or inward (S3 to S4) assuming demand remains
unchanged, equilibrium price is higher and equilibrium quantity decreases. Why? When
supplies are low of goods and services consumers are accustomed to buying, they will
pay higher prices to get what's available.

Manipulating demand and supply can be at your advantage? The answer is yes.
Practical business owners know how to make business supply and demand work to their
advantage. Consider the example below:

Positioning yourself as a rare commodity: De Beers has vaults full of diamonds, but
by limiting supply, they are able to keep prices high. Diamonds are a status symbol for
which consumers are willing to pay. Advertise an item as "limited number available" or
"while supplies last" to appeal to the buyers who want to be among the few to obtain
hard-to-get items.
Notice that supply and demand is being manipulated by the company itself.

Other application of demand supply analysis.

1. During times of major calamities, we often observe that the price of basic commodities
increases very fast. This is not caused by the reduction in supply alone but it can be
accompanied by an increase in the demand of the consumers as they expect the price of
basic commodities to increase in the future due to the effect of the calamity. During the
times of calamities, the rapid increase in the price of basic commodities force the
government to intervene and impose price control measure and even rationing.

Price ceiling- a measure to stabilize prices of basic commodities. This means that the price
cannot go higher than the mandated price ceiling.
✔ The reason behind this is that many consumers may not be able to afford to buy basic
commodities at a given price.
Price floor- another government measure to arrest the price adjustment in the market. The
government sets the price of the commodity and it cannot go lower than the set price. The
imposition of the price floor is to protect certain actors in the market.
For example: for rice planters in achieving a reasonable income, the government may set a
floor price of rice in the market.

2. Applications in the labor market

The demand and supply analysis can also be used in the determination of the wage rate in the
labor market.
Labor market- is composed of those that demand labor services and those that supply labor
services. The demand for labor and the supply of labor in the labor market are motivated by the
changes in the price of labor which is indicated by the wage rate.
Take note that labor services are bought in the labor market not the laborers. The ones buying
the labor services are firms that use these labor services as factor inputs to production.
⮚ If the wage rate is very low, very few laborers are willing to work. On the other hand, if
the wage rate is high, the demand for work is high.

3. Application in the foreign exchange market

Another application of demand and supply analysis is the determination of the foreign exchange
rate. Foreign exchange market is the market in which the currencies of various countries are
converted into each other or exchanged for each other. The exchange rate can be determined
by the interaction of the demand for example US dollars and the supply of US dollars in the
market for foreign exchange. In the Philippines the demand for US dollars is influenced by its
demand for imports since we need to pay the imports in US dollars. As imports become
expensive our quantity demand for US dollar decreases. Hence, the demand for US dollars has
indirect relationship with the exchange rate. The supply of US dollars, on the other hand is
based on the inflows of US dollars into the country brought about by exports receipts,
remittances, and capital inflows. The supply of dollar has a positive relationship with the
exchange rate.
That is why if you notice as the exchange rate increases more OFW’s are motivated to send
remittances to their families in the Philippines.
This also explains why many Filipino workers want to be an OFW. The demand for OFW is also
influenced by the foreign wage rate. As foreign wage rate decreases, foreign firms will demand
more OFWs as they equate wage rate with the value of marginal productivity of workers.
However the supply for OFWs is also influenced by the exchange rate.