DEMAND AND SUPPLY

law of demand and supply

Demand
Demand is the quantity of a goods or services that consumers
are willing and able to purchase at various prices during a given
period of time
Determinants of demand
The demand for the products or services may be determined by
a) Price of the good or service ( what will happen when price of the good
rises or falls?)
b) Price of related goods ( what will happen to the good when the price of
the related good rises or falls?)
c) Price of substitutes (what will happen to the good when the price of the
substitute rises or falls )
d) Income ( what will happen on demand if the income of the consumer
rises or falls?)
e) Tastes and Preferences ( what will happen to the demand of the good
when the tastes and preferences change for a given good?)
Determinants of demand
Demand function
Demand schedule
The demand schedule is a table that shows the
quantity demanded of a good or service at
different price levels
The law of demand
• When the price continues to increase, the quantity of
good demanded by people goes down and vice versa
that is what the economists call the Law of Demand,
meaning that when the price of a good increases, if all
the things remain equal the quantity consumed of
the good goes down, and when the price of good
decreases, Other things being the same, the quantity
demanded of the good goes up
Exceptions to the law of demand
• Articles of ostentation/Veblen goods; these are
commodities which are demanded more when their
prices increases because they indicate social status/
display wealth. On having such type of goods one feels
prestigious over the others
• Giffen goods/inferior goods these are goods which are
demanded more when their prices increases for a lower
income earner
Change in quantity demanded
• The effect of a change in the price of the goods is that there will be
the movement along the demand curve.
• For instance if the price of the good increases from 6 to 8 then the
quantity demanded of the goods will decrease from 6 to 4 and if the
price decreases from 6 to 4 then the quantity demanded will
increase from 6 to 8
• Demand does not change what
changes is the quantity demanded
and thus the movement is along the
Demand curve
Change in quantity demanded
Change in quantity demanded
A change in the quantity demanded refers to movement
along the existing demand curve, D0. This is caused by
the change in price
Change in demand
A change in demand represents a shift in consumer desire to
purchase a particular good or service, irrespective of a variation
in its price
This is caused by the other factors other than price including
price of related goods, price of substitutes, tastes and
preferences and income
The change in any of the factors will affect the whole structure of
demand and one will demand different quantities and will cause a
shift in the demand curve whether to the right or to the left
Change in demand
Change in demand
A change in demand means that the entire
demand curve shifts either left or right. The initial
demand curve D0 shifts to become either D1 or D2.
This could be caused by a shift in tastes and
preferences, changes in population, changes in
income, prices of substitute or complement goods
Types of demand
Joint /complementary demand
Joint demand is the demand for commodities that are consumed
together e.g. bread and jam; gun and bullet; car and petrol
Composite demand
Composite demand refers to the demand for a commodity which
serves several purposes For example, corn can be used as animal
feed, ethanol and food in its whole form or the demand for electricity
Competitive demand
Competitive demand occurs when there are alternative services or
products a customer can choose from that is substitute goods eg
coffee and tea, coke and pepsi
Types of demand
Derived demand
Derived demand is the demand for a good not for its own sake
but as the result of demand of another commodity eg demand
for money in order to purchase other commodities, demand for
pencils will result in the demand for wood, graphite, paint and
eraser materials. In this example, the demand for wood is
dependent on the demand for its uses.
Elasticities of demand
• The elasticity of demand, or demand elasticity, refers to how
sensitive demand for a good is compared to changes in other
economic factors, such as price or income. It is commonly
referred to as price elasticity of demand because the price of a
good or service is the most common economic factor used to
measure it
Price elasticity of demand

The price elasticity of demand is the percentage change in the quantity

demanded of a good or service divided by the percentage change in
the price. It shows the responsiveness of demand due to change in
price levels
Price elasticity of demand
Price elasticity of demand
Given
P1= 4500
Q1= 12000
P2= 5000
Q2= 6000
Calculate the price elasticity of demand =
Price elasticity of demand
12000-6000 x 4500
4500-5000 12000
-6000 X 4500 = 4.5
500 12000
We know from the downward sloping demand curve that price and
quantity demanded are inversely related this means that the price
elasticity coefficient will always be negative number.
The economists usually ignore the minus sign and simply present the
absolute value of the elasticity coefficient to avoid the ambiguity that
may otherwise arise.
Interpretation of elasticities
a) An elastic demand is one in which the elasticity is
greater than one, indicating a high responsiveness to
changes in price.
b) Inelastic demand is the one in which the Elasticity is
less than one indicating low responsiveness to price
changes
c) Unitary elasticity is one in which the elasticity is equal
to one indicating proportional responsiveness of
demand
Factors affecting elasticities of demand
Demand for necessities
The demand for the basic goods is inelastic because the goods
are purchased at any price. The change of price does not matter
as far as the demand for such commodity is concerned
Demand for luxuries
Demand for luxury goods is elastic in a sense that a small change
in price may cause a greater change in quantity demanded
Demand for substitute goods, the commodities which are
substitutes their demand is elastic eg tea and coffee
Degrees of Price Elasticity of demand
Degrees of Price Elasticity of demand
• Perfectly elastic demand is said to happen when a little change in
price leads to an infinite change in quantity demanded (ed=∞)
• Perfectly inelastic demand is opposite to perfectly elastic demand.
Under the perfectly inelastic demand, irrespective of any rise or fall in
price of a commodity, the quantity demanded remains the same (ed =
0)
• The demand is said to be unitary elastic when a given proportionate
change in the price level brings about an equal proportionate change
in quantity demanded (ed = 1)
Degrees of Price Elasticity of demand
• elastic demand refers to a situation in which a small change in price
leads to a big change in quantity demanded. In such a case elasticity
of demand is said to be more than one (ed > 1)
• inelastic demand refers to a situation in which a given percentage
change in price produces a relatively less percentage change in
quantity demanded. In such a case elasticity of demand is said to be
less than one (ed < 1).
Supply
Supply
• Supply refers to the amount of a given product or
service that suppliers are willing to offer to consumers
at a given price level at a given period of time
• Supply is the other side of the market after demand
and at the end we are going to put things together to
determine the equilibrium market price and quantities
Determinants of supply
1) the price of the goods, because generally the higher the price of
the goods, the more you will be willing to sell the goods in the
market.
2) the cost associated with supplying the goods for instance transport
costs, the less the costs the more the goods will be supplied in the
market
3) Better technology allows you to reduce the cost of production as the
cost of production goes down, all of a sudden you are able to produce
and to sell more goods
4) Price of related goods; If the price of substitute production goods rises,
the producers might shift production towards the higher priced goods
causing decrease in supply of original goods
Determinants of supply
5. Taxes and subsidies, a business tax is treated as the cost, so
an increase in business tax will decrease supply and vice versa .
A subsidy lowers the cost of production and hence increases
supply
Quantity supplied= f (Price, Price of inputs, Technology,
price of related goods, taxes and subsidies)
Supply schedule
A supply schedule is a table that shows the quantity supplied at each
price
Supply curve
A supply curve is a graph that shows the quantity supplied at each price
Change in Quantity Supplied
• A movement along a given supply curve caused by a change in
supply price
• The only factor that can cause a change in quantity supplied is
price
Change in quantity supplied
Change in Supply
• A change in supply is a change in the ENTIRE supply
relation. This means changing, moving, and shifting the
entire supply curve.
• The entire set of prices and quantities is changing. In
other words, this is a shift of the supply curve.
• A change in supply is caused by a change in the supply
determinants except price of a good
Change in Supply
Law of Supply
Part 1. As PRICE increases, SUPPLY increases

PRICE goes

SUPPLY goes
up
Then…

up
Part 2. As PRICE decreases, SUPPLY decreases

SUPPLY goes
PRICE goes

down
down

Then…
Law of supply
• According to the law of supply, suppliers will offer more of a good at a
higher price
• Think about this: If I am a seller and people are willing to pay more for
what I am selling how will I behave?
Exceptions to the law of supply
Change in business
It may happen that the seller may plan to enter into an entirely
new business by exiting the current one then the seller may sell
his goods at lower prices to clear them off
Monopoly
When a small number of producers control the supply of goods in
the market then the law of supply may not operate. For example,
in the case of monopoly (single seller) may not necessarily offer
a larger quantity supplied even though the price of goods is
higher. Market control by the monopoly allows it to set the
market price based on demand in the market.
Exceptions to the law of supply
Perishable Goods
In cases of perishable goods, the supplier would offer to sell
more quantities at lower prices to avoid losses due to damage to
the product
Legislation Restricting Quantity
Suppliers cannot offer to sell more quantities at higher prices
where the government has put some regulations on the quantity
of the good to be produced or the price ceiling at which the good
is to be sold in the market
Elasticity of supply
• Elasticity of supply measures the sensitivity or responsiveness of
quantity supplied to a change in price of the commodity.
• Price elasticity of supply measures the responsiveness to the supply
of a good or service after a change in its market price
Elasticity of supply
• If the price of a Ukwaju ice cream increases by 10%, and the supply
increases by 20%

= 20/10 = 2
Interpretation of Elasticity of supply
• Perfectly Inelastic Supply ( Es = 0)
• A service or commodity has a perfectly inelastic supply if a
given quantity of it can be supplied whatever might be the
price. The elasticity of supply for such a service or commodity is
ZERO.
• This indicates that supply of a commodity is not sensitive to
price changes. The same quantity of supply will be supplied at
any alternative prices
Interpretation of Elasticity of supply
•…
Interpretation of Elasticity of supply
Perfectly elastic supply ( Es = ∞ )
• The PES for perfectly elastic supply is infinite, where
the quantity supplied is unlimited at a given price, but
no quantity can be supplied at any other price
• Perfectly elastic indicates that a percentage change in
price causes an infinite change in quantity supplied.
Interpretation of Elasticity of supply
Interpretation of Elasticity of supply
Inelastic Supply ( Es<1)
Inelastic supply indicates that supply is not very sensitive to price
changes. A percentage change in price results into a less
percentage change in quantity supplied
Interpretation of Elasticity of supply
Interpretation of Elasticity of supply
Elastic supply (Es > 1 )
A percentage change in price causes a higher percentage change
in quantity supplied. In general quantity supplied is sensitive to
price changes
Interpretation of Elasticity of supply
Price determination
Ways of price determination
i. Price mechanism: the price is determined by the free interaction of
demand and supply where (Qd=Qs)
ii. Sale auction; price is determined through bidding therefore it is
determined by the highest bidder
iii. Haggling the price is determined through bargaining
iv. Government controls; the government may set minimum or maximum
price
i. Price ceiling (maximum price) is the price set by the government below the
equilibrium price. It aims at protecting consumers against excessive high prices
ii. Price floor (minimum price) is the price set by the government above the
equilibrium price. It aims at motivating producers after realizing that the current
price is low
Price determination
i. Price mechanism
• The price of a product is determined by the law of supply and
demand.
• The equilibrium price of a good is the price at which quantity
supplied equals quantity demanded ( Qd=Qs)
• The price in the market is determined by the free intersection of
the forces of demand and supply and as above the price will be
determined at a point where Qd=Qs
• Graphically, the supply and demand curves intersect at the
equilibrium price
Price determination
Qs=Qd
Price determination
Given the table below determine the equilibrium price and
quantity
Price determination
Given the following demand and supply functions calculate
the equilibrium price and quantity
Qs = 100 + 1P and
Qd = 400 - 5P
Qs=Qd
Therefore: 100 + 1P = 400 - 5P
P= 50
Q= 150
Price determination
ii. Government Price controls
Government price controls; the government may set minimum or
maximum price
i. Price ceiling (maximum price) is the price set by the
government below the equilibrium price. It aims at
protecting consumers against excessive high prices
ii. Price floor (minimum price) is the price set by the
government above the equilibrium price. It aims at
motivating producers after realizing that the current price
is low
Price ceiling vs price floor
Price ceiling vs price floor
• Price ceilings prevent a price from rising above a certain level.
• When a price ceiling is set below the equilibrium price, quantity
demanded will exceed quantity supplied, and excess demand or
shortages will result.
• Price floors prevent a price from falling below a certain level.
• When a price floor is set above the equilibrium price, quantity
supplied will exceed quantity demanded, and excess supply or
surpluses will result.
• When government laws regulate prices instead of letting market
forces determine prices, it is known as price control.
Price ceiling vs price floor
Review questions
1. The estimates suggest the following price elasticities of demand:
0.6 for physician’s service, 4.0 for foreign travel and 1.2 for banking
services. Interpret the given coefficients
2. Explain the factors influencing the price elasticity of demand and
supply
3. Distinguish between the change in quantity demanded from the
change in demand
4. With examples explain the assumptions to the law of demand
5. Explain the determinants of demand and supply