CHAPTER 2

DEMAND, SUPPLY AND MARKET EQUILIBRIUM

 LEARNING OUTCOME

• At the end of this chapter, you should understand:

• What is demand, supply and market equilibrium.
• The difference between the Change in Quantity Demanded and
Changes in Demand.
• What is Elasticity of Demand and Supply.
• Dealing with Changes in Quantity Supplied and changes in Supply
 DEFINITION OF DEMAND

The ability and willingness to buy specific quantities of goods in

a given period of time at a particular price, ceteris paribus.
 LAW OF DEMAND

Law of demand states that the higher the price of a

good, the lower is the quantity demanded for that good
and the lower the price, the higher is the quantity
demanded, ceteris paribus.

P  Qdd  P  Qdd 
NEGATIVE RELATIONSHIP
DEMAND SCHEDULE AND CURVE

Demand Schedule Demand Curve

Price

Price Quantity
5 2 5

4 4 4

3 6 3

2 8 2
DD
1 10 1

0 Quantity
2 4 6 8 10
CHANGES IN QUANTITY DEMANDED VS. CHANGES IN DEMAND
Changes in Qd Changes in DD

Price Price

D D0
Quantity
• Movement along the same DD curve
• Price changes and other factors are constant
• Upward movement  Decrease in quantity
demanded
• Downward movement  Increase in quantity
demanded
D1
Quantity
• Shift in the demand curve
• Occurs when there are changes in other factors
(determinants of demand) but price remains
constant
• Increase in Demand (D0 → D1)
• Decrease in Demand (D1 → D0)
 Tastes
and
trends

Price of
Other
Goods
Expectation

DETERMINANTS
OF DEMAND

Consumers’ Taxation
income and
Subsidy
 PRICE ELASTICITY OF DEMAND

DEFINITION FORMULA

• Measures the sensitivity @

responsiveness of the quantity d = %  Quantity Demanded
demanded due to a change in its %  Price
price.

d = Qd / ½ (Qd1 + Qd2) @ Qd2 – Qd1 / ½ (Qd1 + Qd2)

 P/ ½ (P1 + P2) P2 – P1 / ½ (P1 + P2)
 Perfectly Inelastic: A condition in which the quantity
demanded does not change as the price changes.

Inelastic: A large percentage of change in the price

DEGREE OF ELASTICITY of a good will only affect a small percentage of
change in the quantity demanded.

Price  d =0
Unitary Elastic Demand
d = 1
A condition in which percentage changes in price
equals to percentage changes in quantity demanded.
Elastic: A small percentage of change in the price of
d =  a good will lead to larger percentage of change in
quantity demanded.

d > 1
Perfectly Elastic: A small percentage of change in
price leads to an infinite percentage of change in the
d < 1
quantity demanded.
Quantity Demanded
DEGREE OF ELASTICITY
 INCOME ELASTICITY OF DEMAND
DEFINITION FORMULA

• Measures the Sensitivity @ X = %  Quantity Demanded of good X

responsiveness of the quantity %  Price of good Y
demanded due to a change in
income.

X = Qdx / ½ (Qdx1 + Qdx2) @ Qdx2 – Qdx1 / ½ (Qdx1 + Qdx2)

Py/ ½ (Py1 + Py2) Py2 – Py1 / ½ (Py1 + Py2)
 CROSS ELASTICITY OF DEMAND
DEFINITION FORMULA

• Measures the Sensitivity @

responsiveness of the quantity X = %  Quantity Demanded of good X
%  Price of good Y
demanded for one good due to a
change in the price of another
good.

X = Qdx / ½ (Qdx1 + Qdx2) @ Qdx2 – Qdx1 / ½ (Qdx1 + Qdx2)

Py/ ½ (Py1 + Py2) Py2 – Py1 / ½ (Py1 + Py2)
 RESPONSES OF CROSS ELASTICITY

Price (Good X)

 x =0
Positive Cross Elasticity
-Good X and Y are substitute goods

Negative Cross Elasticity

-Good X and Y are complementary goods

x > 0 x < 0 Zero Cross Elasticity

-Good X and Y have no relationship
Quantity (Good Y)
 RESPONSES OF INCOME ELASTICITY
Elastic Income
-Type of good: Luxury goods such as antique
furniture and diamonds

Income Inelastic Income

 y =0 -Type of good: Normal goods such as food and
clothing
0< y < 1
Negative Income Elasticity
-Type of good: Giffen/ Inferior goods such as used
car and low grade potatoes

Zero Income Elasticity

-Type of good: Necessity Goods such as rice
y > 1  y< 0 and vegetables
Quantity Demanded
 DEFINITION OF SUPPLY

Supply is defined as the ability and willingness to sell or produce a

particular product and services in a given period of time at a particular
price, ceteris paribus.
 LAW OF SUPPLY

Law of supply states that the higher the price of a good, the greater is
the quantity supplied for that good and the lower the price of a good,
the lower is the quantity supplied, ceteris paribus.

P  Qss  POSITIVE
RELATIONSHIP P  Qss 
 SUPPLY SCHEDULE AND CURVE
Supply Schedule Supply Curve

Price
Price Quantity SS
5
5 10
4
4 8
3
3 6 2
2 4 1

1 2 0 Quantity
2 4 6 8 10
 CHANGE IN QUANTITY SUPPLIED VS. CHANGE IN SUPPLY

change in quantity supplied change in supply

Price Price

s0
s1

Quantity
• Movement along supply curve
• Price changes and other factors are constant
• Downward movement  Decrease in quantity
supplied (Contraction)
• Upward movement  Increase in quantity
supplied (Expansion)
Quantity
• Shift in the supply curve
• Occurs when there are changes in other factors
(determinants of supply) but the price remains constant
• Increase in Supply (S 0 → S1)
• Decrease in Supply (S 1 → S0)g
 Cost of
Production

DETERMINANTS Technological
Expectation OF SUPPLY
advancement

Taxes
and
subsidy
 PRICE ELASTICITY OF SUPPLY

Definition Formula

Measures the sensitivity/responsiveness

of the quantity supplied due to a change  ss = %  Quantity Supplied
in the price of a product or service. %  Price

SS = ∆ Qs / ½ (Qs1 + Qs2) @ Qs2 – Qs1 / ½ (Qs1 + Qs2)

∆P/ ½ (P1 + P2) P2 – P1 / ½ (P1 + P2)
 DEGREE OF ELASTICITY
Elastic Supply: A small percentage of change in
the price of a good will lead to larger percentage
of change in the quantity supplied.
Price
 ss =0
Inelastic Supply: A large percentage of change in
the price of a good will only affect a small
 ss < 1
percentage of change of the quantity supplied.
 ss = 1  ss > 1
Unitary Elastic Supply: Percentage change in price
equals the percentage change in the quantity
supplied.

 ss =  Perfectly Elastic Supply: An almost zero percentage

of change in price brings a very large percentage
of change in the quantity supplied.
Perfectly Inelastic Supply: A percentage of change
in price has no effect on the percentage of change
Quantity in the quantity supplied.
DEGREE OF ELASTICITY
 Time Period

Production DETERMINANTS Scale of

Technology OF PRICE ELASTICITY Production
OF SUPPLY

Nature of
good
 MARKET EQUILIBRIUM

A market equilibrium is a situation when quantity demanded and quantity

supplied are equal and there is no tendency for price or quantity to change.

QD= QS
 EQUILIBRIUM PRICE AND OUTPUT

Price
Surplus (QSS > QDD)
5

4
SS

3
E
P* 2

Shortage (QDD > QSS) DD

2 4 Q* 8 10
6
 CHANGES IN DEMAND
Assume: supply is constant Increase in Demand
-DD curve shifts to
the right
-Equilibrium price and
Price quantity increase

S
P1

P*
D1

D0

Quantity
Q* Q1
 CHANGES IN DEMAND
Assume supply is constant
Decrease in
Demand
Price
-DD curve shifts to
the left
-Equilibrium price
S
and quantity
P*
decrease
P1
D0
D1

Quantity
Q1 Q*
 CHANGES IN SUPPLY
Assume demand is constant Increase in Supply
Price -SS curve shifts to the
right
S0
-Equilibrium price
S1 decreases and
P* quantity increases
P1

Quantity
Q* Q1
 CHANGES IN SUPPLY
Assume demand is constant Decrease in
S1
Supply
Price
S0 -SS curve shifts
to the left
P1

-Equilibrium
P*
price increases
and quantity
D decreases
Quantity
Q1 Q*