The Market Forces of

Supply and Demand

The Market Forces of
Supply and Demand
Supply and demand are the two words
that economists use most often.
Supply and demand are the forces that
make market economies work.
Modern microeconomics is about
supply, demand, and market
equilibrium.
Markets
A market is a group of buyers and
sellers of a particular good or service.
The terms supply and demand refer
to the behavior of people . . . as they
interact with one another in markets.
Markets
Buyers determine demand.
Sellers determine supply.
Demand
Quantity demanded
is the amount
of a good that buyers are
willing and able
to purchase.
Law of Demand
The law of demand states that,
ceteris paribus, there is an
inverse relationship between price
and quantity demanded.
Demand Schedule
The demand schedule is a table
that shows the relationship
between the price of the good
and the quantity demanded.
Demand Schedule
Price Quantity
0.00 12
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.00 0

Demand Curve
The demand curve is the downward-
sloping line relating price to quantity
demanded.
Demand Curve
Rs.3
2.50
2.00
1.50
1.00
0.50
2 1 3 4 5 6 7 8 9 10 12 11
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
0
Price Quantity
0.00 12
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.00 0

Ceteris Paribus
Ceteris paribus is a Latin phrase that
means all variables other than the
ones being studied are assumed to be
constant. Literally, ceteris paribus
means other things being equal.
The demand curve slopes downward
because, ceteris paribus, lower prices
imply a greater quantity demanded!
Ceteris Paribus
Ceteris Paribus means other things being
equal. What other things?
Consumer income.
Consumer preferences.
Fashion.
Price of related goods.
Government policies.
Weather conditions.
Market Demand
Market demand refers to the
sum of all individual demands
for a particular good or service.
Determinants of Demand
Market price : A larger quantity is demanded at
a lower price & vice versa.
Tastes, habits and preferences : Demand depends
upon a persons tastes, habits and preferences.
Demand for ice creams, bhel puri etc depends
upon an individuals tastes. Tea, betal leafs,
tobacco etc is a matter of habits. People with
different tastes & habits have different
preferences. A strict veg. will have no demand for
fish and a person who likes non veg will
purchase fish even at a high price.
Determinants of Demand
Expectations : If a consumer expects
that the prices of a product are going
to rise in future, the demand may
increase and vice versa.
Consumer income : A rich consumer
demands more goods than a poor
consumer.
Determinants of Demand
Prices of related goods ( substitutes and
complementary ) : When a desire or a want can
be satisfied by alternative similar goods, they
are called as substitutes. Eg. Peas and beans,
groundnut oil and mustard oil, tea or coffee,
jowar or bajra etc.
Demand for a commodity depends on the
relative prices of the substitutes. There will be
more demand for a commodity if its
substitutes are highly priced.
Determinants of Demand
Complementary products : When, in order to
satisfy a given want, two or more goods are
needed in combination, these goods are
referred to as complementary goods. Eg. car
and petrol, pen and ink, shoes and socks, guns
and bullets. Complementary goods are always
in Joint Demand. Thus, when the price of a
complementary product will fall, the demand
for its complementary product will increase.
Change in Quantity Demanded
versus Change in Demand
Change in Quantity Demanded
Movement along the demand curve.
Caused by a change in the price of
the product.
Changes in Quantity
Demanded
0
D
1

Price of
Cigarettes
per Pack
Number of Cigarettes
Smoked per Day
A tax that raises the
price of cigarettes
results in a movement
along the demand
curve.
A
C
20
2.00
Rs.4.
00
12
Change in Quantity Demanded
versus Change in Demand
Change in Demand
A shift in the demand curve, either
to the left or right.
Caused by a change in a
determinant other than the price.
Changes in Demand
0
D
1

Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
D
3

D
2

Increase in
demand
Decrease in
demand
Change in Quantity Demanded
versus Change in Demand
Variables that
Affect Quantity
Demanded
A Change in
This Variable . . .
Price Represents a movement
along the demand curve
Income Shifts the demand curve
Prices of related
goods
Shifts the demand curve
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number of
buyers
Shifts the demand curve
Two Simple Rules for
Movements vs. Shifts
Rule One
When an independent variable changes and
that variable does not appear on the graph,
the curve on the graph will shift.
Rule Two
When an independent variable does appear
on the graph, the curve on the graph will not
shift, instead a movement along the existing
curve will occur.
Consumer Income
Normal Good
Rs.3.00
2.50
2.00
1.50
1.00
0.50
2 1 3 4 5 6 7 8 9 10 12 11
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
0
Increase
in demand
An increase
in income...
D
1

D
2

Consumer Income
Inferior Good
Rs.3.00
2.50
2.00
1.50
1.00
0.50
2 1 3 4 5 6 7 8 9 10 12 11
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
0
Decrease
in demand
An increase
in income...
D
1
D
2

Exceptions to the law of
Demand
Law of Demand is a universal
phenomenon. Very rarely, it is so
observed that with a fall in price, demand
also falls and a increase in price increases
demand.
The demand curve in such cases is
upward sloping.
Exceptions to the law of
Demand
A few such exceptions are seen in case of:
Giffen Goods : In cases of some inferior goods,
as observed by Scottish economist Robert
Giffen, when price decreases, there is a
decrease in the demand for these products.
Eg. This was observed by Giffen in Italy when
the poor & labour class people purchased less
of potatoes even after the decrease in their
price. With whatever savings they did by
purchasing less of potatoes, they purchased
more of meat which was a preferred good.
Exceptions to the law of
Demand
Snob Appeal : Goods that are used as
Status Symbol eg. Rolls Royce cars,
Johiney Walker Scotch Whisky,
Diamonds etc.
The demand for these goods increases
even if the price is increased because
these goods are purchased for their
exclusiveness which increases with an
increase in price.
Exceptions to the law of
Demand
Speculation : When the consumers understand
that there is a increase in price of a product
and they are expecting a further rise, they will
not mind purchasing more of that product even
if its price is increased.
Consumers psychology : Many consumers do
not purchase products at the time of discount
sales etc assuming that the quality of the
products may have been compromised.
Law of Supply
The law of supply states that, ceteris
paribus, there is a direct (positive)
relationship between price and
quantity supplied.
Supply
Quantity supplied is the amount of a
good that sellers are willing and able
to sell.
Supply Schedule
The supply schedule is a table that
shows the relationship between the
price of the good and the quantity
supplied.
Supply Schedule
Price Quantity
Rs.0.0 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5


Supply Curve
The supply curve is the upward-
sloping line relating price to quantity
supplied.
Supply Curve
Rs.3.
00
2.50
2.00
1.50
1.00
0.50
2 1 3 4 5 6 7 8 9 10 12 11
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
0
Price Quantity
0.00 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5


Market Supply
Market supply refers to the sum
of all individual supplies for all
sellers of a particular good or
service.
Determinants of Supply
Market price : The single largest factor that
affects supply is the price. More commodities
will be supplied at a higher price and vice
versa.
Input prices : When the factors of production
are available at low price, more investment is
encouraged. This increases supply.
Technology : The improvement in the
technique of production leads to increased
supply.
Determinants of Supply
Natural conditions : The supply of
agricultural commodities depends upon
the natural conditions. Whenever there is
good monsoon, conductive temperature,
the supply of such products increases.
Transport conditions : Difficulties in
transport may cause a temporary
decrease in supply. So, even at rising
price, quantity supplied may decrease.
Determinants of Supply
Expectations : When a seller expects a further rise
in the price, he may withhold the supply and
hence the supply may decrease.
Prices of other products : The prices of substitutes
or related products can influence the supply. If the
prices of wheat are increasing, farmers may grow
more of wheat and less of rice. If the price of sugar
rises, the price of jaggary will also rise.
Govt. policy : If the policies of the govt. are
liberalized, more firms may tend to enter the
market and hence supply may rise.
Change in Quantity Supplied
versus Change in Supply
Change in Quantity Supplied
Movement along the supply curve.
Caused by a change in the market price
of the product.
Change in Quantity Supplied
1 5
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
0
S
1.00
A
C
Rs.3.
00
A rise in the price
of ice cream cones
results in a
movement along
the supply curve.
Change in Quantity Supplied
versus Change in Supply
Change in Supply
A shift in the supply curve, either to the
left or right.
Caused by a change in a determinant
other than price.
Change in Supply
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
0
S
1

S
2

S
3

Increase in
Supply
Decrease in
Supply
Change in Quantity Supplied
versus Change in Supply
Variables that
Affect Quantity Supplied

A Change in This Variable . . .
Price Represents a movement along
the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve


Shifts in Curves versus
Movements along Curves
A shift in the supply curve is called a change
in supply.
A movement along a fixed supply curve is
called a change in quantity supplied.
A shift in the demand curve is called a
change in demand.
A movement along a fixed demand curve is
called a change in quantity demanded.
Supply and Demand Together
Equilibrium Price
The price that balances supply and
demand. On a graph, it is the price at
which the supply and demand curves
intersect.
Equilibrium Quantity
The quantity that balances supply and
demand. On a graph it is the quantity at
which the supply and demand curves
intersect.
Supply and Demand Together
Price Quantity
Rs 0 0
0.50 0
1.00 1
1.50 4
2.00 7
2.50 10
3.00 13


Price Quantity
Rs 0 19
0.50 16
1.00 13
1.50 10
2.00 7
2.50 4
3.00 1


Demand Schedule Supply Schedule
At Rs.2.00, the quantity demanded is
equal to the quantity supplied!
Supply
Demand
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
Equilibrium of
Supply and Demand
2 1 3 4 5 6 7 8 9 10 12 11 0
Rs.3.
00
2.50
2.00
1.50
1.00
0.50
Equilibrium
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
2 1 3 4 5 6 7 8 9 10 12 11 0
Rs.3.
00
2.50
2.00
1.50
1.00
0.50
Supply
Demand
Surplus
Excess Supply
Surplus
When the price is above the equilibrium
price, the quantity supplied exceeds the
quantity demanded. There is excess supply
or a surplus. Suppliers will lower the price
to increase sales, thereby moving toward
equilibrium.
Excess Demand
Quantity of
Ice-Cream Cones
Price of
Ice-Cream
Cone
Rs.2.00
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Supply
Demand
Rs.1.50
Shortage
Shortage
When the price is below the equilibrium
price, the quantity demanded exceeds the
quantity supplied. There is excess demand
or a shortage. Suppliers will raise the price
due to too many buyers chasing too few
goods, thereby moving toward equilibrium.
Three Steps To Analyzing
Changes in Equilibrium
Decide whether the event shifts the
supply or demand curve (or both).
Decide whether the curve(s) shift(s) to the
left or to the right.
Examine how the shift affects
equilibrium price and quantity.
How an Increase in Demand
Affects the Equilibrium
Price of
Ice-Cream
Cone
2.00
0 7 Quantity of
Ice-Cream Cones
Supply
Initial
equilibrium
D
1
1. Hot weather increases
the demand for ice cream...
D
2
2. ...resulting
in a higher
price...
Rs.2.50
10
3. ...and a higher
quantity sold.
New equilibrium
S
2
How a Decrease in Supply Affects
the Equilibrium
Price of
Ice-Cream
Cone
2.00
0 1 2 3 4 7 8 9 11 12 Quantity of
Ice-Cream Cones
13
Demand
Initial equilibrium
S
1
10
1. Shortage of milk reduces
the supply of ice cream...
New
equilibrium
2. ...resulting
in a higher
price...
Rs.2.50
3. ...and a lower
quantity sold.