CHAPTER 2

BASIC ANALYSIS
OF DEMAND AND
SUPPLY
 THE MARKET

A market is the
interaction between
buyers and sellers of
trading or exchange. It
is where the consumers
buys and the seller sells.
 1. GOODS MARKET

The most common type of

market because it is
where we buy consumer
goods.
 2. LABOR MARKET

It is where workers offer

services and look for
jobs and where the
employers look for
workers to hire.
 3. FINANCIAL MARKET

A market that includes

the stock market where
securities of
corporations are traded.
 ECONOMIC RESOURCES

Economic resources, also

known as factors of
production, are the
resources used to
produce goods and
services.
 1. LAND

Soil and natural

resources that are found
in nature and are not
man-made. Owners of
the lands receive a
payment known as rent.
 2. LABOR
Physical and human effort
exerted in production. It
covers manual workers
like construction workers,
machine operators, and
production workers, as
well as professionals like
nurses, lawyer and
doctors.
 3. CAPITAL
man-made resources
used in the production of
goods and services,
which include
machineries and
equipment. The owner
of the capital earns an
income called interest.
 DEMAND

Demand is the
willingness of a
consumer to buy a
commodity at a given
price.
 DEMAND SCHEDULE

A demand schedule
shows the various
quantities a consumer is
willing to buy at various
prices.
 DEMAND FUNCTION

A demand function shows

how the quantity
demanded of a good
depends on its
determinants, the most
important of which is
the price of the good
itself.
 DEMAND CURVE
The demand curve is a
graphical representation
of the demand schedule,
with the price measure
on the vertical axis and
the quantity demanded
measured on the
horizontal axis.
 DEMAND CURVE
The downward
slope of the
P
curve indicates
R
I that as the price
C
E of the good
increases the
demand for this
QUANTITY

good decreases.
 INCOME EFFECT
Income effect is felt when a
change in the price of a good
changes a consumer’s real
income or purchasing power.

When the price of a product

decreases, ceteris paribus,
consumers have more relative
income. They can, therefore,
purchase additional products
(and vice versa).
 SUBSTITUTION EFFECT
Substitution effect is felt when
a change in the price of a good
changes demand due to
alternative consumption of
substitute goods.

When the price of a product

decreases, ceteris paribus, the
product becomes cheaper. It is
therefore, more attractive to
other products (and vice versa)
 THE LAW OF DEMAND
Using the assumption “ceteris
paribus,” which means all other
related variables except
those that are being studied
at the moment and are held
constant, there is an inverse
relationship between the
price of a good and the
quantity demanded for the
good.
 THE LAW OF DEMAND

As price increases, the

quantity demanded for
that quantity decreases
and vice versa. The low
price of the good
motivates the consumer
to buy more.
 NON-PRICE
DETERMINANTS OF
DEMAND
If the ceteris paribus assumption is dropped,
non-price variables that also affect demand
are now allowed to influence demand.

The following changes will shift the demand curve

to the right or to the left.
 A change in real incomes or wealth (normal and inferior products).
 A change in tastes or preferences.
 A change in the prices of related products (substitute and
complementary products).
 A change in the expectation of the product’s future price or buyers’
future incomes.
 A change in the number of buyers (population).
 1. A CHANGE IN REAL INCOME OR
WEALTH

If consumers income
decreases, the capacity to
buy decreases and the
demand will also decreases
even when the price does
remain the same.
 2. A CHANGE IN TASTES OR
PREFERENCES

Improved taste for a

product will cause a
consumer to buy more of
that good even if its price
does not change.
 3. A CHANGE IN THE PRICES OF
RELATED PRODUCTS

For substitute goods, if the price

of a good increases, the demand
for that good decrease while the
demand for its substitute will
increase. For complementary
goods, an increase in the demand
for a good will lead into an
increase in the demand for the
complement since they are used
together.
 TYPES OF GOODS
Normal Goods
– any goods for which demand increases
when income increases, and falls when
income decreases but price remains
constant.
 TYPES OF GOODS
Inferior Goods
– generic products, used, or
discounted
NORMAL VS. INFERIOR
GOODS
 TYPES OF GOODS
Substitute Goods
– product from another industry that offers
similar benefits to the consumer as the
product produced by the firms within the
industry.
 TYPES OF GOODS
Complementary Goods
– Material or good whose use is interrelated
with the use of an associated or paired good
such that a demand for one product generates
demand for the other product.
 4. A CHANGE IN THE EXPECTATION
OF THE PRODUCT’S FUTURE PRICE OR
BUYERS’ FUTURE INCOMES

Consumer tends to
anticipate changes in the
price of a good.
 5. A CHANGE IN THE NUMBER OF
BUYERS (POPULATION)

The population makes up the

group of consumers who will
buy the product. The higher
the population, the more
consumers and the higher will
be the demand for the good.
 SUPPLY AND DEMAND

The Demand Curve

A change in the price is a movement along
the demand curve. This is called a change in
“quantity demanded”.

Price Individual product demand

curves always extend from the
upper left to the lower right.
$4 A They are downward sloping.

$1.75 B
Demand Curve

60 80 Quantity Demanded
 SUPPLY AND DEMAND

Marginal Utility
Marginal utility
is the increase in
satisfaction (as
measured in
“utils”) per
additional item
consumed.
SUPPLY AND DEMAND
The Law of
Diminishing
Marginal Utility
As consumers
purchase more of a
product, the value
(satisfaction) of
additional items
purchased declines.
 SUPPLY
Supply refers to the
quantity of the goods
that a seller is willing to
offer for sale.
 SUPPLY SCHEDULE
Supply schedule shows
the different quantities
the seller is willing to
sell at various prices.
 SUPPLY FUNCTION
The supply function
shows the dependence of
supply at various
determinants that affect
it.
 SUPPLY CURVE
The supply curve is a
graphical representation
of the demand schedule.
 THE LAW OF SUPPLY
Using the same assumption of
ceteris paribus (other things
constant) there is a direct
relationship between the
price of a good and the
quantity supplied of that
good. As the price increases,
the quantity supplied of that
product also increases.
 NON-PRICE
DETERMINANTS OF
SUPPLY
Supply Determinants

The following changes will shift the

supply curve to the right or to the left.
 An advance in technology.
 A change in input prices.
 A change in taxes, subsidies, or
regulations.
 A change in the number of firms selling
the product.
 MARKET EQUILIBRIUM
Equilibrium is a state of balance when
demand is equal to supply. The equality
means that the quantity the sellers are
willing to sell is also the quantity that the
buyers are willing to buy for a price. In a
free market the equilibrium price and
quantity occur where the supply and
demand curves intersect.
 SUPPLY AND DEMAND
Equilibrium Price and Quantity

When demand increases, the

demand curve shifts to the right.

Price
Equilibrium
S
price increases,
$4
and equilibrium
$3
quantity
D2 increases.
D1
50 70 Quantity
 SUPPLY AND DEMAND
The Effect of a Change in Demand on
Equilibrium Price and Quantity

In the short run, when demand

increases
1. the equilibrium price increases,
and
2. the equilibrium quantity
increases.

In the short run, when demand

 SUPPLY AND DEMAND
Equilibrium Price and Quantity

When supply increases, the

supply curve shifts to the right.
Equilibrium
price decreases,
Price S1
S2 and equilibrium
quantity
$3 increases.
$2
D

50 60 Quantity
 SUPPLY AND DEMAND
The Effect of a Change in Supply on Equilibrium
Price and Quantity
When supply increases (a rightward shift of the
supply curve)
1.The equilibrium price decreases, and
2. The equilibrium quantity increases.
When supply decreases (a leftward shift of the
supply curve)
1. The equilibrium price increases, and
2. The equilibrium quantity decreases.
SUPPLY AND DEMAND

Consumer
Surplus

is the difference
in what
consumers are
willing to pay for
the price of the
product and what
they are actually
paying for it in
the market.
Price

Consumer
Surplus
S
$8
$7

$6

$5

D Quantity
Demanded
Per Day
90 100110 120
 SUPPLY AND DEMAND

Producer
Surplus
is the difference
in what
suppliers are
willing to sell
the product for
and what they
are actually
receiving for it
in the market.
Price

$5 Producer
Surplus
$4
$3
$2
D
90 100 110120 Quantity
Demanded
Per Day
 SUPPLY AND DEMAND

Prices of Manufactured
Products
Manufactured products are
abundantly available and are
produced in competitive
industries. Examples include
computers, cell phones, CDs, and
bicycles.
Prices of manufactured goods
equal the cost of production plus
a reasonable profit. Prices are
rarely excessive, especially in
the long run.
 SUPPLY AND DEMAND

Prices of Limited-Supply
Products

Examples of limited-supply
products include land, office
space, labor, Super Bowl
tickets, and products sold
by monopolies.

Prices of limited-supply products

can be excessive, even in the
long run.