Eco120 - CHP 2 - Theory of Demand and Supply

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2013 2– 1

CHAPTER 2
DEMAND AND SUPPLY

DEFINITION OF DEMAND
Demand is defined as the ability and willingness
to buy specific quantities of goods
in a given period of time
at a particular price, ceteris paribus.

CLASSIFICATION OF GOODS
AND SERVICES
 Free goods are goods that have no production
cost.
 Public goods are goods that are for common
use and will benefit everyone.
 Economic goods are goods of value that can
be seen and touched. Economic services are
intangible things (with value) that cannot been
seen or touched.

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
12
Price Quantity
10
5 2
8
4 4
6
3 6 DD
4
2 8
2
1 10
0
2 4 6 8 10

INDIVIDUAL AND MARKET
DEMAND
INDIVIDUAL DEMAND
The relationship between the quantity
of a good demanded by a single individual
and its price.

MARKET DEMAND
The relationship between the total quantity
of a good demanded by adding all the quantities demanded
by all consumers in the market and its price.

Consumers’
Consumers’ Tastes
Tastes and
and
income
income trends
trends
Price
Price of
of
related
related goods
goods Population
Population or
or
number
number of
of
buyers
buyers
Supply
Supply ofof
money
money in in Expectation
Expectation
circulation
circulation about
about future
future
prices
prices
Festive
Festive
Level
Level of
of taxation
taxation Advertisement
Advertisement
seasons
seasons and
and
climate
climate
CHANGES IN QUANTITY DEMANDED
VS. CHANGES IN DEMAND
CHANGES IN QUANTITY DEMANDED CHANGES IN DEMAND
Price Price
D1
DD D0
Quantity
Quantity
 Movement along DD curve
 Price changes and other factors are  Shift in the demand curve
constant  Occurs when there are changes in
 Upward movement  Decrease in other factors but price remains
quantity demanded (Contraction) constant
 Downward movement  Increase in  Increase in Demand (D0  D1)
quantity demanded (Expansion)  Decrease in Demand (D1  D0)

EXCEPTIONAL DEMAND
Exceptional Demand is the opposite of the Law of Demand where

as price increases, demand will also increase and vice versa.
SPECULATION
EMERGENCIES
STATUS SYMBOL GOODS
HIGHLY-PRICED GOODS

INTER-RELATED DEMAND
The demand for a good is also affected by the price of

its substitute or complementary goods. Cross demand can be
divided into two: Joint demand and competitive demand.
Derived demand is the demand for a good

which is derived from other goods.

CROSS DEMAND: JOINT DEMAND
VS. COMPETITIVE DEMAND
Cross Demand Positive relationship exists
between substitute goods
Price of pizza Price of pizza
DD
Negative relationship exists P2
P2 between complement
goods
P1 P1
DD
Q1 Q2 Quantity of soft drinks Q1 Q2 Quantity of

soft drinks
Joint Demand Competitive Demand

DERIVED DEMAND
Cross Demand Positive relationship exists
between substitute goods
Price (RM’000)
of pizza Wage
Price rate
of pizza
(RM per hour)
S0DD
S0
P21 Negative relationship exists WR
P21
P between complement
P0 goods
D1
P1 WR
P10
D1
D0DD D0
Q1 QQ0 2 Q1 Quantity Quantity
of soft drinks Q01 Q02 Quantity
Quantityof of
softworkers
drinks
Demand
Joint Demand
and supply for house Demand
Competitive
and supply
Demand
for carpenters

INTERRELATED DEMAND
Composite demand is demand for a good

that has multiple uses
For example: oil can be used for petrol,
kerosene and diesel

COMPOSITE DEMAND
Price Price S1
S0
S0
P1
P1
P0 P0
D1
D0 D0
Q0 Q1 Quantity
Q1 Q0 Quantity of
workers
Demand and supply for petrol Demand and supply for diesel

PRICE ELASTICITY OF DEMAND
DEFINITION:
Measures the sensitivity/responsiveness

of the quantity demanded
due to a change in its price.

PRICE ELASTICITY OF
DEMAND (cont.)
FORMULA:
d = %  Quantity Demanded
%  Price
d = Q2 – Q1 x P1
Q1 P2 – P1

DEGREE OF ELASTICITY
Perfectly Inelastic Demand
Price (RM) Inelastic Demand
A condition in which the quantity demanded does
d =0 not change as the price changes.
A large percentage of change in the price of a good
d < 1 will only affect a small percentage of change in the
Elastic Demand
quantity demanded.
A small percentage of change in the

Unitary
price of a good will leadElastic
to larger
percentage of change in quantity
d =  demanded.
Demand
Perfectly Elastic
A condition in which
Demand
percentage changes in price
equals to percentage
A condition in which a small
changes in quantity
percentage of change in
demanded.
price leads to an infinite
d = 1 percentage of change in the
d > 1 quantity demanded.
Quantity Demanded
Proportion
Proportion
Proportion of
Proportionof the
ofthe
of the
the
expenditure
expenditure
expenditureon
expenditure onon
onaaaa Nature
Nature of
of
Existence
Existence
Existence ofof
Existenceof of product
product
product
product goods
goods
substitutes
substitutes
substitutes
substitutes
Frequently
Frequently Income
Income level
level
purchased
purchased
products
products
Time
Time
Complementary
Complementary dimension
dimension
goods
goods Habits
Habits

RELATIONSHIP TO TOTAL
REVENUE
Total Revenue (TR) = Price (P) x Quantity (Q)
The information on price elasticity of demand will be useful

Price
for the seller to adjust their selling price since it will affect
the total revenue.
DEMAND IS ELASTIC
RM30
Total Revenue
RM20 x 10 = RM200
RM20
If seller increases price to RM30
New Total Revenue
= RM30 x 5 = RM150
 TR =  RM50
D
5 10
Quantity Demanded

REVENUE (cont.)
Price
DEMAND IS INELASTIC
RM2 Total Revenue

RM1 x 15 = RM15
RM1
New Total Revenue
= RM2 x 10 = RM20
 TR =  RM5
10 15
Quantity Demanded

REVENUE (cont.)
Price
DEMAND IS UNITARY ELASTIC
RM2
Total Revenue
RM1 x 20 = RM20
RM1 New Total Revenue
= RM2 x 10 = RM20
 TR =  0
10 20
Quantity Demanded
INCOME ELASTICITY OF
DEMAND
DEFINITION:

of the quantity demanded
due to a change in income.

DEMAND (cont.)
FORMULA:
Y = %  Quantity Demanded
%  Income
Y = Q2 – Q1 x Y1
Q1 Y2 – Y1

RESPONSES OF INCOME
ELASTICITY
Elastic Income
-Type of good: Luxury goods such as antique
furniture and diamonds
Income
y =0
Inelastic Income
-Type of good: Normal goods such as food
and clothing
Negative Income Elasticity

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

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

of the quantity demanded of one product
due to a change in the price of a related product.

DEMAND
FORMULA:
X = %  Quantity Demanded of good X

%  Price of good Y
X = QX2 – QX1 x PY1
QX1 PY2 – PY1

RESPONSES OF CROSS
ELASTICITY
Price of Good X Positive Cross Elasticity

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

-Good X and Y are complementary goods
Zero Cross Elasticity

-Good X and Y have no relationship
x > 0 x < 0
Quantity Demanded
of Good Y
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  P  Qss 
POSITIVE RELATIONSHIP

SUPPLY SCHEDULE AND
CURVE
Supply Schedule Supply Curve
Price Quantity 12
5 10 10
4 8 8
3 6 6
Supply
2 4 4
1 2 2
0
1 2 3 4 5

INDIVIDUAL AND MARKET
SUPPLY
INDIVIDUAL SUPPLY
The relationship between the quantity of a product
supplied by a single seller and its price.

MARKET SUPPLY
The relationship between the total quantity
of a product supplied by adding all the
quantities supplied by all sellers
in the market and its price.

Proportion
Proportion of
of the
the
Cost
Cost of
of production
expenditure on
on aa
production
expenditure Expected
Price
Price of
of related
related Expected
product
product future
goods
goods future price
price
Improvement
Improvement in in Technological
Technological
infrastructure
infrastructure advancement
advancement
Government
Government Number
Number ofof
Policies
Policies sellers
sellers

CHANGE IN QUANTITY SUPPLIED
VS. CHANGE IN SUPPLY
CHANGE IN QUANTITY SUPPLIED CHANGE IN SUPPLY

Price Price
s0
SS s1
Quantity Quantity
 Movement along supply curve  Shift in the supply curve

 Price changes and other factors are  Occurs when there are changes in
constant other factors but the price remains
 Downward movement  Decrease in constant
quantity supplied (Contraction)  Increase in Supply (S0  S1)
 Upward movement  Increase in  Decrease in Supply (S1  S0)
quantity supplied (Expansion)
EXCEPTIONAL SUPPLY
Exceptional Supply is the opposite of the Law of
Supply where as price increases, the quantity supplied
Wage Rate decreases and vice versa
20 Income Effect
(Exceptional Supply
Curve)
15
10
Substitution Effect
Labour
0 1 2 3 4 5 6
INTERRELATED DEMAND
Increase in the supply of one good

brings to an increase in the supply
of another related goods.

PRICE ELASTICITY OF
SUPPLY
DEFINITION:

of the quantity supplied due to a change
in the price of a product or service.

PRICE ELASTICITY OF SUPPLY
(cont.)
FORMULA:
ss = %  Quantity Supplied

%  Price
SS = Q2 – Q1 x P1
Q1 P2 – P1

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.
Inelastic Supply
Price (RM)
ss =0 A large percentage of change in the price of a good
ss = 1 will only affect a small percentage of change of the
quantity supplied.
ss < 1
Unitary Elastic Supply
Percentage change in price equals the percentage
change in the quantity supplied.
Perfectly Elastic Supply

An almost zero percentage of change in price brings
ss =  a very large percentage of change in the quantity
supplied.
Perfectly Inelastic Supply

ss > 1 A percentage of change in price has no effect on
the percentage of change in the quantity supplied.
Quantity Demanded
Time
Time Period
Period
Technology
Technology
improvements
improvements
Nature
Nature of
of the
the
market
market
Availability
Availability and
and mobility
mobility of
of Perishability
Perishability
factors
factors ofof production
production


Eco120 - CHP 2 - Theory of Demand and Supply

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Eco120 - CHP 2 - Theory of Demand and Supply

Uploaded by

Copyright:

Available Formats

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

© Oxford Fajar Sdn. Bhd. (008974-T), 2013 2– 1

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Demand is defined as the ability and willingness

to buy specific quantities of goods

in a given period of time

at a particular price, ceteris paribus.

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Law of demand states that the higher the price

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Demand Schedule Demand Curve

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Exceptional Demand is the opposite of the Law of Demand where

STATUS SYMBOL GOODS

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

The demand for a good is also affected by the price of

Derived demand is the demand for a good

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Q1 Q2 Quantity of soft drinks Q1 Q2 Quantity of

Joint Demand Competitive Demand

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Composite demand is demand for a good

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Measures the sensitivity/responsiveness

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

A small percentage of change in the

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

The information on price elasticity of demand will be useful

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

RM2 Total Revenue

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Measures the sensitivity/responsiveness

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Negative Income Elasticity

0< y < 1 Zero Income Elasticity

Measures the sensitivity/responsiveness

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

X = %  Quantity Demanded of good X

X = QX2 – QX1 x PY1

QX1 PY2 – PY1

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Price of Good X Positive Cross Elasticity

Negative Cross Elasticity

Zero Cross Elasticity

Supply is defined as the ability and willingness

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Law of supply states that the higher the price

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Supply Schedule Supply Curve

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

CHANGE IN QUANTITY SUPPLIED CHANGE IN SUPPLY

 Movement along supply curve  Shift in the supply curve

Increase in the supply of one good

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved