L AW O F

DEMAN
D AND
S U P P LY
• The law of supply and demand is a
theory that explains the interaction
between the sellers of a resource and
the buyers for that resource. The
theory defines what effect the
relationship between the price of the
product the willingness people to
either buy or sell the product.
Generally, as price increases people
are willing to supply more and demand
less and vice versa when the price falls
 • The law of demand states that, if all other
factors remain equal, the higher the price
of a good, the less people will demand that
good. In other words, the higher the price,
Law of Demand the lower the quantity demanded. The
amount of a good that buyers purchase at a
vs Law of higher price is less because as the price of
a good goes up, so does the opportunity
Supply cost of buying that good. As a result,
people will naturally avoid buying a
product that will force them to forgo the
consumption of something else they value
more. The chart below shows that the
curve is a downward slope.
EXCEPTIONS TO THE
LAW OF DEMAND:
Giffen paradox:
The Giffen good or inferior good is
an exception to the law of demand.
When the price of an inferior good
falls, the poor will buy less and vice
versa. For example, when the price of
maize falls, the poor are willing to
spend more on superior goods than on
maize if the price of maize increases,
he must increase the quantity of
money spent on it.
Veblen or
Demonstration effect:
‘Veblan’ has explained the
exceptional demand curve
through his doctrine of
conspicuous consumption.
Rich people buy certain good
because it gives social
distinction or prestige for
example diamonds are bought
by the richer class for the
prestige
Ignorance:
Sometimes, the quality of the
commodity is Judge by its price.
Consumers think that the product
is superior if the price is high. As
such they buy more at a higher
price.
Speculative effect
If the price of the commodity is increasing the
consumers will buy more of it because of the fear that
it increase still further, Thus, an increase in price may
not be accomplished by a decrease in demand.
Fear of shortage
During the times of emergency of
war People may expect shortage of
a commodity. At that time, they
may buy more at a higher price to
keep stocks for the future
 In the case of necessaries like
rice, vegetables etc. people buy
more even at a higher price.

Necessaries:
DEMAND
When clients want a product and
are willing to pay for it, we say
that there is a demand for the
specific product. There must be a
demand for a product before a
manufacturer can sell it. Demand
does not only have to do with the
need to have a product or a service,
but also with the willingness and
ability to buy it at the price
charged for it.
 • Andrew and his mother, Mrs. Jeffries, decided to earn extra
money by selling grape jam at the local craft market. Mrs.
Jeffries would buy the ingredients and make the jam. Andrew
would help his mother seal it in jars and they planned to sell it
at the market on Saturday mornings.
• Before starting to boil the jam, they decided to test the market
to see whether people would be interested in buying their
product. Mrs. Jeffries therefore boiled a few jars of jam and

Illustration asked their friends and family if they were interested in buying
it and how much they would be willing to pay for it. Everyone
was encouraged to taste some of the jam before making a
decision.
• The results Mrs. Jeffries received is are illustrated in the graph
which indicates the demand at different prices.
Demand Curve

In economics, the demand curve is the

graph depicting the relationship
The demand curve for all consumers
between the price of a certain
together follows from the demand
commodity (in this case Andrew’s jam)
curve of every individual consumer: the
and the amount of it that consumers are
individual demands at each price are
willing and able to purchase at that
added together.
given price. It is a graphic
representation of a demand schedule.
 • According to convention, the demand
curve is drawn with price on the vertical
axis and quantity on the horizontal axis.
The demand curve usually slopes
Demand Curve downwards from left to right; that is, it has
a negative association (two theoretical
Characteristics exceptions, Veblen good and Giffen good).
The negative slope is often referred to as
the “law of demand”, which means people
will buy more of a service, product, or
resource as its price falls.
Shift of a Demand Curve

• The shift of a demand curve takes

place when there is a change in any
non-price determinant of demand,
resulting in a new demand curve.
• Non-price determinants of demand
are those things that cause demand
to change even if prices remain the
same—in other words, changes that
might cause a consumer to buy
more or less of a good even if the
good’s price remained unchanged.
 Some of the more important factors are:

the prices of related

goods (both
income population expectations
substitutes and
complements)
• However, demand is the willingness
and ability of a consumer to
purchase a good under the
prevailing circumstances. Thus, any
circumstance that affects the
consumer’s willingness or ability to
buy the good or service in question
can be a non-price determinant of
demand. For example, weather
could effect the demand for beer at
a baseball game.
Law Of Supply

The law of supply is the

microeconomics law that states
that, all other factors being equal,
as the price of a good or service
increases, the quantity of goods or
services that suppliers offer will
increase, and vice versa. The law
of supply says that as the price of
an item goes up, suppliers will
attempt to maximize their profits
by increasing the quantity offered
for sale.
Understanding the Law Of Supply

The chart depicts the law of

supply using a supply curve, which
is upward sloping. A, B and C are
points on the supply curve. Each
point on the curve reflects a direct
correlation between quantity
supplied (Q) and price (P). So, at
point A, the quantity supplied will
be Q1 and the price will be P1, and
so on.
 Illustration:
For example, a business will make more
video game systems if the price of those
systems increases. The opposite is true if
the price of video game systems
decreases. The company might supply 1
million systems if the price is $200 each,
but if the price increases to $300, they
might supply 1.5 million systems.
A. OPERATIONAL ISSUES:
1.Theory of demand and Demand Forecasting
2. Pricing and Competitive strategy
3. Production cost analysis
4. Resource allocation
5. Profit analysis
6. Capital or Investment analysis
7. Strategic planning
Demand Analyses and
Forecasting:
Demand forecasting is the process of analyzing
historical sales data to predicting future sales  to
make informed business decisions as to the
quantity of goods to supply the market.
Pricing and competitive
strategy:
Pricing decisions have been always within
the preview of managerial economics. Price
theory helps to explain how prices are
determined under different types of market
conditions.
Competitions analysis includes the
anticipation of the response of competitions
the firm’s pricing, advertising and marketing
strategies. Product line pricing and price
forecasting occupy an important place here.
Production and
cost analysis:
Production analysis is in physical terms.

While the cost analysis is in monetary terms

cost concepts and classifications, cost-output
relationships, economies and diseconomies of
scale and production functions are some of the
points constituting cost and production
analysis.
Resource Allocation
Managerial Economics is the traditional
economic theory that is concerned with the
problem of optimum allocation of scarce
resources.

Marginal analysis is applied to the problem of

determining the level of output, which
maximizes profit.
In this respect linear programming techniques
has been used to solve optimization problems. In
fact lines programming is one of the most
practical and powerful managerial decision-
making tools currently available.
Profit analysis:
Profit making is the major goal of firms.
There are several constraints here an account
of competition from other products, changing
input prices and changing business
environment hence despite careful planning,
there is always certain risk involved.

Managerial economics deals with techniques

of averting of minimizing risks. Profit theory
guides in the measurement and management
of profit, in calculating the pure return on
capital, besides future profit planning
Capital or investment
analyses
Capital is the foundation of business. Lack of capital
may result in small size of operations. Availability of
capital from various sources like equity capital,
institutional finance etc. may help to undertake large-
scale operations.
Hence efficient allocation and management of capital is
one of the most important tasks of the managers.
The major issues related to capital analysis are:
1.The choice of investment project
2.Evaluation of the efficiency of capital
3.Most efficient allocation of capital.
Strategic planning:
Strategic planning provides a
long-term goals and objectives
and selects the strategies to
achieve the same. . The
perspective of strategic
planning is global.

strategic planning has given

rise to be new area of study
called corporate economics
B. Environmental or External
Issues:

The type of economic system in the country

a. The general trends in production,
employment, income, prices, saving and
investment.
b. Trends in the working of financial
institutions like banks, financial
corporations, insurance companies
c. Magnitude and trends in foreign trade;
d. Trends in labor and capital markets;
e. Government’s economic policies viz.
industrial policy monetary policy, fiscal
policy, price policy etc
Elasticity
is a measure of a variable's sensitivity to a
change in another variable, most commonly
this sensitivity is the change in price relative
to changes in other factors. In business and
economics, elasticity refers to the degree to
which individuals, consumers or producers
change their demand or the amount supplied
in response to price or income changes. It is
predominantly used to assess the change in
consumer demand as a result of a change in a
good or service's price
Price elasticity of demand (PED), which measures the responsiveness
of quantity demanded to a change in price. PED can be measured over a
price range, called arc elasticity, or at one point, called point elasticity.

Price elasticity of supply (PES), which measures the

responsiveness of quantity supplied to a change in price.

Cross elasticity of demand (XED), which measures

responsiveness of the quantity demanded of one good, good X,
to a change in the price of another good, good Y.

Income elasticity of demand (YED), which measures the

responsiveness of quantity demanded to a change in
consumer incomes.
Price elasticity of demand
•• 𝑷𝒓𝒊𝒄𝒆
  𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 =
• There are five cases of price elasticity of demand

• Perfectly elastic demand

• Perfectly inelastic
• Relatively elastic demand
• Relatively inelastic demand
• Unitary demand
 Substitutes – the more substitutes available for
products will make the demand more elastic. 
Necessity – If the product is a basic need, people will
Factors that be willing to pay a higher price for the product. For
example, gas, even if gas doubles, you will still have
to fill up your tank to get to the office daily.
Affect the Time – If the price of cigarettes goes up with $1 per

Elasticity of pack, and there isn’t a lot of substitutes, the smoker

will keep buying his cigarettes, showing and inelastic
demand. The price does not influence the quantity of
Demand demand. However, if the smoker cannot afford the $1
per pack more that he needs to pay and decides to stop
smoking over time, then the price elasticity of
cigarettes will become elastic over the long run.
There are five
cases of price Perfectly Elastic Demand
elasticity of When a small change in price of a
product causes a major change in
demand its demand, it is said to be perfectly
elastic demand. In perfectly elastic
demand, a small rise in price
results in fall in demand to zero,
while a small fall in price causes
increase in demand to infinity. In
such a case, the demand is
perfectly elastic
Perfectly inelastic demand
is the situation where there
no change in quantity
demanded even there is
change in price of the goods,
the demand is said to
be perfectly inelastic.
Simply mean no change in
demand for change in price.
In accordance to the law of
demand, the demand for
goods and services changes
when there is change in its
price
Relatively Elastic
Product
• Relatively elastic demand
refers to the demand when
the proportionate change
produced in demand is
greater than the
proportionate change in
price of a product. The
numerical value of
relatively elastic demand
ranges between one to
infinity.
 Relatively Inelastic
Demand:

Relatively inelastic demand is one

when the percentage change
produced in demand is less than the
percentage change in the price of a
product. For example, if the price of a
product increases by 30% and the
demand for the product decreases
only by 10%, then the demand would
be called relatively inelastic.
 Unitary Elastic Demand:

• When the proportionate

change in demand produces
the same change in the
price of the product, the
demand is referred as
unitary elastic demand. The
numerical value for unitary
elastic demand is equal to
one
 Practice Illustration
Price Quantity Total Revenue Marginal Revenue
Peso per unit Units Peso Peso
20 200 4000
18 280 5040 13
16 360 5760 9
14 440 6160 5
12 520 6240 1
10 600 6000 -3
8 680 5440 -7
6 760 4560 -11
The table has gives an example of the relationships between prices; quantity demanded and total
revenue. As price falls, the total revenue initially increases, in our example the maximum revenue
occurs at a price of P12 per unit when 520 units are sold giving total revenue of P6240.
Income Elasticity
of Demand
Income elasticity of demand
refers to the sensitivity of the
quantity demanded for a
certain good to a change
in real income of consumers
who buy this good, keeping
all other things constant.
Types of Income Elasticity of Demand

• Necessary Good: A type of normal good. An

increase in income leads to a smaller than
proportional increase in the quantity demanded.
• Superior Good: A type of normal good.
Demand increases more than proportionally as
income rises.
• Normal goods have a positive income elasticity
of demand (as income increases, the quantity
demanded increases).
• Inferior goods have a negative income elasticity
of demand (as income increases, the quantity
demanded decreases).
• Zero: The quantity bought/demanded is the
same even if income changes
 The cross elasticity of demand is an
economic concept that measures the
responsiveness in the quantity
demanded of one good when the price
for another good changes. Also called
cross-price elasticity of demand, this
Cross Elasticity of measurement is calculated by taking
the percentage change in the quantity
Demand demanded of one good and dividing it
by the percentage change in the price
of the other good
 COMPLEMENT: A GOOD WITH A
NEGATIVE CROSS ELASTICITY OF
DEMAND, MEANING THE GOOD’S
DEMAND IS INCREASED WHEN THE
PRICE OF ANOTHER GOOD IS
DECREASED.
SUBSTITUTE: A GOOD WITH A POSITIVE
CROSS ELASTICITY OF DEMAND,
MEANING THE GOOD’S DEMAND IS
INCREASED WHEN THE PRICE OF
ANOTHER IS INCREASED.
FORMUL
A
SIGNIFICANCE OF ELASTICITY OF
DEMAND
The concept of elasticity is very useful to the producers and the policy
makers. It is very valuable tool t decide the extent of increase or
decrease in price for a desired change in the quantity demanded for the
products and services in the firm or the economy.
Applications
a. To fix the prices of factors of
production.
b. To fix the prices of goods and
services provided rendered
c. To formulate or revise govt
policies.
d. To forecast demand
e. To plan the level of output and
price.
Prices of factors of
production:
The factors o f production are
land, labor , capital and
organization and technology.
we need to pay rent, wages,
interest, profits and price for
the factors of production
Price fixation
The manufacturer can decide the
amount of prices that can be fixed
for his product based on the
concept of elasticity , if the
manufacturer is monopoly, the
manufacturer is free to fix as long
as it does not attract the attention
of the govt. If the demand for the
product is inelastic, he can fix a
higher price.
Forecasting
Demand:
• The trade can estimate the
quantity of goods to be sold
at different income levels to
raise the targeted revenue.
The impact of changing
income levels on the
demand of the product can
be assessed with the help of
income elasticity.
 Govt policies
I. Tax policies: Govt extensively depends on this concept to
finalize its policies relating to the taxes and revenue, where
the product is such that the people cannot postpone its
consumption, the govt tend to increase the prices. Eg:
Petrol prices.
II. Raising bank deposits: If the govt wants to oblige larger
deposits from the customers , it proposes to raise the rates
of fixed deposits marginally and vice versa.
III. Public Utilities: Govt uses the concept of elasticity in fixing
charges for the public utilities such as electricity tariff,
water charges.
IV. Revaluation or devaluation of currency: The govt must
study the impact of revaluation and devaluation on the
interests of the exporter and importer.
Planning the level of output and
price:

• It helps the producer to evaluate

whether a change in price will
bring in adequate revenue or not,
in general for items whose
demand is elastic, it would
benefit him to charge relatively
low prices. If the demand for the
product is inelastic, a little higher
price may be helpful to him to
get huge profits without losing
sales
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