TOPIC 2

MARKET DEMAND AND SUPPLY

 KEY POINTS
• The law of demand
• Non-price determinants of demand
• The law of supply
• Non-price determinants of supply
• A market supply and demand analysis
• Changes in market equilibrium
• Price ceilings
• Price floors
• Elasticity
 THE LAW OF DEMAND

• An inverse relationship between the price of a

good or service and the quantity buyers are
willing to purchase in a defined time period,
ceteris paribus.
• A demand schedule (table) shows the specific
quantity of a good or service that people are
willing and able to buy at different prices.
• The demand curve shows this relationship.
AN INDIVIDUAL’S DEMAND CURVE
AND SCHEDULE
INDIVIDUAL DEMAND CURVES
MARKET DEMAND
 CHANGE IN QUANTITY
DEMANDED
When price
changes, quantity
demanded
changes

There is a
movement along
the demand curve
 CHANGE IN DEMAND

When a non-price
determinant
changes, demand
changes

Demand curve
shifts
NON-PRICE DETERMINANTS OF
DEMAND
Changes in demand occurs when the following
non-price determinants of demand change:

• number of buyers
• tastes and preferences
• income
• expectations of buyers
• prices of related goods.
 THE LAW OF SUPPLY

• A direct relationship between the price of a

good and the quantity sellers are willing to offer
for sale in a defined time period, ceteris
paribus.
• A supply schedule (table) shows the quantity
of a good or service that firms are willing and
able to offer for sale at different prices.
• The supply curve shows this relationship.
AN INDIVIDUAL SELLER’S SUPPLY
CURVE AND SCHEDULE
INDIVIDUAL SUPPLY CURVES
MARKET SUPPLY
 CHANGES IN QUANTITY
SUPPLIED
When price
changes, quantity
supplied changes

There is a
movement along
the supply curve
 CHANGES IN SUPPLY

When a non-price
determinant
changes, supply
changes

Supply curve shifts

NON-PRICE DETERMINANTS OF
SUPPLY
Changes in supply occurs when the following
non-price determinants of supply change:
• number of sellers
• technology
• input prices
• taxes and subsidies
• expectations of producers
• prices of other goods the firm could produce.
A MARKET SUPPLY AND DEMAND
ANALYSIS
• Any arrangement in which the interaction
of buyers and sellers determines the
price and quantity of goods and services
exchanged.
 EQUILIBRIUM

• A market condition that occurs at any

price for which the quantity demanded
and the quantity supplied are equal.
EQUILIBRIUM
PRICE AND
QUANTITY
 MARKET FORCES IN ACTION

• When there is disequilibrium, market

forces act to bring the market into
balance.
• Disequilibrium could be a surplus or a
shortage.
 SURPLUS AND SHORTAGE

• A surplus is a market condition existing at

any price where the quantity supplied is
greater than the quantity demanded.
• A shortage is a market condition existing
at any price where the quantity supplied
is less than the quantity demanded.
 HOW THE MARKET CLEARS

• When surplus occurs: sellers compete for buyers

by cutting their selling price.
• When shortage occurs: potential customers try to
attain the available goods by paying a higher
price.
• Forces of supply and demand creates an
equilibrium through rising and falling prices.
• This mechanism is also called the Price system.
 CHANGES IN MARKET
EQUILIBRIUM
• Changes in prices and quantities sold in
markets primarily occur because of:
– changes in demand
– changes in supply.
 CHANGES IN DEMAND

• If one of the non-price determinants of

demand (in Chapter 3) changes, then the
equilibrium price and quantity will
change.
– an increase in a non-price determinant of demand
will raise the price and quantity supply
– a decrease in a non-price determinant of demand
will lower the price and quantity supply.
AN INCREASE IN DEMAND
AN DECREASE IN DEMAND
 CHANGES IN SUPPLY

• If one of the non-price determinants of

supply (in Chapter 3) changes, then the
equilibrium price and quantity will
change.
– an increase in a non-price determinant of supply will
lower the price and increase the quantity supply
– a decrease in a non-price determinant of supply will
raise the price and lower the quantity supply.
AN INCREASE IN SUPPLY
AN DECREASE IN SUPPLY
CAN THE LAWS OF SUPPLY AND
DEMAND BE REPEALED?
• For various reasons, governments
implement price controls to influence
market forces.
• Two types of price controls:
– price ceilings
– price floors.
 PRICE CEILINGS

• A legally established maximum price a seller

can charge.
• Governments impose these to ensure that the
wider community can access the product or
service sold.
• It always results in an excess of quantity
demanded over quantity supplied at the ceiling
price.
PRICE CEILINGS
 PRICE CEILINGS

• Example: rent control.

• Consequences:
– excessive shortages
– black markets
– less maintenance
– discrimination.
 PRICE FLOORS
• A legally established minimum price a seller
can be paid.
• Governments impose these to lower the
consumption of a good, or ensure some
employees are not disadvantaged.
• It always results in an excess of quantity
supplied over quantity demanded at the floor
price.
PRICE FLOORS
 PRICE FLOORS

• Examples: minimum wage, agricultural

price supports.
• Consequences:
– unemployment
– overproduction and waste of resources.
 TICKET SCALPING
• Refer to 'The Economics of Ticket Scalping'
case study reading.
• Why is there an arbitrage opportunity for
ticket scalpers?
• Why might event promoters decide to set
prices below equilibrium?
• What strategies could be used to solve the
problem?
THE CONCEPT OF ELASTICITY

• Elasticity explains the sensitivity of one

variable to changes in another variable.
• Useful for business decision-making (e.g.
pricing, marketing) and policy-making.
• The Elasticity Coefficient (Ed) is used to
measure the degree of elasticity.
PRICE ELASTICITY OF DEMAND

• The ratio of the percentage change in the

quantity demanded of a product to a
percentage change in its price.
• The price elasticity of demand formula is:
PRICE ELASTICITY OF DEMAND
What is the Ed if a concert raises ticket prices from
$25 to $30, and the number of seats sold falls from
20 000 to 10 000 (ceteris paribus)?

When price increases by 1%, quantity demand

falls by 2.5%.
PRICE ELASTICITY OF DEMAND
What is the Ed if the concert decreases its ticket
prices from $30 to $25, and quantity demanded
rises from 10 000 to 20 000 seats (ceteris paribus)?

When price decreases by 1%, quantity demand

increases by 5.9%.
 ELASTICITY COEFFICIENTS
• Elasticity coefficients are negative because of the
demand curve slope.
• Ignore the minus sign derived from calculations.

The • Elastic (Ed > 1)

elasticity • Inelastic (Ed < 1)
coefficient
could be: • Unitary elastic (Ed = 1)
 THE TOTAL REVENUE TEST
• Total Revenue is the revenue a firm earns from
sales:
TR = Price x Qd
• The elasticity coefficient gives us the effect on
Total Revenue of a decrease in price:
– elastic: increases total revenue
– inelastic: decreases total revenue
– unitary: no change total revenue.
IMPACT OF A DECREASE IN PRICE
ON TOTAL REVENUE
 VARIATIONS ALONG A
STRAIGHT-LINE DEMAND CURVE
• Price elasticity of demand for a downward-
sloping straight-line demand curve varies as
we move along the curve.
• Any straight line demand curve has three
ranges:
– a price elastic range (at high prices)
– a unitary elastic point
– a price inelastic range (at low prices).
 VARIATIONS ALONG A
STRAIGHT-LINE DEMAND CURVE
 DETERMINANTS OF PRICE
ELASTICITY OF DEMAND
• Factors that influence the price elasticity
of a good or service:
– the availability of substitutes
– share of budget spent on the product
– adjustment to a price change over time.
AVAILABILITY OF SUBSTITUTES
• Demand is more price-elastic for goods that
have close substitutes because consumers can
switch to alternative products.
• Price elasticity depends upon how broadly (or
narrowly) we define the good or service.
– Example: the Ed for Hyundai motor cars is greater
than that for cars in general. Hyundai compete with
cars sold by Kia, Toyota, Mitsubishi and other car
makers.
 SHARE OF BUDGET SPENT ON
THE PRODUCT
• Consumers are more sensitive to a price
change, and the demand curve is more
elastic, when the good or service takes a
large proportion of their income.
• This is because consumers think more
carefully about alternatives when prices
change.
 ADJUSTMENT TO A PRICE
CHANGE OVER TIME
• The longer consumers have to adjust, the
more sensitive they are to a price change,
and the more elastic the demand curve.
• This occurs when people are planning a
holiday at the end of next year, rather than a
necessary trip that needs to be taken next
week.
PRICE ELASTICITY OF SUPPLY

• The ratio of the percentage change in the

quantity supplied of a product to the
percentage change in its price.
PRICE ELASTICITY OF SUPPLY
• Es > 1
Elastic • perfectly elastic when Es = infinity

Unit elastic • Es = 1
when

• Es < 1
Inelastic when • perfectly inelastic when Es = 0
PRICE ELASTICITY OF SUPPLY
 PRICE ELASTICITY AND THE
IMPACT OF TAXATION
• Taxes imposed on price inelastic goods
are an important source of revenue for
governments
– Examples: petrol, tobacco products and
alcohol.
• The study of the incidence of tax shows
us who bears the burden.
THE INCIDENCE OF A TAX ON
PETROL
 TAXES AND MARKETS

• Excise taxes raise revenue for

government and they can be put to good
use.
• They also distort markets and lead to an
inefficient outcome.
• Prevents the attainment of the free
market equilibrium.