Microeconomic Theory and Practice

San Beda University

AY 21-22
Lecture 3: The Basic Analysis of Supply and Demand
• Production Possibilities Curve/ PPF
• The Market
• The Law of Demand
• Demand Schedule and Demand
Curve
• The Demand Function
• Change in Quantity Demanded vs.
Change in Demand
• Forces that cause the demand
curve to change
• The Law of Supply
• Supply Schedule and Supply Curve
• The Supply Function
 Change in Quantity Supplied vs.
Change in Supply
 Forces that cause the supply curve
to change
 Optimization in the use of factors
of production
 Market Equilibrium and
Disequilibrium
 Floor Price and Price Ceiling
 Changes in Demand, Supply, and
Equilibrium
 Price Controls: Floor Price and
Price Ceiling
 Market Equilibrium: A
Mathematical Approach
Question:

• Imagine you are in charge of an entire economy.

• What should you consider when deciding how much of each type of
good and service to produce (e.g. how many cloth and how much
rubber?)
• Would you really consider the production capacity of your economy?
You should!
• Households, firms and governments continually face decisions about
how best to use their scarce resources.

• Scarcity requires trade-offs. Economics teaches us tools to help make

good trade-offs.

• A production possibilities frontier (PPF) is a curve showing the

maximum attainable combinations of two products that may be
purchases with available resources and current technology.
What is production possibilities frontier?

PPF shows the maximum combinations of two

commodities that the economy can produce at full
employment of its available resources.
 PPF shows the consequence of scarcity to the economy.
 It is impossible to produce more of two commodities at a time,
given the
the scarcity of resources.
 Points along the PPF curve are the efficient and the attainable
combinations.
 A point below the PPF curve is attainable but inefficient
combination.
 A point above (outside) the PPF curve are unattainable
combinations.
What are the simplifying assumptions about the
economy in examining the PPF?

• Simplifying assumptions in examining PPF.

 all available resources are used fully.
 all available resources are used efficiently.
 the quantity and quality of available resources are not
changing during our period of analysis.
 technology is not changing during our period of analysis.
 we can produce only two goods with our available
resources and technology.
Table 1.1 Production Possiblities Table
alternatives Bread (tons) Roses (tons)

A 150 0

B 120 20

C 90 40

D 60 60

E 30 80

F 0 100
Table 1.1
Productio
n
Possiblitie
s Table
altern Bread Roses
atives (tons) (tons)

A 150 0

B 120 20

C 90 40

D 60 60
Inefficient points – are points within or below the production possibili
E 30 80
Efficient points – are points along the production possibility line
F 0 100
Economic growth
How can economic growth be attained?

• The application of technology – helps the economy to

attain economic growth.
 Technology can move the economy produce commodities outside
its PPF (efficiency).
 A rightward shift of the PPF indicates economic growth.
 Technology makes the economy to produce more by using few
resources.
 Technology refers to the modern technique in producing goods
and services.
Which graph best represents an increase in
the economy’s resources?

A B
Answer:

It’s graph A given there is evidence of

economic growth since more
economic resources become
available, hence the shift in the PPF
to the right.
Watch the following to learn about more on
scarcity, opportunity cost and the PPC for
supplemental learning.

•https://www.youtube.com/watch?v=kmjzgB_tUJ8
Lecture 3: The Basic Analysis of Supply and Demand

Market

• Where buyers and sellers meet.

• The place where buyers and sellers trade or exchange goods or
services— it is where their transaction takes place
Prices of Basic Commodities

What is a commodity?
• It is a term in used economics that pertains to a good that commands a price.
Examples would be grains such as rice, corn and wheat; utilities such as
electricity; and other products that are normally produced in bulk such as oil,
sugar, etc.
• A commodity is characterized by its uniformity across the
market. Regardless of the producer of the good, the
output will have more or less the same attributes.
• For example, you cannot distinguish rice grains that were harvested by a
farmer in Davao, from rice grains that were harvested by a farmer in Leyte.

• Additionally, commodities are often used as raw materials

or inputs to produce another good.
• For example, wheat is used to make bread and beer, while crude oil is
refined to produce petroleum, which in turn is processed further to
create ink, fuel, paint, plastic, among other things.
 What is Demand?

• Pertains to the quantity of a good or service that people are ready and
willing to buy at given prices within a given time period, when other
factors besides price are held constant.

Demand therefore implies three things:

• desire to possess a thing;
• the ability to pay for it or means of purchasing it; and
• willingness in utilizing it.
Price of a commodity
• Given the characteristics of a commodity, its price is
dictated by the quantity available in the market, taken as a
whole. For example, assume that the supply of rice in the
country largely comes from Central Luzon. If a typhoon hits
and damages the rice crops in that region, expect the
domestic supply of rice to fall. This in turn cause the price
of rice to surge.
Demand
•Economics is about efficient allocation of available (and limited) resources.
With limited resources, firms can run out of capital; individuals can have
their income depleted. This this characteristic is technically known as
Resource Constraint.

•Resource constraints compel firms, governments, and household

consumers to find the best trade off with the least opportunity cost. For
example, firms have to decide on how much of a certain product to
manufacture and how much resources such as labor to utilize.

•Considering the individual or micro level, under the same assumption that
resources are limited, consumers must choose how much of a good they
will buy. Consumer utility refers to a person’s willingness and ability to
consume a good in reaction to price changes.

•Consumer utility forms the basis of the law of

demand.
 Demand and supply FUNCTIONs
The Demand Function

A demand function shows the relationship between the demand for

a good, say X, and the various factors which cause a change in it.

The demand function may be expressed as follows:

Dx = f ( Px, Py, M, T, Pe, M, etc.)
where:
Dx = quantity of commodity x demanded per unit of time
Px = price of commodity x
M = income of the consumer
Py = price of related goods
Pe = price expectation T = taste and preferences
Demand and supply FUNCTIONs

Commonly Stated Demand Function

The quantity demanded for X is the function of its price.

Note: This functional expression is limited only
Qdx = f ( Px) to the relationship between quantity and own price
where: of the commodity . That is, the quantity demanded is a function of price.

Qdx = quantity of commodity x demanded per unit of time

Px = price of commodity x
 Demand and supply FUNCTIONs
The Supply Function

A supply function shows the relationship between the supply for a

good, say X, and the various factors which cause a change in it.

The supply function may be expressed as follows:

Sx = f ( Px, Py, Cp, W, T, etc.)
where:
Sx = quantity of commodity x supplied per unit of time
Px = price of commodity x W = weather condition
Py = price of related goods T = technology
Cp = production cost
Demand and supply FUNCTIONs

Commonly Stated Supply Function

The quantity supplied for X is the function of its price.

Qsx = f ( Px) Note: This functional expression is limited only
to the relationship between the quantity supplied and own price
where: of the commodity . That is, the quantity supplied is a function of price.

Qsx = quantity of commodity x supplied per unit of time

Px = price of commodity x
 Demand and supply FUNCTIONs

Linear Demand Equation Linear Supply Equation

Qdx = a - bP Qsx = -a + bP
where:
Qdx = quantity of commodity x demanded per unit of time
Px = price of commodity x
Qsx = quantity of commodity x supplied per unit of time
Px = price of commodity x

Note: The slope (b) is either + or – in sign.

if b is +, the relationship between the two variables is direct or same direction
if b is -, the relationship between the two variables is inverse or opposite direction.
The Law of Demand

If price goes UP, the quantity demanded will go DOWN.

Conversely, if price goes DOWN, the quantity demanded will
go UP ceteris paribus.
Lecture 3: The Basic Analysis of Supply and Demand
• A demand schedule is a table that shows the
relationship between prices and the specific quantities
demanded at each of these prices
Lecture 3: The Basic Analysis of Supply and Demand
The demand curve is a graphical representation showing the
relationship between price and quantities demanded per time period
Lecture 3: The Basic Analysis of Supply and Demand

Change in Quantity Demanded

 Lecture 3: The Basic Analysis of Supply and Demand

Change in Demand
The Linear Demand equation

Qd = a - bP --- Qd is the dependent variable in this eq.

Ex. Qd = 1500 -50P
- 1500 is the autonomous demand and 50 is
the change in quantity (Q) resulting from a
price change
•a, b are constants
• b= slope (but actually the independent inverse of slope
(run over rise) , measures the change in demand
due to a change in price.
• a = x-intercept , or the quantity demanded when
P=0.
Deriving the linear
demand equation: Qd = a - bP
Using generic equation: To get the price coefficient of
demand, or the b variable:
Qd = a + bP
‘b = ∆Q/ ∆P
P Qd = Q2-Q1 / P2-P1
1 P1 110 Qd1 = 80-110 / 2-1
2 P2 80 Qd2 = -30
3 50 Qd = a+ (-30) P
4 20 Solving for ‘a’, simply choose a Qd
5 0 value from the demand schedule,
plug and solve
50 = a + (-30) (3)
- a = -90 – 50
Qd = 140 -30P a = -(-140)
: Qd = a - bP a= 140
• Qd = 1500 -50P
• Find the Qd with the following prices:
Ans:
Sub the values of P in the Qd equation:
Qd = 1500 -50 (5) = 1250

P Qd
5 1,250
10
15
20
25
Forces that cause the demand curve to change:

•Taste or preferences
•Changing incomes
•Occasional or seasonal products
•Population change
•Substitute goods
•Normal and Inferior goods
•Expectations of future prices
Lecture 3: The Basic Analysis of Supply and Demand

What is Supply?
The quantity of goods or services that firms are
ready and willing to sell at a given price within a
period of time, other factors being held constant.
• It is the quantity of goods or services which a firm is willing
to sell at a given price, at given point in time.
• Thus, supply is a product made available for sale by firms.
• It should be remembered that sellers normally sell more at
a higher price than at a lower price.
Lecture 3: The Basic Analysis of Supply and Demand

The Law of Supply

If the price of a good or service goes UP, the

quantity supplied for such good or service will also
go UP; if the price goes DOWN the quantity
supplied also goes DOWN, ceteris paribus.
Lecture 3: The Basic Analysis of Supply and Demand
• A supply schedule is a schedule listing the various prices of a
product and the specific quantities supplied at each of these
prices
Lecture 3: The Basic Analysis of Supply and Demand
The supply curve is a graphical representation showing the relationship
between the price of the product or factor of production (e.g. labor) and
the quantity supplied per time period
The linear supply equation

• Qs = c + dP - - - generic supply equation

• Derived linear supply equation: Qs= -c + dP
• Qs= -100+20P
--- c represents quantity intercept of the supply (will
always be negative since NO producers will provide a
good if the price is zero.
--- d is the price coefficient of supply. (how responsive
producers are with price)

• Create a Qs schedule showing the supply of oranges in

your town at prices of P10, P20, P30, P40, and P50,
using Qs= -100+20P
Deriving the linear supply equation: Qs = -c +
dP
Using generic equation:
Qs = c + dP
P Qs
1 0
2 20
To get the price coefficient of
supply, or the d variable:
‘d = ∆Q/ ∆P
= Q2-Q1 / P2-P1
= 110 -80 / 5-4
= 30 (for every 1peso increase in price,
producers are willing to supply 30kg more)

3 50
4 P1 80 Q1 Qs = c + 30P
5 P2 110 Q2 Solving for c, simply choose a Qs
value from the supply schedule,
plug and solve
50 = c + 30 (3)
Qs = - 40 + 30P - c = 90 – 50
c = - 40
Change in Quantity Supply and Change in Supply
• Change in Quantity Supplied
Lecture 3: The Basic Analysis of Supply and Demand

Change in Supply
Lecture 3: The Basic Analysis of Supply and Demand

Forces that cause the supply curve to change:

•Technological change - A firm may experience a positive

or negative change in its ability to produce a given level of
output with a given quantity of inputs.
• Number of sellers – Firms can produce and sell more than
one product
- A farmer can plant corn or rice. If the price of rice increases,
it becomes beneficial to plant more rice leading him to plant
less corn

• Weather conditions
• Government policy
• Future expectations
Analytical exercise:

• Assume that the airline market is a perfectly competitive market.

Assume the Philippine domestic market is currently at equilibrium
with a total of 642 million ticketed passengers per year at a price of
P10,000 per ticket.

• Show the effect on demand or supply in the airlines market, if a

study claims that increased exposure to radiation from flying has
large negative health effects. Show the direction of the effect by
drawing an arrow.
 Lecture 3: The Basic Analysis of Supply and Demand
Market Equilibrium
Equilibrium
•Equilibrium generally pertains to a balance that exists when quantity
demanded equals quantity supplied.
•Equilibrium is the general agreement of the buyer and the seller at a
particular price and at a particular quantity. At equilibrium point,
there are always two sides of the story, the side of buyer and that of
the seller.

Equilibrium Market Price

•Equilibrium market price is the price agreed by the seller to offer its
good or service for sale and for the buyer to pay for it. Specifically, it is
the price at which quantity demanded of a good is exactly equal to
the quantity supplied.
Lecture 3: The Basic Analysis of Supply and Demand
• The meeting of supply and demand results to what is
referred to as ‘market equilibrium’
Lecture 3: The Basic Analysis of Supply and Demand
Lecture 3: The Basic Analysis of Supply and Demand
Lecture 3: The Basic Analysis of Supply and Demand
What happens when there is market disequilibrium?

The following may occur:

Surplus
It’s a condition in the market where the quantity supplied is more the quantity
demanded. (Qs > Qd)

Shortage
Its a condition in the market in which demand is higher than supply. (Qs < Qd)

.
CONTROLS ON PRICES

• Are usually enacted when policymakers believe the

market price is unfair to buyers or sellers.
• The government will attempt to provide equity and
security for people. So instead of the market
deciding the price, the government issues a price.
• Result in government-created price ceilings and
floors.
Price Floor
It is the legal minimum price imposed by the
government.

Price Ceiling
It is the legal maximum price imposed by the
government
Lecture 3: The Basic Analysis of Supply and Demand
Lecture 3: The Basic Analysis of Supply and Demand
The Partial Equilibrium Analysis
 The Equation System:
 
Demand equation: QD = a – bP
Supply equation: QS = -c + dP
Equilibrium condition: QD = QS ; hence, a-bP = -c+dP
3 equations and Unknowns (Q D, QS, P)
Exogenous variable: Y
Parameters/coefficients: a, b, c, d

Example:
Look for the PE and QE?
Qd = 68 – 6P ; QS = - 33 + 10P

Process: Simply equate the Qd equation to Qs equation and

solve algebraically to find equilibrium Price (Pe ). Once the Pe
value is determined, plug it to Qd and Qs equations to get
equilibrium quantity (Qe) (can be a surplus or a shortage if in
disequilibrium)
Qd=100-4P Qs= -10 +6P
Lecture 3: The Basic Analysis of Supply and Demand

Discussion Questions. Please prepare your answer in Word

Format as a Seatwork material

1. Describe the difference between demand and supply.

2. In what ways do the forces of demand and supply affect its curve?
3. How does the law of demand and supply affect the market?
4. How does equilibrium occur in the market?
5. What are the price controls of the government?
End
Sources:
G. Mankiw Principles of Microeconomics;
Avila-Bato et al, Microeconomics Simplified; University of Washington presentations

Lesson 4: Please read ahead

- More on price ceilings and price floors
- Price Elasticity and Income elasticity