Demand and Supply

Dr. Aruna Kumar Dash

Associate Professor,
IBS, HYDERABAD
 Demand

Why do roses cost more on Valentine’s day than during the rest of the
year?

Why do TV ads cost more during the cricket world cup(a ten second
spot for TV advertising was worth 4 lakhs in Indian rupee in 2009)

Why do hotels in hills station charges more in summer than the rest of
the year?

Why do cricket pros earn more than hockey pros?

 What is Demand?
 Demand shows the relationship between the price of a good and the
quantity that consumer are willing and able to buy per period, other factors
remaining constant.

 Demand exists if following 3 things are fulfilled

 Willingness to Buy
 Willingness to Pay
 Ability to Pay

Quantity demand: the amount of the good or service that buyers are willing
to purchase at a given price is called the quantity demand.

• What is Law of Demand?

Other things Remaining same, the Quantity Demanded of a Commodity is
Inversely Related to Its Price.
QD = F (P), When P QD OR when P QD

P = F(QD) Not Coming Under Law of Demand

Eg. Wall mart sells more than any other retailers in the World
because prices are among the lowest around Walmart.
Assumptions of Law of demand
 Income of the consumer remains same/constant
 Taste and preferences of the consumer remains same
 Prices of related goods remains same
 No expectations regarding future change in prices and income
 Population is remaining constant
 Demand schedule and demand curve

 Demand can be expressed as a demand schedule or as a demand

curve.
 Demand schedule : listing the various quantities that consumers are
willing to buy at different price. If it is represented in tabular form is
called demand schedule.
 Demand curve: The graphical representation of demand schedule is
called demand curve.
 Demand Schedule

Quantity Demanded Price

100 1
80 2
60 3
40 4
20 5
The graphical representation of demand schedule is called
demand curve.

Demand Curve for

Mango
The price of mango and quantity demanded are negatively related, which means they
move in opposite direction. I other words, when one goes up, the other goes down,
and vice versa.

Why Demand increases when price falls?

Due to 2 reasons
1. Substitution effect of a price change- If mango price declines and other
prices remains constant, mango becomes relatively cheaper. Consumers are willing to
purchase more mango . When mango price falls, consumer substitute mango for other
goods. This is called substitution effect of a price change.
2. The income effect of a price change- Suppose you earn $30 per week from a
part time job. $30 is your money income. Money income is simply the number of
dollar you receive per period, in this case $30 per week. Lets assume one mango cost
is $10. If you will spend all of your income then you can able to buy 3 mangoes. What
if the mango price drops to $6. At the lower price, you can now afford 5 mangos per
week. Your money income remains same ($30 per week), but the decrease in mango
price has increased your real income. Real income is your income measured in terms
of what it will buy. The quantity of mango demand is likely to increase due to income
effects.
The Market Demand Curve is formed by computing the
horizontal summation of the individual demand
curves for all consumers.
 Change in quantity demand (movement along the
demand curve)
 Any movement along a demand curve reflects a change in quantity
demand. The change in quantity demand indicates the relationship
between the price and quantity demanded which is movement along
the demand curve, keeping other things constant. If quantity demand
increases/ decreases due to change in prices is known as movement
along the demand curve.

Change in Quantity
Demanded

A
B
 Shift in demand/ Change in demand
 Change in demand means increase/decrease in demand. If there is increase
or decrease in demand which occurs because of non price factors(other than
price) is known as shift in demand. Due to presence of non price factors the
demand curve will shift inward(leftward) or outward(right)

D1
 Income of the consumer-D is the market demand curve for ‘hot dog’ with a
given level of money income. Suppose consumer income increases. Some
consumer will then be willing and able to buy more hot dogs at each price, so
market demand increases. The demand curve shifts towards right from D to D das.
 Effect of Changes in Income:
A good is a Normal good if an increase in income results in an increase in the
demand for the good. Examples of normal goods are branded dresses, LED TV,
Car, houses, pizza etc. Most of the goods are normal goods.
A good is an Inferior Good if an increase in income results in a reduction in
the demand for the good. Example: unbranded perfumes, used furniture, used
clothing, low quality bread. As income of the consumer increases consumer
moved to more neutrois food and hence the demand for low quality product
falls.

Reduced Demand for Same

Price
 The Rise in the Number of Consumers:
Since the market demand curve consists of the horizontal summation of
the demand curves of all buyers in the market, an increase in the number
of buyers would cause demand to increase.
 Prices of related goods
 substitute goods - an increase in the price of one results in an increase in the
demand for the other. Example Coffee and Tea, pen and pencil,coke and Pepsi.
For example if coke price will increase, the demand for coke will fall and the
demand for Pepsi will increase.
 complementary goods -complementary goods are consumed together.
Example includes Tea and sugar, Car and Petrol, coke and pizza, milk and
cookies, DVD and DVD Player, computer hardware and computer software,
pen and ink, airlines tickets and rental cars, rice and curry, bread and butter.
Remember complementary products are consumed together. An increase in the
price of one results in a decrease in the demand for the other.
 Price of Coffee Rises: Substitute Good of Tea

60

50
 Price of DVDs Rises: Complementary Good of DVD Player

5$

4$
 Tastes and preferences of the consumer
 Population of a country(more/less)
 Expectations of future prices and income.
Expectations

• a higher expected future price will increase current

demand,
• a lower expected future price will reduce current
demand,
• a higher expected future income will increase
current demand (for normal goods, and
• a lower expected future income will reduce current
demand (for normal goods).
 Exceptions of Law of demand
1.prestige goods/Veblen goods/snob effect: It is known as status symbol
goods. For example, Diamond, high end cars etc. may be prestige goods
because higher prestige value of diamond, high end cars, the higher is the
desirability. Rich people may not buy diamond when price falls.
2.Speculations: if consumers except that price of the goods will rise in
future, they will buy more even though high prices. And if consumer except
that prices of the product will fall in future, they will buy less even though
prices are low.
3.Ignorance of the customer: if consumers are ignorant about the rise in
price of the goods they will buy more
4.Giffen goods: this is special type(extreme case) of inferior goods named by
Robert Giffen. It is a special type of inferior goods on which consumer
spends large proportion of income when its price rises, quantity demand also
increases and vice versa. If prices of the product increases demand
increases. This tendency is found for low income group of people.
5.Necessary goods: When prices of necessary goods such as salt, news
paper, medicine price increases, people cant consume less.
6. Psychological bias of customer: Different customer have different
perception about the price of the product. Some customer have the
perception that lower price means bad quality which may not be true always.
Therefore, even low price quantity demand may not increase.
7. Brand loyalty: if a consumer prefer to wear Levis jeans, he would
continue to purchase it irrespective of price increase.
8. Emergency Situation: during emergency situation such as flood, war,
earthquake, Covid 19 lock down period the availability of goods becomes
scarce and uncertain. Therefore consumer prefer to store large quantity of
goods regardless the price
9. Addicted items
10. Demonstration effect(Bandwagon effect): Bandwagon effect is a
psychological phenomenon in which people do something primarily because
other people are doing. It is commonly seen in the politics and consumer
behavior.
 Supply
Just as demand is a relation between price and quantity demanded, supply is
a relation between price and quantity supplied.
Supply: Shows the relationship between the price of a good and the quantity
that producers are willing and able to sell per period, other things remaining
same.
Supply: It is the Quantity of a Good Sellers Wish to Sell at Each Conceivable
Price
Quantity supplied: refers to particular amount offered for sale at particular
price.
QS = F (P)
S = Supply
P = Price
P = F (QS) Not Under the Law of Supply
The law of supply states that the quantity supplied is usually
directly related to its price, other things remaining constant. Thus,
lower the price, smaller the quantity supplied and higher the price
greater the quantity supplied.
Supply Schedule:listing the various quantities that producers/suppliers are
willing to produce at different price. If it is represented in tabular form is called
supply schedule.

Quantity Supplied Price

20 1
40 2
60 3
80 4
100 5
Supply curve: The graphical representation of supply schedule is
called supply curve.
law of Supply:
A Direct and Positive relationship exists between the price of a good
and the quantity supplied in a given time period, ceteris paribus.
Change in Supply: Movement Off Change in quantity supplied:
(Increase/decrease in supply. Movement On or Along
S1
Decrease
in supply

Increase
in supply

Shift of a supply curve: Movement of a supply curve left or right

resulting from a change in one of the determinants of supply other than
price.Note: Non price factors shifts the supply curve.
Movement along a supply curve: Change in quantity supplied
resulting from a change in the price of the good, other things remaining
the same.
Other Factors Affecting Supply/Shift of the supply curve

 the cost of production (Inputs prices)

 technology
 the producers expectations
 the number of producers in the market
 Government policy
the increase in cost of production (Inputs prices)
An increase in cost of production reduces the profitability of producing
the good or service. This reduces the quantity that suppliers are willing
to offer for sale at each price. Thus, an increase in the price of labor,
raw material, capital, or other resource, will be expected to result in a
leftward shift in supply.
Technological improvements and changes that increase the
productivity of labor result in lower production costs and higher
profitability. Supply increases in response to this increase in the
profitability of production.

Supply curve
shifted from S
to S1
An increase in the Number of Producers results in an increase
(a rightward shift) in the market supply curve.

Supply curve
shifted from S
to S1
Expectations and supply
• an increase in the expected future price
results in a reduction in current supply
Expectations

• a higher expected future price will increase current

demand,
• a lower expected future price will reduce current
demand,
• a higher expected future income will increase
current demand (for normal goods, and
• a lower expected future income will reduce current
demand (for normal goods).
Market supply

The market supply curve is the horizontal summation of all

individual supply curves. The derivation of this is equivalent to
that illustrated for demand curves.

Favorable government policy, I mean reduction of tax rate,

shifts the market supply curve towards the right.
The Market supply Curve is formed by computing the
horizontal summation of the individual supply curves
for all producers.

Price Price Price

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5 5 5 p

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Pr
Pr

20 30 50
Quantity supplied Quantity supplied Quantity supplied

Market supply curve is horizontal summation of producer A and B’s supply

curve that 20+30=50. Here 2 producers represents the entire market.
Demand and supply create a market

Demanders(buyers) and suppliers (sellers) have different views

of price. Demanders pay the price and suppliers receive it.
Thus, a higher price is bad news for consumers but good news
for producers. As the price rises, consumers reduce their
quantity demanded along the demand curve and producers
increase their quantity supplied along the supply curve. How is
this conflict between producers and consumers resolved?
 RECAP
Change in quantity demand or change in
quantity supplied is with respect to price
change(price increase /decrease) only. Here,
other factors are remaining constant.

Change in demand or change in supply is with

respect to non-price factors. Here, price is
remaining same/constant. But, due to change in
other factors, the supply or demand curve
shifts(I mean right ward our inward.
 Market Equilibrium
 Equilibrium is Important Because We Never Have
Equilibrium

 Action and Reaction Takes Place Between Participants

In Disequilibrium

 The Process to Have Equilibrium Keeps The Market

Going on

 Equilibrium: Action and Reaction Comes to a Halt,

Tranquility in the Market
 Market Equilibrium
Equilibrium is a State of Representing a Balance of the
Forces of Demand and Supply
Price Quantity Quantity Surplus/ Effects on
Demanded Supplied Shortage Price

5 20 100 Surplus of 80 Fall

4 40 80 Surplus of 40 Fall

3 60 60 Equilibrium Remains the

same
2 80 40 Shortage of 40 Rises

1 100 20 Shortage of 80 Rises

Equilibrium Demand=Supply
Equilibrium Quantity = 60
Equilibrium Price = 3

Surplus

Shortage
Suppose the initial price is Rs.4. At that price, producers supply 80million ice-
cream per week, but consumer demand on 40 million, resulting in excess
quantity supplied, or a surplus of 40 million ice cream per week. Supplier don’t
like getting stuck with unsold ice-cream. Their desire to eliminate the surplus
puts downward pressure on the price. As the price falls, producers reduce their
quantity supplied and consumers increase their quantity demanded. The price
continues to fall as long as quantity supplied is equal to quantity demanded.
Alternatively, suppose price initially at 2, at that price, the demand for ice-cream
is 80 million per week but supply of ice cream is 40 million per week, resulting
excess quantity demanded or shortage of 40 million ice-cream per week.
Producers quickly notice that they have sold out but demand is more. Profit
maximizing producers and frustrated consumers create market pressure for a
higher price. As the price rises, producers increases the quantity supplied and
consumer reduces the quantity demanded. The price continues to rise as long as
QD=QS. Note: Surplus creates downward pressure on the price and shortage
creates upward pressure. As long as QD differs from QS, the differences forces a
price change. Market reaches equilibrium when QD=QS. The demand and supply
curve intersect at equilibrium point, the equilibrium price is 3 and equilibrium
quantity is 60 million ice-cream per week. At that price and quantity, market
clears. Because there is no shortage or surplus, there is no pressure for the price
to change.
Market Equilibrium (Algebraic Example)
Lets Have D = 40 - P
and S = 6 + P
At Equilibrium, D= S
So… (40 - P*) = (6 + P*)
34 = 2P* or P* = 34/2 so... P*=17 (Equilibrium Price)
To find Equilibrium Quantity, plug P* into either the demand
or supply equation.
Equilibrium Quantity = 40 - 17 =23 (From demand Equation)
or Equilibrium Quantity = 6 + 17 = 23 (From Supply Equation)
Demand Exceeds Supply:
The System is at
Disequilibrium

Go to hell,
I do not
bother

Have a
look at
us!
Supply Exceeds Do not bother, we will definitely get even
without spending less
Demand: System
at Disequilibrium

Guys are
ridiculous:
They even do
not to give a
look here
Equilibrium: Tranquility in the System
Demand equal to Supply
Lets go together
Demand Rises (Shift of the Demand Curve Upwards):

Both Quantity and Price

Increases
Demand Falls (Shift of the Demand Curve Downwards):

Both Quantity and Price

Falls
Supply rises (Shift of Supply Curve to the Right):

Price Falls but Quantity

Increases
Supply falls (Shift of the Supply Curve to Left):

Price Increases but Quantity

Decreases
 Effects of Government intervention on Price
control
Price ceiling
A Price Ceiling is a legally mandated maximum price. The purpose of a
price ceiling is to keep the price of a good below the market equilibrium price.
Rent controls and regulated gasoline prices during wartime and the energy
crisis of the 1970s are examples of price ceilings. Effective price ceilings
result in shortages.
Po and Q0 are the equilibrium price and quantity that would prevail without
government regulations. Sometimes public officials try to keep a price below the
market clearing price by setting a price ceiling or a maximum selling price. The
government however has decided that price Po is too high and mandated that
price can not be higher than a maximum allowable ceiling price, denoted by
Pmax. At this lower price, producers (those who have higher cost) will produce less and
quantity supplied will drop to Q1. The consumer on the other hand, will demand
more at this low price, they would like to purchase the quantity Q 2. Demand
therefore exceeds supply, shortage or excess demand develop. The amount of
excess demand is Q2- Q1.
 Price
Supply Curve

$1000 Po
illegal
$600 PMax legal

Demand Curve
o
Q1 Qo Q2 Quantity in thousands
40 50 60
 some people gain and other lose from Price controls. Producers lose as they
receive lower price then before and some may leave the industry. Some not all
consumer gain. Those who can purchase the goods with lower price will be
better off and those who cann’t buy the goods at all worse off.
To have impact on price ceiling, it must be set below the equilibrium price. Eg.
Price ceiling is applied in LPG subsidy or rent control act.
The equilibrium or market clearing rent is $1000 per month and equilibrium
quantity is 50,000 houses. Suppose city officials set a maximum rent of $600
per month. At this celling price, 60,000 rental units are demanded but only
40,000 houses are supplied, resulting in a housing shortage of 20,000 units. This
may create black market.
Note: Price above $600 is illegal and price below $ 600 is legal.
 Price Floors

A Price Floor is a legally mandated Minimum Price. The purpose of a price

floor is to keep the price of a good above the market equilibrium price.
Agricultural Minimum Price Supports and Minimum Wage Laws are examples
of Price Floor. Sometimes public officials set price above the equilibrium price
level. For example, state government regulates the agricultural price in attempt
to ensure farmer to get higher and more stable income then they would
otherwise earn. To achieve higher prices, the government set a price floor, or
minimum selling price that is above the equilibrium price.
Price Supply
Surplus
PMin

P0

Demand
0 Q 3 Q0 Q 2
 The demand and supply curve intersect each other and determines equilibrium
price and quantity. Government think the equilibrium price is less and not
provide any incentive to the producer to produce. To encourage them,
government is setting minimum price the sellers/farmers will get while
producing and supplying the product. Now quantity supplied is Q2 and quantity
demanded is Q3, the difference representing unsold supply. The surplus amount
will be purchased by government to maintain buffer stock.
Price Floor(Minimum Wage Law)
The supply of labour is upward slopping. More labour will be available with higher
wage rate. The demand for labour is downward slopping. Higher the wage rate, the
company will hire less labour. The intersection between demand for labour and
supply of labour determines the wage rate. When wage rate is W 0, the demand for
labour is equal to supply of labour and employment is OL. The price floor must
above the equilibrium price in order to make it effective. Labour union is demanding
min. wage rate which is above the equilibrium wage rate. With higher wage rate,
supply of labour increases and demand for labour falls. Hence, unemployment
occurs. Wage rate
Surplus Supply of labour
WMin

W0

Demand for labour

0 L1 L L2

Labour Demanded & labour Supplied

Thank You