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Chapter 3.

DEMAND, SUPPLY, AND MARKET EQUILIBRIUM
Economics 11- UPLB
Prepared by T.B.Paris, Jr. 11/25/07

Significance

The tools of demand and supply can be applied to a range of important topics such as:

evaluating how global weather conditions will affect agricultural production and market prices of agricultural commodities; assessing the impact of government rent control on dormitory space; understanding how taxes, subsidies, and other government policies affect both consumers and producers.

The Concept of DEMAND

Demand - refers to the various quantities of a good or service that consumers are willing to purchase at alternative prices, ceteris paribus.

Conveys both the elements of desire for the commodity and capacity to pay (must be willing and able). Emphasizes the relationship between quantity bought and its price, although there may be other factors that determine how much a consumer wants to purchase.

The Law of Demand
 Asserts that the quantity demanded of a

good or service is negatively or inversely related to its own price.

When the price increases, less of the good or service will be bought When the price decreases, more of the commodity will be purchased.

WHY SO?

When price decreases. the consumer’s real income (or purchasing power) increases. the consumer substitutes the lower priced good for the more expensive ones. so he tends to buy more.  Income effect  P Q .Two Reasons for the Inverse Relationship  Substitution effect  When price of a good decreases.

Two Reasons for the Inverse Relationship 1. Substitution effect  When price of a good increases. When price increases. 1. Income effect  P Q . so he tends to buy less. the consumer’s purchasing power (or real income) decreases. the consumer tends to substitute it with the lower priced goods.

3 Ways of presenting the demand relationship The relationship between quantity purchased and alternative prices may be presented in 3 ways:  Demand schedule –in tabular form.  Demand curve – in graphical form  Demand function – in equation form .

of pairs) 8 7 6 5 4 3 2 1 0 .1.Demand Schedule TABLE 3. Demand Schedule for Denim Pants Price of Denim Pants (in pesos) 0 50 100 150 200 250 300 350 400 Quantity Demanded per month (No.

Demand Curve. .1. The negative slope of the demand curve depicts the inverse relationship between price and quantity demanded.Demand Curve P 400 Price (in pesos) 300 200 100 D 2 4 6 8 0 Q Quantity Figure 3.

Demand Function  Quantity demanded (Q) is expressed as a mathematical function of price (P). The demand function may thus be written as: Qd = a .0.bP where   a is the horizontal intercept of the equation or the quantity demanded when price is zero (-b) is the slope of the function.  Example: Qd = 8 .02P .

3. 2. 6.Factors Affecting Demand 1. 4. 5. Price of the commodity Prices of related commodities (substitutes and complements) Consumer incomes Tastes and preferences Number of consumers Price expectations .

 Change in demand – is a shift in the entire demand curve (either to the left or to the right) as a result of changes in other factors affecting demand.e.. due solely to a change in price.Change in Quantity Demanded vs. Change in Demand  Change in quantity demanded – is a movement along the same demand curve. all other factors held constant. . i.

Change in quantity demanded Price •A decrease in price from p1 to p2 brings about an increase in quantity demanded from q1 to q2 •It is shown as a movement along the same demand curve p1 p2 D q1 q2 Quantity .

etc.Change in demand Price •An increase in demand means that at the same price such as p1 more will be brought. •It is shown as a shift in the entire demand curve This is a decrease in demand D2 q1 q2 D0 Quantity p1 D1 . due to other factors such as increased incomes. increase in number of consumers.

Change in Demand P P D’ D D’ D Q Increase in Demand Decrease in Demand Q .

Other factors affecting demand  Income:  as income changes. demand a commodity usually changes Normal goods – are goods whose demand respond positively to changes in income. As income increases. “tuyo”. are bought. etc. TVs. bicycles.  Inferior goods – are goods whose demand respond negatively to change in income • Few but existent. Examples are firewood. clothes. • Most goods are normal goods. . “adidas or chicken feet”. more of shoes.

Py Qx  (direct relationship)  Complements – are goods that are used or consumed together. • Examples are coffee and tea. --. • When the price of a complement increases. quantity bought of a good increases.Other factors affecting demand  Prices of related commodities in consumption:  Substitutes – are goods that are substitutable with each other (not necessarily perfect). tennis rackets and tennis balls. • Examples are coffee and sugar. bread and butter. beer and ginebra. Coke and Pepsi. • When the price of a substitute increases.Py Qx (inverse relationship) . --. quantity bought of a good decreases.

its demand will decrease. at every possible price.  If consumer preferences change away from a good.Other factors affecting demand  Consumer tastes and preferences:  When consumer tastes shift towards a particular good. . • Example: consumers preference for drinking mineral water increases so its demand curve will shift rightward. • Example: the demand for VCDs and VHS tapes decreases due to preference for DVDs. greater amounts of a good are demanded at each price. less of the good is demanded than before.

Other factors affecting demand  Consumer expectations: Expectations about future prices and income affect our current demand for many goods and services. Thus.   If we expect prices of dried fish to increase with coming of the rainy season. current demand for dried fish might increase those who expect to lose their jobs due to bad economic conditions. . will reduce their demand for a variety of goods in the current period. we might stock up on the good to avoid the expected price increase.

 Total demand is also known as market demand.  On the other hand. less consumers will cause the market demand to decrease. It is the summation of the individual demand of all consumers  An increase in the number of consumers shifts the market demand curve to the right  Example: demand for housing and transportation increases with an increase in population.Other factors affecting demand  Number of Consumers: affects the total demand for a good. . resulting in a shift to the left of the entire demand curve.

 Obviously. ceteris paribus.refers to the various quantities of a good or service that producers are willing to sell at alternative prices. firms are motivated to produce and sell more at higher prices.  . there are other factors that determine how much a producer would like to produce and sell. However.The Concept of SUPPLY  Supply . Emphasizes the relationship between quantity sold of a commodity and its price.

less of the commodity will be purchased.The Law of Supply  States that the quantity sold of a good or service is positively or directly related to its own price. more of the good or service will be sold When the price decreases. .   When the price increases.

3 Ways of presenting the supply relationship The relationship between quantity supplied and alternative prices may be presented in 3 ways:  Supply schedule –in tabular form.  Supply curve – in graphical form  Supply function – in equation form .

of pairs) 0 1 2 3 4 5 6 7 8 . Supply Schedule for Denim Pants Price of Denim Pants (in pesos) 0 50 100 150 200 250 300 350 400 Quantity Supplied per month (No.2.Supply Schedule TABLE 3.

Supply Curve. The positive slope of the supply curve depicts the direct relationship between price and quantity supplied.2.Supply Curve P 400 S Price (in pesos) 300 200 100 0 2 4 6 8 Q Quantity Figure 3. .

02P .Supply Function  Quantity supplied (Qs) is expressed as a mathematical function of price (P). The supply function may thus be written as: Qs = c + dP where   c is the horizontal intercept of the equation or the quantity demanded when price is zero d is the slope of the function.  Example: Qs = 0 + 0.

Change in Quantity Supplied vs. i. Change in Supply  Change in quantity supplied – is a movement along the same supply curve.  Change in supply – is a shift in the entire supply curve (either to the left or to the right) as a result of changes in other factors affecting supply. due solely to a change in price.e. all other factors held constant. ..

Change in quantity supplied Price S •An increase in price from p1 to p2 results in an increase in quantity supplied from q1 to q2 •It is shown as a movement along the same supply curve p2 p1 q1 q2 Quantity .

due to other factors such as improvement in technology. increase in number of producers. etc. •It is shown as a shift in the entire supply curve p1 This is a decrease in supply q1 q2 Quantity .Change in supply S2 Price S0 S1 •An increase in supply means that at the same price such as p1 more will be sold.

Change in Supply P S S’ P S’ S D’ D Q Increase in Supply Decrease in Supply Q .

5.Other factors affecting supply  There are other factors aside from price that affect the supply schedule. 3. . These are 1. 4. 2. resource prices prices of related goods in production technology expectations number of sellers.

Decreases in resource prices. however. The entire supply curve shifts to the right. translate to an increase in supply. . the supply of the firm's product decreases.Other factors affecting supply  Resource prices:   When prices of inputs to production increase.

• . the supply of ornamental flowers may increase. If vegetable prices decrease.Other factors affecting supply   Prices of related goods in production:  Resources can be employed to produce several alternative goods and services. Examples from agriculture: • a piece of farmland can be use to grow rice. corn. An increase in price of sugarcane may result in decreased supply of rice and corn. or sugarcane. farmers can use their land and labor to produce ornamental flowers instead of vegetables.

New high yielding crop varieties will increase production on the same amount of land. .Other factors affecting supply  Technology: A change in production   techniques can lower or raise production costs and affect supply. Improvements in technology shift the supply curve to the right.  A cost-saving invention will enable firms to produce and sell more goods than before at any given price.

Other factors affecting supply   Producer expectations: When producers expect the price of their product to increase in the future. they may hoard their output for later sale.  . supply may increase in the current period as firms try to increase production as well as to dispose of their inventory. If firms expect that the price of their product will fall in the near future. thus reducing supply in the present period. Thus the supply curve shifts to the left.

  The market supply is the horizontal summation of the supply schedules of individual producers. so will total supply. the supply curve shifts to the left when firms exit the market.Other factors affecting supply   Number of sellers: As the number of sellers increases. more will offered for sale at each possible price. . As more firms enter the market. thus shifting the supply curve to the right. Similarly.

  The price that clears the market is called the equilibrium price and the quantity (sold and bought) is called the equilibrium quantity. .Market Equilibrium  Market equilibrium is that state in which the quantity that firms want to supply equals the quantity that consumers want to buy. The market is said to be "at rest" since the equilibrium price and equilibrium quantity will stay at those levels until either demand or supply changes.

of pairs) 0 1 2 3 4 5 6 7 8 0 Equilibrium Price=200 50 100 150 200 250 300 350 400 Equilibrium Quantity=4 .3.Market Equilibrium TABLE 3. Market for Denim Pants Price of Denim Pants (in pesos) Quantity Demanded per month (No. of pairs) 8 7 6 5 4 3 2 1 0 Quantity Supplied per month (No.

Market Equilbrium  At prices above the equilibrium price. producers will try to reduce price to entice consumers to buy more denim pants. quantity supplied is greater than quantity demanded. .  In a surplus situation. Actions by both producers and the public will wipe out the temporary surplus  At prices below the equilibrium price. thus pushing up the price.  Consumers will try to outbid each other. consumers desire to buy more denim pants than are available. As price rises. firms increase their production while some consumers reduce their purchases. creating a temporary shortage. resulting in a temporary surplus.

Market Equilibrium P 400 S Surplus Price (in pesos) 300 200 100 Shortage 2 4 6 8 0 Q Quantity .

04P = 8 P* = 8/0.02 P 0.02(200) = 8 – 4 = 4  P* =200 per unit.0.04 = 200 Qd = 8 – 0.02P = 0 + 0.02 P  Step by step solution: • • • • 8 .Market Equilibrium  Algebraic solution: equate the demand and supply equations (Qd=Qs).0.02P Qs = 0 + 0. Qd = 8 . Q* = 4 per month .

End – Part 1 .