DEBRE BERHAN UNIVERSITY

ECONOMICS( Econ-1011)
For Mechanical Engineering
students
 Chapter Two

Theory of Demand
and Supply
 Demand
 It states that the consumer must be willing
and able to purchase the commodity, which
he/she desires, given
 A particular price that must be paid for the good
 backed by his/her purchasing power
 All other constraints on the household

 It refers to various quantities of goods or service that a

consumer would purchase at a given time in a market at
various prices, given other things unchanged (ceteris
paribus). The quantity demanded of a particular commodity
depends on the price of that commodity.
 The Law of Demand
 States that when the price of a good rises(falls) and
everything else remains the same, the quantity of
the good demanded will fall(rises).
 The Demand Schedule, Curve and
the function
 Demand schedule (table)
 A list (price- quantity combination) showing the quantity of
a good that consumers would choose to purchase at
different prices, with all other variables held constant.
Showing the r/s b/n P & Qd in table form. Ex..

Combinations A B C D E

Price per kg 5 4 3 2 1

Quantity 5 7 9 11 13
demand/week
Demand curve
 It is a graphical representation of the
relationship between different quantities of a
commodity demanded by an individual at
different prices per time period, citrus paribus.

 Demand function: is a mathematical

relationship between price and quantity
demanded, all other things remaining the
same.
 Qd=f(P)
 Figure 1: The Demand Curve
Price per
Bottle

When the price is $4.00

per bottle, 40,000 bottles
are demanded (point A).

A
$4.00
At $2.00 per bottle,
60,000 bottles are
B demanded (point B).
2.00

40,000 60,000 Number of Bottles

per Month
 Market demand
The market demand schedule, curve or function is derived by horizontally adding
the quantity demanded for the product by all buyers at each price. Example…

Price Individual demand Market

Consumer-1 Consumer-2 Consumer-3
demand

8 0 0 0 0
5 3 5 1 9
3 5 7 2 14
0 7 9 4 20

We can show graphically, to predict the market demand curve at

price equal to 3, as follows:
Cont..
 Numerical examples:
Suppose the individual demand function of a product is given by:
P=10 - Q /2 and there are about 100 identical buyers in the market.
Find the market demand function? (ans: Q = 2000-200P)
 Determinants of demand
The demand for a product is influenced by many factors. Some of
these factors are:
•Price of the product
•Taste or preference of consumers
•Income of the consumers (normal vs inferior goods)
•Price of related goods (Substitute vs Complimentary goods)

•Consumers expectation of income and price

•Number of buyers in the market

Shift of Demand Versus Movement
Along a Demand Curve

• A change in demand is
not the same as a change
in quantity demanded.
• In this example, a higher
price causes lower
quantity demanded.
• Changes in determinants
of demand, other than
price, cause a change in
demand, or a shift of the
entire demand curve, from
DA to DB.
A Change in Demand Versus a Change in
Quantity Demanded

• When demand shifts to

the right, demand
increases. This causes
quantity demanded to be
greater than it was prior to
the shift, for each and
every price level.
A Change in Demand Versus a Change in
Quantity Demanded
To summarize:

Change in price of a good or service

leads to

Change in quantity demanded

(Movement along the curve).

Change in income, preferences, or

prices of other goods or services
leads to

Change in demand
(Shift of curve).
 Example..
Price
Entire demand curve shifts
rightward when:
• income or wealth ↑
• price of substitute ↑
• price of complement ↓
• population ↑
• expected price ↑
• tastes shift toward good

D2
D1

Quantity
 Theory of Supply
 It indicates various quantities of a product that
sellers (producers) are willing and able to provide
at different prices in a given period of time, other
things remaining unchanged, given

 A particular price for the good

 All other constraints on the firm
 Ability and willingness matters
 The Law of Supply

 States that when the price of a good rises and everything

else remains the same, the quantity of the good supplied
will rise, other things remain constant.
Supply in Output Markets
CLARENCE BROWN'S • A supply schedule is a table showing
SUPPLY SCHEDULE how much of a product firms will
FOR SOYBEANS
supply at different prices.
QUANTITY
SUPPLIED
PRICE (THOUSANDS
(PER OF BUSHELS • Quantity supplied represents the
BUSHEL) PER YEAR)
$ 2 0 number of units of a product that a
1.75 10
2.25 20
firm would be willing and able to
3.00 30 offer for sale at a particular price
4.00 45
5.00 45
during a given time period.
The Supply Curve
• A supply curve is a graph illustrating how much
of a product a firm will supply at different prices.
CLARENCE BROWN'S 6

Price of soybeans per bushel ($)

SUPPLY SCHEDULE
FOR SOYBEANS 5
QUANTITY
SUPPLIED
4
PRICE (THOUSANDS
(PER OF BUSHELS
3
BUSHEL) PER YEAR) 2
$ 2 0
1.75 10 1
2.25 20
3.00 30 0
4.00 45
5.00 45 0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
 The Law of Supply
6  The law of supply
Price of soybeans per bushel ($)

5 states that there is a

4 positive relationship
3
between price and
2
1
quantity of a good
0
supplied.
0 10 20 30 40 50  This means that
Thousands of bushels of soybeans
produced per year supply curves
typically have a
positive slope.
 The Supply function

 It shows the following functional relationship: QS = f(P), where S

is quantity supplied and P is price of the commodity.
 Market supply: It is derived by horizontally adding the quantity
supplied of the product by all sellers at each price. Example…
Price per Quantity Quantity supplied Quantity Market supply
unit supplied by by seller 2 supplied by per week
seller 1 seller 3
5 11 15 8 34
4 10.5 13 7 30.5
3 8 11.5 5.5 25
2 6 8.5 4 18.5
1 4 6 2 12
 Determinants of supply

The supply of a particular product is determined by:

price of inputs (cost of inputs)
Technology
prices of related goods
sellers‘ expectation of price of the product
taxes & subsidies
number of sellers in the market
weather, etc.
 Factors That Shift the Supply Curve
 Input prices
 A fall (rise) in the price of an input causes an
increase (decrease) in supply, shifting the supply
curve to the right (left)
 Price of Related Goods
 When the price of an alternate good rises (falls), the
supply curve for the good in question shifts leftward
(rightward)
 Technology
 Cost-saving technological advances increase the
supply of a good, shifting the supply curve to the
right
Factors That Shift the Supply Curve

 Number of Firms
 An increase (decrease) in the number of
sellers—with no other changes—shifts
the supply curve to the right (left)
 Expected Price
 An expectation of a future price increase
(decrease) shifts the current supply
curve to the left (right)
 Factors That Shift the Supply Curve
 Changes in weather
 Favorable weather
 Increases crop yields
 Causes a rightward shift of the supply curve for that crop
 Unfavorable weather
 Destroys crops
 Shrinks yields
 Shifts the supply curve leftward
 Other unfavorable natural events may effect all
firms in an area
 Causing a leftward shift in the supply curve
 A Change in Supply Versus
a Change in Quantity Supplied

Change in price of a good or service

leads to

Change in quantity supplied

(Movement along the curve).

Change in costs, input prices, technology, or prices of

related goods and services
leads to

Change in supply
(Shift of curve).
 Market Equilibrium

 The operation of the market depends on the

interaction between buyers and sellers.

 An equilibrium is the condition that exists

when quantity supplied and quantity demanded
are equal.

 At equilibrium, there is no tendency for the

market price to change.
Market Equilibrium
 Only in equilibrium
is quantity supplied
equal to quantity
demanded.

• At any price level

other than P0, the
wishes of buyers and
sellers do not coincide.
 Effect of shift in Demand and Supply
on equilibrium

 Higher demand leads to  Higher supply leads

higher equilibrium price to lower equilibrium
and higher equilibrium price and higher
quantity. equilibrium quantity.
Decreases in Demand and Supply

 Lower demand leads to  Lower supply leads to

lower price and lower higher price and lower
quantity exchanged, ss*. quantity exchanged, dd*.
Effect of combined Change in demand and supply

• The relative magnitudes of change in supply and demand

determine the outcome of market equilibrium.
Cont.

• When supply and demand both increase, quantity will

increase, but price may go up or down.
Numerical examples
 Given market demand: Answer:
Qd= 100-2P, and market
P* = 30, and Q* = 40
supply: P =(0.5Q) + 10
 Calculate the market There is shortage at
equilibrium P & Q p=25, and surplus at p=35
 Determine, whether there
is surplus or shortage at
P= 25 and P= 35.
 Elasticity of demand

 Elasticity of demand refers to the degree of

responsiveness of quantity demanded of a good to a
change in its price, or change in income, or change in
prices of related goods.
 The greater the reaction the greater will be the elasticity, and the lesser the
reaction, the smaller will be the elasticity.

 Commonly, there are three kinds of demand

elasticity: price elasticity, income elasticity, and
cross elasticity.
Price elasticity of demand
 When there is a big gap in p & Q, we
can use Arc formula as:

Suppose that the price of a commodity is Br. 5 and the quantity demanded at
that price is 100 units of a commodity. Now assume that the price of the
commodity falls to Br. 4 and the quantity demanded rises to 110 units. Find the
Ep ?

Answer: (-0.42 = ed <1, inelastic)

Note that:
• Elasticity of demand is unit free

• Elasticity of demand is usually a negative number because of the law

of demand, with some exceptions.
 Determinants of PED
 The availability of substitutes

 Time

 The proportion of income consumers spend for a product

 The importance of the commodity in the consumers’ budget

Income Elasticity of Demand
 Cross price Elasticity of Demand
 Measures how much the demand for a product is
affected by a change in price of another good.
 Numerical example:
• The cross – price elasticity of demand for substitute goods is positive.
• The cross – price elasticity of demand for complementary goods is negative.
• The cross – price elasticity of demand for unrelated goods is zero.

Unit price of Y Quantity demanded of X

10 1500
15 1000

Given the above table, Calculate the cross –price elasticity of demand
between the two goods. What can you say about the two goods?
 Elasticity of supply

• It is the degree of responsiveness of the supply to change in

price.
• It may be defined as the percentage change in quantity supplied
divided by the percentage change in price, citrus paribus.

 We can use a simple and most commonly used method of point

method to compute the Es:
 The end …..

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