Managerial Economics

(GBS 514)

LECTURE TWO

Mulenga Chonzi Mulenga (PhD)

Course Lecturer
 Demand, Supply and Market Mechanism

• A market means a system in which sellers and buyers of a commodity interact

to settle the price and the quantity to be bought and sold.
• The sellers and buyers may be individuals, firms, factories, dealers and agents.
• The word ‘market’ refers to either a commodity or service (e.g., goods market,
factor market) or a geographical area (e.g., Lusaka market, London market,
Europe market).
• Basic Features:
• A market need not be situated in a particular place or locality.
• Buyers and sellers need not always come in personal contact with each other.
 Market Demand

• The theory of demand explains the relationship

between demand and various factors that affect the
demand of a product
• In economics, demand means a desire backed by
ability and willingness to pay.
• A statement on demand of a product should include
actual quantity Purchased, Price of the
commodity ,the Period of demand and the Place of
demand (the 4 Ps)
 The Law of Demand

• The law of demand can be stated in four ways:

using words, using a table , using a graph and using
an equation
• By using words: the higher the price the lower the
quantity demanded, other factors remaining constant.
• Qx = 100 - 0.25Px

• Qx = a0 - a1Px - a2Py + a3M

• Consumers’ demand for a commodity is determined by –

• Px = price of the commodity
• M = Consumers income
• Py = Price of related commodities
•
• This is expressed as Qx = f (Px, Py, M)
 Exceptions to the Law of Demand
(where the law does not apply)

• It does not apply to Veblen goods (goods used as symbols

of status). Demand increases as the price increases e.g
expensive cars, gold, Diamonds
• It does not apply to giffen goods (low income, non-luxury
good that have very few close substitutes). Demand rises
when the price rises and falls when the price falls e.g
nshima
• It does not apply to goods with perfectly inelastic demand.
• It does not apply when the price increase is expected in the
near future
 The demand schedule
(Demand schedule for tomatoes)

Period(month) Price/case Qty demanded

1 K50 50

2 K40 80

3 K30 130

4 K20 190

5 K10 300

It is a table which provides information on prices and quantities

demanded
The demand curve
 Demand curve (continued)

• The demand curve is a curve which shows various

alternative combinations of prices and the quantity
demanded
• The demand curve has a negative slope which
means price and quantity move in the opposite
direction.
The reasons behind the downward sloping demand curve or law of
demand are:

• (i) Income Effect: when the price of a commodity

falls, the real income of its consumers increases in
terms of this commodity.
• (ii) Substitution Effect: when price of a commodity
falls, it becomes cheaper compared to its
substitutes, other prices remaining constant, or, the
substitute becomes more costly.
 Factors that affect demand

• The price of a product

• Changes in the prices of substitute goods.
• Changes in the prices of complementary products.
• Changes in consumer’s income.
• Changes in consumer’s tastes and preferences.
• Population size. The bigger the population size the
bigger the demand
• Changes in weather conditions
 Change in Demand and change in
Quantity Demanded (continued)

• A change in price causes a change in quantity

demanded, only while other factors remain
constant.
• In other words, any change that arises from change
in price is a change in quantity demanded and it is
explained by movement along the same demand
curve.
• On a graph it is represented by a movement along
the demand curve as shown in the figure below.
Change in Demand and change in
Quantity Demanded
 Shifts in demand curve
• A change in other demand affecting factors than price leads to a
change in demand.
• If a change in one of the other determinants causes demand to rise –
say, income rises – the whole curve will shift to the right.
• Generally, a change in demand is explained by a shift in the entire
demand curve.
• In the graph below, D0 is the original demand curve.
• If price remains constant, but another factor leads to a decrease in
demanded, the demand curve will shift downward from D0 to D1.
But if demand increases, the demand curve will shift from D0 to
D2.
Shifts in demand curve
 Market Supply

• In a market economy, while buyers of a product

constitute the demand side of the market, sellers of
that product make the supply side of the market.
• Supply means the quantity of a commodity which
its producers or sellers offer to sell at a given price,
per unit of time.
 The Law of Supply

• The supply of a commodity depends on its price and cost

of production.
• That is, supply is the function of price and production cost.
• The law of supply is, however, expressed generally in
terms of price-quantity relationship. The law of supply can
be stated as:
• → The supply of a product increases with the increase in
its price and decreases with decrease in its price, other
things remaining constant.
 Reasons

• The higher the price of the good, the more

profitable it becomes to produce. That is, firms will
be encouraged to produce more.
• Given time, if the price of good remains high, new
producers will be encouraged to participate in
production. Thus, total market supply will increase.
 The supply curve

• The supply curve is a curve that shows various

quantities supplied at different prices .
• The graph below shows that there is a positive
relationship between price and the quantity
supplied.
• As price increases the quantity supplied also
increases.
The supply curve
 Determinants of Supply

• (i) The price of the product. The higher the price

the higher the quantity supplied and vice verse.
• (ii) Quality or type of technology used. Better
technology improves productivity.
• (iii) Weather conditions, production and supply of
some products are affected by weather conditions,
e.g. agricultural products.
• The prices of other products. Products which are more
profitable attract more investments than the unprofitable
products.
• Government taxes: Taxes are levies imposed by the
government on firms and they increase costs of
production. High taxes therefore lead to low output.
• Producer subsidies. A producer subsidy is an amount of
money which the government pays a producer in order to
reduce costs of production. Producer subsidies lead to
increased output.
 Movements along and shifts in
the supply curve
• The effect of a change in price on quantity supplied is simply a movement
along the supply curve.
• In general we call this change (move) a change in quantity supplied.
• In other words, any change that arises from change in price is a change in
quantity supplied and it is explained by movement along the same supply
curve.
• Whereas, a change in other supply affecting factors than price leads to a
change in supply.
• Generally, a change in supply is explained by a shift in the entire supply curve.
Change in quantity supplied and change in supply.
 Equilibrium of Demand and
Supply
• The term equilibrium means the ‘state of rest’ – a point
where conflicting interests are balanced.
• It indicates the condition where forces working in
opposite direction are in balance. In a market context:
• → Equilibrium refers to a state of market in which the
quantity demanded of a commodity equals the quantity
supplied of the commodity.
• The equality of demand and supply produces an
equilibrium price and output.
 Equilibrium Price and Quantity

• An equilibrium price is that price which equates

supply and demand. On a graph.
• It is a point where the demand and supply curves
intersect each other as shown in the figure above:-
• The price Po is the market equilibrium price and
the quantity Qo is the market equilibrium quantity.
Shifts in Demand Curve and Changes in Market
Price
 Shifts in Demand Curve and Changes in Market
Price (continued)

• When the demand curve shifts from D0 to D1 the

equilibrium position shifts from E0 to E1.
• The reduction in quantity demanded from Q0 to Q1
pushes the price down from P0 to P1.
• When the DC shifts from D0 to D2 the equilibrium
position shifts from E0 to E2. The increase in
quantity demanded from Q0 to Q2 pushes the price
up from P0 to P2.
Shifts in Supply Curves and Changes in Market
price
 Shifts in Supply Curves and Changes in Market
price (continued)

• When the supply curve shifts from S0 to S1 the

equilibrium position shifts from E0 to E1. The
reduction in quantity supplied from Qo to Q1 pushes
the price up from P0 to P1 .
• When the supply curve shifts from S0 to S2 ( ie when
supply increases) the equilibrium position shifts from
E0 to E2. The increase in quantity supplied from Q 0 to
Q2 pushes the price down from P0 to P2.
 Exercises
An economic consultant for Gumbcorp. recently provided the firm’s marketing manager with this
estimate of the demand function for the firm’s product:
•
• Qxd=12,000 -3Px + 4Py - 1M + 2Ax
•
•where Qxd represents the amount consumed of good X, Px is the price of good X, is the price of good
Y, M is income, and Ax represents the amount of advertising spent on good X.
•
•Suppose good X sells for $200 per unit, good Y sells for $15 per unit, the company utilizes 2,000
units of advertising, and consumer income is $10,000.
•How much of good X do consumers purchase?
•Are goods X and Y substitutes or complements?
•Is good X a normal or an inferior good?
• Suppose that the market for milk can be represented by the following
equations:
Demand: P = 12 – 0.5QD
Supply: P = 0.1QS
• where P is the price per gallon, and Q represents quantity of milk,
represented in millions of gallons of milk consumed per day.
• a) Calculate the equilibrium price and quantity of milk.

• b) To help dairy farmers, the government sets a minimum price of K2.50

per gallon of milk.
• What is the new quantity of milk sold in the marketplace?
• Consider a hypothetical situation at the Mitengo Market in
Ndola where there are 1000 identical individuals buying
bananas, hereafter, to be called commodity X. Each of these
individuals has a demand function given by Qdx = 6-Px. In the
same market there are also 100 identical producers of bananas
from Ndola, each with a supply function given by Qsx = 10Px.
• (a) Find the market demand function and market supply
function
• (b) Obtain the equilibrium price and quantity mathematically