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The Market Forces of

Supply and Demand


The Market Forces of
Supply and Demand
◆ Supply and demand are the two words
that economists use most often.
◆ Supply and demand are the forces that
make market economies work.
◆ Modern microeconomics is about
supply, demand, and market
equilibrium.
Markets

◆A market is a group of buyers and


sellers of a particular good or service.
◆ The terms supply and demand refer
to the behavior of people . . . as they
interact with one another in markets.
Markets
◆ Buyers determine demand.

◆ Sellers determine supply.


Demand

Quantity demanded
is the amount
of a good that buyers are
willing and able
to purchase.
Law of Demand

The law of demand states that,


ceteris paribus, there is an
inverse relationship between price
and quantity demanded.
Demand Schedule

The demand schedule is a table


that shows the relationship
between the price of the good
and the quantity demanded.
Demand Schedule

Pri
Demand Curve

The demand curve is the downward-


sloping line relating price to quantity
demanded.
Demand Curve
Price of
Ice-Cream
Cone

Rs.3

P
2.5
0
2.0
0
1.5
0

0
1.0
0
0.5
0
Quantity
0 1 2 3 4 5 6 7 8 9 1 1 1 of Ice-
0 1 2 Cream
Ceteris Paribus
Ceteris paribus is a Latin phrase that
means all variables other than the
ones being studied are assumed to be
constant. Literally, ceteris paribus
means “other things being equal.”

The demand curve slopes downward


because, ceteris paribus, lower prices
imply a greater quantity demanded!
Ceteris Paribus
■ Ceteris Paribus means “other things being
equal”. What other things?
■ Consumer income.
■ Consumer preferences.
■ Fashion.
■ Price of related goods.
■ Government policies.
■ Weather conditions.
Market Demand

◆ Market demand refers to the


sum of all individual demands
for a particular good or service.
Determinants of Demand
◆ Market price : A larger quantity is demanded at
a lower price & vice versa.
◆ Tastes, habits and preferences : Demand depends
upon a persons tastes, habits and preferences.
Demand for ice – creams, bhel – puri etc depends
upon an individual’s tastes. Tea, betal leafs,
tobacco etc is a matter of habits. People with
different tastes & habits have different
preferences. A strict veg. will have no demand
for fish and a person who likes non – veg will
purchase fish even at a high price.
■ Expectations : If a consumer expects that the
prices of a product are going to rise in future, the
demand may increase and vice – versa.
◆ Consumer income : A rich consumer demands
more goods than a poor consumer.
■ Prices of related goods ( substitutes and
complementary ) : When a desire or a want can
be satisfied by alternative similar goods, they
are called as substitutes. Eg. Peas and beans,
groundnut oil and mustard oil, tea or coffee,
jowar or bajra etc.
■ Demand for a commodity depends on the
relative prices of the substitutes. There will be
more demand for a commodity if it’s
substitutes are highly priced.
■ Complementary products : When, in order to
satisfy a given want, two or more goods are
needed in combination, these goods are
referred to as complementary goods. Eg. car
and petrol, pen and ink, shoes and socks, guns
and bullets. Complementary goods are always
in Joint Demand. Thus, when the price of a
complementary product will fall, the demand
for its complementary product will increase.
Change in Quantity Demanded
versus Change in Demand

Change in Quantity Demanded


◆ Movement along the demand curve.
◆ Caused by a change in the price of
the product.
Changes in Quantity
Price of
Cigarettes
Demanded
per Pack
A tax that raises the
price of cigarettes
C results in a
Rs.4.
movement along the
00
demand curve.

2.00 A

D1
0 12 20 Number of
Cigarettes Smoked
Change in Quantity Demanded
versus Change in Demand

Change in Demand
◆ A shift in the demand curve, either
to the left or right.
◆ Caused by a change in a
determinant other than the price.
Changes in Demand
Price of
Ice-Cream
Cone

Increase in
demand

Decrease in
demand

D2
D1
D3 Quantity
0
of Ice-
Cream
Change in Quantity Demanded
versus Change in Demand
Variables that A Change in
Affect Quantity
Demanded This Variable . . .
Price Represents a movement
along the demand curve
Income Shifts the demand curve
Prices of related Shifts the demand curve
goods
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number of Shifts the demand curve
buyers
Two Simple Rules for
Movements vs. Shifts
■ Rule One
➤When an independent variable changes and
that variable does not appear on the graph,
the curve on the graph will shift.
■ Rule Two
➤When an independent variable does appear
on the graph, the curve on the graph will not
shift, instead a movement along the existing
curve will occur.
Consumer Income
Price of
Normal Good
Ice-Cream
Cone
Rs.3.0 An
0
2.5 increase
0 Increase in
2.0 in demand income...
0
1.5
0
1.0
0
0.5
0
D2
D1 Quantity
0 1 2 3 4 5 6 7 8 9 1 1 1 of Ice-
0 1 2 Cream
Consumer Income
Price of
Inferior Good
Ice-Cream
Cone
Rs.3.00

2.5 An
0
2.0
increase
0 Decrease
in
1.5 in demand income...
0
1.0
0
0.5
0
D2 D1 Quantity
0 1 2 3 4 5 6 7 8 9 1 1 1 of Ice-
0 1 2 Cream
Exceptions to the law of
Demand
■ Law of Demand is a universal
phenomenon. Very rarely, it is so
observed that with a fall in price,
demand also falls and a increase in price
increases demand.
■ The demand curve in such cases is
upward sloping.
Exceptions to the law of
Demand
■ A few such exceptions are seen in case of:
■ Giffen Goods : In cases of some inferior goods,
as observed by Robert Giffen, when price falls,
there is a fall in the demand for these products.
■ Eg. This was observed by Giffen in Italy when
consumers purchased less of cheap potatoes
when the price went down and purchased meat
from the savings.
Exceptions to the law of
Demand
■ Snob Appeal : Goods that are used as “Status
Symbol” eg. Rolls Royce cars, Johney Walker
Scotch Whisky, Diamonds etc.
■ The demand for these goods increases even if
the price is increased because these goods are
purchased for their “exclusiveness” which
increases with an increase in price.
Exceptions to the law of
Demand
■ Speculation : When the consumers understand
that there is a increase in price of a product
and they are expecting a further rise, they will
not mind purchasing more of that product even
if it’s price is increased.
■ Consumer’s psychology : Many consumers do
not purchase products at the time of “discount
sales” etc assuming that the quality of the
products may have been compromised.
Law of Supply

The law of supply states that, ceteris


paribus, there is a direct (positive)
relationship between price and
quantity supplied.
Supply

Quantity supplied is the amount of a


good that sellers are willing and able
to sell.
Supply Schedule

The supply schedule is a table that


shows the relationship between the
price of the good and the quantity
supplied.
Supply Schedule

Pri
Supply Curve

The supply curve is the upward-


sloping line relating price to quantity
supplied.
Price of Supply Curve
Ice-Cream
Cone
Rs.3.
00
2.5
0

Pr
2.0
0
1.5
0
1.0
0
0.5
0
Quantity
0 1 2 3 4 5 6 7 8 9 1 1 1 of Ice-
0 1 2 Cream
Market Supply

◆ Market supply refers to the sum


of all individual supplies for all
sellers of a particular good or
service.
Determinants of Supply
◆ Market price : The single largest factor that
affects supply is the price. More commodities
will be supplied at a higher price and vice
versa.
◆ Input prices : When the factors of production
are available at low price, more investment is
encouraged. This increases supply.
◆ Technology : The improvement in the
technique of production leads to increased
supply.
◆ Natural conditions : The supply of
agricultural commodities depends upon
the natural conditions. Whenever there is
good monsoon, conductive temperature,
the supply of such products increases.
◆ Transport conditions : Difficulties in
transport may cause a temporary
decrease in supply. So, even at rising
price, quantity supplied may decrease.
◆ Expectations : When a seller expects a further rise
in the price, he may withhold the supply and hence
the supply may decrease.
◆ Prices of other products : The prices of substitutes
or related products can influence the supply. If the
prices of wheat are increasing, farmers may grow
more of wheat and less of rice. If the price of sugar
rises, the price of jaggary will also rise.
◆ Govt. policy : If the policies of the govt. are
liberalized, more firms may tend to enter the
market and hence supply may rise.
Change in Quantity Supplied
versus Change in Supply

Change in Quantity Supplied


◆ Movement along the supply curve.
◆ Caused by a change in the market price
of the product.
Change in Quantity Supplied
Price of
Ice-Cream
Cone
S
C
Rs.3. A rise in the price
00 of ice cream cones
results in a
movement along
the supply curve.
A
1.00

Quantity
0 1 5 of Ice-
Cream
Change in Quantity Supplied
versus Change in Supply

Change in Supply
◆ A shift in the supply curve, either to the
left or right.
◆ Caused by a change in a determinant
other than price.
Change in Supply
Price of S3
Ice-Cream
Cone
S1 S2
Decrease
in Supply

Increase
in Supply

Quantity
0 of Ice-
Cream
Change in Quantity Supplied
versus Change in Supply
Variables that
AffectQuantity Supplied A ChangeinThis Variable. . .
Price Represents a movement along
the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve
Shifts in Curves versus
Movements along Curves
◆ A shift in the supply curve is called a
change in supply.
◆ A movement along a fixed supply curve is
called a change in quantity supplied.
◆ A shift in the demand curve is called a
change in demand.
◆ A movement along a fixed demand curve is
called a change in quantity demanded.
Supply and Demand Together
Equilibrium Price
◆ The price that balances supply and
demand. On a graph, it is the price at which
the supply and demand curves intersect.
Equilibrium Quantity
◆ The quantity that balances supply and
demand. On a graph it is the quantity at
which the supply and demand curves
intersect.
Supply and Demand Together
Demand Supply
Schedule Schedule

Price P
At Rs.2.00, the quantity demanded is
equal to the quantity supplied!
Equilibrium of
Price of Supply and Demand
Ice-Cream
Cone
Supply
Rs.3.
00
2.5 Equilibriu
0 m
2.0
0
1.5
0
1.0
0
0.5 Demand
0 Quantity
0 1 2 3 4 5 6 7 8 9 10 11 12 of Ice-
Cream
Excess Supply
Price of
Ice-Cream
Cone
Supply
Rs.3. Surplus
00
2.5
0
2.0
0
1.5
0
1.0
0
0.5 Demand
0 Quantity
0 1 2 3 4 5 6 7 8 9 1 11 12 of Ice-
0 Cream
Surplus

When the price is above the equilibrium


price, the quantity supplied exceeds the
quantity demanded. There is excess supply
or a surplus. Suppliers will lower the price
to increase sales, thereby moving toward
equilibrium.
Excess Demand
Price of
Ice-Cream
Cone

Supply

Rs.2.00

Rs.1.50

Shortage Demand

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of
Ice-Cream Cones
Shortage

When the price is below the equilibrium


price, the quantity demanded exceeds the
quantity supplied. There is excess demand
or a shortage. Suppliers will raise the price
due to too many buyers chasing too few
goods, thereby moving toward equilibrium.
Three Steps To Analyzing
Changes in Equilibrium
◆ Decide whether the event shifts the
supply or demand curve (or both).
◆ Decide whether the curve(s) shift(s) to
the left or to the right.
◆ Examine how the shift affects
equilibrium price and quantity.
How an Increase in Demand
Affects the Equilibrium
Price of 1. Hot weather increases
Ice-Cream the demand for ice cream...
Cone

Supply

Rs.2.50 New equilibrium

2.00
2. ...resulting Initial
in a higher equilibrium
price...
D2

D1
0 7 10 Quantity of
3. ...and a higher Ice-Cream Cones
quantity sold.
How a Decrease in Supply Affects
the Equilibrium
Price of
Ice-Cream 1. Shortage of milk reduces
Cone the supply of ice cream...
S2
S1

New
Rs.2.50 equilibrium

2.00 Initial equilibrium


2. ...resulting
in a higher
price...
Demand

0 1 2 3 4 7 8 9 10 11 12 13 Quantity of
3. ...and a lower Ice-Cream Cones
quantity sold.