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TOPIC 2: DEMAND AND SUPPLY

TOPIC 2 DEMAND AND SUPPLY

Introduction
Have you ever wondered how the price of a particular product (for example your favourite compact disc) is decided and why the price always changes?
This topic discusses demand, and supply. We need to understand the concepts of demand before learning the Theory of Consumer Behaviour (demand section) and the concept of supply to understand the outcome of

production decisions by manufacturers.

In this topic, we will seek answers to our questions by looking at how a market functions. We will begin with the definition of the concept of the market. After discussing the concept of demand and the factors that

determine demand, we will move on to supply.

The market is an institution where the seller and buyer exchange goods and services at an agreed price level. Therefore, the market can be said to be a place or location where the seller and buyer meet for the purpose of

business transactions.

Learning Objectives
By the end of this topic, you should be able to: 1. explain the definition of demand, law of demand, the demand schedule and the demand curve; 2. describe factors that determine demand;
3. differentiate between changes in demand and changes in quantity of

demand;
4. explain the definition of supply, law of supply, the supply schedule

and the supply curve; 5. describe factors that determine supply; and 6. differentiate between changes in supply and changes in quatity of supply.

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2.1 THE THEORY OF DEMAND AND THE DEMAND

CURVE
2.1.1 Demand
Demand can be interpreted as a form of want or need of a consumer towards a particular good or service. When a consumer wants a particular

goods, three things should exist: i. i. iii. needs/wants; ability to possess; and willingness to purchase.

2.1.2 The Law of Demand

This law states that the lower the price of a good, the higher the demand for
it. On the other hand, the higher the price of a good, the lower the demand

for the good.

The law states that demand and price have a reverse or negative relationship.

This is because: 1. when the price of a good decreases, the consumer would increase the
purchase of that good; and reduce the purchase of alternative goods (although the price of the alternative good is still constant, relatively it becomes more expensive when compared to the good that is at a reduced price). On the other hand, where there is a price increase in a certain good, the consumer would start to search for cheaper alternative goods and purchase less of good that has increased in price. For example, when the price of tea goes down, consumers would buy more tea because the price of tea has fallen and has become cheaper [consumers will not buy coffee (an alternative for tea) because the price

would now be higher compared to tea].

2. when the price of goods decreases, the real income of consumers will increase. This is because with the same income, purchasing power has now increased. Therefore, the quantity demanded would also increase. On the other hand, when the price of particular goods increases, the real income of consumers decreases. With the same income, the purchasing power has decreased resulting in a decrease

in the quantity demanded.

2.1.3 The Demand Schedule and the Demand Curve

(a) The Demand Schedule
This schedule shows the quantity demanded for a particular good at every price level at a certain point in time, with the assumption that other factors that influence demand have not changed or are constant.

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Table 2.1:Demand Schedule for Burgers

Price (RM) A
B

Quantity 8 7 6 4 2

C
D

0.05 0.75 1.00 1.50 2.00

Table 2.1 shows the demand for burgers at different price levels. The table
illustrates that the higher the price of burgers the less the quantity demanded

and vice versa.

The information contained in Table 2.1 can be drawn in the form of a graph,

known as the demand curve, as shown in Figure 2.1.

Price

Demand Curve

Quantity

Figure 2.1:Demand curve

The demand curve is a curve that shows the relationship between the price of goods and the quantity demanded. Demand curves, like Figure 2.1, slope downward, from left to right or negative. Greater quantities are

demanded at lower price levels and vice versa.

(b)

Individual Demand and Market Demand

Demand for goods can be seen from two angles: 1. 2. demand by the individual; and demand by the total buyers.

Market demand is the total quantity of goods demanded by all buyers in the market. Therefore, to create a market demand curve we have to add the

demand curves of all the individuals.

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Table 2.2 : Market Demand for Soft Drinks

Price (RM) 1.00
2.00 3.00 4.00 5.00

Abus Demand 50 40 35 30 20

Lims Demand 40 35 30 20 10

Market Demand 90 75 65 50 30

Table 2.2 shows how the market demand can be ascertained for soft drinks.
We assume that there are only 2 consumers in the market. Therefore, the market demand is ascertained by adding Abu and Lims demands. At the RM1 price mark, Abus demand is 50 units and Lims demand is 40 units. Hence, the market demand is (50+40) 90 units and so on. The individual

demand curve and the market curve can be shown in Figure 2.2.
Price Price

Price

Quantity Abus Demand

Quantity
Lims Demand

Quantity Market Demand

Figure 2.2: Market demand curve derived from individual demands

Based on the Law of Demand, create a Schedule for Market Demand

of a particular consumer product and then draw the market demand

curve based on the information found in your table.

2.2 FACTORS THAT DETERMINE DEMAND

The law of demand is true in a state of ceteris paribus that is assuming that
there is no change in other factors that influence demand. Therefore, we can assume that only the price of goods causes change in demand. This assumption enables us to draw the demand curve, but in reality there are

several factors that determine demand, i.e.: (a) taste or consumer preferences; (b) consumer income; (c) price of other goods (alternative/complementary goods); (d) price estimate and future consumer income; and (e) number of buyers in the market.
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(a)

Taste or Consumer Preferences

Taste or in other words preference can influence the pattern of consumer demand towards certain goods. This is because it is related to culture, beliefs and values of a society. For example, advancement in technology has influenced the tastes of consumers towards word processors. The use of computers has reduced the use of typewriters; and the use of hand phones

and facsimiles have reduced the writing of letters.

(b)

Consumer Income

Changes in consumer income will influence demand because it affects purchasing power. Although the price of some goods may not have changed, the consumer will buy more of these goods and services when income increases. Therefore, when consumer income changes, the demand for

goods also changes.

(c)

Price of Other Goods

As a consumer buys many types of goods and services, the price of other goods will also influence demand for certain other goods, like alternative,

complementary and unrelated goods.

Alternative Goods
Alternative goods give the same benefits or have the same uses as the goods they may replace. Therefore, the increase in the price of certain goods will reduce the demand for them but increase the demand for alternative goods. Examples of alternative goods are tea and coffee. With alternative good, the price of a good and the demand for is alternative has a positive relationship. For example, if the price of tea increases, the demand for coffee

will also increase.

Complementary Goods
Complementary goods are goods that are used together like petrol and cars,

camera and film, guns and bullets.

With complementary goods, the price of a good and the demand for a complementary good has a negative relationship. For example, if the price of petrol increases, the demand for cars would decrease or the quantity of

cars demanded would decrease.

Unrelated Goods
If the goods are not alternatives or complementary, these said goods are known as unrelated goods. For example, the demand for watches has no relation with the price of flowers. Likewise, a decrease in the price of water

will not affect the demand for taxies.

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1.

Explain the effects of the increase in the price of petrol (twice more) towards: (a) (b) (c) demand for motorbikes demand for public bus services demand for water

2.

Complete the following statement using the words left or right.

The increase in the price of cassettes will move the demand curve CD to the _____________ side; increase in the price of CD players will move the demand curve CD to the __________side.

(d)

Expected Price and Future Consumer Income

The expectations of the consumer towards price and income in the future
would also influence the demand towards goods. People who expect increase in their future income tend to spend more today compared to those who expect their future income to decrease. In fact, consumers who predict

that prices would increase in future tend to buy more now.

(e)

The Number of Buyers in the Market

The number of buyers in the market can also influence demand because the greater the number of buyers means more demand and therefore increase

in price and vice versa.

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Exercise 2.1
The curves below show demand curves where curve D is the original
demand, curve D1 shows the increase in demand (moving towards the right) while curve D2 is the decrease in demand (moving towards

the left). Price

Quantity
Decide whether the following factors would cause the demand curve to

move towards the right or left? (a) Consumer preference changes, he prefers certain goods. (b) Income increases (normal goods). (c) The price is expected to increase in future. (d) The income is expected to decrease in future. (e) The price of complementary goods decreases. (f) The population increases. (g) The preferences of consumers change to dislike of the said goods. (h) Income increases (inferior goods). (i) Price of alternative goods decreases.

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2.3 CHANGE IN DEMAND AND CHANGE IN

QUANTITY DEMANDED
The demand curve will move towards the right or towards the left when the
factor that determines demand changes. Therefore, when economists speak of a change in demand they means the movement of the demand curve

either to the right or to the left. Meanwhile, the change in the quantity demanded refers to the movement along the demand curve caused by the change in the price of the particular goods only. A higher price can cause the quantity demanded to decrease and a lower price can cause the quantity demanded to increase. Both these concepts can be shown using Figure 2.4.

(a)

(b)

Figure 2.3 : Change in demand and change in quantity demanded Figure 2.3 (a) illustrates the concept of change in demand. Lets say the
original price is P and the demand is Q . If the consumer prefers the goods,
o o

this will increase the demand and the demand curve will move from D to
o

D , where the quantity demanded increases from Q to Q (at the price level
1 o 1

P ).
o

Figure 2.3 (b) also shows the concept of change in quantity demanded that is caused by the change in price of the goods itself. Lets say the original price is Po and the demand is Q . When the price decreases to P , this will cause the movement in the demand curve that is from point A to point C. The decrease in the price has caused the quantity demanded to increase from Q to Q . Meanwhile, if the price increases from P to P , then the
o 1 o 1 o 2

quantity demanded would decrease from Q to Q .

o 2

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Choose and match each statement that follows by writing the correct choice of the number in parentheses. Change in demand ( ) )

Change in quantity demanded ( Change in price Choice 1. 2. 3. ( )

movement on the demand curve movement of the demand curve change in income

2.4 THE THEORY OF SUPPLY AND SUPPLY CURVE

2.4.1 Supply
Supply is the desire and ability of a manufacturer to manufacture goods and services at particular price level within a time frame.

2.4.2 The Law of Supply

The law of supply says that the higher the price of certain goods, the more the quantity supplied, on the other hand, the lower the price of certain goods, the less the quantity supplied.

2.4.3 The Supply Schedule

The table shows the quantity supplied for certain goods at each price level within a particular time, with the assumption that other factors that influence supply have not changed. Table 2.3: Schedule of Supply for Burgers
Price (RM) P Q
R

Quantity 2 4 6 10 14 29

S T

0.05 0.75 1.00 1.50 2.00

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Based on Table 2.3, if the price of burgers is RM 0.50, the quantity supplied
by the manufacturer is only 2. When the price of burgers increases, the quantity of burgers supplied would also increase. The information on supply found in Table 2.3 can be drawn in the form of a curve as shown in Figure 2.4

below. Price

Supply Curve

Quantity

Figure 2.4: Supply Curve

The supply curve is a curve that shows the relationship between the price of certain goods and the quantity of the goods that are supplied. The supply curve in Figure 2.4, indicates that the supply curve has an upward gradient from left to right, showing a positive relationship between price and quantity.

2.4.4 Individual Supply and Market Supply

Like demand, supply can also be divided into 2, i.e.: (a) supply by a manufacturer; and (b) supplies by a number of manufacturers in the market.
Market supply is the total quantity of goods supplied by all the manufacturers in the market. Therefore, the market supply curve is obtained by adding all

the individual supply curves.

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Price (RM) 1.00

2.00

Supply by Seller A Supply by Seller B 180 160 120 75 20

Harga
6

Market Supply 900 800 600 375 100

Harga
6

3.0
4.00 5.00
Harga Price

720 640 480 300 80

0 0 20 180 200 400 600 800 1000 080 200400 600 720 800 1000

0 0 100 200 400 600 800 900 1000

Penjual A

Seller A

Quantity Kuantiti

Penjual B

Seller B

Kuantiti

Market Supply

Kuantiti

Penawaran Pasaran

Figure 2.5 :Obtaining the market supply curve from individual supplies The market supply curve is the total quantity supplied by all the sellers at a particular price level.
Like the example above, supposing there are 2 sellers, A and B who produce soft drinks. If the quantity supplied by the 2 sellers is added, we would get

the market supply as shown in Figure2.5.

2.5 Factors that Determine Supply

Factors that determine supply are as follows: (a) the price of other goods (alternative or complementary goods); (b) the price of the factors of production; (c) technology; (d) expected future price; (e) number of sellers in the market; and (f) weather conditions.

(a)

The Price of Other Goods

Alternative goods
When the price of alternative goods increases, the supply of a good would increase, whereas when the price of alternative goods decreases, the supply 31

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of these goods would decrease. For example, if the price of coffee increases,
tea supply would increase because the higher price of coffee would cause

the demand for it to decrease and the demand for tea to increase. Complementary goods
When the price of complementary goods increases, the supply of these goods decreases. Meanwhile, when the price of complementary goods decreases, the supply of certain goods increases. For example, when the price of cars increases, the supply of petrol decrease because the price of

cars are high causing the consumers to reduce the use of cars.

(b)

Price of the Factors of Production

When the price of factors of production (such as wages, price of raw materials) is high, then the supply of goods would decrease because the cost of production is high. Meanwhile, when the price of the factors of production is low, the supply of these goods will increase because the cost

of production will be cheaper and the profits, high.

(c)

Technology

Advancement in technology has 2 effects on supply: (a) production increases faster; and (b) the cost of production becomes cheaper. Therefore, advancements in technology increase supply.

(d)

Expected Future Price

When an entrepreneur expects a price increase in future, then the present supply will decrease, as he will try to supply the goods at the higher future

price.

(e)

Number of Sellers in the Market

If the number is large, then more goods will be supplied.

(f)

Weather Conditions

Bad weather conditions can affect the production of agricultural commodities

and in turn reduce supplies.

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Exercise 2.2
Price

Quantity The above graph shows three supply curves. The S curve is the original
supply while the S1 curve shows the increase in supply (moving to the right) while the S2 curve shows the decrease in supply (moving to the

left).
Decide whether the following factors can cause the supply curve to move

to the right or to the left. (a) advancement in technology (b) higher price of raw material (c) increase in the number of firms (d) good weather conditions (e) higher expected future price (f) higher wages (g) bad weather conditions

Irrespective of whether we are dealing with changes in supply or demand

and corresponding changes in quantities supplied demanded, the concepts remain the same. Changes in supply are caused by factors that influence

supply, so that the supply curve moves either to the right or to the left. While changes in quantities supplied are caused by the price factor of the goods which causes movement along the particular supply curve. The movement of the supply curve from the S curve to the S1 curve in Figure 2.6 (a) shows the increase in supply.

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Meanwhile, Graph 2.6 (b) shows the change in the quantity supplied, i.e.
when the price falls from P to P , the quantity supplied has reduced from Q
o 1 2

to Q . This means the movement from the higher level of quantity supplied to a lower level of quantity supplied is caused by a decrease in price, whereas the movement from a lower level of quantity supplied to a higher level is caused by an increase in price.
o

Price

Price

P P
S

Q0

Q1

Quantity

Q0 Q1

Quantity

(b) (a) Figure 2.6: Movement on the supply curve Explain what causes changes in quantities supplied. What are the
effects on the price of a particular good, if the supply of its

complementary goods increases?

To obtain detailed information regarding demand and supply, you can read part of the textbook, Economics, by Parkin, M. (2000). Pages 63

71.

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Summary
In this topic, we have seen how demand and supply determine price in the
market. After reading this topic we can predict the effects of the change in demand or supply towards price. A few important concepts in this topic are: 1. The demand curve has a downward gradient from left to right and it has a negative gradient. This means that the relationship between price and quantity demanded is in reverse. The factors that determine demand are income of consumers, consumer preference, price of other goods, expected price and future income of consumers and the number of buyers in the market. To draw the demand curve, the factors

are assumed to be constant.

2. The supply curve has an upward gradient from left to right and it also has a positive gradient. This means that the relationship between price and quantity supplied is positive. Factors that influence the supply are the price of other goods, the price of factors of production, technology, expected price in future and the number of sellers in the market. To

draw the supply curve, all factors are assumed to be constant.

3. The concept of change in quantity demanded or supplied and change in demand or supply. A change in quantity demanded or supplied will cause a change in only one curve and it is caused by the change in the price of the good itself; whereas changes in demand or supply, shift

the curve either to the left or to the right.

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