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Demand

The law of demand


According to the law of demand, there is an inverse relationship between the quantity of a good demanded over a
particular time period and its price, ceteris paribus: as the price of the good increases, the quantity of the good
demanded falls; as the price falls, the quantity demanded increases, all other things equal.

Individual demand
The demand of an individual consumer indicates the various quantities of a good (or service) the consumer is willing and
able to buy at different possible prices during a particular time period, ceteris paribus (all other things equal).

"Willing' means the consumer wants to buy the good; 'able' means that the consumer can afford to buy it.

Ceteris paribus means that all things other than price that can affect how much the consumer is willing and able to buy
are assumed to be constant and unchanging. In fact, the consumer's demand is affected not only by price, but also by
many other things, such as the consumer's income and tastes, and the prices of related goods. For the moment, we put
all those other things aside and concentrate only on the relationship between the quantity of a good the consumer is
willing and able to buy, and its price.

A consumer's demand for a good can be presented as a demand schedule, which is a table listing quantity demanded at
various prices. The table shows a consumer's demand schedule for chocolate bars.

The information contained in the demand schedule can be plotted as a graph, to illustrate the individual demand curve.

Market demand
Market demand indicates the total quantities in the market for the good consumers are willing and able to buy at
different prices (during a particular period of time, all other things equal). Market demand is the horizontal sum of all
individual demands' for that good. The table below shows the individual demand for chocolate for 3 individuals, A,B & C
and the derivation of the market demand schedule as well as the market demand curve.

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Movement along a demand curve or change in quantity demanded
Whenever the price of a good changes, ceteris paribus, it gives rise to a movement along the demand curve as illustrated
in the two diagrams below. There are two types of movements namely extension of the demand curve and contraction
of the demand curve.

Shifts in demand or change in demand


Any change in one or more determinants of demand gives rise to a shift in the whole demand curve, as shown in the
diagram below; this is called a change in demand.

A rightward shift of the demand curve indicates that more is demanded for a given price; a leftward shift of the demand
curve indicates that less is demanded for a given price. A rightward shift of the curve is called an increase in demand; a
leftward shift is called a decrease in demand.

Determinants of Demand (Factors causing shift in demand)


The number of buyers: If there is an increase in the number of buyers (demanders), demand increases and therefore
the market demand curve shifts to the right; if the number of buyers decreases, demand decreases and the curve
shifts to the left. This follows simply from the fact that market demand is the sum of all individual demands.

Tastes: If tastes change in favour of a product (the good becomes more popular), demand increases and the demand
curve shifts to the right; if tastes change against the product (it becomes less popular) demand decreases and the
demand curve shifts to the left.

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Advertising: A good advertising campaign will shift the demand for a product to the right and that of its substitute to
the left.

Income in the case of normal goods: When demand for a good increases in response to an increase in consumer
income, the good is a normal good (a good is normal if the demand for it varies directly with income). Most goods
are normal goods. Therefore an increase in income will give rise to a rightward shift in the demand curve when the
good is normal, and a decrease in income will give rise to a leftward shift.

Income in the case or inferior goods: While most goods are normal, there are some goods the demand for which
falls as consumer income increases; the good is then an inferior good (a good is inferior if the demand for it varies
inversely with income). Examples of inferior goods are used clothes, used cars, and bus tickets. As income increases,
consumers switch to more expensive alternatives (new clothes, new cars, and cars or airplanes rather than travelling
by bus), and so the demand for the inferior goods falls. Thus an increase in income will give rise to a leftward shift in
the demand curve for an inferior good, and a decrease in income will produce a rightward shift.

Prices of substitute goods: Two goods are substitutes if they satisfy a similar need. In economics, one kind of
good (or service) is said to be a substitute good for another kind in so far as the two kinds of goods can be
consumed or used in place of one another in at least some of their possible uses. An example of substitute
goods is Coca-Cola and Pepsi-Cola. A fall in the price of one (say Coca-Cola) will result in a fall in the demand for
the other (Pepsi-Cola). The reason is that as the price of Coca-Cola falls, some consumers will switch from Pepsi
to Coca-Cola, and so the demand for Pepsi will fall. On the other hand, if there is an increase in the price of Coca-
Cola, there will result an increase in the demand for Pepsi as some consumers switch away from Coca-Cola and
towards Pepsi. Therefore for any two substitute goods X and Y, a decrease in the price of X ,will produce a
leftward shift in the demand for Y, while an increase in the price of X will produce a rightward shift in the
demand for Y. In brief, in the case of substitute goods, the price of X and demand for Y change in the same
direction (they both increase or they both decrease).

Prices of complementary goods: Two goods are complements if they tend to be used together. An example of
complementary goods is CDs and CD players. In this case, a fall in the price of one (say CD players) will give rise to an
increase in the demand for the other (CDs). This is because the fall in the price of CD players leads to a bigger
quantity of CD players being purchased, and therefore the demand for CDs will increase. Therefore, for any two
complementary goods X and Y, a fall in the price of X will lead to a rightward shift in the demand for Y, and an
increase in the price of X will lead to a leftward shift in the demand for Y. In the case of complementary goods, the
price of X and the demand for Y change in opposite directions (as one increases, the other decreases).

Expectations of future income: If consumers expect that their future income will increase, their demand for a good
in the present will be likely to increase (rightward shift in the demand curve); if they expect their income to fall in
the future, their demand for a good in the present will be likely to fall (a leftward shift in the demand curve).

Expectations of future price changes: If consumers expect that the price of a good will increase in the future, they
will probably demand more of it in the present in order to take advantage of the lower present price, and so
demand will shift to the right; if they expect that the price will fall in the future, they will demand less of it in the
present, as they will postpone their purchases for the future, and so demand in the present shifts to the left.

Population: Changes in population also influences demand. An increase in the population is likely to increase
demand for all goods and services. Changes in the age distribution will also affect demand. In the case of a young
population, demand for fashionable goods will rise whereas in the case of an ageing population demand for goods
and services consumed by the elderly will rise.

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Supply

The law of supply


According to the law of supply, there is a direct relationship between the quantity of a good supplied over a
particular time period and its price, ceteris paribus: as the price of the good increases, the quantity of the good
supplied also increases; as the price falls the quantity supplied also falls, all other things equal.

Higher prices generally mean that the firm's profits increase, and so the firm faces an incentive to produce more output.
Lower prices mean lower profitability, and so the incentive facing the firm is to produce less. Therefore, there results a
direct relationship between price and quantity supplied: the higher the price, the greater the quantity supplied by the
firm.

Individual supply
The supply of an individual firm indicates the various quantities of a good (or service) the firm is willing and able to
produce and supply to the market for sale at different possible prices, during a particular time period, ceteris paribus.

A firm's supply of a good can be presented as a supply schedule, which is a table showing the various quantities of a
good the firm is willing and able to produce and supply at various prices. The table below shows a firm's supply schedule
for chocolate bars.

The information in the table can be used to draw the individual supply curve of the firm.

Market supply
The market supply indicates the total quantities of a good that firms are willing and able to supply in the market at
different possible prices, and is given by the sum of all individual supplies of that good. Market supply is the horizontal
sum of all individual firms' supplies for a good. The table below illustrates the individual supply for three firms, X, Y & Z,
for chocolate bars. The corresponding market supply schedule and curve can be derived.

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The vertical supply curve
Under certain special circumstances, the supply curve, rather than slope upward, is vertical at some particular fixed
quantity.
A vertical supply curve tells us that even as price increases, the quantity supplied cannot increase; it remains constant.
The quantity supplied is independent of price (it does not depend on price).

There are two reasons why this may occur:


There is a fixed quantity of the good supplied because there is no time to produce more of it. For example, there is a
fixed quantity of theatre tickets in a given theatre, because there are a fixed number of seats. No matter how high
the price, it is not possible to increase the number of seats in a short period of time

There is a fixed quantity of the good because there is no possibility of ever producing more of it. This is the case with
original antiques and original paintings and sculptures of famous artists. It may be possible to make reproductions,
but it is not possible to make more originals. The supply curve is therefore vertical at the fixed quantity of the good
that exists.

Movements along the supply curve


A movement along the supply curve is caused by a change in the price of the product. It is also known as a change in
quantity supplied. There are two types of movements namely extension of the supply curve and contraction of the
supply curve.

Shifts in Supply
A shift in supply is caused by a change in the factors affecting supply apart from price of the product. It is also known as
a change in supply.
A rightward shift means that for a given price, supply increases, i.e. more will be supplied: a leftward shift means that
for a given price, supply decreases, and less will be supplied. A rightward shift of the curve is called an increase in supply;
a leftward shift is called a decrease in supply.

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Factors causing shift in supply
The number of firms: An increase in the number of firms producing the good in question increases supply and gives
rise to a rightward shift in the supply curve; a decrease in the number of firms decreases supply and produces a
leftward shift. This follows from the fact that market supply is the sum of all individual supplies.

Resource prices and costs of production: The firm buys various resources (factors of production) that it uses to
produce its product. If the price of one or more resource rises, production becomes less profitable and the firm
produces less; the supply curve shifts to the left. If one or more resource prices fall, production becomes more
profitable and the firm will produce more; the supply curve shifts to the right. Resource prices are important in
determining the firm's costs of production. In general, when costs of production increase, production becomes less
profitable, and so supply falls (the supply curve shifts to the left) and when costs decrease, supply increases (the
supply curve shifts to the right).

Technology: A new improved technology lowers costs of production, thus making production more profitable.
Supply increases and the supply curve shifts to the right. In the (unlikely) event that a firm employs a less productive
technology, costs of production increase and the supply curve shifts leftward.

Prices Of other goods the firm can produce: Suppose a farmer grows wheat. If the price of another product, say
corn, increases, the farmer may switch to corn production, which is now more profitable; this results in a fall in
wheat supply: the supply curve shifts to the left. If the price of corn falls, corn producers may switch to growing
wheat, as this is now more profitable; the supply of wheat increases and the supply curve shifts to the right.
Therefore the supply curve of a good can shift in response to changes in the prices of other goods that the firm can
produce.

Producer (firm) expectations: If firms expect the price of their product to rise, they may withhold some of their
current supply from the market (Le. not offer it for sale), with the expectation that they will be able to sell it at the
higher price in the future; in this case there will result a fall in supply in the present, and hence a leftward shift in the
supply curve. If the expectation is that the price of their product will fall, they will increase their supply in order to
take advantage of the current higher price, and hence there will be a rightward shift in the supply curve.

Taxes: Firms treat taxes as if they were costs of production. Therefore the imposition of a new tax or the increase of
an existing tax represents an increase in production costs, so supply will fall and the supply curve will shift to the
left. The elimination of a tax or a decrease in an existing tax represents a fall in production costs; supply increases
and the supply curve shifts to the right.

Subsidies: A subsidy is a payment made to the firm by the government, and so has the opposite effect of a tax.
(Subsidies may be given in order to increase the incomes of producers or to encourage an increase in the production
of the good produced.) The introduction of a subsidy or an increase in an existing subsidy is equivalent to a fall in
production costs, and will give rise to a rightward shift in the supply curve, while the elimination of a subsidy or a
decrease in a subsidy will give rise to a leftward shift in the supply curve.

Supply shocks: Supply shocks are sudden events that have an impact on supply, such as unusual weather, war or
cuts in major input supplies (for example, imports of oil). An adverse supply shock, such as unusually bad weather
that affects agricultural output, or a cut in oil supplies, will result in a decrease in supply and leftward shift in the
supply curve. A beneficial supply shock (such as unusually good weather) results in an increase in supply and a
rightward shift in the supply curve.

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Market Equilibrium
Equilibrium is defined as a state of balance between different forces, such that there is no tendency to change. Market
equilibrium is determined at the point where the demand curve intersects the supply curve. The price that prevails in
market equilibrium is the equilibrium price, and the quantity is the equilibrium quantity. At the equilibrium price, the
quantity that consumers are willing and able to buy is exactly equal to the quantity that firms are willing and able to sell.
The buyers and sellers are satisfied, and there is no pressure on price to change. This price is also known as the market
clearing price, or simply market price.

Consider the table below which shows the demand and supply schedules for chocolate bars.

Price of chocolate Quantity demanded of Quantity supplied of


bars ($) chocolate bars per week chocolate bars per week
5 4,000 12,000
4 6,000 10,000
3 8,000 8,000
2 10,000 6,000
1 12,000 4,000

From the above table it can be seen that when the price of chocolate bars is $3, quantity demanded is exactly equal to
quantity supplied, at 8000 chocolate bars.

Let us now consider how the equilibrium position is reached. Let's say that the price in this market is initially $5. At this
price, chocolate producers would be willing and able to produce 12,000 bars, but consumers would only be willing and
able to buy 4000 bars. What will happen? When the producers see that they have unsold output of 8000 bars, they will
lower their price in order to encourage consumers to buy more chocolate. As the price falls, quantity supplied becomes
smaller and quantity demanded becomes bigger. As long as there is a surplus, there will be a downward pressure on
the price. The price will keep falling until it reaches the point where quantity demanded is equal to quantity supplied.

At a lower than equilibrium price, say $2, quantity demanded (10,000 bars) is larger than quantity supplied (6000 bars).
There is now a shortage of chocolate bars, or excess quantity demanded of 4000 bars (10,000-6000). If price were even
lower, at $1, the shortage would be larger, at 8000 bars. Say that the price is initially $1. Chocolate producers would be
willing and able to supply only 4000 bars, whereas consumers would be willing and able to buy 12,000 bars. Producers
will notice that all the chocolate bars will be quickly sold out, and so begin to raise the price. As they do so, the quantity
of bars demanded begins to fall and the quantity supplied begins to increase. The shortage in the chocolate market
exerts an upward pressure on price. The price will keep increasing until the shortage is eliminated; this will happen when
quantity supplied is exactly equal to quantity demanded.

The equilibrium position can be illustrated graphically

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Changes in market equilibrium
Once a price reaches its equilibrium level, consumers and firms are satisfied and will not engage in any action to make it
change. This presupposes that the demand and supply curves are fixed; in other words, that all those factors that can
cause shifts in these curves (the determinants of demand and supply) are constant and unchanging (recall the ceteris
paribus assumption). If there occurs a change in any of the determinants of demand or supply, there will result a shift in
the curves, and the market will adjust to a new equilibrium.

Changes in demand

Changes in Supply

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