Forces of demand and supply interact to determine prices.

Prevailing prices tell producers which goods to produce.

Resource prices tell firms which resources to use to produce profitably.
Resource prices affect income which influence distribution of goods and services.
Consumers are sovereign.
Producers respond to people who are both willing and able to purchase and
determine which goods to produce.
Demand shows the quantities of a good or service that buyers are willing and
able to purchase at various prices during a given time period.
As price decreases, quantity demanded increases – Law of Demand

Why demand curves slope downward

Income effect
If prices of goods decline, consumers are able to buy (more, less) with their fixed
income.

Substitution effect
At a lower price, a product becomes (more, less) attractive relative to other items
serving the same function.

Law of diminishing marginal utility

Economics is a “behavioral science” in that it describes the behavior of economic

agents.
 A demand function is a behavior function for consumers.

Qd = 12,000 – 200P

Quantity
Price Demanded
$50 2,000
40 4,000
30 6,000
20 8,000
10 10,000
Change in quantity demanded
caused by a change in the product’s price
shown by a movement along the demand curve
Change in Demand
caused by a change in one or more of the determinants of demand
shown as a shift of the entire demand curve

Producers sell more at a higher price.

Higher price enables them to cover costs to earn profit.
Supply shows the quantities of a good or service that producers are willing and
able to offer for sale at various prices during a given time period.
As price increases, quantity supplied also increases – Law of Supply

Economics is a “behavioral science” in that it describes the behavior of economic

agents.
A supply function is a behavior function for producers.

Qs = 200P
We describe market behavior using supply and demand functions.

Quantity
Price supplied
$50 10,000
40 8,000
30 6,000
20 4,000
10 2,000

Change in quantity supplied

caused by a change in the product’s price
shown by a movement along the supply curve
Change in Supply
caused by a change in one or more of the determinants of supply
shown as a shift of the entire supply curve

To solve for equilibrium price (Pe), equate Qd to Qs, solve for Pe.
Qd = Qs
12,000 – 200P= 200P
Substitute Pe to Qd or Qs to compute for equilibrium quantity (Qe)
Prove by checking.
At equilibrium price, quantity demanded equals quantity supplied. (no tendency
for change)
 below equilibrium price,
quantity supplied < quantity demanded
shortage ® P
 above equilibrium price,
quantity supplied > quantity demanded surplus ® ¯ P
• Higher demand leads to higher equilibrium price and higher equilibrium
quantity.
• Higher supply leads to lower equilibrium price and higher equilibrium
quantity.
• Lower demand leads to lower price and lower quantity exchanged.
• Lower supply leads to higher price and lower quantity exchanged.

Determinants of Demand
o Taste and preferences (advertisement, fashion, age, sex, culture, health,
technology, climate, location, mode of payment)
o Consumers’ income
o (normal goods or inferior goods
o Price of a related good (substitute/complement)
o Consumers’ expectation
o Number of Buyers

Determinants of Supply
o Number of sellers
o Resource prices
o Technology
o Prices of other goods
o Price Expectation
o Taxes and subsidies
o Exportation and importation
o Calamities

Relative Magnitudes of Change

The relative magnitudes of change in supply and demand

determine the outcome of market equilibrium.
Relative Magnitudes of Change

When supply and demand both increase, quantity will

increase, but price may go up or down or remain
the same.