Elements of Demand and Supply

2
Elements of Demand and Supply

Volumes consumers are willing to buy at certain price levels constitute the market demand for a
product or service. On the other hand, business firms will cater to consumers’ demand by
offering commodities at various prices. The final price of the commodity is determined by the
interaction and relationships of demand and supply in the market based on the cost of producer
and the utility to the buyer. A market is any place where the sellers of a particular good or
service can meet with the buyers of that goods and service where there is a potential for a
transaction to take place. The buyers must have something they can offer in exchange for there to
be a potential transaction. Market can be a physical location or on cyberspace.

Objectives:

After studying this chapter, the students should be able to:

1. Explain demand and how it can change;

2. Explain supply and how it can change;
3. Discuss the relationship between price and quantity demand and quantity supplied;
4. Discuss how supply and demand interact to determine the market equilibrium; and
5. Diagram and explain how changes in the demand and supply affect equilibrium volume
and prices.

A. Demand

Demand is the schedule or a curve of the various quantities of goods and services that
consumers are willing and able to buy at different prices at a given time.

The law of demand states that, assuming all else is held constant, the quantity demanded
for a good rises as the price falls. It should be emphasized that the assumption of “all else
is held constant,” or ceteris paribus in Latin is vital for the law of demand to be effective.

Principles of Economics, Taxation and Agrarian Reform

1
Elements of Demand and Supply

The law of demand implies a downward sloping demand curve, with quantity demanded
increasing as prices decrease. This means that the quantity demanded and price are
inversely related. This behavior can be explained by the following:

1. The law of demand is consistent with common sense. People normally buy more
of low-priced product or service. “Bargains,” “discounts,” “sales” at reduced
prices are aimed at inviting consumers, hence increased demand.

2. Law of diminishing marginal utility, the theory that for each additional unit of a
product an individual consumes, the less utility or satisfaction the person derives
from it. This explains the market strategy of “eat all you can” promos of some
restaurants.

3. The income effect is defined as the result of a change in a product's price relative
to the consumer's disposable income. When the price of a good changes, the real
or actual income of the consumer who wants that good also changes. A decrease
in the price of the product or service would mean that the consumer can buy more
of the product or service, or otherwise. A P200.00 budget for rice can buy 5
kilograms considering the P40.00 per kilogram market price for the commodity.
When the said price increases to P45.00/kg without adjusting the budget, the
consumer can buy only 4.44 kilograms of rice. On the other hand, 5.71 kilograms
of rice priced at P35.00/kg can be bought by the same P200.00 budget.

4. The substitution effect takes place when, as the result of a price increase, the
consumer will substitute another product in its place, or forgo the product
altogether. This concept, however, depends on what sort of product has gone up
in price, and how the consumer views that product. If the product is a necessity,
then the substitution effect will become clear, since the consumer, who cannot do
without the product, will shift, or substitute, a lower-cost version of the same
item. When the prices of commercial rice reach exorbitant levels, some
consumers demand for the lower- priced NFA rice, in lieu of commercial rice.

Determinants of Demand

Demand is the driving force for any economy. The purchases made by household and
individuals to satisfy the unlimited needs, wants, and desires, keep businesses going. In
the Philippines, more than 9 billion pesos worth of goods and services were consumed by
households in 2014 as shown below. Demand for goods and services results to more
economic activities like putting up of new businesses or expansion, creating employment
and income for consumer spending.

Principles of Economics, Taxation and Agrarian Reform

2
Elements of Demand and Supply

HOUSEHOLD FINAL CONSUMPTION EXPENDITURE

Annual 2013 and 2014
AT CURRENT AND CONSTANT 2000 PRICES, IN MILLION PESOS

At Current Prices At Constant Prices

ITEMS Growth Growth
2013 2014 Rate 2013 2014 Rate
(%) (%)
HOUSEHOLD FINAL
CONSUMPTION 8,464,883 9,159,243 8.2 4,694,760 4,948,250 5.4
EXPENDITURE

1. Food and Non-alcoholic

3,605,777 3,868,950 7.3 1,965,151 2,053,608 4.5
beverages
2. Alcoholic beverages,
110,059 126,588 15.0 63,540 70,094 10.3
Tobacco
3. Clothing and Footwear 116,635 127,205 9.1 75,625 79,742 5.4
4. Housing, water,
electricity, gas and other 1,062,100 1,149,574 8.2 519,375 547,227 5.4
fuels
5. Furnishings, household
equipment and routine 326,101 350,603 7.5 249,442 261,869 5.0
household maintenance
6. Health 218,729 250,472 14.5 109,462 120,923 10.5
7. Transport 894,369 997,368 11.5 385,344 424,026 10.0
8. Communication 264,281 275,399 4.2 251,031 258,835 3.1
9. Recreation and culture 154,391 166,089 7.6 108,269 114,032 5.3
10. Education 334,586 367,081 9.7 146,143 153,662 5.1
11. Restaurants and hotels 318,553 345,623 8.5 195,181 208,356 6.8
12. Miscellaneous goods
1,059,301 1,134,290 7.1 626,197 655,875 4.7
and services
Source: Philippine Statistics Authority
Posted: 29 January 2015

It is said that without demand, businesses would not bother to produce anything. This
leads us then to the question of what factors affect demand. A condition of ceteris paribus
is an important assumption for a better understanding of how each determinant affect
demand.

1. Price – The inverse relationship of price and demand would show that when prices rise,
the quantity demanded falls and vice versa. Price is an important consideration in the
purchase and consumption of goods and services. How consumers react to changes in
prices of commodity can be further explained by elasticity of demand.

2. Income – Purchases depend on the level of disposable income that the household is
willing to spend .Normally, when income rises, the quantity demanded will also increase

Principles of Economics, Taxation and Agrarian Reform

3
Elements of Demand and Supply

because of the additional purchasing power of the consumer. In such case, where the
demand for a particular commodity exhibits a direct relationship with income, that
particular product is a normal good. Goods for which the income effect is reversed,
meaning demand may drop when income rise, are classified as inferior goods.

It should be emphasized that what is a normal good for one person may be an inferior
good for another person, and vice versa. One needs to analyze the income effect and to
remember that, a good is normal if market demand increases as income increases, on
average and a good is inferior if market demand decreases as average income increases.

3. Tastes – Some economists use the term "tastes" as a catchall category for consumers'
attitude towards a product. Taste refers to the desire, preferences and opinions for a good
or service. This is the desire, emotion, or preference for a good or service. There is a
clear-cut explanation as to how tastes affect demand: a favorable change in the consumer
preference for a product would result to increase in demand for that product.
Correspondingly, when tastes fall, it will depress the quantity demanded.

4. Prices of related goods or services – A change in the price of related products can either
increase or decrease the demand for a product depending on whether the related product
is a substitute or a complement. Substitute good is one that can replace the other good
while complement or complementary good is one that is used together with the other
good.

Principles of Economics, Taxation and Agrarian Reform

4
Elements of Demand and Supply

As shown above, the change in the price of substitutes and complements impacts on
the demand for the other good. For substitutes, an increase in the price would have
Good A lead to an increase in the demand for the substitute good B, and when the
price of Good A decreases, the demand for Substitute Good B will decrease. When
the price of pork increases, consumers tend to buy the lower-priced poultry products.

For complements, an increase in the price of one of the goods will decrease demand
for the complementary good. Conversely, a decrease in the price of one of the goods
will increase demand for the complementary good. The price of gasoline impacts on
the sales of cars.

There are many goods that are not related at all and they are aptly called unrelated
goods. They are not affected all by the changes in their respective prices.

5. Consumer Expectations – refer to a confident belief or strong hope that a particular

event will happen in the future. The consumer expectations on future prices, income,
and value of economic goods affect today’s demand for the product or service.
In anticipation of a lower price of gasoline taking effect 6:00 the following morning,
car owners may opt to limit or even delay gassing up today. Car owners will behave
differently if tomorrow’s prices grow higher. They may decide to fill their tanks until
full and avail today’s lower price. If future prices are expected to be lower, demand
is less for a given price, because a person decides to delay the purchase. If future
prices are expected to be higher, demand may be higher for a given price, because a
person prefers to buy now before the good becomes too expensive.
When people expect that the value of something will rise, then they demand more of
it as experienced in the real estate, stock market, and pre-need business. Also, people
who expect their incomes to increase in the future will often increase their
consumption today. On the other hand, workers and employees of companies
undergoing restructuring and possible manpower reduction may decide to limit
current expenditures on the essentials and necessities.

Principles of Economics, Taxation and Agrarian Reform

5
Elements of Demand and Supply

6. Number of buyers in the market - The number of buyers affects overall, or

aggregate, demand. As the number of buyers entering the market rises, so does the
quantity demanded -- even if prices do not change.

Demand Schedule and Demand Curve

Below is a hypothetical demand for pandesal at various levels of prices ranging

from P1.00/piece to P5.00/piece. The demand curve is the graphical
representation of the demand schedule. The demand curve is downward sloping
showing the inverse relationship between price and quantity demanded.

Demand Schedule for Pandesal

Price/ piece Quantity

Demanded
1 55
2 38
3 26
4 18
5 10

Principles of Economics, Taxation and Agrarian Reform

6
Elements of Demand and Supply

Movement along the Demand Curve

When the change in demand is brought about by adjustments in the price of goods and services,
we have a movement along the demand curve. Based on the graph below, when the price is
increased from P10.00 to P20.00, there was a contraction in quantity demanded from 350 to 200 .
A decrease in the price from P10.00 to P5.00 resulted to an increase in quantity demanded from
350 to 550.

Shifts of the Demand Curve

Changes in the non-price determinants of demand lead to changes in demand or a shift of the
demand curve. Changes that raise the quantity buyers are willing to purchase at any given price
shift the demand curve to the right. When the quantity buyers that will buy decreases, the
demand curve shifts to the left.

Principles of Economics, Taxation and Agrarian Reform

7
Elements of Demand and Supply

B. Supply

Supply is the schedule or a curve of the various quantities of goods and services that
producers are willing and are able to sell at different prices at a given time.

To a supplier, price is equated to revenue, an incentive for them to produce and sell the
product. The higher the price, the higher the incentive, and the greater the quantity
supplied.

The law of supply states that, assuming all else is held constant, the quantity supplied for
a good rises as the price increases. Similar to the Law of Demand, the assumption of “all
else is held constant,” ceteris paribus in Latin is important for the law of supply to be in
effect.

The law of supply indicates a direct relationship between price and quantity supplied as
shown by an upward sloping supply curve.

Determinants of Supply

1. Price: The positive relationship of price and supply would show that when prices
rise, the quantity supplied increases. The degree of reaction can be measured by
elasticity of supply.
2. Resource Prices: The cost of acquiring the inputs of production (land, labor,
capital, entrepreneurship) determines the production cost and the ability to supply
a good. If resource prices increase, then production cost is higher and results to
reduction in the quantity of the good for sale. When producers get their resources
at lower prices, there is a possibility of producing additional units of the good for
sale.

Principles of Economics, Taxation and Agrarian Reform

8
Elements of Demand and Supply

3. Production Technology: Technology refers to the processes by which inputs are

turned into outputs. Improvements in technology enable the firms to produce
more with fewer resources. The firms become more efficient and capable of
achieving the desired output with the minimum use of resources. Improvements
in technology result to decrease in the “per unit” production costs, encouraging
firms to produce more supply. A decline in technology means producers can sell
less of a good.

4. Prices of Other Goods: One characteristic of resources is that it has alternative

uses. Resources can be combined to produce other goods. A garment factory can
utilize its machines and manpower in the production of in-demand or better-
priced garments to be more profitable. This is what you call substitute in
production. This would result to an increase in the supply of the substitute
product.

5. Sellers' Expectations: It is expected of sellers to hold on to their stocks and sell

less when there is a prediction of higher prices for their products. On the other
hand, if future prices are expected to decline, producers and sellers will dispose of
their products now. Profit is a motivating factor for business. Hence, sellers seek
to sell their goods at the highest possible price.

6. Number of Sellers: When there are more producers and sellers offering a good or
service, there would be more supply for the commodity. However, with fewer
sellers, the corresponding supply would also be lesser.

Principles of Economics, Taxation and Agrarian Reform

9
Elements of Demand and Supply

Supply Schedule and Supply Curve

Below is a hypothetical supply for pandesal at various levels of prices ranging

from P1.00/piece to P5.00/piece. The supply curve is the graphical representation
of the supply schedule. The supply curve is upward sloping showing the direct
relationship between price and quantity supplied.

Supply Schedule for Pandesal

Price/ piece Quantity

Supplied
1 11
2 30
3 42
4 51
5 60

Principles of Economics, Taxation and Agrarian Reform

10
Elements of Demand and Supply

Movement along the Supply Curve

A Change in Quantity Supplied is a change in the specific amount of the good that sellers are
willing and able to purchase. It is caused by a change in the supply price and is indicated by a
movement along the supply curve from one point to another.

A. Price Increase B. Price Decrease

Graph A shows that at P5.00, quantity supplied is at 20 units. When the price increased to
P10.00, the suppliers reacted positively by increasing the supply to 50 units.

Graph B, on the other hand shows the effect of decreasing the price from P1 to P2. Quantity
supplied also decreased from Q1 to Q2. Using the figures in Graph A, decreasing the price from
P10.00 to P5.00 results to a 30 unit reduction in the supply.

Principles of Economics, Taxation and Agrarian Reform

11
Elements of Demand and Supply

Shifts of the Supply Curve

Changes in the non-price determinants of supply lead to a change in supply or a shift of the
supply curve. Changes that raise the number of quantity buyers who are willing to purchase at
any given price shift the demand curve to the right. A decrease in supply, shifts the supply curve
to the left while an increase in supply, shifts the supply curve to the right.

Principles of Economics, Taxation and Agrarian Reform

12
Elements of Demand and Supply

C. Market Equilibrium
Economic equilibrium is defined as the point where supply equals demand for a product and the
equilibrium price is where the hypothetical supply and demand curves intersect. The interplay of
supply and demand in the market resulted to a market equilibrium where equilibrium quantity is
at 500 units and the equilibrium price (EP) is at P60.00 as shown by the graph below.

With price (P1) higher than the equilibrium price (EP), it can be seen that the quantity supplied is
more than the quantity demanded, hence there is a surplus. Producers will have the tendency to
lower their price to encourage buyers to buy the excess supply.

When the price (P2) is below the equilibrium price, there would be a shortage or excess
demand. Consumers will compete for the limited supply and offer higher price for the
commodity.

Principles of Economics, Taxation and Agrarian Reform

13
Elements of Demand and Supply

Competition among buyers and sellers determines the equilibrium price. This price will continue
to prevail unless disturbed brought about by changes in the determinants of demand and supply
or some exogenous factors.

Economic equilibrium can be static or dynamic and may exist in a single market or multiple
markets. It can be disrupted by exogenous factors, such as a change in consumer preferences,
which can lead to a drop in demand and consequently a condition of oversupply in the market. In
this case, a temporary state of disequilibrium will prevail until a new equilibrium price or level is
established, at which point the market will revert back to economic equilibrium.

Shifts in the supply and demand curves affect the market equilibrium as shown by the series of
graphs below. Based on your assumptions, you can analyze each graph and discuss how the new
market equilibrium is determined.

Principles of Economics, Taxation and Agrarian Reform

14
Elements of Demand and Supply

References:
Mankiw, G.N., (2012). Essentials of Economics 6th Edition.
Harvard University: South-Western, Cengage Learning

Mastrianna F.V.(2013).Basic Economics 16th Edition.

South-Western Cengage Learning

McConnel, C. et.al (2012). Economics: Principles,

Problems, and Policies (Global Edition). McGraw Hill Co.,
Inc.

Stock W.A., (2013) Introduction to Economics: Social

Issues and Economic Thinking

http://www.amosweb.com/
http://economics.about.com
http://economicsconcepts.com/
ph.images.search.yahoo.com
http://www.merriam-webster.com/dictionary
http://www.nscb.gov.ph/
http://useconomy.about.com/

Principles of Economics, Taxation and Agrarian Reform

15