Determination of Price by Demand and Supply

IN THIS MODULE, YOU WILL:

MODULE

1. Study how demand and supply determine equilibrium price;

17 2. Identify some problems which can be solved only by demand and

supply analysis; and

3. Look into the effects of government actions on market prices

Price and quantity demanded are inversely related. A rise in
price lowers quantity demanded while a fall in price raises quantity
demanded. On the other hand, price and quantity supplied are directly Demand, Supply and Equilibrium
related. A rise in price raises quantity supplied while fall in price lowers
The interaction of demand and supply results in an equilibrium
quantity supplied.
price. The equilibrium price is attained when quantity demanded
In the earlier modules, we analyzed supply and demand equals quantity supplied. At the equilibrium price, the quantity of the
separately. We have seen that consumers demand different amounts good that buyers are willing and able to buy equals the quantity that
of goods as determined by this good’s price. Similarly, producers the sellers are willing and able to sell. At the equilibrium level, price
willingly supply different amounts of a good depending on this good’s has no tendency to change because both the buyers and the sellers
price. In this module, we study demand and supply together and see have been satisfied.
how they determine the price of a good or service sold in a market and
its quantity.
Table 17.1 Demand and Supply Schedule for Suman because the amount that buyers want to buy is just equal to the
amount that sellers want to sell.

Demand Curve, Supply Curve and Equilibrium

Points Price in Quantity Quantity State of Pressure
pack (₱) Demanded supplied Market on Price The market equilibrium can also be shown through a demand
(Packs) (Packs)
and supply. Figure 17.1 shows that the Equilibrium price (₱30) comes
A 50 9 18 Surplus Downward
at the intersection of the demand and supply curves.
B 40 10 16 Surplus Downward
C 30 12 12 Equilibrium Neutral
D 20 15 7 Shortage Upward
E 10 20 2 Shortage upward
P
SURPLUS
Table 17.1 shows the demand and supply schedule for suman. Notice
that point A where the price is ₱ 50, quantity demanded is nine packs 50 . .
. .

Price of Suman (₱ )
while quantity supplied is 18 packs. Because quantity supplied is
40
greater than quantity demanded, there is a suplus of suman. As such,
sellers of suman are not able to sell all the suman they want to sell. 30 . EQUILIBRIUM
They respond to the surplus by lowering their prices.
20 . .
At point E where the price is ₱ 10, quantity demanded is 20
packs while quantity supplied is two packs. Because quantity
10 . SHORTAGE
.
Q
demanded is greater than quantity supplied, there is a shortage of 5 10 15 20 25
suman. With this, many buyers chase a few goods. Sellers can take
advantage of the shortage by raising their prices. Quantity of Suman
( Packs)
At point C where the price is ₱ 30, quantity demanded is 12
packs while quantity supplied is also 12 packs. Because quantity
demanded is equal to quantity supplied, there is equilibrium in the
market for suman. In this case, price has no tendency to rise or fall
At prices higher than equilibrium price, there is a surplus. At prices cost of transport, hence, the increase of the market price for farm
lower than the equilibrium price, there is a shortage. products.

At the price of ₱50, quantity supplied is 18 while quantity

demanded is nine packs. There is a surplus at price ₱50. The same is
Figure 17.2 Supply Shift
true at price ₱40. In these situations, price moves downward. At the
price of ₱10, quantity demanded is 20 packs while quantity supplied is
P
D
..
S2
S1

...
two packs. There is a shortage at price ₱10. The same is true at price
₱20. In these situations, price moves upward.

Price of Palay ( ₱ )
-----------------------------------------------------------------------
2,000
...
Self – Check

.. .
.. .
1. What is meant by equilibrium price?
----------------------------------------------------------------------- 1,000
Effects of a Shift in Supply or Demand S2 D
S1
English writer Gregory King noted in the 17th century that when
the harvest is poor, the prices of farm products are higher. When the
Q
0 500 800
harvest is plentiful, the prices of farm products are lower. Why did he
observe such things? Quantity of Palay
( Sacks )
Bad weather or calamities like typhoon or flood decreases the
supply of farm products. This is shown in the leftward shift of the
supply curve in Figure 17.2 where the supply curve for palay moved
from S1 to S2. As a result, the quantity of palay available in the market
decreased from 800 sacks to 500 sacks while in the market price
increased from ₱1,000 per sack to ₱2,000 per sack. The damage
brought about by these normal flow of goods and might even raise the
 An increase in the income of households increases the demand SYNTHESIS
for farm products. This is shown in the rightward shift of the demand
curve in Figure 17.3 where the demand curve for palay moved from
D1 to D2. As a result, the quantity of palay available in the market  The interaction of demand and supply results in an equilibrium
increased from 800 sacks to 900 sacks while in the market price price. The equilibrium price is attained when quantity demanded
increased from ₱1,000 per sack to ₱1,500 per sack. An overall positive equals quantity supplied.
economic condition of the households triggers an improvement in  At prices higher than equilibrium price, there is a surplus. At
economic endeavors as well as encourage suppliers to increase their prices than the equilibrium price, there is a shortage.
production.  The demand and supply diagram is used to examine how shifts
in demand and supply affect the equilibrium price and quantity.
Figure 17.3 Demand Shift
 Both the interaction of demand and supply and government
actions determine the price and quantity that prevail in the
market. Government interventions in the market include the
imposition of price controls and taxes on sellers.
P
D1 ..
D2
S
.. MODULE REVIEW
Price of Palay ( ₱ )

1,500
. .. . A. Vocabulary. Define the following terms and use each in a
sentence.

1,000 . D2
1. equilibrium price

S 2. shift in the demand curce

D1
3. movement along the supply curve
Q
0 800 900 4. interaction of demand and supply
Quantity of Palay
( Sacks )
B. Review Questions. Answer the following. 1. What is the equilibrium price?

1. What are determined by the interaction of demand and supply?
2. How does the behavior of buyers and sellers drive the market price
towards the equilibrium level?
3. When price ceiling is set below the equilibrium price, what happens
to quantity demanded and quantity supplied?
4. What will happen to the price faced by the buyers of alcoholic
beverages when a tax is imposed on the sellers of alcoholic drinks?
C. Activities
2. At the equilibrium price, what is quantity demanded and quantity
supplied?
3. At what prices would there be a surplus? At what prices would there
be a shortage?
VALUING
What factors should the buyers and sellers consider in deciding
how much of a commodity to buy and sell?

From the table below, graph the demand and supply curves 1. The equilibrium price at which the quantity of the god that buyers
then answer the question that follow. are willing and able to buy equals the quantity that sellers are willing
and able to sell. At the equilibrium level, price has no tendency to
Supply Price Demand change because both the buyers and the sellers have been satisfied.

20 10 120 2. Supply and demand analysis allows us to explain why prices go up

30 15 100 or go down or remain constant.
40 20 90
50 25 80
60 30 60
70 35 40
80 40 20
90 50 5
 GLOSSARY Supply - represents how much the market can offer

Surplus –is the amount of an asset or resource that exceeds the

portion that is utilized.
Consumers - is the one who pays something to consume goods and
services produced Supply Curve – is a graphical representation of the relationship
between the price of a good or service and the quantity supplied for a
Demand - refers to how much (quantity) of a product or service is
given period of time.
desired by buyers
Shortage – a state or situation in which something needed cannot be
Demand Curve – a graph showing how the demand for a commodity
obtained in sufficient amounts.
or service varies with changes in its price.

Equilibrium - is defined as the price pair where the quantity

demanded is equal to the quantity supplied.

Market - is defined as the sum total of all the buyers and sellers in
the area or region under consideration

Neutral - are goods whose demand is independent of income

Price - is a reflection of supply and demand.

Producers - a person, company, or country that makes, grows, or

supplies goods or commodities for sale.

Quantity Demanded - is the amount of a product people are willing

to buy at a certain price

Quantity Supplied - refers to the amount of a certain good

producers are willing to supply when receiving a certain price.