Demand and Supply

Analysis
Learning Outcomes
Conceptual Understanding of Demand,
Demand Curve and Law of Demand.
To Understand effects of determinants of
demand on Demand Function.
To Understand causes of change in Demand.
 Demand
Demand: effective desire
Demand is that desire which backed by willingness and ability to
buy a particular commodity.
Amount of the commodity which consumers are willing to buy
per unit of time, at that price.
Things necessary for demand:
Time
Price of the commodity
Amount (or quantity) of the commodity consumers are willing
to purchase at the price
 Types of Demand

Direct and Derived Demand

Direct demand is for the goods as they are such as Consumer
goods
Derived demand is for the goods which are demanded to
produce some other commodities; e.g. Capital goods
Recurring and Replacement Demand
Recurring demand is for goods which are consumed at frequent
intervals such as food items, clothes.
Durables are purchased to be used for a long period of time
Wear and tear over time needs replacement
Complementary and Competing Demand
Some goods are jointly demanded hence are complementary in
nature, e.g. software and hardware, car and petrol.
Some goods compete with each other for demand because
they are substitutes to each other, e.g. soft drinks and juices.
 Determinants of Demand
Price of the product
Single most important determinant
Negative effect on demand
Higher the price-lower the demand
Income of the consumer
Normal goods: demand increases with increase in consumers
income
Inferior goods: demand falls as income rises
Price of related goods
Substitutes
If the price of a commodity increases, demand for its
substitute rises.
Complements
If the price of a commodity increases, quantity demanded of
its complement falls.
 Determinants of Demand
Contd

Tastes and preferences

Very significant in case of consumer goods
Expectation of future price changes
Gives rise to tendency of hoarding of durable
goods
Population
Size, composition and distribution of
population will influence demand
Advertising
Very important in case of competitive markets
 Demand Function

Interdependence between demand for a product and its

determinants can be shown in a mathematical functional
form
Dx = f(Px, Y, Py, T, A, N)
Independent variables: Px, Y, Py, T, A, N
Dependent variable: Dx
Px: Price of x
Y: Income of consumer
Py: Price of other commodity
T: Taste and preference of consumer
A: Advertisement
N: Macro variable like inflation, population growth, economic
growth
 Law of Demand
A special case of demand function which shows relation between
price and demand of the commodity
Dx = f(Px)
Other things remaining constant, when the price of a commodity
rises, the demand for that commodity falls or when the price of a
commodity falls, the demand for that commodity rises.
Price bears a negative relationship with demand
Reasons
Substitution Effect : When the price of a commodity falls (rises), its
substitutes become more (less) expensive assuming their price has
not changed.
Income Effect: When the price of a particular commodity falls, the
consumers real income rises, hence the purchasing power of the
individual rises.
 Demand Schedule and Individual
Demand Curve

Point e
on Demand 35
Demand Price (Rs (000 d
Curve per cup) cups)
30
a 15 50 c
b 20 40 25
b
c 25 30 20
d 30 20 a
15
e 35 10
O
10 20 30 40 50
Quantity of coffee
 Change in Demand

Shift in demand curve from D0 to

Price
D1 D1
D0 More is demanded at same
D2 price (Q1>Q)
Increase in demand caused by:
A rise in the price of a substitute
A fall in the price of a
complement
P A rise in income
A redistribution of income
towards those who favour the
commodity
A change in tastes that favours
the commodity
0
Q2 Q Q1 Quantity Shift in demand curve from D0 to
D2
Less is demanded at each price
(Q2<Q)
 Exceptions to the Law of Demand
Law of demand may not operate due to the following
reasons:
Giffen Goods
Snob Appeal
Demonstration Effect
Future Expectation of Prices (Panic buying)
Addiction
Neutral goods
Life saving drugs
Salt
Amount of income spent
Match box
 Market Demand

Market: interaction between sellers and buyers of a

good (or service) at a mutually agreed upon price.
Market demand
Aggregate of individual demands for a commodity at a
particular price per unit of time.
Sum total of the quantities of a commodity that all
buyers in the market are willing to buy at a given price
and at a particular point of time (ceteris paribus)
Market demand curve: horizontal summation of
individual demand curves
 Supply

Indicates the quantities of a good or service that the

seller is willing and able to provide at a price, at a given
point of time, other things remaining the same.
Supply of a product X (Sx) depends upon:
Price of the product (Px)
Cost of production (C)
State of technology (T)
Government policy regarding taxes and subsidies (G)
Other factors like number of firms (N)
Hence the supply function is given as:
Sx = (Px, C, T, G, N)
 Law of Supply
Law of Supply states that other things remaining the same, the
higher the price of a commodity the greater is the quantity supplied.
Price of the product is revenue to the supplier; therefore higher price
means greater revenue to the supplier and hence greater is the
incentive to supply.
Supply bears a positive relation to the price of the commodity.

Supply Schedule Supply Curve

Point on Price Supply (000 35
Supply (Rs. Per cups per e
Curve cup) month) 30
a 15 10 25 d
c
b 20 20 20
b
c 25 30 15 a
d 30 45
e 35 60 0
10 20 30 40 50 60
Quantity of Coffee
 Change in Supply

Shift in the supply curve from

S0 to S1
Price S2 More is supplied at each
S0 price (Q1>Q0)
Increase in supply caused by:
S1
Improvements in the
technology
Fall in the price of inputs
P
Shift in the supply curve from
S0 to S2
Less is supplied at each
price (Q2<Q0)
Decrease in supply caused by:
O A rise in the price of inputs
Q2 Q0 Q1 Quantity Change in government
policy (VAT)
 Market Equilibrium
Equilibrium occurs at the price where the quantity demanded and
the quantity supplied are equal to each other.
At point E demand is equal to supply hence 25 is equilibrium price

Price Demand
Supply (000 cups/
Price (000 cups/ month)
S (Rs) month)

15 10 50

E 20 15 40
25
25 30 30
30 45 15

D 35 70 10
O 30 Quantity
 Market Equilibrium
For prices below the equilibrium, Quantity demanded exceeds
quantity supplied (D>S)
Price pulled upward
For prices above the equilibrium, Quantity demanded is less than
quantity supplied (D<S)
Price pulled downward.
At point E demand is equal to supply hence 25 is equilibrium price.

Price
S Supply Demand
Price (000 cups/ (000 cups/
30 (Rs) month) month)
E 15 10 50
25
20 15 40
20
25 30 30
30 45 15
D
35 70 10
O
30 Quantity
 Changes in Market Equilibrium
(Shifts in Supply Curve)
The original point of equilibrium is
at E, the point of intersection of
curves D1 and S1, at price P and
quantity Q Price
S0
An increase in supply shifts the
supply curve to S2 D1 S1

Price falls to P2 and quantity rises S2

to Q2, taking the new equilibrium to P0 E0
E2 E
P E2
A decrease in supply shifts the S0
P2
supply curve to S0. Price rises to S1
P0 and quantity falls to Q0 taking S2 D1
the new equilibrium to E0
O
Thus an increase in supply raises Q0 Q Q2 Quantity
quantity but lowers price, while a
decrease in supply lowers quantity
but raises price; demand being
unchanged
 Changes in Market Equilibrium
(Shifts in Demand Curve)

The original point of equilibrium is

at E, the point of intersection of
Price curves D1 and S1, at price P and
quantity Q
D2 An increase in demand shifts the
D1
S1 demand curve to D2
Price rises to P1 and quantity rises to
D0 Q1 taking the new equilibrium to E1
P1 E1
A decrease in demand shifts the
E
P demand curve to D0
E2
P* Price falls to P* and quantity falls to
D2
Q* taking the new equilibrium to E2.
S1 D0 D1 Thus, an increase in demand
raises both price and quantity,
O
Q* Q Q1 while a decrease in demand lowers
Quantity
both price and quantity; when
supply remains same.
 Change in Both Demand and Supply
Initial equilibrium is at E1, with price
quantity combination (P1, Q1).
D2 An increase in both demand and
Price D2 supply takes place;
D1
S1 demand curve shifts to the right
S2 from D1 D1 to D2 D2
supply curve also shifts to the
right from S1 S1 to S2 S2.
P2 E2
P1 The new equilibrium is at E2, and
E1 E0
price quantity is (P2, Q2).
An increase in both supply and
S1 D demand will cause the sales to rise,
D2 2
S2 D1 but
O the price will increase if increase
Q1 Q2 Quantity in D>S (as at E2 )
No change in price if increase in
D=increase in S (as at E0 )
 The government announces a price hike in petrol and diesal in the
month of September. Resultantly, the cost of transportation of
vegetables rises leading to a rise in price of vegetables. Draw a
diagram showing the impact of these changes on demand for
vegetables.
Shirt manufacturers of Jalandhar are facing declining sales due to stiff
competition from imported Chinese garments. Thus, demand falls due
to the presence of a better substitute in the market. The manufacturers
call a meeting to solve the problem. They decide to cut production of
shirts thus offering lesser quantity for sale at the same price. However,
the fall in demand is lesser than the fall in supply. Show these changes
with the help of diagram depicting market equilibrium.
The growers of a local Indian variety of bananas are facing competition
from imported bananas from Argentina and Brazil. This has led to a fall
in demand for Indian variety over the last two years. The banana
growers call a meeting and cut production. However, fall in demand is
less than fall in supply. Show these changes.
 Summary
Demand is defined as the desire to acquire a commodity to satisfy
human wants, which is backed by ability to pay the price.
Categories of demand are made on the basis of the nature of
commodity demanded (consumer goods and capital goods); time
unit for which it is demanded (short run and long run); relation
between two goods (substitutes and complements), etc.
The law of demand states that the consumers will buy more of the
commodity when prices are high and less when prices are low,
provided all the other factors of demand remains constant.
Demand for a product X (Dx) is a function of price of the commodity X
(Px), income of the consumer (Y), price of related (substitutes or
complements) commodities (Po), tastes and preference of the
consumer (T), advertising (A), future expectations (Ef), population
and economic growth (N).
A change in quantity demanded denotes movements along the
demand curve due to a change in price, while a change in demand
denotes a rightwards or leftward shift of the demand curve due to a
change in the other determinants of demand other than price.
 Summary
Supply is defined as the willingness to produce and sell the commodity by
production units or firms.
The law of supply states that firms will sell more of the commodity when
prices are high and less of the commodity when prices are low provided all
the other factors of supply remains constant.
Supply of a product X (Sx) is a function of price of the product (Px), cost of
production (C), state of technology (T), Government policy regarding taxes
and subsidies (G), other factors like number of firms (N).
Change in quantity supplied refers to movements along the same supply
curve due to change in the price of the commodity. However when change in
supply is associated with change in the factors like costs of production,
technology, etc. it causes a shift of the supply curve upwards or downwards
Market equilibrium occurs where demand and supply are equal. This
equilibrium determines the price in the market through the forces of demand
and supply. Comparative statics is the process of comparison between two
equilibrium situations.
An increase in both supply and demand will cause the sales to rise, but the
effect on price can be positive, negative or equal to zero, depending on the
extent of the shifts in the demand and supply curves.