Download STUDY UNIT: 4 CHAPTER: 7 DEMAND, SUPPLY AND PRICES 7.1

STUDY UNIT: 4
CHAPTER: 7
DEMAND, SUPPLY AND PRICES
7.1 Demand and supply: an introductory overview
Households own factors of production sell these factors to firms in the factors market and receive rent, wages,
salaries, interest and profit.
 Rent -natural recourses
 Wages & Salaries – Labour
 Interest – Capital
 Profit – entrepreneurship.
Firms combine these factors of production to produce goods and services that are sold in the goods markets to
households who use the income to purchase services and stock.
Demand and supply are often likened to the two blades of a pair scissors that interact to determine the
equilibrium price and equilibrium quantity in the market.
7.2 Demand
Is the outcome of decisions about which wants to satisfy, given the available means. If you demand something,
you intend to buy it and that you have the means(purchasing power) to do so.
Demand is the quantities of a good or service that the potential buyers are willing and able to buy.
Wants are unlimited desires or wishes that people have for goods and services.
Demand is only affective if the consumer is able and willing to pay for the goods or services.
Demand is a flow concept (measured over a period)
Individual demand
What determines the quantity of something?
 The price of the product :lower price more is bought
 The price of related products: complements and substitutes. Substitutes are goods which can be used
instead of other good
 Income of the consumer : higher income more can be bought
 The taste/preference of the consumer : don’t like product you wont buy a lot
 Size of the household : more people more product will be bought
One thing that does not determine quantity bought is the availability or supply, the availability can only affect
the actual outcome in the market.
ECONOMIC THEORY IS SIMPLIFIED COMMON SENSE BUT IT IS STRUCTURED, DISCIPLINED OR LOGICAL
COMMON SENSE.
Demand can be expressed in words, schedules, curves and equations.
Verbal concept
The quantity of a good demanded by an individual in a particular period depends on the price of the good, the
price related goods, income of the individual, taste, number of people in household and any other possible
influence.
Equation concept
Qd:
Quantity
Px:
Price
Pg:
Price of related goods
Y:
Income
T:
Taste
N:
Number of people in household
LAW OF DEMAND
OTHER THINGS BEING EUAL(CETERIS PARIBUS) THE
HIGHER THE PRICE OF THE GOOD, THE LOWER THE
QUANTITY DEMANDED.
Qd=f(PX,Pg,Y,T,N)
Dependent variable: Qd
Independent: PX,Pg,Y,T,N
The purpose of theory: understand things by reducing the details to a minimum
When focusing on the relationship between Qd and Px we assume that PX,Pg,Y,T,N do not change.
So we rewrite equation Qd=f(PX,Pg,Y,T,N) to Qd=f(PX) ceteris paribus
Schedule concept
POSSIBILITY
PRICE OF
GOODS
1
2
3
4
5
A
B
C
d
e
QUANTITY
DEMANDED
6
5
4
3
2
Curve concept
WEEKLY DEMAND OF GOODS
7
6
5
4
WEEKLY DEMAND
OF GOODS
3
2
1
0
1
2
3
4
5
6
Each point indicates the quantity of goods demanded at that price. By joining the points we obtain the demand
curve DD, the demand curve indicates the relationship between the quantity of goods demanded and price of
goods , on assumption everything else stays the same
Bases of any diagram is the axes
Vertical axes (independent):
Horizontal axes(dependent):
- Negative/ inverse relationship
Recap of concepts:
 Using words: refers to the entire relationship, between quantity demanded and the price of the goods
or service.
 Using numbers( schedule): demand schedule is a table which shows the quantity of a good demanded
at each possible price
 Using graphs: demand curve is the line that which indicates the quantity demanded of a good at each
price
 Using symbols: is a shorthand way of expressing the relationship between quantity of a good and its
price
Market demand
The individual demand curve is one of the most important building block of microeconomic theory. In a market
system all the plans of the consumers and producers of a good or service have to be taken into account.
Market demand is simply the sum of all the individual demands. To obtain a market demand schedule , all the
demand schedules are simply added together, the market demand curve can be obtain also but just adding all
the curves together.
Movements along the demand curve and shifts of the curve.
Movement-slope of the curve
Shift-position or intercept of the curve
Movement along a demand curve (change in quantity demanded)
If the price of the products changes: we obtain the change in the quantity demanded by comparing the
relevant points on the fixed, given or unchanged demand curve by moving along the curve. This is how we
determine the change in quantity demanded.
Shift of the demand curve(change in demand)
A change in any determinants of demand other than the price of the product will shift the demand curve. The
price is elevated to centre stage by measuring it on the vertical axis, changes in the other determinants of the
demand is reflected only as shifts of the curve itself. This is change in demand.
Difference between the change in quantity demanded and change in demand
 A change in the price of a related good
There is 2 categories: substitutes and complements
o Substitutes
Used to replace another good, if the rice of the substitute is increased a greater quantity of
the good will be demanded.
The curve will shift to the right.
o Complements
Used jointly to satisfy want. A fall in the price of a complementary product increases the
demand for the product and this is illustrated by rightward shift of curve, an increase in the
price of the complement will lead to a decrease in the demand for the product shift to the
left.
o Change in the income of consumers
Increase will lead to a increase in the demand and the curve will shift to the right whereas a
decrease in the income will lead to a decrease in the demand and curve will shift to the left.
Normal goods- is when income decrease demand decrease
Inferior good- when income increase demand decrease, for example a family will change
bread for meat because they have more money.
o Change in taste
When taste change demand changes, when taste decreases the demand will decrease and
curve will shift leftward. When taste increase the demand will increase and curve will shift
rightward. Advertising and Fashion can play a role in this change.
o Change in population
The larger the population the bigger the demand, smaller population the smaller the
demand. Increase in population will shift curve to the tight, ceteris paribus.
o Other influences
 A change in expected future prices
Expected price change can change in demand, if price is about to fall consumer will
wait till price has fallen, current demand will fall but future demand will increase.
Ceteris paribus.
 Distribution of income
Demand may also change if a constant total income is redistributed among the
different households in the economy. The demand for goods bought mostly by lowincome households will increase, while the demand
DETERMINANT
CHANGE
EFFECT ON MARKET
CORRECT DESCRIPTION
DEMAND CURVE
ON EFFECT
Price of the good
Increase
Upward movement
A fall in the quantity
along the demand curve demanded
Decrease
Downward movement
An increase in the
along the demand curve quantity demanded
Prices of related good
Substitutes
Increase
Rightward shift of the
An increase in demand
demanded curve
Leftward shift of the
A fall in demand
demand curve
Complements
decrease
Leftward shift of the
A fall in demand
demand curve
Rightward shift of the
An increase in demand
demanded curve
Income
(normal good)
Increase
decrease
Taste
Increased
Decrease
Population
Expected future price of
goods
increase
Expected to increase
Price expected to fall
Rightward shift of the
demand curve
Leftward shift of the
demand curve
An increase in demand
Rightward shift of the
demand curve
Leftward shift of the
demand curve
rightward shift of the
demand curve
Leftward shift of the
demand curve
Increase in demand
Rightward shift of the
demand curve
Leftward shift of the
demand curve
Increase in demand
A fall in demand
Fall in demand
Increase in demand
A fall in demand
Fall in demand
Absolute price – rand and cents
Relative price – ratio between the price and the prices of other goods
a fall in the price does not only mean that the absolute price falls but the relative price also, the good therefor
becomes relatively and absolutely cheaper than before, all the other goods become relativity more expensive
than before
7.3 Supply
Defined as the quantities of a good or service that producers plan to sell at each possible price during a certain
period.
Supply is a flow concept which is measured over a period of time, also be expressed in words, schedules,
curves or equations.
Individual supply
What determines supply in a period?
 Price of goods
Higher the price the more you will produce, ceteris paribus.
 The prices of alternative products
Always consider the prices of alternatives outputs that they can produce with the same recourses,
these outputs are sometimes referred to as a substitutes in production.
 Prices of factors of factors of production and other inputs
To make a profit he has to cover his costs of production.
 Expected future prices
 State of technology
New technologies that enable producers to produce at lower cost will increase the quantity supplied
at each price.
Supply decisions must not be confused with demand decisions or with actual outcomes in the market.
Suppliers have no guarantee that their produce will sell.
Verbal concept
The quantity of a good supplied by an individual producer in a aprticular period is a function of the price of the
good, the prices of alternative outputs, the prices of the factors of production, the expected future prices of
the good and the stat of technology.
Equation concept
QS
=Quantity of goods supplied
PX
=price of goods
PG
=price of alternative outputs
PF
=prices of factors of production and other inputs
PE
=expected future prices of goods
TY
=technology
Expressed as:
QS=F(PX,PG,PF,PE,TY)
Focus primarily on the relationship between the quantity supplied and the price of the good
We therefore state:
QS=F(PX,PG,PF,PE,TY)- bars indicate they are kept constant
QS=F(PX)
Supply concept
possibility
Price of goods
A
B
C
D
E
1
2
3
4
5
Quantity
supplied
500
1000
1500
2000
2500
Curve concept
supply
6
5
4
3
2
1
0
Series 1
Summary of concepts:
 Using words
Supply refers to the entire relationship between the quantity supplied of a commodity and the price
of that commodity, other things being equal. usually positive relationship, higher price higher supply
 Using numbers
Show the quantity supplied at each price .
 Graphs
Indicate the quantity supplied of a good at each price. Ceteris paribus.
 Symbols
Equation shorthand way of expressing the relationships between quantity supplied of a good and its
price, ceteris paribus.
Market supply
To move from a individual supply to a market supply the individual supplies are counted together horizontally.
The market supply curve shows the relationship between the price of the product and the quantities supplied
during a particular time.
QS=f(PX,PG,PF,PE,TY,N)
QS
= Quantity supplied
PX
=Price per product
PG
=Price of alternative outputs
PF
=Price of factors of production and other inputs
PE
=Expected future prices of the product
TY
=Technology
N
=Number of firms supplying the same product
Other possible determinants include:
 Government policy
Subsidies on particular goods or services tend to raise their supply, while taxes toe reduce supply
 Natural disasters
 Joint products and by-products
Some products are produced jointly (meat and leather) with the result that a change in the supply of
the major product results in a similar change in the supply of a by-product. Sometimes called
complements of production.
 Productivity
This is related to technology, a change in the productivity of factors of production will lead to a
change in supply. If productivity falls, production cost increase, ceteris paribus, and supply decreases.
Some of the determinants of supply are interdependent. If relative price of a production is expected to
increase the number of firm supplying the market will tend to increase.
MOVEMENT ALON THE SUPPLY CURVE AND SHIFTS OF THE CURVE
The supply curve shows the relationship between the price of the product and the quantity supplied ,ceteris
paribus. At a price of P1 the quantity supplied will be Q1, if price increases to P2 the quantity supplied will also
increase to Q2.
 Movement – Change in the price of the product, which we measure on the vertical axis, a change in
quantity supplied
 Shift – Changes in any factor of production, change in supply
A – Fall on supply
B – increase in supply
Determinant
Change
Price of the good
Increase
Decrease
Price of alternative
products
Increase
Decrease
Prices of joint products
Increase
Decrease
Prices of inputs
Increase
Decrease
Expected future prices
Technology
Number of firms
Price is expected to
increase
Price is expected to fall
Cost-reducing
improvement
Cost-increasing
improvement
More firms enter market
Firms leave market
Effect on market supply
curve
Upward movement along
the supply curve
Downward movement
along the supply curve
Leftward shift of the
supply curve
Rightward shift of the
supply curve
Rightward shift of the
supply curve
Leftward shift of the
supply curve
Leftward (upward) shift
of the supply curve
Rightward (downward)
shift of the supply curve
Rightward shift of the
supply curve
Leftward shift of the
supply curve
Rightward shift of the
supply curve
Leftward shift of the
supply curve
Rightward shift of the
supply curve
Leftward shift of the
supply curve
Correct description of
effect
An increase in quantity
supplied
A decrease in the
quantity
A decrease in supply
A increase in supply
An increase in supply
An decrease in supply
A decrease inputs
An increase in supply
An increase in supply
An decrease in supply
An increase in supply
An decrease in supply
An increase in supply
An decrease in supply
7.4 Market equilibrium
Equilibrium, excess demand and excess supply
Equilibrium is a state of rest in which opposing forces are balanced and in which there is no tendency for
change.
Excess demand – When quantity demanded is greater than supplied.
Excess supply – When quantity supplied is greater that quantity demanded
Equilibrium – quantity demanded is equal to quantity supplied
When there is excess demand
Firms sell their products but households do not obtain the quantity of the product which they would like to
buy at a particular price. To obtain a bigger quantity households bet on the products for the highest price,
firms realise they can rise the price. As the price rises the quantity supplied increases along the supply curve
and the demand decreases along the demand curve, this process will continue till equilibrium is reached.
When there is excess supply
Firms find that they cannot sell all their products. They cut their production and compete with each other to
find buyers by reducing the price. The result is a fall in quantity supplied along the supply curve and a increase
in demand along the demand curve. This process continues until equilibrium is reached.
The function of prices on a market economy
Prices cause adjustments in the quantities demanded and supplied of each good
Two functions in a market economy
1. Rationing function - prices serve to ratio the scarce supplies of goods and services to those who place
the highest value on them
2. Allocative function - In markets where there is a excess demand prices increase, higher prices means
more profit, ceteris paribus. Excess supply results in decrease in price an a decrease in profit.