THEORY OF DEMAND and SUPPLY
Recap from last session
▪Definition of Demand
▪Laws of Demand
▪Exception to law of Demand
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Prof. Trupti Mishra, School of Management, IIT Bombay
Change in the Demand
❑ Change in quantity demanded
▪Occurs when price changes
▪Movement along demand curve
❑ Change in demand
▪Occurs when one of the other variables, or determinants of
demand, changes
▪Demand curve shifts rightward or leftward
Prof. Trupti Mishra, School f Management, IIT Bombay
Change in the Demand Curve
P
80
D1
70
Demand
60 increase
Price (Rupees)
D0
50
• •
D2
40
• •
30
Demand
20 decrease
10
Qd
0 100 300 500 700 900 1,100 1,300 1,500
Quantity
A Shifts in the Demand Curve
Price of
Cigarettes,
per Pack.
A policy to
discourage
smoking shifts the
demand curve to
the left.
B A
RS 2.00
D1
D2
0 10 20 Number of Cigarettes
Smoked per Day
6
A Movement Along the Demand Curve
Price of
Cigarettes,
per Pack.
C A tax that raises
the price of
Rs 4.00 cigarettes results
in a movements
along the demand
curve.
A
Rs 2.00
D1
0 12 20 Number of Cigarettes
Smoked per Day
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Supply
Supply of a goods refers to the various quantities of the
good which a seller is willing and able to sell at a different
prices in a given market, at a particular point of time.
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Law of Supply
▪ The law of supply states that, other things equal, the quantity
supplied of a good rises when the price of the good rises.
▪ Example: when the price of a good falls from 25 to 10, the
quantity supplied falls from 31 to 16.
▪ 9
Factors Influencing Supply
▪ Price of good or service (P)
▪ Input prices (PI )
▪ Prices of goods related in production (Pr)
▪ Technological advances (T)
▪ Expected future price of product (Pe)
▪ Number of firms producing product (F)
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Supply Function
- Supply function
- shows relation between P & Qs when all other variables are
held constant
▪ Qs = g(P)
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Supply Function: Example
Qs = 10Px
If Px = 2, Qs = 20
If Px =5,Qs = 50
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Generalize Supply Function
Qs h kP lPI mPr nT rPe sF
❑ k, l, m, n, r, & s are slope parameters
▪ Measure effect on Qs of changing one of the variables while holding
the others constant
❑ Sign of parameter shows how variable is related to Qs
▪ Positive sign indicates direct relationship
▪ Negative sign indicates inverse relationship
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Variable Relation to Qs Sign of Slope Parameter
P Direct k = Qs/ P is positive
PI Inverse l = Qs/ PI is negative
Inverse for substitutes m = Qs/ Pr is negative
Pr Direct for complements m = Q / P is positive
s r
T Direct n = Qs/ T is positive
Pe Inverse r = Qs/ Pe is negative
F Direct s = Qs/ F is positive
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Supply Schedule
- The supply schedule is a table that shows the relationship
between the price of the good and the quantity supplied.
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Supply Schedule: Example
Price of Ice-cream Cone Quantity of cones Supplied
(Rs)
0.00 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5
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Market supply Schedule
Price of Ice-cream Cone
(Rs)
A B Market
0.00 0 + 0 = 0
0.50 0 0 0
1.00 1 0 1
1.50 2 2 4
2.00 3 4 7
2.50 4 6 10
3.00 5 8 13
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Supply Curve
-The supply curve is a graph of the relationship between the
price of a good and the quantity supplied.
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Supply Curve: Example
Price of
Ice-Cream
Cone
Rs 3.00
2.50
2.00
1.50
1.00
0.50
Quantity of
0 1 2 3 4 5 6 8 10 12 Ice-Cream
Cones
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The Determinants of Quantity Supplied
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Shifts in
Supply P
S2
80
S0
70 S1
60 • •
Price (Rupees)
Supply
decrease
50
40
• •
30
Supply
20 increase
10
Qs
0 100 300 500 700 900
Quantity
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Market Equilibrium
• Equilibrium refers to a situation in which the price has reached
the level where quantity supplied equals quantity demanded.
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Session Summary
• The demand curve shows how the quantity of a good depends
upon the price.
– According to the law of demand, as the price of a good falls, the
quantity demanded rises. Therefore, the demand curve slopes
downward.
36
Session Summary
– In addition to price, other determinants of how much consumers
want to buy include income, the prices of complements and
substitutes, tastes, expectations, and the number of buyers.
– If one of these factors changes, the demand curve shifts.
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Session Summary
• The supply curve shows how the quantity of a good
supplied depends upon the price.
• According to the law of supply, as the price of a good
rises, the quantity supplied rises. Therefore, the supply
curve slopes upward.
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Session Summary
• In addition to price, other determinants of how much
producers want to sell include input prices, technology,
expectations, and the number of sellers.
• If one of these factors changes, the supply curve shifts.
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Session Summary
• Market equilibrium is determined by the intersection of the supply
and demand curves.
• At the equilibrium price, the quantity demanded equals the quantity
supplied.
• The behavior of buyers and sellers naturally drives
markets toward their equilibrium.
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