DEMAND and SUPPLY

OBJECTIVES:

Explain the difference between a change in the quantity

demanded and a change in demand.
Differentiate between a movement along the demand curve
and a shift of the demand curve.
Explain the difference between a change in the quantity
supplied and a change in supply.
Differentiate between a movement along the supply curve and
a shift of the supply curve.
Explain how the equilibrium price and quantity are
determined.
Discuss restrictions on the market mechanism.
 DEMAND AND SUPPLY

 A demand schedule is a table that lists the quantities demanded at different prices
when all other influences on planned purchases are held constant.
 The information in a demand schedule can also be illustrated graphically by drawing
a demand curve.
 Ceteris paribus is a Latin phrase that means “all other things remain constant”.
 Individual demand is the demand of a particular buyer.
 Market demand is the sum of the individual demands of all buyers in the market.
THE DEMAND CURVE AND THE LAW OF
DEMAND

Table 1: Market demand schedule for chocolate bars

Price (N$) Quantity demanded

1 400
2 300
3 200
4 100
 DEMAND CURVE

• Demand Curve: A demand curve is the

graphic representation of the law of
demand.
• The law of demand states that more of a
good will be demanded when the price is
lower and less of a good will be demanded
when the price is higher, other things
equal.
FIGURE 1: MARKET DEMAND CURVE FOR
CHOCOLATE BARS
 DEMAND CURVE

• The P is the independent variable because it determines the value of the

quantity. Thus, plotted on the Y-axis.
• Qd over a period of time is the dependent variable and we always plot it on
the X-axis.
• The demand curve slope down from left to right, reflecting the law of
demand.
• Price and quantity demanded are inversely (negatively) related and the curve
has a negative slope.
• While considering the relationship between the price and the quantity
demanded we have assumed ceteris paribus.
• A change in the price will change the quantity demanded.
• Graphically we illustrate it by a movement along the demand curve.
• E.g. If the price increases from N$1 to N$2, the quantity demanded
falls from 400 to 300 units.
• The formula for the demand curve is as follows: Q = f(P), ceteris paribus.
 NORMAL DEMAND

Two factors determine normal demand:

• The substitution effect: When the price of a product falls while the
prices of other products remain the same, it will become relatively
cheaper compared to the other products and the quantity demanded will
increase.
• The income effect: A decrease in the price of a product causes an
increase in the purchasing power of consumers’ incomes.

A movement along a demand curve (a change in the quantity

demanded)
When the price of a good changes it will cause a change in the quantity
demanded and graphically it is shown as a movement along the demand
curve.
 CHANGES IN DEMAND: DEMAND SHIFTERS
(EXOGENOUS VARIABLES)

• Exogenous variables are factors that cause shifts of the demand curve. A change
in anything besides the price will shift the entire demand curve.
Figure 2: Shifts of the demand curve (changes in demand)
THE EXOGENOUS VARIABLES OR SHIFT FACTORS
OF DEMAND ARE AS FOLLOWS:
• The income of the consumer.
• Our income determines our purchasing power.
• The demand for goods increases as income increases and the demand
curve will shift to the right. A decrease in income will?
• Prices of Related Goods. Two kinds of related goods are
substitutes and complementary goods.
• Substitutes are used to replace other goods because they perform the same
function.
• For substitute goods, a decrease in the price of one good will decrease the demand for the
other good.
• An increase in the price of one good will increase the demand for the other good.
• Complementary goods are used together, such as CDs and CD players.
• A decrease in the price of one good will increase the demand for the other good
• A increase in the price of one good will decrease the demand for the other good.
THE EXOGENOUS VARIABLES OR SHIFT FACTORS
OF DEMAND ARE AS FOLLOWS: (CONTINUE)

• The taste or preference of the consumer.

• A change in consumer taste that makes a product more popular will shift the
demand curve to the right.
• If the product becomes less popular, the demand curve will shift to the left.
• The number of potential buyers.
• An increase in the number of buyers in the market will shift the demand curve
to the right.
• Decrease in the number of buyers will shift the demand curve to the left.
• Expected Future Prices.
• If consumers expect that prices will increase, the demand will increase. If you
hear that the price of petrol will increase next week, you will probably fill up
your tank before the price increase.
• Expectations that prices may decrease will decrease demand, because
consumers will wait for the lower prices before they buy.
 3. SUPPLY

• A supply schedule is a table that lists the various quantities of

a good that producers are willing and able to supply at
different prices when all other influences are held constant.
• The information in a supply schedule can be illustrated by
drawing a supply curve.
 THE SUPPLY CURVE AND THE LAW OF
SUPPLY
• The law of supply states that, in general, sellers are willing and able to make
available more of their product at a higher price than at a lower price, other things
being constant.

Table 2: Market supply schedule for chocolate bars.

Price (N$) Quantity supplied

1 200

2 300

3 400

4 500
Figure 2: Market supply curve for chocolate bars
 MARKET SUPPLY
CURVE FOR
CHOCOLATE BARS

The price is the independent variable because price determines the value of the quantity
supplied and we always plot it on the Y-axis.
Quantity supplied is the dependent variable always plotted on the X-axis.
The supply curve will normally slope upwards from left to right reflecting the law of supply.
Price and quantity supplied are directly or positively related and the curve has a positive
slope.
A change in the price will change the quantity supplied. Graphically we illustrate it by a
movement along the supply curve. If the price rises from N$1 to N$2, the quantity supplied
on the market will rise from 200 to 300 units.
The formula for the supply curve is as follows: Q = f(P), ceteris paribus.
• If the price of a good changes, it will cause a change in the quantity supplied and graphically
it is shown as a movement along the supply curve.
A movement along a supply curve (a change in the quantity supplied)
 CHANGES IN SUPPLY: SUPPLY SHIFTERS
(EXOGENOUS VARIABLES)

Figure 3: Shifts of the supply curve (changes in supply)

 THE EXOGENOUS VARIABLES OR SHIFT FACTORS
OF SUPPLY ARE AS FOLLOWS:

 The price of factors of production and other inputs.

 To make a profit, a producer must be able to cover his production cost.
 An increase in the price of factors of production or any other input will increase the
production cost and reduce the profitability of the product, causing a decrease in
supply. The supply curve will shift to the left.
 A decrease in the price of any input will decrease production cost and result in more
profit for firms. This will cause an increase in supply and shift the supply curve to
the right.
 Technology.
 Improvements in technology will reduce the amount of resources needed to produce
a certain level of output and result in lower production cost. This will increase
supply and shift the supply curve to the right.
 Prices of alternative products.
 A farmer may sell his ostriches and switch to sheep farming in response to a drastic
increase in the price of mutton.
 The higher price of mutton will signal to the farmer that higher profits can be made with
mutton.
 This will cause an increase in the supply of mutton and shift the supply curve to the right.
 THE EXOGENOUS VARIABLES OR SHIFT FACTORS OF SUPPLY
ARE AS FOLLOWS:

 Taxes and subsidies.

 Higher taxes have the same impact on supply as an increase in prices of factors of production.
 It imposes an additional cost on producers and will decrease supply, shifting the supply curve to
the left.
 Subsidies are the opposite of taxes and will decrease production cost. This will increase supply
and shift the supply curve to the right.
 Number of sellers supplying the product.
 An increase in the number of sellers will increase the market supply and shift the supply curve to
the right, while a decrease in the number of sellers will shift the supply curve to the left.
 Expected future prices.
 Suppliers are influenced by what they expect will happen to the price of their
products in future.
 If they expect future prices to rise, they will supply more. On the other hand, if they
expect future prices to fall, they will supply less.
 Natural disasters.
 Natural disasters like floods, droughts or earth quakes have a devastating effect on
supply and will shift the supply curve to the left.
 4. MARKET EQUILIBRIUM

• Equilibrium is a state of balance where all opposing forces are

balanced and there is no tendency for the system to change.
• Prices are determined on the market by the interaction of
demand and supply.
• Market equilibrium occurs at that price where the quantity
demanded by consumers is equal to the quantity supplied.
• At the point of market equilibrium, the forces of demand and
supply balance so that there is no tendency for the market price
to change as long as the underlying factors remain the same.
FIGURE 4: MARKET EQUILIBRIUM, EXCESS
DEMAND AND EXCESS SUPPLY
 FIGURE 4: MARKET EQUILIBRIUM, EXCESS DEMAND AND EXCESS SUPPLY

 The market is in equilibrium at that point where the demand curve and the supply
curves intersect.
 At that price quantity demanded is equal to the quantity supplied. On the figure above
equilibrium price is N$2 and the equilibrium quantity is 300 units.
 Excess supply is when quantity supplied is greater than quantity demanded.
 At the price of N$3 the market is in disequilibrium. Producers are willing to supply
400 chocolate bars to the market, but the quantity demanded is only 200 units.
 There is a situation of excess supply on the market. You can also call it a surplus.
 In response to this producers will reduce the price to dispose of the excess stocks they have.
 When the price falls, quantity demanded will increase while quantity supplied will decrease.
 This will continue until the equilibrium price of N$2 is reached.
 Excess demand is when quantity demanded is greater than quantity supplied.
 At the price of N$1 the market is also in disequilibrium. The quantity demanded is
400 chocolate bars but producers are only willing to supply 200 units of the product to
the market.
 There is a situation of excess demand on the market. It is also called a shortage.
 This will lead to an increase in the market price.
 When price rises, quantity demanded will decrease while quantity supplied will increase. This process will
continue until the equilibrium price of N$2 is reached.
 5. CHANGES IN DEMAND AND SUPPLY

• Once a market is in equilibrium, the equilibrium price and quantity will remain
unchanged until one of the exogenous variables or shift factors changes. A change
in one of those factors will shift the demand or supply curves to the left or to the
right. The result will be a change in the equilibrium price and quantity.
• Changes in demand
• A change in demand can be an increase or a decrease. Changes in demand can be
caused by any factor except the price of the product. They are the following:
 The income of the consumer
 The prices of related goods
 The taste or preference of the consumer
 The number of potential buyers
 Expectations of future price changes
 AN INCREASE IN DEMAND

• Figure 5: Increase in demand

 AN INCREASE IN DEMAND
• Suppose the market is initially in equilibrium at price P1 and quantity Q1. The
demand curve is D1 and the supply curve S1.
• When any of these factors change, say for instance the incomes of consumers
increase, there will be an increase in demand and the demand curve will shift to the
right.
• The new demand curve is D2.
• The supply curve remains the same.
• The shift will disturb the equilibrium and there will be a shortage in the market at
price P1.
• If shortages exist in the market, prices will tend to rise.
• The equilibrium price will therefore increase from P1 to P2 and the equilibrium
quantity will increase from Q1 to Q2.
 A DECREASE IN DEMAND

Figure 6: Decrease in demand

 A DECREASE IN DEMAND

• Suppose the market is in equilibrium at price P1 and quantity Q1.

• The demand curve is D1 and the supply curve S1.
• When any of these factors change, for instance the incomes of consumers
decrease, demand will decrease and the demand curve will shift
downwards to the left.
• The new demand curve is D2. The supply curve remains the same. After
the shift there will be a surplus at price P1.
• Producers will try to eliminate the surplus by decreasing prices.
• The equilibrium price will decrease from P1 to P2 and the equilibrium
quantity will decrease from Q1 to Q2.
 Changes in supply

Changes in supply can be caused by any of the determinants of the

quantity supplied except the price. They are as follows:
• The price of factors of production and other inputs
• Technology
• The prices of alternative products
• Taxes and subsidies
• The number of sellers supplying the product
• Expected future prices of the product
• Natural disasters
 AN INCREASE IN SUPPLY

• Figure 7: Increase in supply

 AN INCREASE IN SUPPLY

• Suppose the market is in equilibrium at price P1 and quantity Q1.

• The demand curve is D1 and the supply curve S1.
• If one of the factors listed above change, for instance there is a decrease
in production cost, supply will increase and the supply curve will shift
downwards to the right.
• The demand curve remains the same.
• The shift of the supply curve will disturb the equilibrium so that a surplus
will exist at price P1.
• If there are surpluses in the market, prices will tend to fall.
• The equilibrium price will decrease from P1 to P2 and the new
equilibrium quantity will increase from Q1 to Q2.
 A DECREASE IN SUPPLY

• Figure 8: Decrease in supply

 A DECREASE IN SUPPLY

• Suppose the market is in equilibrium at price P1 and quantity

Q1. The demand curve is D1 and the supply curve is S1.
• A change in one of the factors listed above, for instance an
increase in production cost, supply will decrease and shift the
supply curve upwards to the left.
• The new supply curve is S2.
• Demand remains the same. After the shift a shortage will exist
in the market at price P1 and prices will increase.
• The equilibrium price will increase from P1 to P2 and the
equilibrium quantity will decrease from Q1 to Q2.
 6. LIMITATIONS ON MARKET
EQUILIBRIUM

• The public and the government may feel that prices determined on the market by the
interaction of demand and supply are unfairly low to sellers or unfairly high to buyers.
• The government can then use price controls such as price ceilings and price floors to
address the problem.
Price ceiling
• Price ceilings is the maximum prices or price controls.
• Price ceilings are introduced to keep prices low for buyers and it is the maximum price
that may be charged for a product or a service.
Governments set maximum prices for the following reasons:
To keep the prices of basic foods low
To avoid exploitation of consumers by producers
To combat inflation
 Figure 9: Price ceiling

 Price Pc is the price ceiling and is below the equilibrium price.

 Price below the equilibrium price indicate a shortage in the market.
 Since price is not allowed to rise, there is no incentive for suppliers to increase the quantity supplied and the
shortages will remain.
 This can give rise to long waiting lists in the case of flats or long queues at service stations or shops because there
is not enough petrol or goods. Buyers often have to bribe the officials who enforce the controls or pay them for
favours.
 Price ceilings are imposed to keep prices low but often have the opposite effect.
Price floors
• A second restriction, price floors, also called minimum prices or price supports, are
sometimes used in agriculture.
• It sets a minimum price for agricultural products to support farmers’ incomes and to
guarantee the prices they receive for their products.
• It can also be used in the form of a minimum wage (on the factor market) to ensure a
higher income for low-income groups such as farm or domestic workers.
Figure 10: Price floor
• The price floor is PF and is set above the equilibrium price. Price floors create
surpluses on the market, but because the market mechanism is not allowed to
function, the government has to intervene to clear the market. The options are as
follows:
The government can buy the surplus products and export, store or destroy them.
The government can introduce production quotas to limit the production of the
products.
• Although farmers will benefit, there will be a cost to society:
Consumers will have to pay artificially high prices for the goods.
The government uses taxpayers’ money to dispose of the surpluses.

In modern economies most governments prefer to use subsidies in

agriculture instead of price floors, but minimum wages on factor
markets are used quite often.
END!!