This ppt is about supply and demand in economy

1. Lecture 2

2. Plan of the lecture
1. The relationship between demand and price
2. The demand curve
3. Non-price determinants of demand
4. Movements along and shifts in the demand curve
5. The relationship between supply and price
6. The supply curve
7. Non-price determinants of supply
8. Movements along and shifts in the supply curve
9. Equilibrium price and output
10.Effects of the shifts in the demand curve and in the
supply curve

3. Demand and supply
• Demand: the consumers‘ (or customers‘)
willingness and readiness to purchase
something at different prices
• Supply: the producers‘ (or sellers‘) willingness
and readiness to provide something at
different prices

4. The relationship between demand and price,
i.e. the law of demand
The law of demand: when the price of a good rises,
the quantity demanded will fall, and vice versa
The income and substitution effects are useful
concepts as they help to explain why people react
to a price rise by buying less.
‘Quantity demanded’ refers to the amount that
consumers are willing and able to purchase at a
given price over a given period (e.g. a week, or a
month, or a year)

5. Income and Substitution Effects
 Let the price rise, then:
people will feel poorer. They will not be able to afford to buy so much
of the good with their money. The purchasing power of their income
(their real income) has fallen. This is called the income effect of a price
rise.
the good will now cost more than alternative or ‘substitute’ goods,
and people will switch to these. This is called the substitution effect of
a price rise.
 Similarly, when the price of a good falls,
the quantity demanded will rise. People can afford to buy more (the
income effect),
they will switch away from consuming alternative goods (the
substitution effect).

6. The demand schedule
• Market demand schedule is a table showing the
different total quantities of a good that consumers are
willing and able to buy at various prices over a given
time period
• Demand schedule for an individual is a table showing
the different quantities of a good that a person is
willing and able to buy at various prices over a given
period of time.
• To obtain the market demand schedule for potatoes,
we simply add up the quantities demanded at each
price by all consumers
• Notice that we are talking about demand over a
period of time (not at a point in time). Thus we would
talk about daily demand or weekly demand or annual
demand or whatever.
price
(pence
per kg)
total
market
demand
(tonnes)
A 20 700
B 40 500
C 60 350
D 80 200
E 100 100

7. The market demand curve
• Price is measured on the vertical axis; quantity demanded is measured on the horizontal
axis.
• Point E shows that at a price of 100p per kilo, 100 000 tonnes of potatoes are demanded
each month.
• When the price falls to 80p we move down along the curve to point D.
• Like market demand curves, individuals’ demand curves generally slope downwards from
left to right: they have negative slope.
Demand curve is a graph showing
the relationship between
the price of a good and the
quantity of the good demanded
over a given time period.

8. Demand function
• We can represent the relationship between the
market demand for a good and the determinants of
demand in the form of an equation. This is called a
demand function.
• Thus an equation relating quantity demanded to
price could be in the form: Qd = a − bP
• For example, the actual equation might be: Qd =
10 000 − 200P. As price (P) changes, the equation
tells us how much the quantity demanded (Qd)
changes.

9. Demand schedule and demand curve derived
from demand function Qd = 10 000 − 200P
From demand
function can be
calculated a
demand
schedule or
demand curve,
as shown in the
table and
diagram.

10. More complex demand functions
• In a similar way, we can relate the quantity
demanded to two or more determinants. For
example, a demand function could be of the form:
Qd = a − bP + cY + dPs − ePc
• This equation says that the quantity demanded (Qd)
– will fall as the price of the good (P) rises,
– will rise as the level of consumer incomes (Y) rises,
– will rise as the price of a particular substitute (Ps ) rises
and
– will fall as the price of a particular complement (Pc) rises,
by amounts b, c, d and e respectively.

11. THE DEMAND FOR LAMB
Notice, if we had not
considered the price
of beef and annual
personal disposable
income, the demand
function for lamb
would look like:
Qd = 217.1 – 0.112PL
This simple demand
curve is constructed
on the assumption
that
‘other things remain
equal’ (ceteris paribus)

12. Complementary goods
• Complementary goods are those that are
consumed together: cars and petrol, bread and
butter, cell phone and battery.
• The higher the price of complementary goods, the
fewer of them will be bought and hence the less
will be the demand for this good.
• For example, the demand for batteries will depend
on the price of cell phone. If the price of cell phone
goes up, the demand for batteries will fall.

13. Substitute goods
• Substitute goods is a pair of goods which are
considered by consumers to be alternatives to
each other. As the price of one goes up, the
demand for the other rises.
• For example, the demand for coffee will
depend on the price of tea. If tea goes up in
price, the demand for coffee will rise.

14. Normal and inferior goods
• Normal good is a good whose demand rises as
people’s incomes rise.
• Inferior good is a good whose demand falls as
people’s incomes rise.

15. Non-price determinants of demand
• Tastes: the more desirable people find the good, the
more they will demand
• The price of substitute goods
• The price of complementary goods
• Income: as people’s incomes rise, their demand for
normal goods will rise but it will fall for inferior goods.
• Expectations of future price changes: if people think
that prices are going to rise in the future, they are
likely to buy more now before the price does go up.

16. Movements along and shifts in the demand
curve
• A demand curve is constructed on the assumption
that ‘other things remain equal’ (ceteris paribus),
that none of the non-price determinants of demand,
other than price, changes. The effect of a change in
price is then simply illustrated by a movement along
the demand curve
• What happens, then, when one of these non-price
determinants does change? The answer is that we
have to construct a whole new demand curve: the
curve shifts.

17. An increase in demand
If a change in one of
the non-price
determinants causes
demand to rise – say,
income rises – the
whole curve will shift
to the right. This
shows that at each
price more will be
demanded than
before.

18. Shifts in and movements along
demand curves
• A shift in the demand curve is referred to as a
change in demand, whereas a movement
along the demand curve as a result of a
change in price is referred to as a change in
the quantity demanded.

19. The relationship between supply and price,
i.e. the law of supply
The law of supply: when the price of a good
rises, the quantity supplied will also rise, and
vice versa
‘Quantity supplied’ refers to the amount that
producers are willing and able to supply at a
given price over a given period (e.g. a week, or
a month, or a year)

20. Three reasons for law of supply
Let the price rise, then:
As firms supply more, costs rise more and more rapidly
The higher the price of the good, the more profitable it
becomes to produce. Firms will thus be encouraged to
produce more of it by switching from producing less
profitable goods.
Given time, if the price of a good remains high, new
producers will be encouraged to set up in production. Total
market supply thus rises.
The first two determinants affect supply in the short
run. The third affects supply in the long run.

21. The supply schedule
• Market supply schedule is a table showing the
different total quantities of a good that producers
are willing and able to supply at various prices over
a given time period
• Supply schedule for an individual producer is a
table showing the different quantities of a good that
a producer is willing and able to supply at various
prices over a given period of time.
• To obtain the market supply schedule for potatoes,
we simply add up the quantities supplied at each
price by all producers
• Notice that we are talking about supply over a
period of time (not at a point in time). Thus we
would talk about daily supply or weekly supply or
annual supply or whatever.
price
(pence
per kg)
total
market
supply
(tonnes)
A 20 100
B 40 200
C 60 350
D 80 530
E 100 700

22. The market supply curve
• Price is measured on the vertical axis; quantity supplied is measured on the horizontal axis.
• Point E shows that at a price of 100p per kilo, 700 000 tonnes of potatoes are supplied each
month.
• When the price falls to 80p we move down along the curve to point D.
• Like market supply curves, individuals’ supply curves generally slope upwards from left to
right: they have positive slope.
Supply curve is a graph showing
the relationship between
the price of a good and the
quantity of the good supplied
over a given time period.

23. Supply function
• We can represent the relationship between the
market supply of a good and the determinants of
supply in the form of an equation. This is called a
supply function.
• Thus an equation relating quantity supplied to price
could be in the form: Qd = a + bP
• For example, the actual equation might be: Qs =
500 + 1000P. As price (P) changes, the equation tells
us how much the quantity supplied (Qd) changes.

24. Substitutes in supply and goods in
joint supply
• Substitutes in supply - these are two goods
where an increased production of one means
diverting resources away from producing the
other
• Goods in joint supply - these are two goods
where the production of more of one leads to
the production of more of the other.

25. More complex supply equations
• More complex supply equations would relate
supply to more than one determinant.
• For example:
Qs = 200 + 80P − 20a1 − 15a2 + 30j,
where P is the price of the good, a1 and a2 are
the profitabilities of two alternative goods
that could be supplied instead, and j is the
profitability of a good in joint supply.

26. Non-price determinants of supply
• The costs of production: The higher the costs of production, the less profit
will be made at any price. Firms will cut back on production, probably
switching to alternative products whose costs have not risen so much. Costs
of production will rise if wages, raw material prices, rents, interest rates or
any other input prices rise.
• Technology
• Government subsidies and taxes
• The profitability of alternative products (substitutes): If a product which is
a substitute in supply becomes more profitable to supply than before due
to rise of their prices or fall in their production costs, producers are likely to
switch from the first good to this alternative.
• The profitability of goods in joint supply: If more petrol is produced, due to
a rise in demand and hence its price, then the supply of diesel will rise too.

27. Movements along and shifts in the supply
curve
• A supply curve is constructed on the assumption
that ‘other things remain equal’ (ceteris paribus),
that none of the non-price determinants of supply,
other than price, changes. The effect of a change in
price is then simply illustrated by a movement along
the supply curve
• What happens, then, when one of these non-price
determinants does change? The answer is that we
have to construct a whole new supply curve: the
curve shifts.

28. An increase in supply
If a change in one of
the non-price
determinants causes
supply to rise – say,
wages fall – the
whole curve will shift
to the right. This
shows that at each
price more will be
supplied than before.

29. Non-Equilibrium: shortage
• If the price started at 20p per
kg, demand would exceed
supply by 600 000 tonnes
• Consumers would be unable
to obtain all they wanted and
would thus be willing to pay a
higher price.
• Producers, unable or
unwilling to supply enough to
meet the demand, will be
only too happy to accept a
higher price.
price
(pence
per kg)
total
market
supply
(tonnes)
total
market
demand
(tonnes)
A 20 100 700
B 40 200 500
C 60 350 350
D 80 530 200
E 100 700 100
• The effect of the shortage, then, will be to drive up the price.
• The same would happen at a price of 40p per kilogram. There would still be
a shortage; price would still rise.
• But as the price rises, the quantity demanded falls and the quantity supplied
rises. The shortage is progressively eliminated.

30. Non-Equilibrium: surplus
• What would happen if the price
started at a much higher level:
say, at 100p per kg?
• In this case supply would exceed
demand by 600000 tonnes. The
effect of this surplus would be to
drive the price down as farmers
competed against each other to
sell their excess supplies.
• The same would happen at a
price of 80p per kg. There would
still be a surplus; price would still
fall.
price
(pence
per kg)
total
market
supply
(tonnes)
total
market
demand
(tonnes)
A 20 100 700
B 40 200 500
C 60 350 350
D 80 530 200
E 100 700 100
• In fact, only one price is sustainable – the price where demand equals supply:
namely, 60p per kilogram, where both demand and supply are 350 000 tonnes.
When supply matches demand the market is said to clear. There is no shortage
and no surplus.

31. Equilibrium price and output
• Equilibrium price is Pe (60p) and equilibrium quantity is Qe (350 000 tonnes).
• At any price above 60p, there would be a surplus. Thus at 80p there is a surplus of 330 000 tonnes:
more is supplied than consumers are willing and able to purchase at that price. Price will fall to the
equilibrium price of 60p.
• At any price below 60p, there would be a shortage. Thus at 40p there is a shortage of 300 000
tonnes. Price will rise to 60p.
• The equilibrium price is the only price where the producers’ plans to supply exactly match the
consumers’ plans to buy.

32. Effect of a shift in the demand curve
 What would happen to price and
quantity if the demand curve
shifted to the right?
 If a rise in consumer incomes
led to the demand curve shifting
to D2, there would be a shortage
of h − g at the original price Pe1.
 This would cause price to rise to
the new equilibrium Pe2. There
would be a movement along the
supply curve from point g to
point i, and along the new
demand curve (D2) from point h
to point i. Equilibrium quantity
would rise from Qe1 to Qe2.
Thus, if one of the determinants of demand changes (other than price), the
whole demand curve will shift. This will lead to a movement along the supply
curve to the new intersection point.

33. Effect of a shift in the supply curve
 What would happen to price and
quantity if the supply curve shifted to
the left?
 If costs of production rose, the supply
curve would shift to the left: to S2.
 There would be a shortage of g − j at
the old price of Pe1. Price would rise
from Pe1 to Pe3. Quantity would fall
from Qe1 to Qe3.
 In other words, there would be a
movement along the demand curve
from point g to point k, and along the
new supply curve (S2) from point j to
point k.
To summarise: likewise, if one of the determinants of supply changes (other than
price), the whole supply curve will shift. This will lead to a movement along the
demand curve to the new intersection point.

34. Summary
• If the demand for a good exceeds the supply, there will be
a shortage. This will lead to a rise in the price of the good.
• If the supply of a good exceeds the demand, there will be
a surplus. This will lead to a fall in the price.
• Price will settle at the equilibrium. The equilibrium price
is the one that clears the market: the price where
demand equals supply.
• If the demand or supply curve shifts, this will lead either
to a shortage or to a surplus. Price will therefore either
rise or fall until a new equilibrium is reached at the
position where the supply and demand curves now
intersect.