3. Determinants of Demand
• Price
• Income
• Prices of Related Goods
• Advertisement
• Consumer Taste and Preferences
• Credit facilities
• Government policies etc
4. The Law of Demand
• Law of demand – there is an inverse relationship between
price and quantity demanded.
Quantity demanded rises as price falls - provided other
things remain constant.
Quantity demanded falls as prices rise - provided
other things remain constant.
5. Law of Demand
Substitution effect
• The change in the relative price (the price of one good relative to the prices of other
goods) causes the substitution effect.
• If all prices changed by same margin, there would be no substitution effect
Income effect
• Money income – the number of rupees/ dollars you receive per period.
• Real income – measure in terms of how many goods and services you can buy
Diminishing marginal utility
• Marginal utility – additional satisfaction you derive from each item.
• The Marginal utility you derive from each additional item consumed decreases as your
consumption increases (example: pizza slices)
6. The Law of Diminishing Marginal
Utility
The more of a good consumed the smaller the
increase in total utility
Marginal utility from each additional unit
Declines as more is consumed
Disutility / Negative marginal utility
8. Total Utility and Marginal Utility You Derive from
Drinking Water after Jogging Four Miles
Total utility increases with each of the
first 4 glasses of water consumed but
by smaller and smaller amounts
The 5th glass causes TU to fall
Marginal utility declines
MU of the 5th glass is negative
5
Glasses (8-ounce)
4
3
2
1
0
20
40
60
80
Total
utility
(a) Total utility (b) Marginal utility
5
Glasses (8-ounce)
4
3
2
1
0
20
40
Marginal
utility
9. The Demand Curve
• The demand curve is the graphic representation of the law of
demand.
• The demand curve slopes downward from left to the right
indicating that ;
“As the price goes up, the quantity demanded goes down and vice-
versa”
11. Law of Demand
• The demand curve is downward sloping for the following reasons:
• At lower prices, existing buyers may buy more.
• At lower prices, new buyers may also enter the market.
12. Exceptions to ‘law of demand’
• When the price of a good is already too low then small increase in its price may not
reduce its demand.
• When the good is by perception is an ‘Inferior Good’ then any fall in its price may not
increase its demand. Such goods are also termed as ‘Giffen Goods’.
• Luxury goods
• Fear of Scarcity of the Good in near future may lead to its demand going up even if its
price is rising.
• Goods of which people are habituated. Example Liquor, Cigarettes etc
13. Other Things Constant
• Rule ‘Other things remain constant’ - places a limitation on the
application of the law of demand.
• All other factors that affect quantity demanded are assumed to remain
constant.
• These other factors can be ; Income, Prices of related goods, fashion,
Advertisement, population, season etc
14. Other Determinants of Demand
Income
Tastes
Prices of Related Goods
Population
Season
Fashion etc
15. • A movement along a demand curve is the graphical
representation of the effect of a change in price on the
quantity demanded.
Shifts in Demand
Versus
Movements Along a Demand Curve
16. • A shift in demand is the graphical representation of the effect of
anything other than price on demand.
Shifts in Demand Versus
Movements Along a Demand
Curve
17. Change in Quantity Demanded
D1
Change in quantity demanded
(a movement along the curve) on
account of change in Price
B
0
Price
(per
unit)
Quantity demanded (per unit of time)
100
$2
$1
200
A
19. Shift Factors of Demand
• Shift factors of demand are factors that cause shifts in the demand
curve:
• Change in Income.
• Change in the prices of other goods.
• Change in Tastes.
• Change in Expectations.
• Change in Number of Buyers
• Taxes on subsidies to consumers etc.
20. Factors that Shift Demand
Demand
Number
Of
Buyers
Price of
Related Goods
Expectations
Demographics
Tastes
And
Preferences
Consumer
Income
21. Market Demand and
Consumers Surplus
0 Quantity per period
D
1
2
Price
per
unit
Consumer surplus at a price of 2 is
shown by the grey area.
If the price falls to 1, consumer
surplus increases to include the
purple area.
At a zero price, consumer surplus
increases to the entire area under
the D curve.
22. Food for Thought
• https://www.forbes.com/sites/forbesbusinesscouncil/2020/10/20/
why-you-shouldnt-give-away-your-product-for-
free/?sh=45ce234a3604
23. Consumption
– Money price
– Time price
Willing to pay premium for time-saving goods
Role of Time in Demand
25. What is Supply?
Supply is the total amount of a specific good or service that
is available to consumers at specific price during a given time
period.
This relates closely to the demand for a good or service at a
specific price; All other things being constant, the supply
provided by producers will rise if the price rises because all
firms look to maximize profits and vice-versa.
26. The Law of Supply
• The law of supply states that there is a positive
relationship between price and quantity of a
good supplied.
• This means that supply curves will have a
positive slope.
• The algebraic formula for supply represents
the supply of an item at any given price is
represented by equation of a line: S= a+bP
where:
S=Units supplied;
P=Price
a and b are Constant
0
1
2
3
4
5
6
0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
Price
of
soybeans
per
bushel
($)
27. Determinants of Supply
Price of the good or service.
Cost of producing the good, which in turn depends on:
The price of required inputs (labor, capital, and land),
The technologies that can be used to produce the product
and few others
The prices of related products.
Consumer Demand
Government Policies
Infrastructure availability, etc.
28. A Change in Supply due to Price Versus
a Change in Quantity Supplied due to other Determinants
• A change in supply is
not the same as a
change in quantity
supplied.
• In this example, a higher
price causes higher
quantity supplied, and a
movement along the
Supply curve.
• The second case is example of changes in other determinants of
supply, other than price, causing an increase in supply, or a
shift of the entire supply curve, from SA to SB.
29. • When supply shifts to the
right, supply increases due
to changes in other
determinants of supply.
• This causes quantity
supplied to be greater than
it was prior to the shift, for
each and every price
level.
A Change in Supply due to Price Versus
a Change in Quantity Supplied due to other Determinants
30. A Change in Supply due to Price Versus
a Change in Quantity Supplied due to other
Determinants
To summarize:
Change in price of a good or service
leads to
Change in quantity supplied
(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to
Change in supply
(Shift of curve).
31. From Individual Supply
to Market Supply
• The supply of a good or service can be defined for an
individual firm, or for a group of firms that make up a
market or an industry.
• Market supply is the sum of all the quantities of a good
or service supplied per period by all the firms selling in
the market for that good or service.
32. Market Supply
As is the case of market demand, the
market supply is the horizontal summation
of individual firms’ supply curves.
33. Market Equilibrium • The operation of the market
depends on the interaction
between buyers and sellers.
• An equilibrium is the condition
that exists when quantity
supplied and quantity demanded
are equal.
• At equilibrium, there is no
tendency for the market price to
change.
34. Market Equilibrium
• Only at equilibrium the
quantity supplied equals to
the quantity demanded.
• At any price level other
than P0, the wishes of
buyers and sellers do not
coincide.
35. Market Disequilibria • Excess demand, or shortage, is
the condition that exists when
quantity demanded exceeds
quantity supplied at the
current price.
• When quantity demanded
exceeds quantity supplied,
price tends to rise until
equilibrium is restored.
36. Market Disequilibria
• Excess supply, or surplus, is
the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.
• When quantity supplied
exceeds quantity demanded,
price tends to fall until
equilibrium is restored.
37. Increase in Demand and Supply
• Higher demand leads to higher
equilibrium price and higher
equilibrium quantity.
• Higher supply leads to lower
equilibrium price and higher
equilibrium quantity.
38. Decreases in Demand and Supply
• Lower demand leads to lower price and
lower quantity exchanged.
• Lower supply leads to higher price
and lower quantity exchanged.
39. Relative Magnitudes of Change
• The relative magnitudes of change in supply and
demand determine the outcome of market equilibrium.
40. Government Set Prices
Although markets tend to lean toward equilibrium, in some
cases the government steps in to control prices.
The government can impose a Price Ceiling or a Price Floor to
regulate prices.
41. Price Ceilings
• A price ceiling is a maximum price that can legally be charged for a
good. The price is artificially held below the equilibrium price and is
not allowed to rise.
Who benefits from this?
• The government places price ceilings on some goods that are
considered “essential” and might become too expensive for
consumers.
• Because these price ceilings are set below equilibrium, they end up
causing shortages (more demand than supply)
42. Example: Rent Control
• Some cities like NYC instituted rent controls when housing prices were rising rapidly
and current city residents could no longer afford rent.
• Rent is only allowed to rise a certain percentage each year, but stays below equilibrium
• Price ceilings provide a gain for buyers and a loss for sellers
• Has resulted in a shortage of apartments because they require owners to accept a price
that is lower than the equilibrium price.
• Rather than accept the low price, owner often convert the apartments to
condominiums and sell them, decreasing the supply of available apartments
44. Price Floors
• A price floor is a minimum that can legally be charged for a good. The price
is artificially held above the equilibrium price and is not allowed to fall.
• The government sets price floors when it wants sellers to receive a
minimum price.
Who benefits from this?
• Because these price ceilings are set above equilibrium, they end up causing
surpluses (more supply than demand)
45. Example: Farm Subsidies and Minimum Support
Price Policy Impact
• Technological advances have greatly increased the supply of agricultural products.
• The government sets a price floor that allows farmers to produce as much as they
want to sell at a set price.
• Government extends assurance that it will buy excess crops and store them and
then distribute them through public distribution system.
• This results in surplus production of such crops (in excess of demand and farmers
get price that is more than ideal market price).
