SEBI Grade A 2020: ECONOMICS: DEMAND & SUPPLY

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CURRENT AFFAIRS: February 3 Week

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 SEBI Grade A 2020: ECONOMICS: DEMAND & SUPPLY
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CURRENT AFFAIRS: February 3 Week
Table of Contents

Demand ......................................................................................................................... 3
Meaning of Demand ...................................................................................................... 3
Factors that determine demand ................................................................................... 3
Demand Curve ............................................................................................................. 3
Rationale behind the Law of Demand ........................................................................... 4
Exceptions to the Law of Demand ................................................................................ 5
Understanding the Shifts & Movements along a Demand Curve ........................................ 5
Factors that shift the Demand Curve ............................................................................ 5
Elasticity of Demand .................................................................................................. 6
Total Outlay Method of Calculating Price Elasticity .......................................................... 6
Determinants of Price Elasticity of Demand ................................................................... 6
Income Elasticity of Demand ....................................................................................... 6
Cross Elasticity of Demand.......................................................................................... 6
Supply ........................................................................................................................... 7
Meaning of Supply ........................................................................................................ 7
Factors that determine Supply ..................................................................................... 7
Supply Curve ............................................................................................................... 7
Factors that shift the Supply Curve .............................................................................. 8
Elasticity of Supply .................................................................................................... 8
Equilibrium- Determination of Price and Quantity .............................................................. 8

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Demand

Meaning of Demand
All consumers demand goods and services. This demand is derived from consumers’ tastes and preferences
and is bound by income. Given a limited income, the consumer prioritizes what goods and services to
purchase.

In short “By demand, we mean the various quantities of a given commodity or service which
consumers would buy in one market in a given period of time, at various prices, or at various
incomes, or at various prices of related goods.”
The law of demand holds that other things being equal, as the price of goods/services rises, its
quantity demanded falls. The vice versa is also true viz. If the price of goods/services falls, its
quantity demanded increases.

Factors that determine demand

• Price of the commodity: Other things being equal, the demand for a commodity is inversely related
to its price.
• Price of related commodities (Substitutes & Complementary Goods):
o Substitutes: Substitutes are goods which can be consumed in place of one another. If the price
of banana (substitute) rises, the demand curve of apple (original goods) shifts to the right and
vice versa.
o Complementary Goods: Complementary Goods are goods which are normally consumed together.
So if the price of petrol (complement) rises, the demand curve for the car (original good) shifts
to the left.
• Level of Household Income: Other things being equal, the larger the average money income of the
household, the larger is the quantity demanded of a particular good (in most cases). Inferior goods are
exceptional in this case and their demand will decrease as income increases.
• Consumer’s Preferences and Taste: Goods which are more in fashion command higher demand than
goods which are out of fashion.
• Size of Population: Generally, the larger the size of the population of a country or a region is, greater
is the demand for commodities.
• Composition of Population: More old people in a region increase the demand for spectacles, walking
sticks, etc.
• Distribution of Income: If Income is being unequally distributed amongst the population, it will affect
demand.

Demand Curve
Let’s have a look at the below list where we have put the monthly demand of apples at different prices.

Price of Apples (Per Kg) Quantity Demanded (in Kg)

40 30

50 25

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 SEBI Grade A 2020: ECONOMICS: DEMAND & SUPPLY
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CURRENT
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70 15

80 10

As you can see, if the price of apples increases, people are able to afford less quantity of it. If you plot this
data on a graph, it will look something like below which is the demand curve.

Rationale behind the Law of Demand

Below are the explanations as to why demand curve slope downwards.
● Law of Diminishing Marginal Utility: People will buy more quantity at lower price because they want
to equalize the marginal utility of the commodity and its price. So a rational consumer will not pay more
for lesser satisfaction. He is induced to buy additional units in order to maximize his satisfaction or utility.
● Substitution Effect: When the price of a commodity falls, it becomes relatively cheaper than other
commodities. It induces consumers to substitute the commodity whose price has fallen for other
commodities which have now become relatively expensive. The result is that the total demand for the
commodity whose price has fallen increases.
● Income Effect: When the price of a commodity falls, the consumer can buy the same quantity of the
commodity with lesser money or he can buy more of the same commodity with the same amount of
money. This is called the income effect. Due to the operation of income effect and substitution effect the
law of demend holds.
● Arrival of New Consumers: When the price of a commodity falls, more consumers start buying it. This
raises the number of consumers of a commodity at a lower price and hence the demand for the
commodity.
● Different Usage: If some commodities have multiple usage and their prices fall, they will be used for
varied purposed and their demand will increase. Whereas an increase in prices will limit their usage.

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 SEBI Grade A 2020: ECONOMICS: DEMAND & SUPPLY
Exceptions
CURRENT to the Law
AFFAIRS: 3rd Week
of Demand
February
● Conspicuous Goods: Also known as Veblen Effect or Prestige Goods Effect, this effect takes place
when consumers measure the utility of a commodity by its price i.e., if the commodity is expensive they
think that it has got more utility. Diamonds are one example. Higher the price of diamonds, higher is
the prestige value attached to them and hence higher is the demand for them.
● Giffen Goods: If the price of bread goes up, poor people will have no option but to cut down other
expenses (for eg. milk, vegetables etc.) and keep buying the bread (since it is still the cheapest food).
So Giffen Goods’ demand will increase even if the price increases.
● Conspicuous Necessities: There are some necessities of being in a social group (for eg. refrigerator,
television etc.). Despite the fact that the prices of television sets, refrigerators etc. have been
continuously rising, their demand does not show any tendency to fall.
● Future Expectations about Prices: When the prices rise, households expect that the prices in the
future will be still higher and they tend to buy larger quantities of the commodities. However, it is to be
noted that it is not the law of demand which is invalidated here but there is a change in one of the factors
which was held constant while deriving the law of demand, namely change in the price expectations of
the people.
● Irrational and Impulsive Purchases: When consumers tend to be irrational and make impulsive
purchases without any rational calculations about price and usefulness of the product, in such contexts
the law of demand fails.
● Demand for necessaries: The law of demand does not apply much in the case of necessaries of life.
Irrespective of price changes, people have to consume the minimum quantities of necessary
commodities.
● Speculative Goods: In the market for stocks and shares, more will be demanded when the prices are
rising and less will be demanded when prices decline.

Understanding the Shifts & Movements along a Demand Curve

When an increase in the price of apples from Rs 40 to Rs 50, the quantity demanded decreases from 30 Kgs
to 25 Kgs. This price changes result in a movement along the given demand curve.

If there is a change in any other variable influencing quantity demanded, the change is a shift in the
demand curve or a change in the demand. For eg. if a consumer gets a bonus and is now able to buy
more apples, this will be a shift in the demand curve towards right.

A rightward shift in the demand curve: (when more is demanded at each price) can be caused by a rise
in income, a rise in the price of a substitute, a fall in the price of a complement, a change in tastes in favour
of this commodity, an increase in population, and a redistribution of income to groups who favor this
commodity.

A leftward shift in the demand curve: (when less is demanded at each price) can be caused by a fall in
income, a fall in the price of a substitute, a rise in the price of a complement, a change in tastes against
this commodity, a decrease in population, and a redistribution of income away from groups who favour this
commodity.

Factors that shift the Demand Curve

• Change in Consumer Income (as explained above)
• Population Change: People who come to metropolitan cities in search of employment are one of the
examples. This rise in population will shift the demand curve to the right.
• Consumer Preferences: Wedding season in India trigger the rate of wedding halls thereby shifting the
demand curve to the right since there is an increased demand of location-friendly wedding halls.
• Price of Related Goods: Prices of related goods can affect the demand curve of the original good. There
are 2 types of related goods:
o Substitutes: Substitutes are goods which can be consumed in place of one another. If the price
of banana (substitute) rises, the demand curve of apple (original goods) shifts to the right and
vice versa.
o Complements: Complements are goods which are normally consumed together. So if the price of
petrol (complement) rises, the demand curve for the car (original good) shifts to the left.

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Elasticity of Demand
Elasticity of demand is defined as the responsiveness of the quantity demanded of a good to changes in one
of the variables on which demand depends or we can say that it is the percentage change in quantity
demanded divided by the percentage in one of the variables on which demand depends. These variables are
price of the commodity, prices of the related commodities, income of the consumers and other factors on
which demand depends. Elasticity of demand is also called as price elasticity of demand.

Total Outlay Method of Calculating Price Elasticity

Price Elasticity = (% change in quantity demanded)/(% change in price)
where % change in quantity demanded = (new quantity - initial quantity)*100/(initial quantity)
and % change in price = (new price - initial price)*100/(initial price)
Determinants of Price Elasticity of Demand
● Availability of Substitutes
● Position of a commodity in a consumer’s budget
● Nature of the need that a commodity satisfies
● Number of uses to which a commodity can be put
● Time Period
● Consumer Habits
● Tied Demand
● Price Range

Income Elasticity of Demand

Income elasticity of demand is the degree of responsiveness of quantity demanded of a good to a small
change in the income of consumers.
Income Elasticity of Demand = (% change in demand)/(% change in income)

Cross Elasticity of Demand

The demand for a particular commodity may change due to changes in the prices of related goods. These
related goods may be either complementary goods or substitute goods.
Substitute Goods: In the case of substitute commodities, the cross demand curve slopes upwards (i.e. is
positive) showing that more quantities of a commodity, will be demanded whenever there is a rise in price
of a substitute commodity.
Complementary Goods: Here a change in the price of a good will have an opposite reaction on the demand
for the other commodity which is closely related or complementary.

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Supply
CURRENT AFFAIRS: February 3 Week

Meaning of Supply
While the law of demand is easy to understand from a consumer’s perspective, to understand the law of
supply you need to think from a producer’s perspective. A producer’s desire is to maximize profits. The law
of supply holds that other things being equal, as the price of goods/services rises, its quantity
supplied will rise. The vice versa is also true viz. If the price of goods/services falls, its quantity
supplied will decline.
Factors that determine Supply
● Price of the good
● Prices of related goods
● Prices of factors of production
● State of technology
● Government Policies
● Other Factors (Government’s Industrial and Foreign Policies, Goals of the Firm, Infrastructural Facilities,
Market Structure, Natural Factors etc.)

Supply Curve
The more quantity supplied will bring more revenue to the producer, increasing the potential to earn more
profit. Let’s have a look at the below list where we have put the monthly demand of apples at different
prices.

Price of Apples (Per Kg) Quantity Supplied (in Kg)

40 10

50 15

60 20

70 25

80 30

So, in a nutshell, an apple producer will supply more quantities of apples where he gets more incentive.
Plotting this data on a graph will give us the supply curve.

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Understanding the Shifts & Movements along a Supply Curve

This is very much similar to how we saw it above in the case of Demand Curve. A change in price results in
a movement along a supply curve and a change in any other variable that influences quantity supplied
produces a shift in the supply curve.

Factors that shift the Supply Curve

● Change in Input Costs: Increase in input costs (raw material etc.) shifts the supply curve to the left.
● Improvement in Technology: An improvement in technology enabling a cost reducing innovation shifts
the supply curve to the right.
● Change in the size of the industry: A growth in the size of industry shifts the supply curve to the right.

Elasticity of Supply
The elasticity of supply is defined as the responsiveness of the quantity supplied of a good to a change in
its price.
Elasticity of Supply = (% change in quantity supplied)/(% change in price)
Types of Supply Elasticity
● Perfectly Inelastic Supply: If as a result of a change in price, the quantity supplied of a good remains
unchanged, we say that the elasticity of supply is zero or the good has perfectly inelastic supply.
● Relatively less-elastic supply: If as a result of a change in the price of a good its supply changes less
than proportionately, we say that the supply of the good is relatively less elastic or elasticity of supply
is less than one.
● Relatively greater-elastic supply: If elasticity of supply is greater than one i.e., when the quantity
supplied of a good changes substantially in response to a small change in the price of the good we say
that supply is relatively elastic.
● Unit-elastic: If the relative change in the quantity supplied is exactly equal to the relative change in
the price, the supply is said to be unitary elastic.
● Perfectly elastic supply: Elasticity of supply said to be infinite when nothing is supplied at a lower
price but a small increase in price causes supply to rise from zero to an infinitely large amount indicating
that producers will supply any quantity demanded at that price.

Equilibrium- Determination of Price and Quantity

Any seller would like to set a higher price (for higher profits) for his products. However, market forces will
sooner or later penalize him for that. If the price of apples is set too high (say Rs 100 per kg), buyers will
switch to other sellers and this seller will end up with high unsold inventory. And if the price of apples is set
too low (say Rs 30 per kg), the seller will run short of stock very soon. With trial and error or good
judgement, the seller will settle on a price which equates the power of supply and demand.
In the condition of a market equilibrium, every buyer who wishes to buy the product the market
price should be able to do so and the seller should not be left with any unwanted inventory.
If you merge the above demand and supply curve in a same line graph, you will find that both curves meet
at

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A shortage occurs when quantity demanded exceeds quantity supplied. On the other hand, a
surplus occurs when quantity supplied exceeds quantity demanded.
Price Ceiling and Floors
A price ceiling is a legal maximum that can be charged for a good whereas a price floor is a legal
minimum that can be charged for a good.

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