WEEK 4 MODULE IN APPLIED

CHAPTER 2:ECONOMICS
APPLICATION OF DEMAND AND SUPPLY

2.1. THE MARKET

A market is an interaction between buyers and sellers of trading or exchange. It is where
the consumer buys and the seller sells. The goods market is the most common type of market
because it is where we buy consumers goods. The labor market is where workers offer services
and look for jobs, and where employers look for workers to hire. There is also the financial market
which includes the stock market where securities of corporations are traded.
The market is important because it is where a person who has excess goods can dispose
them to those who need them. This interaction should lead to an implicit agreement between buyers
and sellers on volume and price. In a purely competitive market (similar products), the agreed
price between a buyer and seller is also the market price or price for all.

DEMAND
It is logical for people to expect an increase in the demand for bathing suits, ice cream,
suntan lotion, and umbrellas during summer. During the typhoon months, people may start buying
raincoats, boots, and cold medicines. In June, when the school year starts, demand for textbooks,
school supplies, and uniforms normally go up. Valentine’s day cause demand for flowers and
chocolates to surge. We can therefore see that in various seasons of the year, demand for certain
type of goods will increase. On the other hand, demand for rice, fish, salt, and milk tends to be
consistent all year.
Demand is the willingness of a consumer to buy a commodity at a given price. A demand
schedule shows the various prices.
A demand function shows how the quantity demanded of a good depends on its
determinants, the most important of which is the price of the good itself, thus, the equation:
Qd = f(P)
This signifies that the quantity demanded for a good is dependent on the price of that good.
Presented in Table 2.1 is a hypothetical monthly demand schedule for vinegar (in bottles) for one
individual, Maria. The quantity demanded is determined at each price with the following demand
function:
Qd = 6 – P/2
Table 2.1 Hypothetical Demand Schedule of Maria for Vinegar (in bottles)
Price per bottle Number of Bottles
P0 6
2 5
4 4
6 3
8 2
10 1

At a price of P10 per bottle, Maria is willing to buy one bottle of vinegar for a given month.
As price goes down to P8, the quantity she is willing to buy goes up to two bottles. At a price of
P2, she will buy five bottles. There is a negative relationships between the price of a good and the
quantity demanded for that good. A lower price allows the consumer to buy more, but as price
increases, the amount the consumer can afford to buy tends to go down.
 The demand curve is a graphical illustration of the demand schedule, with the price
measured on the vertical axis (Y) and the quantity demanded measured on the horizontal axis (X).
The values are plotted on the graph and are represented as connected dots to derive the demand
curve (Figure 2.1). The demand curve slopes downward indicating the negative relationship
between the two variables which are price and quantity demanded.

Figure 2.1 Hypothetical Demand Curve of Maria for Vinegar (in bottles) for One Month
The downward slope of the curve indicates that as the price of vinegar increases, the
demand for these good decreases. The negative slope of the demand curve is due to income and
substitution effects.
Income effect is felt when a change in a price of a good changes consumer’s real income
or purchasing power, which is the capacity to buy with a given income. In other words, purchasing
power is the volume of goods and services one can buy with his/her income. If a good becomes
more expensive, real income decreases and the consumer can only buy less goods and services
with the same amount of money income. The opposite holds with a decrease in the price of a good
and increase in real income.
Substitution effect is felt when a change in the price of a good changes demand due to
alternative consumption of substitute goods. For example, lower price encourages consumption
away from higher-priced substitutes on top of buying more with the budget (income effect).
Conversely higher price of a product encourages the consumption of its cheaper substitutes further
discouraging demand for the former already limited by less purchasing power (income effect).

THE LAW OF DEMAND

After observing the behaviour of price and quantity demanded in the above schedule, we
can now state the Law of Demand. Using the assumption ceteris paribus, which means all other
related variables except those that are being studied at the moment and are held constant, There is
an inverse relationship between the price of a good and the quantity demanded for that good. As
price increases, the quantity demanded for that product decreases. The low price of the good
motivates the consumer to buy more. When price increases, the quantity demanded for the good
decreases.
NON-PRICE DETERMINANTS OF DEMAND

The five determinants of demand are:

1. The price of the good or service.

2. Prices of related goods or services. These are either complementary (purchased along
with) or substitutes (purchased instead of).
3. Income of buyers.
4. Tastes or preferences of consumers.
5. Expectations. These are usually about whether the price will go up.

For aggregate demand, the number of buyers in the market is the sixth determinant.

Demand Equation or Function

This equation expresses the relationship between demand and its five determinants:

qD = f (price, income, prices of related goods, tastes, expectations)

It says that the quantity demanded of a product is a function of five factors: price, income
of the buyer, the price of related goods, the tastes of the consumer and any expectation the
consumer has of future supply, prices, etc.
Price. The law of demand states that when prices rise, the quantity of demand falls. That also
means that when prices drop, demand will grow. People base their purchasing decisions on price
if all other things are equal.
The exact quantity bought for each price level is described in the demand schedule. It's
then plotted on a graph to show the demand curve.
If the quantity demanded responds a lot to price, then it's known as elastic demand. If the
volume doesn't change much, regardless of price, that's inelastic demand.
The demand curve only shows the relationship between the price and quantity. If one of
the other determinants changes, the entire demand curve shifts.

Income
When income rises, so will the quantity demanded. When income falls, so will demand.
But if your income doubles, you won't always buy twice as much of a particular good or service.
There's only so many pints of ice cream you'd want to eat, no matter how wealthy you are. That's
where the concept of marginal utility comes into the picture. The first pint of ice cream tastes
delicious. You might have another. But after that, the marginal utility starts to decrease to the point
where you don't want any more.
Prices of related goods or services
The price of complementary goods or services raises the cost of using the product you
demand, so you'll want less. For example, when gas prices rose to P180 a gallon in 2008, the
demand for Hummers fell.
Gas is a complementary good to Hummers. The cost of driving a Hummer rose along
with gas prices.
The opposite reaction occurs when the price of a substitute rises. When that happens,
people will want more of the good or service and less of its substitute. That's why Apple continually
innovates with its iPhones and iPods. As soon as a substitute, such as a new Android phone,
appears at a lower price, Apple comes out with a better product. Then the Android is no longer
a substitute.
Tastes
When the public’s desires, emotions or preferences change in favor of a product, so does
the quantity demanded. Likewise, when tastes go against it that depresses the amount demanded.
Brand advertising tries to increase the desire for consumer goods. For example,
Buick spent millions to make you think its cars are not only for older people.

Expectations
When people expect that the value of something will rise, they demand more of it. That
explains the housing asset bubble of 2005. Housing prices rose, but people bought more because
they expected the price to continue to go up. Prices increased even more until the bubble burst in
2006. Between 2007 and 2011, housing prices fell 30 percent. But the quantity demanded didn't
grow. Why? People expected prices to continue falling. Record levels of foreclosures entered the
market due to the subprime mortgage crisis. Demand didn't increase until people expected future
prices would, too.

Number of buyers in the market

The number of consumers affects overall, or “aggregate,” demand. As more buyers
enter the market, demand rises. That's true even if prices don't change. That was another reason
for the housing bubble. Low-cost and sub-prime mortgages increased the number of people who
could afford a house. The total number of buyers in the market expanded, which increased demand
for housing. When housing prices started to fall, many realized they couldn't afford their
mortgages. At that point, they foreclosed. That reduced the number of buyers, driving down
demand.

SHIFTS OF DEMAND CURVE

A shift in demand means at the same price, consumers wish to buy more. A movement
along the demand curve occurs following a change in price.

Movement along the demand curve

A change in price causes a movement along the demand curve.

Figure 2.2
 A shift in the demand curve occurs when the whole demand curve moves to the right or
left. For example, an increase in income would mean people can afford to buy more widgets
even at the same price.
The demand curve could shift to the right for the following reasons:

 The good became more popular (e.g. fashion changes or successful advertising campaign)
 The price of a substitute good increased.
 The price of a complement good decreased.
 A rise in incomes (assuming the good is a normal good, with positive YED)
 Seasonal factors.

Evaluation higher price causes movement along and later shift

If there is an increase in the price of petrol, there would be a movement along the demand
curve, and a smaller quantity would be bought. However, there is likely to be only a small fall in
demand because demand for petrol tends to be quite price inelastic.

Figure 2.3
However, in the long term, the demand curve may shift to left as well because people
respond to the higher price by looking for alternatives, for example, they buy an electric car and
so no longer need petrol.

SUPPLY
Demand showed us the side of the consumers and their reactions to changes in price and
other determinants. We now look at the side of the supplier
Supply refers to the of quantity of goods that a seller is willing to offer for sale. The supply
schedule shows the different quantities the seller is willing to sell at various prices. The supply
function shows the dependence of supply on the various determinants that affect it.
 Assuming that the supply function is given as: Qs = 100 + 5P and is used to determine the
quantities supplied at the given prices.

Table 2.2: Supply Schedule of Domeng for fish in One Week

Price of Fish (per Kilo) Supply (in kilos)
P20 200
40 300
60 400
80 500
100 600

As can be seen in Table 2.2, the relationship between the price of fish and the quantity that
Domeng is willing to sell is direct. The higher the price, the higher the quantity supplied. When
plotted into a graph, we obtain the supply curve

Figure 2.4. Supply Curve of Fish of Domeng for One Week

We derive a supply curve is upward sloping, indicating the direct relationship between the
price of the good and the quantity supplied of that good.

THE LAW OF SUPPPLY

After observing the behaviour of price and quantity supplied in the above schedule, we can
now state the Law of Supply. Using the same assumption of “ceteris paribus” (other things
constant) there is a direct relationship between the price of a good and the quantity supplied of that
good. As the price increases, the quantity supplied of that product also increases. The high price
of the good serves as motivation for the seller to offer more for sale. Thus, when price increases,
the quantity supplied of the good increases since the seller will take this as an opportunity to
increase his/her income.
NON-PRICE DETERMINANTS OF SUPPLY
In the above analysis (Figure 2.4), the only factors that are vary are price and quantity
demanded. However, in real life, supply is influenced by factors other than price. These factors are
assumed constant for the purpose of simplifying the study of the relationship between price and
the quantity supplied.
If the assumption of ceteris paribus is dropped, non-price variables are now allowed to
influence supply. These non-price factors are cost of production, technology and availability of
raw materials and resources. These non-price determinants can cause an upward or downward
change in the entire supply of the product, and this change is referred to as a shift of the supply
curve.

SHIFTS OF THE SUPPLY CURVE

Just like in the case of demand, there are also movements along and shifts of the supply
curve. In the curve in Figure 2.4, what we see are changes in the quantities supplied due to different
prices of fish. These changes are reflected on a single supply curve and are changes from one point
to another profit on the same curve. This is referred to as a movement along the supply curve. The
reason for a movement along the supply curve is the change in the price of the good. Once supply
increases due to a non-price determinant, the entire supply curve will shift to the right to reflect an
increase, or to the left to reflect a decrease as shown in Figure 2.5.
The supply function will allow now read: S = f(P,C,T,A,R), where the supply (S) of a good
is a function of the price of that good (P), the cost of production (C), technology(T), and the
availability of raw materials and resources (AR).
As a non-price determinant, the cost of production refers to the expenses incurred to
produce the good. An increase in cost will normally result in a lower supply of the good even when
the price will not change since the producer has to shell out more money to come up with the same
amount of output. With the same budget and a higher cost, the producer will only produce a smaller
amount of the good, and therefore, the supply of the good in the market will decrease. This is
reflected in a rightward shift of the supply curve from S1 to S2 in Figure 2.5.
Technology is another significant non-price determinant of demand. The use of improved
technology in the production of a good will result in the increased supply of that good. On the
other hand, the use of obsolete or improper technology in production will result in a downward
shift of the supply curve from S1 to S2.
Another possible non-price determinant supply than can cause an upward shift of the curve
from S1 to S2 is through improved availability of raw materials and resources. Since more
resources can be used to produce a bigger output of the good, then supply increases.
Figure 2.5. Rightward Shift in the Market Supply Curve for Fish in Quinta Market for One week

The leftward shift of the curve of fish due to change in a non-price determinant. For
example, the effect of an increase due to an improved technology in catching fish leads to a
rightward shift to the supply curve to S2 which means the suppliers will sell more fish for the same
price.

2.2. DEMAND AND SUPPLY IN RELATION TO THE PRICES OF BASIC

COMMODITIES
MARKET EQUILIBRIUM
If the forces of demand and supply operate together, we can show how price is determined
in a market economy. Alfred Marshall, a British economist, defined the law of Demand and Supply
Equilibrium is the state of balance when demand is equal to supply. The equality means
that the quantity that sellers are willing to sell is also the quantity that buyers are willing to buy for
a price. As a market experience are willing to transact. The price at which demand and supply are
equal is the equilibrium price. In Figure 2.6 market equilibrium is attained at the point of
intersection of the demand and supply curves.
 Figure 2.6.Market Demand and Supply Curves for Fish in the Quinta Market for One Week

In Figure 2.6, the price of a good in the market is the equilibrium price. It is the price at
which the quantity demanded is equal to the quantity supplied. This is how most commodities in
the market are priced by their producers or sellers.

DETERMINATION OF MARKET EQUILIBRIUM

Market Equilibrium is attained when the quantity demanded is equal to the quantity
supplied.
Assuming that the demand function for Good X is : Qd = 60 – P/2 and the spply function
for Good X is : Qs = 5 + 5P
Applying the equations, we derive the following demand and supply schedules given the
following prices:

Equilibrium quantity is attained where Qd = Qs

 Equilibrium quantity is 55 since quantity supplied and quantity demanded are both 55 at
the price of P10, which is the equilibrium price.
Example of Determination of Market Equilibrium
Assume a demand and a supply function as the following:
P = 50 – 2Qd (Demand) P = 20 + 4Qs (Supply)
Where:
P = price Qd = demand Qs = Supply in thousands
The demand curve is downward sloping with the negative slope – 2 while the supply curve
is upward sloping with positive slope 4. At equilibrium, the price at which buyers are willing to
buy a certain volume is also the price at which sellers are willing to sell the same volume. Thus,
for the same price, buyers are willing to buy while sellers are willing to sell the same volume. To
compute equilibrium Price (P) and Quantity (Q), we have to equate the demand and supply
functions, as follows:
50 – 2Qd = 20 + 4Qs
At equilibrium, P = 40 and Q = 5 as illustrated by the demand-supply schedule and graph
below.

Figure 2.7.Demand-Supply Graph

Assume a demand and a supply functions, as follows:
P = 50 – 2Qd (Demand) P = 20 + 4Qs (Supply)
P = price Qd = Demand 4Qs = Supply in thousands
Table 2.3 Demand-Supply Schedule
D S P
48 24 1
46 28 2
44 32 3
42 36 4
40 40 5
 38 44 6
36 48 7
34 52 8
32 56 9
30 60 10

APPLICATION OF DEMAND AND SUPPLY IN RELATION TO HOUSING

SHORTGAGE
With close to 100 million Filipinos, limited land area, and shortage of funds to build houses
for all the Filipino families, the country continues to suffer from a shortage in mass housing that
is expected to reach 6.5 million units by 2030, Profriends President and CEO Guillermo Choa told
reporters in a briefing in Makati City. (Danesa O. Rivera, GMA News October 2, 2014). Housing
Shortage has been perennial problem in the country with accumulated backlog of about 3.92
million units from 2001 to 2011. (Source: Subdivision and Housing Developers Association
(SHDA).
Housing in the country is a problem evident because of the rapid growth of Philippine
population (see Figure 2.8). More people will mean a higher demand for housing. The supply of
houses is less than existing demand for them since more and more Filipinos are added to the
population annually. There seemingly a lack of government priority to build homes for the
homeless. Filipinos are see putting up shanties and makeshift homes in the streets, under bridges,
close to the railroad tracks, and near creeks, which proves to be dangerous since these overflow
during typhoons and inundate the areas, causing risk to the lives of the poor who have no other
choice as to where they should live.
Hardly does housing grow faster than population to decrease the housing backlog (Figure
2.8). It is the poor who suffer an increasing backlog to decent housing due to the increasing
population.

Figure 2.8.Housing and Population

There is obviously an excess of demand compared to supply housing even among ordinary
Filipinos. Buying and owning one’s home is always the dream of every Filipino family but it is
expensive to build a house in the country. Since many Filipinos are middle-or low-income earners,
they cannot afford the high cost of housing. Prices or real estate and construction materials are
even on the rise although with a significant decrease in July, 2017 as shown Figure 2.9.
 Figure 2.9 Philippine Average Construction Cost

Other people who dream of owning their own house may opt to borrow money from
financial institutions such as banks. They may apply for what we call real estate loans to buy their
dream houses. They may also borrow from the state-owned Pag-IBIG Fund if they are regular
contributing members of the fund.
Real estate loans are hard to come by for middle- and low-income earners and have a long
process of application. In addition, banks need to charge high interest rate that is a burden on the
borrower. An additional difficulty is that interest on loans is usually high and even if the first year
interest rates are low, these rates are subject to an upward adjustment usually on the second year
and onward, depending on the market rates.
The option for those who cannot afford to buy houses is to rent them from the owners
paying on a monthly basis. But there are laws on rent such as the one sponsored by former Senator
Joey Lina that tend to protect and favour the renters. This has led to reluctance on the part of
owners to rent out their property, thus further limiting housing opportunities for the Filipino.
Rent control is a type of intervention that affects prices. Rent control is equivalent to the
setting of a price ceiling on the rent.
 Figure 2.10. Demand and Supply Curves for Housing

The ideal situation in Figure 2.10 is at the point where the demand and supply curves
intersect otherwise called market equilibrium. The government can intervene by setting rent
control that is equivalent to a price ceiling. It indicates the homeowners cannot set the rent higher
than the price ceiling set by the government. However, if price ceiling is set below this equilibrium
point, homeowners will be motivated to rent out their property such that supply will decrease and
this will result in an excess of demand over the supply of housing, making it even more difficult
for people to buy their own houses.