MODULE 2

Part 2

Price Theory: Demand and Supply

Price Theory aims to explain how prices are determined in a market, how individuals
behave when price levels change. The second package endeavors to explain how changes in
the prices of a product impact on the demand or supply level of another product or service.

We proceed to our discussion of Demand and Supply. In Module 1, we recall that the study
of economics is necessitated by the scarcity of resources and the absence of limitation of
wants and needs, seemingly contrarian concepts but amenable nonetheless to rational
analysis.

Everyone wants or needs something. At some point in our life, we demand goods or
services. We also know that if we are willing to pay the right price, someone is willing to
sell us, supply us what we want or need.

When two individuals, or firms or countries agree to supply one party with a good or
service in exchange for money(the agreed upon price) or some other good or
service(barter). In this case, you have a market. The market maybe the palengke or
talipapa as we know them but need not be a physical location like e-commerce, in sites like
Tuguegarao Buy and Sell, Lazada or Shoppee.

Whenever and wherever there is exchange of goods and services(i.e., it may be inside the
classroom, in one’s residence, over the internet), then there is a market.

We can analyze better a market by looking at these prior assumptions in our discussion.

1. That the economy functions in a market/capitalists economy where the government

exercises minimal supervision over price setting.
2. The market transactions are happening under normal circustances because
calamities as typhoons, volcanic eruptions and the like tend to distort the normal
interactions between price and quantity demanded/supplied.
3. That the government does not interfere in the setting of prices.
4. That buyers nor sellers do not have any control over the prices of goods of services
in a market. Why is that? There are too many buyers and too many sellers of
commodities that not one can set the price. How then do indicative prices
determined? When sellers and buyers meet, according to their best judgement, they
 haggle. When both decide a price is fair, exchange happens, This is the economic
principle of the invisible hand operating.

Before we continue, try to study the following concepts.

1. Market – a place where buyers and sellers interact and engage in exchange. It is
also a mechanism through which buyers and sellers interact in order to determine
the price and quantity of a good or service.

2. Price – the value of a good in terms of money.

3. Demand – a reflection of consumer’s desire for a commodity.

4. Supply – the amount of a commodity available for sale.

5. Aggregate Demand - the totality of consumers’ demand.

6. Aggregate Supply – the totality of producers’ supply.

7. Demand Schedule – the quantities consumers are willing to buy of a good at

various prices.

8. Supply Schedule – the quantities producers are willing to offer for sale at various
prices.

9. Non-price factors - factors other than price that also affect demand and supply.

10. Demand function - shows how quantity demanded is dependent on its determinant.

11. Supply function – shows how quantity supplied is dependent on its determinant.

12. Equilibrium – condition of balance or equality.

13. Price ceiling – the maximum limit at which the price of a commodity is set.

14. Price floor - the minimum limit beyond which the price of a commodity is not
allowed to fall.

15. Surplus – excess of supply over demand for a good.

 16. Shortage – excess of demand over supply.

17. Subsidy – government assistance given to either producers or consumers.

Let us start from the side of demand. What is demand? It is our desire to consume a good
or avail of a service to answer our needs and wants. Needs are the things we need for
physical survival as food clothing and shelter. Wants are the things we can do without.
They are not important for our physical survival. Still, wants can make life more
comfortable, could make life more worth living like bus rides, radios, movies, haircuts, etc.

As a general rule, we consume more of a product as its price go lower and consume less as
it goes higher. For example, a dress sold for PhP 200 would certainly have a demand but
once it is put on sale at PhP 50, then suddenly the demand would skyrocket. This is the
normal reaction of a rational human beings to price changes.

This tendency can be better illustrated via a demand schedule for a softdrink brand.

Demand Schedule for Funta Softdrink

Per Week

Price per Bottle of Funta Quantity Demanded

(in PhP) (in # Bottles)
45 100
40 150
35 250
25 300
20 350

If plotted on a chart where the vertical axis represents the price and the horizontal axis, the
quantity demanded, this would now be called the demand curve.
 Quantity Demanded
(in # Bottles)

50
45
40 Quantity Demanded
35 (in # Bottles)
30
25
20
15
10
5
0
100 150 250 300 350

Normally, the demand curve slopes downward to the right showing the inverse relationship
between price and demand. The higher the price, the lower the demand. In this context,
price is the strongest driver of quantity demanded.

However, there are non-price factors that influence the level of quantity demanded.

1. Taste and Preferences – what is in fashion, what is popular is usually preferred.

2. Income – the higher the income, the higher the quantity demanded.
3. Expectation of future prices - if prices are expected to increase in the near future,
demand level increases.
4. Prices of related goods like substitutes and complements – if the price of a substitute
product is reduced, there is an observed reduction in the demand for other like
products. Example, if the price of safeguard soap is reduced, the demand for
Bioderm or other bath soap tend to decrease because they now prefer to buy the
lesser priced variant.
5. Size of population – the bigger the population, the bigger the demand.

Now let us look at the other side of the transaction, the supply schedule. Imagine that this
time, we are the supplier, or the producer of a good or a service. How would we behave in
a market when faced with consumers wanting a good for a certain quantity and price?

As producers, we sell in a market with the hope that you can make the most income from
consumers. If consumers are willing to pay more for the product, the better it is for the
producer. If they are not, producers will have to bargain with the consumers until they
agree on a certain price and quantity that make them both happy. Briefly, we can say that
the higher the price of a commodity, the bigger the quantity of the good or service they are
willing to sell. Conversely, the lower the price, the lesser the quantity they are willing to
supply. Now let us look at a hypothetical supply schedule.

Supply Schedule for Funta Softdrinks

Per Week

Price per Bottle of Funta Quantity Supplied

(in PhP) (in # Bottles)
45 350
40 300
35 250
25 150
20 100

When plotted in a graph, this is how the supply curve will look like.

Quantity Supplied
(in # Bottles)

50
45
40 Quantity Supplied
35 (in # Bottles)
30
25
20
15
10
5
0
100 150 250 300 350

Normally, the supply curve slopes downward to the left showing the direct relationship
between price and demand. The higher the price, the higher the quantity supplied.
If both the demand and supply schedule were to be juxtaposed, this is how it is goin to look
like.

Demand and Supply Schedule for Funta Softdrinks

Per Week

Price per Bottle of Funta Quantity Demanded Quantity Supplied

(in PhP) (in # Bottles) (in # Bottles)
45 100 350
40 150 300
35 250 250
25 300 150
20 350 100

As can be seen in the following supply and demand curve, the downward sloping demand
curve and the upward sloping supply curve intersect at the price where quantity demanded
is equal to quantity supplied. This is what is termed as market equilibrium condition or the
“equilibrium point”.

The area above the equilibrium point shows the area of surplus – the area where the
prices are higher and not all products can be bought by consumers and, as expected, the
area beneath the equilibrium point is the area of shortage, an area where prices are low
and producers are unwilling to sell less.

In summary, we can say that there is a “direct relationhip” between price and supply
and an “inverse relationship” between price and demand. The higher the price, the
more the quantity supplied, the lower the price, the higher the quantity demanded. This
is, in economics, called the “law of supply and demand”.

You remember the most dominant factor in changing the level of supply and demand?
Yes, it is price. But there are non-price factors that may also change the level of
quantity supplied or quantity demanded. While the price of a commodity remains
constant, the demand may increase or decrease because of non-price factors.

The demand curve above shows a “shift to the right” meaning the price of the

commodity remains constant but there is an increase in the demand level like when you
are expecting the price of gasoline to increase three days from now, you now purchase
more even if there is no price increase yet. Conversely, this may happen also to the
producers. Demand or supply curves may shift to the right or to the left.

Now do the following(Learning Tasks)

1. What insights on human nature may be gleaned from the law of supply and
demand?
2. Provided with the following demand and supply schedule of pork, plot a line graph
showing the following(1 graph):
a. The demand and supply curve
b. Area of shortage
c. Area of surplus
 Supply and Demand Schedule of Pork/Week

Price/kg. Supply in kg. Demand in kg.

160 100 900
180 300 700
200 500 500
220 700 300
240 900 100

3. Presuming prices remain constant, in 2 separate graphs illustrate and discuss the
movement :
a. what happens to the demand curve if an across-the-board increase in salaries
and wages is given by the government.
b. what happens to the supply curve if prices of raw materials used in production
are lessened because they are in season.

4. http://econbyreyrey.blogspot.com/2015/10/non-price-determinants-supply-
demand.html

Read this short article, answer the following:

In each of the non-price factors mentioned in the article, cite and discuss a concrete
example applicable to our own economy.

Direction:

Submit your output of the learning tasks on or before March 20, 2021 to my email.