Basic Principles of Market Demand and Market Supply

How much is the price of tomatoes today? What about atis? Calamansi? The prices of
the products may be known if you are just in the market place to buy them. Prices at this time
may be different compared this morning, compared yesterday or even last week or last month.
Prices even vary depending on the place. Prices in Manila may be different in Batangas or in
Ilocos and Bicol.
This chapter examines the working of the pricing system in a highly competitive market
with many firms competing like the market for agricultural products. The concept market simply
refers to bringing together of buyers and sellers.
First we look at demand, then at supply, then see the interplay of these two to show how
price is determined. We then turn to examine how the other determinants of demand and
supply will affect the equilibrium price and equilibrium quantity.

THE MARKET

Market bring together buyers and sellers in the product market of resource market. A
market exists as long as there are buyers and sellers who agree on the price; hence, a
transaction takes place: The agreed price is called the market price or equilibrium price. A
market is an interaction between buyers and sellers of trading and exchange. It is where the
consumer buys and the seller sells.

Figure 3.2
3 Elements of the Market

Buyers Sellers

Transaction Equilibrium price

Take note that the market does not exist in a definite place only, it can exist anywhere
where there are buyers and sellers who agree on the price, hence, transaction takes place.

The goods market is the most common 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.

The financial market which includes the stock market where securities of corporations are
traded.

DEMAND

Demand refers to the quantity of a product or service that the buyer is willing and able to
purchase at various possible prices at any given time, ceteris paribus (Latin words which mean
all other things constant). Of course, buyers want low price rather than a high price given all
other things constant. Who among the buyers you know prefers to buy goods at higher prices
holding other things constant?

The Law of Demand

The Law of Demand states that “the higher the price (P) of the good, the lesser the
quantity demanded (Qd)”, or alternatively stated, “the lower the price, the higher the quantity
demanded all other things held constant.”

A buyer is a buyer if he is willing and if he is able to buy the goods. Willing to buy means
he really wants and has the interest on the goods while able to buy if he has the ability to pay.
Most people in the field of marketing and selling may fail to achieve their goals, if they are not
able to detect who their buyers are. One may be very good in sales demonstration making
people interested and willing to buy but do these target buyers have the money with which to
buy? Otherwise, they are not buyers.

Demand Function, Demand Schedule & Demand Curve

The Law of Demand which shows the inverse relation between price and quantity can be
illustrated in three different ways through a demand function, demand schedule and a demand
curve.

Demand function is expressed in terms of a mathematical equation as follows:

Qd = 80 - 4P

The demand function above shows that the slope or coefficient of the price is – 4 which
means that for every peso increase in price, quantity demanded decreases by 4 units. The
constant term 80 is the maximum quantity the market can absorb, and that when the product is
free or has a zero price.

Demand schedule is a list or table that shows the inverse relation between price and
quantity demanded all other things constant.

Table 3.1
Demand Schedule

Point Price Quantity demanded

A 0 80
B 5 60
C 10 40
D 15 20
E 20 0

The demand function can be expressed in a tabular form called demand schedule as
shown in Table 3.1.

The shows that as price goes up from P10 to P15, quantity demanded decreases from
40 to 20 units.

Demand curve is a locus of points that shows the inverse relation between price and
quantity demanded, all other things constant.
 Figure 3.3
Demand curve

Price

20

15

10

5
Qty.

0 20 40 60 80

The graph of the demand schedule and the curve is downward sloping which reflect an
inverse relation between quantity demanded and price. At point D, the quantity demanded is 20
units and the price P15 and as the price goes down to P10 at point C, quantity demanded
increases from 20 to 40 units.
To sum up, demand function, demand schedule and demand curve differ only in the
manner they are presented. The first is in the form of an equation, the second in the form of list
or table and the third, in the form of a locus of points or a graph. They are actually the same as
they all show the inverse relation of price of the good and quantity demanded, all other things
constant.
Determinants of Demand

The demand curve reflects the relationship between the price and quantity demanded,
but price is not the only variable of factor that can influence the consumer’s demand. Other
determinants of demand or the other factors that may affect demand are as follows:

1. Income has direct relation for normal goods but if the product is an inferior good, its
relationship to demand is inverse.

As income rises, the demand for normal goods also increases. On the other
hand, there are products for which demand rises as income declines. We call them
inferior or giffen goods. Dried fish (tuyo), sardines, eggs and noodles are products
whose demand increases when income of buyers declines.

2. Tastes and preferences have direct relation to demand. If one’s taste is in favor of the
product, the higher will be the demand for it.
 3. Prices of related goods and services for substitute goods like rice and bread, if the
price of rice increases, demand for bread increases, so relation is direct but inverse for
complementary goods like bread and butter. If price of bread increase, other things
constant, the demand for butter declines.
4. Buyer’s expectations about future prices has direct relation to demand. If price is
expected to increase, people tend to panic buy, hence demand increases.
5. Number of Buyers has direct relation to demand. The more the number of buyers the
higher demand.

Change in Quantity demanded vs. change in Demand

A change in quantity demanded (ΔQd) occurs when there is a change in the price of the
good itself.
Figure 3.4 shows that an increase in price from P10 to P15 results to a decrease in
quantity demanded from 40 units to 20 units representing a movement along a given demand
curve from point A to point B. A change in quantity demanded therefore, is illustrated by the
movement form one point to another along a given demand curve.
Change in demand (ΔD) occurs when there is a change in any of the other determinants
of demand such as income, number of buyers, price expectations, etc.
If the other determinants of a demand identified above are allowed to vary, the entire
demand curve will shift either to the left of the right. Such shift of the demand curve is called a
change in demand.
An increase in demand is represented by a shift of the demand curve to the right from
D1 to D2 and a shifts to the left if demand decreases from D1 to D3.
SUPPLY
Supply shows the different quantities of good that sellers are willing and able to sell at
any given time at various possible prices other things constant.
The Law of Supply
The Law of supply demonstrates the direct relation between the price and quantities that
will be sold. This means that the higher the price, the higher the quantity supplied. Producers
supply more at a higher price because it will mean higher revenue.
Supply Function, Supply Schedule and Supply Curve
Given supply function as follows:
Qs = - 10 + 5 P
Where: Qs is quantity supplied
P is the price
The function show the coefficient or the slope of the price, interprets that for every peso
increase in price, quantity supplied will increase by 5 units while the constant term -10 implies
that if price is zero, no one will ever supply the good and is tantamount to say that no one will
supply if price is below P2.
 The supply schedule in Table 3.2 shows that as price increases the corresponding
quantity supplied also increases.
Similarly, Figure 3.6 shows that the supply curve is upward sloping to the right reflecting
that as price increases the quantity supplied also increases.

Determinants of Supply
Aside from the price of the product there are other factors that determined of affect
supply. These are the following:
1. Resource price has an inverse relation to supply. High payment for land, labor, capital
and entrepreneur discourages sellers hence there will be a decrease in supply.
2. Technology has a direct relation to supply. An improved technology encourages
producers hence there will be an increase in supply.
3. The price of related goods or price of competing products has an inverse relation to
supply. For farmers, palay and corn are competing product, if the price of palay
increases farmers will plant palay rather than corn its competing product to take
advantage of higher price of palay.
4. Firm expectations about future prices has an inverse relation to supply. If the price of
rice is expected to increase, traders tend to hoard, hence, there will be a decrease in
supply.
5. Number of suppliers has a direct relation to supply. The more number of sellers, the
higher the supply.
6. Taxes and Subsidy have inverse and direct relation to supply, respectively.

Change in Quantity Supplied versus Change in Supply

Figure 3.7
A curve depicting a change in quantity supplied

A change in quantity supplied occurs when there is a change in the price of good itself
all other things constant.

A change in supply occurs whenever any of the other determinants of supply changes.
An increase in supply is represented by a shift of the supply curve to the right. Alternatively, a
decrease in supply is represented by a shift of the supply curve to the left.
Figure 3.8
The Change in Supply
In Fig. 3.8, a shift to the right of the supply curve, S to S, represents an increase in
supply, while a shift to the left, S, to S, represents a decrease in supply.
MARKET EQUILIBRIUM
We can now combine our analysis of demand and supply and see how market clears or
how a market equilibrium is attained.

The term equilibrium means that all forces in the market are in balance. An
equilibrium is attained where quantity demanded is equal to quantity supplied: Qd = Qs

a. Finding the equilibrium price (Pe) and equilibrium quantity through (Qe) mathematical
analysis
Consider the demand function Qd = 80 – 4P and
supply function Qs = -10 + 5P
The equilibrium price can be determined as follows:
Equilibrium Condition: Qd = Qs,
Substituting functions in the equation
80 – 4P = -10 +5P
80 + 10 = 5P + 4P
90 = 9P
90 = 9P
9 = 9
10 = P
Is the equilibrium price really P10? To find if it is so, substitute
P = 10 and check. Is Qd = Qs, if so then Pe = 10
Substituting P = 10, Qd = Qs
80 – 4P = -10 + 5P
80 – 4 (10) = -10 + 5 (10)
80 – 40 = -10 + 50
40 = 40
Then we can conclude that Pe = 10 and Qe = 40 units
b. Finding the equilibrium price (Pe) and equilibrium quantity (Q e) through tabular
analysis
Table 3.3

Quantity Demanded Price Quantity Supplied Qs – Qd

(Qe) (Qs)
80 0 (10) (90)
60 5 15 (45)
40 10 40 0
 20 15 65 45
0 20 90 90
Table 3.3 is the result of combining the demand schedule. Table 3.1 and supply
schedule of Table 3.2 The equilibrium price can be determined by comparing Qd and Qs.
What is the price level in which Qd = Qs? It is at price P10 where Qd = Qs = 40 units. So
the equilibrium price (Pe) is P10 and equilibrium quantity (Qe) is 40 units.
Any price above P10, say at P15, Q s = 65 and Qd = 20 hence, there is surplus of 45
units.
However, any price below Pe or below P10, Qd > Qs which will result to shortage in the
market. At P = P5, Qd = 60 and Qs = 15 hence shortage is 45 units.
c. Finding the equilibrium price (Pe) and quantity (Qe) through graphical analysis.
Figure 3.9
Figure 3.9 is the result of combining demand curve in Figure 3.3 and supply curve in
Figure 3.6. The intersection of the demand curve D and supply curve S is at point E indicated
that the equilibrium price is P10 and equilibrium quantity is 40 units.
A surplus is the excess of the quantity supplied over quantity demanded. Example, at
P15, the buyers would be willing to purchase 20 units, but producers would have produced and
offered 65 units. The difference brings a surplus of 15 units. A surplus brings the market price
down to equilibrium price, sellers would rather reduce the price than to incur additional storage
cost or experience spoilage of perishable products that can cause great loss.
When the quantity demanded is higher than quantity supplied, there is a shortage of the
product. At price P5, Qd = 60 units but Qs = 15 units, hence a shortage of 45 units. A shortage
brings the price up to the equilibrium price. Buyers would bid up the price to avail the product.
The equilibrium price is the most stable price in the market.
Effect of a Change in Demand or a Change in Supply to Market Equilibrium
Figure 3.10
The Effect of An Increase in Demand

An increase in the demand for the good is shown by a rightward shift of the demand
curve, D1 to D2 in Figure 3.10 holding supply unchanged. The effect is change in equilibrium
point from E to A, said shift of the demand curve gives rise to new equilibrium price P12.50 from
P10 and equilibrium quantity of 50 units from 40 units.
Demand curve may shift to the right with increase in income of consumers if product is a
normal good, and if consumers change their taste in favor of that goods. Other determinants
that will increase and have direct relation to demand will shift the demand curve to the right.

Figure 3.11
The Effect of A Decrease in Demand
 A decrease in demand as in Figure 3.11 is shown by a leftward shift of the demand
curve from D1 to D2 supply is unchanged. This causes change in equilibrium point from E to B
resulting to a decrease in both the equilibrium price and the equilibrium quantity from P10 to
P7.50 and from 40 to 30 units respectively.

Figure 3.12
The Effect of an Increase in Supply

An improvement in technology increases supply for the commodity, hence, a rightward

shift of the supply curve from S 1 to S2 in Figure 3.12. The equilibrium point changes from point E
to C resulting to a decrease in the equilibrium price from P10 to P7.50 and an increase in the
equilibrium quantity to 50 units from the original 40 units.
Effect of Decrease Supply
Figure 3.13
The Effect of A Decrease Supply

An increase in taxes discourage sellers, so supply for the commodity decreases, hence
supply curve shifts to the left from S1 to S2 in Fig. 3.13. The equilibrium point changes from E to
D. This causes an increase in the equilibrium price from P10 to P12.50 and a decrease in the
equilibrium quantity from 40 to 30 units.

Effects of Simultaneous Changes in the demand and supply

Figure 3.14
Supply Increases, Demand Increases

Supply curve shifts to the right as well as the demand curve. Equilibrium point at E,
changes to point A as in Figure 3.14. These changes result to an increase in equilibrium
quantity from 40 to 60 units, the price remaining unchanged (i.e. there is an equal increase in
demand and supply).

Figure 3.15
Supply Increases, Demand Decreases

Figure 3.15 shows that supply curve shifts to the right and demand curve shifts to the left
with the equilibrium point shifting from E to B. These changes lead to a decrease in the
equilibrium price from P10 to ₱5 while quantity does not change (i.e. the decrease in demand is
exactly the same as the increase in supply). The effect of equilibrium quantity depends on
whether the decrease in demand is larger than the increase in supply.

Figure 3.16
Supply Decreases, Demand Increases

Fig. 3.16 shows that supply curve shifts to the left and demand curve to the right causing
a change in equilibrium point from E to C. These changes cause an increase in equilibrium price
from P10 to P15 while equilibrium quantity is constant at 40 units (i.e. the increase in demand is
offset by an equal decrease in supply).

Figure 3.17
Supply Decreases, Demand Decreases

Figure 3.17 depicts the supply curve and a demand curve shifting to the left with the
equilibrium point changing from point E to point D. These changes result to decline in
equilibrium quantity from 40 to 20 units with no change in equilibrium price at P10 (i.e. there is
an equal decrease in demand and supply). Therefore, a decrease in demand and supply leads
to a decrease in the equilibrium quantity while the equilibrium price of the product remains
constant or equal.n