MODULE MANAGERIAL ECONOMICS

CHAPTER 3: Market Forces: demand and supply

Objectives:
a. Understand how demand and supply works
b. Understand how an increase in demand affects market equilibrium
c. Understand how a decrease in demand affects market equilibrium
d. Understand how an increase in supply affects market equilibrium
e. Understand how a decrease in supply affects market equilibrium
f. Understand what happens when there is a decrease in supply and
demand?

MARKET FORCES: DEMAND AND SUPPLY

Market forces tend to drop the price if the quantity supplied exceeds quantity demanded and
prices rise if quantity demanded exceeds quantity supplied. This movement continues until there
are no more changes, and quantity demanded equals quantity supplied. This result is market
equilibrium

The result of the interaction between consumers and producers in a competitive market
determines Supply and Demand equilibrium, price and quantity.

DEMAND ANALYSIS

Demand analysis is a research done to estimate or find out the customer demand for a
product or service in a particular market.

Demand curve Movement along the demand curve

2 2

1 1
1 1

2 1 2 1
1 1
The graph shows that as the price of the product increases the quantity demanded decreases,
so, the higher the price of the product the lower will be its demand.

When the quantity demanded of a commodity changes, due to the rise or fall in the prices of
that commodity there is a movement in the demand curve.

Factors that influence demand curve

 Income
 Taste and preferences
 Prices of related goods
- Substitution goods
- Complementary goods
 Consumer’s expectation
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 Number of consumer
 Advertisement expenditure

The demand changes as a result of changes in price, other factors determining it being held
constant. We shall explain below in detail how these other factors determine market demand for
a commodity.

These other factors determine the position or level of demand curve of a commodity.

It may be noted that when there is a change in these non-price factors, the whole curve shifts
rightward or leftward as the case may be. The following factors determine market demand for a
commodity.

Income of the People:

The demand for goods also depends upon the incomes of the people. The greater the incomes
of the people, the greater will be their demand for goods. In drawing the demand schedule or
the demand curve for a good we take income of the people as given and constant. When as a
result of the rise in the income of the people, the demand increases, the whole of the demand
curve shifts upward and vice versa.

The greater income means the greater purchasing power. Therefore, when incomes of the
people increase, they can afford to buy more. It is because of this reason that increase in
income has a positive effect on the demand for a good.

When the incomes of the people fall, they would demand less of a good and as a result the
demand curve will shift downward. For instance, as a result of economic growth in India the
incomes of the people have greatly increased owing to the large investment expenditure on the
development schemes by the Government and the private sector.

As a result of this increase in incomes, the demand for good grains and other consumer goods
has greatly increased. Likewise, when because of drought in a year the agriculture production
greatly falls, the incomes of the farmers decline. As a result of the decline in incomes of the
farmers, they will demand less of the cotton cloth and other manufactured products.

Tastes and Preferences of the Consumers:

An important factor which determines the demand for a good is the tastes and preferences of
the consumers for it. A good for which consumers’ tastes and preferences are greater, its
demand would be large and its demand curve will therefore lie at a higher level. People’s tastes
and preferences for various goods often change and as a result there is change in demand for
them.

The changes in demand for various goods occur due to the changes in fashion and also due to
the pressure of advertisements by the manufacturers and sellers of different products. On the
contrary, when certain goods go out of fashion or people’s tastes and preferences no longer
remain favourable to them, the demand for them decreases.
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Changes in Prices of the Related Goods:

The demand for a good is also affected by the prices of other goods, especially those which are
related to it as substitutes or complements. When we draw the demand schedule or the demand
curve for a good we take the prices of the related goods as remaining constant.

Therefore, when the prices of the related goods, substitutes or complements, change, the whole
demand curve would change its position; it will shift upward or downward as the case may be.
When the price of a substitute for a good falls, the demand for that good will decline and when
the price of the substitute rises, the demand for that good will increase.

For example, when price of tea and incomes of the people remain the same but the price of
coffee falls, the consumers would demand less of tea than before. Tea and coffee are very
close substitutes. Therefore, when coffee becomes cheaper, the consumers substitute coffee
for tea and as a result the demand for tea declines. The goods which are complementary with
each other, the fall in the price of any of them would favorably affect the demand for the other.

For instance, if price of milk falls, the demand for sugar would also be favorably affected. When
people would take more milk, the demand for sugar will also increase. Likewise, when the price
of cars falls, the quantity demanded of them would increase which in turn will increase the
demand for petrol.

Substitution goods

In consumer theory, substitute goods or substitutes are goods that a consumer perceives as
similar or comparable, so that having more of one good causes the consumer to desire less of
the other good. Formally, good is a substitute for good if, when the price of rises, the demand
for rises

Complementary goods

A complementary good is a good whose use is related to the use of an associated or

paired good. Two goods (A and B) are complementary if using more of good A requires the
use of more of good B. For example, the demand for one good (printers) generates demand for
the other (ink cartridges).

Consumers’ Expectations with Regard to Future Prices:

Another factor which influences the demand for goods is consumers’ expectations with regard to
future prices of the goods. If due to some reason, consumers expect that in the near future
prices of the goods would rise, then in the present they would demand greater quantities of the
goods so that in the future they should not have to pay higher prices. Similarly, when the
consumers expect that in the future the prices of goods will fall, then in the present they will
postpone a part of the consumption of goods with the result that their present demand for goods
will decrease.
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Number of consumer
The market’s demand for a good is influenced by adding up the individual demands of
the present as well as prospective consumers of a good at various possible prices. The
greater the number of consumers of a good, the greater the market demand for it. The
increase in consumers can happen when more and more favored substitute goods than
a specific commodity. Then the number of substitute’s buyers will rise. When the
seller expands to a new market to distribute goods, or when there is a growth in the
population, the demand for a specific good can also escalate.

Advertisement Expenditure:
Advertisement expenditure made by a firm to promote the sales of its product is an important
factor determining demand for a product, especially of the product of the firm which gives
advertisements. The purpose of advertisement is to influence the consumers in favour of a
product. Advertisements are given in various media such as newspapers, radio, and television.
Advertisements for goods are repeated several times so that consumers are convinced about
their superior quality. When advertisements prove successful they cause an increase in the
demand for the product.

For more knowledge please check the link provided;

https://youtu.be/51gBc_7kpTk

SUPPLY ANALYSIS

Supply curve

Movements along the Supply Curve

How do coffee companies decide how much coffee to produce? One of the driving factors is, of
course, the market price coffee can be sold for. This can be best understood by looking at the
supply curve below.
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 On the vertical axis, we have the price of coffee

 On the horizontal axis, we have the quantity of coffee that coffee companies are willing to
produce.

 The supply curve demonstrates the relationship between the price of coffee and the quantity
of coffee supplied.

 When coffee is priced at $2 per unit, coffee producers are willing to produce 4 units of
coffee. When Coffee rises to $6 per unit, producers are willing to provide 12 units of coffee.

 Holding other factors constant, the higher the price the more producers are willing to
supply to the market.

 The reverse is also true, the lower the price the fewer producers are willing to supply to the
market place.

 Changes in price will cause movements along the supply curve.

Shifts in The Supply Curve

It makes perfect sense why changes in price would impact the number of units’ producers are
willing to supply to the marketplace. The higher the price, the more money they can make from
selling more units.

Price is not the only factor that will determine the number of units’producers are willing to
supply to the market place. Other factors include;

 Cost of production

 Taxes

 Natural disasters

 Technology changes

These factors will change the number of units’ producers are willing to provide to the market
place at ANY price. This is represented by a shift in the supply curve.

Going back to our coffee example, let’s assume the cost to produce coffee falls. What will that
mean for the number of units’ coffee companies are willing to supply to the market?

Since it has become less expensive to produce coffee, companies will be willing to sell more
coffee at every price point (if they can make a profit).

This is represented as a shift of the supply curve to the right from S1 to S2 as illustrated below.

 At the original cost of production (S1) when the market price of coffee was $6 coffee
companies were willing to sell 12 units of coffee. When the price fell to $2, they were only
willing to sell 4 units.

 When the cost to produce coffee falls (S2) coffee companies have a higher profit margin and
are willing to sell more coffee at any price.

 When the price of coffee is at $6 coffee companies are now willing to sell 14 units of coffee.
When the price falls to $2 they are willing to sell 6 units of coffee.

 When the Supply Curve shifts to the right (S2) companies are willing to sell more
units then they were previously willing to sell (S1) at every price point.
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 The opposite is also true. If the cost to produce coffee increases, coffee companies would
be willing to sell fewer units of coffee at every price point.

Two major takeaways

1. Changes in price cause movements up and down the supply curve

2. Changes in factors such as the cost of production shift the entire supply curve to the right
(increased supply at any price) or the left (decreased supply at any price)

MARKET EQUILIBRIUM

Supply and demand Equilibrium

In the diagram below, you can see the Supply and Demand equilibrium with equilibrium price
and quantity.

 P* is the equilibrium price

 Q* is the equilibrium quantity

Why is the Equilibrium Specifically at Price P* and Quantity Q*?

At a higher price, there would be more quantity

supplied than demanded so the seller would have
to lower his price to sell his goods. If the sellers
raise their price too high, where the demand is
less than what they have to offer, then they will
have a surplus that will force them to lower their
price until they can sell their entire supply
At a lower price, there would be more
quantity demanded than supplied so the buyer
would have to spend more to buy goods. If the
sellers set their price too low, then they will sell
their entire supply before they can satisfy the
demands of the market. This would result
in a shortage in the market.

How an increase in demand affects market equilibrium

We will now look at how changes in Supply and Demand affect the equilibrium. We will note the
changes in equilibrium price and quantity .
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In the above graph, we see an increase or upward shift in the demand curve from D1 to D2.
This increase can be because of some factors. The result of this increase in demand while
supply remains constant is that the Supply and Demand equilibrium shifts from price P1 to P2,
and quantity demanded and supplied increases from
Q1 to Q2.

How a decrease in demand affects market

equilibrium

In the graph, we see a decrease or downward shift

in the demand curve from D1 to D2. This decrease
can be because of some factors that affect demand.
The result of this decrease in demand while supply
remains constant is that the equilibrium falls from
price P1 to P2, and quantity demanded and supplied
decreases from Q1 to Q2

How an increase in supply affects market

equilibrium

In the graph, we see an increase or upward

shift in the supply curve from S1 to S2. This
increase can occur because of a number of
factors. The result of this increase in
supply while demand remains constant is
that the Supply and Demand equilibrium
shifts from price P1 to P2, and quantity
demanded and supplied increases from Q1
to Q2.

How a decrease in supply affects market

equilibrium

In the graph, we see a decrease or downward

shift in the supply curve from S1 to s2. This
decrease can be because of a number of
factors that affect supply. The result of this
decrease in supply while demand remains
constant is that the equilibrium falls from price P1
to P2, and quantity demanded and supplied
decreases from Q1 to Q2

What happens when there is a decrease in supply

and demand?

In this graph, both S & D fall from D1 to D2 and S1 to

S2 respectively. The result is price increasing from P1
to P2 and quantity demanded and supplied
decreasing from Q1 to Q2.
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For more knowledge please check the link provided;

https://www.youtube.com/watch?v=WZ0I9t9QoZ0

http://www.economicsdiscussion.net/essays/economics/6-important-factors-
thainfluence-the-demand-of-goods/926
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https://www.intelligenteconomist.com/supply-and-demand/