MMB 4163

BUSINESS ECONOMICS

Learning Unit 2:
Demand and Supply

Tan Chiang Ching

School of Business and Management
University of Technology Sarawak (UTS)
96000 Sibu, Sarawak
LEARNING OUTCOME

▪ Understand the law of demand and supply

▪ Describe the demand and supply curve
▪ Apply demand and supply determinants
▪ Demonstrate how equilibrium quantity and price is achieved using
diagrams and equation.
▪ Explain how market equilibrium can change

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Supply and Demand

▪ The concept of demand and supply is the basic concept in

market economy.

▪ The price system will determine how resources, products and

services are distributed.

▪ Distribution is made based on wants and the ability to pay.

▪ Anyone who has wants and is willing to pay will obtain what is
required.
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Demand

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Demand

▪ The concept of demand is used to describe, analyse and

behaviour of buyers in market.

▪ Demand can be defined as the total amount of goods

required and able to be purchased by consumers at various
price levels in a particular period of time.

▪ Relationship between demand quantities with price and related

variables (ceteris paribus) – assuming that other variables
remain constant while prices change.
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Law of Demand

▪ A demand curve with negative gradient indicates an inverse

relation between demand quantity and price level (Figure 1)

▪ When price increases, demand quantity decreases, and when

price decreases, demand quantity increases.

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Table 1: Demand Table

Price (RM) Demanded Quantity (Unit)

1 60

2 50

3 40

4 30

5 20

6 10

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Figure 1: Demand Curve

Price
(RM)

6
5
4
3
2
1
D
Quantity
(Unit)
10 20 30 40 50 60

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Demand and Quantity Demanded

▪ Demand curve illustrates the relationship between price and quantity

at a certain point of time only; with the assumption that other factors
remain unchanged.

▪ However, it cannot show the relationship for a longer period of time

due to the changes in other demand determinants.

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Demand and Quantity Demanded

▪ Movement along the demand curve indicates the changes of

demanded quantity caused by the good's own price change.

▪ This movement is related to the law of demand. When price

changes, buyers will make changes to the quantity of the goods
willing to be purchased. (Figure 2)

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Figure 2: Change of Quantity Demanded

Price (RM)
The shift from point A to B
D indicates increase in
10
C quantity demanded

6 A
The shift from A to
B point C shows
2
decrease in quantity
demanded
D
Quantity
(Unit)
10 30 60

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Shifts in Demand Curve

▪ Shifts in demand curve caused by changes in other determinant

variables are known as demand change.

▪ The right shift of demand curve indicates increase in demand.

▪ The shift to the left indicates decrease in demand quantity. (Figure

3)

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Figure 3: Change of Demand

Price (RM) Shift from point A to point B

D₁
indicates increase in
D₀ demand
D₂

A
C B The shift from point A
to point C indicates
D₁ decrease in demand
D₀
D₂ Quantity
(Unit)

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Demand Determinants

1. Price of Related Goods (Substitute Goods)

▪ The change in price of goods that are related to a commodity
will cause shifts the position of a demand curve.

▪ Substitute goods are goods that can be used as substitutes in

the use of a commodity. Examples butter to margarine or meat
to fish. (Refer to Figure 4)

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 Figure 4: Changes in the Price of Substitute Goods

Price of Y Price of X Good X

Good Y
D D₁
D₀
B
P₂

A B
A P₁
P₁

D D₁
D₀
Quantity Quantity
Q₂ Q₁ of Y Q₁ Q₂ of X
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Figure 4: Changes in the Price of Substitute Goods

▪ Assume that product Y is the substitute for X, when the price of Y

increases, consumers will reduce the purchase of Y and substitute it by
increasing the purchase of X.

▪ Consequently, quantity demanded for Y decreases while the demand for

X increases though price unchanged and vice versa.

▪ Price increase of Y from P1 to P2 will result in consumers reducing the

use of Y, and substituting with X.

▪ Even though the price of X remains unchanged, demand for X had

increased as a result of the increase in Y price.

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Demand Determinants

2. Price of Related Goods (Complementary Goods)

▪ Complementary goods are goods that can be consumed
together to get satisfaction.

▪ Examples are car with petrol and pen with ink.

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Figure 5: Changes in the Price of Complementary Goods

▪ The price of petrol (Z) increases from P1 to P2. This will cause
quantity demanded for petrol to decrease.

▪ As a result of the increase of petrol price, consumers will reduce

demand for cars (X), even if the price of cars remain unchanged.

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 Figure 5: Changes in the Price of Complementary Goods

Price of Z Price of X
Good Z Good X
D₀
D
D₁
B
P₂

B A
A P₁
P₁

D₀
D
D₁
Quantity Quantity
Q₂ Q₁ of Z Q₂ Q₁ of X

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Demand Determinants

3. Income
▪ Normally, income is positively related to demand. When income
increases, demand also increases and vice versa.

▪ For inferior goods, the increase in income will decrease

demand.

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Demand Determinants

4. Preferences
▪ When consumers' preference towards a commodity increases,
consumers will tend to make purchases at every price level.

▪ The demand curve for the particular commodity for example KFC
will shift to the right

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Demand Determinants

5. Prediction on Change of Price and Income in the Future

▪ Consumers may be able to predict future changes in price and
income, for example during the festive seasons.

▪ If price is expected to increase in the future, current demand will

increase.

▪ On the other hand, current demand will decrease if price and

income is expected to decrease in future.

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Individual Demand and Market Demand

▪ Market demand table or curve is the total sum or aggregate of

demand table or curve of all individual buyers present in the market.

▪ We can obtain the market demand table or curve by summing up

quantities demanded by all individual buyers at each price level.

▪ The relationship between price and quantity in the market is

influenced by the same determinant variables that influence.

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Table 2: Derivation of Market Demand

Market Demand
Price (RM) Quantity Demand (Unit)
(Unit)
Consumer 1 Consumer 2 Total
1 30 60 90
2 25 50 75
3 20 40 60
4 15 30 45
5 10 20 30
6 5 10 15
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Figure 6: Derivation of Market Demand Curve
Price Price Price

D D D

6 6 6

3 3 3

1 1 1
D D D

5 20 30 Qty 10 40 60 Qty 15 60 90 Qty

Consumer 1 Consumer 2 Market Demand Curve

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Supply

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Supply

▪ Behaviour of sellers in market is analysed and predicted using the

concept of supply

▪ Supply can be defined as table or curve that relates various quantities

of goods to be sold at a certain time at various price levels, while
other variables remain unchanged

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Law of Supply

▪ Price of goods positively influences quantity supplied. Increase in

price will increase the quantity supplied and vice-versa.

▪ The positive relationship between price and supply quantity is known

as the law of supply.

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Table 3: Supply Table for Good X

Price (RM) Quantity Supplied (Unit)

1 10
2 20
3 30
4 40
5 50
6 60

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Figure 7: Supply Curve for Good X

Price
(RM)
S

S
Quantity
(Unit)
20 60

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Supply and Quantity Supplied

▪ Change in price of a good or service leads to change in quantity

supplied (movement along a supply curve, see in Figure 8).

▪ Change in costs, input prices, technology, or prices of related goods

and services leads to change in supply (shift of a supply curve, see in
Figure 9).

▪ Increase in production cost will bring about decrease in supply and

further causes the supply curve to shift to the left and vice versa
(Figure 9).

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Figure 8: Change in Quantity Supplied

Price Increase in price will

(RM)
cause an increase in
S quantity supplied
B from Point A to
Point B.
A

C
Decrease in quantity
supplied caused by price
decrease of the product
S itself is shown by the
Quantity
(Unit) movement from Point A to
Point C.
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Change in Supply

▪ Shows the change in supply due to factors of supply determinants

such as price of other goods, production cost, price prediction and
number of producers.

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Figure 9: Change in Supply

Price
(RM) S₂ Increase in production
S₀ cost will bring about
decrease in supply and
further causes the
C A B
S₁ supply curve to shift to
S₂
the left from Point A to
Point C in curve S₀ to S₂

S₀
S₁ Quantity
(Unit)

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Supply Determinants

1. The Cost of Production

▪ For a firm to make a profit, its revenue must exceed its costs.

▪ Cost of production depends on a number of factors, including

the available technologies and the prices and quantities of the
inputs needed by the firm (labour, land, capital, energy, and so
on).

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Supply Determinants

2. Price of other goods

▪ Correlation of goods in production process influences the
supply of a particular good when a price change for related
good occurs.

▪ Correlation of goods in production process can be divided into

two which are:
i. Substitutes in supply
ii. Complements in supply

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Supply Determinants

i. Substitutes in supply
▪ Substitutes in supply refers to goods that can be produced to
substitute the production of other goods without having to
make significant changes in the production process.

▪ E.g.: the production of rice flour and glutinous rice flour can be
done using the same machine.

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Supply Determinants

i. Substitutes in supply
▪ If the profit or price of a substitute good in the production
increases, producer will shift production to that particular good
and decrease the production of other goods

▪ If the price of rice flour increases, producer will suspend the

production of glutinous rice flour to be substituted with the
production of rice flour, in order to gain current profit.

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Supply Determinants

ii. Compliments in supply

▪ A complement in supply to a good x is a good y such that an
increase in the production of y increases the supply of x.
Complements in supply are usually goods that are jointly
produced.
▪ Gold and copper: An increase in the price of gold tends to
increase the number of people prospecting for gold and, in the
process, increases not just the quantity of gold supplied to the
market but also the quantity of copper. Thus, copper and gold
are complements in supply.
▪ Beef and leather: An increase in the price of beef increases the
slaughter of cows, thereby increasing the supply of leather.

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From Individual Supply to Market Supply

▪ market supply The sum of all that is supplied each period by all
producers of a single product.

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Figure 10: Deriving Market Supply from Individual Firm Supply
Curves

■ Total supply in the marketplace is the sum of all the amounts supplied
by all the firms selling in the market. It is the sum of all the individual
quantities supplied at each price. 41
Figure 10: Deriving Market Supply from Individual Firm Supply
Curves

■ Total supply in the marketplace is the sum of all the amounts supplied
by all the firms selling in the market. It is the sum of all the individual
quantities supplied at each price.
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Market Equilibrium

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Market Equilibrium

▪ Demand and supply are models that explain the respective

behaviour of consumers and sellers in market.

▪ The point of intersection between the demand and supply curves is

the market equilibrium point.

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Market Equilibrium

▪ The term equilibrium is used in economics to explain a condition

when all variables have reached an established position with no
tendency to change any further.

Equilibrium change only will happen if there is change in other

influence or determinants.

▪ At the point of market equilibrium, the need of buyers is equal to

the need of sellers, that is, quantity demanded is equal to quantity
supplied.

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Market Equilibrium

▪ The particular quantity and price are known as equilibrium quantity

and equilibrium price. ( Figure 11)

▪ Point e is known as equilibrium point, while Pe and Qe represent

equilibrium price and quantity respectively.

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Figure 11: Market Equilibrium

Price (RM) Point e is known as equilibrium

S point, while Pe and Qe
D
represent equilibrium price and
quantity respectively.
e
Pe

S
D
Quantity
(Unit)
Qe

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Equilibrium, Surplus & Shortage

▪ Excess in demand is sometimes referred to shortage, while excess

in supply is known as surplus.

▪ Excess in demand is shown using negative value whereas excess in

supply using positive value. Zero surplus value indicates
equilibrium.

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Equilibrium, Surplus & Shortage

▪ Shortage occurs when quantity demanded exceeds quantity

supplied at a certain price level. Shortage will increase the pressure
on price. Hence, increase in price will reduce shortage.

▪ Surplus occurs when quantity supplied exceeds quantity demanded

at a certain price level. Surplus will be reduced when there is
decrease in price. Hence, surplus reduces the pressure on price .
(See Figure 12)

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Figure 12: Equilibrium, Surplus and Shortage

Price (RM)

D S
Surplus

e
Pe

Shortage
S
D
Quantity
(Unit)
Qe
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Table 4: Market Surplus, Shortage and Equilibrium

Quantity Quantity Shortage (-)

Pressure on
Price Demanded Supplied OR
Price
(Unit) (Unit) Surplus (+)
1 18 2 - 16 Increased
2 16 4 - 12 Increased
3 14 6 -8 Increased
4 12 8 -4 Increased
5 10 10 0 Equilibrium
6 8 12 +4 Decreased
7 6 14 +8 Decreased
8 4 16 + 12 Decreased
9 2 18 + 16 Decreased
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Change in Market Equilibrium

▪ Demand and supply always shift to the left or right as a response

to changes in other determinant variables.

▪ Hence, change in other variables will result in the change of

quantity and price equilibrium.

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Demand Change

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Figure 13: Effects of Demand Curve Shifts Towards Equilibrium
(Demand Increase)

• When demand increases while

Price (RM) D₁ supply remains unchanged,
D₀ S equilibrium price and quantity
E₁
will also increase.
P1
E₀ • When demand increases,
P0
demand curve D0 will shift to D1.
D1 and E1 are then new demand
D₁ curve and new point of market
S equilibrium.
D₀

Q0 Q1 Quantity (Unit)
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Figure 14: Effects of Demand Curve Shifts Towards
Equilibrium (Demand Decrease)

Price (RM)
When demand decreases
D₀ S
while supply remains
D₁
unchanged, equilibrium
E₀ price and quantity will
P0 decrease
E₁
P1

S
D₁ D₀
Quantity
(Unit)
Q1 Q0
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Supply Change

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Figure 15: Effects of Supply Curve Shifts Towards Equilibrium
(Supply Increase)

Price (RM)
When supply increases and
D S₀ demand remains unchanged,
S₁ equilibrium price will decrease
E₀ whereas equilibrium quantity
P0 will increase.
E₁
P1

S₀
S₁ D
Quantity
(Unit)
Q0 Q1
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Figure 16: Effects of Supply Curve Shifts Towards Equilibrium
(Supply Decrease)

Price (RM)
S₁
When supply decreases and
D S₀ demand remains unchanged,
E₁ equilibrium price will increase
P1
E₀ whereas equilibrium quantity
P0 will decrease.
S₁

S₀
D
Quantity
(Unit)
Q1 Q0
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Market in the Form of
Equation

59
Market in the Form of Equation

▪ The relationship between market demand and market supply for a

particular good and their respective determinants can be
represented in the form of equations.

▪ The equations are known as demand function and supply

function respectively.

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Demand Function

▪ Demand function shows the relationship between quantity demanded and its
determinants in the form of function.

▪ The general function of demand can be written as:

𝑸𝒅 = 𝒇(𝑷𝒈 , 𝑷𝒔 , 𝑷𝒄 , 𝐘, 𝐓, 𝐏𝐞𝐠)

Q d = Demand function Y = Income

Pg = Price of the good itself T = Taste

Ps = Price of substitute goods Peg = Price prediction of the good itself

Pc = Price of complementary goods

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Example

𝑄𝑑 = 𝑎 − 𝑏𝑃
Where, Q d = quantity demanded,
a = constant
b = demand curve gradient
P = price of good

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Figure 21: Demand Curve

Price
(RM) 𝑄𝑑 = 𝑎 − 𝑏𝑃
D
a = ???

If slope (b) = 5, what is

4
the Qₓ?

D
Quantity
(Unit)
Qₓ 5
0
63
Supply Function

▪ The general function of supply can be written as:

𝑸𝒔 = 𝒇(𝑷𝒈 , 𝑪𝒈 , 𝑷𝒔 , 𝑷𝒄 , 𝐏𝐞𝐠)

Q s = Supply function
Pg = Price of the good itself

Cg = Production Cost

Ps = Price of substitute goods in production

Pc = Price of jointly produced goods
Peg = Price prediction

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Example

𝑄𝑠 = 𝑎 + 𝑏𝑃
Where, Q s = quantity supplied,
a = constant
b = supply curve gradient
P = price of good

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Figure 22: Supply Curve

Price (RM) 𝑄𝑠 = 𝑎 + 𝑏𝑃
S

a = ???
Pₓ

If slope (b) = 8, what is

the Pₓ?
S
Quantity
-5 15 (Unit)

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Market Equilibrium

▪ Market equilibrium occurs when demand quantity is equivalent to

supply quantity or 𝐐𝐝 = 𝐐𝐬 .

▪ Equilibrium price and quantity can be obtained from the equations.

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Example

68
Figure 23: Market Equilibrium Price of RM5 and Equilibrium
Quantity of 10 Units

Price (RM)

10 D
S
𝑄𝑠 = −5 + 3𝑃
e
5

𝑄𝑑 = 20 − 2𝑃
1.7
S D
-5 0 10 20
Quantity
(Unit)

69
Thank You

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