Theory of Demand and Supply

Demand:
In economics demand is defined as consumers' willingness and ability to consume a given good.
In other words, Demand is an economic principle referring to a consumer’s desire to purchase
goods and services and willingness to pay a price for a specific good or service. To be demand,
three conditions must be met
1. Desire to purchase
2. Ability to purchase and
3. Willingness to pay
According to Benham, “Demand for anything, at a given price, is the amount of it which will be
bought per unit of time at that price”

Demand is a multivariate relationship, that is, it is determined by many factors simultaneously.

Some of the most important determinates of the market demand for a particular product are its own
price, consumers’ income, price of other commodities, consumers’ tastes, income distribution,
total population, consumers’ wealth, credit availability, government policy, past levels of demand,
past levels of income, etc.

Law of Demand:

The law of demand states that other factors being constant (ceteris paribus), price and quantity
demand of any goods and services are inversely related to each other. An increase in price will
decrease the quantity demanded of most goods. On the other hand, a decrease in price will increase
the quantity demanded of most goods. The inverse relationship between price and quantity
demanded of a good is known as the law of demand and is typically represented by a downward
sloping line known as the demand curve.
Demand Schedule:

A market demand schedule is a table showing the quantity of a commodity that consumers are
willing and able to purchase over a given period of time at each price of the commodity while
holding constant all other relevant economic variables on which demand depends (the ceteris
paribus assumption). Let’s look at a simple example.

Table: 1 Demand Schedule

Price of Apple Quantity Demanded
(Per Kg) (Per Kg per weak)

100 2
90 3
80 4
70 5
60 6
50 7

Table-1 presents a hypothetical demand schedule for apple. At each price, we can determine the
quantity of apples that consumers purchase. For example, at TK. 100 per kg, consumers will buy
2 kg of apples. At a lower price, more apples are bought. Thus, at a price of TK. 90 per kg, the
quantity bought is 3 kg. At yet a lower price equal to TK. 80, the quantity demanded is still greater.
And so forth, we can determine the quantity demanded at each price listed in Table 1.
Demand Curve:

The graphical representation of the demand schedule is called a demand curve. The demand
curve shows the quantity demanded of a given product at varying price points, holding all else
constant. The relationship between price and quantity demanded is also known as the demand
curve. In a typical representation, the price will appear on the left vertical axis, the quantity
demanded on the horizontal axis.

(Price) P D

P1

P0

D
Q (quantity)
0 Q1 Q0
Figure 1: Demand curve
.

We show the demand curve in figure 1 which graphs the quantity of apples demanded on the
horizontal axis and price of apple on the vertical axis. Note that quantity and price are inversely
related; that is P goes up and Q goes down. The curve slopes downward, going from northwest to
southeast. This important property is called the law of downward sloping demand curve
Another Explanation of Demand Schedule and Demand Curve
 Factors Affecting Demand Curve
There are many factors that can shift the demand curve. Here the most important.

Income: When income rises, so will the quantity demand. 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.
The first point 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 higher price of complementary goods or services raises
the cost of using the product you demand, so you'll want less. For example, when the price of
electricity rises, the demand for air conditioner (AC) decreases. Electricity is a complementary
good to AC. The cost of AC rose along with electricity 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. For example, when the price of beef rises, the demand for chicken
increases.

The size of the market: The size of the market-measured say, by the population clearly affects
the market demand curve. For example, California’s 40 million people tend to buy 40 times more
apples and cars than do Rhode Island’s 1 million people.

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.

Expectations: Your expectations about future may affect your demand for a good or service today.
If you expect to earn a higher income next month, you may choose to save less now and spend
more of your current income to buy ice cream. If you expect the price of ice cream to fall tomorrow,
you may be less willing to buy an ice cream cone at today’s price.

Weather: Change in demand also depends on the weather. For example, in the rainy season
demand for umbrella rises, on the other hand in the winter season, demand for warm clothes
increases and demand for ice-cream and cold-drinks decreases.
 Supply

Definition of Supply:

Supply is a fundamental economic concept that describes the total amount of a specific good or
service that is available to consumers. In other words, supply is the willingness and ability of
producers to create goods and services to take them to market. Supply is positively related to price
given that at higher prices there is an incentive to supply more as higher prices may generate
increased revenue and profits.

Law of Supply

The law of supply is the microeconomic law that states that all other factors being equal, as the
price of a good or service increases, the quantity of that good or service that suppliers offer will
increase, and vice versa. The law of supply says that as the price of an item goes up, suppliers will
attempt to maximize their profits by increasing the quantity offered for sale
Supply Schedule:
A supply schedule is a table showing the quantity supplied of a commodity at each price for a
given period of time. In other words, the supply schedule for a commodity shows the relationship
between its market price and the amount of that commodity that producers are willing to produce
and sell, other things held constant.
Table 2: Supply Schedule
Price of Ice-cream Quantity Supplied
(Per piece)
0 0
1 3
2 6
3 9
4 12
5 15
6 18

Table-2 presents a hypothetical supply schedule for ice cream. At each price, we can determine
the quantity of ice cream that producers supplied in the market. For example, at TK. 0.00, no
commodity at all will be produced. When the price is Tk 1, the quantity supplied is 3. As the price
of ice cream increases, ever more ice cream will be produced.

Supply Curve: The supply curve is a graphical depiction of the supply schedule that illustrates
the relationship between the price of a good and the quantity supplied. Figure 2 shows the typical
case of an upward-sloping supply curve for an individual commodity.

Figure 2: Supply Curve

Another Explanation of Supply schedule and Supply curve

The quantity supplied is the actual amount of a good or service producers are willing to sell at
some specific price. A supply schedule shows how much of a good or service producers will
supply at different prices. The table in Figure 3-6 shows how the quantity of coffee beans made
available varies with the price—that is, it shows a hypothetical supply schedule for coffee beans.

The table shows the quantity of coffee beans farmers are willing to sell at different prices. At a
price of $0.50 per pound, farmers are willing to sell only 8 billion pounds of coffee beans per year.
At $0.75 per pound, they’re willing to sell 9.1 billion pounds. At $1, they’re willing to sell 10
billion pounds, and so on.

The supply schedule can be represented graphically by a Supply curve, as shown in Figure 3-6.
Suppose that the price of coffee beans rises from $1 to $1.25; we can see that the quantity of coffee
beans farmers are willing to sell rises from 10 billion to 10.7 billion pounds. This is the normal
situation for a supply curve, reflecting the general proposition that a higher price leads to a higher
quantity supplied. Supply curves normally slope upward: the higher the price being offered, the
more of any good or service producers will be willing to sell.
 Factors affecting supply curve

There are many factors which affect the supply curve which are discussed below-

1. Technology: Technology is the knowledge that helps the people to produce different goods
and services. When economists talk about “technology,” they don’t necessarily mean high
technology—they mean all the methods people can use to turn inputs into useful goods and
services. In that sense, the whole complex sequence of activities that turn corn from an Iowa
farm into cornflakes on your breakfast table is technology. And when a better technology
becomes available, reducing the cost of production—that is, letting a producer spend less
on inputs yet produce the same output— supply increases, and the supply curve shifts to the
right. For example, an improved strain of corn that is more resistant to disease makes
farmers willing to supply more corn at any given price.

2. Input prices: An input is any good or service that is used to produce another good or
service. Inputs, like output, have prices. And an increase in the price of an input makes the
production of the final good more costly for those who produce and sell it. So producers are
less willing to supply the final good at any given price, and the supply curve shifts to the
left. For example, newspaper publishers buy large quantities of newsprint (the paper on
which newspapers are printed). When newsprint prices rose sharply in 1994–1995, the
supply of newspapers fell: several newspapers went out of business and a number of new
publishing ventures were canceled. Similarly, a fall in the price of an input makes the
production of the final good less costly for sellers. They are more willing to supply the good
at any given price, and the supply curve shifts to the right.

3. Weather: Climatic conditions are very important for agricultural products.

4. Expectations: When suppliers have some choice about when they put their good up for sale,
changes in the expected future price of the good can lead a supplier to supply less or more
of the good today. For example, consider the fact that gasoline and other oil products are
often stored for significant periods of time at oil refineries before being sold to consumers.
In fact, storage is normally part of producers’ business strategy. Knowing that the demand
for gasoline peaks in the summer, oil refiners normally store some of their gasoline produced
 during the spring for summer sale. Similarly, knowing that the demand for heating oil peaks
in the winter, they normally store some of their heating oil produced during the fall for
winter sale. In each case, there’s a decision to be made between selling the product now
versus storing it for later sale. Which choice a producer makes depends on a comparison of
the current price versus the expected future price. This example illustrates how changes in
expectations can alter supply: an increase in the anticipated future price of a good or service
reduces supply today, a leftward shift of the supply curve. But a fall in the anticipated future
price increases supply today, a rightward shift of the supply curve.

5. Number of Sellers: An increase in the number of producers will cause an increase in supply
and vice-versa. For example, if Ben and Jerry were to retire from the ice cream business,
the supply in the market would fail.

6. Government policy: Removing tariffs and quotas on imported automobiles increases total
automobile supply. Lower direct taxes (e.g. tobacco tax, VAT) reduce the cost of
production, as well as increase the supply. Increase in government subsidies will also reduce
the cost of goods, and increase supply. For example, train subsidies reduce the price of train
tickets.
7. Special influences: Internet shopping and auctions allow consumers to compare the prices
of different dealers more easily and drives high-cost sellers out of business.

8. Goods in joint Supply: Joint supply occurs when two goods are supplied together. E.g., If
you produce beef, you will get leather as a side effect.

9. Goods in competitive

Please search in goggle/ YouTube, you will get detail about the factors affecting
demand and supply.
 Market Equilibrium

A market equilibrium comes at the price at which quantity demanded equals quantity supplied. At
that equilibrium, there is no tendency for the price to rise or fall. The equilibrium price is called
market-clearing price. Figure 3 represents the market equilibrium.

Figure: 3 Market Equilibrium

In the above figure, the demand curve DD and the supply curve SS intersect each other at point
E. So, the equilibrium point is E, at that point the equilibrium price is p and the equilibrium
quantity is Q.

TYPES of GOODS

Substitutes Goods: Two goods for which an increase in the price of one lead to an increase in the
demand for the other is called substitute goods (when a fall in the price of one good reduces the
demand for other goods, the two goods are called substitutes goods). Substitutes are often pair of
goods that are used in place of each other such as hot dogs and hamburgers, sweaters and
sweatshirts and movie tickets and DVD rentals, beef and chicken.

Complements Goods: Two goods for which an increase in the price of one lead to a decrease in
the demand for the other. (When a fall in the price of one goods raises the demand for other goods,
the two goods are called complements goods). Complements are often pair of goods that are used
together such as, gasoline and automobiles, computers and software and peanut butter and jelly.

➢ Extension & Contraction of demand/ changes in the

quantity demanded
➢ Changes in the price of a commodity causes movements along the demand curve; such
movements are called changes in the quantity demanded.

➢ If price decreases, then we move down and to the right along the demand curve; this is an
increase in the quantity demanded which is known as extension of demand.

➢ If price increases, then we move upward and to left along the demand curve, this is a decrease
in the quantity demanded which is called contraction of demand.
change in demand/
 ELASTICITY

Elasticity is an economic measure of how sensitive an economic factor is to another. In economics,

elasticity is the measurement of the percentage change of one economic variable in response to a
change in another. The definition of elasticity, a measure of responsiveness of consumers to
changes in prices or incomes.

The meaning of the price elasticity of demand, which measures the responsiveness of the quantity
demanded to changes in price.

The meaning of the income elasticity of demand, a measure of the responsiveness of demand to
changes in income.

The cross-price elasticity of demand measures the responsiveness of demand for one good to
changes in the price of another good.

The meaning of the price elasticity of supply, which measures the responsiveness of the quantity
supplied to changes in price

Price Elasticity of Demand

Price Elasticity of Demand:

The price elasticity of demand (sometimes simply called price elasticity) measures how much
the quantity demanded of a good change when its price changes. The precise definition of price
elasticity is the percentage change in quantity demanded divided by the percentage change in price.

Percentage change in quantity demanded

Price elasticity of demand Ed = _________ _______ __ ________ _ _________
Percentage change in price

Since we know that a percentage change in price can be rewritten as

 Δ𝑃𝑟𝑖𝑐𝑒
Price

And a percentage change in quantity to

Δ𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
Quantity

We can rearrange the original equation as

Δ𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
Δ𝑃𝑟𝑖𝑐𝑒
𝑝𝑟𝑖𝑐𝑒

Which is the same as saying

Δ𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 ∗ 𝑃𝑟𝑖𝑐𝑒 Δ𝑄 𝑃
= .
Δ𝑃𝑟𝑖𝑐𝑒 ∗ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 Δ𝑃 𝑄
1. Perfectly Elastic Demand:

When a small or zero change in price of a product causes a major change in its demand, it is said
to be perfectly elastic demand. In perfectly elastic demand, a small rise in price results in fall in
demand to zero, while a small fall in price causes increase in demand to infinity.

In perfectly elastic demand, the demand curve is represented as a horizontal straight line, which
is shown in Figure-2:

Though, perfectly elastic demand is a theoretical concept and cannot be applied in the real situation.
However, it can be applied in cases, such as perfectly competitive market and homogeneity
products. In such cases, the demand for a product of an organization is assumed to be perfectly
elastic.

2. Perfectly Inelastic Demand:

A perfectly inelastic demand is one when there is no change produced in the demand of a
product with change in its price. The numerical value for perfectly inelastic demand is zero
(ep=0).

For example, consider the demand for a good when people pay no attention to the price— say,
shoelaces. Suppose that consumers will buy 1 billion pairs of shoelaces per year regardless of the
price. In this case, the demand curve for shoelaces would look like the curve of Figure 3: it would
be a vertical line at 1 billion pairs of shoelaces (at point Q). Since the percent change in the quantity
demanded is zero for any change in the price, the price elasticity of demand in this case is zero.
The case of Zero price elasticity of demand is known as perfectly inelastic demand.
In case of perfectly inelastic demand, demand curve is represented as a straight vertical line,
which is shown in Figure-3:

It can be interpreted from Figure-3 that the movement in price from OP1 to OP2 and OP2 to OP3
does not show any change in the demand of a product (OQ). The demand remains constant for any
value of price. Perfectly inelastic demand is a theoretical concept and cannot be applied in a
practical situation. However, in case of essential goods, such as salt, the demand does not change
with change in price. Therefore, the demand for essential goods is perfectly inelastic.

3. Price Elastic Demand:

When a 1 percent change in price calls forth more than a 1 percent change in quantity demanded,
the good has price-elastic demand. For example, if a 1 percent increase in price yields a 5 percent
decrease in quantity demanded, the commodity has a highly price-elastic demand.

Mathematically, elastic demand is known as more than unit elastic demand (ep>1). For example,
if the price of a product increases by 20% and the demand of the product decreases by 25%, then
the demand would be relatively elastic. The demand curve of price elastic demand is gradually
sloping, as shown in Figure-4:
It can be interpreted from Figure-4 that the percentage change in demand from OQ1 to OQ2 is
relatively larger than the percentage change in price from OP1 to OP2. For example, the price of
a particular brand of cold drink increases from Rs. 15 to Rs. 20. In such a case, consumers may
switch to another brand of cold drink. However, some of the consumers still consume the same
brand. Therefore, a small change in price produces a larger change in demand of the product.

4. Price Inelastic Demand:

Price inelastic demand is one when the percentage change produced in demand is less than the
percentage change in the price of a product. For example, if the price of a product increases by
30% and the demand for the product decreases only by 10%, then the demand would be called
relatively inelastic. The numerical value of relatively elastic demand ranges between zero to one
(ep<1). Marshall has termed relatively inelastic demand as elasticity being less than unity.

The demand curve of relatively inelastic demand is rapidly sloping, as shown in Figure-5:
It can be interpreted from Figure-5 that the proportionate change in demand from OQ1 to OQ2 is
relatively smaller than the proportionate change in price from OP1 to OP2. Let us understand the
implication of relatively inelastic demand with the help of an example.

5. Unit Elastic Demand:

When the percentage change in demand is equal to the percentage change in the price of the
product, the demand is referred as unitary elastic demand. The numerical value for unitary elastic
demand is equal to one (ep=1).

The demand curve for unitary elastic demand is represented in Figure-6:

From Figure-6, it can be interpreted that change in price OP1 to OP2 produces the same change
in demand from OQ1 to OQ2. Therefore, the demand is unitary elastic.
Example-:

The demand schedule for milk is given in Table-3:

Calculate the price elasticity of demand and determine the type of price elasticity.

Solution:

P= 15

Q = 100

P1 = 20

Q1 = 90

Therefore, change in the price of milk is:

∆P = P1 – P

∆P = 20 – 15

∆P = 5

Similarly, change in quantity demanded of milk is:

∆Q = Q1 – Q

∆Q = 90 – 100

∆Q = -10

The change in demand shows a negative sign, which can be ignored. This is because of the reason
that the relationship between price and demand is inverse that can yield a negative value of price
or demand.
Price elasticity of demand for milk is:

ep = ∆Q/∆P * P/Q

ep = 10/5 * 15/100

ep = 0.3

The price elasticity of demand for milk is 0.3, which is less than one. Therefore, in such a case,
the demand for milk is relatively inelastic.
Book:1. N_Gregory_Mankiw_Principles_of_Economic- chapter 4 and chapter 5-
Page 65-101 (Especially Market Equilibrium -Page -76)

Book-3 - Economics by Paul Samuelson, William Nordhaus (Chapter- 3&4, Page-

45)