SECTION 3: DEMAND AND SUPPLY

Specific Objective: To explain the term “market”.

Concept of a Market.
What is a ‘Market’?

 A market is a situation where buyers and sellers communicate for the purpose of exchanging
goods and services. A market occurs where buyers and sellers meet to exchange money for
goods.

NB. This type of market may either be a physical marketplace where people come together to
exchange goods and services in person, as in a bazaar or shopping centre, or a virtual market
where buyers and sellers do not interact, as in an online market.
Exercise: List 5 physical markets and 5 virtual markets
The elements of a market include:
 Buyers/ Consumers
 Sellers/ Producers
 Goods and services
 Price

Specific Objective: To identify the market forces.

Identifying the Market Forces
 The forces of demand and Supply
 Conditions
 Non-price factors
 Determinants of demand and supply

https://www.investopedia.com/university/economics/economics3.asp

DEMAND
Demand– the amount of goods and services people are willing and able to purchase at various
prices during a specific time period
Eg. The demand for Pens at a price of $5 is 1000 units per week.

Demand Curve – a curve showing the relationship between the price of a good and the
quantity demanded. It shows the quantities demanded at different prices.
 The demand curve slopes downward (negatively sloping)
 From left to right

1
 SECTION 3: DEMAND AND SUPPLY

SUPPLY
Supply – is the number of goods and services that sellers want to sell over a specified
period of time at a particular price.

Eg. When the price of an orange is 65 cents the quantity supplied is 3000 oranges a
week.

Supply Curve – A graph of the quantity supplied of a good at different prices.

 The supply curve slopes upward (Positively sloping)
 From left to right

Determinants of Demand
 The price of the good itself – the price of the good is considered to be the first
condition of demand. If price increases, quantity demanded will decrease; however, if
price decreases, quantity demanded will increase.
 Changes in Income – increasing income causes demand to rise, whilst decreasing
income cause demand to fall.
Also, a decrease in taxes will give consumers more disposable income and a greater
ability to buy (demand more). However, an increase in taxes will decrease consumers
disposable income, resulting in a decrease in demand.
 Price of substitutes - Two goods are substitutes if an increase in the price of one of
them causes an increase in the demand for the other.

2
 SECTION 3: DEMAND AND SUPPLY

Example, an increase in the price of pizza would increase the demand for spaghetti if
the goods were substitutes.
 Price of Complements - Two goods are complements if an increase in the price of one
of them causes a decrease in the demand for the other.
Example, an increase in the price of pizza would decrease the demand for Coca-Cola
if the goods were complements.
 Tastes and Fashion – a change in tastes or fashions in favour of a good will cause
demand for that good to increase. When taste and fashions move away from a
product, demand for it will fall.
 Advertising – an increase in advertising causes an increase in demand and a decrease
in advertising causes a fall in demand, ceteris paribus
 Expectations of future price changes – if consumers expect that the price of a product
will increase in the near future, demand increases in the present. Similarly, if they
expect prices to fall soon, consumers might choose not to buy now (demand falls) and
wait for the price fall.
 Seasonal Factors – example during peak periods (Holidays) demand increases
 Changes in Population – increases in population causes demand to increase.
Decreases in population cause demand to fall.
 Rates of interest on consumer credit – when interest rates on loans to buy consumer
goods are low demand increases. If interest rates rise, demand decreases.

NB. Changes in the price of a good cause a movement along the demand; whilst a
change in any other determinant of demand causes a shift in the supply curve.

Determinants of Supply
 Price of the good itself – price affects supply. As price increases, ceteris paribus,
quantity supplied increases. The greater the price the higher the quantity the producer
will wish to supply (to capitalise on potential profits). The lower the price, the lesser
the quantity the producer will wish to supply (to retain resources for more profitable
use later on).
NB. Changes in the price of a good causes a movement along the supply curve; whilst
a change in any other determinant of supply causes a shift in the supply curve.
 Cost of Production
 Technological progress
 The number of firms in the industry
 Producers consumption of his own good or service
 Prices of related outputs
 Taxes and Subsidies (Government Policies)
 Weather Conditions for agricultural products

3
 SECTION 3: DEMAND AND SUPPLY

Using diagrams to describe the relationship between price and demand and price and
supply.
Law of Demand – states that there is a negative or inverse relationship between price and
quantity of a good demanded. The quantity demanded of a good increase when its price
decreases, and falls when its price increases. This relationship can be shown by a demand
schedule, a demand curve or a demand function.

Law of Supply – states that there is a positive relationship between price and quantity of a
good supplied. The supply of a good increases as its price increases, and falls as its price
decreases. This can be shown by a supply schedule, a supply curve or a supply function.

4
 SECTION 3: DEMAND AND SUPPLY

Demand Schedule
A demand schedule shows the different quantities of goods that a consumer is willing to buy
at various prices.
Prices and quantities normally move in opposite directions.

Exercise.
1. Draw the demand curve using the information provided in the table below.

5
 SECTION 3: DEMAND AND SUPPLY

2. Using one graph show individual demand curves for both consumers and the market
demand.

Supply Schedule
A supply schedule shows the different quantities of goods that a supplier/ producer is willing
to supply at various prices.
Prices and quantities normally move in same direction.

6
 SECTION 3: DEMAND AND SUPPLY

Exercise.
1. Draw the supply curve using the information provided in the table below.

Specific Objective: To explain the concept of Ceteris Paribus

Ceteris Paribus is latin for assuming ‘all things held constant’ or ‘all things remaining the
same’.
The concept of ceteris paribus is important in economics because in the real world it is
usually hard to isolate all the different variables.

7
 SECTION 3: DEMAND AND SUPPLY

Assuming ceteris paribus allows us to simplify economics – we can understand how

something like higher price will affect – demand – ignoring all other factors which might
complicate the outcome.

Example of Ceteris Paribus in Economics

1. Ceteris paribus – higher oil prices should lead to less demand for oil.
2. Ceteris paribus – higher prices of coffee should encourage growers to try and increase the
supply of coffee.

NB. Illustrate using diagrams

Specific Objective: To explain the concept of market equilibrium and disequilibrium

Market equilibrium

 ‘Market equilibrium’ or the ‘equilibrium point’ occurs where, supply = demand (where the
demand and supply curves intersect). When the market is in equilibrium, there is no tendency
for prices to change. We say the ‘market-clearing price’ has been achieved.
 Equilibrium price – price where quantity demanded is equal to the quantity supplied.
 Equilibrium quantities – consumer and supplier quantities are equal. No surplus, no shortage
(The 3rd Law).
 The price mechanism refers to how supply and demand interact to set the market price and
amount of goods sold
 At most prices planned demand does not equal planned supply. This is a state of
disequilibrium because there is either a shortage or surplus and firms have an incentive to
change the price.

Market equilibrium

Market equilibrium can be shown using supply and demand diagrams

In the diagram below, the equilibrium price is Pe. The equilibrium quantity is Qe.

8
 SECTION 3: DEMAND AND SUPPLY

Market Schedule for Slices of Cheese Pizza

Price ($) Quantity Demanded Quantity Supplied
0.50 1000 200
1.00 800 400
1.50 600 600
2.00 400 800
2.50 200 1000

Download schedules and diagrammatic representation of market equilibrium and insert here.

9
 SECTION 3: DEMAND AND SUPPLY

If price is below the equilibrium (ie. Price Ceiling)

 If price was below the equilibrium at P2 then demand would be greater than the supply.
Therefore, there is a shortage of (Q2 – Q1)
 If there is a shortage, firms will increase prices and supply more. As price rises, there will be
a movement along the demand curve and less will be demanded.
 Therefore, price will rise to Pe until there is no shortage and supply = demand

If price is above the equilibrium (ie. Price Floor)

 If price was above the equilibrium (e.g. P1), then supply (Q1) would be greater than
demand (Q3) and therefore there is too much supply. There is a surplus.
 Therefore firms would reduce price and supply less. This would encourage more
demand and therefore the surplus will be eliminated. The market equilibrium will be
at Q2 and Pe.

10
 SECTION 3: DEMAND AND SUPPLY

If there was an increase in income the demand curve would shift to the right (D1 to D2).
Initially, there would be a shortage of the good. Therefore, the price and quantity supplied
will increase leading to a new equilibrium at Q2
An increase in supply would lead to a lower price and more quantity sold.

Shortages and Surplus

 Shortage – occurs where, QD > QS
- Occurs at any price below equilibrium
- Price will rise over time toward equilibrium

 Surplus – occurs where, QS > QD

- Occurs at any price above equilibrium
- Price will fall overtime toward equilibrium
Use diagram on ‘slide 10’ of power-point – Chpt 4 part II Market Equilibrium.

11
 SECTION 3: DEMAND AND SUPPLY

Types of Goods

1. Complementary Goods (X.ED)

 A complementary good or complement good in economics is a good which is
consumed with another good. If goods A and B were complements, more of
good A being bought would result in more of good B also being bought.
However, if less of good A being bought would also result in less of good B
being bought.

 If the demand for car increases then the demand for petrol also increases.
Example: If a person has a car he/ she must seek petrol or CNG, so such type
of goods that are inter-related are known as Complementary goods. More cars
need more usage of petrol or CNG are a pair of goods consumed together.

 Other examples: tennis ball and tennis racket; DVD player and DVD disks to
play in it; iPhone and Apps to use with an iPhone.

2. Substitute Goods (X.E.D)

 are alternatives to each other ie. two goods that can be consumed or used in
place of one another. As the price of one goes up (ceteris paribus) will result in
an increase in the demand for its substitute goods. However, a decrease in
price (again ceteris paribus) will result in a decrease in demand for its
substitutes
 eg. Pepsi and Coca-Cola. If the price of Coca-Cola rises/ increases people may
move towards or switch to Pepsi.

3. Normal Goods (Y.E.D ˃ 0)

 the quantity demanded of such commodities increases as the consumer’s
income increases and decreases as the consumer’s income decreases. Such
goods are called normal goods. eg. bread, clothing etc

4. Inferior Goods (Y.E.D ˂ 0)

 an inferior good is a good that decreases in demand when consumer income
rises, unlike normal goods, for which the opposite is observed.
 an inferior good is often associated with lower socio-economic groups.
Inferiority, in this sense, is an observable fact relating to affordability rather
than a statement about the quality of the good. As a rule, these goods are
affordable and adequately fulfill their purpose, but as more costly substitutes
that offer more pleasure become available, the use of the inferior goods
diminishes.

12
 SECTION 3: DEMAND AND SUPPLY

 Example; corned beef (tinned meat) – this is a cheap form of meat, when
income rises/ increases you buy fresh meat; bus travel - when income rises
you can afford to buy a car and therefore no longer need the car; Instant
coffee - when income rises you buy expensive bread instead.

5. Giffen Goods (P.E.D)

 is an inferior good which people consume more of as price rises, violating the
law of demand.
 In the Giffen good situation, cheaper close substitutes are not available.
Because of the lack of substitutes, the income effect dominates, leading people
to buy more of the good, even as its price rises.
 The concept of a Giffen good is limited to very poor communities with a very
limited choice of goods. Empirical evidence is hard to find.
 The idea is that if you are very poor and the price of your basic
foodstuff (e.g. bread) increases, then you can’t afford the more
expensive alternative food (meat) therefore, you end up buying more
bread because it is the only thing you can afford.

6. Luxury Goods (Y.E.D ˃ 1)

 A luxury good means an increase in income causes a bigger percentage
increase in demand. It means that the income elasticity of demand is greater
than one. For example, HD TV’s would be a luxury good. When income rises,
people spend a higher percentage of their income on the luxury good.
 are those goods whose demand falls when price falls.

7. Snob Goods (P.E.D)

 A good where an increase in price encourages people to buy more of it. This is
because they think more expensive goods are better.

13
 SECTION 3: DEMAND AND SUPPLY

1st ASSESSMENT
1. a. Define the term ‘market’. (2 marks)
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________

b. Identify the TWO types of markets, giving an example of EACH. (4 marks)

_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________

c. Identify the FOUR elements of a market. (4 marks)

_____________________________________________________________________
_____________________________________________________________________

2. Place the following determinants of demand and supply in their respective place in the
table below. (17 marks)
Changes in Income Cost of Production Taste and Fashion Weather Conditions

Price of the good itself Price of Substitutes Technological Progress

Seasonal Factors Price of Related Output Advertising Changes in Population

Taxes and Subsidies Expectations of future price changes

Rates of interest on consumer credit The number of firms in the industry

Producer’s consumption of his or her own good or service

Price of complements

NB. EACH factor excluding ONE may only be used once.

Determinants of Demand Determinants of Supply

14
 SECTION 3: DEMAND AND SUPPLY

3. Draw a properly labelled :

i. ‘Demand curve’ (5 marks)

ii. ‘Supply curve’ (5 marks)

END OF ASSESSMENT Total (37 marks)

15