BISHOPS GRADE 9 EMS

DEMAND, SUPPLY AND

PRICE DETERMINATION
In this section of work, you will learn about the following concepts…
 The difference between wants and demand
 What determines the quantity demanded?
 The law of demand
 Reasons for the law of demand
 Movements ALONG and SHIFTS OF the demand curve
 Factors causing SHIFTS OF the Demand Curve
 The Theory of Supply
 Movements Along the Supply Curve
 The Law of supply
 Price Determination
 SHIFTS of Demand and Changes in Market Equilibrium
 SHIFTS of Supply and Changes in Market Equilibrium
 Changes in Market Equilibrium

Name: _______________________________
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Introduction
In grade 8 we introduced you to the economic problem. There it was explained that all economic
actions arise from scarcity and that our wants exceed the productive resources at our disposal to
satisfy these wants. In order to solve this basic economic problem, important decisions about what
to produce, how to produce and for whom to produce have to be taken.

In a market economy these decisions are mainly resolved by market forces which lead to price
formation. These prices reflect the terms under which buyers and sellers are willing to exchange
goods and services. The success or failure of any market economy therefore depends on how
efficiently these price signals are conveyed to producers and consumers of products.

The purpose of this study unit is to explain how prices are established in a market economy,
through the interaction of demand and supply.

Demand
Let us begin our study of demand and supply by building a model of demand. You must make a
clear distinction between the demand for a good or service and wants.

Wants: the unlimited desires or wishes that people have for goods and services.

Demand: the quantity of a certain good that people are willing and able to purchase.

Therefore the amount we demand reflects a decision on which wants are going to be satisfied.
Unlike wants, the demand for a good or service has to be backed up by buying power. Without
buying power (income) there can be no demand.

What determines the amount demanded?

Each one of us is a consumer of goods and services. Each day we require certain goods and
services in order to stay alive. The amount of any particular good we plan to buy depends on many
diverse factors. Let us list a few of these factors from our own experience:

 the price of the good

 the prices of other goods
 the income at our disposal
 our preferences
 weather conditions
 many more

The price of a particular good or service is probably the most important factor mentioned above.

Although all the other factors like income and the prices of related goods play a very important
role in the demand for a specific product they can never be as important as the price of the good
itself. In the light of this, we have to ask what is the relationship between the price and the
quantity demanded of a good?

The answer to this important question is provided by the law of demand.

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The law of demand states:
 the higher the price of a good or service, the smaller the quantity demanded
or
 the lower the price of a good or service the greater the quantity demanded.

Obviously this law will apply only if all the other factors we have listed (income, preferences,
weather etc.) remain unchanged – we refer to the situation where all other factors remain
constant as ceteris paribus. The law of demand states that there is a definite relationship between
the market price of a product (e.g. maize) and the quantity demanded of that product, all other
things remaining the same.

Movements ALONG and SHIFTS OF the demand curve

Movements ALONG the Demand Curve

In Table 1 we give a hypothetical example of a demand schedule for maize. At any price, there is a
definite quantity of maize which will be bought by all the consumers in the market. For instance,
Table 1 shows that at R5 a bag, consumers will buy 1 000 bags per month. At a lower price, say R4
per bag, the quantity which consumers will buy increases to 2 000 bags.

Table 1: Demand Schedule (shows the relationship between price and quantity demanded)

Price (P) Quantity demanded (Q)

(Rand per bag) (Bags per month)
5 1 000
4 2 000
3 3 000
2 4000
1 5 000

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We can also represent the information given in Table 1 graphically. The vertical axis shows the
different prices of maize, measured in Rands per bag. The horizontal axis shows the quantities of
maize (in terms of number of bags) demanded per month.

Figure 1: Movement ALONG the Demand Curve

Using the figures provided in table 1 on the previous page, plot the demand curve for maize on the
graph paper below. Label the X axis QUANTITY and the Y axis PRICE.

We call this the demand curve. We can draw a demand curve for any demand schedule. Note that
Q (quantity) decreases when P (price) increases - we call this type of relationship an inverse
relationship.

An important property of the demand curve is that it slopes downward from left to right, which
reflects this inverse relationship. This representation illustrates the law of demand which in fact
applies to all goods - maize, meat, pizzas, hamburgers and also services such as those of
hairstylists, medical practitioners and architects.

The diagram shows that when price changes, it causes a MOVEMENT ALONG the demand curve.
This will always be the case when the price of the good itself changes. Any other factor that affects
demand will cause a SHIFT OF the entire demand curve.

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Reasons for the law of demand
a) The substitution effect
It is important to realise that when the price of a good rises (ceteris paribus) its price,
relative to all other prices, rises.

In other words, substitutes for the good that has risen in price become relatively cheaper
(cheaper in relation to that good).

Because there are substitutes for most goods (e.g. coffee for tea, margarine for butter,
pears for apples etc) consumers will try to buy less of the product and more of its
substitutes.

Thus explaining that as the price of a certain good or service increases, the quantity
demanded of that good or service will decrease.

b) The income effect

When a price increases, the consumer is in reality in a poorer situation than he or she was
before, because now the same amount of money buys less of that product than before. If
income remains unchanged, any increase in the price of a product will make consumers
relatively poorer.

They will thus be forced to reduce the quantities demanded of at least some goods and
services. In all probability consumers will reduce their demand for the product whose price
has increased.

Both the substitution and the income effects help to explain the inverse relationship between
price and quantity demanded and hence the law of demand.

SHIFTS OF the Demand Curve

As mentioned previously when price changes, it causes a MOVEMENT ALONG the demand curve.
Any other factor that affects demand will cause a SHIFT OF the entire demand curve.

Factors other than price that will cause a SHIFT OF the entire demand curve are…
a) the income at our disposal
b) our preferences
c) the prices of other goods

Example…
The table below shows the original demand schedule and then the demand schedules once
consumers had experienced both a decrease and an increase in their income.

Table 2: Demand Schedule (shows the impact on quantity demanded due to an

increase/decrease in incomes)
Price (P) Quantity demanded (Q) Quantity demanded (Q) Quantity demanded (Q)
(Rand per (Bags per month) (Bags per month) (Bags per month)
bag) AFTER increase in income AFTER decrease in income
5 1 000 2 000 0
4 2 000 3 000 1 000
3 3 000 4 000 2 000
2 4 000 5 000 3 000
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 1 5 000 6 000 4000

Figure 2: SHIFTS OF the Demand Curve

Using the figures provided in Table 2 on the previous page, draw ALL THREE of the demand curves
for maize on the graph paper below. Once again label the X axis QUANTITY and the Y axis PRICE.

Factors causing SHIFTS OF the Demand Curve

a) The income of the consumers

The consumers’ spending ability will be affected by their income. Their income determines
their purchasing power, that is, their ability to purchase goods and services. The higher their
income, the more goods and services they are able to buy and vice versa.

 An increase in INCOME will SHIFT the demand curve to the right.

 An decrease in INCOME will SHIFT the demand curve to the left.

b) The taste (or preference) of the consumers

Consumers’ decisions will also be influenced by their taste. The more they a certain
good/service, the more of that good/service they will plan to buy. Many things influence our
taste, but marketing plays a big role in influencing our willingness to purchase goods and
services.

 An increase in our PREFERENCE for a good or service (backed up by the ability to

purchase) will SHIFT the demand curve the right.
 An decrease in our PREFERENCE for a good or service (backed up by the ability to
purchase) will SHIFT the demand curve the left.

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c) The prices of related products
Consumers decisions about how many goods/services to purchase will also depend on the
prices of related products. Here we have to distinguish between complements and substitutes.

Substitutes: goods which can be used instead of the good in question. Eg Apple or Samsung
 An increase in the price of a substitute (Apple) will cause an increase in the demand
(rightward SHIFT of demand) for the product in question (Samsung), ceteris paribus.
 A decrease in the price of a substitute (Apple) will cause an decrease in the demand
(leftward SHIFT of demand) for the product in question (Samsung), ceteris paribus.

Complements: goods that are used/bought together. Eg Fish and chips

 A decrease in the price of a complementary product (Fish) increases the demand
(rightward SHIFT of demand) for the product concerned (Chips), ceteris paribus.
 An increase in the price of a complementary product (Fish) decreases the demand
(leftward SHIFT of demand) for the product concerned (Chips), ceteris paribus.

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Supply
Let us now turn our attention from demand to supply. Supply is always more difficult for us to
comprehend as we are consumers and therefore we demand goods and services. Supply looks at
things from the producer’s point of view.

Supply: the quantities of a good or service that producers are willing and able to sell at each
possible price.

Table 3: Supply schedule (shows relationship between price and quantity supplied)

Price (P) Quantity supplied (Q)

(Rand per bag) (Bags per month)
5 5 000
4 4 000
3 3 000
2 2 000
1 1 000

Figure 3: Movement ALONG the Supply Curve

Using the figures provided in Table 3 above, plot the supply curve for maize on the graph paper
below. Label the X axis QUANTITY and the Y axis PRICE.

From Figure 3 we can see that more bags of maize will only be offered at higher prices.

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The law of supply states that…

 the higher the price of a good the greater the quantity supplied
or
 the lower the price the smaller the quantity supplied (ceteris paribus)

With regards to supply, in Grade 9, we will only look at the relationship between the price of the
product and the quantity supplied. Clearly the amount producers plan to sell on the market will
also depend on a variety of other factors such as…
 the cost of factors of production
 the price of other products that they could produce
 weather conditions

Apart from the first factor (i.e. the price of the product) all the other factors are basically
concerned with cost factors. Their influence on the quantity supplied stems from their influence
on the cost of production.

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Price determination
We now know what demand and supply curves look like, but we still haven’t determined at what
price maize will actually be sold at yet!

Table 4 shows us that when we combine the market forces of demand and supply, the two will
come into equilibrium (balance) at a certain price. We call this price the equilibrium market price.

Table 4: The market equilibrium schedule

Price Quantity demanded Quantity supplied Excess D/Excess S
(Rand per bag) (bags per month) (bags per month) Pressure on price
5 1 000 5 000 Excess S (4 000) - Decrease
4 2 000 4 000 Excess S (2 000) - Decrease
3 3 000 3 000 Neutral
2 4 000 2 000 Excess D (2 000) - Increase
1 5 000 1 000 Excess D (4 000) - Increase

From Table 4 above we can see the following:

At a price of R5 per bag…
 producers supply 5 000 bags on the market each month
 but at that price, the quantity demanded by consumers is only 1 000 bags per month.
 this situation will not last as each month there will be an excess supply of 4 000 bags of
maize (4 000 bags of maize will remain unsold).
 as the stock of maize piles up, some suppliers will drop their prices a little to try and sell
some of their stock.
 in other words, if suppliers wish to get rid of their maize, they will have to lower their
prices.

At a price of R1 per bag...

 consumers demand 5 000 bags each month
 but at that price, the quantity supplied by suppliers is only 1 000 bags per month.
 this situation will not last as each month there will be an excess demand of 4 000 bags of
maize.
 disappointed customers will offer to pay more to make sure they get some maize. In other
words, consumers will compete with one another in order to satisfy their wants.
 this will create upward pressure on prices.

At a price of R3 per bag…

 consumers demand and producers supply exactly 3 000 bags per month
 therefore there is no excess demand or supply at this price
 this is known as price equilibrium
 there is no reason for price to change from this point unless some other supply or demand
factor changes and forces the equilibrium to change.

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 Figure 4: Market equilibrium
Using the figures provided in Table 4 above, plot both the supply and demand curves for maize on
the graph paper below. Label the X axis QUANTITY and the Y axis PRICE.

Once you have completed your diagram illustrate the following on your diagram…
 Equilibrium price (Pe) and equilibrium quantity (Qe)
 Indicate the excess supply at a price of R5
 Indicate the excess demand at a price of R1

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SHIFTS of Demand and Changes in Market Equilibrium

There are four possible scenarios that could change the equilibrium price and quantity…
a) Rightward shift of the demand curve
b) Leftward shift of the demand curve
c) Rightward shift of the supply curve
d) Leftward shift of the supply curve

As we have only looked at SHIFTS OF the demand curve, we will only examine the first two
possibilities.

a) Rightward shift of the demand curve

A rightward shift of the demand curve could be caused by…

 Increase in consumer incomes
 Increase in the preference for a good or service
 Decrease in the price of complementary goods
 Increase in the price of a substitute good

In any of these examples above, the demand curve will SHIFT to the right which will cause a new
equilibrium price and quantity. The movement to a new equilibrium price and quantity goes as
follows (see diagram below)…

1) Any of the factors mentioned above

causes demand to shift to the right.
2) At the initial equilibrium price (P) there
is now an excess demand (D > S @ P).
3) This excess demand causes price to
increase (P – P1) and the quantity to
increase (Q – Q1).
4) A new equilibrium is now created.

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b) Leftward shift of the demand curve

A leftward shift of the demand curve could be caused by…

 Decrease in consumer incomes
 Decrease in the preference for a good or service
 Increase in the price of complementary goods
 Decrease in the price of a substitute good

In any of these examples above, the demand curve will SHIFT to the left which will cause a new
equilibrium price and quantity. The movement to a new equilibrium price and quantity goes as
follows (see diagram below)…

1) Any of the factors mentioned above causes

demand to shift to the left.
2) At the initial equilibrium price (P) there is
now an excess supply (S > D @ P).
3) This excess supply causes price to decrease
(P – P1) and the quantity to decrease (Q –
Q1).
4) A new equilibrium is now created.

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