LECTURE TWO

THEORY OF DEMAND AND SUPPLY

The Concept ‘DEMAND’ refers to the quantities of goods and services a consumer is willing and able to Purchase at a given price
during a particular time period.

The key words are WILLINGNESS and ABILITY TO PAY. .

When a consumer is only willing to have a particular commodity, this is considered as a mere Desire. It is the strong feeling of
wanting something.

Demand is different from mere desire because it is back up by the ability to pay.

When demand is back up by the ability to pay, it is called Effective demand and when it is not back up by the ability to pay, it is
called Ineffective demand.

 There are different types of demand which include the derived demand, complementary demand, competitive demand and
composite demand.

i. Derived Demand: This is the demand for a commodity which is not needed for direct satisfaction, but rather for the
production of other goods and services. E.g. steel for making cars, the demand for labour and other factors of production,

ii. Complementary or Joint Demand: This refers to the demand for commodities that are needed together for a consumer’s
maximum satisfaction. The demand for one necessitates the demand for the other E.g Car and Petrol, Bread and Butter,
Printers and Ink etc.

iii. Competitive Demand: This refers to the demand of commodities which can be used interchangeable (Close Substitutes).
E.g. Milo and Bournvita, Fish and Meat etc.

iv. Composite Demand: This refers to the total demand for a commodity which has several uses. When one commodity can
be used for two or more purposes. E.g. Sugar, Milk, cassava, etc.
 Demand Schedule: This is a table showing the relationship between the series of prices and the quantity demanded of a commodity.

 Individual Demand Schedule shows the various quantities that a consumer purchases at each of the existing price.
 Market Demand Schedule shows the various quantities that all consumers in the market purchases at each of the existing
price.

Prices (₦) Consumer A (Qty) Consumer B (Qty) Market Demand (2)

5 10 50 60
4 20 60 80
3 30 70 100
2 40 80 120
1 50 90 140

LAW OF DEMAND: At higher prices, lesser commodities are demanded for and vice versa, showing an inverse relationship between
price and quantity demanded for.

Demand curve: It is a downward sloping curve showing the relationship between the price and quantity demand of a commodity.
D
5
4
Prices
3
2

1
D
0 10 20 30 40 50
Quantity demanded
Factors influencing Demand.

i. Price: if the price of a commodity increases, an individual will decrease his consumption of for such commodity and vice
versa thereby enforcing the law of demand.

ii. Income: The higher the income of a consumer, the higher the consumption for a commodity which is normal. For an
inferior goods, the higher the income, the lower the demand for such goods. Therefore, increase in income brings about
a subsequent increase in demand for such goods.

iii. Price of Related goods: The degree of relation among commodities can determine their quantities demanded for. For a
competitive/ substitute commodity, an increase in the price of one leads to an increase in the demand for the other and
vice versa. For a complementary/Joint goods, an increase in the price of one leads to a decrease in the demand for the
other.

iv. Taste: The most obvious determinant of your demand is your tastes. If you like ice cream, you buy more of it.

v. Expectations: Your expectations about the future may affect your demand for a good or service today. For example, if
you expect to earn a higher income next month, you may be more willing to spend some of your current savings buying
ice cream.

vi. Government regulations: Government can regulate the prices of goods and services which in turn affects the quantity
demand for such goods and services.

vii. Number of buyers: If the number of buyers increases, the quantity demanded will also increase and vice versa.
 CHANGES IN QUANTITY DEMANDED
Changes in quantity demanded arise as a result of changes in the price of the commodity.

D
5
4
Price
3
2

1
D
0 10 20 30 40 50
Quantity demanded
Fig 1: Movement along the demand curve

An increase in price leads to decrease in the quantity demanded (upward movement along the curve)
A decrease in price leads to increase in the quantity demanded (downward movement along the curve)
CHANGES IN DEMAND
Changes in demanded arise as a result of changes in all other factors affecting demand except price of the commodity. When one of
the determinants of demand (except price) changes, the demand curve shifts.

D1
D0
D2

decrease Increase
Price

D1
D0
D2

Quantity demanded
Positive changes in the factors that affect demand leads to an outward shift (from D0 to D1).
Negative changes in the factors that affect demand leads to an inward shift (from D0 to D2).

SUPPLY

Supply can be defined as the quantity of goods and services a supplier is willing and able to offer for sale at a specified market price
at a period of time.

Stock of a commodity is different from supply. Stock of a commodity is what the firm has produced but only in his warehouse and
hasn’t put up for sale.

Supply Schedule: This is a table showing the relationship between the series of prices and the quantity supplied of a commodity.

 Individual Supply Schedule shows the various quantities that a producer supplies at each of the existing price.
 Market Supply Schedule shows the various quantities that all producers in the market supplies at each of the existing price.

Law of Supply: The law of supply states that the higher the price the higher the quantity supplied and vice versa, indicating a positive
relationship between price and quantity supplied.

Supply Curve: This is an upward sloping curve showing the relationship between price and the quantity supplied in the market.

S
5
4
Price 3
2
1
S
0 10 20 30 40 50
Quantity supply
Supply Curve: This is an upward sloping curve showing the relationship between price and the quantity supplied in the market.

Factors affecting Quantity Supplied

i. Price: The price of a commodity influences the quantity a supplier will offer for sale in the market. The higher the price,
the more willing the seller will be able to sell and vice versa.

ii. Price of related Commodity: If the price of a related good rises in the market, sellers would shift to the production of that
commodity and less of the other.

iii. Input prices/ Cost of Production: The higher the price of input, the lower the quantity supplied.

iv. Technology: The improvement in technology will have a positive impact on the quantity supplied to the market by the
supplier while poor technology will have a negative effect on the quantity supplied to the market thereby reducing the
quantity supplied.

v. Expectation: If the supplier expects the price of a commodity to increase tomorrow, he will rather supplied little to the
market while if he expect the price to decrease tomorrow, he will bring all his commodity to the market today before the
market price falls.

vi. Government regulations: Government can regulate the prices of goods and services which in turn affects the quantity
supply for such goods and services.
CHANGES IN QUANTITY SUPPLIED

Changes in quantity suppy arise as a result of changes in the price of the commodity.

S
5
4
Price 3
2
1
S
0 10 20 30 40 50
Quantity supply
An increase in price leads to increase in the quantity supplied (upward movement along the curve)
A decrease in price leads to decrease in the quantity supplied (downward movement along the curve)

CHANGES IN SUPPLY
Changes in supply arise as a result of changes in all other factors affecting suppy except price of the commodity. When one of the
determinants of supply (except price) changes, the supply curve shifts.

S2
S0
decrease S1
Price

S2 Increase
S0
S1

Quantity supplied
EQUILIBRIUM ANALYSIS

Equilibrium is a situation in which supply and demand have been brought into balance. It denotes a point of consistency between what
the seller brings to the market and what the consumer is willing to purchase.

At this intersection, quantity demanded (QD) equals quantity supplied (QS). Therefore QD = QS

Equilibrium Price: the price that balances supply and demand. That is, the market clearing price.

Equilibrium Quantity: the quantity supplied and the quantity demanded when the price has adjusted to balance supply and demand

D S

Surplus
P
Shortage

S D

Qd

A surplus denotes Excess supply i.e (QS > QD). This exists when prices are set higher than the equilibrium price.

A shortage denotes Excess Demand i.e (QD < QS ). This exists when prices are set lower than the equilibrium price.
 Changes in Equilibrium

A shift in supply holding the demand constant decreases the equilibrium price but increases the equilibrium quantity while a shift in
demand holding supply constant increases the equilibrium price and quantity. If both demand and supply shifts by the same
magnitude, the equilibrium price will increase while the quantity remain constant.

D1
D0 S0 S1
P1

P3
P0

P2
D1
S0 S1 D0

0 Q0 Q1 Q2 Q3

MATHEMATICAL ANALYSIS OF THE EQUILIBRIUM

Given the quantity demand function Qd=20 – 5p while quantity supplied is given as Qs = 8 + p. What is the equilibrium price and
quantity?