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1 - Demand and Supply Analysis-1
1 - Demand and Supply Analysis-1
and Supply
Analysis
Demand ?????
▪ The process to satisfy human wants/ needs/desires.
▪ Want: having a strong desire for something
▪ Need: lack of means of subsistence
▪ Desire: an aspiration to acquire something
▪ Demand: effective desire
▪ Demand is that desire which is backed by willingness and
ability to buy a particular commodity.
▪ Demand is the quantity of a commodity/goods/service
which consumer/buyer are willing and able to buy at a
given price for a particular unit of time.
Types of Demand
▪ Direct(Autonomous) and Derived Demand
▪ Direct demand is for the goods as they are such as Consumer
goods (Own sake by final consumer)
▪ Derived demand is for the goods which are demanded to
produce some other commodities; e.g. Capital goods (for
production of Other Products)
Dx = f(Px)
Dx = a - bPx
▪ Other things remaining constant, (ceteris paribus) when the price of a commodity
rises, the demand for that commodity falls or when the price of a commodity falls,
the demand for that commodity rises.
▪ Price bears a negative relationship with demand
Reasons behind the Law
▪ Price effect
▪ Substitution Effect : When the price of a commodity falls (rises), its substitutes
become more (less) expensive assuming their price has not changed.
▪ Income Effect: When the price of a particular commodity falls, the consumer’s real
income rises, hence the purchasing power of the individual rises.
▪ Law of Diminishing Marginal Utility: as a person consumes successive units of a
commodity, the utility derived from every next unit (marginal unit) falls.
• Law of Diminishing Marginal Utility
– Marginal utility for successive units consumed goes on decreasing.
– When the good is consumed in standard quantity, continuously and in
multiple units and the good is not addictive in nature.
• The following diagrams show Total Utility (TU) and Marginal Utility (MU)
curves
TU of X MU of X
MU
TU
O O
Quantity of X Quantity of X
The Law of Demand
• The law of demand
states that there is a
negative, or inverse,
relationship between
price and the quantity
of a good demanded
and its price.
• This means that
demand curves slope
downward.
Demand Schedule and Individual
Demand Curve
Point on e
Demand Price (Rs Demand 35
Curve per cup) (‘000 cups) d
a 15 50 30
c
b 20 40 25
c 25 30 b
20
d 30 20 a
15
e 35 10
O
10 20 30 40 50
Quantity of coffee
Change in Demand
◼ Shift in demand curve from D0 to
D1
◼ More is demanded at same price.
Price D1
◼ Increase in demand caused by:
D0
◼ A rise in the price of a
D2
substitute
◼ A fall in the price of a
complement
◼ A rise in income
◼ A redistribution of income
towards those who favour the
commodity
◼ A change in tastes that favours
the commodity
0 ◼ Shift in demand curve from D0 to
Quantity
D2
◼ Less is demanded at each price.
Movements Along and Shifts of The
Demand Curve
Price
Entire demand curve shifts
rightward when:
• income or wealth ↑
• price of substitute ↑
• price of complement ↓
• population ↑
• expected price ↑
• tastes shift toward ↑
D2
D1
Quantity
Movements Along and Shifts of The
Demand Curve
Price
Entire demand curve shifts
leftward when:
• income or wealth ↓
• price of substitute ↓
• price of complement ↑
• population ↓
• expected price ↓
• tastes shift toward ↓
D1
D2
Quantity
Exceptions to the Law of Demand
Law of demand may not operate due to the following
reasons:
▪ Giffen Goods – display direct price demand relationship –
Rice (inferior goods)
▪ Snob Appeal – veblen goods - Diamond
▪ Demonstration Effect - items of luxury, fashion
▪ Future Expectation of Prices (Panic buying)
▪ Goods with No Substitutes
▪ Life saving drugs, petrol and diesel
▪ Insignificant proportion of income spent
▪ Match box, Salt
Supply?????
• Indicates the quantities of a good or service that the seller/producer
is willing and able to provide at a price, at a given point of time, other
things remaining the same.
• Supply of a product X (Sx) depends upon:
– Price of the product (Px)
– Cost of production (C)
– State of technology (T)
– Government policy regarding taxes and subsidies (G)
– Other factors like number of firms (N)
• Hence the supply function is given as:
Sx = (Px, C, T, G, N)
Law of Supply
▪ Law of Supply states that other things remaining the same, the higher the
price of a commodity the greater is the quantity supplied.
▪ Price of the product is revenue to the supplier; therefore higher price
means greater revenue to the supplier and hence greater is the incentive
to supply.
▪ Supply bears a positive relation to the price of the commodity.
Quantity
Changes in Supply and in Quantity
Supplied
Price
Entire supply curve shifts S2
leftward when: S1
• price of input ↑
• price of alternate good ↓
• number of firms ↓
• expected price ↑
• unfavorable weather
Quantity
Market Equilibrium
Market Equilibrium
• Equilibrium occurs at the price where the quantity
demanded and the quantity supplied are equal to each
other.
• For prices below the equilibrium, quantity demanded
exceeds quantity supplied (D>S). Pulling price upward.
• For prices above the equilibrium, quantity demanded is
less than quantity supplied (D<S). Pushing price
downward.
Supply Demand
Price S Price (‘000 cups (‘000 cups /
(Rs) / month) month)
E
25
15 10 50
20 15 40
25 30 30
D 30 45 15
O
30
35 70 10
Quantity
Market Equilibrium
E
4. until price reaches its
$3.00
equilibrium value of $3.00
.
H
1.00 J
Excess Demand
D
25,000 50,000 75,000 Number of pens per
1. At a price of $1.00 per
Month
Pen an excess demand of
50,000 pen . . .
23
Excess Demand
• Excess demand
– At a given price, the excess of quantity demanded
over quantity supplied
• Price of the good will rise as buyers compete
with each other to get more of the good than
is available
24
Excess Supply and Price Adjustment
D
35,000 50,000 65,000 Number of pens per
Month
25
Excess Supply
• Excess Supply
– At a given price, the excess of quantity supplied
over quantity demanded
• Price of the good will fall as sellers compete
with each other to sell more of the good than
buyers want
26
Changes in Market Equilibrium
(Shifts in Supply Curve)
◼ The original point of equilibrium is
at E, the point of intersection of
curves D1 and S1, at price P and
quantity Q
Price S0
◼ An increase in supply shifts the
supply curve to S2. D1 S1
◼ Price falls to P2 and quantity rises S2
to Q2, taking the new equilibrium E0
P0
to E2 . E
P E2
◼ A decrease in supply shifts the P2 S0
supply curve to S0. Price rises to S1
P0 and quantity falls to Q0 taking S2 D1
the new equilibrium to E0
O
◼ Thus an increase in supply raises Q0 Q Q2 Quantity
quantity but lowers price, while a
decrease in supply lowers
quantity but raises price; demand
being unchanged.
Changes in Market Equilibrium
(Shifts in Demand Curve)
• The original point of equilibrium
is at E, the point of intersection of
curves D1 and S1, at price P and
quantity Q
Price
D2 • An increase in demand shifts the
D1
S1 demand curve to D2 .
• Price rises to P1 and quantity rises to Q1
D0 taking the new equilibrium to E1
P1 E1
E • A decrease in demand shifts the
P demand curve to D0.
P* E2
D2 • Price falls to P* and quantity falls to Q* taking
the new equilibrium to E2.
S1 D0 D1 • Thus, an increase in demand
O Q* raises both price and quantity,
Q1
Quantity
while a decrease in demand
lowers both price and quantity;
when supply remains same.
Increases in Demand and Supply