The Law of Demand

and Supply and the

Market Equilibrium
Module 2
 Basic Commodities
 The term commodity, as used in economics, pertains to a homogeneous good that commands a
price. Examples would be grains such as rice, corn, and wheat; utilities such as electricity; and
other products that are normally produced in bulk such as oil, sugar, etc. A commodity is
characterized by its uniformity across the market. Regardless of the producer of the good, the
output will have more or less the same attributes.

 Due to the homogeneous nature of commodities, they can be easily traded

in the international market. One of the largest and more popular
commodity exchanges in the world include the Chicago Mercantile
Exchange (CME) Group which facilitates trade of meat, grains, and Commodities are
metals, among other things. Some of the commodity exchanges under the distinguished by
CME Group include The Chicago Board of Trade (CBOT), CME, and the their homogeneity
New York Mercantile Exchange (NYMEX). In the country, commodities which makes them
such as agricultural products and energy are traded through the Manila tradable.
Commodity Exchange (MCX).
 Basic Commodities
 Commodities are often used as raw materials or inputs to produce another good (secondary
products).
 Given the characteristics of a commodity, its price is dictated by the quantity available in the
market, taken as a whole.
 In the case of highly differentiated products, one brand will most likely be priced higher due to
its perceived effectiveness or quality rather than the volume available in the market.

 On a global scale, local prices of imported goods are also

influenced by events in the exporting country, Essentially, a
local producer imports a good for three main reasons:
(1) the good is not available locally,
(2) the cost of importing is cheaper than procuring the
same good locally, and
(3) the quality of the imported good is better than a similar
good sold locally.
What is

Demand
 Demand
 Consider what limited resource means: firms can
run out of capital; an individual's income can be
depleted. These situations illustrate a characteristic
known technically as resource constraint. This
Consumer utility
constraint compels firms, governments, and forms the basis of
household consumers to find the best trade off with the law of demand.
the least opportunity cost. For example, firms have
to decide on how much of a certain product to
manufacture and how many resources such as
labor to utilize. In the same way, governments
have to decide on how much to spend on rebuilding
a highway or how often to do repairs on public
infrastructure.
 The Law of Demand
 Consumer utility refers to a person's
  willingness and ability to
consume a good in reaction to price changes.
 The law of demand states that as the price of a good goes up , the
quantity demanded of that good goes down , all other things remaining
constant (ceteris paribus). This means that consumers tend to buy
more of a certain good at lower prices. Conversely, as this good
becomes more expensive, consumers will tend to buy less.
 The inverse relationship of price and quantity demanded is best
explained through a demand curve. A demand curve illustrates the
linear attribute of the law of demand. Points along the curve
correspond to quantity demanded at varying price levels.
The Law of Demand
 The Law of Demand The inverse
 The inverse relationship between  price and quantity demanded is
represented by the downward-sloping demand curve. Inverse relationship between price
refers to the direction of change for the two variables-price and and quantity demanded is
quantity. When the price increases , the quantity demanded represented by the
decreases , and vice versa. downward-sloping
demand.
  The downward-sloping demand curve implies a negative slope. Remember that the slope of a
linear function is rise over run given two points on the curve. Think of the change in the y-axis
to represent the "rise,“ while the change in the x-axis corresponds to the "run.“ Knowing that
price represents the y-axis in your demand curve diagram and quantity demanded
corresponds to the x-axis, it can be inferred that the slope of the demand curve is equal to
change in over change in . [The Greek letter delta means "change" in a variable.]

 
 The Law of Demand
 Given a demand schedule or a table of price and quantity values, you will be
able to construct a demand curve and calculate its slope. Just remember to
plot the price variable on the y-axis and the quantity demanded variable on
the x-axis.
Example: Calculate the slope of the demand curve based on the demand
schedule for ice cream.
 
Price (₱) Quantity Demanded
(scoops) By plugging the values in the
150 0 equation for the slope of the
100 2 demand curve, you will get an
50 4 answer of -25. The negative
sign denotes that it is a
25 5
downward-sloping curve.
Determinants of Demand

Income
Substitute
Complementary Goods
Consumer Expectations
Taste and Preferences
 Income
 The extra spending money by a consumer is referred to in economics as disposable
income. Disposable income refers to the net amount after taxes and other
mandatory contributions have been deducted. This additional money is what drives a
consumer's desire to buy more of a good.
 Typically, as consumers' income rises (↑), quantity demanded of goods also increases
(↑). This is known as the income effect. Goods that display this attribute are identified
as normal goods. Clothes can be an example.
 The vertical axis is represented by income rather
than by price. This convention of graphing
consumer income and quantity demanded is
formally known as the Engel curve, which was
named after Ernst Engel, a German statistician
from the 19th century (1821-1896). He also
postulated Engel's law, which states that food
expenditure as part of household income
decreases as income rises.
 Income
 One contradiction to the  income effect is the
case of inferior goods. Goods that exhibit a
decline in quantity demanded as consumer
income rises are called inferior goods.

 Inferior goods are often of poorer quality than

normal goods. This drives consumers to forego
consumption of inferior goods and would instead
buy better or higher quality goods when their
income level improves. An example would be
buying vegetables instead of meat or choosing a
cheaper variety of fish rather than prime cuts of
meat.
 Income
 In terms of elasticity, there are two further categories of normal goods-luxury and
necessity. Remember that elasticity is a measure of responsiveness of one
variable to a change in another variable. In this case, income elasticity relates
to the change in quantity demanded in response to an adjustment in income.

Luxury goods exhibit Necessity goods shows

an increase in demand an increase in demand
more than the that is less than the
proportionate increase proportionate increase
in income. in income.
 Income
 One contradiction to the law of demand is the case of Veblen goods, named after
Thorstein Veblen, an American economist who came up with the idea. The Veblen effect
is the propensity of a good, identified as Veblen good, to increase in demand when its
price soars to the point of being extremely overpriced. Like luxury goods, owning Veblen
goods conveys high status. But in contrast to luxury goods, Veblen goods are not driven
by an increase in income. Rather, the appeal comes from their expensiveness and
exclusivity. The more expensive they get, the higher the demand. For example, a luxury
brand's most exclusive and most expensive limited edition line is commonly a Veblen
good. Often, only a handful of people in the world can afford such goods.
 Substitutes
 Goods that meet the same
  requirements or fulfill
the same needs as another good are called
substitutes.
 To illustrate, assume that good B is a substitute for
good A. As the price of good A increases the
quantity demanded of its substitute also increases .
The idea behind substitutes is basically having
alternatives.
 When a good becomes more expensive, its
alternatives become relatively cheaper and
generally more appealing. This is known as the
substitution effect.
 Complementary Goods
 Complementary goods are generally consumed
  or used together. There is
interdependence between the two goods.
 To illustrate, assume that good B and good A are complementary goods. An
increase in price of good A decreases the quantity demanded of good A ,
following the law of demand. Correspondingly, quantity demanded of its
complementary good declines .
 Consumer Expectations
 Another factor that influences price and quantity demanded is consumer
expectations. When consumers anticipate the price of a particular product to rise,
they will tend to buy more of that product now before the perceived or scheduled
price increase. This is commonly observed in the case of oil price increases.
 For example, consumer expect the prices of ingredients and canned goods to rise
during the Christmas holidays. As a result, consumers tend to buy and stock up
on holiday goods way before the holiday, which drives demand up before a price
increase.
 Taste and Preferences
 Finally, other considerations such as increased popularity, taste, and personal
preference influence the demand for a specific good. This is more evident in the
case of branded products. Some consumers will be inclined to buy a certain
brand because of the perceived status of owning it.
 Examples of goods that are largely driven by consumers' taste and preferences
are cars, gadgets, and mobile phones. Downloading a certain smartphone
application or mobile game that everyone has is an example. In both instances,
price has nothing to do with the consumers' decision to buy the good. Rather, the
rise in demand was driven by factors such as preference and popularity.
 Movement along the Demand Curve
versus Shift of the Demand Curve
 Since price is a function of quantity demanded, this can
  be mathematically represented by the demand curve
equation. In this linear equation, a is the constant, which stands for the factors that are assumed to not
change, while b represents the slope, which in the case of a demand curve is negative .

  Demand Curve Equation

 By looking at the equation, you can conclude that an increase in the value of will only result from a decrease
in the value of , an increase in the value of a, or both. Revisit the demand curve to see the graphical
representation of the demand equation. Price, being a function of quantity, means that any change in price is
a movement along the demand curve. In the case of the demand curve, imagine a movement from point A to
point B or vice versa. A change in either of the variables in the x- and y-axes will result in a movement along
the demand curve rather than a shift.
 As you have learned, changes in nonprice variables will shift the demand curve. Only price-driven changes to
the quantity demanded are represented by a movement along the demand curve.
What is

Supply
 The Law of Supply
 Under the same premise of scarcity and  efficient allocation of resources, the
quantity supplied of a product or service is a function of its price. But in contrast
to the demand curve, which considers the consumers' perspective,
understanding changes in the quantity supplied requires appreciating the
standpoint of sellers and producers.
 While quantity demanded is based on consumer's utility, quantity supplied is
based on the profit-maximizing characteristics of firms. This means that there is
a positive relationship between price and quantity supplied; both variables move
in the same direction.
 To simplify, the law of supply states that, ceteris paribus, an increase in price
causes an increase in quantity supplied . Conversely, a fall in price causes a
drop in quantity supplied.
 The Law of Supply The supply curve
 The direct relationship between price and quantity illustrates the positive
supplied is best explained by looking at the supply curve. relationship between
The supply curve illustrates the positive relationship price and quantity
between price and quantity supplied. Points along the supplied.
curve correspond to quantity supplied at varying price
levels.
 Notice that in contrast to the demand curve, the supply
curve is upward sloping. An upward-sloping supply
curve signifies that the variables in the x- and y-axes
have a positive relationship. A positive slope means
that the two variables move in the same direction.
When variable 1 rises, the same happens to variable
2. More specifically, a higher price level corresponds
to a higher quantity supplied, and vice versa.
 The Law of Supply
 Recall the discussion on how to calculate the slope of the demand curve. The
same principle applies in computing the slope of the supply curve. Only this
time, the sign is expected to be positive.
Slope of the Supply Curve
  𝑟𝑖𝑠𝑒 ∆ 𝑦 − 𝑎𝑥𝑖𝑠 ∆ 𝑃
slope= = =
𝑟𝑢𝑛 ∆ 𝑥 −𝑎𝑥𝑖𝑠 ∆ 𝑄 𝑠

 Observe that when plotting a demand or supply schedule, the convention is to

have the price variable on the y-axis and the quantity variable on the x-axis.
Additionally, the demand or supply curves may be drawn as straight lines since
the slope at any point will be the same.
The Law of Supply
Determinants of Supply

Technology
Input Prices
Prices of Other Goods
Producer Expectations
Government Policy
 Technology
 Firms nowadays have to keep abreast of the latest innovations in order to
compete and stay one step ahead of their competitors.
 Technology aids manufacturers either by minimizing delays in production or by
directly increasing labor productivity. Both translate to less cost, more output per
unit of resource, and subsequently, more profit. Following the law of supply, new
technology tends to improve productivity, which in turn increases output or
quantity supplied.
 Input Prices
 Recall the factors of production discussed at the beginning of this unit: land,
labor, capital, and entrepreneurship. The efficient allocation of these resources
results in more profit from the supplier's point of view. Firms have to determine
the right balance of inputs to achieve maximum returns. An increase in input
prices drives up costs. Higher costs lead to a decrease in quantity supplied.
 Prices of Other Goods
 Manufacturers often produce several products
  in the same or related line.
Consider a manufacturer that produces two goods, A and B. As the price of
good A rises the quantity supplied of good A also increases . This follows the
law of supply. What happens then to this manufacturer's other product (good
B)? Due to the higher potential profit from good A, the manufacturer might
decide to transfer some of its resources (from good B) to the production of good
A. This will lead to a decline in output for good B .
 Producer Expectations
 Producers who anticipate a surge in factor
  prices tend to increase production
before the higher input prices become in effect. This leads to an increase in
quantity supplied . For example, a cabinet maker who expects the price of wood
to increase in the coming months will use his or her stock of wood now to create
as many cabinets as possible (before the cost of making a cabinet increases).
The cabinets that will be sold at the higher price level will yield higher returns for
the cabinet maker.
 Government Policy
Excise tax
Is●a tax imposed on a
manufactured good. It is
applicable to producers and
sellers as opposed to value-
added tax (VAT) that is paid
only by consumers or end
users. Excise tax increases
input prices and cost of
production, which ultimately
leads to a decrease in output
or quantity supplied .
Subsidy Import quota
Is●
a monetary assistance by the
government in support of target
Is●a limit
  to the volume of
industries or sectors of the raw materials that local
economy. The government is in
the business of ensuring that all
producers can bring into
the country. It is
sectors of the economy are doing
well. A subsidy results in lower particularly restrictive to
costs for recipient producers manufacturers that rely
because the government pays a heavily on imported raw
portion of the costs. Agriculture materials for their
subsidy is a popular example. A
subsidy enables producers to
production. The limit on
continue operation or lower their raw materials leads to
costs of production. Lower costs lower quantity supplied .
as you have learned lead to more
output and quantity supplied
 Movement along the Supply Curve versus Shift of the Supply

Curve
Like the demand curve, it is a linear equation, which means its slope is the same at all
points of the curve. In this linear equation, c is the constant and it stands for the factors
that assumed to not change. The positive slope of the supply curve is represented by d.

  Supply Curve Equation

 Graphically, a change in price signifies a movement along the supply curve. However,
changes in the variable c or the other determinants of supply will cause a shift in the supply
curve.
 Market
Equilibrium
 Market Equilibrium
 A market is a meeting place for buyers and sellers where the buyer can purchase
goods from a seller for a price that is agreeable to both. In economics, "market" is
not limited to physical location (e.g., wet market) but also includes contemporary,
online platforms that are typical of the financial market (e.g., stock exchange).
 For an exchange of goods   to happen, the buyer
and seller must agree on the price. This price is
referred to as the market price. It is represented
as the intersection of the demand and supply
curves.
 The point where consumer and supplier
expectations meet is known as the market
equilibrium. At this point, quantity demanded is
equal to the quantity supplied . It determines the
equilibrium price (*) and quantity (*).
 Market Equilibrium Market disequilibrium
results to either surplus or
 Shortage happens in the market
  when there is excess
shortage of goods and
demand. At market price, quantity demanded exceeds the services.
quantity supplied in the market . To eliminate the shortage,
suppliers tend to increase production to meet demand.
This will increase prices. The higher prices will discourage
consumers from buying so quantity demanded will
eventually decline and continue to converge in the market
equilibrium level.
 In contrast, excess supply results in market surplus. At
market price, quantity supplied exceeds the quantity
demanded in the market . In reaction, producers will try to
get rid of the excess supply of goods and producing less.
The cheaper price will attract consumers and increase
quantity demanded until the points converge in the market
equilibrium.
 Equilibrium Price and Quantity versus Shift in
the Demand and Supply Curves
 First, consider what will happen to the equilibrium price and quantity when the
demand curve shifts. For example, assume that there is an across-the-board
adjustment to workers' wages. This will result in an increase in income that will shift
the demand curve to the right.
 The shift in the demand curve and the effect on the
market equilibrium are illustrated in the picture. An
increase in income increases the capacity of
consumers to buy more quantities of goods, thus
shifting the demand curve to the right. This higher
demand curve (D') moves the equilibrium level from
point 1 to point 2. An increase in income ultimately
leads to higher levels of price and quantity.
 Equilibrium Price and Quantity versus Shift in
the Demand and Supply Curves
 Consider what will happen to the market
equilibrium in the case of a shift of the supply
curve. For example, a new manufacturing
technology was discovered that greatly reduces
the production time of suppliers. The improved
efficiency results in increased output for
suppliers. Graphically, this will shift the supply
curve to the right.
 A shift in the supply curve (S’ to S) results in a
lower market equilibrium level (point 1 to point 2).
This lower equilibrium level translates to a
reduced price level and higher quantity. A new
technology can lower the prices and increase the
quantity.
Consumer
Protection
 Consumer Protection
You have learned that market mechanisms in the form of demand and supply
interactions driven by consumers’ buying behavior and producers’ profit-maximizing
behavior result an equilibrium level of price and quantity. This equilibrium price is also
referred to as the prevailing market price, which is the price that consumers pay.
To avoid intentional manipulation of supply and other poor The suggested retail price
business practices that may affect the market price, the (SRP) printed on product
government through the Department of Trade and Industry labels serves as a guide to
(DTI) regularly monitors commodity prices and evaluates consumers on the
production processes to come up with consumer purchase acceptable price of the
guides in the form of suggested retail prices (SRPs). SRPs goods they are buying.
provide a benchmark for consumers to compare market
prices. Some SRPs are stamped on the packaging of
products to dissuade vendors from imposing unreasonably
high markups.
 Consumer Protection
Additionally, the Consumer Protection Group (CPG)
under the management of DTI was formed, as the
name implies, to protect consumer rights and enforce
consumer protection laws. An example of a consumer
protection law in the country is the "no return, no
exchange” policy. This policy prohibits businesses from
posting "no return, no exchange“ signs anywhere in
their establishments or on receipts because it is
considered deceptive. Consumers in the country can in
fact return or exchange merchandise when defects are
found or discovered after the purchase and subject to
additional guidelines.
The specific guidelines like the number of days when
you can return the merchandise and the refund policy
may vary per establishment although clothes retail
stores generally accept returns or exchanges within
seven days of purchase.