CHAPTER 2:

DEMAND AND SUPPLY THEORIES

PREPARED BY:

NOR HAMIZA MOHD GHANI

UiTM JOHOR
Jan’10
 objectives

Demand
Classification of goods & services
Demand curve
Determinants of Demand
Movements along and shifts in the DD curve
Exceptional Demand

Supply
Supply curve
Determinants of supply
Movements along and shifts in the SS curve
Price & Output determination
 Elasticity
Price elasticity of DD
Types
Determinants
Uses
Income elasticity of DD
Definition & Measurement
Types & uses
Cross elasticity of DD
Definition & Measurement
Types & uses
Price elasticity of SS
Definition & Measurement
Types & uses
Equlibrium price & Qtty
Movement to new equilibrium

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 Classification of goods & services
Conventional Perspective
1. Free goods
3. Public goods
Offered by nature
 Goods that have a common use
Unlimited SS
& are benefit to everyone
Zero production cost
 Non-excludability
No price tag
 Ex: public parks &
No opportunity cost
recreation,roads, streetlights
Ex: air,rainwater,sunlight,sea etc
etc
2. Economic goods 4. Services
Physical goods made by man  Intangible goods
Limited SS  Ex: education,health care,
Price tag security, etc
Involves production cost &
opportunity cost
Ex: T-shirt,book,pen,jeans
etc

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 Types of goods

 1.Inferior goods - ex: second-hand car

 2. Necessity goods- ex: food
 3. Normal goods- ex: T-shirt
 4. Luxury goods- ex: jewellery

Related goods

1. Substitute goods- a product that can be used in place of another product

Ex: tea & coffee

2. Complemantary goods- goods that must be used together

Ex: car & tyre

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 Islamic Perspective

Concept of goods

1. Al-Tayyibat- good, clean & pure things

- the ethical & spiritual values of consumer goods
2. Al- Rizq - "Godly sustenance", "Divine bestowal" @
"Heavenly gifts"
- Allah is the only Sustainer & Provider for
all creatures
3.Tarafiah - Goods which cause wastage/ extravagance-FORBIDDEN

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 Classification of goods based on
hierarchy of needs

Goods that contribute towards

Kamaliyah the perfection of life.eg:
jewellery, luxury car etc

Goods that enhance

the quality/comfort of
Hajiyah life, e.g:TV, car,
telephone

Goods which fulfill our

basic needs.eg:
Dharuriyah food,shelter,clothes

Tarafiah: Goods & services forbidden by Islam because they are

harmful to us. Ex: gambling, alcoholic beverages
(excluded from the hierarchy of needs) 7
 Definition of demand
• Desire to buy goods or services with ability and willingness
to pay for that goods at a given time, cateris paribus.

Definition of quantity demanded (Qd)

 The amount (number of units) of a goods or services that a
household would buy in a given time period if it could buy all
it wanted at the current market price.

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 The law of demand
• As price rises, the quantity demanded
decreases (P↑,Qd↓)
and
• As price falls, the quantity demanded
increases (P ↓,Qd ↑)
with all else equal or ceteris paribus
• Negative relationship between price and
quantity demanded.
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 The law of demand:
Demand schedule
• A demand schedule is a Siti’s demand schedule
table showing For rambutan
how much of a given Price Qd ( kg per
month)
product a household would (RM per kg)
be willing to buy at different
prices.
8.00 2
• Demand curves are usually
derived from demand 6.00 4
schedules.
4.00 6

2.00 8

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The law of demand: Demand curve
Siti’s demand • The demand curve is a graph
illustrating how much of a given
Price (RM per call) product a household would be
willing to buy at different prices.
• The law of demand states that
there is negative relationship
between price and the Qd
• This means that the demand
curves slope downward

D
Qd (Calls per month)

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The law of demand: Demand curve
• Individual demand is the demand of
one buyer in a market at various
prices
• Market demand is the sum of
demands of all buyers in a market at
various prices

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 Determinants of demand

1.Price factor
2.Non-price factors

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 Determinants of demand:
1. Price factor: price itself

Law of demand:
• As price rises, the quantity demanded
decreases (P↑,Qd↓)
and
• As price falls, the quantity demanded
increases (P ↓,Qd ↑)
with all else equal or ceteris paribus
• Negative relationship between price and
quantity demanded
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 Determinants of demand:
2. Non-price factors

i. The price of related goods

ii. Consumer’s income
iii. Taste and preference
iv. The number of buyers in the market/
population
v. Seasonal factor

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 Determinants of demand: 2. Non-price factors

i. Price of related goods

• Substitute
-Goods that can serve as replacements for one another
-When the price of one increases, demand for the others goes up
-Example: palm oil and soybean oil are substitutes so the demand for soybean oil
increases when the price of palm oil rises
Ppalm oil↑, Qd palm oil↓, Dsoybean oil↑
Price of palm oil Price of soybean oil

P1

Po P

D1
D0 Do
Quantity of palm oil Quantity of soybean oil
Q1 Q0 Qo Q1

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 contd..
• Complements
-Goods that ‘go together’
-A decrease in the price of one results in an increase in a demand for the other, vice versa.
-Example: Pen and ink are complements, so the demand for ink decreases when the price of pen rises
Ppen↑, Qd pen↓, D ink↓

Price of pen Price of ink

P1

Po P

D0
D0 D1
Quantity of ink
Quantity of pen
Q1 Q0 Q1 Q0

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 Determinants of demand: 2. Non-price factors

ii. Income
• is the sum of all households wages, salaries, and other forms of earnings in a
given period of time
• As income increases the demand for most goods will increase
• With an increase in income, consumers have the purchasing power to demand
for more goods
-Two types of goods
a. Normal good: when income increase, demand for this good also
increase. Example: cloth
b. Inferior/ giffen: when income increase, demand for this good
decrease. Example: used car, bundle shirt

iii. Taste and fashions

• What people like and dislike without regard the budgetary consideration of
price and income
• Example: changes in music

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 Determinants of demand: 2. Non-price factors

iv. The number of buyers in the market/ population

The greater the number of buyers in a market, the demand will
increase
• Example: the demand for parking spaces

v. Seasonal factor
• During festive seasons, demand for certain product will increase
• Example: During Chinese New Year, demand for mandarin oranges will
increase

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The distinction between changes in Qd and
changes in demand
Changes in Qd
• Def: Movement along the same
demand curve
• Factor influence is price
determinant
-Example:P↑, Qd↓
• change in price of a good or
service leads to change in Qd
Changes in demand
• Def: Shift of demand curve
• Factor influence is non-price
determinants
-price will remains constant
• change in income, taste and
preference, and price of related
goods leads to change in demand
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The distinction between changes in Qd and
changes in demand
Changes in Qd Changes in demand
Price Price
C
P1 contraction

A expansion P
Po
D1
B D2 Do
P2
D
Q1 Q2 Qo Q1 Qd
Two types of movement:
Qo Q2 Qd Two types of shifting
1.Rightward: increase in demand from Qo to Q1
1.Expansion: occurs when P decrease leads
to an increase in Qd (downward movement) (Do to D1). Occurs when
from Qo to Q2 (A to B)
-price of substitute good ↑
2.Contraction: occurs when P increase
-price of complement good ↓
leads to a decrease in Qd (upward
movement) from Qo to Q2 (A to C) -consumer’s income ↑
-expected future price ↑ (etc…)
2.Leftward:decrease in demand from Qo to Q2
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(Do to D2). Occurs when (vice versa from rightward)
 Exceptional Demand
• Def: against the law of demand where as the price increases, the quantity
demanded also increase.

Price
DD

Quantity

• Exceptional demand occurs when:

 Status symbol goods – not for satisfaction but for ostentation.
 Emergencies/war – usually basic necessities such as salt, rice, sugar, oil
 Highly priced goods - good quality, higher price

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 Definition of supply
• Amount of a particular product or service that
firm would be willing and able to offer/sell at
a particular price
Definition of quantity supplied (Qs)
 represents the number of units of a
product that a firm would be willing and
able to offer for sale at a particular price
during a given time period.
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 The Law of Supply
• As price rises, the quantity supplied will also
increase (P↑,Qs ↑)
and
• As price falls, the quantity supplied will fall
(P ↓,Qs ↓)
with all else equal or ceteris paribus
• The law of supply states that there is a positive
relationship between price and quantity of a good
supplied.
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 The Law of supply: Supply schedule
Yes’s supply schedule for • A supply schedule is a table
soybeans showing how much of a
product firms will supply at
Price Qs (thousands
of bushels per
different prices.
(USD per
bushel) year) • Supply curves are usually
derived from supply
1.75 10
schedules.

2.25 20

3.00 30

4.00 45

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 The Law of Supply: Supply curve
Yes’s supply • A supply curve is a graph
Price (USD per bushel)
illustrating how much of a
S product a firm will supply
4.00 per period of time at
different prices
3.00
• supply curves have a
2.25
positive slope
1.75

10 20 30 45
Thousands of bushels of soybean produced
per year

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 The Law of Supply: Supply curve
• Individual supply is the supply of one
seller in a market at various price
• Market supply is the sum of all the
quantities of a good or service supplied
per period by all the firms selling in the
market for that good or service.

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 Determinants of supply

1. Price factor
2. Non-price factors

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 Determinants of supply:
1. Price factor: price itself
• As price rises, the quantity supplied will also
increase (P↑,Qs ↑)
and
• As price falls, the quantity supplied will fall
(P ↓,Qs ↓)
with all else equal or ceteris paribus
• positive relationship between price and
quantity of a good supplied
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 Determinants of supply:
2. Non-price factors
i. Cost of production/ prices of raw material
ii. Technological advancement
iii. Government policies
iv. Price of related goods
v. Number of suppliers
vi. Expected future price

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 Determinants of supply:
2. Non-price factors
i. Cost of production/ prices of raw material
• The cost of producing the good, which in turn depends on
the piece of required inputs (labour, capital and land)
• Example: when the wages of workers increase, the cost of
production will increase, thus supply will decrease
ii. Technological advancement
• Generally will increase the supply of product
• Technology advancement reduces the use of input and cost
of production, so more output can be produced using the
same amount of input and cost

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 Determinants of supply:
2. Non-price factors
iii. Government policies
• Taxes imposed by the government on certain goods will reduce supply
on the market
• Disincentives to producer because it increase the cost of production
• Example: Tax on cigarettes
iv. Price of other goods
• Substitute good: an increase in the price of substitute good, decreases
the supply of the good
• Example: when the prices of soybean oil increase, the supply of
soybean oil produce will be increase and the supply of palm oil will be
decrease
• Complements good: an increase in the price of the good will increase
the supply of other good
• Example: shuttlecock and racket

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 Determinants of supply:
2. Non-price factors
v. Number of suppliers
• The larger the number of suppliers supplying a good, the
larger is the supply of the good
• Example: increase in stationary shop in Perak will increase
the supply of stationary good in Perak

vii. Expected future price

• If the producers expect in the near future will increase,
supply for today will reduced and vice versa

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 The distinction between changes in Qs and
changes in supply
Changes in Qs Changes in supply

• Def: Movement along the same • Def: Shift of supply curve

supply curve
• Factor influence is price
determinant
-Example:P↑, Qs ↑
• change in price of a good or
service leads to change in Qs
• Factor influence is non-price
determinants
-price will remains constant
• change in cost, input prices,
technology or prices of other
goods leads to change in Qs

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 The distinction between changes in Qs and
changes in supply
Changes in Qs Changes in supply
Price (P) Price (P) S1
S2
S S3
P2 B
P1 P
A expansion
P0 C contraction
Qs Q1 Q2 Q3 Qs
Qo Q1 Q2
Two types of shifting
Two types of movement: 1.Rightward: increase in supply from Q2
to Q3(S2 to S3). Occurs when
1.Expansion: P increase leads to an
-price of substitutes good ↓
increase in Qs (upward
movement), from A to B -price of complements good ↑
-expected future price ↓
2.Contraction: P decrease leads to a
-when gov gives subsidies
decrease in Qs (downward
movement), from A to C 2.Leftward:decrease in demand from Q2 to
Q1 (S2 to S1). 0ccurs when (vice versa
from rightward) 35
 Exceptional Supply (labor market)

Def: Is against the law of supply where as the price increases, the
quantity supplied decreases.
Price

SS
Qs
Factor:

 Income effect
A higher income induces an increase in demand for leisure. So, less time spent on work and
there is a decrease in the quantity of labor supplied.

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END

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