SUPPLY & DEMAND

Naheed Memon
MBA
Fall 2022
12/15/2022 Managerial Economics 1
Demand
• The demand for a good or service is defined as quantities of good or service that
people are ready to buy at various prices within some given time period, other
factors besides price held constant.
• The combined responses to price changes of all individuals for a specific product
or service formulate the total market demand. The change in price moves
inversely with the quantity demanded and vice versa. This phenomenon is
referred to as the law of demand.
• Changes in price levels of a product result in changes in the quantity demanded
i.e movement along the demand curve.
• Changes in non price determinants result in changes in demand i.e shifts in the
demand curve.

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Non-Price Factors Affecting Demand
Factors that can cause demand to change are called non price determinants of demand. Following is a list of these determinants:
• Tastes & Preferences: Economists use a general-purpose category in their list of nonprice determinants called tastes
and preferences to account for the personal likes and dislikes of consumers for various goods and services. These tastes
and preferences may themselves be affected by other factors. Advertising, promotions, and even government reports
can have profound effects on demand via their impacts on people’s tastes and preferences for a particular good or
service.

• Income: As people’s incomes rise, it is reasonable to expect their demand for a product to increase, and vice versa

• Prices of related products. A good or service can be related to another by being a substitute or by being a complement.
If the price of a substitute product changes, we expect the demand for the good under consideration to change in the
same direction as the change in the substitute’s price.
• Future Expectations: If enough buyers expect the price of a good or service to rise (fall) in the future, it may cause the
current demand to increase (decrease). In most markets, speculation among buyers and sellers is an important factor
to consider. Buyers and sellers act on a current price of a product not for its immediate consumption but because of the
possibility of gaining from some future transaction.

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Supply
The Supply of a good or service is defined as quantities of good or service that
people are ready to sell at various prices within some given time period, other
factors besides price held constant. Just as in the case of demand, supply is based
on an assumed length of time within which price and the other factors can affect
the quantity supplied.
Unlike the law of demand, law of supply states that quantity supplied is related
directly to price, other factors held constant.
Changes in prices result in changes in the quantity supplied (i.e movements along
the supply curve). Whereas changes in non price factors result in changes in the
supply (i.e shifts of the supply curve).

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Non-Price Determinants of Supply
• Costs and technology
• Prices of other goods or services offered by the seller.
• Future expectations.
• Number of sellers
• Weather conditions

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Market Equilibrium

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• Equilibrium price: The price that equates the quantity demanded with the quantity
• supplied (i.e., the price that clears the market of a surplus or shortage).
• Equilibrium quantity: The amount that people are willing to buy and sellers are willing
• to offer at the equilibrium price level.
• Shortage: A market situation in which the quantity demanded exceeds the quantity
• supplied, at a price below the equilibrium level.
• Surplus: A market situation in which the quantity supplied exceeds the quantity
• demanded, at a price above the equilibrium level.

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Short Run
a. Period in which sellers already in the market respond to a change in equilibrium
price by adjusting the number of certain resources, which economists call
variable inputs. Examples of such inputs are labor hours and raw materials. A shortrun
adjustment by sellers can be envisioned as a movement along a particular supply
curve.
b. Period in which buyers already in the market respond to changes in equilibrium
price by adjusting the quantity demanded for a particular good or service. A
short-run adjustment by buyers can be envisioned as a movement along a particular
demand curve.

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• An increase in demand causes equilibrium price and quantity to rise. (See Figure 3.6a.)
• A decrease in demand causes equilibrium price and quantity to fall. (See Figure 3.6b.)
• An increase in supply causes equilibrium price to fall and quantity to rise. (See Figure 3.6c.)
• A decrease in supply causes equilibrium price to rise and quantity to fall. (See Figure 3.6d.)

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Long Run
a. Period in which new sellers may enter a market or the original sellers may
exit from a market. This period is long enough for existing sellers to either increase
or decrease their fixed factors of production. Examples of fixed factors include property,
plant, and equipment. A long-run adjustment by sellers can be seen graphically
as a shift in a given supply curve.
b. Period in which buyers may react to a change in equilibrium price by changing
their tastes and preferences or buying patterns. (The Wall Street Journal and other
sources of business news may refer to this as a “structural change” in demand.) A
long-run adjustment by buyers can be seen graphically as a shift in a given demand
curve.

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 Demand Elasticity

Naheed Memon
EMBA
Fall 2021
12/15/2022 Managerial Economics 16
Economic Concept of Elasticity
• we can define elasticity as a percentage relationship between two variables, that is, the percentage change in
one variable relative to a percentage change in another. In different terms, we divide one percentage by the
other :
• Elasticity = Percent change in A /Percent change in B

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Price Elasticity of Demand
• The price elasticity of demand is defined as a percentage change in quantity demanded caused by a 1 percent
change in price.
• percentage change in quantity demanded
= delta Quantity demanded/Initial quantity demanded.
• “percentage change in price,” can be written as
= delta Price/ Initial price.

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Measurement of Price Elasticity

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Categories of Elasticity
Relative elasticity of demand:
• Ep > 1 (in absolute terms)
• This occurs when a 1 percent change in price causes a change in quantity
demanded greater than 1 percent
Relative inelasticity of demand:
• 0 < Ep < 1 (in absolute terms)
Here the percentage change in price is greater than the corresponding
change in quantity
Unitary elasticity of demand:
• Ep = 1 (in absolute terms)
A 1 percent change in price results in a 1 percent change in quantity in the
opposite direction.
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Perfect elasticity:
• Ep = (in absolute terms)
• In this case, there is only one possible price, and at that price an unlimited
quantity can be sold. The demand curve for Ep = is a horizontal line.
Perfect inelasticity:
• Ep = 0
• Under this condition, the quantity demanded remains the same regardless of
price. Such a demand curve may exist for certain products within a particular
price range.

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Factors Affecting Demand Elasticity
➤ Ease of substitution
➤ Proportion of total expenditures
➤ Durability of product
➤ Possibility of postponing purchase
➤ Possibility of repair
➤ Used product market
➤ Length of time period

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Cross Price Elasticity of Demand
• Cross-price elasticity deals with the impact (again, in percentage terms) on the quantity demanded of a
particular product created by a price change in a related product (while everything else remains constant).

• What is the meaning of “related” products? In economics, we talk of two types of relationships: substitute
good and complementary good.
• Much of the time when we consider cross-price elasticity we are dealing with similar

products (not just different brands of the same product) in a more general sense. Thus, chicken and beef can

be substitutes; a change in the price of chicken will influence the consumption of beef.

• Complements are products that are consumed or used together.

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• The definition of cross-price elasticity is a measure of the percentage change in quantity demanded of product
A resulting from a 1 percent change in the price of product B. The general equation can be written as

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Demand Elasticity and Revenue`
• There is a relationship between the price elasticity of demand and revenue received.
• A decrease in price would decrease revenue if nothing else were to happen.
• But because demand curves tend to be downward sloping, a decrease in price will increase the quantity
purchased, and this will increase receipts.
• If price decreases and, in percentage terms, quantity rises more than price has dropped, then total revenue will
increase.

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Marginal Revenue
• This concept can be defined as the change in total revenue as quantity changes by one unit.
• Arc marginal revenue, MR = TR>Q for discrete change in Q
• This can also be defined at a point using derivatives as
Point marginal revenue, MR = dTR>dQ

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• Marginal revenue is positive as total revenue rises (and the demand curve is elastic).
• When total revenue reaches its peak (elasticity equals 1), marginal revenue reaches zero.
• This is exactly true when using point marginal revenue and point elasticity, and approximately true when
using arc marginal revenue and arc elasticity.

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• Figure 4.7 shows the mathematical and graphical relationship between the demand curve and marginal
revenue (MR).
• It turns out that when the demand curve is described by a straight line, the marginal revenue curve is twice as
steep as the demand curve.
• Under these circumstances, the marginal revenue curve can be drawn by bisecting the distance between the Y-
axis (vertical axis) and the demand curve.
• at the point where marginal revenue crosses the X-axis (horizontal axis), the demand curve is unitarily elastic
(and total revenue reaches its maximum).

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