Demand and

Supply
Prof. K. V. Bhanu Murthy
Micro approach

 So far we have talked of markets in the context

of Central Problems.
 Let us now study markets formally at the micro
level.
 We start with Commodity Markets.
 What happens in markets?
 What happens to consumers – the demand side of
the story?
 What happens to producers – the supply side of
the story?
Determinants of Demand

 Market price
 Consumer income
 Prices of related goods: substitute and
complements
 Tastes (new products)
 Expectations
 Age Distribution
 Technology - Product
Demand Function

Qdx=f(Px, Pc, Ps, I, T, E, Ad, Ty)

dQdx/dPx<0
dQdx/dPs>0

dQdx/dPc<0

dQdx/dI => not known : depends on nature of good

dQdx/dE>0

dQdx/dAd=> not known : depends on nature of good

Generic Demand Function
Changes in Quantity Demanded

Px
In increase in price results in a movement
along the demand curve.
C
$4.00

A
2.00

D1

0 12 20 Number of Cups of Coffee

(Qdx)
Shift in Demand

Px
D2

D1 A shift in demand
(Ps – Price of Tea
Rises)
$2.00

D2

D1

0 10 20 Qdx
Change in Quantity Demanded versus
Change in Demand

Variables that
Affect Quantity Demanded A Change in This Variable . . .
Price Represents a movement along
the demand curve
Income Shifts the demand curve
Prices of related goods Shifts the demand curve
Tastes (new products) Shifts the demand curve
Expectations Shifts the demand curve
Age Distribution Shifts the demand curve
Determinants of Supply

 Market price
 Input prices
 Expectations
 Restrictions
 Technology – Process
 Indirect Tax
Change in Quantity Supplied versus Change in Supply

Variables that
Affect Quantity Supplied A Change in This Variable . . .
Price Represents a movement along
the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Restrictions Shifts the supply curve

Indirect Tax – Shift of Supply Curve

 Determinants of Supply Function

Qsx=f(Px, Pi,T, E, Rs, Tax)

dQsx/dPx>0 Own price rises

dQsx/dPi<0 Input Price rises

dQsx/dT>0 Better process technology

dQsx/dE<0 Future price rise

dQsx/dRs=> Supply function becomes vertical

during market period
dQsx/dT=> Supply function contracts
Marketable Surplus
 Supply has many aspects to it.
 First, a certain quantity is supplied at a given price. This is the ‘Supply Price’.
 As supply price increases the quantity supplied increases.
 Qs = f(Px) => dQsx/dPx>0 . This is movement along the supply curve
 Second, there is cost of producing each additional unit – this is ‘Marginal Cost’
=> ∆ TC/∆ Qs = MC. This is the minimum price at which the producer is willing
to sell.
 Third, unless there is surplus production over ‘own consumption’ there is no
possibility of selling in the market. This is ‘Marketable Surplus’ => Total
Production (-) Self Consumption (including seed).
 Fourth, not all of marketable surplus reaches the market. Thus, ‘Marketable
Surplus’ (-) Wastage ( due to pilferage, rodents, weather, etc)= ‘Marketed
Surplus’
 Fifth, sometimes there are restrictions on supply due to railway strike,
weather (flood), Rice Control Order, etc. During this period even if the price is
high the supplier cannot increase supply. This known as ‘Market Period’.
Marginal Cost and Supply
Function
Change in Quantity Supplied

Px
Supply
curve, S1

2 As price changes,
quantity supplied
changes
1.50

0 2 3 Qsx

Expansion in Supply-
When other factors change
S1
Rightward Shift: Expansion
of supply. At the same price
more is available .

Px
S2

S3

P1

0 Qsx
10 20 30
What is equilibrium?

Price

Supply

2.00
Initial
equilibrium

D1

0 7 10 Quantity
How does Equilibrium of Supply and Demand take place?

In the market period supply becomes vertical

Equilibrium price

Supply
Px2

Equilibrium
Px0
Px1

Demand

Excess SS
Equilibrium Excess DD
quantity

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Qdx & Qsx

 Excess DD & Excess SS
If and when price is Px1 => Excess Demand = From 4 units
to 10 units. Price will rise from Px1 to Px0 (ex-ante)

If and when price is Px2=> Excess Supply = From 2 units to 12

units. Price will fall from Px2 to Px0 (ex-ante)

When price is Px0=> No Excess Demand = No Excess

Supply: DD=SS; Equilibrium is 7 units.
When price is Px0 neither quantity nor price change.
Forces of DD & SS are in equilibrium. This is an identity
DD≡SS (Ex-post)
How an Shift in Demand
Affects the Equilibrium
Px
Shift in taste towards new product.

Supply

$2.50 New equilibrium

2.00
Initial
equilibrium
D2

D1

0 7 10 Qdx & Qsx

 How an shift in Supply affects
Equilibrium?
Px

Overall effect depends

on supply response
S1

$2.50 S2
New equilibrium
2.00 Further
resulting supply
in a higher Initial
price... equilibrium
D2

D1

0 7 10 13
Qdx & Qsx
How technology Affects Equilibrium?
Better Process Technology lowers
cost of production & expands supply
Price

S1

P2
Initial equilibrium Better product technology
S2 raises demand

P1

P0
D2

D1

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Qdx & Qsx

Marginal Cost and Supply
Function
Quasi Rent