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Principles of Economics second edition © Oxford Fajar Sdn. Bhd. (008974-T) 2010

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Ch. 2: 1

CHAPTER 2

DEMAND AND SUPPLY

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Ch. 2: 2

DEFINITION OF DEMAND

Demand is defined as the ability and

willingness to buy specific quantities of goods in a given period of time at a particular

price, ceteris paribus.

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Ch. 2: 3

CLASSIFICATION OF GOODS AND

SERVICES

FREE GOODS PUBLIC GOODS Free goods are goods that have no production cost. Public goods
FREE GOODS
PUBLIC GOODS
Free goods are goods that
have no production cost.
Public goods are goods that
are for common use and will
benefit everyone.
ECONOMIC GOODS AND SERVICES Economic goods are goods of value that can be seen and
ECONOMIC GOODS AND SERVICES
Economic goods are goods of value that can be seen and
touched.
Economic services are intangible things (with value) that
cannot been seen or touched.

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Ch. 2: 4

LAW OF DEMAND

Law of demand states that the higher the

price of a good, the lower is the quantity

demanded for that good and the lower the price, the higher is the quantity demanded, ceteris paribus.

P  Q dd 
P 
Q dd 
P  Q dd 
P 
Q dd 
NEGATIVE RELATIONSHIP
NEGATIVE RELATIONSHIP

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Ch. 2: 5

DEMAND SCHEDULE AND CURVE

Demand Schedule

Price

Quantity

12

5

2

10

4

4

8

3

6

6

2

8

4

1

10

2

 

0

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Demand Curve

2 4 6 8 10
2
4
6
8
10

DD

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Ch. 2: 6

INDIVIDUAL AND MARKET

DEMAND

INDIVIDUAL DEMAND

The relationship between the quantity of a good

demanded by a single individual and its price.

MARKET DEMAND

The relationship between the total quantity of a good demanded by adding all the quantities demanded by all consumers in the market and

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its price.

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Ch. 2: 7

Tastes and Consumers’ trends income Price of related goods Population or number of buyers Supply
Tastes and Consumers’ trends income Price of related goods Population or number of buyers Supply
Tastes and
Consumers’
trends
income
Price of
related goods
Population or
number of
buyers
Supply of
money in
circulation
DETERMINANTS
OF DEMAND
Expectation
about future
prices
DETERMINANTS OF DEMAND Expectation about future prices Advertisement Festive Level of taxation seasons and
DETERMINANTS OF DEMAND Expectation about future prices Advertisement Festive Level of taxation seasons and
DETERMINANTS OF DEMAND Expectation about future prices Advertisement Festive Level of taxation seasons and

Advertisement

Festive Level of taxation seasons and climate
Festive
Level of taxation
seasons and
climate

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Ch. 2: 8

CHANGES IN QUANTITY DEMANDED

VS. CHANGES IN DEMAND

CHANGES IN QUANTITY DEMANDED

Price DD
Price
DD

Quantity

Movement along DD curve

Price changes and other factors are constant

Upward movement Decrease in

quantity demanded (Contraction)

Downward movement Increase in quantity demanded (Expansion)

Principles of Economics second edition © Oxford Fajar Sdn. Bhd. (008974-T) 2010

CHANGES IN DEMAND

Price

D 1 D 0
D 1
D
0

Quantity

Shift in the demand curve

Occurs when there are changes in other factors but price remains constant

Increase in Demand (D 0 D 1 )

Decrease in Demand (D 1 D 0 )

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Ch. 2: 9

EXCEPTIONAL DEMAND

Exceptional Demand is the opposite of the Law of Demand where as price increases, demand will also increase and vice versa.

GIFFEN GOODS SPECULATION
GIFFEN GOODS
SPECULATION
EMERGENCIES
EMERGENCIES
STATUS SYMBOL GOODS
STATUS SYMBOL GOODS
HIGHLY-PRICED GOODS
HIGHLY-PRICED GOODS

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Ch. 2: 10

INTER-RELATED DEMAND

CROSS DEMAND
CROSS DEMAND

The demand for a good is also affected by the price of

its substitute or complementary goods. Cross demand can be divided into two: Joint demand and competitive demand.

DERIVED DEMAND

Derived demand is the demand for a good which

is derived from other goods.

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Ch. 2: 11

CROSS DEMAND: JOINT DEMAND

VS COMPETITIVE DEMAND

P2

P1

Cross Demand

Positive relationship exists between substitute goods

Price of pizza

Price of pizza

Negative relationship exists between complement goods DD Q 1 Q 2 Quantity of soft drinks
Negative relationship exists
between complement
goods
DD
Q 1
Q 2
Quantity of soft drinks

P2

P1

DD Q 1 Q 2 Quantity of
DD
Q 1
Q 2
Quantity of

soft drinks

Joint Demand

Competitive Demand

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Ch. 2: 12

PRICE ELASTICITY OF DEMAND

DEFINITION:

Measures the sensitivity/responsiveness of the quantity demanded due to a change in its price.

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Ch. 2: 13

PRICE ELASTICITY OF DEMAND (cont.)

d

FORMULA:

=

%  Quantity Demanded %  Price

d FORMULA: = %  Quantity Demanded %  Price  d = x P 1
d FORMULA: = %  Quantity Demanded %  Price  d = x P 1

d

=

x

P 1 P 2 P 1

   

Q 2 Q 1 Q 1

 d = x P 1 P 2 – P 1     Q 2 –
2 – P 1     Q 2 – Q 1 Q 1 Principles of Economics

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Ch. 2: 14

DEGREE OF ELASTICITY

Perfectly Inelastic Demand Inelastic Demand

A condition in which the quantity demanded does

A large percentage not change of as change the price in the changes. price of a good

will only affect a small percentage of change in the

Elastic Demand

A small

percentage of change in the

price of a good will lead to larger

percentage of change in quantity

Price (RM)

d =0

 d < 1  d =   d = 1  d >
 d < 1
 d = 
 d = 1
 d > 1

Perfectly Elastic

A condition in which

Demand

demanded.

percentage changes in price

A condition equals changes to in in percentage which quantity a small percentage demanded. of change in price leads to an infinite percentage of change in the quantity demanded.

Quantity Demanded

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Ch. 2: 15

Proportion of the Existence of substitutes expenditure on a product Nature of goods DETERMINANTS Frequently
Proportion of the Existence of substitutes expenditure on a product Nature of goods DETERMINANTS Frequently
Proportion of the
Existence of
substitutes
expenditure on a
product
Nature of
goods
DETERMINANTS
Frequently
Income level
OF PRICE
purchased
products
ELASTICITY OF
DEMAND
Time
Complementary
dimension
goods
Habits
OF DEMAND Time Complementary dimension goods Habits Principles of Economics second edition © Oxford Fajar

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Ch. 2: 16

RELATIONSHIP TO TOTAL

REVENUE

Total Revenue (TR) = Price

(P) x Quantity (Q)

Price The information on price elasticity of demand will be useful for the seller to
Price
The information on price elasticity of demand will be useful
for the seller to adjust their selling price since it will affect
the total revenue.
DEMAND IS ELASTIC
RM30
Total Revenue
RM20 x 10 = RM200
RM20
If seller increases price to RM30
New Total Revenue
= RM30 x 5 = RM150
 TR =  RM50
D
5
10
Quantity Demanded

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Ch. 2: 17

RELATIONSHIP TO TOTAL

REVENUE (cont.)

Total Revenue (TR) = Price

(P) x Quantity (Q)

Price

RM2

RM1

DEMAND IS INELASTIC Total Revenue RM1 x 15 = RM15 If seller increases price to
DEMAND IS INELASTIC
Total Revenue
RM1 x 15 = RM15
If seller increases price to RM2
New Total Revenue
= RM2 x 10 = RM20
 TR =  RM5
D
10
15
Quantity Demanded

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Ch. 2: 18

RELATIONSHIP TO TOTAL

REVENUE (cont.)

Total Revenue (TR) = Price

(P) x Quantity (Q)

Price

DEMAND IS UNITARY ELASTIC

RM2

RM1

Total Revenue RM1 x 20 = RM20 If seller increases price to RM2 New Total
Total Revenue
RM1 x 20 = RM20
If seller increases price to RM2
New Total Revenue
= RM2 x 10 = RM20
 TR =  0
D
10
20
Quantity Demanded

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Ch. 2: 19

INCOME ELASTICITY OF DEMAND

DEFINITION:

Measures the sensitivity/responsiveness of the quantity demanded due to a change in income.

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Ch. 2: 20

INCOME ELASTICITY OF DEMAND (cont.)

Y

FORMULA:

=

%  Quantity Demanded %  Income

Y FORMULA: = %  Quantity Demanded %  Income  d = x Y 1
Y FORMULA: = %  Quantity Demanded %  Income  d = x Y 1

d

=

x

Y 1 Y 2 Y 1

   

Q 2 Q 1 Q 1

 d = x Y 1 Y 2 – Y 1     Q 2 –
2 – Y 1     Q 2 – Q 1 Q 1 Principles of Economics

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Ch. 2: 21

RESPONSES OF INCOME

ELASTICITY

Elastic Income

-Type of good: Luxury goods such as antique furniture and diamonds

Income

 y =0 0 <  y < 1  y > 1  y
 y =0
0 <  y
< 1
 y > 1
 y < 0

Inelastic Income

-Type of good: Normal goods such as food and clothing

Negative Income Elasticity

-Type of good: Giffen/ Inferior goods such as used car and low grade potatoes

Zero Income Elasticity

-Type of good: Necessity Goods such as rice and vegetables

Quantity Demanded

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Ch. 2: 22

CROSS ELASTICITY OF DEMAND

DEFINITION:

Measures the sensitivity/responsiveness of the quantity demanded of one product due to a change in the price of a related product.

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Ch. 2: 23

INCOME ELASTICITY OF DEMAND

FORMULA:

X

= %  Quantity Demanded of good X %  Price of good Y

Quantity Demanded of good X %  Price of good Y  x = Q x2
Quantity Demanded of good X %  Price of good Y  x = Q x2

x

=

Q x2 Q x1 Q x1

 x = Q x2 – Q x1 Q x1 x P y1 P y2 –

x

P y1 P y2 P y1

 x = Q x2 – Q x1 Q x1 x P y1 P y2 –
x2 – Q x1 Q x1 x P y1 P y2 – P y1 Principles of

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Ch. 2: 24

RESPONSES OF CROSS

ELASTICITY

Positive Cross Elasticity

-Good X and Y are substitute goods

Price of Good X

x =0

 x > 0  x < 0
 x > 0
 x < 0

Negative Cross Elasticity

-Good X and Y are complementary goods

Zero Cross Elasticity

-Good X and Y have no relationship

Quantity Demanded of Good Y

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Ch. 2: 25

DEFINITION OF SUPPLY

Supply is defined as the ability and

willingness to sell or produce a particular product and services in a given period of time at a particular price, ceteris paribus.

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Ch. 2: 26

LAW OF SUPPLY

Law of supply states that the higher the price of a good, the greater is the quantity

supplied for that good and the lower the

price of a good, the lower is the quantity supplied, ceteris paribus.

P  Q ss 
P 
Q ss 
P  Q ss 
P 
Q ss 
POSITIVE RELATIONSHIP
POSITIVE RELATIONSHIP

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Ch. 2: 27

SUPPLY SCHEDULE AND CURVE

Supply Schedule

Price

Quantity

5

10

4

8

3

6

2

4

1

2

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12

10

8

6

4

2

0

Supply Curve

1 2 3 4 5
1
2
3
4
5

Supply

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Ch. 2: 28

INDIVIDUAL AND MARKET SUPPLY

INDIVIDUAL SUPPLY

The relationship between the quantity of a product

supplied by a single seller and its price.

MARKET SUPPLY

The relationship between the total quantity of a product supplied by adding all the quantities supplied by all sellers in the market and its price.

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Ch. 2: 29

Cost of production Expected future price Price of related goods Technological DETERMINANTS OF SUPPLY advancement
Cost of
production
Expected
future price
Price of
related goods
Technological
DETERMINANTS
OF SUPPLY
advancement
Improvement in
Number of
infrastructure
sellers
Government
Policies

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Ch. 2: 30

CHANGE IN QUANTITY SUPPLIED

VS. CHANGE IN SUPPLY

CHANGE IN QUANTITY SUPPLIED

Price SS
Price
SS

Quantity

Movement along supply curve

Price changes and other factors are constant

Downward movement Decrease in quantity supplied (Contraction)

Upward movement Increase in quantity supplied (Expansion)

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CHANGE IN SUPPLY

Price s 0 s 1
Price
s 0
s 1

Quantity

Shift in the supply curve

Occurs when there are changes in

other factors but the price remains

constant

Increase in Supply (S 0 S 1 )

Decrease in Supply (S 1 S 0 )

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Ch. 2: 31

EXCEPTIONAL SUPPLY

Wage Rate

Exceptional Supply is the opposite of the Law of Supply where as price increases, the quantity supplied decreases and vice versa

20

15

10

5

0

Income Effect (Exceptional Supply Curve) Substitution Effect Labour 1 2 3 4 5 6
Income Effect
(Exceptional Supply
Curve)
Substitution Effect
Labour
1
2
3
4
5
6

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Ch. 2: 32

PRICE ELASTICITY OF SUPPLY

DEFINITION:

Measures the sensitivity/responsiveness of the quantity supplied due to a change in the price of a product or service.

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Ch. 2: 33

PRICE ELASTICITY OF SUPPLY (cont.)

FORMULA:

ss

=

%  Quantity Supplied %  Price

 s s = %  Quantity Supplied %  Price  S S = x
 s s = %  Quantity Supplied %  Price  S S = x

SS

=

x

P 1 P 2 P 1

   

Q 2 Q 1 Q 1

 S S = x P 1 P 2 – P 1     Q 2
2 – P 1     Q 2 – Q 1 Q 1 Principles of Economics

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Ch. 2: 34

DEGREE OF ELASTICITY

Elastic Supply

A small percentage of change in the price of a good will lead to larger percentage of change in the quantity supplied.

Inelastic Supply  ss =0  ss = 1 A large percentage of change in
Inelastic Supply
 ss =0
 ss = 1
A large percentage of change in the price of a good
will only affect a small percentage of change of the
quantity supplied.
 ss < 1
Unitary Elastic Supply
Percentage change in price equals the percentage
change in the quantity supplied.
Perfectly Elastic Supply
 ss = 
An almost zero percentage of change in price
brings a very large percentage of change in the
quantity supplied.
Perfectly Inelastic Supply
 ss > 1
A percentage of change in price has no effect on
the percentage of change in the quantity supplied.
Quantity Demanded

Price (RM)

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Ch. 2: 35

Time Period Technology improvements
Time Period
Technology
improvements

Perishability

Time Period Technology improvements Perishability DETERMINANTS OF PRICE ELASTICITY OF SUPPLY Availability and
DETERMINANTS OF PRICE ELASTICITY OF SUPPLY Availability and mobility of factors of production Nature of
DETERMINANTS
OF PRICE
ELASTICITY OF
SUPPLY
Availability and
mobility of
factors of
production
Nature of the
market

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Ch. 2: 36