CHAPTER II: APPLICATION OF SUPPLY AND DEMAND

Lesson I: Prices of Basic Commodoties, Demand and Supply

A. The Market Setting

Market Price – refer to the number of pesos you must give up in exchange for goods or services you acquired.
Example, If the money price of a hamburger is P100 and the money price of hot dog is P50, then the opportunity cost to
you of buying hamburger is the value you place on two hot dogs.

The Basic Decision-making Units

 A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary
producing units in a market economy.
 An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a
new product and turning it into a successful business.
 Households are the consuming units in an economy.

The Circular Flow of Economic Activity

The circular flow of economic activity shows the connections between firms and households in input and output
markets.

Input Markets
Input markets include:

 The labor market, in which households supply work for wages to firms that demand labor.
 The capital market, in which households supply their savings, for interest or for claims to future profits, to firms
that demand funds to buy capital goods.
 The land market, in which households supply land or other real property in exchange for rent.
B. Market Demand
Demand – refers to the relationship between the price of the good or service and the quantity or number of units all
consumers in the market would choose to buy during a given period of time.
Quantity Demanded - is the amount (number of units) of a product that a household would buy in a given time period if
it could buy all it wanted at the current market price.
Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying
in the market for that good or service.

In Economics viewpoint, Demand refers to the relationship between price and quantity demanded while the term
Quantity Demanded refers to a given quantity chosen by buyers at a particular price.

Price and Quantity Demanded are normally assumed as negatively related because:
1. when a price of a good rises, the quantity demanded goes down, ceteris paribus (Latin word meaning “all other
things held constant”)
2. when the price of good falls, the quantity demanded goes up, ceteris paribus.
Take note that the word ceteris paribus is added to note of the fact that price alone does not determine the quantity
of good or service that consumer buy. Many factors other than price determine the quantity of good or service
bought in the market.

What are the factors that determine “demand”?

• “P.O.I.N.T.”
– P rice of other goods available to the household (substitute or complementary)
– O utlook (consumer expectation of the future income, wealth and prices)
– I ncome (normal goods versus inferior goods)
– N umber of potential customers (pop.of market)
– T aste or preferences (fads or trends)

Demands in Output Market

Demand Schedule - is a table showing how much of a given product a household would be willing to buy at different
prices. Demand curves are usually derived from demand schedules.

Sample Demand Schedule

ABC Co. Demand Schedule for Hamburgers
Price (pesos per unit) Quantity Demanded (units per week)
0 100,000
10 90,000
20 80.000
30 70,000
40 60,000
50 50,000
60 40,000
70 30,000
80 20,000
90 10,000
100 0

Demand Curve – is a graph illustrating how much of a given product a household would be willing to buy at different
prices.
As the price of the good changes, there is a movement along the demand curve. On the above curve, we can observed
that:

1. An increase in Quantity Demanded represent in an increase in the number of units that consumers would
choose to buy in response to a fall in price. It is represented graphically by the rightward movement along the
demand curve. (From A to B)
2. A decrease in Quantity Demanded represent a decrease in the nimber of units that consuners would choose to
buy in response to a rise in price. It is represented graphically by a leftward movement along the demand curve.
(from B to A)

The Law of Demand

The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good
demanded and its price. This means that demand curves slope downward.
Other Properties of Demand Curve
• Demand curves intersect the quantity (X)-axis, as a result of time limitations and diminishing marginal utility.
• Demand curves intersect the (Y)-axis, as a result of limited incomes and wealth.

Related Goods and Services

• Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a
given period of time. It is a flow measure.
• Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure.
• Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when
income is lower.
• Inferior Goods are goods for which demand falls when income rises.
• Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when
income is lower.
• Inferior Goods are goods for which demand falls when income rises.
• Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for
the other goes up. Perfect substitutes are identical products.
• Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the
other, and vice versa.

Shift of the Demand Curve

• A change in demand is not the same as a change in quantity demanded.

• In this example, a higher price causes lower quantity demanded.
• Changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand
curve, from DA to DB.
• When demand shifts to the right, demand increases. This causes quantity demanded to be greater than it was prior to
the shift, for each and every price level.

To summarize:
1. Change in price of a good or service leads to change
in quantity demanded (movement along the curve)
2. Change in income, preferences, or prices of other good
or service leads to change in demand (shift of curve).