Further Discussions:

Economists use supply and demand analysis to study various issues such as value of dollars,
diverse inflation and unemployment, government regulation of businesses and environmental
protection. Prices of such goods and services are determined by the interaction of the supply and
demand. On a supply and demand curve graph, we will be able to see how we determine prices
of commodities in a free market. With the view provided by Adam Smith, the father of modern
economics, he stated that people in a market system are led by an invisible hand to promote
societal well-being.

Laws have placed ceilings on some prices (such as rents) to protect buyers, whereas legislation
has placed floors under other prices such as farm products) to protect sellers. Yet, somehow,
everything such regulations touches seem to end up in even greater disarray that it was before.

Demand and Quantity Demanded

Demand (From Meriam Webster)

: a forceful statement in which you say that something must be done or given to you

: a strong need for something

: the ability and need or desire to buy goods and services

Demand means the desire for a particular good backed up by sufficient purchasing power.
Demand is also the schedule of various quantities of commodities which buyers are willing to
purchase at various prices in a given time and place.

The quantity demanded of any product normally depends on its price. Quantity demanded also
depends on a number of other determinants, including population size, consumer incomes, tastes,
and the prices of other products.

- The Demand Curve: As the price of an item rises, the quantity demanded normally falls.
As the price falls, the quantity demanded normally rises, all other things held constant.
 - Shift of the Demand Curve: A change in the price of a good produces a movement along
a fixed demand curve. By contrast, a change in any other variable that influences quantity
demanded produces a shift of the entire demand curve.
o Example: factor that can shift demand curves: Consumer Incomes. If average
income rise, consumers will purchase more of most goods, including milk, even if
the prices of goods remain the same. That is, increase in income normally shift
demand curves outward to the right, establishing a new equilibrium price and
quantity.
o Population. Population growth affects quantity demanded in more or less the
same way as increases in average incomes. For instance, a larrgere population will
presumably want to consume more milk, even if the price of milk and average
incomes do not change, thus shifting the entire demand curve to the right. The
equilibrium price and quantity both rise. And increases in particular population
segments can elicit shifts in demand.
o Consumer Preferences. If the dairy industry mounts a successful advertising
campaign extolling the benefits of drinking milk, families may decide to but more
at any given price. Alternatively, a medical report on the dangers of kidney stones
may persuade consumers to drink less milk.

Supply and Quantity Supplied

The quantity supplied is the number of units that sellers want to sell over a specified period of
time.

- As the price of any commodity rises, the quantity supplied normally rises. As the price
falls, the quantity supplied normally falls.
- Shift of the Supply Curve: A chance in the price of the good causes a movement along a
fixed supply curve. But price is not the only influence on the quantity supplied. If any of
these other influences change, the entire supply curves shifts.
- Example: factor that can shift supply curves: Size of the Industry.
- Technological Progress. Another influence that shifts supply curves is technological
change. Suppose some enterprising farmer discovers that cows prodce more milk if they
 listen to Mozart during milking time. Thereafter, at any given price, farms will be able to
produce more milk; that is the supply curve will shift outward to the right.
- Prices of Inputs. Changes in input prices also shift supply curves. Suppose a drought
raises the price of animal feed. Farmers will have to pay more to keep their cows alive
and healthy and consequently will no longer be able to provide the same quantity of milk
at each possible price. Increases in the prices of inputs that suppliers must buy will shift
the supply curve inward to the left.
- Prices of Related Outputs. Dair farms sell products other than milk. If cheese prices
rise sharply, farmers may decide to use some raw milk to make cheese, thereby reducing
the quantity of milk supplied.
-

Equilibrium of Demand and Supply

Alfred Marshall was the first to develop the standard supply and demand graph demonstrating a
number of fundamentals regarding supply and demand including the supply and demand curves,
market equilibrium, the relationship between quantity and price in regards to supply and demand
which is known as the market equilibrium.

In the market, supply and demand interact freely. Supply is represented by producers or sellers
while demand is represented by buyers. Buyers are willing and able to buy more goods at lower
prices, while producers want to offer more goods at higher prices. There is therefore a
contradiction between the two parties. At a high price, sellers offer more goods because they are
encouraged, but buyers are able to buy fewer goods. The result is a surplus of goods. This means
quantity supplied is greater than quantity demanded. To sell the surplus goods, sellers compete
with one another in decreasing their price. Buyers can take more goods at a lower price. But
producers are discouraged to produce at a very low price. The result is shortage of goods. This
means the quantity demanded is greater than quantity supplied. In this process, an equilibrium
price (meaning in balance at rest) should be established. This is a situation where quantity
supplied and quantity demanded are equal. There is no surplus or shortage.

Supply and Demand Schedules Indicating the Equilibrium Price and Equilibrium Quantity

Quantity Supplied Price Quantity Demanded

 5 P 6.00 9
6 7.00 8
7 8.00 7
8 9.00 6
9 10.00 5
10 11.00 4

When the supply and demand curves intersect, the market is in equilibrium.  This is where the
quantity demanded and quantity supplied is equal.

As you can see on the chart, equilibrium occurs at the intersection of the demand and supply
curve, which indicates no allocate inefficiency. At this point, the price of the goods will be P*
and the quantity will be Q*. These figures are referred to as equilibrium price and quantity.

Surplus and shortage:

If the market price is above the equilibrium price, quantity supplied is greater than quantity
demanded, creating a surplus.  Market price will fall.

Example: if you are the producer, you have a lot of excess inventory that cannot sell. Will you
put them on sale? It is most likely yes. Once you lower the price of your product, your product’s
quantity demanded will rise until equilibrium is reached. Therefore, surplus drives price down.
If the market price is below the equilibrium price, quantity supplied is less than quantity
demanded, creating a shortage. The market is not clear. It is in shortage. Market price will rise
because of this shortage.

Example: if you are the producer, your product is always out of stock. Will you raise the price to
make more profit? Most for-profit firms will say yes. Once you raise the price of your product,
your product’s quantity demanded will drop until equilibrium is reached.  Therefore, shortage
drives price up.

If a surplus exists, price must fall in order to entice additional quantity demanded and reduce
quantity supplied until the surplus is eliminated.  If a shortage exists, price must rise in order to
entice additional supply and reduce quantity demanded until the shortage is eliminated.

Government regulations will create surpluses and shortages in the market.  When a price ceiling
is set, there will be a shortage. When there is a price floor, there will be a surplus.

Price Floor is legally imposed minimum price on the market. Transactions below this price are
prohibited. Policy makers set floor price above the market equilibrium price which they believed
is too low. Price floors are most often placed on markets for goods that are an important source
of income for the sellers, such as labor market. Price floor generate surpluses on the market.
Example: minimum wage.

Price Ceiling is legally imposed maximum price on the market. Transactions above this price
are prohibited. Policy makers set ceiling price below the market equilibrium price which they
believed is too high. Intention of price ceiling is keeping stuff affordable for poor people. Price
ceiling generates shortages on the market. Example: Rent control.

INCOME ELASTICITY
The coefficient of income elasticity measures a product’s percentage change in quantity as a ratio
of the percentage change in income which caused the change in quantity.

=
FIVE TYPES OF GOODS

There are five possible income demand curves:

1. High income elasticity of demand:

In this case increase in income is accompanied by relatively larger increase in quantity

demanded. Here the value of coefficient Ey is greater than unity (Ey>1). E.g.: 20% increase in
quantity demanded due to 10% increase in income.

2. Unitary income elasticity of demand:

In this case increase in income is accompanied by same proportionate increase in quantity

demanded. Here the value of coefficient Ey is equal to unity (Ey=1). E.g.: 10% increase in
quantity demanded due to 10% increase in income.

3. Low income elasticity of demand:

In this case proportionate increase in income is accompanied by less than increase in quantity
demanded. Here the value of coefficient Ey is less than unity (Ey<1). E.g.: 5% increase in
quantity demanded due to 10% increase in income.

4. Zero income elasticity of demand:

This shows that quantity bought is constant regardless of changes in income. Here the value of
coefficient Ey is equal to zero (Ey=0). E.g.: No change in quantity demanded even 10% increase
in income.

5. Negative income elasticity of demand:

In this case increase in income is accompanied by decrease in quantity demanded. Here the value
of coefficient Ey is less than zero/negative (Ey<0). E.g.: 5% decrease in quantity demanded due
to 10% increase in income.
 %∆Qd = %∆I
YED = 1
EXAMPLE:

According to our survey, when the income of Starbuck’s consumer increase by 10% , there are
increase of 37% in quantity demanded. Since the YED is more than 1, therefore it is an elastic
goods (luxuries goods).  

Income elasticity of demand can be used as an indicator of industry health, future consumption
patterns and as a guide to firms investment decisions. For example, the "selected income
elasticities" below suggest that an increasing portion of consumer's budgets will be devoted to
purchasing automobiles and restaurant meals and a smaller share to tobacco and margarine

Income elasticities are closely related to the population income distribution and the fraction of
the product's sales attributable to buyers from different income brackets. Specifically when a
buyer in a certain income bracket experiences an income increase, their purchase of a product
changes to match that of individuals in their new income bracket. If the income share elasticity is
defined as the negative percentage change in individuals given a percentage increase in income
bracken the income-elasticity, after some computation, becomes the expected value of the
income-share elasticity with respect to the income distribution of purchasers of the product.

Income elasticities are notably stable over time and across countries due to the law of one
price.The law of one price (LoP) is an economic concept which posits that "a good must sell for
the same price in all locations". This law is derived from the assumption of the inevitable
elimination of all arbitrage.

The law of one price constitutes the basis of the theory of purchasing power parity, an
assumption that in some circumstances (for example, as a long-run tendency) it would cost
exactly the same number of, for example, US dollars to buy euros and then to use the proceeds to
buy a market basket of goods as it would cost to use those dollars directly in purchasing the
market basket of goods.
CROSS ELASTICITY- measures the responsiveness of the quantity demanded for a good to a
change in the price of another good, ceteris paribus. The coefficient of XED can identify whether
a good is a substitute or a complement. The formula for XED is given by;

=
Substitute Goods are products that a consumer perceives as similar or comparable, so that having
more of one product makes them desire less of the other product. Formally, X and Y are
substitutes if, when the price of X rises, the demand for Y rises.

Example for Substitute Goods. When XED is positive, the related goods are substitutes. For
example, if the price of Coca Cola increases from 50p to 60p per can, and the demand for Pepsi
Cola increases from 1m to 2m per year, the XED between the two products is:
+100/+20 = (+) 5 (The positive sign means that the two goods are substitutes.)

Complement Goods- an increase in the demand for A accompanies an increase in the quantity
demanded for B.

Example for Complement Goods.

 When XED is negative, the goods are complementary products. The equation is the same
as for substitutes.
 For example, if the price of Cinema Tickets increases from £5.00 to £7.50, and the
demand for Popcorn decreases from 1000 tubs to 700, the XED between the two products
will be:
-30/+50  = (-) 0.6 (The negative sign means that the two goods are complements)

 Another example of this would be the demand for hot dogs and hot dog buns. The supply
and demand of hot dogs is represented by the figure at the right with the initial demand
D1. Suppose that the initial price of hot dogs is represented by P1 with a quantity
demanded of Q1. If the price of hot dog buns were to decrease by some amount, this
would result in a higher quantity of hot dogs demanded. This higher quantity demanded
would cause the demand curve to shift outward to a new position D2. Assuming a
constant supply curve S of hot dogs, the new quantity demanded will be at D2 with a new
price P2.
The cross elasticity of demand measure underlies the following rule about complements and
substitutes:

If two goods are substitutes, a rise in the price of one of them tends to raise the quantity
demanded of the other; so their cross elasticities of demand will normally be positive. If two
goods are complements, a rise in the price of one of them tends to decrease the quantity
demanded of the other item, so their cross elasticities will normally be negative. Notice that,
because cross elasticities can be positive or negative, we do not customarily drop minus signs as
we do in a calculation of the ordinary price elasticity of demand.

Price Elasticity of Demand

Law of demand states that, all else being equal, as the price of a product increases (↑), quantity
demanded falls (↓); likewise, as the price of a product decreases (↓), quantity demanded
increases (↑). In simple terms, the law of demand describes an inverse relationship, and an
elasticity, between price and quantity of demand. There is a negative relationship between the
quantity demanded of a good and its price. In this case,we expect that the demand for a certain
good will increase or decrease in relation with the changes in price. And that is how price
elasticity of demand will be computed.

Price elasticity of demand (PED or Ed) is a measure used in economics to show the

responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its
price, ceteris paribus. More precisely, it gives the percentage change in quantity demanded in
response to a one percent change in price (ceteris paribus, i.e. holding constant all the other
determinants of demand, such as income).

It is a measure of responsiveness of the quantity of a raw good or service demanded to changes

in its price. The formula for the coefficient of price elasticity of demand for a good is: It is a
measure of responsiveness of the quantity of a raw good or service demanded to changes in its
price. The formula for the coefficient of price elasticity of demand for a good is.

The above formula usually yields a negative value, due to the inverse nature of the relationship
between price and quantity demanded, as described by the "law of demand".For example, if the
price increases by 5% and quantity demanded decreases by 5%, then the elasticity at the initial
price and quantity = −5%/5% = −1. The only classes of goods which have a PED of greater than
0 are Veblen and Giffen goods. Although the PED is negative for the vast majority of goods and
services, economists often refer to price elasticity of demand as a positive value (i.e., in absolute
value terms).

Value Descriptive Terms

Perfectly inelastic demand

Inelastic or relatively inelastic demand

 Unit elastic, unit elasticity, unitary elasticity, or unitarily elastic demand

Elastic or relatively elastic demand

Perfectly elastic demand

A decrease in the price of a good normally results in an increase in the quantity demanded by
consumers because of the law of demand, and conversely, quantity demanded decreases when
price rises. As summarized in the table above, the PED for a good or service is referred to by
different descriptive terms depending on whether the elasticity coefficient is greater than, equal
to, or less than −1. That is, the demand for a good is called:

 relatively inelastic when the percentage change in quantity demanded is less than the

percentage change in price (so that Ed > - 1);
 unit elastic, unit elasticity, unitary elasticity, or unitarily elastic demand when the
percentage change in quantity demanded is equal to the percentage change in price (so that
Ed = - 1); and
 relatively elastic when the percentage change in quantity demanded is greater than the
percentage change in price (so that Ed < - 1).

As the two accompanying diagrams show, perfectly elastic demand is represented graphically as

a horizontal line, andperfectly inelastic demand as a vertical line. These are the only cases in
which the PED and the slope of the demand curve (∆P/∆Q) are both constant, as well as
the only cases in which the PED is determined solely by the slope of the demand curve (or more
precisely, by the inverse of that slope).

5 TYPES OF PRICE ELASTICITY

1. Perfectly elastic demand: The demand is said to be perfectly .elastic when a very
insignificant change in price leads to an infinite change in quantity demanded. A very small fall
in price causes demand to rise infinitely. Likewise a very insignificant rise in price reduces the
demand to zero. This case is theoretical which is never found in real life.
2. Perfectly inelastic demand: The demand is said to be perfectly inelastic when a change in
price produces no change in the quantity demanded of a commodity. In such a case quantity
demanded remains constant regardless of change in price. The amount demanded is totally
unresponsive of change in price. The elasticity of demand is said to be zero.
3. Elastic demand: The demand is relatively more elastic when a small change in price causes a
greater change in quantity demanded. In such a case a proportionate change in price of a
commodity causes more than proportionate change in quantity demanded. If price changes by
10% the quantity demanded of the commodity change by more than 10% i.e. 25%. The demand
curve in such a situation is relatively flatter.
4.Inelastic demand: It is a situation where a greater change in price leads to smaller change in
quantity demanded. The demand is said to be relatively inelastic when a proportionate change in
price is greater than the proportionate change in quantity demanded. For example If price falls by
20% quantity demanded rises by less than 20% i.e 15%.
5. Unitary elastic demand: The demand is said to be unit when a change in price produces
exactly the same percentage change in the quantity demanded of a commodity. In such a
situation the percentage change in both the price and quantity demanded is the same. For
example if the price falls by 25% the quantity demanded rises by the same 25%. It takes the
shape of a rectangular hyperbola. Numerically elasticity of demand is said to be equal to 1.(ed =
1).

SAMPLE PROBLEM
(to be solve by my classmate)

Solve for the Elasticity of the following:

1. The price of Hamburger in CHARburger eatery increases from 9 to 10 pesos.This leads

to a decrease in demand from QD= 8 burgers to QD=3 burgers.SOLVE FOR THE
PRICE ELASTICITY OF DEMAND AND CLASSIFY THE ELASTICITY.

2. Suppose the price of Safety pin in Alden's store increases from 2 to 3 pesos.This results
in a decrease in demand from QD= 22 pieces to QD=20 pieces.

3. Suppose the original price of a good was 6 pesos and it increased to 12 pesos.The
consumer responded by decreasing his demand for that good from 200 to 100.

Factors affecting price elasticity of demand

1. The number of close substitutes – the more close substitutes there are in the market, the
more elastic is demand because consumers find it easy to switch. E.g. Air travel and train
travel are weak substitutes for inter-continental flights but closer substitutes for journeys
of around 200-400km e.g. between major cities in a large country.
2. The cost of switching between products – there may be costs involved in switching. In
this case, demand tends to be inelastic. For example, mobile phone service providers may
insist on a12 month contract which has the effect of locking-in some consumers once a
choice has been made
3. The degree of necessity or whether the good is a luxury – necessities tend to have an
inelastic demand whereas luxuries tend to have a more elastic demand. An example of a
necessity is rare-earth metals which are an essential raw material in the manufacture of
solar cells, batteries. China produces 97% of total output of rare-earth metals – giving
them monopoly power in this market.
4. The proportion of a consumer's income allocated to spending on the good – products
that take up a high % of income will have a more elastic demand
5. The time period allowed following a price change – demand is more price elastic, the
longer that consumers have to respond to a price change. They have more time to search
for cheaper substitutes and switch their spending.
 6. Whether the good is subject to habitual consumption – consumers become less
sensitive to the price of the good of they buy something out of habit (it has become the
default choice).
7. Peak and off-peak demand - demand is price inelastic at peak times and more elastic at
off-peak times – this is particularly the case for transport services.
8. The breadth of definition of a good or service – if a good is broadly defined, i.e. the
demand for petrol or meat, demand is often inelastic. But specific brands of petrol or beef
are likely to be more elastic following a price change.

Price Elasticity of Supply

Price elasticity of supply (PES or Es) is a measure used in economics to show the
responsiveness, or elasticity, of the quantity supplied of a good or service to a change in its price
or cost. The elasticity is represented in numerical form, and is defined as the percentage change
in the quantity supplied divided by the percentage change in price. When the coefficient is less
than one, the said good can be described as inelastic; when the coefficient is greater than one, the
supply can be described as elastic. An elasticity of zero indicates that quantity supplied does not
respond to a price change: it is "fixed" in supply. Such goods often have no labor component or
are not produced, limiting the short run prospects of expansion. If the coefficient is exactly one,
the good is said to be unitary elastic. The quantity of goods supplied can, in the short term, be
different from the amount produced, as manufacturers will have stocks which they can build up
or run down.

Factors affecting the Price Elasticity of Supply

Spare production capacity: If there is plenty of spare capacity then a business can increase output
without a rise in costs and supply will be elastic in response to a change in demand. The supply
of goods and services is most elastic during a recession, when there is plenty of spare labour and
capital resources.
Stocks of finished products and components: If stocks of raw materials and finished products are
at a high level then a firm is able to respond to a change in demand - supply will be elastic.
Conversely when stocks are low, dwindling supplies force prices higher because of scarcity in
the market.

The ease and cost of factor substitution: If both capital and labour are occupationally mobile then
the elasticity of supply for a product is higher than if capital and labour cannot easily be
switched. A good example might be a printing press which can switch easily between printing
magazines and greetings cards.

Time period and production speed: Supply is more price elastic the longer the time period that a
firm is allowed to adjust its production levels. In some agricultural markets the momentary
supply is fixed and is determined mainly by planting decisions made months before, and also
climatic conditions, which affect the production yield. In contrast the supply of milk is price
elastic because of a short time span from cows producing milk and products reaching the market
place.

Percentage change in quantity supplied divided by the percentage change in price:

 When Pes > 1, then supply is price elastic

 When Pes < 1, then supply is price inelastic
 When Pes = 0, supply is perfectly inelastic
 When Pes = infinity, supply is perfectly elastic