Basic Principles of

Demand and Supply

Lesson 2.1
The Market
 Is an interaction between buyers and sellers of trading or
exchange. It is where the consumer buys and the seller
sells.
 The goods market is the most common type of market
because it is where we buy consumer goods.
 The labor market is where workers offer services and look
for jobs, and where employers look for workers to hire.
 Financial market, on the other hand, includes the stock
market where securities of corporations are traded.
Demand

 Is the willingness of a consumer to buy a commodity at a

given price.
 A demand schedule is a table that shows the various
quantities the consumer is willing to buy at various prices
 A demand function shows how the quantity demanded
of a good depends on its determinants, the most
important of which is the price of the good itself, thus
the equation: Qd = f(P). This signifies that the quantity
demanded of a good depend on the prices of that
good.
Hypothetical Demand Schedule of Martha for
Vinegar (in bottles)

Price per bottle Number of bottles

₱0 6
2 5
4 4
6 3
8 2
10 1
Demand Curve
Quantity Demanded
12

10

0
0 1 2 3 4 5 6 7

The downward slope of the curve indicates that as the price of vinegar
increases, the demand for this good decreases. The negative slope of
the demand curve is due to income and substitution effects.
 Income effect – is felt when a change in the price of a
good changes consumer’s real income or purchasing
power, which is the capacity to buy within a given
income.
 Purchasing power - is the volume of goods and services one can
buy with his/her income.

 Substitution effect – is felt when a change in the price of

a good changes demand due to alternative
consumption of substitute goods
The Law of Demand

 Using the assumption “ceteris paribus” the law of

demand states that if price goes UP, the quantity
demanded will go DOWN. Conversely, if price goes
DOWN, the quantity demanded will go UP.

 Ceteris paribus – means all other related variables

except those that are being studies at the moment are
held constant
Non-Price Determinants of Demand

1. Income
2. Taste
3. Expectations
4. Price of related goods
5. And population

This non-price determinants can cause an upward or downward

change in the entire demand for the product and this change is
referred to as a shift of the demand curve. This demand function will
now read: D = f(P, T, Y, E, PR, NC).
Shifts of the Demand Curve

 When a change in the price of a good causes the

quantity demanded for that good to change, this is
illustrated on the same curve and is simply a movement
from one point to another on that curve
 Shifts Demand Curve Even if the price
remains
12 unchanged, an
increase in say
10
preference, will
cause Manuel’s
demand to
8
increase per week.
The rightward shift
6
of the demand
curve indicates an
4 increase in
demand. On the
2 other hand, the
leftward shift of
0 demand curve
0 1 2 3 4 5 6 7 8 9
indicates
decrease in
demand.
Supply

 Refers to the quantity of goods that a seller is willing to

offer for sale.
 The supply schedule shows the different quantities the
seller is willing to sell at various prices.
 The supply function shows the dependence of supply on
the various determinants that affect it.
Supply Schedule of Pedro for Fish in One Week

Price of Fish (per kilo) Supply (in kilos)

₱20 200
40 300
60 400
80 500
100 600
Supply Curve
Quantity Supplied
120

100

80

60

40

20

0
0 100 200 300 400 500 600 700

We derive a supply curve that is upward sloping, indicating the direct

relationship between the price of the good and the quantity supplied
of that good.
The Law of Supply

 States that if the price of a good or service goes UP, the

quantity supplied for such good or service will also go
UP; if the price goes DOWN the quantity supplied also
goes DOWN, ceteris paribus.
Non - Price Determinants of Supply
1. Cost of production
2. Optimization in the use of factors of production
3. Number of sellers
4. Weather Conditions
5. Technology
6. Availability of raw materials

The supply function will now read: S=f(P,C,T,AR), where the Supply (S)
of a good is a function of the price of that good (P), the cost of
production (C) technology (T), and the availability of raw materials
and resources (AR).
 Shift of Supply Curve In this figure, we see
the shift in supply
curve of fish due to
120 a change in a non-
price determinants.
For example, the
100
typhoon leads to a
decrease in the
supply of fish. This
80
means the supplier
will sell less fish for
60 the same price. The
leftward shift of the
supply curve
40 indicates a
decrease in supply.
On the other hand,
20
the rightward shift
of demand curve
0
indicates an
0 100 200 300 400 500 600 700 increase in supply.
Demand and Supply in Relation
to the Prices of Basic
Commodities
Lesson 2.2
Market Equilibrium

 Is a state of balance when demand is equal to supply.

This means that the quantity that sellers are willing to sell
is also the quantity that buyers are willing to buy for a
price.
 The price at which demand and supply are equal is the
equilibrium price
Determination of Market Equilibrium
 Assuming that the demand function for good X is: Qd= 60 – P/2 and
the supply function for Good X is: Qs= 5+5P.
 Applying the equations, we derive the following demand and
supply schedules given the following prices

Price Demand Supply

0 60 5
2 59 15
4 58 25
6 57 35
8 56 45
10 55 55
12 54 65
14 53 75
16 52 85
 Quantity Demanded and Supplied of Fish
90

80

70

60
In this figure, the price
of a good in the
50
market. It is the price
40
at which the quantity
demanded is equal
30 to the quantity
supplied.
20

10

0
0 2 4 6 8 10 12 14 16 18

Supply Demand
 Equilibrium quantity is attained where Qd = Qs

 Equilibrium quantity is 55 since quantity supplied and

quantity demanded are both 55 at the price of P10,
which is the equilibrium price
Determining Demand and Supply
Equilibrium
 Suppose that the demand for soda is given by the following
equation: Qd=16–2P where Qd is the amount of
soda that consumers want to buy (i.e., quantity demanded),
and P is the price of soda.
 Suppose the supply of soda is Qs=2+5P where Qs is the
amount that producers will supply (i.e., quantity supplied).
 Finally, suppose that the soda market operates at a point where
supply equals demand, or Qd=Qs
Samples:

 Qd = 50 - 5P and Qs = 5 + 10P.
 Qd = 300 - 50P and Qs = -100 + 150P
Quiz: Find the Pe and Qe

1. Qs = -4 + 8P
Qd = 26 – 2P

2. Qd = 10,000-80P
Qs=20P

3. QD=500 – 50P
QS= 50 + 25P
Elasticities of Demand
and Supply
Lesson 2.3
Elasticity

Is the degree of their response to a change

Is a measure of how much buyers and sellers
respond to changes in market conditions

The coefficient of elasticity is the number obtained

when the percentage change in demand is divided
by the percentage change in determinant
Elasticity of Demand
1. Price Elasticity of Demand – responsiveness of demand to a change
in the price of the good. The value of price elasticity may be
measured in two ways:

a) Arc Elasticity – the value of elasticity is computed by choosing two points on the
demand curve and comparing the percentage changes in the quantity and the
price of those two points. The computation of arc elasticity makes use of the following
formula:

Ep={(Q2 - Q1) / (Q2 + Q1)} / {(P2 - P1) / (P2 + P1)}

where :
Q2 = new quantity demanded
Q1= original quantity demanded
P2 = new price of the good
P1= original price of the good
Elasticity of Demand

b) Point elasticity – measures the degree of elasticity on a single

point on the demand curve. Changes on a single point are
infinitesimally small.

Ep={(Q2 - Q1) / Q1)} / {(P2 - P1) / P1)}

2. Income elasticity of Demand – this measures how the quantity
demanded changes as consumer income changes. Income
elasticity of Demand is equal to (% change in quantity demanded)
/ (% change in income)

A positive sign (+) for IE signifies that the good demanded is a normal
good, which is what a consumer tends to buy more when his income
increases (e.g. steak, pizzas and luxury items). A negative sign (-) for IE
indicates the demand for inferior goods which are bought when
incomes are low.
3. Cross Price elasticity of Demand – this measures how the quantity
demanded changes the price of related good changes. Cross
elasticity (CE) measures the responsiveness of the demand for a
good to the change in the price of substitute good or a
complement.

A positive sign (+) for CE signifies that the two good involved are
substitute goods which means that as the price of the substitute
increases, the demand for the other good will increase. A negative
sign (-) for CE indicates that the two goods are complements, which
means that the demand for a good will increase when a price of a
complement decreases.
E р= Q2 — Q1 ÷ P2 — P1
(Q1+Q2)/2 (P1+P2)/2

Where:
E р = coefficient arc price elasticity
Q1= original quantity demanded
Q2= new quantity demanded
P1= original price
P2= new price
 Suppose we have  Assuming that we want to determine how
the following price consumers would react if price of good X will
and quantity decrease. Applying the formula, we can solve
schedule for good the elasticity coefficient assuming that price will
decrease from P6.00 to P4.00 and quantity will
X. increase from 0 to 10 units.

P Q E р= 10 — 0 ÷ 4—6
6 0 (0+10)/2 (6+4)/2

4 10 E р= 10 ÷ (— 2)
5 5
2 20
E р = 50
E р = - [5]
0 30 (-10)
Interpretation of the elasticity
coefficient

|Ed| > 1 = elastic

|Ed| = 1 = unitary

|Ed| < 1 = inelastic

Degree of Elasticity
1. Elastic – a change in a determinant will lead to a proportionately greater
change in demand or supply. The absolute value of the coefficient of
elasticity is greater than 1. If the price of LPG increases by 10% and as a
result the quantity demanded goes down by 12%, then we say that the
demand for LPG is elastic.
2. Inelastic – a change in a determinant will lead to a proportionately lesser
change in demand or supply. The absolute value of the coefficient of
elasticity is less than 1. Suppose the price of cellphone load goes up by 5%
and the quantity demanded goes down by 3%, then we can say that
demand for cellphone load is inelastic.
3. Unitary elastic – a change in determinant will lead to a proportionately
equal change in demand or supply. The absolute value of the coefficient
of elasticity is equal to 1. Let us say that the price of string beans goes down
by 6% and as a result, the quantity demanded goes up by 6% also, we
describe the demand for string beans as unitary elastic.
Graphical illustration of demand elasticity

 Elastic Demand
Graphical illustration of demand elasticity

 Inelastic Demand
Graphical illustration of demand elasticity

 Unitary Demand
Graphical illustration of demand elasticity

 Perfectly Elastic
Graphical illustration of demand elasticity

 Perfectly Inelastic
DETERMINANTS OF DEMAND ELASTICITY

 Ease of Substitution
 Proportion of total expenditures spent on the product
 Durability of product
postponing purchase
possibility of repair
Used product market
Length of time period
Elasticity of Supply

Price Elasticity of Supply – determines whether the supply

curve is steep or flat. A steep curve signifies a high degree
of elasticity or ability to change, while a flat curve
indicates an inability to change in response to a change in
the price of the good.
Graphical illustration of supply elasticity

 Elastic Supply
Graphical illustration of supply elasticity

 Inelastic Supply
Graphical illustration of supply elasticity

 Unitary Supply
Graphical illustration of supply elasticity

 Perfectly Elastic
Graphical illustration of supply elasticity

 Perfectly Inelastic
Quiz: ½ Crosswise. Determine the elasticity in the
given situation whether elastic, inelastic or unitary.
Situation Price Quantity
71
A 929

91
B 489

112
C 365

145
D 239

178
E 86

316
F 39
Quiz: ½ Crosswise. Determine the elasticity in the
given situation whether elastic, inelastic or unitary.
Situation Price Quantity
71
A 929

91 Solve for:
B 489

112 1. From Situation

C 365
E to B
145
D 239 2. From Situation
A to F
178
E 86 3. From Situation F
316 to C
F 39