JMJ Marist Brothers

COLLEGE OF BUSINESS ADMINISTRATION

Notre Dame of Marbel University
City of Koronadal

A MODULE IN BAC 101 (BASIC MICROECONOMICS)

MODULE 5, WEEKS 5 TO 9
DEMAND AND SUPPLY ANALYSIS

LEARNING OUTCOMES
At the end of the session, students can answer the following question:

1. Why are the demand and supply concepts important in the analysis of the economics of the firm?

INTRODUCTION
The concepts of demand and supply are useful for explaining what is happening in the market place.
Every market transaction involves an exchange and many exchanges are undertaken in a single day. The
circular flow of economic activity explains clearly that every day there are a number of exchanges taking
place among the four major sectors mentioned earlier.

A market is a place where we buy and sell goods and services. A buyer demands goods and services from
the market and the sellers supply the goods in the market. In economics, demand is “the quantity of goods
and services that will be bought for a given price over a period of time”.

This chapter describes demand and supply which is the driving force behind a market economy. This is
one of the most important managerial factors because it assists the managers in predicting changes in
production and input prices. The manager can take better decisions regarding the kind of product to be
produced, the quantity, the cost of the product and its selling price. Let us understand the concept of
demand and its importance in decision making.

ACTIVITY
Reflection Paper. Read and reflect on the case Micro Factors Affecting Demand for Tanishq Products.
Answer the question at the end of the article.

Case
Micro Factors Affecting Demand for Tanishq Products

Price of Jewellery–Symbol of Quality

Price of a commodity is known to have a direct influence on demand for it. This follows from the Law of
Demand. But in the case of Tanishq jewellery this does not hold true, making it an exception to the Law.
This can be explained in terms of Veblen effect, where the price of a commodity is regarded as an
indicator of its quality. Sometimes certain commodities are demanded just because they happen to be
expensive or prestige goods, and hence have a "snob appeal". These are generally luxury articles that are
purchased by the rich as status symbols. The price of Tanishq jewellery is regarded by patrons as being
the just cost of the purity and trustworthiness of the brand. Not only was Tanishq the first to offer branded
jewellery in India, but it was also the first to introduce concepts such as testing the purity of jewellery
through the Karat meter, a buyback guarantee as well as Notes other exchange schemes. Each move by
Tanishq has shown its confidence in its own product. This has in turn inspired confidence in its
customers, who are loyal. Usually, when the price of gold bullion increases people tend to curb/postpone
their purchases of gold ornaments. However, the demand for Tanishq jewellery is independent of this
price factor because each piece of jewellery represents a promise of quality and purity, each piece is
something different and new, each piece is something special. As such the income and substitution effects
do not adversely affect the demand for Tanishq jewellery, and price has title impact overall. But it has
also been observed that an escalation in the gold price, diamonds seem to have caught the fancy of the
customer and the promotional offers are being designed to provide customers with enhanced value.

Designs Offered

The average Indian has always been very discerning when it comes to the purchase of jewellery.
However, with the spread of globalization customers want the best quality in terms of designs. Best
quality is provide to meet the international standards. Creativity is the buzzword. Tanishq's primary
customer, the urban Indian woman, has come along way. She is smart, educated, and confident of
handling career and family, and looking to secure value for her money. Today's urban women no longer
wear jewellery only at weddings and formal occasions. They require trendy accessories that match her
attire and reflect her personality. In this context the demand is vast and widespread in terms of prices. The
women of today want the best of everything and have become more and more and more selective in their
choices. The brand's designs address the needs of the modern woman. Tanishq had crafted award-winning
designs in 18 karat and 24 karat gold and gemstone jewellery. It's new range looks beautiful and yet is
affordable and feels light.

Promotional Schemes

With cutthroat competition in the market, every company comes up with schemes to woo the customers.
These offers are all the more visible during the festival season. Purchase of jewellery can happen any time
of the year like - for birthdays, anniversaries, gifting, impulse purchases, etc. and of course for marriages
as well. Therefore, in absolute terms, there is no lean period for jewellery - the jewellery market can be
stimulated throughout the year through a host of well-designed marketing inputs. Tanishq to promote its
brand comes up with all kinds of schemes like a jewellery exhibition which brings fresh talent to the
forefront, launched a nationwide jewellery design competition on May 22nd 2004, 'Get Gold free with
Diamonds' promotional offer across all 66 exclusive Tanishq boutiques in India. Its also specially
designed the three crowns for the Ponds Femina Miss India Contest this year. It reached out to the target
group through exclusive working women's meets, where well known career women spoke about issues
relevant to working women. In addition, 'Tanishq Collection-G' ran joint promotions with brands such as
L'Oreal and Wills Lifestyle, which it believed appeal to a similar set of consumers. Tanishq has
successful stimulated demand for jewellery throughout the year through launches of new jewellery
collections, a range of exchange programs and other offers (such as the recently concluded "Impure to
Pure" exchange offer) and a number of in-store events. As a result of these efforts, even while the market
for jewellery declined by more than 15% last year, Tanishq grew by 40% for the third successive year.
Amongst the most recent initiatives of Tanishq has been the targeting of the wedding market by making
special offers on wedding jewellery. This promotional scheme has had the masses thronging in, in very
large numbers. It also got the 4th Annual Lycra Images Fashion Awards in the Jewellery category.

Discounts

Discounts play a major role in determining the demand for a product. Tanishq periodically offers
discounts. In 2002 it offered a vast gamut of discounts in its showrooms in Bihar during the festival of
Dhanteras resulting in sales of 5 crore in one particular store. During its fifth anniversary celebrations
Tanishq offered discounts to customers, and the response was so overwhelming that extra security was
called to handle the crowd even before the store opened. At select points of time in the year Tanishq also
offers 20%-40% discount on making charges, which is also a large crowd puller.
Guarantee
Tanishq has managed to establish its position in the market because its quality products are backed by a
guarantee certificate. Each item of jewellery that is sold is accompanied by a guarantee card that states the
weight of the gold/platinum as well as the cartage of the gemstones used. In case of any discrepancy the
company is liable for legal action. All diamonds used are VVS certified, and the platinum is passed by the
official Platinum Authority of India. 100% purity backed by an ironclad guarantee is thus the hallmark of
Tanishq jewellery. This is a major demand inducer as the traditional jewelers are increasingly fudging on
such things.
Question: Analyze the role of other factors (other than price of products) in influencing the demand for
Tanshiq's products.
ACQUISITION OF NEW KNOWLEDGE (Live Lecture-Discussion via Schoology)
Contents:
Demand Analysis
Demand
Law of demand
Quantity Demanded for Goods and Services
Demand Schedule
Demand Curve
Change/Shifts in the Demand Curve
Change in Quantity Demanded for Goods and Services: Extension and Contraction
Determinants of demand
Demand Function
Types of demand
Elasticity of Demand
Supply Analysis
Supply
Quantity Supplied of Goods and Services
Law of supply
Supply Schedule
Supply Curve
Change in the Quantity Supplied of Goods and Services: Extension and Contraction
Change in Supply: Shifts in the Supply Curve
Determinants of supply
Elasticity of supply
Supply Function
A. DEMAND ANALYSIS
Demand means the ability and willingness to buy a specific quantity of a commodity at the prevailing
price in a given period of time. Therefore, demand for a commodity implies the desire to acquire it,
willingness and the ability to pay for it.
Law of demand states that the quantity of a commodity demanded in a given time period increases as its
price falls, ceteris paribus (other things remaining constant).
Quantity demanded for goods and services is the amount of an item that buyers are willing and able to
buy/purchase over a period of a certain price, given all other influences on their decision to buy constant.
Demand schedule is a table showing the quantities of a good that a consumer is willing and able to buy at
the prevailing price in a given time period.
Demand Schedule for Eggs
Price (pesos per dozen) Quantity Demanded (dozens per week)

32.00 1,000
31.75 2,000
31.50 3,000
31.25 4,000
31.00 5,000
30.75 6,000
30.50 7,000
30.25 8,000
Demand Curve is a graphical representation of the relationship between price and quantity demanded for
goods and services. It indicates the total quantity of a product that consumers are willing and able to
purchase at a given price level (ceteris paribus). The price is quoted in the Y axis and the quantity
demanded is quoted in X axis. Each point on the curve refers to a quantity that will be demanded at a
given price. The demand curve is a downward sloping curve (left to right) showing that as price falls,
quantity demanded rises. This inverse relationship between price and quantity is called the law of
demand. When price changes, there is an increasing or decreasing movement along the curve.

33
Price (in pesos)
32
31
30 Demand
29 Curve
1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000
Quantity
De-
manded
Change/Shift in Demand is a change in the relationship between the price of the good and the quantity
demanded caused by a change in something other than the price of the good – Causes shifts in the entire
demand curve: increase in demand – shift to the right; decrease in demand – shift to the left.
The Determinants of Demand
Determinants Change in the Determinants Change in Demand (∆D)

Tastes and preferences of consumers Increase Increase

Number of consumers Increase Increase
Income of consumers Increase (normal good) Increase
Increase (inferior good) Decrease
Prices of other related goods Increase (substitute) Increase
Increase (complement) Decrease
Future price expectation Increase in price tomorrow Increase today
Future income expectation Increase in income tomorrow Increase today

Other Determinants of Demand. There are other factors affecting the demand for a commodity aside from
what has been mentioned awhile ago.

1. Price of related goods: The price of related goods like substitutes and complementary goods also
affect the demand. In the case of substitutes, rise in price of one commodity lead to increase in
demand for its substitute. In the case of complementary goods, fall in the price of one commodity
lead to rise in demand for both the goods.
2. Money Circulation: The more the money in circulation, the higher the demand and vice versa.
3. Value of money: When there is a rise or fall in the value of money there may be changes in the
relative prices of different goods and their demand.
4. Weather Condition: When weather is bad, demand will fall, and vice versa.
5. Advertisement and Salesmanship: If the advertisement is very attractive for a commodity, demand
will be more. Similarly if the salesmanship and publicity is effective then the demand for the
commodity will be more.
6. Government policy: Taxation: High taxes will increase the price and reduce demand while low taxes
will reduce the price and extend the demand.
7. Credit facilities: Depending on the availability of credit facilities the demand for commodities will
change. More the facilities, more demand.
8. Multiplicity of uses of goods: If the commodity has multiple uses then the demand will be more than
if the commodity is used for a single purpose.
Change in Quantity Demanded for Goods and Services extends and contracts the demand curve which is
a change in the amount of a good buyers are willing and able to buy/purchase in response to a change in
the price of the good - Movement along a constant demand curve.

With a fall in price, more of a commodity is bought, there is an extension of the demand curve. When
lesser quantity is demanded with a rise in price, there is a contraction of demand.

From the above graph we can understand that an increase in prices result in the contraction of demand. If
the price increases from P10 to P12, then the demand for the commodity falls from 55 units to 40 units
(contraction). On the other hand when there is a fall in price, it results in the extension of demand. Let us
assume that the price falls from P10 to P7, then the quantity demanded of 55 units increases to 75 units
(extension).

Demand function is a function that describe how much of a commodity will be purchased at the
prevailing prices of that commodity and related commodities, alternative income levels, and alternative
values of other variables affecting demand.

Price is not the only factor which determines the level of demand for a good. Other important factor is
income. The rise in income will lead to an increase in demand for a normal commodity. A few goods are
named as inferior goods for which the demand will fall when income rises. Another important factor
which influences the demand for a good is the price of other goods. Other factors which affect the
demand for a good apart from the above mentioned factors are: changes in population, changes in fashion,
changes in taste, and changes in advertising.

A change in demand occurs when one or more of the determinants of demand change and it is expressed
in the following equation: QdX = f (Px , Pr , Y, T, EX , Ep , Adv….), where, QdX = quantity demanded of
good X; Px = the price of good X; Pr = the price of a related good; Y = income level of the consumer; T =
taste and preference of the consumers; EY= expected income; Ep = expected price; and Adv =
advertisement cost.

The above mentioned demand function expresses the relationship between the demand and other factors.
The quantity demanded of commodity X varies according to the price of commodity (Px ), income (Y),
the price of a related commodity (Pr ), taste and preference of the consumers (T), expected income (E Y )
and advertisement cost (Adv) spent by the organization.

Determination of the Demand Function: An Algebraic Solution

Case 1: Using 2 point-slope formula: When P and Qd are in regular intervals.

Case 2: Using regression: When any of P and Qd or both P and Qd are in irregular intervals.
Case 3: Using regression: When one variable (any P or Qd) is given.

Case 1. Using 2 point-slope formula: When P and Qd are in regular intervals.

Given
Price Quantity Demanded

2 50
4 40
6 30
8 20
10 10
2-point Slope Formula:
y-y1 = m (x-x1)
where m = Δy/Δx = y2-y1/x2-x1
y-y1 = y2-y1/x2-x1(x-x1) or q-q1=q2-q1/p2-p1(p-p1)

Computing for the Demand Function using the First 2 ordered pairs:
Price (x) Quantity Demanded (y)

2 (p1) 50 (q1)
4 (p2) 40 (q2)

Substitution of Values and Computation

y-y1 = y2-y1/x2-x1(x-x1) or q-q1=q2-q1/p2-p1(p-p1)
q-50=40-50/4-2(p-2)
q-50=-10/2(p-2)
q-50=-5(p-2)
q-50=-5p+10
q=-5p+10+50
qd=-5p+60 -------- Quantity Function of Demand

Computing for the price function (inverse function of demand)

qd=-5p+60 -------- Quantity Function of Demand
 5p=60-q
5p/5=60/5-q/5
p=12-0.2q -------- Price Function of Demand

Case 2: Using regression: When any of P and Qd or both P and Qd are in irregular intervals.

Given
Price Quantity Demanded

2 28
6 23
10 20
14 15
17 12

Formulas

Slope: m=n∑xy-[∑x(∑y)] / n∑x2-(∑x)2

Y Intercept: b=∑y/n – m(∑x/n)

Price (x) QD (y) xy x2

2 28 56 4
6 23 138 36
10 20 200 100
14 15 210 196
17 12 204 289
∑x=49 ∑y=98 ∑xy=808 ∑x2=625

Determination of the Slope: Substitute each column summations to the corresponding places in the slope
formula, where ∑xy=808; ∑x=49; ∑y=98; ∑x2=625 and n=5 (number of cases).
m=n∑xy-[∑x(∑y)] / n∑x2-(∑x)2
m=5(808)-(49)(98) / 5(625)-(49)2
m=4,040-4,802 / 3,125-2,401
m=-762 / 724
m=-1.05
Determine the Intercept:
b=∑y/n – m(∑x/n)
b=98/5-(-1.05)(49/5)
b=19.6+1.05(9.8)
b=19.6+10.29
b=29.89
Determine the Quantity Function of Demand
From the computation, m=-1.05 and b=26.62. Following the form: y=mx+b or q=mp+b, substitute m
and b to the slope intercept form. So, the quantity function of demand is

qd=-1.05p+29.89 ------ Quantity Function of Demand

Determine the Price Function of Demand
As qd=-1.05p+29.89, then
1.05p=29.89-q
1.05p/1.05=29.89/1.05-q/1.05
p=24.47 – 0.95q ------- Price Function of Demand
Case 3: Using regression: When one variable (any P or Q) is given.
Given
Year Quantity Demanded

2016 40
2017 75
2018 98
2019 109
2020 120

Formulas

Slope: m=∑xy/∑x2
Y Intercept: b= ∑y/n

Quantity x-values xy x2
Demanded (y)

40 -2 -80 4
75 -1 -75 1
98 0 0 0
109 1 109 1
120 2 240 4
∑y=442 ∑x=0 ∑xy=194 ∑x2=10

Determine the Slope (m)

m=∑xy/∑x2
m=194/10
m=19.4
Determine the Intercept (b)

b= ∑y/n
b=442/5
b=88.4

Determine the Demand Function

q=mp+b
q=19.4x+88.4------ Demand Function

Types of Demand. Demand may be defined as the quantity of goods or services desired by an individual,
backed by the ability and willingness to pay.

1. Direct and indirect demand: (or) Producers’ goods and consumers’ goods: Demand for goods that are
directly used for consumption by the ultimate consumer is known as direct demand. On the other
hand demand for goods that are used by producers for producing goods and services is indirect
demand.
2. Derived demand and autonomous demand: When a produce derives its usage from the use of some
primary product it is known as derived demand (demand for tires is derived from demand for car).
Autonomous demand is the demand for a product that can be independently used (demand for a
washing machine).
3. Durable and nondurable goods demand: Durable goods are those that can be used more than once,
over a period of time (microwave oven) Nondurable goods can be used only once (Band-aid).
4. Firm and industry demand: Firm demand is the demand for the product of a particular firm (Dove
soap). The demand for the product of a particular industry is industry demand (demand for steel in the
Philippines).
5. Total market and market segment demand: A particular segment of the market’s demand is called as
segment demand (demand for laptops by engineering students). The sum total of the demand for a
product by various segments in economy is total market demand – sum of individual demands
(demand for laptops in Philippines).
6. Short run and long run demand: Short run demand- demand with its immediate reaction to price
changes and income fluctuations. Long run demand-exist as a result of the changes in pricing,
promotion or product improvement after market adjustment with sufficient time.
7. Joint demand and composite demand: When two goods are demanded in conjunction with one
another at the same time to satisfy a single want, it is called as joint or complementary demand
(demand for gasoline and cars). A composite demand is one in which a good is wanted for several
different uses (demand for iron rods used for various purposes).
8. Price demand, income demand and cross demand: Demand for commodities by the consumers at
alternative prices are called as price demand. Quantity demanded by the consumers at alternative
levels of income is income demand. Cross demand refers to the quantity demanded of commodity X
at a price of a related commodity Y which may be a substitute or complementary to X.

Price Demand: The ability and willingness to buy specific quantities of a good at the prevailing price
in a given time period.
Income Demand: The ability and willingness to buy a commodity at the available income in a given
period of time.
Cross Demand: The ability and willingness to buy a commodity or service at the prevailing price of
the related commodity: substitutes or complementary products. For example, people buy more of
wheat when the price of rice increases.
9. Exceptional demand: The demand curve slopes from left to right upward if despite the increase in
price of the commodity, people tend to buy more due to reasons like fear of shortages or it may be an
absolutely essential good. The law of demand does not apply in every case and situation. The
circumstances when the law of demand becomes ineffective are known as exceptions of the law.
Some of these exceptions are:

1. Giffen Goods: Some special varieties of inferior goods are termed as Giffen goods. Sir Robert
Giffen of Ireland first observed that people used to spend more of their income on inferior goods
like potato and less of their income on meat. After purchasing potato, they did not have surplus to
buy meat. So the rise in price of potato compelled people to buy more potato and thus raised the
demand for potato. This is against the law of demand known as Giffen paradox.
2. Conspicuous Consumption / Veblen Effect: This exception to the law of demand is associated
with the doctrine propounded by Thorsten Veblen. A few goods like diamonds are purchased by
the rich and wealthy sections of society. The prices of these goods are so high that they are
beyond the reach of the common man. The higher the price of the diamond, the higher its prestige
value. So when the price of the good falls, the consumers think that the prestige value of the good
comes down. So quantity demanded of the good falls with the fall in their price.
3. Conspicuous Necessities: Certain things become the necessities of modern life. So, we have to
purchase them despite their high price. The demand for TV, automobiles, refrigerators etc. has
not gone down in spite of the increase in their price. These things have become the symbol of
status. So they are purchased despite their rising price.
4. Ignorance: A consumer’s ignorance is another factor that at times induces him to purchase more
of the commodity at a higher price. This is especially true, when the consumer believes that a
high-priced and branded commodity is better in quality than a low-priced one.
5. Emergencies: During emergencies like war, famine, etc households behave in an abnormal way.
Households accentuate scarcities and induce further price rise by making increased purchases
even at higher prices because of the apprehension that they may not be available. On the other
hand during depression,, fall in prices is not a sufficient condition for consumers to demand more
if they are needed.
6. Future Changes in Prices: Households also act as speculators. When the prices are rising,
households tend to purchase large quantities of the commodity out of the apprehension that prices
may still go up. When prices are expected to fall further, they wait to buy goods in future at still
lower prices. So quantity demanded falls when prices are falling.
7. Change in Fashion: A change in fashion and tastes affects the market for a commodity. When a
digital camera replaces a normal manual camera, no amount of reduction in the price of the latter
is sufficient to clear the stocks. Digital cameras on the other hand, will have more customers even
though its price may be going up.
8. Demonstration Effect: It refers to a tendency of low income groups to imitate the consumption
pattern of high income groups. They will buy a commodity to imitate the consumption of their
neighbors even if they do not have the purchasing power.
9. Snob Effect: Some buyers have a desire to own unusual or unique products to show that they are
different from others. In this situation even, when the price rises the demand for the commodity
will be more.
10. Speculative Goods/Outdated Goods: Speculative goods like shares do not follow the law of
demand. Whenever the prices rise, the traders expect the prices to rise further so they buy more.
Goods that go out of use due to advancement in the underlying technology are called outdated
goods. The demand for such goods does not rise even with fall in prices.
11. Seasonal Goods: Goods which are not used during the off-season will also be subject to similar
demand behavior.
12. Goods in Short Supply: Goods that are available in limited quantity or whose future availability is
uncertain also violate the law of demand.
Elasticity of Demand. In economics, the term elasticity means a proportionate (percentage) change in
one variable relative to a proportionate (percentage) change in another variable. The quantity demanded
of a good is affected by changes in the price of the good, changes in price of other goods, changes in
income and changes in other factors. Elasticity is a measure of just how much of the quantity demanded
will be affected due to a change in varied factors.

Elasticity of demand is the degree of responsiveness of the demand for a commodity due to a fall in its
price. A fall in price leads to an increase in quantity demanded and vice versa.

The elasticity of demand may be: Price Elasticity, Income Elasticity and Cross Elasticity

Price Elasticity (Ep). The response of the consumers to a change in the price of a commodity is measured
by the price elasticity of the commodity demand. The responsiveness of changes in quantity demanded
due to changes in price is referred to as price elasticity of demand. The price elasticity of demand is
measured by dividing the percentage change in quantity demanded by the percentage change in price.

Ep = proportionate change in the quantity demanded / proportionate change in price or percentage change
in quantity demanded (%∆Qd) / Percentage change in price (%ΔP) or q2-q1/q1 ÷ p2-p1/p1 (using the
point formula); q2-q1/(q2+q1)/2 ÷ p2-p1/(p2+p1)/2 (arc elasticity formula). Quantity demanded is 20
units at a price of Php500. When there is a fall in price to Php400 it results in a rise in demand to 32 units.
Therefore the change in quantity demanded is12 units resulting from the change in price of Php100. The
Price Elasticity of Demand is = 500 / 20 x 12/100 = 3 by using the arc elasticity formula.

Determinants of Price Elasticity of Demand. The exact value of price elasticity for a commodity is
determined by a wide variety of factors. The two factors considered by economists are the availability of
substitutes and time. The better the substitutes for a product, the higher the price elasticity of demand.
The longer the period of time, the more the price elasticity of demand for that product. The price elasticity
of necessary goods will have lower elasticity than luxuries.

The elasticity of demand depends on the following factors:

1. Nature of the commodity: The demand for necessities is inelastic because the demand does not
change much with a change in price. But the demand for luxuries is elastic in nature.
2. Extent of use: A commodity having a variety of uses has a comparatively elastic demand.
3. Range of substitutes: The commodity which has more number of substitutes has relatively elastic
demand. A commodity with fewer substitutes has relatively inelastic demand.
4. Income level: People with high incomes are less affected by price changes than people with low
incomes.
5. Proportion of income spent on the commodity: When a small part of income is spent on the
commodity, the price change does not affect the demand therefore the demand is inelastic in nature.
6. Urgency of demand / postponement of purchase: The demand for certain commodities are highly
inelastic because you cannot postpone its purchase. For example medicines for any sickness should
be purchased and consumed immediately.
7. Durability of a commodity: If the commodity is durable then it is used it for a long period. Therefore
elasticity of demand is high. Price changes highly influences the demand for durables in the market.
8. Purchase frequency of a product/ recurrence of demand: The demand for frequently purchased goods
are highly elastic than rarely purchased goods.
9. Time: In the short run, demand will be less elastic but in the long run, it is more elastic.

The following are the possible combination of changes in price and quantity demanded (Price Elasticity
of Demand).. The slope of each combination is depicted in the following graphs.
1. Elastic Demand (Ed >1) a small percentage change in price leading to a larger change in quantity
demanded - %∆Qd>%∆P

2. Unit Elastic Demand (Ed =1) the percentage change in quantity demanded is the same as the
percentage change in price that caused it - %∆Qd=%∆P

3. Inelastic Demand (Ed < 1) a change in price leads to a smaller percentage change in quantity
demanded - %∆Qd<%∆P

In a specific single demand curve, the lower line segment are points having inelastic demand; upper line
segment are points with elastic demand; and the middle segment are point(s) having unitary demand.
4. Perfectly Elastic Demand (Ed = ∞) a small change in price will change the quantity demanded by an
infinite amount.

5. Perfectly Inelastic Demand (Ed = 0) the quantity demanded does not change regardless of the
percentage change in price.

Income Elasticity. Income elasticity of demand measures the responsiveness of quantity demanded to a
change in income. It is measured by dividing the percentage change in quantity demanded by the
percentage change in income (%∆Qd<%∆Y or q2-q1/(q2+q1)2 ÷y2-y1/(y2+y1)/2). If the demand for a
commodity increases by 20% when income increases by 10% then the income elasticity of that
commodity is said to be positive and relatively high. If the demand for food were unchanged when
income increases, the income elasticity would be zero. A fall in demand for a commodity when income
rises results in a negative income elasticity of demand.

The following are the various types of income elasticity:

1. Income Elasticity is Greater than 1. The change in income increases the demand for that commodity
more than the change in income (Ey > 1).
2. Unitary Income Elasticity. The change in income leads to the same percentage of change in the
demand for the good (Ey = 1).
3. Income Elasticity is Less than 1. The change in income increases the demand for the commodity but
at a lesser percentage than the change in income (Ey < 1).
4. Zero Income Elasticity. The increase in income of the individual does not make any difference in the
demand for that commodity (Ey = 0).
5. Negative Income Elasticity. The increase in the income of consumers leads to less purchase of those
goods (Ey < 0).

The positive income elasticity of demand can be classified as unitary, more than unitaryy and less than
unitaryy. We can understand from the above graphs that the product which is highly elastic in nature will
grow faster when the economy is expanding. The performance of firms having low income elasticity on
the other hand will be less affected by the economic changes of the country.

With a rise in consumer’s income, the demand increases for superior or normal goods and decreases for
inferior/Veblen goods and vice versa. The income elasticity of demand is positive for superior goods or
normal goods and negative for inferior/Veblen goods since a person may shift from inferior to superior
goods with a rise in income.

Cross Elasticity. The quantity demanded of a particular commodity varies according to the price of other
commodities. Cross elasticity measures the responsiveness of the quantity demanded of a commodity
due to changes in the price of another commodity. For example the demand for tea increases when the
price of coffee goes up. Here the cross elasticity of demand for tea is high. If two goods are substitutes
then they will have a positive cross elasticity of demand (Coke and Pepsi). In other words, if two goods
are complementary to each other then negative cross elasticity may arise (cell phone and charger).

The responsiveness of the quantity of one commodity demanded to a change in the price of another good
is calculated with the following formula. Ec=percentage change in quantity demand for commodity X /
percentage change in price of commodity Y (%∆qdx÷%∆py or q2x-q1x/(q2x+q1x)/2÷p2y-p1y/(p2y+p1y)/2). If
two commodities are unrelated goods, the increase in the price of one good does not result in any change
in the demand for the other goods. For example the price fall in salt does not make any change in the
demand for shoes.

Significance of Elasticity of Demand. The concept of demand elasticity is useful for the managers for
the following decision making activities.

1. Helpful to a monopolist in fixing price. Individual producer under imperfect competition has to
consider the demand for his product when he fixes its price thus, taking into account the response of
his customers in formulating price policy.
2. Helpful to the Government in formulating taxation Policies. Finance authorities have to consider the
nature of the elasticity of demand for a commodity before implementing taxes.
3. Helpful in determination of rewards for factors of production. If the demand for labor on a particular
industry is relatively inelastic, it will be easier for the trade union to get their wages raised - apply to
other factors of production whose demands are relatively inelastic.
4. Helpful in determination of terms of trade. It is possible to calculate the terms of trade between two
countries only by taking into account the mutual elasticities of demand for each others products. The
term “terms of trade” implies the rate at which one unit of a domestic commodity will exchange for
units of commodity of a foreign country.
5. Helpful in determining the exchange rate. Before deciding to devalue or revalue domestic currency in
relation to foreign currencies the government has to study carefully the elasticities of demand for its
imports and exports.
6. Helpful in declaring certain industries as public utilities. Enables the government to decide as to what
particular industries should be declared as public utilities and being consequently owned and operated
by the state.

B. SUPPLY ANALYSIS

Supply of a commodity refers to the various quantities of the commodity which a seller is willing and
able to sell at different prices in a given market at a point of time, other things remaining the same.
Supply is what the seller is able and willing to offer for sale. The Quantity supplied is the amount of a
particular commodity that a firm is willing and able to offer for sale at a particular price during a given
time period.

Quantity Supplied of Goods and Services is the amount of goods and services sellers are willing and able
to sell at a particular price.

Law of Supply is the relationship between price of the commodity and quantity of that commodity
supplied. i.e. an increase in price will lead to an increase in quantity supplied and vice versa.

Supply Schedule is a table showing how much of a commodity, firms can sell at different prices.
Supply Curve is a graphical representation of how much of a commodity a firm sells at different prices.
Quantities of milk offered for sale are measured along OX and prices along OY. The supply curve slopes
upwards; from the left to right (m=+).

Supply Schedule of Milk

Price per liter Quantity Supplied of Milk

10 20
8 15
7 12
6 10
5 8
4 6
3 4
2 2
1 0
Change in quantity supplied of goods and services is a change in the quantity of goods and services that
sellers are willing and able to sell as influenced by price – extension or contraction: movement along the
supply curve – quantity offered for sale increases or decreases because price has risen or fallen – moving
up or down in the same supply curve.

Prices are measured along OY and quantities for sale along OX. At PM price, OM is offered, but at price
P’M’ (which is higher than PM), OM’ is offered (more).

Change in Supply: Shifts of the Supply Curve: Incrrease or Decrease

Shift to the Right. SS’ is the old supply curve and BB’ is the new supply curve. Increase in supply, for
OM’ (more) is offered instead of OM at the same price (PM = P’M’). The same quantity OM is offered at
a lower price LM. Increase in supply signifies that either more is offered at the same price or the same
quantity is offered at a lower price

Shift to the left. SS’ is the old supply curve and BB’ is the new supply curve. OM’ (less) is offered in
place of OM, although price is the same (P’). M’=PM) and the same quantity OM is offered at a higher
price LM. Decrease in supply means that less is offered at the same price or the same quantity is offered
at a higher price.

Elasticity of supply is the responsiveness of a quantity supplied to a unit change in price of that
commodity (%ΔQs / %∆P) or Es = q2-q1/(q2+q1)/2 ÷p2-p1 / (p2+p1)/2.
Price elasticity of supply measures the responsiveness of changes in quantity supplied to a change in
price.

Kinds of Supply Elasticity

Elastic supply: The change in quantity supplied is more than the change in price (Ex>0). Supply is said to
be elastic when a given percentage change in price leads to a larger change in quantity supplied - the
numerical value of Es will be greater than one but less than infinity – sensitive suppliers – luxuries.

Unitary elastic: The percentage change in quantity supplied equals the change in price (Es=1). If price and
quantity supplied change by the same magnitude, then we have unit elasticity of supply. Any straight line
supply curve passing through the origin has an elasticity of supply equal to 1 – neutral sensitivity – either
a luxury or a necessity.
Inelastic supply: The proportionate change in supply is less than the change in price (Es<1). Supply is
said to be inelastic when a given percentage change in price causes a smaller change in quantity supplied.
The numerical value of elasticity of supply is greater than zero but less than one – insensitive suppliers –
necessities.

Perfectly elastic: Suppliers are willing to supply any amount at a given price (Es=∞). The numerical value
of elasticity of supply, in exceptional cases, may reach up to infinity – extreme sensitivity – highly
luxurious products (Veblen goods). Supply curve - parallel to the horizontal axis. The economic
interpretation of this supply curve is that an unlimited quantity will be offered for sale at the price OP.
If price slightly drops down below OP, nothing will be supplied.

Perfectly inelastic: If there is no response in supply to a change in price (Es = 0). Exceptional case of zero
elasticity – extreme insensitivity – highly necessity products (medicines or supply curve of land from the
viewpoint of a country, or the world as a whole.
Important observations

Any straight supply curve that intersects the vertical axis above the origin has an elasticity of supply
greater than one.

Elasticity of supply will be less than one if the straight supply curve cuts the horizontal axis on any point
to the right of the origin.

All supply curves which pass through the origin are unitary elastic. A, B and C are the supply curves of
three different commodities. The price elasticity of supply for all 3 curves is equal to one. Although A is
steeper and C is flatter, elasticity will be equal to one which means, any straight line supply curve that
passes through the origin has unitary elastic supply, irrespective of the angle it makes with the origin.
The flatter the curve, more is the elasticity at the point of intersection. Supply curves S (flatter curve) and
S1 (steeper curve) intersect each other at point E.

Recap of Supply Elasticity Coefficients

Factors Influencing Elasticity of Supply

1. Nature of the commodity: If the commodity is perishable in nature then the elasticity of supply will
be less. Durable goods have high elasticity of supply.
2. Time period: If the operational time period is short then supply is inelastic. When the production
process period is longer the elasticity of supply will be relatively elastic.
3. Scale of production: Small scale producer’s supply is inelastic compared to the large producers.
4. Size of the firm and number of products: If the firm is a large scale industry and has more variety of
products then it can easily transfer the resources. Therefore supply of such products is highly elastic.
5. Natural factors: Natural calamities can affect agricultural products so they are relatively inelastic.
6. Nature of production: If goods need more workmanship or for artistic goods, elasticity will be high.

Apart from the above mentioned factors, future expectations of the market, natural resources of the
country and government controls can also play a role in determining supply of a good. In the long run,
supply is affected by cost of production. If costs are rising, some of the existing producers may withdraw
from the field and new entrepreneurs may be scared of entering the field.

Most desirable price elasticity of supply for a firm. It is desirable for a firm to be highly responsive to
changes in price and other market conditions. This is because a high PES makes the firm
more competitive than its rivals and it allows the firm to generate more revenue and profits.

Improving price elasticity of supply. Because a high price elasticity of supply is desirable, it is necessary
for firms to undertake actions that improve their ability to respond quickly to changes in market
conditions which may include:

1. Creating spare capacity

2. Using the latest technology
3. Keeping sufficient stocks
4. Developing better storage systems
5. Prolonging the shelf life of products
6. Developing better distribution systems
7. Providing training for workers
8. Having flexible workers who can do a range of jobs
9. Locating production near to the market
10. Allowing inward migration of labor if there is a labor shortage

Determination of the Supply Function: An Algebraic Solution

Case 1: Using 2 point-slope formula: When P and QS are in regular intervals

Case 2: Using regression: When any of P and QS or both P and QS are in irregular intervals
Case 3: When only 1 variable is given

NOTE TO THE STUDENTS: The determination of the supply function using algebra is the same with
demand.

Conclusion

The supply and demand models can be broken into two parts: the law of demand and the law of supply. In
the law of demand, the higher a supplier's price, the lower the quantity of demand for that product
becomes. The law itself states, "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." This
correlates largely to the opportunity cost of buying more expensive items wherein the expectation is that
if the buyer must give up consumption of something they value more to buy the more expensive product,
they will likely want to buy it less.

Similarly, the law of supply correlates to the quantities that will be sold at certain price points. Essentially
the converse of the law of demand, the supply model demonstrates that the higher the price, the higher the
quantity supplied because of an increase in business revenue hinges upon more sales at higher prices.
The relationship between supply in demand relies heavily on maintaining an equilibrium between the two,
wherein there is never more or less supply than demand in a marketplace which shall bring us to the next
topic, market equilibrium..

C. MARKET EQUILIBRIUM

When the supply and demand curves intersect, the market is in equilibrium. This is where the quantity
demanded and quantity supplied are equal. The corresponding price is the equilibrium price or market-
clearing price, the quantity is the equilibrium quantity.

Putting the supply and demand curves

from the previous sections together.
These two curves will intersect at
Price = $6, and Quantity = 20.

In this market, the equilibrium price is

$6 per unit, and equilibrium quantity is
20 units.

At this price level, market is in

equilibrium. Quantity supplied is equal
to quantity demanded ( Qs = Qd).

Market is clear.

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 exist, 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.

If the market price (P) is higher than $6 (Qd = Qs),

for example, P=8, Qs=30, and Qd=10.
Since Qs>Qd, there are excess quantity supplied in

The
market, the market is not clear. Market is in surplus.

THE PRICE WILL DROP BECAUSE OF THIS

SURPLUS.
If the market price is lower than equilibrium price, $6,
for example, P=4, Qs=10, and Qd=30.
Since Qs<Qd, There are excess quanitty demanded

in the
market. Market is not clear. Market is in shortage.

THE PRICE WILL RISE DUE TO THIS SHORTAGE.

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.

Changes in equilibrium price and quantity. Equilibrium price and quantity are determined by the
intersection of supply and demand. A change in supply, or demand, or both, will necessarily change the
equilibrium price, quantity or both. It is highly unlikely that the change in supply and demand perfectly
offset one another so that equilibrium remains the same.

Example: This example is based on the assumption of Ceteris Paribus.

1) If there is an exporter who is willing to export oranges from Florida to Asia, he will increase
the demand for Florida’s oranges. An increase in demand will create a shortage, which increases the
equilibrium price and equilibrium quantity.

2) If there is an importer who is willing to import oranges from Mexico to Florida, he will
increase the supply for Florida’s oranges. An increase in supply will create a surplus, which lowers the
equilibrium price and increase the equilibrium quantity.

3) What will happen if the exporter and importer enter the Florida’s orange market at the same
time? From the above analysis, we can tell that equilibrium quantity will be higher. But the import and
exporter’s impact on price is opposite. Therefore, the change in equilibrium price cannot be determined
unless more details are provided. Detail information should include the exact quantity the exporter and
importer is engaged in. By comparing the quantity between importer and exporter, we can determine who
has more impact on the market.

In the following table, an example of demand and supply increase is illustrated.

In this graph, supply is constant, demand increases. As

the new demand curve (Demand 2) has shown, the new
curve is located on the right hand side of the original
demand curve.

The new curve intersects the original supply curve at a

new point. At this point, the equilibrium price (market
price) is higher, and equilibrium quantity is higher also.
 In this graph, demand is constant, and supply increases.
As the new supply curve (SUPPLY 2) has shown, the
new curve is located on the right side of the original
supply curve.

The new curve intersects the original demand curve at a

new point. At this point, the equilibrium price (market
price) is lower, and the equilibrium quantity is higher.

In this graph, the increased demand curve and increased

supply were drawn together. The new intersection point
is located on the right hand side of the original
intersection point.

This new equilibrium point indicated an equilibrium

quantity which is higher than the original equilibrium
quantity. The equilibrium price is also higher. It is
because demand has increased relatively more than
supply in this case.

Equilibrium Price and Equilibrium Quantity Determination: An Algebraic Approach

If, for example, out of the demand and supply functions computation, the following demand and supply
functions were derived: P = 6Qs – 18 (Supply Function); P = 32 – 4Qd (Demand Function). Notice that
the structure of each function is in the form Y=mx+b. Because we are looking for the equilibrium price
(P*) and equilibrium quantity (Q*), we simply equate the two functions. Remember that equilibrium
means the “balance” between the two variables, in this case, supply and demand (S=D).

Equilibrium Quantity Determination:

S=D
6Qs – 18 = 32 – 4Qd ---Equate the demand and supply functions
6Q+4Q = 32+18 --- Combine like terms by transposition
10Q=50
10Q/10=50/10 --- divide both side by the coefficient of the unknown
Q*=5 ------- Equilibrium Quantity
Equilibrium Price Determination:

Substitute the value of the Q* to any of the original given demand and supply functions. Let us take the
demand function first: P = 32 – 4Qd. Because Q*=5, then

P=32-4Qd
=32-4(5)
=32-20
P*=12 ------ Equilibrium Price

APPLICATION (Written task). In not more than 1,000 words, answer the questions at the end of the
case:

The Market for Professional Basketball

Toward the end of the 1970s, the NBA seemed on the brink of collapse. Attendance had sunk to little
more than half the capacity. Some teams were nearly bankrupt. Championship games did not even merit
prime-time television coverage. But in the 1980s, three superstars turned things around. Michael Jordan,
Larry Bird, and Magic Johnson created millions of fans and breathed new life into the sagging league.
New generations of stars, including Dwayne Wade, Carmelo Anthony, and LeBron James, continue to
fuel interest.

Since 1980 the league has expanded from 22 to 30 teams and game attendance has more than doubled.
New franchises have sold for record amounts. More importantly, league revenue from broadcast rights
jumped more than 40-fold from $19 million per year during the 1978–1982 contract to $785 million per
year during the 2002–2008 contract. Popularity also increased around the world as international players,
such as Yao Ming of China and Dirk Nowitzki of Germany, joined the league (basketball is now the most
widely played team sport in China). NBA rosters in 2007 included more than 70 international players.
The NBA formed marketing alliances with global companies such as Coca-Cola and McDonald’s, and
league playoffs are now televised in more than 200 countries in 45 languages to a potential market of 3
billion people.

What is the key resource in the production of NBA games? Talented players. With supply relatively
fixed, the greater demand boosted average pay to $4.9 million by 2007 for the 450 or so players in the
league. Such pay attracts younger and younger players. Stars who entered the NBA right out of high
school include Kobe Bryant, Kevin Garnett, and LeBron James. After nine players entered the NBA draft
right out of high school in 2005, the league, to stem the flow, required draft candidates to be at least 19
years old and out of high school for one year.

But rare talent alone does not command high pay. Top rodeo riders, top bowlers, and top women
basketball players also possess rare talent, but the demand for their talent is not sufficient to support pay
anywhere near NBA levels. NBA players earn nearly 100 times more than WNBA players. For example,
Diana Taurasi, a great college player, earned only $40,800 on her first pro season. Men earn more than
women in all professional sports except in tennis, where prize money is the same. Some sports are not
even popular enough to support professional leagues (like the U.S. women’s pro soccer league folded).

NBA players are now the highest-paid team athletes in the world earning 60 percent more than pro
baseball’s average and at least double that of pro football and pro hockey. Both demand and supply
determine average pay.
Questions

1. In what sense can we speak of a market for professional basketball?

2. Who are the demanders and who are the suppliers?
3. What are some examples of how changes in supply or demand conditions have affected this
market?

ASSESSMENT

 Quiz. For ten (10) points each, answer the following problems by showing all possible solutions.

1) Determine the demand function of firm A using the following table.

FIRM A

PRICE QUANTITY DEMANDED

12 28
14 22
15 20
20 15
26 13
30 10

2) Determine the demand function of firm B using the following table.

FIRM B
MONTH QUANTITY DEMANDED
August 10
September 16
October 22
November 28
December 35

3. Determine the supply function of firm C using the following table.

FIRM C

PRICE QUANTITY SUPPLIED

10 20
14 22
 17 27
22 30
30 36
35 45

4. Determine the supply function of firm D using the following table.

FIRM D

PRICE QUANTITY SUPPLIED

10 20
20 40
30 60
40 80
50 100

5) Determine the equilibrium quantity (Q*) and equilibrium price (P*) of the following functions:

Ps = 12Q – 30
Pd = 50 – 8Q

ASSIGNMENT

For 10 points each, answer the following:

1) What is meant by production? Describe its assumptions.

2) What are fixed and variable inputs?
3) Distinguish between the laws of return to variables proportion and the laws of returns to
scale.
4) How is economies of scale defined? What is internal and external economies of scale?

REFERENCE

Principles of economics (n.d.). Retreived January 14, 2021 from

https://opentextbc.ca/principlesofeconomics