ECO109

Business
Economics

Week 2: Demand, Supply an

Operations of marke
Lesson Objectives
By the end of this topic, students will be able to:
1. Define the concept of marginal utility, and be able to explain how it affects
purchasing decision
2. Relationship between demand and marginal utility
3. Explain the law of demand and supply
4. Understand the determinants of demand and supply and
5. Compare the shifts in demand and supply curves and the movement along a
particular curve.
6. Explain market equilibrium and analyse the changes in price and quantity with
the help of demand and supply analysis.
7. Understand the application of demand and supply analysis in business
ntroduction

Why do watermelon cost more during

Ramadan month than other months of the
year?
Why do TV ads cost more on certain periods
(such as during the FIFA World cup).
Why do hotel rooms in Maafushi cost more in
schools holidays?
Why do Doctors earn more than a
Salesperson?
Most economic questions boil down to the
workings of demand and supply
Therefore, in this chapter we will visit
Demand, Supply and Operations of
markets.
Markets

omics, a market is any place where two or more parties can meet to
in an economic transaction.
et transaction may include goods, services, information, currency, or any
ation that passes from one party to another.
ve several essential functions:
ting Exchange: Markets provide venues where buyers and sellers can
exchange goods and services. These exchanges contribute to economic
and growth.
e Generation for Firms: Markets allow firms to sell their goods and
e revenue. Whether it’s a physical retail outlet or an online platform,
enable businesses to reach consumers.
g Consumer Needs: Consumers can buy the goods and services they need
ets. Whether it’s groceries, clothing, or electronics, markets fulfill
er demands.
Utility
Utility…

Consumers make Utility is subjective and

choices based on their varies from person to
preferences and the person. It depends on
utility they expect to factors like taste,
receive from different preferences, and
options. individual circumstances.
Marginal Utility
Marginal utility refers to
the additional Positive Marginal Utility:
Utility For example, the first slice of
satisfaction or benefit that a When each additional unit pizza brings joy, and the
consumer derives from consumed increases overall second slice adds more
consuming one more unit of satisfaction. pleasure.
a specific good or service.

Negative Marginal Utility:

Utility
Zero Marginal Utility: Occurs
When each extra unit
when the additional unit
consumed leads to
consumed neither increases
diminishing satisfaction. For
nor decreases overall
instance, eating too much
satisfaction. At this point, the
chocolate might make you
consumer is indifferent.
feel sick.
 This law states that the first units o
consumption of a good or service
yield more satisfaction than
subsequent units.

As consumption increases,
the additional satisfaction gained
Law of from each extra unit
Diminishing consumed falls—a concept known
Marginal Utility as diminishing marginal utility.

This idea helps determine the

optimal quantity of a good or
service a consumer is willing to
purchase.
 Demand refers to the quantity of a good or service that consumers are willing and able to
purchase at various prices during a given time.
If you demand something, then you
1. Want it.
2. Can afford it.
3. Plan to buy it.

Demand
Wants are the unlimited desires or wishes that people have for goods and services.
How many times have you thought that you would like something “if only you could afford it” or
“if it weren’t so expensive”?

curves
Scarcity guarantees that many of our wants will never be satisfied.
Demand reflects a decision about which wants to satisfy.
The quantity demanded of a good or service is the amount that consumers plan to buy during a
given time period at a particular price.
The quantity demanded is not necessarily the same as the quantity actually bought.
Sometimes the quantity demanded exceeds the amount of goods available, so the quantity bough
is less than the quantity demanded.
• The quantity demanded is measured as an amount per unit of time.
• For example, suppose that you buy one cup of coffee a day. The quantity of coffee that you
demand can be expressed as 1 cup per day, 7 cups per week, or 365 cups per year.
 • Many factors influence buying plans, and
one of them is the price.
• We look first at the relationship between
the quantity demanded of a good and its
price.
Demand • To study this relationship, we keep all
other influences on buying plans the same
curves… and we ask:
• How, other things remaining the same,
does the quantity demanded of a good
change as its price changes?
• The law of demand provides the answer.
The law of demand
The law of demand states:
Other things remaining the same, the higher the price
of a good, the smaller is the quantity demanded; and
the lower the price of a good, the greater is the quantity
demanded.
 1. Substitution Effect
When the price of a good rises, other things remaining
same, its relative price (its opportunity cost) rises.
• Although each good is unique, it has substitutes. As t
opportunity cost of a good rises, the incentive to
economize on its use and switch to a substitute becom
stronger.

Q: Why does a higher 2. Income Effect

When a price rises, other things remaining the same, th
price reduce the price rises relative to income.
• Faced with a higher price and an unchanged income,
quantity demanded? people cannot afford to buy all the things they previo
bought. They must decrease the quantities demanded
at least some goods and services.
 • The term demand refers
to the entire relationship
between the price of a
good and the quantity
Demand demanded of that good.
Curve and • Demand is illustrated by
the demand curve and
Demand the demand schedule.
Schedule • The term quantity
demanded refers to a
point on a demand
curve—thethe quantity
demanded at a
particular price.
For example, if the price of a bar is 50¢, the quantit
demanded is 22 million a week. If the price is $2.50
the quantity demanded is 5 million a week.
 A change in any influence on buy
plans other than the
price of the good itself results in
demand schedule and a shift of t
demand curve.

For example:

A change in income changes the

A Change demand for energy bars. At a pric
$1.50 a bar, 10 million bars a we
in Demand demanded at the original income
C of the table) and 20 million bar
week are demanded at the new h
income (row C’).

A rise in income increases the

demand for energy bars. The dem
curve shifts rightward, as shown
shift arrow and the resulting red c
 • When any factor that influences buying
plans changes, other than the price of
good, there is a change in demand.

A Change in Six main factors bring changes in deman

They are changes in
Demand 1. The prices of related goods
2. Expected future prices
3. Income
4. Expected future income and credit
5. Population
6. Preferences
1. The prices of
related goods
• The quantity of energy bars that consumers plan to buy depends in part on the pric
of substitutes for energy bars.
• A substitute is a good that can be used in place of another good.
• For example, a bus ride is a substitute for a train ride; a hamburger is a substitute
hot dog; and an energy drink is a substitute for an energy bar.
• If the price of a substitute for an energy bar rises, people buy less of the substitute
more energy bars.
• For example, if the price of an energy drink rises, people buy fewer energy drinks a
more energy bars. The demand for energy bars increases.
• The quantity of energy bars that people plan to buy also depends on the prices of
complements with energy bars.
• A complement is a good that is used in conjunction with another good.
• Hamburgers and fries are complements, and so are energy bars and exercise.
• If the price of an hour at the gym falls, people buy more gym time and more energy
bars.
The Impact of a Change in the Price
of Related Goods
2. Expected future
prices
Positive Relationship:
Relationship
When consumers expect prices to increase in the future, they tend
to buy more of the product in the present. This leads to an increase in
demand for that product.

Negative Relationship:
Relationship
If consumers expect prices to decrease in the future, they may postp
their purchases.
purchases As a result, there is a decrease in demand.

For instance,
instance imagine people anticipating higher smartphone prices next ye
They might rush to buy smartphones now, boosting current demand. On the
other hand, if they expect prices to drop, they might delay their purchases
3. Income
umers’ income influences demand. When income increases,
umers buy more of most goods; and when income decreases,
umers buy less of most goods.

e specifically:

or Normal Goods:
As income rises, people tend to demand more of these goods
(and vice versa).

Examples include clothing, electronics, and restaurant meals.

or Inferior Goods:

As income increases, demand for these goods may actually fall

fall.
An example could be store-brand
brand items: wealthier individuals
might opt for more expensive name brands instead.
he Impact of a
Change in
Income
4. Expected future income and credit

When expected future income increases or credit

becomes easier to get, demand for a good might increase
now.

For example, a salesperson gets the news that she will

receive a big bonus at the end of the year, so she goes
into debt and buys a new car right now, rather than
waiting until she receives the bonus.
5. Population

 Demand also depends on the size and the age

structure of the population.
The larger the population, the greater is the demand
for all goods and services; the smaller the
population, the smaller is the demand for all goods
and services.

 Also, the larger the proportion of the population

in a given age group, the greater is the demand
for the goods and services used by that age
group.
 Demand depends on preferences.
preferences

 Preferences determine the value that people place on each goo

and service.

 Preferences depend on such things as the weather, information

and fashion.
6. For example, greater health and fitness awareness has shifted
Preferences preferences in favor of energy bars, so the demand for energy
bars has increased.

 When people have specific tastes, desires, and inclinations,

they express their preferences through their purchasing
decisions.
 Movement along th

Linking with
our energy Shift of
bar
example…
hange in the Quantity
emanded Versus a Change
Demand

Changes in the influences on buying

plans bring either a change in the
quantity demanded or a change in
demand. Equivalently, they bring
either a movement along the demand
curve or a shift of the demand curve.
The distinction between a change in
he quantity demanded and a change
n demand is the same as that
between a movement along the
demand curve and a shift of the
demand curve
Supply Curves

• Just as demand is a relation between price and quantity demanded, supply is a relation between price and
quantity supplied.
• Supply indicates how much producers are willing and able to offer for sale per period at each possible price,
other things constant.
• If a firm supplies a good or service, the firm
• 1. Has the resources and technology to produce it.
• 2. Can profit from producing it.
• 3. Plans to produce it and sell it.
• A supply is more than just having the resources and the technology to produce something. Resources and
technology are the constraints that limit what is possible.
• The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at
a particular price.
Supply Curves

Many factors influence selling plans, and one of them is the price of the
good.

We look first at the relationship between the quantity supplied of a good

and its price.

To isolate the relationship between the quantity supplied of a good and

its price, we keep all other influences on selling plans the same and
ask:
How does the quantity supplied of a good change as its price
changes when other things remain the same?
The Law
of supply Supply Curve

The law of supply states

hat, all else being equal,
he quantity supplied of a
good or
service increases as
ts price rises,
and decreases as its
price falls.
n other words, there is
a positive
elationship between
price and quantity
supplied.
 Supply curve

Supply Curve and

Supply Schedule
What is the distinction between supply and quantity
supplied?
• The term supply refers to the entire relationship
between the price of a good and the quantity
supplied of it.
• Supply is illustrated by the supply curve and the
supply schedule.
• The term quantity supplied refers to a point on a
supply curve—the
the quantity supplied at a particular
price.

Supply
schedule
A Change in Supply
When any factor that influences selling plans other than the price of the good changes, there is
a change in supply.

Six main factors bring changes in supply.

1. The prices of factors of production
2. The prices of related goods produced
3. Expected future prices
4. The number of suppliers
5. Technology
6. The state of nature
1. The prices of factors
of production
The prices of the factors of production used to produce a good
influence its supply.

To see this influence, think about the supply curve as a minimum-

minimum
supply-price
price curve.
If the price of a factor of production rises, the lowest price that a
producer is willing to accept for that good rises, so supply decrease
For example, during 2008,
• as the price of jet fuel increased, the supply of air travel decrease
• Similarly, a rise in the minimum wage decreases the supply of
hamburgers.
2. The prices of related
goods produced
• Example: A farmer can plant corn or
soybeans. If the price of soybeans rises,
he will plant (supply) less corn.
• Sometimes, two products are necessarily
produced together. Example: Cattle
provide both beef and leather. An increas
in the price of beef encourages more
cattle farming, and hence increase the
supply of leather.
3. Expected future prices

If the expected future price of a good rises, the return

from selling the good in the future increases and is higher
than it is today. Therefore, supply decreases today and
increases in the future.
4. The number of suppliers

The larger the

number of • As new firms enter an
firms that industry, the supply in that
produce a industry increases.
good, the • As firms leave an industry,
greater is the the supply in that industry
supply of the decreases.
good.
5. Technology

he term “technology” is used broadly to

ean the way that factors of production are
sed to produce a good.
technology change occurs when
a new method is discovered that lowers
the cost of producing a good.
For example, new methods used in the
factories that produce computer chips
have lowered the cost and increased the
supply of chips.
6. The state of nature

he state of nature includes all the natural

orces that influence production.
It includes the state of the weather and,
more broadly, the natural environment.
Good weather can increase the supply of
many agricultural products and bad
weather can decrease their supply.
Extreme natural events such as
earthquakes, tornadoes, and hurricanes
can also influence supply.
Supply curve shift
When supply increases, the supply curve shifts
ightward, and the quantity supplied at each price
s larger.
For example,
at $1.00 per bar, on the original (blue) supply
curve, the quantity supplied is 6 million bars a
week.
On the new (red) supply curve, the quantity
supplied is 15 million bars a week.
Look closely at the numbers in the table!
A Change in Supply Versus a Change in
Quantity Supplied
• A change in supply is not
the same as a change in
quantity supplied.
supplied.

• In this example, a higher

price causes higher
quantity supplied,
supplied, and a
move along the demand
curve.
• In this example, changes in determinants of supply, other than
price, cause an increase in supply,
supply, or a shift of the entire supply
curve, from SA to SB.
A Change in Supply Versus a
Change in Quantity Supplied
• When supply shifts to
the right, supply
increases. This causes
quantity supplied to be
greater than it was prior
to the shift, for each and
every price level.
A Change in Supply Versus a Change in Quantity
Supplied
To summarize:

Change in price of a good or service

leads to

Change in quantity supplied

(Movement
Movement along the curve).
curve

Change in costs, input prices, technology, or prices of

related goods and services
leads to

Change in supply
(Shift of curve).
Linking with
our energy
bar
example…
From Individual Supply to Market
Supply

• The supply of a good or service can be defined for an individual firm,

or for a group of firms that make up a market or an industry.
• Market supply is the sum of all the quantities of a good or service
supplied per period by all the firms selling in the market for that good
or service.
Market Supply

As with market demand, market supply is the horizontal summation of

individual firms’ supply curves.
• The operation of the market depends on the interaction between buyers and
sellers.
• An equilibrium is the condition that exists when quantity supplied and
quantity demanded are equal.
• At equilibrium, there is no tendency for the market price to change.
Market Equilibrium

• Only in equilibrium
is quantity supplied
equal to quantity
demanded.
• At any price level
other than P0, the
wishes of buyers
and sellers do not
coincide.
arket Disequilibria

Excess demand, or
shortage, is the condition
that exists when quantity
demanded exceeds quantity
supplied at the current
price.
• When quantity demanded
exceeds quantity
supplied, price tends to
rise until equilibrium is
restored.
arket Disequilibria

Excess supply, or surplus,

is the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.

• When quantity supplied

exceeds quantity
demanded, price tends to
fall until equilibrium is
restored.
Increases in Demand and
Supply

Higher demand leads to Higher supply leads to lower

higher equilibrium price and equilibrium price and higher
higher equilibrium quantity. equilibrium quantity.
Decreases in Demand and
Supply

Lower demand leads to Lower supply leads to

lower price and lower higher price and lower
quantity exchanged. quantity exchanged.
Relative Magnitudes of Change

• The relative magnitudes of change in supply and

demand determine the outcome of market equilibrium.
Relative Magnitudes of Change

• When supply and demand both increase, quantity

will increase, but price may go up or down.
Now revisit the following Lesson
Objectives
By the end of this topic, students will be able to:
1. Define the concept of marginal utility, and be able to explain how it affects
purchasing decision
2. Relationship between demand and marginal utility
3. Explain the law of demand and supply
4. Understand the determinants of demand and supply and
5. Compare the shifts in demand and supply curves and the movement along a
particular curve.
6. Explain market equilibrium and analyse the changes in price and quantity with
the help of demand and supply analysis.
7. Understand the application of demand and supply analysis in business (mostly
covered in tutorial class)
References