Demand and Supply

By

Dr. Mahendra Parihar

Associate Professor,
MPSTME, NMIMS Mumbai
DEMAND:

Demand is essential for the creation, survival and profitability of a firm.

In the words of Prof. J. Harvey “demand in economics is the desire to possess something and the
willing and ability to pay a certain price in order to possess it”.
similarly, Stonier and Hague stated, “Demand in economics means demand backed up by enough
money to pay for the goods demanded.

Demand has therefore the following four dimensions:

 Price
 Time
 Market
 Amount
The Demand Side of the Market

• Every market has a demand side and a

supply side.

• Demand side represented by a market

demand curve

• The amount of the commodity buyers would

like to purchase at different prices.
Demand changes due to the following factors:
 Price
 Change in taste and preferences of individual
 Change in income and distribution of income
 Change in expectations
 Change in weather
 Change in saving
 Consumer credit policy
 Elasticity of demand
 Advertisement
 Change in population
 Demonstration effect
 Price of substitutes
etc….
In functional form
( Individual Consumer Demand)
• Qdx = f(Px, I, Py, T)

• Qdx = Quantity demanded of commodity X by an individual per time

period ( year, month, week, day or other unit of time)

• Px= Price per unit of commodity X

• I = Consumer Income

• Py= Price of related commodities

• T= Consumer Taste
Market Demand Curve

• Horizontal summation of demand curves of

individual consumers

• The market demand curve shows the various

quantities of the commodities demanded in the
market per time period, at various alternative
prices.
Cont..

• Negatively slopped – Prices and Quantity are

inversely related.

Quantity demanded of the commodity

increases when its price falls and decreases
when its price rises.

.
Functional form

•QDX =F(Px, N, I, Py, T)

N = Number of consumers in the market

I = Consumers Income

Py= Prices of related commodities

T= Tastes

Any change in these will cause the market demand curve of the commodity to shift in the same direction and as a result of the

shift in the individual’s demand curve.

Market demand curve is simply the horizontal summation of the individual demand curve only if the consumption decision of

individual consumers and independent.

Horizontal Summation: From
Individual to Market Demand
Law of Demand

• A decrease in the price of a good, all other things held constant,

will cause an increase in the quantity demanded of the good.

• An increase in the price of a good, all other things held constant,

will cause a decrease in the quantity demanded of the good.

• Demand curve –assumption - that buyers tastes, buyers incomes,

the number of consumers in the market and the price of related
commodities ( substitutes & Compliments) are unchanged.

• Any changes will cause a demand curve to shift.

Change in Quantity Demanded

Price
An increase in price
causes a decrease in
quantity demanded.
P1

P0

Quantity
Q1 Q0
Change in Quantity Demanded

Price
A decrease in price
causes an increase in
quantity demanded.

P0

P1

Quantity
Q0 Q1

Slide 12
Changes in Demand

• Change in Buyers’ Tastes

• Change in Buyers’ Incomes

• Normal Goods(Normal good is the most common type-consumption increases when

the income increases. Clothes, when your income increases you buy more clothes.) 

Inferior Goods ( consumption decreases when the available income increases).

• Change in the Number of Buyers

• Change in the Price of Related Goods

• Substitute Goods ( Tea – Coffee, Margarine – Butter)

• Complementary Goods

Slide 13
Change in Demand

An increase in demand refers

Price
to a rightward shift in the
market demand curve.

P0

Quantity
Q0 Q1

Slide 14
Change in Demand

A decrease in demand refers

Price
to a leftward shift in the
market demand curve.

P0

Quantity
Q1 Q0

Slide 15
Exceptions to the law of Demand:

 Giffin goods
 Veblen goods/Snob effect
 Price speculation
 Consumer psychological bias or illusion
Supply:
By supply is meant the quantity of goods offered for sale at a given price during a given
period of time. In other words, supply is related to both price as well as time. A
supply schedule shows how much a producer is willing and is able to offer for sale
during a certain time period.
Price Quantity Supplied

Rs. 10 200 Units

Rs. 12 300 Units

Rs. 15 400 Units

Rs. 18 500 Units

Rs. 20 600 Units

Determinant of Supply:
 Objectives of a firm
 Cost of production
 Prices of related commodities
 Natural conditions
 Speculations
 Level of technologies
 Scale of production
 Infrastructure
 Skilled workers
 Government policy etc….
Law of Supply

• A decrease in the price of a good, all other

things held constant, will cause a decrease in
the quantity supplied of the good.
• An increase in the price of a good, all other
things held constant, will cause an increase in
the quantity supplied of the good.
The supply side of the Market
• Market Supply Curve

• The Amount of a Commodity that sellers would

offer for a sale at various prices

• Higher prices will induce sellers to sell more

• Supply curve drawn on the assumption of

constant technology and input or resource.
Change in Quantity Supplied

A decrease in price
Price causes a decrease in
quantity supplied.

P0

P1

Quantity
Q1 Q0

Slide 21
Change in Quantity Supplied

An increase in price
Price causes an increase in
quantity supplied.

P1

P0

Quantity
Q0 Q1

Slide 22
Changes in Supply

• Change in Production Technology

• Change in Input Prices
• Change in the Number of Sellers

Slide 23
Change in Supply
An increase in supply refers to a
rightward shift in the market
Price supply curve.

P0

Quantity
Q0 Q1

Slide 24
Change in Supply
A decrease in supply refers to a
leftward shift in the market
Price supply curve.

P0

Quantity
Q1 Q0
Exceptions to the law of supply:

 Future price
 Need for cash
 Self-consumption
 Saving
 The supply curve of labour etc…
The Equilibrium Price

• Equilibrium price of a commodity is

determined at the intersection of the market
demand curve and the market supply curve.
• The equilibrium price causes quantity demanded
to be equal to quantity supplied.
Market Equilibrium

Price

D S

Quantity
Q
Market Equilibrium

Price

D0 D1 S0

An increase in demand will

cause the market
P1 equilibrium price and
quantity to increase.
P0

Quantity
Q0 Q1
Market Equilibrium

Price

D1 D0 S0

A decrease in demand will

cause the market
P0 equilibrium price and
quantity to decrease.
P1

Quantity
Q1 Q0
Market Equilibrium

Price An increase in
supply will
D0 cause the
S0 S1
market
equilibrium
price to
decrease and
quantity to
P0 increase.

P1

Quantity
Q0 Q1
Market Equilibrium

Price A decrease in
supply will
D0 cause the
S1 S0
market
equilibrium
price to
increase and
quantity to
P1 decrease.

P0

Quantity
Q1 Q0

32
Elasticity of Demand
Elasticity – the concept
• The responsiveness of one variable to changes
in another
• When price rises, what happens
to demand?
• Demand falls
• BUT!
• How much does demand fall?
Elasticity – the concept
• If price rises by 10% - what happens to
demand?
• We know demand will fall
• By more than 10%?
• By less than 10%?
• Elasticity measures the extent to which
demand will change
Elasticity
• 4 basic types used:
• Price elasticity of demand
• Price elasticity of supply
• Income elasticity of demand
• Cross elasticity
Elasticity
• Price Elasticity of Demand
• The responsiveness of demand
to changes in price
• Where % change in demand
is greater than % change in price – elastic
• Where % change in demand is less than % change
in price - inelastic
 Elasticity
The Formula:
% Change in Quantity Demanded
___________________________
Ped =
% Change in Price

If answer is between 0 and -1: the relationship is inelastic

If the answer is between -1 and infinity: the relationship is elastic

Note: PED has – sign in front of it; because as price rises

demand falls and vice-versa (inverse relationship between
price and demand)
Elasticity
Price (£)
The demand curve can be a
range of shapes each of which
is associated with a different
relationship between price and
the quantity demanded.

Quantity Demanded
Elasticity
• Income Elasticity of Demand:
• The responsiveness of demand
to changes in incomes
• Normal Good – demand rises
as income rises and vice versa
• Inferior Good – demand falls
as income rises and vice versa
Elasticity
• Income Elasticity of Demand:

• A positive sign denotes a normal good

• A negative sign denotes an inferior good
Elasticity
• Cross Elasticity:
• The responsiveness of demand
of one good to changes in the price of a
related good – either
a substitute or a complement

% Δ Qd of good t
__________________
Xed =
% Δ Price of good y
Elasticity
• Goods which are complements:
• Cross Elasticity will have negative sign (inverse
relationship between the two)
• Goods which are substitutes:
• Cross Elasticity will have a positive sign (positive
relationship between the two)
Elasticity
• Price Elasticity of Supply:
• The responsiveness of supply to changes
in price
• If Pes is inelastic - it will be difficult for suppliers
to react swiftly to changes in price
• If Pes is elastic – supply can react quickly to
changes in price

% Δ Quantity Supplied
____________________
Pes =
% Δ Price
Determinants of Elasticity
• Time period – the longer the time under
consideration the more elastic a good is likely to be
• Number and closeness of substitutes –
the greater the number of substitutes,
the more elastic
• The proportion of income taken up by the product
– the smaller the proportion the more inelastic
• Luxury or Necessity.
etc.
Uses of Elasticity of Demand:

Fixation of price
Formulation of tax policy
Price discrimination
Factor pricing
Policy of devaluation
Policy of nationalization etc….