Chapter 2

THEORY OF
DEMAND AND
SUPPLY
At the end of this chapter, you should be able
to:

• Describe all types of goods.

• Explain the definition of demand, law of demand, individual demand,
and market demand.
• Differentiate between change in quantity demanded, change in
demand, the determinants of demand, and exceptional demand.
• Explain the definition of supply, law of supply, individual supply, and
market supply.
• Differentiate between change in quantity supplied, change in supply, the
determinants of supply, and exceptional supply.
 2.1 CLASSIFICATION OF GOODS

• Goods can be classified into different categories based on their distinctive

characteristics; from responsiveness of quantity demanded to price change, to
income change, to change of price of other goods, and so forth.
• Under economics, goods are categorized into the following 3 groups:
Types of Goods

Free Goods Economics Goods Publics Goods

 Economic goods
• Economic goods are limited in
Free Goods supply and they are man-made
Public goods
• Free goods are • Public goods are non
goods.
available without • Economic goods require effort to be excludable and non-rivalrous
production. goods that everyone can
produced and involve cost of
• Free goods, such as consume and enjoy.
production.
sunlight, air, trees, rain • Consumers have to pay for the (a) Non-excludability means
water and rivers, are that no one can be prevented
goods.
usually referred to as • Economic goods also involve from using the good once it
'gifts of nature' since is provided.
opportunity cost.
they are provided by • Examples of these goods are (b) Non-rivalrous consumption,
nature. or non-exhaustibility, means
notebooks, pencils, skateboards and
• There is no element of that the consumption of the
cars.
rivalry with these • Economic goods are divided into 2 good by one person will not
goods, but this does reduce the amount available
sub-groups:
not mean that they are to others. If the good is
(a) Perishable goods: cannot last long,
unlimited. supplied to one person, it is
such as fruits, meat and vegetables.
made available to all.
(b) Non-perishable goods: can last for
a longer time, such as houses, gardening
tools, and televisions etc.
 Islamic Economics: Types of Goods

Dharuriyyah Hajiyyah Kamaliyyah Tarafiyyah

Necessity goods Comfort goods Non-permissible
Eg: Food Eg: Microwave Luxury goods goods
2.2 Demand, Law of Demand, Individual Demand and Market
Demand
1. Definition of Demand
Demand is defined as the different quantities of goods or services which buyers are
willing and able to buy at different possible prices in a given period of time, ceteris
paribus.

2. The Law of Demand

• The law of demand states that when the price of a good itself increases, the quantity
demanded for the good will fall and when the price of the good decreases, the quantity
demanded will increase, ceteris paribus.
• In other words, the law of demand shows an inverse relationship between the quantity
demanded and the price of the good itself.
3. Individual Demand and Market Demand
1. Individual demand: This refers to the demand of goods and services from a single
consumer.
2. Market demand: This is a horizontal summation of all the individual demand in a
particular market.
Movement Along A Demand Curve VS Shift of A Demand Curve
1. Change in quantity demanded: Happens because of change in the price of the
goods itself.
2. Change in Demand: Happens because another factors
 2.4 Determinants of Demand

1. Price Factor: Movement along a

demand curve
• According to the law of demand, changes
in the price of the good itself will cause a
change in the quantity demanded.
• When the price of the good increases,
assuming other factors influencing
demand are ceteris paribus, the quantity
demanded for that particular good will
fall.
2. Consumers' preferences
• Preferences or tastes is influenced by the types of advertising or information that the
consumer gets, the changes in fashion trends, seasons, and so forth. Changes in tastes will
cause a change in demand.
• Favourable change leads to an increase in demand and will shift the demand curve to the
right.
• For example, when a consumer changes his or her beverage preference from soft drinks to
strawberry milkshakes, this consumer will demand more of the strawberry milkshake.

3. Consumers' income
• Higher individual income, the demand for normal or superior goods and services will
increase.
• A rise in income will shift the demand curve of normal goods rightward, and vice versa.
• A normal good is any good that increases in demand when income increases, such as food or
clothing. A superior good is similar to a normal good, but is relatively expensive and scarce,
such as diamonds or luxury cars
4. Number of potential consumers/Market size
• Generally, a higher number of buyers or a bigger population in the market will
lead to an increase in demand, causing the demand curve to shift to the right.
However, if the size of the market is small or there are fewer potential buyers,
then the demand curve shifts to the left.

5. Changes in the prices of related goods and services

• Related goods refer to other goods that have a relationship with a particular
good. There are two types of related goods, i.e. substitute goods and
complementary goods.
i. Substitute goods : LED tv vs LCD tv; Margerine vs butter
ii. Complementary goods
• Goods that must be used or
consumed together. Complementary
goods cannot be used without each
other.
• Examples: printers and ink cartridges,
bread and butter, cars and petrol.
• When the price of petrol increases,
people will tend to use less of their
cars to conserve petrol. Hence, these
two products are negatively related.
7. Socio and economic conditions
• When the economy is in recession/crisis, people are uncertain about
their future income and job.
• They will tend to have lower income and to spend less. Hence, less
goods would be demanded.
• However, if the economy is booming, the purchasing power of the
people is higher and the demand of goods would tend to increase.
• Example: In war, the demand for food and weapons will increase
while the demand for goods such as sportswear or leisure items will
decrease.
2.6 SUPPLY, LAW OF SUPPLY, INDIVIDUAL
SUPPLY AND MARKET SUPPLY
1. Definition of Supply
• Supply is defined as the producer's ability and willingness to supply different
quantities of goods and services at different possible prices and time range,
ceteris paribus

2. The Law of Supply

• The law of supply states that when the price of a good itself increases, the
quantity supplied for the good will increase and when the price of the good
decreases, the quantity supplied will decrease, ceteris paribus.
3. Individual Supply and Market Supply
1. Individual supply- This refers to the supply of goods and services
from a single seller.
2. Market supply curve- This curve can be derived by horizontal
summation of all individual supply curves, i.e. by adding up all the
quantities supplied by all sellers in the market at each price
4. Change in Quantity
Supplied and Change in
Supply
• The change in quantity supplied is
shown by a movement along the
same supply curve.
• The factor that determines a change
in quantity supplied is the price of
the good itself.
• A change in supply is caused by
relevant factors other than the price
of the product which will involve the
shift of the supply curve. The price of
the good itself will not be the cause
of a change in supply.
 2.7 Determinants of Supply

1. Price of the good itself

(movement along a supply curve)
• According to the law of supply, changes in the
price of the good itself will cause a change in
the quantity supplied.
• When the price of the good increases, assuming
other factors influencing supply are ceteris
paribus, the quantity supplied for that
particular good will increase.
2. Cost and availability of the factors of production
• If there is an increase in wages (workers), the cost of production will increase.
• The profit of suppliers will decrease, thus reducing the supply of goods and
shifting the entire supply curve leftward.

3. Changes in the prices of related goods

(a) Goods in joint supply or complementary goods
• Joint supply goods or complementary goods refer to goods which are supplied
at the same time. For example, beef and leather are supplied at the same time
when a cow is slaughtered.
• When the price of beef increases, the quantity supplied for beef will increase
and the supply of leather will also increase since both goods are
complementary goods.
(b) Goods in competitive supply or substitute goods
• The supply of a good will decrease if there is an increase in the price of a
substitute good.
• Example a normal sports car and a hybrid sports car.
• When a producer increasing the quantity supplied of hybrid sports cars, the
supply of normal sports cars declining.
• This situation happens because some of the resources now are being used to
produce hybrid sports cars.
4. Level of technology
• Higher technology levels allow a smaller quantity of resources to be used for
production, which in turn reduces the cost of production
• This thus increases the supply of a product by shifting the entire supply curve
rightwards.

5. Government or economic policy

• Government policies consist of taxation and subsidies.
• When the production of goods is taxed, this increases the cost of production and
reduces the amount of profit earned.
• This will lead to a decrease in supply. The entire supply curve shifts leftward.
Subsidies work in a different way, where, when the government subsidizes the
production of goods, this encourages the producers to produce more.
• This in turn will increase supply. The entire supply curve shifts rightwards.
6. Producers' expectations of future prices
• If the producers anticipate that the future price of smartphones will
increase, the producers will supply less at that present time.
• Hence, this will decrease the supply of smartphones.

7. Number of suppliers
• With more suppliers, more outputs can be produced in the market.
• Supply will increase and, hence, the supply curve will shift to the
right.
 2.8 Supply of Goods and Services from an Islamic
Perspective
• In Islam, supply is influenced by Islamic values.
• A Muslim producer must not produce or sell any goods and
services that are forbidden by Islam.
• In Islam, supply is not only meant to satisfy the demand of
consumers or to maximize the producers' profit, but also meant to
take care of the whole society.
• In other words, the Muslim producers should supply a sufficient
amount of Dharuriyyah goods (basic goods) and Hajiyyah goods
(comfort goods), before supplying Kamaliyyah goods (luxury
goods).
• Muslim producers must not supply goods and services that are
wasteful and dangerous to society.
• For example, they must not supply goods and services such as liquor,
drugs and gambling. This basically means they must avoid supplying
goods and services that are forbidden in Islam
• Muslim producers must also not undertake transactions that
are forbidden by Allah S.WT.
• For example, the Muslim producer should conduct his/her business
transactions in the best possible manner while respecting his/her
customers. The actions of cheating and mistreating customers or
conducting business rudely are considered bad in Islam .
THANK YOU