CHAPTER 2 DEMAND AND SUPPLY

DEFINITION OF DEMAND Demand is defined as the ability and willingness to buy specific quantities of goods in a given period of time at a particular price, ceteris paribus.

CLASSIFICATION OF GOODS AND SERVICES Free goods are goods that have no production cost. Public goods are goods that are for common use and will benefit everyone. Economic goods are goods of value that can be seen and touched. Economic services are intangible things (with value) that cannot be seen or touched.

NEGATIVE RELATIONSHIP LAW OF DEMAND Law of demand states that the higher the price of a good, the lower is the quantity demanded for that good and the lower the price, the higher is the quantity demanded, ceteris paribus. P  Qdd  P  Qdd  NEGATIVE RELATIONSHIP

DEMAND SCHEDULE AND CURVE Price (RM) Demand Curve 5 4 3 2 1 6 8 10 DD Price Quantity 5 2 4 3 6 8 1 10 Quantity (units)

INDIVIDUAL AND MARKET DEMAND INDIVIDUAL DEMAND The relationship between the quantity of a good demanded by a single individual and its price.   MARKET DEMAND The relationship between the total quantity of a good demanded by adding all the quantities demanded by all consumers in the market and its price.

Population or number of buyers Consumers’ income Tastes and trends Price of related goods Population or number of buyers DETERMINANTS OF DEMAND Supply of money in circulation Expectation about future prices Level of taxation Advertisement Festive seasons and climate

CHANGES IN QUANTITY DEMANDED VS. CHANGES IN DEMAND Price D1 D0 Quantity Shift in the demand curve Occurs when there are changes in other factors but price remains constant Increase in Demand (D0  D1) Decrease in Demand (D1  D0) CHANGES IN DEMAND Price DD Quantity Movement along DD curve Price changes and other factors are constant Upward movement  Decrease in quantity demanded (Contraction) Downward movement  Increase in quantity demanded (Expansion)

EXCEPTIONAL DEMAND GIFFEN GOODS SPECULATION EMERGENCIES Exceptional Demand is the opposite of the Law of Demand where as price increases, demand will also increase and vice versa. GIFFEN GOODS SPECULATION EMERGENCIES STATUS SYMBOL GOODS HIGHLY-PRICED GOODS

INTER-RELATED DEMAND CROSS DEMAND The demand for a good is also affected by the price of its substitute or complementary goods. Cross demand can be divided into two: Joint demand and competitive demand.

CROSS DEMAND: JOINT DEMAND VS. COMPETITIVE DEMAND Price of pizza Price of pizza DD P2 P2 P1 P1 DD Q2 Q1 Quantity of soft drinks Q1 Q2 Quantity of spaghetti a) Joint Demand b) Competitive Demand Negative relationship exists between complement goods Positive relationship exists between substitute goods

INTER-RELATED DEMAND DERIVED DEMAND Derived demand is the demand for a good which is derived from other goods.

DERIVED DEMAND Derived Demand Wage rate (RM per hour) Price (RM) S0 S0 P1 WR1 P0 WR0 D1 D1 D0 D0 Quantity of houses Q0 Q1 Q0 Q1 Quantity of workers Demand and supply for houses Demand and supply for carpenters

INTERRELATED DEMAND COMPOSITE DEMAND Composite demand is demand for a good that has multiple uses For example: oil can be used for petrol, kerosene and diesel

COMPOSITE DEMAND Price Price S1 S0 S0 P1 P1 P0 P0 D1 D0 D0 Q0 Q1 Quantity of petrol Q1 Q0 Quantity of diesel Demand and supply for petrol Demand and supply for diesel

PRICE ELASTICITY OF DEMAND DEFINITION: Measures the sensitivity/responsiveness of the quantity demanded due to a change in its price.

PRICE ELASTICITY OF DEMAND (cont.) FORMULA: d = %  Quantity Demanded %  Price d = Q2 – Q1 x P1 Q1 P2 – P1

DEGREE OF ELASTICITY Elastic Demand d > 1 Perfectly Elastic Demand A small percentage of change in the price of a good will lead to larger percentage of change in quantity demanded. d > 1 Perfectly Elastic Demand A condition in which a small percentage of change in price leads to an infinite percentage of change in the quantity demanded. d =  Inelastic Demand A large percentage of change in the price of a good will only affect a small percentage of change in the quantity demanded. d < 1 Unitary Elastic Demand A condition in which percentage changes in price equals to percentage changes in quantity demanded. d = 1 Perfectly Inelastic Demand A condition in which the quantity demanded does not change as the price changes. d =0

DEGREE OF ELASTICITY d =0 d < 1 d =  d = 1 d > 1 Price (RM) d =0 d < 1 d =  d = 1 d > 1 Quantity Demanded

OF PRICE ELASTICITY OF DEMAND Proportion of the expenditure on a product Proportion of the expenditure on a product Nature of goods Existence of substitutes Existence of substitutes DETERMINANTS OF PRICE ELASTICITY OF DEMAND Income level Frequently purchased products Time dimension Complementary goods Habits

RELATIONSHIP TO TOTAL REVENUE Total Revenue (TR) = Price (P) x Quantity (Q) The information on price elasticity of demand will be useful for the seller to adjust their selling price since it will affect the total revenue. Price DEMAND IS ELASTIC Total Revenue RM20 x 10 = RM200 If seller increases price to RM30 New Total Revenue = RM30 x 5 = RM150  TR =  RM50 RM30 RM20 D 5 10 Quantity Demanded

RELATIONSHIP TO TOTAL REVENUE (cont.) Total Revenue (TR) = Price (P) x Quantity (Q) Price DEMAND IS INELASTIC Total Revenue RM1 x 15 = RM15 If seller increases price to RM2 New Total Revenue = RM2 x 10 = RM20  TR =  RM5 RM2 RM1 D 10 15 Quantity Demanded

RELATIONSHIP TO TOTAL REVENUE (cont.) Total Revenue (TR) = Price (P) x Quantity (Q) Price DEMAND IS UNITARY ELASTIC Total Revenue RM1 x 20 = RM20 If seller increases price to RM2 New Total Revenue = RM2 x 10 = RM20  TR =  0 RM2 RM1 D 10 20 Quantity Demanded

INCOME ELASTICITY OF DEMAND DEFINITION: Measures the sensitivity/responsiveness of the quantity demanded due to a change in income.

INCOME ELASTICITY OF DEMAND (cont.) FORMULA: Y = %  Quantity Demanded %  Income Y = Q2 – Q1 x Y1 Q1 Y2 – Y1

RESPONSES OF INCOME ELASTICITY Elastic Income Type of good: Luxury goods such as antique furniture and diamonds Income y =0 Inelastic Income Type of good: Normal goods such as food and clothing Negative Income Elasticity Type of good: Giffen/ Inferior goods such as used car and low grade potatoes 0 < y < 1 Zero Income Elasticity Type of good: Necessity Goods such as rice and vegetables y > 1 y< 0 Quantity Demanded

CROSS ELASTICITY OF DEMAND DEFINITION: Measures the sensitivity/responsiveness of the quantity demanded of one product due to a change in the price of a related product.

CROSS ELASTICITY OF DEMAND FORMULA: X = %  Quantity Demanded of good X %  Price of good Y X = QX2 – QX1 x PY1 QX1 PY2 – PY1

RESPONSES OF CROSS ELASTICITY Price of Good X Positive Cross Elasticity Good X and Y are substitute goods x =0 Negative Cross Elasticity Good X and Y are complementary goods Zero Cross Elasticity Good X and Y have no relationship x > 0 x < 0 Quantity Demanded of Good Y

DEFINITION OF SUPPLY Supply is defined as the ability and willingness to sell or produce a particular product and services in a given period of time at a particular price, ceteris paribus.

POSITIVE RELATIONSHIP LAW OF SUPPLY Law of supply states that the higher the price of a good, the greater is the quantity supplied for that good and the lower the price of a good, the lower is the quantity supplied, ceteris paribus. P  Qss  P  Qss  POSITIVE RELATIONSHIP

SUPPLY SCHEDULE AND CURVE Supply Curve 10 8 6 4 2 12 1 3 5 Supply Price Quantity 5 10 4 8 3 6 2 1

INDIVIDUAL AND MARKET SUPPLY INDIVIDUAL SUPPLY The relationship between the quantity of a product supplied by a single seller and its price.   MARKET SUPPLY The relationship between the total quantity of a product supplied by adding all the quantities supplied by all sellers in the market and its price.

Proportion of the expenditure on a product Cost of production Expected future price Price of related goods DETERMINANTS OF SUPPLY Improvement in infrastructure Technological advancement Government Policies Number of sellers

CHANGE IN QUANTITY SUPPLIED VS. CHANGE IN SUPPLY Price s0 s1 Quantity Shift in the supply curve Occurs when there are changes in other factors but the price remains constant Increase in Supply (S0  S1) Decrease in Supply (S1  S0) Price SS Quantity Movement along supply curve Price changes and other factors are constant Downward movement  Decrease in quantity supplied (Contraction) Upward movement  Increase in quantity supplied (Expansion)

EXCEPTIONAL SUPPLY Exceptional Supply is the opposite of the Law of Supply where as price increases, the quantity supplied decreases and vice versa Wage Rate 20 Income Effect (Exceptional Supply Curve) 15 10 Substitution Effect 5 Labour 1 2 3 4 5 6

INTERRELATED SUPPLY JOINT SUPPLY Increase in the supply of one good brings to an increase in the supply of another related goods.

PRICE ELASTICITY OF SUPPLY DEFINITION: Measures the sensitivity/responsiveness of the quantity supplied due to a change in the price of a product or service.

PRICE ELASTICITY OF SUPPLY (cont.) FORMULA: ss = %  Quantity Supplied %  Price SS = Q2 – Q1 x P1 Q1 P2 – P1

DEGREE OF ELASTICITY ss > 1 ss < 1 ss =0 ss = 1 ss < 1 Elastic Supply A small percentage of change in the price of a good will lead to larger percentage of change in the quantity supplied. ss > 1 Inelastic Supply A large percentage of change in the price of a good will only affect a small percentage of change of the quantity supplied. ss < 1 Price (RM) ss =0 ss = 1 ss < 1 Unitary Elastic Supply Percentage change in price equals the percentage change in the quantity supplied. ss = 1 Perfectly Elastic Supply An almost zero percentage of change in price brings a very large percentage of change in the quantity supplied. ss =  ss =  Perfectly Inelastic Supply A percentage of change in price has no effect on the percentage of change in the quantity supplied. ss =0 ss > 1 Quantity Supplied

OF PRICE ELASTICITY OF SUPPLY Time Period Technology improvements Nature of the market DETERMINANTS OF PRICE ELASTICITY OF SUPPLY Availability and mobility of factors of production Perishability