1. LECTURE 2 LAW OF DEMAND AND SUPPLY

2. DEMAND
Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price the relationship between price and quantity demanded is known as the demand relationship. For the seller demand means that buyers are able and willing to purchase at a particular price.

3. The Law of Demand
The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more.

4. The graph below shows that the curve is a downward slope.
A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the negative relationship between price and quantity demanded. The higher the price of a good the lower the quantity demanded (A), and the lower the price, the more the good will be in demand (C).
The chart below shows that the curve is a downward slope.

5. Factors Influencing Demand
A number of factors help to determine how much a consumer will buy. Some of the most important factors are: 1. Income of the consumer: A consumer’s demand is influenced by the size of his income. With increase in the level of income, there is increase in the demand for goods and services. A rise in income causes a rise in consumption.

6. As a result, a consumer buys more.
Continued
As a result, a consumer buys more.
For most of the goods, the income effect is positive. But for the inferior goods, the income effect is negative. That means with a rise in income, demand for inferior goods may fall.

7. 2. Price of the commodity: Price is a very important factor, which influences demand for the commodity. Generally, demand for the commodity expands when its price falls, in the same way if the price increases, demand for the commodity contracts. It should be noted that it might not happen, if other things do not remain constant.

8. 3. Changes in the prices of related goods:
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3. Changes in the prices of related goods:
Sometimes, the demand for a good might be influenced by prices changes of other goods. There are two types of related goods. They are substitutes and complements. Tea and Coffee are good substitutes. A rise in the price of coffee will increase the demand for tea and vice versa. Bread and butter are complements. A fall in the price of bread will increase the demand for butter and vice versa.

9. 4. Tastes and preferences of the consumers: Demand depends on people’s tastes, preferences, habits and social customs. A change in any of these must bring about a change in demand. For example, if people develop a taste for tea in place of coffee, the demand for tea will increase and that for coffee will decrease.

10. Continued
5. Price expectations:
Expectations of people regarding the future prices of goods also influence their demand. If people anticipate a rise in the prices of goods in future due to some reasons, the demand for goods will rise to avoid more prices in future. Contrarily, if the people expect a fall in price, the demand for the commodity will fall.

11. 6. Change in the distribution of income: If the distribution of income is unequal, there will be many poor people and few rich people in society. The level of demand in such a society will be low. On the other hand, if there is equitable distribution of income, the demand for necessaries commonly consumed by the poor will increase and the demand for luxuries consumed by the rich will decrease. However, the net effect of an equitable distribution of income is an increase in the level of demand.

12. Continued
7. Advertising:
An effective advertising campaign could increase the quantity demanded of a particular good. It could also decrease the demand for a competing good.

13. Changes IN Demand
A change in price will result in a movement along a demand curve.
A change in a non-price variable will result in a shift in the demand curve.
An outward shift in demand will occur if income increases, in the case of a normal good; however, for an inferior good, the demand curve will shift inward noting that the consumer only purchases the good as a result of an income constraint on the purchase of a preferred good.
Normal good
A good for which demand increases when income increases and falls when income decreases but price remains constant.
Inferior good
a good that decreases in demand when consumer income rises; having a negative income elasticity of demand.

14. The demand curve is a graphical representation of an economic agent's willingness to purchase a given quantity of a good or service at a specific price based on preferences, income, and other prevailing factors at a given point in time. Demand curves in combination with supply curves, which depict the price to quantity relationship of producers, are a representation of the goods and services market. Where the two curves (demand and Supply) intersect is market equilibrium, the price to quantity relationship where demand and supply are equal.

15. Shifts in the demand curve are related to non-price events that include income, preferences and the price of substitutes and complements. An increase in income will cause an outward shift in demand (to the right) if the good or service assessed is a normal good or a good that is desirable and is therefore positively correlated with income. Alternatively, an increase in income could result in an inward shift of demand (to the left) if the good or service assessed is an inferior good or a good that is not desirable but is acceptable when the consumer is constrained by income .

16. THE DEMAND CURVE

17. Price elasticity of demand
Definition The Price Elasticity of Demand (commonly known as just price elasticity) measures the rate of response of quantity demanded due to a price change. Formula: PEoD = (% Change in Quantity Demanded)/(% Change in Price)

18. Calculating the Price Elasticity of Demand
Step 1 Identify the prices and the new prices Price(OLD) Price(NEW) Step 2 Identify the prices and the new quantities demanded QDemand(OLD) QDemand(NEW) Note: To calculate the price elasticity, we need to know what the percentage change in quantity demand is and what the percentage change in price is. It's best to calculate these one at a time.

19. Step 3 Calculate the Percentage Change in Quantity Demanded The formula used to calculate the percentage change in quantity demanded is: ([QDemand(NEW) - QDemand(OLD)] [(QDemand(NEW) + (QDemand(OLD)]/2 Step 4 Calculate the Percentage Change in Price Similar to before, the formula used to calculate the percentage change in price is: [Price(NEW) - Price(OLD)] [Price(NEW)+Price(OLD)/2 Step 5 Calculate the Price Elasticity of Demand We go back to our formula of: PEoD = (% Change in Quantity Demanded) (% Change in Price)

20. E.g.. "Given the following data, calculate the price elasticity of demand when the price changes from $9.00 to $10.00" Using the chart on the bottom. d
Price 10 9 d
Quantity

21. SOLUTION Step 1 Identify the prices and the new prices Price(OLD)=9 Price(NEW)=10 Step 2 Identify the prices and the new quantities demanded QDemand(OLD)=150 QDemand(NEW)=110 Step 3 Calculate the Percentage Change in Quantity Demanded The formula used to calculate the percentage change in quantity demanded is: ([QDemand(NEW) - QDemand(OLD)] [(QDemand(NEW) + (QDemand(OLD)]/2 By filling in the values we wrote down, we get: [ ] [( )/2] = (-40/130) = We note that % Change in Quantity Demanded = (We leave this in decimal terms. In percentage terms this would be -30.7%). Now we need to calculate the percentage change in price.

22. Step 4 [Price(NEW) - Price(OLD)] [Price(NEW) +Price(OLD)/2] By filling in the values we wrote down, we get: [10 - 9] [(10+9)/2] = (1/9.5) = .105 Step 5 PEoD = (% Change in Quantity Demanded)/(% Change in Price) PEoD = (-0.307) (0.105) = -2.9 When we analyze price elasticities we're concerned with their absolute value, so we ignore the negative value. We conclude that the price elasticity of demand when the price increases from $9 to $10 is 2. 9.

23. Interpreting the Price Elasticity of Demand
The higher the price elasticity, the more sensitive consumers are to price changes. A very high price elasticity suggests that when the price of a good goes up, consumers will buy a great deal less of it and when the price of that good goes down, consumers will buy a great deal more. A very low price elasticity implies just the opposite, that changes in price have little influence on demand

24. Rule for elasticity of demand
If PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes)
If PEoD = 1 then Demand is Unit Elastic
If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

25. supply
Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship. Price, therefore, is a reflection of supply and demand.

26. The Law of Supply
Like the law of demand, the law of supply demonstrates the quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue.

27. A, B and C are points on the supply curve
A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation between quantity supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and the price will be P2, and so on.

28. FACTORS INFLUENCING SUPPLY
1. Goals of the firm:
Generally, the aim of the firm is to maximize profits. Besides, maximum sales, maximum output and maximum employment are also the goals of the firm. These goals and change in them affect the supply of the commodity.
2. Price of the substitutes:
The supply of particular goods is inversely related to the price of its substitutes.

29. 3. The price of factors of production:
With the rise in the price of factors of production the cost of production rises. This result in decrease of supply and vice versa.
4. Change in technology:
A change in technique of production may lead to a change in supply if the technique of production improves, cost of production will fall. Even at the same prices, producers will like to supply more.

30. 5. The price of the commodity: The supply of a commodity very much depends on its price. There is direct and positive relationship between the price of the commodity and its supply. 6. Expected change in price: In case producers expect an increase in the price, they will withdraw goods from the market. Consequently, supply will decrease. If price is expected to fall in future, supply will naturally increase.

31. 7. Taxation policy: The production of the commodity is discouraged if heavy tax on its production is imposed. On the contrary, tax concessions encourage producers to increase supply. 8. Number of producers: If the number of producers producing a commodity increases, its supply will increase. With the exit of producers, the supply would decrease.

32. 9. Natural factors: Natural calamities like flood, drought and cyclone reduce the supply of a commodity. If natural disasters are absent, production and supply of a good will increase. 10. Means of transport: Goods transport and communication facilitates free and quick mobility of factors of production to the producing centers and the final products to the market. Presence of good means of transport and communication thus increases the supply of a good. The supply curve will shift to left.

33. Changes in Supply
A change in the price of a good or service, holding all else constant, will result in a movement along the supply curve. A change in the cost of an input will impact the cost of producing a good and will result in a shift in supply; supply will shift outward if costs decrease and will shift inward if they increase. A change in the expected demand for a good or service will result in a shift in supply; supply will shift outward if goods and service will expect to increase and will shift inward if there is an expectation for consumers preferences to change in favor of an alternate good or service.

34. THE SUPPLY CURVE

35. PRICE ELASTICITY OF SUPPLY
Price elasticity of supply (PES) measures the responsiveness of quantity supplied to a change in price. It is necessary for a firm to know how quickly, and effectively, it can respond to changing market conditions, especially to price changes. The following equation can be used to calculate PES. % change in quantity supplied % change in price

36. Example Calculate the price elasticity of supply using the formula when the price changes from $5 to $6 and the quantity supplied changes from 20 units per supplier per week to 30 units per supplier per week. Solution Percentage change in quantity supplied = (30 − 20) ÷ {( ) ÷ 2} = 40% Percentage change in price = ($6 − $5) ÷ {($6 + $5) ÷ 2} = 18% Price elasticity of supply = 40% ÷ 18% = 2.22

37. RULE FOR PRICE ELASTICITY OF SUPPLY EoS approaches infinity, supply is perfectly elastic. Producers are very sensitive to price change. EoS > 1, supply is elastic. Producers are relatively responsive to price changes. EoS = 1, supply is unit elastic. Producers’ response and price change are in same proportion. EoS < 1, supply is inelastic. Producers are relatively unresponsive to price changes. EoS approaches 0, supply is perfectly inelastic. Producers are very insensitive to price change

38. Determinants of PES
How firms respond to changes in market conditions, especially price, is an important consideration for the firm itself, and to an understanding of how markets work.
The key considerations are:
Are resource inputs readily available
Are factors mobile - are workers prepared to move to where they are needed
Can finished products be easily stored, and are there existing stocks
Is production running at full capacity
How long and complex is the production cycle or production process

39. Improving Price Elasticity Of Supply
Because a high PES is desirable, it may be necessary for firms to undertake actions that improve their speed of response to changes in market conditions. Examples of these actions include:
Creating spare capacity
Using the latest technology
Keeping sufficient stocks
Developing better storage system
Prolonging the shelf life of products
Developing better distribution systems
Providing training for workers
Having flexible workers who can do a range of jobs
Locating production near to the market
Allowing inward migration of labor if there is a labor shortage

40. A "shortage" exists when the quantity demanded at the current price is greater than the quantity supplied. In the case of shortage, we would expect the market price to go up. In this case, less motivated buyers do not purchase the good and producers have a strong incentive to supply more at the higher market price. This process will continue until the quantity demanded is equal to the quantity supplied. A "surplus" exists when the quantity supplied is greater than the quantity demanded. In this case, we would expect the market price to go down. The lower market price entices more consumers into buying, but lower profits create an incentive for producers to reduce the quantity supplied.

41. Equilibrium
When supply and demand are equal (when the supply function and demand function intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the current economic condition. At the given price, suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are demanding.

42. As you can see on the chart, equilibrium occurs at the intersection of the demand and supply curve, which indicates no allocative inefficiency. At this point, the price of the goods will be P* and the quantity will be Q*

43. THE END THANK YOU TUTORIAL CLASS
Bring your calculators for your tutorial class as we will be doing some calculations on price elasticity of demand and supply