1. LEARNING OUTCOME 2 & 3
DEMAND AND SUPPLY

2. DEMAND EFFECTIVE DEMAND
desire to purchase backed by the ability to pay
DETERMINANTS OF DEMAND:
Price
Tastes
Income
Fashion
Advertising
Availability and price of substitutes
Price of compliments
Time of year
Consumers’ expectations
Availability of credit
Population
Utility yielded

3. UTILITY
UTILITY
the satisfaction which we obtain from goods and services
MARGINAL UTILITY
the satisfaction obtained from the last unit
will diminish with each successive unit consumed - the law of diminishing marginal utility
TOTAL UTILITY
the satisfaction obtained from all units consumed
CONSUMER OPTIMUM
maximising total utility - the theory of equi-marginal returns:
MU A = MU B = MU C = MU n
Price A Price B Price C Price n

4. THE LAW OF DEMAND
More will be demanded at lower prices and less at higher price.
Reasons for slope of Demand Curve:
Law of Diminishing Marginal Utility
Substitution Effect
Income Effect
When price rises from P to P1 quantity demanded contracts from Q to Q1.
When price falls from P to P2 quantity demanded extends from Q to Q2

5. QUIZ Wants backed up by money What is meant by effective demand?
Price, tastes, availability of substitutes
and the price of compliments
Name any 4 determinants of demand
How do we refer to the satisfaction
yielded by the last unit consumed?
Marginal Utility
What happens to satisfaction as we
consume more of a commodity?
Marginal utility decreases with each
unit consumed
How can individuals maximise their
total satisfaction?
By equalising the marginal utility: price ratio for all goods consumed
Describe the relationship between
price and quantity demanded.
It is an inverse relationship
Law of Diminishing Marginal Utility
The Substitution Effect
The Income effect
What explains this relationship?
What happens on the demand curve
when price rises?
There is a contraction of demand
What happens on the demand curve
when price falls?
There is an extension of demand

6. PRICE ELASTICITY OF DEMAND
Measures the responsiveness of demand to price changes
> 1 is relatively price elastic < 1 is relatively price inelastic = 1 is unit price elasticity
E = % change in Quantity Demanded % change in Price
Products which are price elastic have a relatively flat demand curve so that in response to even a relatively small price change, quantity demanded changes more than in proportion to price.
Products which are price inelastic
have a relatively steep demand curve so that even relatively large price changes generate proportionately smaller changes in quantity demanded.

7. PRICE ELASTICITY OF DEMAND
With straight line demand curves elasticity will vary along the length of the curve.
E=% Change in Quantity Demanded
% Change in Price
10 x 100
= 100%
1 x 100 = 20% = 5 5
Relatively Elastic
10 x 100
= 25%
1 x 100 = 50% = 0.5 2
Relatively Inelastic
Perfectly Elastic Demand
Perfectly Inelastic Demand

8. PRICE ELASTICITY OF DEMAND
When using the formula for price elasticity of demand, the sign
is assumed to be negative (-).
This is because normal goods follow the law of demand and have a
normal, downward sloping demand curve.
Products whose quantity demanded increases when price increases
would give a positive (+) value for price elasticity and have an
exceptional demand curve.
If a positive (+) value is obtained this is an exceptional good – one
which does not follow the law of demand ie one which has an
exceptional demand curve.
An example of this could be the demand for a painting by a particular
artist, which only becomes desirable as an investment by a collector,
when the price starts to rise.

9. QUIZ 300 x 100 25 x 100 100 1 = 25% = 4 ie fairly elastic
What is the price elasticity of demand if the price of
Commodity X rises from 80p to 85p and, as a result, the demand
falls from 100 per week to 75 per week?
25 x 100
= 25% = 4 ie fairly elastic
5 x %
If the demand for commodity Y rises from 1,200 to 1,500 in response
to a price reduction from £2.00 to £1.50, calculate the price
elasticity of demand.
300 x 100
= 25% = 1 ie unit elasticity
50 x %
200

10. INCOME ELASTICITY OF DEMAND
Measures the responsiveness of demand to changes in income
> 1 is relatively income elastic
< 1 is relatively income inelastic
= 1 is unit income elasticity
E = % change in Quantity Demanded
% change in Income
Products for which quantity demanded increases when income increases and vice versa have a positive(+) income elasticity value.
These would be normal goods ie goods which follow the law of demand
eg steak.
Products for which quantity demanded increases when income decreases and vice versa have a negative (-) income elasticity value.
These would be giffen goods ie of inferior quality eg sausages

11. QUIZ
Calculate the income elasticity of demand for commodity A if, in response to an increase in income of 5%, quantity demanded increases from 200 per week to 275 per week.
What kind of commodity is A?
+ 75 x 100
= % =
+ 5% %
A normal good eg biscuits
What is the income elasticity of demand for commodity B if demand increases from 5,000 to 5,500 units per week when when real income falls by 2.5%.
+500 X 100
5, = + 10% = - 4
-2.5% %
What kind of commodity is B?
A giffen good eg bread

12. CHANGES IN DEMAND
When there is a change in a determinant of demand other
than price then the demand curve shifts .
If tastes change in favour
of a commodity then more
is demanded at all prices
and the demand curve shifts
forward to the right.
If the price of a substitute falls
then less of the commodity will
be demanded at all prices and the
demand curve shifts backward to
the left.

13. QUIZ Say what happens to demand in each of the following cases:
The demand for a normal good
when its price rises.
A contraction in quantity
demanded.
The demand for a luxury good
when its price falls.
An extension in quantity
demanded
The demand for a giffen good
when income rises.
A backward shift in demand
to the left.
A forward shift in demand
to the right.
The demand for a good when
the price of its complement falls.
The demand for a good when the
price of a close substitute rises.
A forward shift in demand
to the right.
The demand for a good which has
recently been declared bad for
health.
A backward shift in demand
to the left.

14. SUPPLY the willingness to sell a commodity at a given price
THE LAW OF SUPPLY
More will be supplied at higher prices and less at lower prices.
There is a direct relationship between price and quantity supplied resulting in
a supply curve sloping upwards from
left to right.
A fall in price results in
a contraction of supply
An increase in price results in
an extension of supply

15. ELASTICITY OF SUPPLY
measures the responsiveness of supply to changes in price
E = % change in Quantity Supplied
% change in Price
Depends on the ability of suppliers to respond to price changes
therefore depends on:
the time it takes to alter production levels
availability of stocks
availability of factors of production
the ease of entry of new firms into the market
An increase in costs will
shift supply to the left.
A decrease in costs will
shift supply to the right.

16. THE PRICE MECHANISM
Prices are determined by market forces ie the interaction
of supply and demand.
The interaction of supply and demand determines the market clearing price ie equilibrium price – the price at which all goods supplied are demanded.
Any price above this will mean excess supply which will force price down.
Any price below this will mean excess demand which will push up price.
Equilibrium price will change with changes in demand and/or supply in
Response to changes in the determinants of demand and supply.

17. INTERVENTION IN THE MARKET
This happens when there is market failure or the price system is not working properly ie the price is too low or too high for those involved
The Government may set a maximum price to protect the purchasers.
If the maximum price set (Maxp) is below
equilibrium price, there will be excess
demand which could result in a “black market”
for the commodity.
The Government may set a minimum price to protect the incomes of the suppliers eg the minimum wage in the labour market.
If the minimum price set (Minp) is
above equilibrium price, there will be
excess supply which, in the labour market, too high a minimum wage would cause unemployment.

18. TAXES AND SUBSIDIES
Intervention in the market can also be by means of government taxes and
subsidies.
Indirect taxes eg excise duty are placed on products in order to
raise revenue for the government and/or to discourage consumption
of certain commodities such as cigarettes and alcohol.
Taxes have the effect of shifting the supply curve to the left thereby increasing price.
Subsidies are given to producers to encourage the production of
certain products.
Subsidies have the effect of shifting the supply
curve to the right thereby lowering price.

19. CHANGES IN EQUILIBRIUM PRICE
Equilibrium price will change whenever there is a change in any of the determinants of demand and/or supply.
Any of these changes in determinants (other than price) cause shifts in the demand and/or supply curves, altering the market clearing price.
FORWARD SHIFT IN DEMAND INCREASES EQUIL PRICE
BACKWARD SHIFT IN DEMAND DECREASES EQUIL PRICE
FORWARD SHIFT IN SUPPLY DECREASES EQUIL PRICE
BACKWARD SHIFT IN SUPPLY
INCREASES EQUIL PRICE
COMBINATION OF SHIFTS
INCREASING EQUIL PRICE
COMBINATION OF SHIFTS
DECREASING EQUIL PRICE

20. AND FINALLY ……
Complements such as CDs and CD players are said to be in joint demand since one is no use without the other.
Close substitutes such as butter and margerine are said to be in competitive demand since they both perform the same function and consumers will choose between them.
Joint supply is where the production of one product
eg oil automatically leads to the production of another eg petrol or paint or plastics
Where the total supply of one commodity is fixed
because of limited resources, a reduction in the supply
of one necessitates the reduction of another – these
are said to be in competitive supply eg milk and cheese.

21. QUIZ What factors changes equilibrium price?
Changes in any of the determinants
of demand and/or supply.
Give 2 examples of market
intervention.
The minimum wage and price
capping.
To encourage the consumption of
some products and discourage
others.
Why might governments intervene
in markets?
Name 2 products in joint demand.
Tennis racquets and tennis balls.
Name 2 products in joint supply.
Beef and leather
Give an example of products in
competitive demand.
Gas and electricity
Give an example of competitive
supply.
Land for housing and land for
recreation