DEMAND AND
SUPPLY
CHAPTER TWO
Focus Questions
What is demand?
What is the difference between demand and
quantity demanded?
Why do price and quantity demanded move in
opposite directions?
What is the difference between a demand schedule
and a demand curve?
When Demand Changes, the Curve Shifts
What Factors Cause Demand Curves to Shift?
Elasticity of Demand and its components
What Is Demand?
A market is any place where people come together to buy and
sell goods or services.
Economists often say a market has two sides: a buying side and a selling
side.
In economics, the buying side is referred to as demand, and the
selling side is referred to as supply.
The word demand has a specific meaning in economics. It refers to the
willingness and ability of buyers to purchase different
quantities of a good at different prices during a specific time
period.
Willingness to purchase a good refers to a person’s want or desire
for the good.
Having the ability to purchase a good means having the money to pay
for the good.
Both willingness and ability to purchase must be present for demand to
exist.
It is important for you to remember that if either one of these
conditions is absent, there is no demand.
What Does the Law of Demand “Say”?
Suppose the average price of a shirt rises from $10 to $15.
Will customers want to buy more or fewer of the shirt at
the higher price?
Most people would say that customers would buy
fewer shirt.
Now suppose the average price of a shirt falls from $10 to
$5.
Will customers want to buy more or fewer shirt at the
lower price? Most people would say more.
This law says that as the price of a good increases, the
quantity demanded of the good decreases.
The law of demand also says that as the price of
a good decreases, the quantity demanded of
the good increases.
In other words, price and quantity demanded
move in opposite directions (an inverse
relationship).
Quantity demanded is the number of units of a
good purchased at a specific price.
For example, suppose the price of meat is $5 a
item, and Yusuf buys two items. In this case two
items of meat is the quantity demanded of meat at
$5 a item.
The Law of Demand in Numbers and
Pictures
The law of demand can be
represented both in numbers and
pictures.
The economic term for this type
of numerical chart showing the
law of demand is demand
schedule.
If we connect all points, from A to
D which comes from demand
schedule, we have a line that
slopes downward from left to
right. This line, called a demand
curve.
demand curve is the graphic
representation of the law of
demand.
Individual Demand Curves and Market
Demand Curves
An individual demand curve and a market demand curve
are different.
An individual demand curve is the demand curve that
represents an individual’s demand.
For example, Harry’s demand curve represents Harry’s
demand for, say, shoes.
A market demand curve is simply the sum of all the
different individual demand curves added together.
When Demand Changes, the Curve
Shifts
Demand can go up, and it can go down.
For example, the demand for orange juice can rise or fall. The
demand for CDs can rise or fall.
Every time the demand changes for a good, any good, the
demand curve for that good shifts. By shift we mean that it
moves; it moves either to the right or to the left.
For example, if the demand for materials increases, the
demand curve for materials shifts to the right.
If the demand for materials decreases, the demand curve for
materials shifts to the left.
Demand increases →Demand curve shifts rightward
Demand decreases →Demand curve shifts leftward
What Factors Cause Demand Curves to
Shift?
1) Income
As their income changes, people may buy more or less of a particular
good.
You might think that if income goes up, demand will go up, and if
income goes down, demand will go down.
Much of what happens depends on what goods are involved.
If a person’s income and demand change in the same direction (both
go up, or both go down), then the good is called a normal good.
If, however, income and demand go in different directions (one goes up,
while the other goes down), the good is called an inferior good.
If a person buys the same amount of the good when income changes,
the good is called a neutral good.
In economics, neutral goods refers either to goods whose demand is
independent of income , Examples of this prescription medicines.
2) Preferences
People’s preferences affect how much of a good they buy. A
change in preferences in favor of a good shifts the demand curve
to the right.
A change in preferences away from a good shifts the demand
curve to the left.
3) Prices of Related Goods
Demand for goods is affected by the prices of related goods.
The two types of related goods are substitutes and
complements.
When two goods are substitutes, the demand for one good
moves in the same direction as the price of the other good.
In other words, many people coffee is a substitute for tea.
Thus, if the price of coffee increases, the demand for tea increases
as people substitute tea for the higher-priced coffee.
Two goods are complements if they are consumed together. For example,
Books and Pens are used together to study.
With complementary goods, the demand for one moves in the opposite
direction as the price of the other.
4) Number of Buyers
The demand for a good in a particular market area is related to the number of
buyers in the area.
The more buyers, the higher the demand; the fewer buyers, the lower the
demand.
The number of buyers may increase because of a higher birthrate, increased
immigration, or the migration of people from one region of the country to
another.
Factors such as a higher death rate or the migration of people can also cause
the number of buyers to decrease.
5) Future Price
Buyers who expect the price of a good to be higher in the future may buy the
good now, thus increasing the current demand for the good.
Buyers who expect the price of a good to be lower in the future may wait until
the future to buy the good, thus decreasing the current demand for the good.
What Factor Causes a Change in Quantity
Demanded?
We identified the factors (income, preferences, etc.) that
can cause demand to change, but what factor can cause a
change in quantity demanded? Only one: price.
For example, the only thing that can cause customers to
change their quantity demanded of orange juice is a change
in the price of orange juice; the only thing that can cause a
change in the quantity demanded of fruits is a change in the
price of fruits.
So how do we represent a change in quantity demanded?
When quantity demanded changes, the curve doesn’t move
right or left.
Instead, the only movement is to a different point along a
given demand curve, which stays in the same place on the
graph.
Elasticity of
demand
Elasticity of demand
Elasticity is a measure of responsiveness of a dependent
variable to changes in an independent variable.
Accordingly, we have the concepts of elasticity of demand
and elasticity of supply (chapter 3).
Elasticity of demand refers to the degree of
responsiveness of quantity demanded of a good to a change
in its price, or change in income, or change in prices of
related goods (Cross Elasticity).
Commonly, there are three kinds of demand elasticity:
A. Price elasticity,
B. Income elasticity, and
C. Cross elasticity.
Price Elasticity of Demand
Price elasticity of demand means degree of
responsiveness of demand to change in price.
It indicates how consumers react to changes in price. The
greater the reaction the greater will be the elasticity,
and the lesser the reaction, the smaller will be the
elasticity.
Price elasticity of demand is a measure of how much the
quantity demanded of a good responds to a change in the
price of that good, computed as the percentage change in
quantity demanded divided by the percentage change in
price.
Price elasticity demand can be measured in two ways.
These are Traditional and Midpoint elasticity.
Price Elasticity of Demand
a. Traditional methods for Price Elasticity of Demand
This is calculated to find elasticity at a given point. The price elasticity
of demand can be determined by the following formula.
Price Elasticity of Demand
Note that:
i) If 1, demand is said to be elastic and the product is
luxury product
ii) If 0 1, demand is inelastic and the product is
necessity
iii) If = 1, demand is unitary elastic.
iv) If = 0, demand is said to be perfectly inelastic.
v) If = , demand is said to be perfectly elastic.
Example
1) Ahmed currently demands 100 items a week for
$20 per each. Suppose the price raises of this
good to $22 per each in price. As a result, the
quantity demanded falls from 100 to 75.
Calculate the elasticity of demand by using the
Traditional methods and also find the effect Total
Revenue an explain..
2) Fatma now lowers the price of her goods from
$20 to $18. Suppose the quantity demanded rises
from 100 to 105, Calculate the elasticity of
demand by using the Traditional methods and
also find the effect Total Revenue an explain.
Price Elasticity of Demand
b. Midpoint methods for price elasticity of demand
In midpoint price elasticity of demand, the average of the
old and the new values of both price and quantity
demanded are used.
The formula for measuring midpoint elasticity is given
below.
Example
Suppose a product's price increases from
$10 to $12, and the quantity demanded
decreases from 100 units to 80 units,
calculate the price elasticity of demand by
using midpoint method and also find the
effect Total Revenue an explain.
Suppose a product's price decreases from
$14 to $12, and the quantity demanded
increases from 120 units to 180 units,
calculate the price elasticity of demand by
using midpoint method and also find the
effect Total Revenue an explain.
An Important Relationship Between Elasticity
and Total Revenue
To see how elasticity of demand relates to a business’s total
revenue, let’s consider four cases in detail.
Case 1: Elastic Demand and a Price Increase
Elastic demand + Price decrease= Total revenue increase
Case 2: Elastic Demand and a Price Decrease
Elastic demand + Price increase = Total revenue decrease
Case 3: Inelastic Demand and a Price Increase
Inelastic demand + Price increase = Total revenue increase
Case 4: Inelastic Demand and a Price Decrease
Inelastic demand + Price decrease = Total revenue decrease
Determinants of price Elasticity of Demand
The following factors make price elasticity of demand elastic or
inelastic other than changes in the price of the product.
I. The availability of substitutes: the more substitutes available
for a product, the more elastic will be the price elasticity of
demand.
II. Time: In the long- run, price elasticity of demand tends to be
elastic. Because:
• More substitute goods could be produced.
• People tend to adjust their consumption pattern.
III. The proportion of income consumers spend for a product:-
the smaller the proportion of income spent for a good, the less
price elastic will be.
IV. The importance of the commodity in the consumers’ budget:
• Luxury goods → tend to be more elastic, example: gold.
• Necessity goods → tend to be less elastic example: Salt.
Income Elasticity of Demand
Example
Based on the following table which indicates expenditure of the
household on a commodity, answer the questions that follow ( The
price of the good is $20 ).
Income per Month Quantity demanded (per month)
$5,000 120
$10,000 100
$20,000 80
$40,000 60
Determine:
A) Calculate income elasticity of demand, if income increases from
$5,000 to $10,000 and if income increases from $20, 000 to $40,000.
B) Is this a normal or an inferior or a luxury good? Justify.
Cross Price Elasticity of Demand
Example
1) When the price of tea in local café rises from $4 to $6 per
cup, demand for coffee rises from 3500 cups to 6000 cups a
day despite no change in coffee prices.
A) Determine cross price elasticity.
B) Based on the result, what kind of relation exists between
the two goods?
2) When the price of product X falls from $14 to $10 per unit,
demand for that product coffee rises from 500 cups to 580
cups a day despite no change in coffee prices.
A) Determine cross price elasticity.
B) Based on the result, what kind of relation exists between
the two goods?
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