Chapter-3

Demand and Supply

What is demand?
• Demand is the willingness and ability of consumers to buy
goods and services at different price level over a given time
period.
• The quantity demanded of a good or service is the amount
that consumers plan to buy during a given time period at a
particular price.
• The law of demand: Other things remaining the same, the
higher the price of a good, the smaller is the quantity
demanded; and the lower the price of a good, the greater is the
quantity demanded
Why does a higher price reduce the quantity
demanded?
❑ Substitution Effect
When the price of something goes up, people look for cheaper
alternatives. For example, if the price of coffee increases, more
people might switch to drinking tea instead because it's more
affordable.
❑ Income Effect
When prices go up but your income stays the same, you feel like
you have less money to spend. This means you might buy less of
that expensive item or cut back on other things. For example, if
rent goes up, you might eat out less or buy fewer clothes.
Demand Schedule
and Demand Curve

• A demand curve shows the relationship

between the quantity demanded of a good
and its price when all other influences on
consumers planned purchases remain the
same.
• A demand schedule is a table showing
how much of a given product a household
would be willing to buy at different prices.
• Demand curves are usually derived from
demand schedules
• Another way of looking at the demand
curve is as a willingness and ability to pay
curve. The willingness and ability to pay is
a measure of marginal benefit.
When does movement
along the demand
curve takes place?
• Movement along the demand curve
occurs when there is a change in the price
of the good or service, leading to a change
in quantity demanded.
• An increase in price (P↑) leads to a
decrease in quantity demanded (Q↓),
while a decrease in price (P↓) leads to an
increase in quantity demanded (Q↑).
• This movement follows the law of
demand, which states that price and
quantity demanded have an inverse
relationship, assuming other factors remain
constant.
 How does the demand
curve shift?

•The demand curve shifts when factors other than price change.
•A rightward shift means an increase in demand.
•A leftward shift means a decrease in demand.
 Factors that causes a demand curve to shift:
1) Prices of Related Goods
❑ Substitutes: Goods that can replace each other. If the price of a substitute
increases → demand for the original good increases. If the price of a
substitute decreases → demand for the original good decreases.
Example: If energy drink prices rise, people buy more energy bars.
❑ Complements: Goods used together. If the price of a complement increases
→ demand for the original good decreases. If the price of a complement
decreases → demand for the original good increases.
Example: If the price of cinema tickets decreases, the demand for popcorn and
soft drinks increases.
2) Expected Future Prices
If people expect prices to rise in the future → demand increases now. If people
expect prices to fall in the future → demand decreases now.
Example: If people think the price of energy bars will increase next month, they
buy more now.
 Factors that causes a demand curve to shift:
3)Income and Its Effect
Normal good: A normal good is one for which demand increases as income
increases.
Higher income → demand increases. Lower income → demand decreases.
Example: More income leads to more demand for air travel.
Inferior Good: An inferior good is one for which demand decreases as
income increases.
Higher income → demand decreases. Lower income → demand increases.
Example: Bus rides decrease as people can afford cars.
4)Expected Future Income and Credit
If people expect higher income or easier access to credit → demand
increases.
If people expect lower income or harder access to credit → demand
 Factors that causes a demand curve to shift:

5)Population Size
Larger population → higher demand for goods and services.
Smaller population → lower demand.
6)Preferences and Trends
Changes in consumer preferences increase or decrease demand.
Trends, health awareness, fashion, or seasons affect demand.
Example: Increased fitness awareness leads to higher demand for energy
bars.
Supply
What is supply?
• It refers to the amount that producers are willing to offer for sell at
different price level for a given period of time.
• The quantity supplied of a good or service is the amount that
producers plan to sell during a given time period at a particular price.
Example: 1,000 cars per day
• The law of supply: Other things remaining the same, the higher the
price of a good, the greater is the quantity supplied; and the lower
the price of a good, the smaller is the quantity supplied
The law of supply
Supply Curve and
Supply Schedule

• A supply curve shows the relationship

between the quantity supplied of a good
and its price when all other influences on
producers’ planned sales remain the
same.
• A supply schedule lists the quantities
supplied at each price when all the other
influences on producers’ planned sales
remain the same.
 When does movement
along the supply curve
takes place?
• Movement along the supply curve occurs
when there is a change in the price of the good
or service, leading to a change in the quantity
supplied.
• An increase in price (P↑) leads to an
increase in quantity supplied (Q↑), while a
decrease in price (P↓) leads to a decrease in
quantity supplied (Q↓).
• This movement follows the law of supply,
which states that price and quantity supplied
have a direct relationship, assuming other
factors remain constant.
 How does the supply
curve shift?

•The supply curve shifts when factors

other than price change.
•A rightward shift means an increase in
supply.
•A leftward shift means a decrease in
supply.
 Factors that causes a supply curve to shift:
• Prices of Factors of Production –If the cost of inputs (like
labour, raw materials, or machinery) increases, production
becomes more expensive, and supply decreases (shifts left). If
input costs decrease, supply increases (shifts right).
• Prices of Related Goods – If a producer can make two goods
using the same resources, they may shift production to the more
profitable one. If the price of one good rises, its supply increases,
while the supply of the alternative good decreases.
Example:
If the price of cotton rises, textile producers may reduce the
supply of wool fabrics to focus on cotton production.
 Factors that causes a supply curve to shift:
• Expected Future Prices – If producers expect prices to rise in the
future, they may reduce supply now to sell at higher prices later,
shifting the supply curve left. If prices are expected to fall, supply
increases today.
• Number of Suppliers – More businesses entering an industry
increase supply (shift right), while firms leaving the market
decrease supply (shift left).
• Technology – Better technology reduces production costs, making it
easier to produce more goods, so supply increases (shifts right).
• State of Nature – Good weather or favourable natural conditions
increase supply (shift right), while natural disasters, bad weather, or
environmental shocks reduce supply (shift left).
Market Equilibrium
Where does market
equilibrium occurs?
•Market equilibrium occurs when
quantity demanded equals quantity
supplied.
•The equilibrium price is the price at
which this balance is achieved.
•The equilibrium price eliminates
shortages and surpluses.
If the price is too high, supply exceeds
demand (surplus)
If the price is too low, demand exceeds
supply (shortage)
Price Adjustments (price
as a regulator)
❑ What Happens When Demand Increases?
•Suppose more people join health clubs and
want to buy more energy bars.
•This shifts the demand curve to the right
(from blue to pink).
•At the old price of $1.50, there is now a
shortage (QD=20m>QS=10)
•To remove the shortage, the price rises to
$2.50 per bar.
•At $2.50, the new equilibrium quantity is 15
million bars per week.
•Supply did not change, but suppliers move
along the supply curve to provide more
energy bars at the new higher price.
 Key things to remember!

❑ When demand in an economy

increases (shifts to the right) and the
supply remains unchanged, we
assume there is an excess demand
in the economy.
❑ An excess demand in an economy
can also be referred as shortage.
❑ The shortage leads to a rise in the
price of goods which causes
movement along the curve until
the new equilibrium is established.
 Price Adjustments
(price as a regulator)
❑ What Happens When Supply Increases?
Suppose producers adopt a cost-saving
technology, making it cheaper to produce
energy bars.
• This shifts the supply curve to the right
(from blue to pink).
• At the old price of $1.50, there is now a
surplus (supply is 20 million bars, but
demand is only 10 million).
• To remove the surplus, the price falls to
$1.00 per bar.
• At $1.00, the new equilibrium quantity is
15 million bars per week.
• Demand did not change, but buyers
move along the demand curve,
purchasing more energy bars at the new
lower price.
 Key things to remember!

❑ When supply in an economy

increases (shifts to the right) and the
demand remains unchanged, we
assume there is an excess supply
of goods in the market.
❑ An excess supply in an economy
can also be referred as surplus.
❑ The surplus leads to a fall in the
price of goods which causes
movement along the curve until
the new equilibrium is established.