Diploma in Management Studies

Microeconomics ECO001
Lecture 2- Demand and Supply
• Competitive Market and Relative price
• Demand and Quantity Demanded
• Factors that affect Demand
• Supply and Quantity Supplied
• Factors that affect Supply

Ref: Parkin, Chapter 3

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Learning Outcomes
• After this lecture, students should be able to:
• Define Demand
• Distinguish between a change in demand and a
change in quantity demanded
• Explain the factors that influence demand
• Define Supply
• Distinguish between a change in supply and a
change in quantity supplied
• Explain the factors that influence supply

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Markets and Prices
• A market is any arrangement that enables
buyers and sellers to get information and do
business with each other.
• A competitive market is a market that has
many buyers and many sellers so no single
buyer or seller can influence the price.
• The money price of a good is the amount of
money needed to buy it.
• The relative price of a good—the ratio of its
money price to the money price of the next best
alternative good—is its opportunity cost.
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Demand
• If you demand something, then you
– 1. Want it,
– 2. Can afford it, and
– 3. Have made a definite plan to buy it.
• Wants are the unlimited desires or wishes people
have for goods and services.
• Demand reflects a decision about which wants to
satisfy.
• The quantity demanded of a good or service is the
amount that consumers plan to buy during a particular
time period, and at a particular price.
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Law of Demand
• The law of demand states other things
remaining the same (ceteris paribus):
– the higher the price of a good, the smaller is
the quantity demanded; and
– the lower the price of a good, the larger is the
quantity demanded.
• The law of demand results from
– Substitution effect
– Income effect

Substitution Effect and Income Effect

• Substitution effect
When the relative price (opportunity cost) of a good
or service rises, people seek substitutes for it, so
the quantity demanded of the good or service
decreases.
• Income effect
When the price of a good or service rises relative to
income, people cannot afford all the things they
previously bought, so the quantity demanded of the
good or service decreases.

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Demand Curve and Demand Schedule

• The term demand refers to the entire

relationship between the price of the good
and quantity demanded of the good.
• 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.

Demand Curve
– The figure shows a
demand curve for
energy bars.
– A rise in the price,
other things remaining
the same, brings a
decrease in the
quantity demanded
and a movement
along the demand
curve.

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Willingness and Ability to Pay
– A demand curve is also
a willingness-and-ability-
to-pay curve.
– The smaller the quantity
available, the higher is
the price that someone
is willing to pay for
another unit.
– Willingness to pay
measures marginal
benefit.
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Change in Demand
• When any factor that influences buying plans
other than the price of the good changes, there is
a change in demand for that good.
• The quantity of the good that people plan to buy
changes at each and every price, so there is a
new demand curve.
– When demand increases, the demand curve
shifts rightward.
– When demand decreases, the demand curve
shifts leftward.
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Factors that Affect Demand

Six main factors that change demand are

• The prices of related goods
• Expected future prices
• Income of consumers
• Expected future income of consumers
• Population
• Preferences (Tastes)

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Price of Related Goods

• Related Goods are either substitutes or
complements
• A substitute is a good that can be used in
place of another good.
• A complement is a good that is used in
conjunction with another good.
• When the price of substitute for a product rises,
or when the price of a complement of a product
falls, the demand for the product increases.

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 Expected Future Prices and Income
• Expected Future Prices - If the price of a good is
expected to rise in the future, current demand fore the
good increases and the demand curve shifts
rightward.
• Income - When income increases, consumers buy
more of most goods and the demand curve shifts
rightward.
– A normal good is one for which demand increases
as income increases
– An inferior good is a good for which demand
decreases as income increases.
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Expected Future Income, Population

and Preferences
• Expected Future Income - When income is
expected to increase in the future, the demand
might increase now.
• Population - The larger the population, the
greater is the demand for all goods.
• Preferences - People with the same income
have different demands if they have different
preferences.

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 Increase in Demand

• The figure shows an

increase in demand.

• Because an energy bar is

a normal good, an increase
in income increases the
demand for energy bars.

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Change in Quantity Demanded

• A Movement along
the Demand Curve
- When the price of the
good changes and
everything else remains
the same, the quantity
demanded changes
and there is a
movement along the
demand curve.

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Change in Demand
• A Shift of the Demand
Curve
– If the price remains the
same but one of the
other influences on
buyers’ plans changes,
demand changes and the
demand curve shifts.

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Supply
• If a firm supplies a good or service, then the firm
- 1. Has the resources and technology to produce it,
- 2. Can profit from producing it and;
- 3. Has made a definite plan to produce and sell it.
• Resources and technology determine what it is
possible to produce. Supply reflects a decision about
which technologically feasible items to produce.
• 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.

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 Law of Supply
• The law of supply states that 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 results from the general tendency for the
marginal cost of producing a good or service to increase as
the quantity produced increases.
• Producers are willing to supply a good only if they can at
least cover their marginal cost of production.

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Supply and Supply Curve

• The term supply refers to the entire
relationship between the quantity supplied
and the price of a good.

• The 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.

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Supply Curve
– The figure shows a
supply curve of energy
bars.
– A rise in the price of an
energy bar, other things
remaining the same,
brings an increase in the
quantity supplied.

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Minimum Supply Price

– A supply curve is also a
minimum-supply-price
curve.
– As the quantity produced
increases, marginal cost
increases.
– The lowest price at which
someone is willing to sell
an additional unit rises.
– This lowest price is
marginal cost.

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 Change in Supply
• When any factor that influences selling plans other
than the price of the good changes, there is a
change in supply of that good.
• The quantity of the good that producers plan to
sell changes at each and every price, so there is a
new supply curve.
– When supply increases, the supply curve shifts
rightward.
– When supply decreases, the supply curve shifts
leftward.

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Factors that Affect Supply

The five main factors that change
supply of a good are
• The prices of productive resources
• The prices of related goods produced
• Expected future prices
• The number of suppliers
• Technology

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 Prices of Productive Resources
• Productive Resources: land (raw
materials, energy), labour, capital
– If the price of resource used to produce a
good rises, the minimum price that a supplier
is willing to accept for producing each quantity
of that good rises.
– So a rise in the price of productive resources
decreases supply and shifts the supply curve
leftward.

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Prices of Related Goods Produced

• Goods are substitute in production if they are
produced using the same resources.
– The supply of a good increases if the price of a substitute in
production falls. For example: Supply of apple increases
when price of oranges drop if apple and oranges both used
the same resources

• Goods are complements in production if they

must be produced together.
– The supply of a good increases if the price of a complement
in production rises. For example,: Supply of beef increases
when demand for leather increases

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Expected Future Prices and Number of
Suppliers
• Expected Future Prices - If the price of a
good is expected to rise in the future, supply of
the good today decreases and the supply curve
shifts leftward.
• The Number of Suppliers -The larger the
number of suppliers of a good, the greater is
the supply of the good. An increase in the
number of suppliers shifts the supply curve
rightward.
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Technology
• Advances in technology create new
products and lower the cost of producing
existing products, so advances in
technology increase supply and shift the
supply curve rightward.
• A natural disaster is a negative
technology change, which decreases supply
and shifts the supply curve leftward.

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Increase in Supply

– An advance in the
technology for
producing energy
bars increases the
supply of energy bars
and shifts the supply
curve rightward.

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Change in Quantity Supplied

• A Movement Along
the Supply Curve
–When the price of the
good changes and other
influences on sellers’
plans remain the same,
the quantity supplied
changes and there is a
movement along the
supply curve.

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 Change in Supply

• A Shift of the Supply

Curve
–If the price remains
the same but some
other influence on
sellers’ plans changes,
supply changes and
the supply curve shifts.

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Exercise 2.1
• An increase in the quantity of tea demanded
occurs whenever
• A) the population of tea drinkers grows.
• B) the price of coffee (its substitutes) rise.
• C) tea drinkers receive an increase in their
incomes.
• D) the price of lemons (its complement) falls.
• E) the price of the tea falls.

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Exercise 2.2
• Which of the following would result in a
decrease in the supply of computers?
• A) An increase in the wage of workers in
the computer industry.
• B) An improvement in the technology of
producing computers.
• C) An increase in consumers’ preference in
internet surfing.
• D) An increase in consumers' incomes.
• E) An increase in the number of producer
of computers. 33

Exercise 2.3
• Which of the following will NOT cause a
shift in the demand curve for rice?
• A) Consumers have a stronger preference
in consuming rice.
• B) A decrease in the price of vegetables (a
complement to rice).
• C) An increase in the price of rice.
• D) A decrease in the price of noodle (a
substitute to rice).
• E) An increase in consumers' incomes.
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 Exercise 2.4
• What happens to the demand curve of
bread when:
• (1) The consumers’ income increases?
• (2) There is a decrease in the price of
biscuits, its main substitutes?
• (3) The price of flour (the raw materials
in making bread) increases?

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Exercise 2.5

• What happen to the supply curve of car when:

• (1) The workers in the car industry
successfully demanded a higher wage?
• (2) Many producers leave the industry due to
poor prospects?
• (3) There is an increase in the price of petrol?

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Exercise 2.6

Evaluate whether the following statement is true

or false, justify your answer.

(i) An increase in price results in increase

in supply but not an increase in the quantity
supplied.

(ii) An improvement in technology will shift

the good’s supply curve rightward.

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