Competitive

Markets: Demand & Shariq Nisar

Supply
Definitions: Demand & Supply
1. Microeconomics is the study of behavior of firms, individual consumers and industries and the determination of market prices and quantities of
goods and services, and factors of production.
2. Market is a situation where potential buyers and potential sellers come together to establish an equilibrium price and quantity for a good or
service. This allows an exchange to take place, and it enables the needs and wants of both parties to be fulfilled.
3. Demand is the willingness and ability to purchase a good or service at a certain price over a given time period.
4. Law of demand states as the price of a good falls, the quantity demanded of the product normally increases, ceteris paribus.
5. Change in demand is caused by a change in non-price factor, and it is represented by a shift of the demand curve.
6. Change in quantity demanded is caused by a change in price, and it is represented by a movement along the demand curve.
7. Supply is the willingness and ability to produce a quantity for a good or service at a given price, in a given time period.
8. Law of supply states as the price of the good rises, the quantity supplied of the product normally increases, ceteris paribus.
9. Change in supply is caused by a change in non-price factor, and it is represented by a shift of the supply curve.
10. Change in quantity supplied is caused by a change in price, and it is represented by a movement along the supply curve.
11. Market equilibrium is a situation where prices are stable, and the quantity of goods and services supplied is equal to the quantity demanded.
12. Consumer surplus is the extra satisfaction gained by consumers from paying a price that is lower than that which they were prepared to pay. It is
shown by an area under the demand curve and above the equilibrium price.
13. Producer surplus is the excess of actual earnings that a producer makes from a given quantity of output, over and above the amount the producer
would be prepared to accept for that output. It is shown by an area above the supply curve and under the equilibrium price.
14. Allocative efficiency is when resources are allocated in the most efficient way from society’s point of view, and occurs when demand equals supply
and community surplus is maximized.
Law of Demand

As price of a product falls, the

quantity demanded of the
product will usually increase,
ceteris paribus.
Non-Price Determinants of Demand
Income Price of other goods
• Normal goods • Substitute goods
• As income rises → Demand for • Two products that are similar to each other.
the product also rises. • Examples include Big Mac and Quarter Pounder.
• Small increase in demand for • Fall in price for Big Mac → Increase in quantity demanded for Big Mac → Decrease in quantity
necessities, such as food, clothes demanded for Quarter Pounder.
etc. • Increase in price for Big Mac → Decrease in quantity demanded for Big Mac → Increase in
• Large increase in demand for quantity demanded for Quarter Pounder.
other products, such as cinemas, • Complement goods
cars etc. • Products that are often purchased together.
• Inferior goods • Examples include shoes and socks.
• As income rises → Demand for • Fall in price for shoes → Increase in quantity demanded for shoes → Increase in quantity
the product falls. demanded for socks as well.
• Consumers starts to buy higher • Increase in price for shoes → Decrease in quantity demanded for shoes → Decrease in
priced substitutes in place of quantity demanded for socks as well.
inferior goods. • Unrelated goods
• Examples include cheap wine, • If products are unrelated, then changes in price of one product will have no effect to the price
store’s own cookies or baked for another product.
goods. • For example, change in the price of Big Mac will not have an effect on the price of iPhone 7
Plus.
Non-Price Determinants of Demand
Tastes/Preferences Changes in income distribution

• Marketing may influence buyers to buy the product → • Better pay for poor and worse pay for the rich → Increase in
demand for necessities.
Increased demand for the product.
Government policy changes
Size of population
• Changes in direct taxes → Changes in consumer spending →
• Growing population → Increase in demand for most
Changes in demand.
products.
• Some policies such as ban of cigarettes and alcohol affect demand
• Changes in age structure of the population in relevant markets.

• Altering age structure affects demand for certain Seasonal changes

products. • Changes in seasons → Changes in pattern of demand in the

• If a country has more young people living there → economy.

Increase in demand for education. • For example, there will be more demand for ice cream during
summer than winter.
 Law of Supply

As price of a product rises, the

quantity supplied of the product
will usually increase, ceteris
paribus.
Non-Price Determinants of Supply
1. Costs of factors of production 4. Expectations
• Increase in costs of factors of production → Increase the • Producers make decisions about what to supply based on
firm’s costs. expectations of future prices.
• Fall in costs of factors of production → Increases supply of • Producers may assume that higher demand → higher price, so
the product. producers will supply more of the product to meet up with the
2. Price of other products expectations.

• Producers have a choice as to what they are going to • If demand for product falls → Producers will reduce the supply
produce. of the product.

• For example, cloth producers may be able to produce • Expectations and confidence has a strong influence on
shoes with a minimal change in production facilities. production decisions.

• If price of cloth rises → producers will sell more cloth and 5. Government intervention
fewer shoes. • Most common ways governments intervene in a market is
3. State of technology through imposing indirect taxes or providing subsidies.

 Improvements in state of technology in a firm or industry ALWAYS REMEMBER!!

→ Increase in supply. • CHANGE IN PRICE OF GOOD → MOVEMENT ALONG THE DEMAND
 Natural disasters might cause state of technology to OR SUPPLY CURVE.
deteriorate → Decrease in supply. • CHANGE IN OTHER DETERMINANTS OF DEMAND OR SUPPLY →
SHIFTING THE DEMAND OR SUPPLY CURVE TO THE LEFT OR RIGHT.
Equilibrium
Changes in
Equilibrium

Changes in equilibrium by change in demand

Changes in equilibrium by change in supply

Questions
In the demand function, Qd = 35 - 5P and the supply function Qs = -10 + 10P, Qd and Qs
are quantities demanded and supplied per month in thousands of units of good Z, and P
is price in ₹.

1. Calculate the equilibrium price and quantity.

2. When P = 2 and P = 6, determine whether there’s an excess demand or excess supply

and calculate the amount of this in each case.

3. Plot the demand and supply curves, and identify the equilibrium price and quantity on
your graph.
35 - 5P = -10 + 10P When P=2

15P = 45 Qd = 35,000 - 5,000 * ₹2 = 35,000 - 10,000 = 25,000 units

P = ₹3 Qs = -10,000 + 10,000 * ₹2 = -10,000 + 20,000 = 10,000 units

Qd = 35,000 - 5,000 * ₹3 = 35,000 - 15,000 Qd > Qs, so there’s an excess demand.

Qd = 20,000 units Amount of excess demand = 25,000 - 10,000 = 15,000 units

Qs = -10,000 + 10,000 * ₹3 = -10,000 + 30,000

When P=6
Qs = 20,000 units
Qd = 35,000 - 5,000 * ₹6 = 35,000 - 30,000 = = 5,000 units
 
Qs = -10,000 + 10,000 * ₹6 = -10,000 + 60,000 = 50,000 units
Equilibrium price = ₹3, Equilibrium quantity = 20,000 units
Qd < Qs, so there’s an excess supply.
Amount of excess supply = 50,000 - 5,000 = 45,000 units
Definitions: Elasticities
• Price elasticity of demand (PED) is a measure of the responsiveness of the quantity demanded for a good or service to change in its price.
• Inelastic demand is where a change in price of a good or service leads to a proportionately smaller change in the quantity demanded of the good
or service. PED value is between zero and one.
• Elastic demand is where a change in price of a good or service leads to a proportionately larger change in the quantity demanded of the good or
service. PED value is greater than one.
• Cross elasticity of demand (XED) is a measure of the responsiveness of the demand for one good or service to a change in price of another good
or service.
I. Substitute goods are goods that can be used against each other, such as sugar or honey. Substitute goods have a positive cross elasticity of
demand.
II. Complementary goods are goods which can be used together, such as MP3 players and headphones. Complementary goods have a
negative cross elasticity of demand.
• Income elasticity of demand (YED) is a measure of the responsiveness of the demand for a good or service to a change in income.
I. Normal goods have positive income elasticity of demand. As income rises, the demand for the good increases.
II. Inferior goods have negative income elasticity of demand. As income rises, the demand for the good decreases.
• Price elasticity of supply (PES) is a measure of the responsiveness of the quantity supplied for a good or service to a change in its price.
• Inelastic supply is where a change in price of a good or service leads to a proportionately smaller change in the quantity supplied of the good or
service. PES value is between zero and one.
• Elastic supply is where a change in price of a good or service leads to a proportionately larger change in the quantity supplied of the good or
service. PES value is greater than one.
Elasticities
Price Elasticity of Demand (PED) Three categories of PED
Measure of how much quantity demanded of a product changes Inelastic demand
when there is a change in price of a product.
 Happens when PED is less than 1 and greater than 0.
 PED = % change in quantity demanded of a product/% change
 Change in price → Proportionally smaller change in quantity demanded →
in price of a product
Total revenue gained by the firm increases when price increases.
 If PED = 0, change in price → No effect on quantity demanded
Elastic demand
→ % change would be 0 → PED is perfectly inelastic.
 Happens when PED is less than infinity and greater than 1.
 If PED = infinity, change in price → Demand will fall to 0.
 Change in price → Proportionally larger change in quantity demanded →
 Normal goods have PED between 0 and 1.
Total revenue gained by the firm decreases when price increases.
 Demand for commodities tend to be inelastic since they are
Unit elastic demand
scarce resources.
 Happens when PED = 1.
 Demand for manufactured goods tend to elastic due to variety
of choice presented to customers.  Change in price → Proportionate, opposite change in quantity demanded
→ Total revenue gained by the firm stays the same when price increases.
Determinants of PED
Number and closeness of substitutes

 More substitutes for a product → More elastic the demand for

the product will be.

 Products with fewer substitutes → Inelastic demand for the

product.

Necessity of the product and how widely the product is

defined

 Necessity products such as food, clothes → Demand is inelastic.

 Products that are people’s wants → Demand is elastic.

Time period considered

 PED is inelastic in the short term and becomes more elastic in the
long term.
Elasticities
Cross Elasticity of Demand (XED) Income Elasticity of Demand (YED)
Measure of how much the demand of the product Measure of how much the demand for a product
changes when there is a change in price of another changes when there is a change in consumer’s
product. income.
 XED = % change in quantity demanded of  YED = % change in quantity demanded of the
product X/% change in price of product Y product/% change in customer’s income
 If XED is positive, two goods, like wheat and rice,
 If YED is positive, it is a normal good.
are substitute goods.
 If XED is negative, two goods, like iPod and  Low positive YED → Necessity good, such as food.
earphones, are complementary goods.  High positive YED → Superior good, such as luxury
 XED doesn’t change if two goods compared are products.
unrelated to each other.
 If YED is negative, it is an inferior good.
Price Elasticity of Supply (PES)
Measure of how much the supply of a product changes when there is a
change in the price of the product.
 PES = % change in quantity supplied of a product/% change in price of the
product
 Same effects as PED but in this case, it is the supply of a product being
impacted, rather than the demand.
 Supply for commodities tend to be inelastic and manufactured goods tend
to be elastic due to same reasons as mentioned in PED section. 
Determinants of PES
 How much costs rise as output is increased
• Rise in total costs → Producers doesn’t increase supply → PES is
inelastic.
• Existence of unused stocks, mobility of factors of production prevents
a huge rise in costs for products.
 Time period considered
• Same effects as PED, except the effects are on supply of the product,
instead of demand of the product.
 Ability to store stock
• High levels of stock → Firms tend to react quickly to price changes →
PES of the product is elastic.
Questions

The price of meat increases by 10%, the quantity demanded PED = YED for bread =
of meat falls by 12% and the quantity of fish consumed Demand for meat is [(20,000 - 16,000)/16000] * 100 = 25%
increases by 9%. price elastic. Spending on bread fell by =
-10%
1. Calculate the price elasticity of demand (PED) for meat
YED =  
and state if the demand for meat is price elastic or YED for food =
inelastic. YED for restaurants =
2. Calculate the cross-price elasticity for demand between  
meat and fish, and state what kind of products meat and Bread is an inferior good.
fish are to each other. XED = 0.9 Food is a necessity good.
Fish and meat are Restaurants is a luxury product.
An individual’s income increased from ₹ 16,000 to ₹ 20,000.
substitute goods.
The spending on purchases of bread fell by 10% while the
spending on purchases of food in general and eating out in
restaurants increased by 15% and 30% respectively.
3. Calculate the income elasticity for demand (YED) for each
item and state the kind of item it is.