2. ECO 162-Demand and Supply

MICROECONOMICS (ECO 162)

DEMAND AND SUPPLY(Ms. Tai Nyuk Chin)

LEARNING OUTCOMES

• At the end of this lesson, the students should be able to:

i. Define the meaning of demand/supply and law of demand/supply.

ii. Construct a demand and supply curve.

iii. Differentiate between the change in demand/supply and change in quantity demanded/supplied.

iv. Identify the determinants of demand/supply.

Demand

• Demand indicates willingness and ability to buy .

• Demand depends on many factors, most of which is price.

• Price has a negative effect on willingness to buy. – All else equal (ceteris paribus), as the price of a

product falls, the quantity demanded will rise and vice versa.

Law Of Demand

A law which stated that as the price of a good or service increases, consumer’s demand for the good or service will decrease and vice versa given that all other factors being equal (‘ceteris paribus’ ).

Price ,Demand : Price ,

Demand

Demand Curve

• Demand curve show the relationship between the price of the good and the quantity that consumers are willing to buy.

• Suppose people are willing to buy 2 kg of mango at a price of RM2/kg, but are willing to buy 3 kg if the price falls to RM1/kg.

Demand Curve• Because a change in price will always push the quantity demanded in

the opposite direction, all demand curves will have a negative slope (left side up)

• At $2, people will buy 20 pounds, but at $1, they will buy 30 pounds.Figure 1 : Demand Curve

Q of Mango (Kg)

2

1

Price (RM)

INDIVIDUAL DD AND MARKET DD

• Individual DDIndividual consumer's demand for a particular

good• Market DDAggregate of the demand of all potential customer

(market participants) for a specific product over a specific period in a specific market.

The market demand curve is determined by taking the horizontal summation of all individual demand curves.

INDIVIDUAL DD AND MARKET DD

Figure 2 : Individual and market demand curve

Demand curve: Exercise

PRICE (RM)QUANTITY DEMANDED, Qdd (KG)

LAURIE JAMES SCOTTY

10.00 36 33 31

20.00 31 29 20

30.00 24 21 15

40.00 15 14 11

50.00 8 7 5

The table above shows the demand for Strawberries in a week.Based on the information given, draw the market demand for Strawberries on a graph paper.

DETERMINANTS OF DEMAND

1. Income Factor• Normally, we expect that as one's income rises, the demand

for a product will rise and vice versa.• However, the statement will not always be true as dd

depends on income elasticity of dd.• An increase in income will cause;

a) Demand for normal good to increase - rightward shift

E.g: Income increased, dd for car increase (normal goods)

b) Demand for inferior good to decrease - leftward shift

E.g: Income increased, dd for maggi mee decreased (inferior goods)


2. Price of related goods a) Substitute good• Goods that can be used to replace another goods.• E.g. Cola VS Pepsi, Milo VS ovaltine• If the price of Cola increase, dd for Pepsi will increase.

b) Complement goods• Goods that are used together with another goods.• E.g. Coffee and sugar, fuel and car• If the price of fuel increase, dd for car will decrease.


3. Tastes or Preferences• It involves the fact that there are certain psychological

reasons for liking or disliking a particular good. • The principle : the more (less) we like a good or service,

the greater (less) is our demand for it.

4. Expectations /Forecast• The principle: If consumers expect the price to rise

(fall) in future, the demand rises (falls) today.

E.g. Fuel price expected to rise tomorrow, demand for fuel today will increase.


5. Population (Number of Buyers)• When there are more buyer exist, demand for a particular

goods tend to increase.

6. Advertisements• Advertised goods normally have higher demand because

of awareness of the goods.

7. Festive seasons and climate• During festive seasons, different product will be in high

demand.• E.g. During Hari Raya, demand for lemang will be

greater.

Exceptional demand

• Exceptional demand is against the law of demand where as price increase, demand will also increase.

• Normal demand curve shows a negative relationship between price and quantity demanded.

• However, exceptional demand curve shows positive relationship.

• Exceptional demand can be explain through the following;i. Giffen goods

ii. Status symbol goods

iii. Speculation

iv. Emergencies

Exceptional demand

• Exceptional demand curve shows positive relationship. (The higher the price, the higher the demand, vice versa)

Exceptional demand

i. Giffen Goods• A Giffen good is an extreme type of inferior goods. • Demand is strengthened with a rise in price or weakened

with a fall in price : when the price of a Giffen good rises, consumers actually buy more and vice versa.

• E.g. Poor household in Hunan, China were shown to buy more rice when the price of rice is high. They buy less rice when the price was subsidized (cheaper). The main reason for this is that, even when expensive, rice was still the cheapest source of calories affordable. Therefore, when the price of rice was cheaper, households had more money left over after buying rice. Some of this was spent on buying more expensive foods (meat, vegetables and fruit), which reduced their need for rice.

Exceptional demand

ii. Status symbol goods• Refers to commodities which are purchased by rich

people not for their satisfaction but for their ‘snob-appeal’.

• For such goods, it is not the price that is important but the possession confers a social distinction on the holder.

• e.g.: Diamonds, world famous painting, antique goods.• When price of diamond decrease, and even lower

income group can owned it, diamonds no longer confer any prestige or social distinction. Thus, demand of diamonds for rich people will decrease.

Exceptional demand

iii. Speculation • When price of a good is increasing and is expected

to increase further in the future, consumer will buy more of the good even if it is sold at higher prices.

iv. Emergencies• During emergencies periods like war and natural

disaster, people would buy more goods regardless the high prices.

• Such goods includes basic necessities goods such as salt, rice, sugar and oil.

Inter related demandi. Cross Demand Relationship between the price of complementary or substitutes goods

and quantity of good. Can be divided into two: Joint demand and Competitive demand.

a. Joint Demand A demand for a particular good is likely to increase the demand for another

good. Complementary goods such as Pen and ink, toothbrush and toothpaste

b. Competitive Demand An increase in the demand for one good will reduce the demand for

another good. Substitutes goods such as Pepsi cola and coca cola, KFC and McDonalds,

PROTON and HONDA

Inter related demandii. Derived Demand Demand for a good that is derived from other goods. The demand for a good increases, demand for the factor of

production to produce goods will also increase. E.g.: House: bricks, cement, tiles etc

(Demand for bricks is derived since its demand depends on the demand for houses, building, etc)

Change in Demand and Quantity Demanded

• What is the difference between a change in demand and a change in the quantity demanded?

• Change in Demand ( Shift in DD curve) A change in demand is a shift of the entire demand curve. The changes might be due to factors such as prices of related

goods, expectations of buyer, tastes and preferences and etc.• Change in Q demanded (Movement along DD curve) A change in the quantity demanded is a movement along the

demand curve (up or down). It can only occur from a change in the price of the goods

itself.

A Change in Demand Vs a Change in Quantity Demanded

To summarize:

Change in price of a good or service leads to

Change in quantity demanded(Movement along the curve).

Change in income, preferences, orprices of other goods or services

leads to

Change in demand(Shift of curve).

Figure 3 : Change in DD and Q demanded

Supply

• Supply indicates ability and willingness to sell. • Like demand, the supply of a product depends

upon many different factors and, like demand, one obvious factor is price.

• However, while high prices discourage buyers, they are likely to encourage sellers.

• Price has a positive effect on willingness to sell. – All else equal, as the price of a product rises, the

quantity firms are willing to sell will rise as well.

Law of Supply

• Law of Supply A law which stated that the higher the price of a good, the

higher the quantity supplied for that goods and vice versa. (‘Ceteris Paribus’)

The law of supply indicates a positive or direct relationship between price and quantity supplied.

A seller would want to sell goods at higher price as it means higher profit for them.

Price , Qss : Price , Qss

Supply Curves

• A supply curve illustrates the relationship between the price of the good and the quantity that firms are willing to sell.

• For example, firms might be willing to sell 600 tonnes of wheat at a price of $3, but be willing to sell 900 tonnes at a price of $4.

Supply Curves

• Since a change in price will push the quantity supplied in the same direction, supply curves will have a positive slope (right-side up).

Figure 4 : Supply curve

INDIVIDUAL SS AND MARKET SS

• Individual SS Defined as the relationship between the quantities supplied of

a good by a single seller and its price.• Market Supply The relationship between the total quantities supplied by all

sellers in the market and its price. The market supply is obtained by adding up the quantities

supplied by individual sellers.

INDIVIDUAL SS AND MARKET SS

Supply curve: Exercise

PRICE (RM)QUANTITY SUPPLIED, Qss (KG)

TED BARNEY MARSHALL

10.00 7 6 7

20.00 14 13 13

30.00 22 17 21

40.00 31 25 24

50.00 36 30 34

The table above shows the supply for Strawberries in a week.Based on the information given, draw the market supply for Strawberries on a graph paper.

DETERMINANTS OF SUPPLY

1. Cost of production Supply will change in response with the factors of

production; labour, capital or land. If the factors of production’s cost rises, the cost of production

will as well rises, thus will reduce the supply of the good. E.g.: Wages for workers in producing clothes has increased.

Therefore, the cost of production of 1 unit of clothe will increase and clothes manufacturer will reduce the supply of clothes.


2. Price of related goods

i. Substitute Goods• Goods that can be used to replace another goods.• E.g: Pizza VS Spaghetti, milo VS ovaltine• An increase in the price of a substitute good; Supply of a good will decrease (Shift leftward) and vice versa. E.g.: Price of Pizza increase, producer will supply more pizza and less spaghetti.

ii. Complement Goods• Goods that are used together with another goods.• E.g: Fuel and car• An increase in the price of a complement good; Supply of a good will increase (Shift rightward) and vice versa. E.g.: Price of car increase, producer will supply more car. The supply of fuel will

also increase.


3. Expectation of seller When seller expected a higher price of a good in the future, the

smaller will be today’s supply of the good and vice versa. E.g.: If government announced an increase in the price of sugar

in the next 5 months, the current supply of sugar will decrease because the supplier wants to sell after the price hike in order to gain more profits at the new price.

4. Technological advancement Improvements in technologies have the most important

influence in supply. New innovations in technologies enable producers to use fewer

factors of productions and it will help to decrease the cost of production


5. Population (Number of Sellers) The market supply is simply the sum of the individual seller’s

supplies. Therefore, the larger the number of firms supplying a good, the

larger is the supply of the good.

6. Government policies Some supplies of good is also affected by the implementation of

various government policies, such as taxes and subsidies. Taxes imposed on a good will increase the cost of production, while

subsidies will reduce the cost of production. When taxes imposed on a good, the supply will decrease as the cost

of production rises. On the other hand, subsidies help to reduce the cost of production,

thus will increase the quantities supplied.

Exceptional supply

• Exceptional supply is against the law of supply where, as price increase, supply will decrease.

• Normal supply curve shows a positive relationship between price and quantity demanded.

• However, exceptional supply curve shows negative relationship.

• Exceptional supply can be explain through the ‘Backward Bending Labor Supply Curve’

Exceptional supply

• ‘Backward Bending Labor Supply Curve’• Every labor will only have 24 hours of his

day either on work or on leisure.

• Non working day will be considered as his

leisure time. The opportunity cost of working

is to forgo the hours of leisure.

• An increase in wage rate will encourage the

worker to work more hours and thus

sacrificing his leisure time. (Substitution

effect)

• After certain number of hours, workers are

unwilling to substitute their leisure time for

work although the wage rate is high. (Income

effect)

Income effect

Substitution effect

Leisure is preferred

Work is preferred

CHANGE IN SS AND Q SUPPLIED

• What is the difference between a change in SS and a change in the quantity supplied?

• Change in SS (Shift in SS curve) A change in Supply is a shift of the entire SS curve due to

a change in other factors while price remains constant. The changes might due to factors such as prices of related

goods, expectations of seller, government policies and etc.

• Change in Q Supplied (Movement along SS curve) A change in the quantity supplied is a movement along

the supply curve due to a change in price while other factors remain constant.

CHANGE IN SS AND Q SUPPLIED

Shift of SS curve: Change in SS Movement along SS curve: Change in Quantity SS

Market Equilibrium

A situation where Qdd = Qss Determined by the intersection of both the DD and SS curve. No tendency for market price to increase or decrease.

Figure 4.1: Equilibrium point (Qss =Qdd)

Equilibrium point (P = RM50, Q = 90 units)

Classification of goods and services

• The production and distribution of goods and services are the main concern in economics.

• Goods/products would be defined as anything that anyone wants or needs which is tangible.

• E.g.: Clothes, foods and machine, etc..• Services would be the performance of any duties or

work for another; helpful or professional activity which is intangible.

• E.g.: mechanics, teacher and police, etc..

Classification of goods and services

CONVENTIONAL PERSPECTIVES

i. Free Goods

ii. Public Goods

iii. Economic Goods

ISLAMIC PERSPECTIVES

i. Dharuriyah

ii. Hajiyat

iii. Kamaliat

iv. Tarafiat

Classification of goods and services: Conventional perspective

• Free goodsis a gift of nature and supplied without labor

and without limit as an item of consumption which is useful to people.

It is naturally in abundant supply and therefore it needs no conscious effort to obtain it.

E.g.: fresh air, sunlight, rainCan free merchandises regarded as ‘free

goods’?


• Public GoodsRefers to the goods/services that can be consumed

by several individuals simultaneously without diminishing the value of consumption to any one of the individual (non-rivalry)

E.g.: Street sign, Street lightA pure public good possess the characteristic of

non-excludability which means that any individual cannot be prevented from consuming it whether or not they pays for it.

E.g.: fresh air, a beautiful view, national defense


• Economic GoodsCharacterized by their scarcity since demand and

individual effort is required to obtain it.Physical objects or services which has value to people

and can be sold for a price in the marketplace. Individual can be excluded from consuming it.

Rivalry concept exist.

Classification of goods and services: Islamic perspective

i. Dharuriyah Goods Goods that are classified as basic needs and necessary for a

living. Without these goods, men will not be able to continue their life. E.g.: Foods, clothes, shelter, etc.

ii. Hajiyyah Goods Considered as comfort goods. These goods will improve the quality of human life and

provide comfort. Without these kind of goods, men will feel less comfortable in

life. E.g.: Refrigerators, computer, television, radio, etc.

Classification of goods and services: Islamic perspective

iii. Tahsiniyyah or Kamaliyyah goods Refers to luxury goods that contribute towards the perfection of

human life. These goods complete the needs of men but without them, men

can still survive and live in comfort. E.g.: Mercedes car, bungalow house, gold watch, etc.

iv. Tarafiyyah goods Tarafiyyah goods are not permissible (haram) since this goods

bring negative impact to the society. These goods are not only extravagant which lead to wastage,

but it also cause harm to men. E.g.: Golden chair, antique painting, etc.

END OF CHAPTER 2

THANK YOU

Documents

2. ECO 162-Demand and Supply