Chapter 1_Supply & Demand

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Chapter 1

Basic

Concepts ofEconomics(Supply &

Demand)


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Demand)

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Economics Definition

Adam Smith: Economics is anenquiry into the nature & causes

of the wealth of nations.

Samuelson: It is the study of

how societies use scarceresources to produce valuablecommodities and distribute them

among different people. 22IETR Ch 1. Basics of


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Economics Definition

Dr. Alfred Marshall: Economicsis a study of mans action in theordinary business of life. It

enquires about the income andhow it is used.

Benham: Economics is a study ofthe factors affecting the size,

distribution and stability of a

33IETR Ch 1. Basics of


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The Economic Problem

1. Multiple wants but scarcity ofresources.

2. Opportunity Cost: It is the pricethat must be paid in order tosatisfy a particular want when

productive resources are scarce. 3. Free and Scarce goods.



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Demand

Definition: Demand in Economics isthe desire for something along withthe willingness and ability to pay a

certain price to possess the object ofdesire.

For demand the necessary conditions

are:1. Desire.

2. Willingness to pay.

3. Abilit to a .55IETR Ch 1. Basics of


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Law of Demand

The 1st Law of demand states that allother things remaining constant, agreater quantity will be demanded ifthe price is lowered.

Exceptions:

1. Essential goods or goods consumed in

small amount (e.g. Salt) are usuallyunaffected by price change.

2. Anticipating higher price may lead topeople buying the product in larger

quantity, thus increasing the demand.66IETR Ch 1. Basics of


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Effects of Price Rise

Income Effect: When price rises,people may not be able to afford acommodity. i.e. the purchasing power

of their income has reduced. The sizeof income effect is directlyproportional to the part of theincome spent on the good.

Substitution Effect: If substitute of

a product is available, people will77IETR Ch 1. Basics of


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Demand Curve

The relationship between the marketprice of a good and the quantitydemanded of that good is called as

the demand curve or demandschedule.

Quantity demanded and price

change are inversely related to eachother. The curve is downward slopingin nature hence this is also known as

The Law Of Downward Sloping



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Demand Curve



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Factors influencingDemand

1. The price of related goods:Substitute goods or Complementarygoods.

2. Tastes: A highly desirable good ismore in demand. E.g.: Fashionableclothes.

3. The number and price of substitutegoods.

4. The number and price of

Complementary goods. 1010IETR Ch 1. Basics of


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Elasticity of Demand

Elasticity of Demand is the sensitivityor responsiveness of demand to thechanges in price. In simple words, it

is the steepness of the slope of thedemand curve.

Types of elasticity of demand:

1. Price Elasticity.

2. Income Elasticity.

3. Cross Elasticity. 1111IETR Ch 1. Basics of


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1. Price Elasticity ofDemand

It is the responsiveness of demand tothe changes in price.

Price elasticity of demand gives themeasure of how much the quantitydemanded of a good changes whenits price changes.



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Elastic Demand (e>1)

The demand is said to be elasticwhen a change in price causes aproportionately larger change in the

quantity demanded. It is exhibited by Luxurious or

Consumergoods like cars, TVs,

laptops etc. E.g. If the price of LCD TVs increases,

there will be a significant decrease in

the quantity demanded. 1313IETR Ch 1. Basics of


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Perfectly Elastic Curve



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Inelastic Demand (e


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Perfectly Inelastic Demand



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Unit Elasticity (e=1)

Unit elasticity is seen when thequantity demanded changes insame proportion as the price.

The shape of the demand curve isneither horizontal nor vertical but

a Rectangular Hyperbola.



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Unit Elasticity (e=1)



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Factors affecting price

elasticity of demand:

1. Availability and price of substitute.

2. Degree of necessity3. Utility or number of uses of thecommodity.4. New Purchasers buying due to a fall in

price.5. Durability of goods.6. Proportion of Income involved.



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Problem:

The price of an article has decreasedfrom Rs. 400 to Rs. 350. Due to this the

quantity sold has increased from 800 to1000. Calculate the coefficient ofelasticity and comment on its nature.



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Problem:The price of an article has decreased from Rs. 400

to Rs. 350. Due to this the quantity sold hasincreased from 800 to 1000. Calculate thecoefficient of elasticity and comment on itsnature.

Solution:

% change in price=12.5%

% change in quantity=25%

ep= 25/12.5= 2



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2. Income Elasticity of Demand:

It is the ratio of percentage change in quantity demanded tothe percentage change in the income.

E.g. For a 20% rise in a consumers income if an 8% rise in a

products demand is seen then income elasticity of demand isgiven as:



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Factors affecting Income

elasticity of demand:1. Degree of necessity: In a developed country,

rise in income will lead to a rise in demand

for luxury items such as cars but thedemand for basic goods such as vegetablesetc. will increase only slightly.

1. Demand for certain goods actuallydecreases when peoples income increases.Eg. When income rises, people may switchto butter or ghee instead of using vegetable

oil. 2323IETR Ch 1. Basics of


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3. Cross Elasticity of Demand:

It is the measure of the responsiveness of demand for one productwith respect to the change in price of another product.

Cross elasticity enables us to predict how much the demand curvefor the first product shift when the price of second productchanges.



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Example of Crosselasticity

If Tea (X) is a substitute for Coffee(Y), then an Increase in price ofcoffee will lead to an increase in

demand for Tea.

Other examples: Petrol and Sale of

cars, Ghee and butter etc. 2525IETR Ch 1. Basics of


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4. Promotional Elasticityof Demand

It is also known as advertisingelasticity of demand. It is an indicatorof how the demand is influenced by

its promotional activities. It is defined as the percentage

change in sales divided by the

percentage change in advertisingexpenses.



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Supply

In economics, supply is theamount of some productproducers are willing and able tosell at a given price all otherfactors being held constant.

Law of Supply: It statesthat, all other factorsremaining constant, as the

price of a good or service2727IETR Ch 1. Basics of


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Supply Curve

The relationship between the marketprice of a good and the amount ofthat good that producers are willing

to produce and sell is known assupply curve or supply schedule.

Quantity supplied and price change

are directly related to each other. Thecurve is upward sloping in nature.

This is obvious because sellers want

to sell their products in more2828IETR Ch 1. Basics of


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Supply Curve



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Factors affecting supplycurve

1. Cost of Production: At highercost of production, less profitwill be made at any price. Thus,firms cut back production byswitching to alternativeproducts.

1. Change in input prices.

2. Change in Technology.3030IETR Ch 1. Basics of


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Factors affecting supplycurve

2. Natural and unpredictableevents: Calamities, weatherchanges, wars, machinerybreakdowns.

3. The aims of Producers.

4. Expectations of future pricechanges.

5. Profitability of Goods in joint3131IETR Ch 1. Basics of


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Price elasticity of supply

Price elasticity of supply (PES) isdefined as the responsiveness ofthe supply of a given good to achange in the price of that good,when other things remainconstant.



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Equilibrium of Supplyand Demand

When supply and demand areequal (i.e. when the supply curveand demand curve intersect) theeconomy is said to be atequilibrium.

The equilibrium price is the pricewhere the quantity demandedmatches the quantity supplied.

At equilibrium, suppliers are3333IETR Ch 1. Basics of


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Equilibrium



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Disequilibrium

1. Excess Supply: If the price isset too high, excess supply willbe created within the economy.



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Disequilibrium

2. Excess Demand: Excess demand iscreated when price is set below theequilibrium price. Because the price is so

low, too many consumers want the goodwhile producers are not making enough ofit.

3636IETR Ch 1 Basics of

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Chapter 1_Supply & Demand