REPUBLIC OF THE PHILIPPINES

UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

Topic: DEMAND AND SUPPLY FUNCTION Subject: MANAGERIAL ECONOMICS

Reporters: Instructor:

LAGAO, KEZIAH MAE Mrs. CHERRYVILLE S. MEJARES

TABAQUE, CHLOE IMOGEN M.

TONOG, JUZELLE ANNE

MIRASOL, BRIAN E.

AMAR, IVELYN P.

EBRADO, IRA J.

Learning Objectives:
To be able to:

- Understand the concept of demand and supply functions;

- Identify the factors that influence demand and supply;
- Familiarize with the mechanics of demand as well as supply;
- Discuss the different types of demands and supply;
- Differentiate the elasticity of demand and elasticity of supply;

INTRODUCTION:

The concepts of demand and supply are useful for explaining what is happening in
the market place. Every market transaction involves an exchange and many exchanges are
undertaken in a single day. The circular flow of economic activity explains clearly that every
day there are a number of exchanges taking place among the major sectors.

A market is a place where we buy and sell goods and services. A buyer demands goods and
services from the market and the sellers supply the goods in the market. In economics,
demand is “the quantity of goods and services that will be bought for a given price over a
period of time”. For example, if 10 laptops are purchased in the Philippines during a year at
an average price of ₱25,000/- then we can say that the annual demand for laptops is 10
laptop units at the rate of ₱25,000/-.

This chapter describes demand and supply which is the driving force behind a market
economy. This is one of the most important managerial factors because it assists the
managers in predicting changes in production and input prices. The manager can take
better decisions regarding the kind of product to be produced, the quantity, the cost of the
product and its selling price. Let us understand the concept of demand and its importance
in decision making.

Demand: Demand means the ability and willingness to buy a specific quantity of a
commodity at the prevailing price in a given period of time. Therefore, demand for a
commodity implies the desire to acquire it, willingness and the ability to pay for it.

Law of demand: The quantity of a commodity demanded in a given time period increases

as its price falls, ceteris paribus. (I.e. other things remaining constant)

Demand schedule: a table showing the quantities of a good that a consumer is willing and
able to buy at the prevailing price in a given time period. (Table – 1)

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

Table – 1: The Demand Schedule for Coke

Price of Coke (200 ml) In Rupees Quantity Demanded

50 1
45 2
40 3
35 5
30 7
25 9
20 12
15 15
10 20

Demand Curve:

A curve indicating the total quantity of a product that all consumers are willing and

able to purchase at the prevailing price level, holding the prices of related goods, income

and other variables as constant.

A demand curve is a graphical representation of a demand schedule. The price is

quoted in the ‘Y’ axis and the quantity demanded over time at different price levels is quoted
in ‘X’ axis. Each point on the curve refers to a specific quantity that will be demanded at a
given price. The demand curve, (DD) is downward sloping curve from left to right showing
that as price falls, quantity demanded rises. This inverse relationship between price and
quantity is called as the law of demand. When price changes, there is said to be a movement
along the curve from point A to B.

Graph – Demand Curve

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

Shifts in Demand:

Shift of the demand curve occurs when the determinants of demand change. When
tastes and preferences and incomes are altered, the basic relationship between price and
quantity demanded changes (shifts). This shifts the entire demand curve upward (rightward)
and is called as increase in demand because more of that commodity is demanded at that
price. The downward shift (leftward) is called as decrease in demand. The new demand
curvesD1 D1 D1 and D0 D0 can be seen in the Graph below.

Graph – Shift in Demand Curve

Therefore, we understand that a shift in a demand curve may happen due to the
changes in the variables other than price. The movement along a demand curve takes place
(extension or contraction) due to price rise or fall.

Extension and Contraction of Demand Curve:

When with a fall in price, more of a commodity is bought, then there is an extension of the
demand curve. When lesser quantity is demanded with a rise in price, there is a contraction
of demand.

Graph –Extension and Contraction in Demand Curve

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

From the above graph we can understand that an increase in prices result in the
contraction of demand. If the price increases from P2 to P then the demand for the commodity
fall from OQ2 to OQ. Therefore, the demand curve DD contracts from ‘b’ to ‘a’ on the other
hand when there is a fall in price, it results in the extension of demand. Let us assume that
the price falls from P2 to P1 then the quantity demanded OQ2 increases to OQ1 and the
demand curve extends from point ‘b’ to ‘c’

Demand function is a function that describe how much of a commodity will be

purchased at the prevailing prices of that commodity and related commodities, alternative
income levels, and alternative values of other variables affecting demand.

Price is not the only factor which determines the level of demand for a good. Other
important factor is income. The rise in income will lead to an increase in demand for a
normal commodity. A few goods are named as inferior goods for which the demand will fall,
when income rises. Another important factor which influences the demand for a good is the
price of other goods. Other factors which affect the demand for a good apart from the above-
mentioned factors are:

Changes in Population

Changes in Fashion

Changes in Taste

Changes in Advertising

A change in demand occurs when one or more of the determinants of demand change
and it is expressed in the following equation.

QdX = f (Px, Pr, Y, T, Ey, Ep, Ad….)

Where,

Qd X = Quantity demanded of good ‘X’ P x

= the price of good X

Pr = the price of related good

Y = income level of a costumer

T = taste and preferences of the consumers

Ey = expected income

Ep = expected price

Adv =advertisement cost

The above-mentioned demand function expresses the relationship between the

demand and other factors. The quantity demanded of commodity X varies according to the
price of commodity (Px), income (Y), the price of a related commodity (Pr), taste and preference
of the consumers (T), expected income (Ey) and advertisement cost (Adv) spent by the
organization.

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

Determinants of Demand:

There are various factors affecting the demand for a commodity. They are:

1. Price of the good: The price of a commodity is an important determinant of demand.

Price and demand are inversely related. Higher the price less is the demand and vice
versa.
2. Price of related goods: The price of related goods like substitutes and
complementary goods also affect the demand. In the case of substitutes, rise in price
of one commodity lead to increase in demand for its substitute. In the case of
complementary goods, fall in the price of one commodity lead to rise in demand for
both the goods.
3. Consumer’s Income: This is directly related to demand. A change in the income of
the consumer significantly influences his demand for most commodities. If the
disposable income increases, demand will be more.
4. Taste, preference, fashions and habits: These are very effective factors affecting
demand for a commodity. When there is a change in taste, habits or preferences of
the consumer, his demand will change. Fashions and customs in society determine
many of our demands.
5. Population: If the size of the population is more, demand for goods will be more. The
market demand for a commodity substantially changes when there is change in the
total population.
6. Money in Circulation: More the money in circulation, higher the demand and vice
versa.
7. Value of Money: The value of money determines the demand for a commodity in
the market. When there is a rise or fall in the value of money there may be changes
in the relative prices of different goods and their demand.
8. Weather Condition: Weather is also an important factor that determines the demand
for certain goods.
9. Advertisement and Salesmanship: If the advertisement is very attractive for a
commodity, demand will be more. Similarly, if the salesmanship and publicity is
effective then the demand for the commodity will be more.
10. Consumer’s future price expectation: If the consumers expect that there will be a
rise in prices in future, he may buy more at the present price and so his demand
increases.
11. Government policy (taxation): High taxes will increase the price and reduce
demand, while low taxes will reduce the price and extend the demand.
12. Credit facilities: Depending on the availability of credit facilities the demand for
commodities will change. More the facilities higher the demand.
13. Multiplicity of uses of goods: If the commodity has multiple uses then the demand
will be more than if the commodity is used for a single purpose.

Demand Distinctions: Types of Demand

Demand may be defined as the quantity of goods or services desired by an individual,
backed by the ability and willingness to pay.

Types of Demand:
1. Direct and indirect demand: (or) Producers’ goods and consumers’ goods:
demand for goods that are directly used for consumption by the ultimate
consumer is known as direct demand (example: Demand for T shirts). On the
other hand, demand for goods that are used by producers for producing
goods and services. (example: Demand for cotton by a textile mill)
2. Derived demand and autonomous demand: when a produce derives its
usage from the use of some primary product it is known as derived demand.
(example: demand for tires derived from demand for car) Autonomous demand
is the demand for a product that can be independently used. (example:
demand for a washing machine)
3. Durable and non-durable goods demand: durable goods are those that can
be used more than once, over a period of time (example: Microwave oven) Non-
durable goods can be used only once (example: Band-aid)

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

4. Firm and industry demand: firm demand is the demand for the product of a
particular firm. (example: Dove soap) The demand for the product of a
particular industry is industry demand (example: demand for steel in India)
5. Total market and market segment demand: a particular segment of the
markets demand is called as segment demand (example: demand for laptops
by engineering students) the sum total of the demand for laptops by various
segments in India is the total market demand. (Example: demand for laptops
in India)
6. Short run and long run demand: short run demand refer to demand with its
immediate reaction to price changes and income fluctuations. Long run
demand is that which will ultimately exist as a result of the changes in pricing,
promotion or product improvement after-market adjustment with sufficient
time.

7. Joint demand and Composite demand: when two goods are demanded in
conjunction with one another at the same time to satisfy a single want, it is
called as joint or complementary demand. (example: demand for petrol and
two wheelers) A composite demand is one in which a good is wanted for several
different uses. (example: demand for iron rods for various purposes)

8. Price demand, income demand and cross demand: demand for

commodities by the consumers at alternative prices are called as price
demand. Quantity demanded by the consumers at alternative levels of income
is income demand. Cross demand refers to the quantity demanded of
commodity ‘X’ at a price of a related commodity ‘Y’ which may be a substitute
or complementary to X.

Price Demand: The ability and willingness to buy specific quantities of a good at the
prevailing price in a given time period.
Income Demand: The ability and willingness to buy a commodity at the available income
in a given period of time.
Market Demand: The total quantity of a good or service that people are willing and able to
buy at prevailing prices in a given time period. It is the sum of individual demands.
Cross Demand: The ability and willingness to buy a commodity or service at the prevailing
price of the related commodity i.e. substitutes or complementary products. For
example, people buy more of wheat when the price of rice increases.

Exceptional demand curve: The demand curve slopes from left to right upward if despite
the increase in price of the commodity, people tend to buy more due to reasons like
fear of shortages or it may be an absolutely essential good. The law of demand does
not apply in every case and situation. The circumstances when the law of demand
becomes ineffective are known as exceptions of the law. Some of these important
exceptions are as under.
1. Giffen Goods:

Some special varieties of inferior goods are termed as Giffen goods. Sir Robert
Giffen of Ireland first observed that people used to spend more of their income on
inferior goods like potato and less of their income on meat. After purchasing potato,
the staple food, they did not have staple food potato surplus to buy meat. So, the rise
in price of potato compelled people to buy more potato and thus raised the demand
for potato. This is against the law of demand. This is also known as Giffen paradox.

2. Conspicuous Consumption / Veblen Effect:

This exception to the law of demand is associated with the doctrine

propounded by Thorsten Veblen. A few goods like diamonds, etc. are purchased by
the rich and wealthy sections of society. The prices of these goods are so high that
they are beyond the reach of the common man. The higher the price of the diamond,
the higher its prestige value. So, when price of these goods falls, the consumers think
that the prestige value of these goods comes down. So, quantity demanded of these
goods falls with fall in their price. So, the law of demand does not hold good here.

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

3. Conspicuous Necessities:

Certain things become the necessities of modern life. So, we have to purchase
them despite their high price. The demand for T.V. sets, automobiles and refrigerators
etc. has not gone down in spite of the increase in their price. These things have
become the symbol of status. So, they are purchased despite their rising price.

4. Ignorance:
A consumer’s ignorance is another factor that at times induces him to
purchase more of the commodity at a higher price. This is especially true, when the
consumer believes that a high-priced and branded commodity is better in quality
than a low-priced one.

5. Emergencies:

During emergencies like war, famine, etc. households behave in an abnormal

way. Households accentuate scarcities and induce further price rise by making
increased purchases even at higher prices because of the apprehension that they
may not be available. On the other hand, during depression, fall in prices is not a
sufficient condition for consumers to demand more if they are needed.

6. Future Changes in Prices:

Households also act as speculators. When the prices are rising households
tend to purchase large quantities of the commodity out of the apprehension that
prices may still go up. When prices are expected to fall further, they wait to buy goods
in future at still lower prices. So, quantity demanded falls when prices are falling.

7. Change in Fashion:

A change in fashion and tastes affects the market for a commodity. When a
digital camera replaces a normal manual camera, no amount of reduction in the price
of the latter is sufficient to clear the stocks. Digital cameras on the other hand, will
have more customers even though its price may be going up. The law of demand
becomes ineffective.

8. Demonstration Effect:

It refers to a tendency of low-income groups to imitate the consumption

pattern of high-income groups. They will buy a commodity to imitate the
consumption of their neighbors even if they do not have the purchasing power.

9. Snob Effect:

Some buyers have a desire to own unusual or unique products to show that
they are different from others. In this situation even when the price rises the demand
for the commodity will be more.

10. Speculative Goods/ Outdated Goods/ Seasonal Goods:

Speculative goods such as shares do not follow the law of demand. Whenever
the prices rise, the traders expect the prices to rise further so they buy more. Goods
that go out of use due to advancement in the underlying technology are called
outdated goods. The demand for such goods does not rise even with fall in prices.

11. Seasonal Goods:

Goods which are not used during the off-season (seasonal goods) will also be
subject to similar demand behavior.

12. Goods in Short Supply:

Goods that are available in limited quantity or whose future availability is

uncertain also violate the law of demand.

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

Elasticity of Demand
In economics, the term elasticity means a proportionate (percentage) change in one
variable relative to a proportionate (percentage) change in another variable. The quantity
demanded of a good is affected by changes in the price of the good, changes in price of other
goods, changes in income and changes in other factors. Elasticity is a measure of just how
much of the quantity demanded will be affected due to a change in price or income.
Elasticity of Demand is a technical term used by economists to describe the degree
of responsiveness of the demand for a commodity due to a fall in its price. A fall in price
leads to an increase in quantity demanded and vice versa.

The elasticity of demand may be as follows:

Price Elasticity
Income Elasticity and
Cross Elasticity

Price Elasticity:
The response of the consumers to a change in the price of a commodity is measured
by the price elasticity of the commodity demand. The responsiveness of changes in quantity
demanded due to changes in price is referred to as price elasticity of demand. The price
elasticity of demand is measured by dividing the percentage change in quantity demanded
by the percentage change in price.
Price Elasticity = Proportionate change in the Quantity Demanded
/ Proportionate change in price

Percentage change in quantity demanded

= -----------------------------------------------

Percentage change in price

ΔQ / Q 10

= --------- = -------- = 0.5

ΔP / P 20

ΔQ = change in quantity demanded

ΔP = change in price
P = price
Q = quantity demanded

For example:
Quantity demanded is 20 units at a price of ₱500. When there is a fall in price to
₱400 it results in a rise in demand to 32 units. Therefore, the change in quantity demanded
is 12 units resulting from the change in price of ₱100.
The Price Elasticity of Demand is = 500 / 20 x 12/100 = 3

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

The Determinants of Price Elasticity of Demand

The exact value of price elasticity for a commodity is determined by a wide variety of
factors. The two factors considered by economists are the availability of substitutes and
time. The better the substitutes for a product, the higher the price elasticity of demand. The
longer the period of time, the more the price elasticity of demand for that product. The price
elasticity of necessary goods will have lower elasticity than luxuries.

The elasticity of demand depends on the following factors:

1. Nature of the commodity: The demand for necessities is inelastic because the
demand does not change much with a change in price. But the demand for luxuries
is elastic in nature.
2. Extent of use: A commodity having a variety of uses has a comparatively elastic
demand.
3. Range of substitutes: The commodity which has a greater number of substitutes
has relatively elastic demand. A commodity with fewer substitutes has relatively
inelastic demand.
4. Income level: People with high incomes are less affected by price changes than
people with low incomes.
5. Proportion of income spent on the commodity: When a small part of income is
spent on the commodity, the price change does not affect the demand therefore the
demand is inelastic in nature.
6. Urgency of demand /postponement of purchase: The demand for certain
commodities are highly inelastic because you cannot postpone its purchase. For
example, medicines for any sickness should be purchased and consumed
immediately.
7. Durability of a commodity: If the commodity is durable then it is used it for a long
period. Therefore, elasticity of demand is high. Price changes highly influences the
demand for durables in the market.
8. Purchase frequency of a product/ recurrence of demand: The demand for
frequently purchased goods are highly elastic than rarely purchased goods.
9. Time: In the short run demand will be less elastic but in the long run the demand
for commodities are more elastic.

Income Elasticity:
Income elasticity of demand measures the responsiveness of quantity demanded to
a change in income. It is measured by dividing the percentage change in quantity demanded
by the percentage change in income. If the demand for a commodity increases by 20% when
income increases by 10% then the income elasticity of that commodity is said to be positive
and relatively high. If the demand for food were unchanged when income increases, the
income elasticity would be zero. A fall in demand for a commodity when income rises results
in a negative income elasticity of demand.

The following are the various types of income elasticity:

Zero Income Elasticity: The increase in income of the individual does not make any
difference in the demand for that commodity.
Negative Income Elasticity: The increase in the income of consumers leads to less
purchase of those goods.
Unitary Income Elasticity: The change in income leads to the same percentage of change
in the demand for the good.
Income Elasticity is Greater than 1: The change in income increases the demand for that
commodity more than the change in the income.
Income Elasticity is Less than 1: The change in income increases the demand for the
commodity but at a lesser percentage than the change in the Income.

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

Cross Elasticity
The quantity demanded of a particular commodity varies according to the price of
other commodities. Cross elasticity measures the responsiveness of the quantity demanded
of a commodity due to changes in the price of another commodity. For example, the demand
for tea increases when the price of coffee goes up. Here the cross elasticity of demand for tea
is high. If two goods are substitutes then they will have a positive cross elasticity of demand.
In other words, if two goods are complementary to each other the negative income elasticity
may arise.
The responsiveness of the quantity of one commodity demanded to a change in the
price of another good is calculated with the following formula.

% change in demand for commodity A

Ec = ---------------------------------------------------
% change in price of commodity B

If two commodities are unrelated goods, the increase in the price of one good does
not result in any change in the demand for the other goods. For example, the price fall in
Tata salt does not make any change in the demand for Tata Nano.

Significance of Elasticity of Demand:

The concept of elasticity is useful for the managers for the following decision-making activities
1. In production i.e. in deciding the quantity of goods to be produced
2. Price fixation i.e. in fixing the prices not only on the cost basis but also on the basis
of prices of related goods.
3. In distribution i.e. to decide as to where, when, and how much etc.
4. In international trade i.e. what to export, where to export
5. In foreign exchange
6. For nationalizing an industry
7. In public finance

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

SUPPLY FUNCTION:
Supply a commodity refers to the various quantities of the commodity which a seller
is willing and able to sell at different prices in a given market at a point of time, other things
remaining the same. Supply is what the seller is able and willing to offer for sale. The
Quantity supplied is the amount of a particular commodity that a firm is willing and able to
offer for sale at a particular price during a given time period.

Supply Schedule: is a table showing how much of a commodity, firms can sell at different
prices.
Law of Supply: is the relationship between price of the commodity and quantity of that
commodity supplied. i.e. an increase in price will lead to an increase in quantity
supplied and vice versa.
Supply Curve: A graphical representation of how much of a commodity a firm sells at
different prices. The supply curve is upward sloping from left to right. Therefore the
price elasticity of supply will be positive.

1. The cost of factors of production: Cost depends on the price of factors. Increase in
factor cost increases the cost of production, and reduces supply.
2. The state of technology: Use of advanced technology increases productivity of the
organization and increases its supply.
3. External factors: External factors like weather influence the supply. If there is a flood,
this reduces supply of various agricultural products.
4. Tax and subsidy: Increase in government subsidies results in more production and
higher supply.
5. Transport: Better transport facilities will increase the supply.
6. Price: If the prices are high, the sellers are willing to supply more goods to increase
their profit.
7. Price of other goods: The price of other goods is more than ‘X’ then the supply of ‘X’
will be increased.

Elasticity of Supply: Elasticity of supply of a commodity is defined as the responsiveness

of a quantity supplied to a unit change in price of that commodity.

ΔQs / Qs
Es = -----------------
ΔP / P

ΔQs = change in quantity supplied

Qs = quantity supplied
ΔP = change in price
P = price

Kinds of Supply Elasticity

Price elasticity of supply: Price elasticity of supply measures the responsiveness of
changes in quantity supplied to a change in price.
Perfectly inelastic: If there is no response in supply to a change in price. (Es = 0)
Inelastic supply: The proportionate change in supply is less than the change in price
(Es =0 1)

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 REPUBLIC OF THE PHILIPPINES
UNIVERSITY OF ANTIQUE
COLLEGE OF BUSINESS AND ACCOUNTANCY
SIBALOM, ANTIQUE

Unitary elastic: The percentage change in quantity supplied equals the change in price
(Es=1)
Elastic: The change in quantity supplied is more than the change in price (Ex= 1- ∞)
Perfectly elastic: Suppliers are willing to supply any amount at a given price (Es=∞)

The major determinants of elasticity of supply are availability of substitutes in the

market and the time period, Shorter the period higher will be the elasticity.
Factors Influencing Elasticity of Supply
1. Nature of the commodity: If the commodity is perishable in nature then the elasticity
of supply will be less. Durable goods have high elasticity of supply.
2. Time period: If the operational time period is short then supply is inelastic. When the
production process period is longer the elasticity of supply will be relatively elastic.
3. Scale of production: Small scale producer’s supply is inelastic in nature compared
to the large producers.
4. Size of the firm and number of products: If the firm is a large-scale industry and
has more variety of products then it can easily transfer the resources. Therefore,
supply of such products is highly elastic.
5. Natural factors: Natural calamities can affect the production of agricultural products
so they are relatively inelastic.
6. Nature of production: If the commodities need more workmanship, or for artistic
goods the elasticity of supply will be high.

Apart from the above-mentioned factors future expectations of the market, natural
resources of the country and government controls can also play a role in determining supply
of a good. In the long run, supply is affected by cost of production. If costs are rising, some
of the existing producers may with draw from the field and new entrepreneurs may be scared
of entering the field.

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