MICROECONOMICS

UNIT- I
(DEMAND, SUPPLY AND MARKET
EQUILIBRIUM)
By: Ms. Saima

WHAT IS ECONOMICS?
Economics is a social science that focuses on the production, distribution, and
consumption of goods and services, and analyzes the choices that individuals,
businesses, governments, and nations make to allocate resources.
Assuming humans have unlimited wants within a world of limited means, economists
analyze how resources are allocated for production, distribution, and consumption.
Modern economists have divided the subject of economics into 2 parts:
The study of microeconomics focuses on the choices of individuals and businesses,
and macroeconomics concentrates on the behavior of the economy as a whole, on an
aggregate level.
 BASIS FOR
MICROECONOMICS MACROECONOMICS
COMPARISON
Meaning The branch of economics that studies The branch of economics that studies the
the behavior of an individual consumer, behavior of the whole economy, (both
firm, family is known as national and international) is known as
Microeconomics. Macroeconomics.
Deals with Individual economic variables Aggregate economic variables
Tools Demand and Supply Aggregate Demand and Aggregate
Supply
Concerned with Theory of Product Pricing, Theory of Theory of National Income, Aggregate
Factor Pricing, Theory of Economic Consumption, Theory of General Price
Welfare. Level, Economic Growth.
Scope Covers various issues like demand, Covers various issues like, national income,
supply, product pricing, factor pricing, general price level, distribution,
production, consumption, economic employment, money etc.
welfare, etc.
Importance Helpful in determining the prices of a Maintains stability in the general price level
product along with the prices of factors and resolves the major problems of the
of production (land, labor, capital, economy like inflation, deflation, reflation,
entrepreneur etc.) within the economy. unemployment and poverty as a whole.
Also known as Price Theory Theory of Income and Emplyment

ECONOMY
An economy encompasses all of the activities related to the production, consumption,
and trade of goods and services in an entity, whether the entity is a nation or a small
town.
An economy must perform 3 basic activities for its survival and development:
production, consumption and capital formation.
Production is the process of creating goods and services or increasing the values of
commodities already produced; consumption is using up of goods and services to
satisfy human wants directly; and capital formation means addition to the capital
stock economy that helps in further production.
An economy is called a closed economy when it has no economic relations with other
countries and called an open economy when it has economic relations with other
countries or rest of the world.
ECONOMIC PROBLEM
Economic problem is basically the problem making choices in the use of scarce
resources for satisfaction of unlimited wants.
Causes of economic problem:
1. Human wants are unlimited
2. Resources to satisfy wants are limited
3. Resources have alternative uses
Scarcity of resources gives rise to economic problems. Had the resources been in
abundance, unlimited goods and services would have been produced to satisfy
unlimited human wants and there would have been no economic problem.

DEMAND
Demand for a particular good by a consumer means the quantities of the good that
he is willing to buy at different prices within a given period of time .

Demand=Willingness to Pay+Ability to Pay

Demand can be at 2 levels- individual demand and market demand.

INDIVIDUAL DEMAND & MARKET DEMAND
Individual demand is the demand of a single consumer for a good or service at a
given price, with other factors as money income, tastes, and preferences, prices of
other goods constant. It can be graphically depicted by a downward sloping demand
curve for a single consumer.
Market demand refers to the demand of all consumers of a good or service at a
given price, with other factors as money income, tastes, and preferences, prices of
other goods constant. It can be graphically obtained by aggregating the individuals’
consumer demand for a commodity. In simple words, the horizontal summation of all
individual demand curves for a good or service gives you the market demand curve.

DETERMINANTS OF INDIVIDUAL DEMAND

1. Price of the given Commodity
The most vital factor that affects the demand for a commodity is its price. Usually,
there is an inverse relationship between the price and demand of a commodity (also
known as the Law of Demand), which means that when the price of a commodity rises,
its demand declines, and vice-versa. For example, if the price of coffee increases,
then its quantity demanded will decrease, as the satisfaction level derived by the
consumers from its consumption will fall due to the rise in price.

2. Price of Related Goods

Related goods are the goods in which a change in the price of one good affects the change in
the demand for another good. There are two types of related goods, namely., substitute
goods and complementary goods.

Substitute Goods: The goods which can be used in the place of one another to satisfy a
specific want are known as substitute goods. It means that an increase in the price of one
good, increases the demand for its substitute, and vice-versa. For example, if the price of a
commodity, let’s say, tea increases, then the demand for its substitute, let’s say, coffee will also
increase, as it will now become comparatively cheaper than tea. As demand for substitute
goods compete with each other in the market, they are also known as Competitive Goods.

Complementary Goods: The goods which are used by the consumers together to satisfy a
specific want are known as complementary goods. It means that an increase in the price of one
good decreases the demand for its complementary good, and vice-versa. For example, if the
price of a commodity, let’s say, bread increases, then the demand for its complementary good,
let’s say, butter will decrease, as it will be costlier for the consumers to buy and consume both
of these goods. In other words, the price of a good is inversely related to the demand for its
complementary good.
3. Income of the Consumer
The income of the consumer also affects the demand for a commodity. However, the
way income of a consumer affects the demand depends upon the nature of the
commodity. The goods can be normal goods and inferior goods.

Normal Goods: The goods for which demand will rise if the income of the consumer
increases, and vice-versa is known as normal goods. For example, if the income of a
consumer increases, then his demand for goods like luxury cars, smartphones, jewelry,
etc., will also increase.

Inferior Goods: The goods for which demand will decrease if the income of the
consumer increases, and vice-versa is known as inferior goods. It happens so because
now the consumer has the ability to purchase commodities of good quality. For
example, if the income of a consumer increases, then his demand for goods like
canned food, used cars, etc., will decrease, as the consumer can now purchase good
quality goods.

4. Tastes and Preferences

There is a direct effect of tastes and preferences of a consumer on the demand for a
commodity. It means that a change in the tastes or preferences of the consumers’
increases or decreases the demand for a commodity. It includes habits, customs,
fashion, etc. For example, if a particular clothing style is in fashion, then its demand
among the consumers will also increase. However, if a clothing style gets out of
fashion, then its demand among the consumers will decrease.

5. Expectation of Change in the Price in Future

If a consumer expects that the price of a commodity is going to increase in the near
future, then he/she will try to buy it in more quantity in the present, increasing its
demand. In other words, there is a direct relationship between the future expectations
of changes in the price of a commodity in future and its demand in the present. For
example, if people think that price of diesel will rise in the future, then they will try to
fill up the tanks of their vehicles, increasing the demand for diesel.
DETERMINANTS OF MARKET DEMAND

1. Size and composition of population

The size of the population in a country affect the market demand for a commodity. An
increase in the population of a country increases the market demand for goods, and vice-
versa. The composition of the population involves the male ratio, female ratio, children ratio,
etc., which affects the demand for a commodity. For example, if the population of a country
includes more men, then the demand for commodities used by men, such as shaving cream, etc.,
will also rise.

2. Season and weather

The seasonal and weather conditions of a place also have an impact on the market demand
for a commodity. For example, during the summer season, the demand for cotton clothes, ice
cream, etc., increases, during the rainy season the demand for raincoats, umbrellas, etc.,
increases.

3. Distribution of income
The way income is distributed in a country also impacts the demand for a commodity. If the
income is distributed equally in a country, then the market demand for a commodity will also
increase. However, if the income is unevenly distributed among the rich and poor, then the
market demand for a commodity will be low.
DEMAND FUNCTION
Demand function depicts the relationship between the quantity demanded and the
determinants of demand.

Da= f(Pa, Pr, Y, T)

Where Da is the quantity demanded of commodity ‘a’ at a given time
f stands for function
Pa is the price of commodity ‘a’
Pr is prices of related commodities
Y shows the income of the consumer
T stands for the taste and preferences of the consumer

LAW OF DEMAND
According to the law, other things being constant, quantity demanded of a commodity
is inversely related to the price of the commodity .
Price and demand move in opposite direction. Thus, when the price of a commodity
rises, demand falls; and when the price falls, demand rises provided factors other
than the price remain unchanged.
DEMAND SCHEDULE AND DEMAND CURVE
Demand schedule is a tabular statement showing different quantities of a commodity
demanded at different prices during a given period of time.
Demand curve is a graphical representation of the demand schedule.
Demand curve generally slopes downward from left to right.
MARKET DEMAND SCHEDULE AND CURVE
Market demand curve is obtained by horizontally summing up individual demand curves.

EXCEPTIONS TO THE LAW OF DEMAND

1. Giffen Goods
Giffen Goods is a concept that was introduced by Sir Robert Giffen. Giffen goods
are a special category of inferior goods in whose case demand for a commodity
falls with a fall in its price. However, the unique characteristic of Giffen goods is that
as its price increases, the demand also increases. And this feature is what makes it an
exception to the law of demand.
The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a
staple in the Irish diet. During the potato famine, when the price of potatoes
increased, people spent less on luxury foods such as meat and bought more potatoes
to stick to their diet. So as the price of potatoes increased, so did the demand, which
is a complete reversal of the law of demand.
2. Veblen Goods
The second exception to the law of demand is the concept of Veblen goods. Veblen
Goods is a concept that is named after the economist Thorstein Veblen, who
introduced the theory of “conspicuous consumption“. According to Veblen, there are
certain goods that become more valuable as their price increases. If a product is
expensive, then its value and utility are perceived to be more, and hence the demand
for that product increases.
And this happens mostly with precious metals and stones such as gold and diamonds
and luxury cars such as Rolls-Royce. As the price of these goods increases, their
demand also increases because these products then become a status symbol.

3. The expectation of Price Change

There are times when the price of a product increases and market conditions are such
that the product may get more expensive. In such cases, consumers may buy more of
these products before the price increases any further. Consequently, when the price
drops or may be expected to drop further, consumers might postpone the purchase to
avail the benefits of a lower price.
There are also times when consumers may buy and store commodities due to a fear
of shortage. Therefore, even if the price of a product increases, its associated
demand may also increase as the product may be taken off the shelf or it might
cease to exist in the market.
4. Necessary Goods and Services
Another exception to the law of demand is necessary or basic goods. People will
continue to buy necessities such as medicines or basic staples such as sugar or salt
even if the price increases. The prices of these products do not affect their associated
demand.

5. Change in Income
Sometimes the demand for a product may change according to the change in income.
If a household’s income increases, they may purchase more products irrespective of
the increase in their price, thereby increasing the demand for the product. Similarly,
they might postpone buying a product even if its price reduces if their income has
reduced. Hence, change in a consumer’s income pattern may also be an exception to
the law of demand.

6. Effect of demonstration
Middle-income consumers tend to imitate or copy the upper-middle-class consumer
behaviours and may tend to purchase the same products or services of the upper-
middle class.

7. Changes in taste, preferences, and fashionable products

Consumers’ changes in taste and preferences in fashionable products don’t change
the quantity demanded with an increase in price rise as the consumers are willing to
spend more on these products and services.
CHANGE IN DEMAND AND CHANGE IN QUANTITY
DEMANDED
CHANGE IN QUANTITY DEMANDED: Effect of change in price of a commodity on its
demand is called change in quantity demanded. (Expansion and contraction of
demand)
It is represented graphically in the form of movement along a demand curve.

CHANGE IN DEMAND: Effect of change in factors other than the price of a commodity
on its demand is called change in demand. (Increase and decrease in demand)
It is represented graphically in the form of shift in demand curve.

CAUSES OF RIGHTWARD SHIFT AND LEFTWARD

SHIFT OF DEMAND CURVE
Causes of rightward shift Causes of leftward shift
1. Rise in price of substitute goods 1. Fall in price of substitute goods
2. Increase in income of buyers of 2. Fall in income of buyers of normal
normal goods goods
3. Favourable change in taste of 3. Unfavourable change in taste of
commodity commodity
4. Fall in price of complementary 4. Rise in price of complementary
goods goods
CHANGE IN QUANTITY DEMANDED CHANGE IN DEMAND

CASE: TWO WAYS TO REDUCE THE QUANTITY OF

SMOKING DEMANDED
Public policymakers often want to reduce the amount that people smoke because of smoking’s
adverse health effects. There are two ways that policy can attempt to achieve this goal. One
way to reduce smoking is to shift the demand curve for cigarettes and other tobacco products.
Public service announcements, mandatory health warnings on cigarette packages, and the
prohibition of cigarette advertising on television are all policies aimed at reducing the
quantity of cigarettes demanded at any given price. If successful, these policies shift the
demand curve for cigarettes to the left, as in panel (a).
Alternatively, policymakers can try to raise the price of cigarettes. If the government taxes the
manufacture of cigarettes, for example, cigarette companies pass much of this tax on to
consumers in the form of higher prices. A higher price encourages smokers to reduce the
numbers of cigarettes they smoke. In this case, the reduced amount of smoking does not
represent a shift in the demand curve. Instead, it represents a movement along the same
demand curve to a point with a higher price and lower quantity, as in panel (b).
SUPPLY
Supply refers to quantity of commodity which the firm/producer is willing to supply at a
particular price and time.

DETERMINANTS OF SUPPLY:
Own price of the commodity
Change in technology
Change in price of inputs or factors of production
Change in tax rate/subsidy
Price of related goods
Objectives of the firm
Nature of the commodity
SUPPLY FUNCTION
Supply function explains the functional relationship between supply of a commodity
and the determinants of supply.

Sn= f(Pn, Pr, T, F, O…)

Where Sn is the quantity supplied of commodity ‘n’
f stands for function
Pn is the price of commodity ‘n’
Pr is prices of related commodities
T stands for Technology of production
F is cost of factors of production
O is objectives of the firm

LAW OF SUPPLY
The law of supply states, when price of a commodity rises, supply also rises and when price
falls, supply also falls, provided other factors remain unchanged.

Examples around you:

•When college students learn that computer engineering jobs pay more than English
professor jobs, the supply of students with majors in computer engineering will
increase.
•When consumers start paying more for cupcakes than for donuts, bakeries will
increase their output of cupcakes and reduce their output of donuts in order to
increase their profits.
•When your employer pays time and a half for overtime, the number of hours you are
willing to supply for work increases.
SUPPLY SCHEDULE AND SUPPLY CURVE
Supply schedule is a Tabular statement showing different quantities of a commodity
which a firm is ready to sell at different prices during a given period of time.
Supply curve is a graph of the relationship between the price of a good and the
quantity supplied.
Supply curve of a firm is generally positive sloped as it rises rightwards when price
rises and its slopes leftwards when price falls.
MARKET SUPPLY
Market supply is the total quantity supplied of a commodity by all the producers at a
given price over a given period.
A market supply schedule shows the total of various quantities offered for Sale by all
the individual forms at different prices. It is also called industry’s supply.
Market supply curve is obtained through horizontal summation of all individual supply
curves.
CHANGE IN SUPPLY AND CHANGE IN QUANTITY
SUPPLIED
CHANGE IN QUANTITY SUPPLIED: When supply changes due to change in own price
of the commodity. (Expansion and contraction of supply)
It is represented graphically in the form of movement along a supply curve.

CHANGE IN SUPPLY: Effect of change in factors other than the price of a commodity
on its supply. (Increase and decrease in supply)
It is represented graphically in the form of shift in supply curve.

CAUSES OF RIGHTWARD SHIFT AND LEFTWARD

SHIFT OF SUPPLY CURVE
Causes of rightward shift Causes of leftward shift
1. Fall in the prices of related goods 1. Rise in the prices of related goods
2. Fall in prices of inputs 2. Rise in prices of inputs
3. Improvement in technology 3. technology becoming obsolete
4. Change in objectives of firm from 4. Change in objectives of firm from
profit maximization to sales sales maximization to profit
maximization maximization
5. Decrease in tax 5. Increase in tax
6. Increase in number of firms in the 6. Decrease in number of firms in the
market market
CHANGE IN QUANTITY SUPPLIED CHANGE IN SUPPLY

SUPPLY AND DEMAND TOGETHER (MARKET

EQUILIBRIUM)
Equilibrium: Figure shows the market supply curve and market demand curve
together. Notice that there is one point at which the supply and demand curves
intersect. This point is called the market’s equilibrium. The price at this intersection is
called the equilibrium price, and the quantity is called the equilibrium quantity. Here
the equilibrium price is $2.00 per cone, and the equilibrium quantity is 7 ice-cream
cones.
The dictionary defines the word equilibrium as a situation in which various forces are
in balance—and this also describes a market’s equilibrium. At the equilibrium price,
the quantity of the good that buyers are willing and able to buy exactly balances
the quantity that sellers are willing and able to sell. The equilibrium price is
sometimes called the market-clearing price because, at this price, everyone in the
market has been satisfied: Buyers have bought all they want to buy, and sellers have
sold all they want to sell.
MARKETS NOT IN EQUILIBRIUM
Excess Supply:
At a price of $2.50 per cone, the quantity of the good supplied (10 cones) exceeds
the quantity demanded (4 cones). There is a surplus of the good: Suppliers are
unable to sell all they want at the going price. A surplus is sometimes called a
situation of excess supply. When there is a surplus in the icecream market, sellers of
ice cream find their freezers increasingly full of ice cream they would like to sell but
cannot. They respond to the surplus by cutting their prices. Falling prices, in turn,
increase the quantity demanded and decrease the quantity supplied. These changes
represent movements along the supply and demand curves, not shifts in the curves.
Prices continue to fall until the market reaches the equilibrium.
Excess Demand:
In this case, the price is $1.50 per cone, and the quantity of the good demanded
exceeds the quantity supplied. There is a shortage of the good: Demanders are
unable to buy all they want at the going price. A shortage is sometimes called a
situation of excess demand. When a shortage occurs in the ice-cream market, buyers
have to wait in long lines for a chance to buy one of the few cones available. With
too many buyers chasing too few goods, sellers can respond to the shortage by
raising their prices without losing sales. These price increases cause the quantity
demanded to fall and the quantity supplied to rise. Once again, these changes
represent movements along the supply and demand curves, and they move the
market toward the equilibrium.
 Thus, regardless of whether the price
starts off too high or too low, the
activities of the many buyers and
sellers automatically push the market
price toward the equilibrium price.
Once the market reaches its
equilibrium, all buyers and sellers are
satisfied, and there is no upward or
downward pressure on the price.

Law of supply and demand: The

claim that the price of any good
adjusts to bring the quantity supplied
and the quantity demanded for that
good into balance.

THREE STEPS TO ANALYZING CHANGES

IN EQUILIBRIUM
1. Decide whether the event shifts the supply or demand curve (or perhaps both).
2. Decide in which direction the curve shifts.
3. Use the supply-and demand diagram to see how the shift changes the equilibrium
price and quantity.

Example 1: Suppose that one summer the weather is very hot. How does this event
affect the market for ice cream?
1. The hot weather affects the demand curve by changing people’s taste for ice
cream. That is, the weather changes the amount of ice cream that people want to buy
at any given price. The supply curve is unchanged because the weather does not
directly affect the firms that sell ice cream.
2. Because hot weather makes people want to eat more ice cream, the demand curve
shifts to the right. Figure 10 shows this increase in demand as a shift in the demand
curve from D1 to D2 . This shift indicates that the quantity of ice cream demanded is
higher at every price.
3. At the old price of $2, there is now an excess demand for ice cream, and this
shortage induces firms to raise the price. As Figure 10 shows, the increase in demand
raises the equilibrium price from $2.00 to $2.50 and the equilibrium quantity from 7
to 10 cones. In other words, the hot weather increases the price of ice cream and the
quantity of ice cream sold.
Example 2: Suppose that during another summer, a hurricane destroys part of the
sugarcane crop and drives up the price of sugar. How does this event affect the
market for ice cream?

Example 3: Now suppose that a heat wave and a hurricane occur during the same
summer.
SUMMARY