Chapter Three

Demand and Supply

 Demand

1. Demand and Quantity Demanded

Demand Quantity Demanded
If you demand something,
then you The quantity demanded of a
1. Want it, good or service is the number
2. Have enough money to buy
of units of that good or
it, and
3. Have made a plan to buy it. service that consumers are
willing to buy, and plan to
Wants are the unlimited
desires or wishes people have buy, at a particular price
for goods and services. Demand
during a given time period.
reflects a decision about which
2. The law of demand:

The law of demand states that:

“There is a negative relationship between the price

of a good and the quantity demanded of that good,
ceteris paribus (keeping all other factors constant)”.

In other words, the higher the price of a good, the

smaller is the quantity demanded, keeping all other
factors constant (ceteris paribus). The lower the
price of a good, the larger is the quantity demanded,
keeping all other factors constant (ceteris paribus).
The negative relationship between price and quantity
demanded results from Substitution effect and Income
effect.
A) Substitution effect:
When the price of a good X rises, relative to the prices
of other goods, good X becomes relatively more
expensive, while other goods become relatively
cheaper.
Therefore, consumers will reduce the quantity
demanded of X and will increase their demand on a
substitute for X. That is, consumers will substitute
another good for X.
B) Income effect:
 When the price of good X rises, while consumers’
income and the prices of other goods are constant,
consumers will not afford to buy the same quantity of
goods and services they previously bought.

 That is, the purchasing power of their income (which

is known as real income) will decrease. Therefore, the
quantity demanded of good X (and other goods or
services as well) will decrease.
 Therefore, as the price of good X increases, both
substitution and income effects will lead to a
decrease in the quantity demanded of X. The sum
of the substitution and income effects is the total
price effect.
Qd of other
As the Price of X increases Qd of X
goods

Substitution Effect Decreases Increases

Income Effect Decreases Decreases

Total Price Effect Decreases Undetermined

3. Demand Schedule
The demand schedule is a table that shows the
negative relationship between the price of a good
and the quantity demanded of that good, holding
other factors constant.
Price Quantity Demanded
(Pounds per 1 can of (Cans of Pepsi)
Pepsi)
0 20
1 18
2 16
3 14
4 12
5 10
4. Demand Curve

 The demand curve is a curve that shows the

negative relationship between the price of a good
and the quantity demanded of that good, holding
other factors constant.
Demand for Pepsi
6

5
Price (L.E per 1 can of Pepsi)

0
0 5 10 15 20 25

Quantity Demanded of Pepsi

A rise in the price of Pepsi, other things remaining
the same, causes a decrease in the quantity
demanded and a movement up along the demand
curve.
A fall in the price of Pepsi, other things remaining
the same, causes an increase in the quantity
demanded and a movement down along the demand
curve.
 The Demand curve is a willingness-and-ability-to-
pay curve. The higher the price, the smaller is the
number of consumers willing and able to pay the
price.
5. Demand Function
QD = f(P)
QD = a – bP
Where:
QD : quantity demanded.
a : the intercept which is the value of QD when the price = 0. The
value of (a) represents the maximum quantity demanded.
(-) : the negative sign indicates the negative relationship between
the price and the quantity demanded.
b : the slope of the demand function. It is the change in quantity
demanded due to a one-unit change in price.
Example:
How to derive the demand function from the following table?
Price
Quantity Demanded
(Pounds per 1 can of
(Cans of Pepsi)
Pepsi)
0 20
1 18
2 16
3 14
4 12
5 10
(a) is the value of QD when price equals zero; then
a = 20.
(b) is the slope of the demand function. It is
calculated as:

This means that when price increases by 1 pound

quantity demanded decreases by 2 cans of Pepsi.
So we can write the equation as:
QD = 20 – 2P
6. A Change in Demand
 When anything affect buying plans other than the
change in the price of the good, there is a change in
demand for that good.
 Factors that change demand and shift demand curve
are:
 The prices of related goods
 Expected future prices
 Consumers’ Income
 Expected future income and credit
 Population
 Preferences (Tastes)
1. Prices of Related Goods:

Related Goods

Substitutes Complements

Are goods that can be used Are goods the are

in place of another good. consumed together.
Example: Tea and Coffee Example: Tea and Sugar

When the price of a When the price a

substitute rises, the demand complement rises, the
for the good increases and demand for the good
its demand curve shifts to decreases and its demand
the right. curve shifts to the left.
 If the price of coffee (a substitute for tea) rises,
holding other things constant, people buy less of
coffee (the substitute good) and buy more of tea
(the main good).
A rise in the price of sugar (a complement to tea),
holding other things constant, leads to a decrease in
the demand for tea, because people will reduce
their quantity of sugar demanded so they will have
to reduce their consumption of tea. Therefore, the
demand for tea decreases and the demand curve for
tea will shift to the left.
2. Expected future prices
 If you expect that prices are going to increase in the future,
then the demand for a good is going to increase now.
 Example, if you expect that the price of sugar is going to
increase next month, today you are going to demand more
sugar. Therefore, the demand curve for sugar will shift to
the right.
 In contrast, if you plan to buy a new laptop and you expect
that the price of laptops will decrease next month, you will
reduce your demand now and wait until next month to buy
it. Therefore, today’s demand curve for laptops will shift to
the left.
3. Consumers’ Income
We have to differentiate between two different types of goods: Normal goods and Inferior goods.

Normal goods Inferior goods

 In case of normal  In case of inferior goods,
goods, when income when income increases,
increases, consumers consumers buy less of
buy more of this this commodity and the
commodity and the demand curve shifts
demand curve shifts leftward.
rightward.  Ex: Public transportation
 Ex: cars
4. Expected Future Income and Credit
 When you expect that your income is going to
increase next month or when credit is easy to
obtain, the demand will increase now and demand
curve shifts to the right.

 When you expect that your income is going to

decrease next month or when credit is difficult to
obtain, the demand will decrease now and demand
curve shifts to the left.
5. Population
The larger the population, the greater is the demand
for all goods. An increase in population means an
increase in the number of consumers, so demand
increases and demand curve shifts to the right.
6. Preferences:
People with the same income have different demands
if they have different preferences.
When a good becomes fashionable for whatever
reason, demand for this good increases because tastes
changed in favor of that good. This shifts the demand
curve to the right.
 7. A Change in the Quantity Demanded Versus
a Change in Demand
A shift in demand curve A movement along the curve
  When the price of the good
If the price remains the same but
one of the other factors affecting changes and everything else
demand changes, demand changes remains the same, the quantity
and the demand curve shifts demanded changes and there is
a movement along the demand
curve.
 Supply
1. Supply and Quantity Supplied

Supply Quantity Supplied

If a firm supplies a good or The quantity supplied of a
service, then the firm good or service is the
- Has the resources and the number of units of that good
technology to produce it, or service that producers
- Can profit from producing are willing to sell, and plan
it, and
to sell, during a given time
- Has made a definite plan to period at a particular price.
produce and sell it.
2. The Law of Supply

 The law of supply states that, there is a positive

relationship between the price of the good and
the quantity supplied of the same good, ceteris
paribus.

 In other words, The law of supply states that

other things remaining the same, the higher the
price of a good, the greater is the quantity
supplied; and the lower the price of a good, the
smaller is the quantity supplied.
3. Supply Schedule

 The supply schedule is a table that shows the positive

relationship between the price of a good and the quantity
supplied of the same good, holding everything else
constant.
Price Quantity Supplied
(Pounds per 1 can (Cans of Pepsi)
of Pepsi)
0 10
1 12
2 14
3 16
4 18
5 20
4. Supply Curve
 The supply curve is a curve that shows the positive
relationship between the price of a good and the
quantity of that good supplied, holding everything
else constant.
Supply
6

4
Price

0
8 10 12 14 16 18 20 22
Quantity Supplied
5. Supply Function
Qs = f(P)
Qs = c + d P
Where:
Qs: quantity supplied.
c : the intercept of the supply function, which is the value of Q s
when price = 0.
(+) : the positive sign stands for the positive relationship between
the price and the quantity supplied.
d : the slope of supply function. It is calculated as the change in
quantity supplied due to a one-unit change in price.
Example:

How to obtain the supply function from this table?

Price Quantity Supplied

(Pounds per 1 can of (Cans of Pepsi)
Pepsi)
0 10
1 12
2 14
3 16
4 18
5 20
(c) is the value of Qs when price equals zero; then c = 10.
(d) is the slope of the supply function. It is calculated as:

This means that when price increases by 1 pound

quantity supplied increases by 2 cans of Pepsi.

Therefore, the supply function is given as:

Qs = 10 + 2P
6. Factors Affecting Supply

 Factors that affect selling plans (shift the supply

curve):
1. The prices of factors of production
2. The prices of related goods produced
3. Expected future prices
4. The number of suppliers
5. Technology
6. State of nature
1. Prices of factors of production:
 If the price of a factor of production used to
produce a good rises, the minimum price that a
supplier is willing to accept for producing each
quantity of that good rises.
 So a rise in the price of a factor of production,
decreases the supply of the good and shifts the
supply curve leftward.
Example:
 Ifwage rates increase, the cost of labor increases
and therefore supply curve shifts to the left.
2. Prices of Related Goods:

Related Goods

Substitutes Complements

A substitute in
production for a good is Goods are complements
another good that can in production if they
be produced using the must be produced
same resources. together.

The supply of a good

The supply of a good
increases if the price of
increases if the price of
a substitute in
a complement in
production falls.
production rises.
Ex: T-shirts and
Ex: printer and cartridge
Sweatshirts.
 Ifthe prices of T-shirts increase, then the supply of
sweatshirts decreases as producers are going to shift
resources from the production of sweatshirts to the
production of T-shirts.

 If the price of cartridge increases, the supply of

printers increases and the supply curve of printers’
shifts to the right.

 The supply of olives will increase if the price of olive

oil increases.
3. Expected future prices:
If the expected future price of a good rises, the
supply of the good today decreases and the supply
curve shifts leftward.
Example:
 If the producer expects that the price of meat is
going to increase next month, then supply of meat
is going to decrease now, in order to sell more next
month at higher prices and maximize profits.
4. The number of suppliers:
 The larger the number of suppliers of a good, the greater is
the supply of the good. An increase in the number of
suppliers shifts the supply curve rightward.
5. Technology:
 Advances in technology create new products and lower the
cost of producing existing products. So advances in
technology increase supply and shift the supply curve
rightward.
6. The State of Nature
 The state of nature includes all the natural forces that
influence production such as the weather.
 For example, natural disasters (e.g. floods or tornadoes)
decrease supply of agricultural products and shift their
supply curve leftward.
7. A Change in the Quantity Supplied Versus a Change
in Supply
A) Movement Along the Supply Curve (change in quantity
supplied)
 When the price of the good changes and other factors
remain constant, the quantity supplied changes and
there is a movement along the supply curve.
B) A shift of the Supply Curve (change in supply)
If the price remains the same but one or more of the
other factors affecting supply change, supply changes
and the supply curve shifts either to the right if
supply increases or shifts to the left is supply
decreases.