Demand and Supply
The most fundamental of concepts in economics, supply and demand make up the backbone of market economies.
Utility: Utility is the satisfaction people get from consuming a good or a service. Utility varies from person to
person.
Demand: refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the
amount of a certain product people are willing to buy at a certain price, and the relationship between price and
quantity demanded is known as the demand relationship.
Supply: represents how much the market can offer. The quantity supplied refers to the amount of a certain good
producers are willing to supply when receiving a certain price. The correlation between price and how much of a
good or service is supplied into the market is known as the supply relationship. Price therefore, is a reflection of
supply and demand.
The Law of Demand
The law of demand states that, if all other factors remain equal, the higher the price, the lower the quantity
demanded. The chart below shows that the curve is a downward slope:
A, B and C are points upon the demand curve. Each point upon the curve reflects a direct relationship between
quantities demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1,
and so on. The demand relationship curve illustrates the negative relationship between price and quantity demanded.
The higher the price the less the quantity demanded (A), and the lower the price, the more quantity will be demanded
(C).
Factors Influencing Demand
The amount of a good demanded depends on:
• the price of the good;
• the income of consumers;
• the demand for alternative goods which could be used (substitutes);
• the demand for goods used at the same time (complements);
• whether people like the good (consumer taste).
The Law of Supply
The law of supply states that the higher the price, the higher the quantity supplied. Producers supply more at a higher
price because selling a higher quantity at a higher price offers greater revenues. The supply relationship shows an
upward slope.
A, B and C are points upon the supply curve. Each point upon the curve reflects a direct relationship between
quantities supplied (Q) and price (P). So, at point B, the quantity supplied will be Q2 and the price will be P2, and so
on.
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Factors Influencing Supply
Supply depends on:
• the price of the good;
• the cost of making the good;
• the supply of alternative goods the producer could make with the same resources (competitive supply);
• the supply of goods actually produced at the same time (joint supply);
• unexpected events that affect supply.
Equilibrium
When supply and demand is equal the economy is said to be in equilibrium. At this point, the allocation of goods is
at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being
demanded. At the given price, suppliers are selling all the goods that they have produced and consumers are getting
all the goods that they are demanding.
Equilibrium price indicates there is no allocative inefficiency. At this point, the price of the goods will be P and the
quantity will be Q. These figures are referred to as equilibrium price and quantity.
Disequilibrium
Disequilibrium occurs whenever the price or quantity is not equal to P or Q.
Excess Supply
If price is set too high, excess supply will be created within the economy, and there will be allocative inefficiency.
At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At P1, however, the quantity
that the consumers want to consume is at Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much
is being produced and too little is being consumed. The suppliers are trying to produce more goods, which they hope
to sell in hope of increasing profits, but those consuming the goods will purchase less because the price is too high,
making the product less attractive.
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Excess Demand
Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many
consumers want the good while producers are not making enough of it.
In this situation, at price P1, the quantity of goods demanded by consumers at this price is Q2. Conversely, the
quantity of goods that producers are willing to produce at this price is Q1. Thus, there are too few goods being
produced to satisfy the wants (demand) of the consumers. However, as consumers have to compete with one other to
buy the good at this price, the demand will push the price up, making suppliers want to supply more, thereby
bringing the price closer to its equilibrium.
Shifts vs. Movement
For economics, the “movements” and “shifts” in relation to the supply and demand curves represent very different
market phenomena:
Movements – A movement refers to a change along a curve. On the demand curve, a movement denotes a change in
both price and quantity demanded from one point on the demand curve to another point on the curve. The movement
implies that the demand relationship remains dependable. Therefore, a movement along the demand curve will occur
when the price of the good changes and the quantity demanded changes in accordance to the original demand
relationship. In other words, a movement occurs when a change in quantity demanded is caused only by a change in
price, and vice versa.
Like a movement along the demand curve, a movement along the supply curve means that the supply relationship
remains consistent. Therefore, a movement along the supply curve will occur when the price of the good changes
and the quantity supplied changes in accordance to the original supply relationship. In other words, a movement
occurs when a change in quantity supply is caused only by a change in price, and vice versa.
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Shifts – A shift in a demand or supply curve occurs when a good's quantity demanded or supplied changes even
though price remains the same. It means that quantity demand is affected by a factor other than price.
Indirect Taxes and Subsidies
In the figure below an indirect tax has been added to SS. This has the effect of shifting the supply curve up vertically
by the amount of the tax.
In this figure a subsidy has been given to the firm. This has the effect of making firms willing to supply more at each
price and so shifts the supply curve downwards.
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Price Elasticity of Demand
Price elasticity of demand measures the responsiveness of demand to a given change in price:
PED = Percentage change in quantity demanded/Percentage change in price.
Features of price elasticity of demand
Feature Elastic goods Inelastic goods
PED value Greater than 1 Less than 1
A rise in price means A larger fall in demand A smaller fall in demand
Slope of demand curve Flat Steep
Number of substitutes Many Few
Type of good Luxury Necessity
Price of good Expensive Cheap
Example Expensive cars Petrol
Income Elasticity of Demand
Income elasticity of demand (YED) measures the responsiveness of demand to a given change in income:
YED = Percentage change in quantity demanded/Percentage change in income
If YED is negative then the good is inferior.
If YED is positive then the good is normal.
Cross Elasticity of Demand
Cross elasticity of demand (XED) measures the responsiveness of demand for one good (z) to a given change in the
price of a second good (w):
XED = Percentage change in quantity demanded of good A/Percentage change in the price of good B
If XED is positive then the two goods are substitutes.
If XED is negative then the two goods are complements.
Price Elasticity of Supply
Price elasticity of supply (PES) measures the responsiveness of supply to a given change in price.
PES = Percentage change in quantity supplied/Percentage change in price.
Features of elasticity of supply
Feature Elastic goods Inelastic goods
PES value Greater than 1 Less than 1
A rise in price means A larger rise in supply A smaller rise in supply
Slope of supply curve Flat Steep
The good is produced Rapidly Slowly
The time period is Months Days
The firm has Large stocks Limited stocks
Example Screws Beef
Iqbal Mahmood
Economics Faculty
