Pamantasan ng Lungsod ng Maynila

College of Architecture and Sustainable Built Environment

Business Management and Application for Architecture

Law of Demand and Supply

De Vera Cabasag, Vanessa V.

Pastrano, Danielle Angeli G.
Peñalosa, Rochelle Anne P.

Ar. Nadia Kristine N. Cruz

Instructor

Date of Submission
02/12/2024
I. BASIC PRINCIPLES OF SUPPLY AND DEMAND

Definition

● The law of demand and supply is the backbone of a market economy. The fundamental
concept refers to the relationship between the sellers and buyers of a particular resource.
Here, a change in one of the parameters causes a change in another. According to this
theorem, when there is a higher demand for a commodity, the need for its supply will be
high and vice versa. The equation states that the desire for a product and its fulfillment are
interdependent.

● The law of supply and demand is based on two economic laws: the law of supply and the
law of demand. According to the law of supply when prices rise, companies see more
profit potential and increase the supply of goods and services. The law of demand states
that as prices rise, consumers buy fewer goods.

Introduction to the Market

A market is a place that facilitates the exchange of goods and services. It may be represented by
physical locations where transactions are made. These include retail stores and similar businesses that
sell individual items to wholesale markets selling goods to distributors. The virtual market or
Internet-based stores on the other hand are auction sites such as Amazon, eBay, Shopee, and Lazada
are examples of markets where transactions can occur entirely online, and the parties involved do not
physically connect.

II. DEMAND

Definition

Demand is the amount of a product that consumers are willing and able to purchase at any given price.
It is an economic concept that relates to a consumer's desire to purchase goods and services and
willingness to pay a specific price for them. An increase in the price of a good or service decreases the
quantity demanded. Whereas a decrease in the price of a good or service will increase the quantity
demanded.

1. Law of Demand

● The law of demand states that the higher the price, the lower the quantity demanded; and the
lower the price, the higher the quantity demanded. Naturally, consumers are willing and able
to buy less as the price rises. This results in a downward-sloping demand curve.
● The law of demand states that there is an inverse relationship between price and quantity
demanded.
○ Consumers tend to buy more units when the unit price is lower, ceteris paribus.
○ Ceteris paribus means that we hold other things unchanged.
 Figure 1 : The demand curve

Shifts in Demand Curve

The demand curve can shift outward (to the right) or inward (to the left). If the demand curve shifts
out, this means that more is demanded at each price level. This increase in demand is shown by the
shift to a new demand curve, D1 in the diagram. An inward shift to a new curve at D2 indicates a
decrease in demand; this indicates that less is demanded at each price level.

Figure 2: Shift in Demand curve

Factors that affect demand

1. The price of the product

● There is an inverse (negative) relationship between the price of a product and the
amount of that product consumers are willing and able to buy. Consumers want to
buy more of a product at a low price and less of a product at a high price. This inverse
relationship between price and the amount consumers are willing and able to buy is
often referred to as The Law of Demand. (Experimental Economics Center, 2006)

2. Increase and decrease in consumers’ income.

 ●
The effect that income has on the amount of a product that consumers are willing and
able to buy depends on the type of goods we're talking about. For most goods, there is
a positive (direct) relationship between a consumer's income and the amount of the
good that one is willing and able to buy. In other words, for these goods when income
rises the demand for the product will increase; when income falls, the demand for the
product will decrease. We call these types of goods normal goods. (Experimental
Economics Center, 2006)
3. A change in tastes and fashion.
● This is a less tangible item that still can have a big impact on demand. There are all
kinds of things that can change one's tastes or preferences that cause people to want to
buy more or less of a product. (Khan Academy, 2018)

4. Change in the price of other goods.

● While it is clear that the price of a good affects the quantity demanded, it is also true
that expectations about the future price or expectations about tastes and preferences,
income. Complementary goods are those used alongside another good. For example,
if demand for holidays increases.
5. Population changes
● A society with relatively more children, like the United States in the 1960s, will have
a greater demand for goods and services like tricycles and daycare facilities. A
society with relatively more elderly persons, as the United States is projected to have
by 2030, has a higher demand for nursing homes and hearing aids. Similarly, changes
in the size of the population can affect the demand for housing and many other goods.
Each of these changes in demand will be shown as a shift in the demand curve. (Khan
Academy, 2018)

6. Government legislation may also have an impact on the demand for certain products.
● When legislation was passed making child seats compulsory in vehicles there was a
significant increase in demand at any given price. (Bristol Cathedral Choir School,
2010)

2. Quantity Demanded (Qd)

Linear Demand Function

A linear demand function is an algebraic formula for calculating demand curves without having to
draw a demand function graph.

Qd = a +bP + cM+ dPR +eT + f Pe + gN

Where:

P = price of good or service

M = income of consumers
PR = prices of related goods and services
T = taste patterns of consumers
PE = expected future price of the product
N = number of consumers in marker

The intercept of this equation is a. This is the quantity demanded for a good when all the other
variables are equal to zero. The other parameters b, c, d, e, f, and g are called slope parameters.

Direct Demand Function

The direct demand function or simple demand shows how quantity demanded, Qd, is related to
product price, P, when all other variables are held constant.

Qd = f(P)

Inverse Demand Function

Naturally, price (P) is plotted on the vertical axis & quantity demanded (Qd) is plotted on the
horizontal axis. The equation plotted is the inverse demand function

P = f(Qd)

III. SUPPLY

Definition
Supply is a fundamental economic concept that describes the total amount of a specific good or
service that is available to consumers. Supply can relate to the amount available at a specific price or
the amount available across a range of prices if displayed on a graph. This relates closely to the
demand for a good or service at a specific price; all else being equal, the supply provided by
producers will rise if the price rises because all firms look to maximize profits.

The Law of Supply

The law of supply simply states that there is a direct relationship between price and quantity supplied.
This means that producers tend to want to sell more units when the per unit price is higher, ceteris
paribus.

Figure 3: The supply curve

Shifts in Supply Curve
Similar to demand, supply can also change independently of any price change. Supply at each price
level can increase or the amount supplied at each price level can decrease.

Figure 4: Shifts in Supply Curve

Factors that Affect Supply

1. Change in costs.
● A supply curve shows how quantity supplied will change as the price rises and falls, assuming
ceteris paribus—no other economically relevant factors are changing. If other factors relevant
to supply do change, then the entire supply curve will shift. A shift in supply means a change
in the quantity supplied at every price. (Khan, Academy, 2016)

2. Weather can have a significant impact on the supply of agricultural products.

● In 2014, the Manchurian Plain in Northeastern China—which produces most of the country's
wheat, corn, and soybeans—experienced its most severe drought in 50 years. A drought
decreases the supply of agricultural products, which means that at any given price, a lower
quantity will be supplied. Conversely, especially good weather would shift the supply curve to
the right. (Khan, Academy, 2016)

3. Introduction of new technology.

● A technological improvement that reduces costs of production will shift supply to the right,
causing a greater quantity to be produced at any given price. For instance, in the 1960s, a
major scientific effort nicknamed the Green Revolution focused on breeding improved seeds
for basic crops like wheat and rice. By the early 1990s, more than two-thirds of the wheat and
rice in low-income countries around the world was grown with these Green Revolution
seeds—and the harvest was twice as high per acre.(Khan, Academy, 2016)

4. Legislation can also have a significant impact on the supply of some products.
● Government policies can affect the cost of production and the supply curve through taxes,
regulations, and subsidies. For example, the U.S. government imposes a tax on alcoholic
beverages that collects about $8 billion per year from producers. Taxes are treated as costs by
 businesses. Higher costs decrease supply for the reasons discussed above. (Khan, Academy,
2016)

Quantity Supplied (Qs)

Quantity supplied is the amount of a good or service offered for sale during a given period. The time
can be a week, a month, or even years.

General Supply Function

Qs = f(P, PI, Pr, T, Pe, F)

Where:

Qs = quantity
P = price of good or service
PI = input prices
Pr= prices of related goods and services
T = technological advances
PE = expected future price of the product
N = number of firms producing products

The other parameters k, l, m, n, r, & s are called slope parameters.

The sign of the parameter shows how the variable is related to Qs. A positive sign indicates a direct
relationship, and a negative sign indicates an inverse relationship.

Direct Supply Function

The direct supply function, or Supply shows how quantity supplied, Qs, is related to product price, P,
when all other variables are held constant.

Qs = f(P)

Inverse Supply Function

Traditionally, price (P) is plotted on the vertical axis & quantity supplied (Qs) is plotted on the
horizontal axis.

P= f(Qs)
IV. MARKET EQUILIBRIUM

The Determination of Price and Quantity

The Equilibrium Price is the price that balances supply and demand. In any market it is the price at
which quantity demanded equals quantity supplied. Equilibrium price and quantity are determined by
the intersection of demand and supply curves. At the point of intersection

Qd = Qs

Figure 3: The Market Equilibrium

Disequilibrium
The Disequilibrium of prices happens when the market experiences imbalances where the shortage
and surplus occurs.

● Excess demand (Shortage)

When the price is below the equilibrium price, the quantity demanded exceeds the quantity
supplied. This is what we call excess demand or a shortage.

● Excess Supply (Surplus)

When the price is above the equilibrium price, the quantity supplied exceeds the quantity
demanded. This is what we call an excess supply or a surplus.

V. PRICE ELASTICITY OF SUPPLY

Definition
● The Price Elasticity of Supply (PES), as defined by Lynham (2018), is calculated as the
percentage shift in quantity supplied divided by the percentage shift in price. Moreover,
according to the National Institute of Open Schooling, the price elasticity of supply gauges
how the quantity supplied of a commodity reacts to alterations in its price.

● According to Ross (2022), goods and services are classified as either elastic or inelastic based
on their responsiveness to changes in price. Elastic products are highly sensitive to price
movements, while inelastic products are not easily influenced by changes in price.

○ If increasing the supply of a product is difficult due to factors such as a shortage of

capacity or challenges in hiring additional workers, the supply is considered inelastic.
In such cases, a price increase will result in a smaller percentage change in supply.
(Pettinger, 2019).

○ On the other hand, when companies can easily increase their supply, the supply is
elastic, and a price increase will lead to a more significant percentage change in
supply (Pettinger, 2019).
Factors Affecting Elasticity of Supply
Various factors influence the price elasticity of supply. Recognizing these factors can assist businesses
and policymakers in making well-informed decisions regarding pricing and production levels
(FasterCapital, 2023).

1. Availability of Resources
● Suppliers can quickly increase their production in response to changes in supply if the
necessary resources for manufacturing a specific commodity are readily available
without incurring significant costs. The concept leads to a high price elasticity of
supply, as suppliers can easily adjust their output levels to match fluctuations in
demand.

Examples:
● Consider wheat farming, which is flexible in responding to changes in
demand because it's widely available. Farmers can freely increase production
as needed.

● Producing rare metals like gold is less flexible due to their limited
availability, making it difficult to increase production in response to demand.

2. Time Frame for Production

● If suppliers can swiftly boost production, the supply's price elasticity would be high.
Conversely, if increasing production takes a considerable amount of time, the price
elasticity of supply would be low.

Examples:
● Growing crops like wheat and corn are easily adjustable because they have a
short production cycle, allowing farmers to increase output rapidly.

● Making items like cars and planes is less flexible because the complex
manufacturing process takes a long time to increase production.

3. Degree of Competition in the Market

● In markets with intense competition, suppliers are inclined to adapt their production
in response to demand shifts, resulting in a high price elasticity of supply. On the
other hand, in markets with less competition, suppliers may be less inclined to adjust
to demand changes, resulting in a low price elasticity of supply.

Examples:
● The smartphone market is very competitive, so companies can easily make
more or fewer phones based on demand.
 ● The prescription drug market is less competitive because of regulations and
patents, so companies might not change production quickly in response to
demand shifts.

Tools Used to Summarize the Relationship Between Supply and Price

These tools, as highlighted by Khan Academy (2019), are essential for understanding and analyzing
the principles of supply in economics.

1. Supply SchedulesCurves
● These are tables that provide a systematic display of the quantity supplied at various
price points.

2. Supply Curves
● Represented in graph form, supply schedules visually illustrate the correlation
between the quantity supplied and corresponding prices.

5 Categories of Price Elasticity of Supply

Elasticity can be categorized according to the number calculated in the PED formula.

If Percentage change in
quantity ÷ percentage change Category of Elasticity Description
in price is equals to..

∞ or Infinity Perfectly elastic The reaction to price is total

and endless: a price change
leads to the quantity dropping
to zero.

> 1 or Greater than 1 Elastic Shows a strong reaction to

changes in price.

1 Unitary Indicates a consistent reaction

of either demand or supply.

< 1 or Less than 1 Inelastic Signals a weak reaction to

changes in price.

0 Perfectly inelastic There is absolutely no change

in quantity when the price
changes.
Price Elasticity of Supply (PES) Formula (Lynham, 2018)

%𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
● Price Elasticity of Supply =
%𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

● % change in quantity supplied = [(Q1 - Q0) / Q0] x 100%

○ Q0 - Old quantity
○ Q1 - New quantity

● % change in price = [(P1 - P0) / P0 ] x 100%

○ P0 - Old price
○ P1 - New price

● To summarize,
(𝑄1 − 𝑄0)
𝑄0
𝑥 100%
Price Elasticity of Supply (PES) = (𝑃1 − 𝑃0)
𝑃0
𝑥 100%

Practical Applications Using Examples

Example 1:
Given the following data for the supply and demand of movie tickets, calculate the
price elasticity of supply when the price changes from $9.00 to $10.00 (Prateek Agarwal,
2018).

Price Quantity Demanded Quantity Supplied

$ 7.00 100 25

$ 8.00 90 45

$ 9.00 75 75

$ 10.00 55 105

$ 11.00 30 125

Given:
P0 or Price (Old) = $9
P1 or Price (New) = $10
Q0 or Quantity Supplied (Old) = 75
Q1 or Quantity Supplied (New) = 105

Solve:
(𝑄1 − 𝑄0)
𝑄0
𝑥 100%
PES = (𝑃1 − 𝑃0)
𝑃0
𝑥 100%
 (105 − 75)
75
𝑥 100%
PES = (10 − 9)
9
𝑥 100%
40%
PES =
11.11 %

PES = 3.6
Since the answer is greater than 1, therefore it is Elastic.

Example 2:
If the price of oranges increases by 40% per kg and its quantity supplied increases
from 100 to 125 kgs. Calculate price elasticity of supply of oranges (National Institute of
Open Schooling).

Given:
%change in price = 40%
Q0 or Quantity Supplied (Old) = 100
Q1 or Quantity Supplied (New) = 125

Solve:
(𝑄1 − 𝑄0)
𝑄0
𝑥 100%
PES =
40%

(125 − 100)
100
𝑥 100%
PES =
40%

25%
PES =
40%

PES = 0.625
Since the answer is less than 1, therefore it is Inelastic.

Example 3:
Using the data shown in the table below about supply of alarm clocks, calculate the
price elasticity of supply from point L to point M. Classify the elasticity (Khan Academy).

Point Price Quantity Supplied

K $9 70

L $ 10 80
 M $ 11 88

N $ 12 95

Given:
P0 or Price (Old) = $10
P1 or Price (New) = $11
Q0 or Quantity Supplied (Old) = 80
Q1 or Quantity Supplied (New) = 88

Solve:
(𝑄1 − 𝑄0)
𝑄0
𝑥 100%
PES = (𝑃1 − 𝑃0)
𝑃0
𝑥 100%

(88 − 80)
80
𝑥 100%
PES = (11 − 10)
10
𝑥 100%

10%
PES =
10%

PES = 1
Since the answer is 1, therefore it is Unitary.

Importance of Price Elasticity of Supply (PES)

According to Pettinger (2019), Understanding PES is crucial for any business that wants to:
● optimize its operations
● maximize profits
● stay competitive in the market

VI. PRICE ELASTICITY OF DEMAND

Definition
● The price elasticity of demand is a measurement of the change in demand for a product or
service in relation to a change in its price.
● Various categories of elasticity identify the ratio of change in demand in relation to price.
Elastic demand is considered if a change in demand is substantially large when there is a price
change or when the demand point is drawn out far from the previous point. Inelastic demand
is considered if a change in demand is small when there is a price change or when the quantity
does not draw out much from its previous point.
● In some cases, the ratio varies because the prices of some goods are very inelastic therefore
price decrease does not boost demand that much, and a price increase does not harm demand
 either. On the other hand, some goods are much more elastic in price causing great changes in
demand or supply.
● A significant example of goods with minimal price elasticity is gasoline. Despite the price
fluctuations, consumers will continue to avail as much as they need to. Common consumers
of gasoline include drivers, airlines, and the trucking industry.

Importance
● The importance of price elasticity of demand to sellers is for them to make smart and
informed decisions regarding consumer pricing sensitivity thus coming up with pricing
strategies.
● Price elasticity of demand is key for product makers to establish manufacturing plans, and
vigilantly plan out future production and expansion projects.
● Most importantly, the price elasticity for demand is key for government units to assess taxing
on goods to regulate the market.

PED Formula
● It is a method used to measure the change in the demand for products and services due to
changes in the price. It shows the relationship between the price of products in the market to
the demand.

Explanation for the formula

This formula shows the responsiveness of demand to price changes in the market. It is the measure of
elasticity of demand in relation to price which is calculated by dividing the percentage change in
quantity (∆Q/Q) by the percentage change in price (∆P/P). When plotted in a graph, the price and
quantity demanded move in opposite directions, and the price elasticity of demand is always a
negative number, an indication of a downward-sloping demand curve andusually read at an absolute
value, without a negative sign. It is also not followed by any units as it is a ratio of percentage
changes.
Price Elasticity of Demand =
Percentage Change in Quantity (∆Q/Q) ÷ Percentage Change in Price (∆P/P)
Furthermore, the percentage change in quantity and price can be calculated using the Midpoint
Method for Elasticity. It uses the same base of average quantity and average price no matter when the
price rises or falls and comes up with the same elasticity between two different price points. The
Midpoint Method is expressed as the following equations:

(𝑄1− 𝑄0)
Percentage (%) change in quantity =[ (𝑄1 + 𝑄0) / 2 ] × 100
(𝑃1− 𝑃0)
Percentage (%) change in price = [ (𝑃1 + 𝑃0) / 2 ] × 100

Where:
Q0 - Initial quantity
Q1 - Final quantity
P0 - Initial price
P1 - Final price

In reiteration, the price is elastic if demand fluctuates by a large amount when the price varies a little.
This happens when products have substitutes and consumers are relatively price-sensitive. The price is
considered inelastic if demand changes in a small bound even if there is a significant price change.
This happens when there is a lack of suitable substitutes and consumers are still willing to buy despite
relatively high prices.

How to calculate?

1. Identify P0 and Q0, which are the initial price and quantity, and then the final price point and
quantity, which are termed Q1 and P1 respectively.
2. Solve the numerator of the formula which is the percentage change in quantity.
(𝑄1− 𝑄0)
(∆𝑄/𝑄) = [ (𝑄1 + 𝑄0) / 2 ] × 100

3. Solve the denominator of the formula which is the percentage change in price.
(𝑃1− 𝑃0)
(∆𝑃/𝑃) = [ (𝑃1 + 𝑃0) / 2 ] × 100

4. Finally, calculate the price elasticity of demand by dividing the expression in Step 2 by Step
3.
Price Elasticity of Demand = (∆𝑄/𝑄) ÷ (∆𝑃/𝑃)

Factors that affect Price Elasticity of Demand

1. Presence of substitutes
● The presence of products that can be substituted for others affects the price elasticity
of demand. The more accessible for shoppers to purchase substitute products, the
more the price will decrease.
● A significant example is the consumers who enjoy both coffee and tea. If the price for
coffee increases, they can easily switch to tea, and vice versa.
 2. Urgency of purchase
● The elasticity of product demand increases with the level of discretion in the
purchase. In other words, when a purchase is more discretionary, its demand is more
responsive to price increases, resulting in a greater decline in quantity demanded.
Conversely, for products with lower levels of discretion, the decline in quantity
demanded is less notable.
● A significant example is planning to buy a new washing machine but you still have an
old one that works, but it is outdated. Instead of immediately purchasing a new one,
you will just wait for its price to decrease in the future or for the old one to break
down. Another example for inelastic price are products that has few good substitutes
such as luxury items, addictive products, and add-on products.

3. Duration of price change

● This is the length of time that the price change lasts also known as time sensitivity.
Consumers may accept prices that are fluctuating by season rather than completely
change their buying habits.
● A significant example is mall sales. Demand responsiveness to price changes is
different for one-day sale than that of seasonal price change or even a year.

5 Categories of Price Elasticity of Demand

Elasticity can be categorized according to the number calculated in the PED formula.

Percentage change in Category of Description

quantity ÷ percentage elasticity
change in price =

∞ or Infinity Perfectly Elastic Changes in price result in demand declining to

zero

Greater than 1 Elastic Changes in price yield a significant change in

demand

1 Unitary elasticity Changes in price yield equivalent (percentage)

changes in demand

Less than 1 Inelastic Changes in price yield an insignificant change in

demand

0 Perfectly Inelastic Changes in price yield no change in demand

Practical applications using examples

Example # 1:
Suppose that the price of mangoes falls by 6% from Php90.00 per kilo to Php 84.60. In response,
grocery shoppers increase their mango purchase by 20%. What is the type of elasticity of demand for
mangoes?
Given:
 P0 - Php 90
P1 - Php 84.60
(∆P/P) - 6%
(∆Q/Q) - 20%
Solve:
PED = (∆Q/Q) ÷ (∆P/P)
PED = 0.20 ÷ 0.06 = 3.33
PED = 3.33, greater than 1, Elastic
Thus:
The demand for mangoes is 3.33, elastic.

Example # 2:
There is a surge in gasoline price at 75% that resulted in the decline of purchasing of gasoline by 25%.
Calculate the price elasticity of demand.
Given:
Percentage change in quantity = (-)25%
Percentage change in price = 75%
Solve:
PED = Percentage change in quantity ÷ Percentage change in price
PED = -0.25 ÷ 0.7
PED = -0.3571, less than 1, Inelastic
Thus:
The price elasticity of demand for gasoline is 0.3571, inelastic.

Example # 3: (using the Midpoint Method)

Calculate the price elasticity of demand when the price falls from point B to point A using data from
the figure below:

Solve:
(𝑄1− 𝑄0)
(∆𝑄/𝑄) = [ (𝑄1 + 𝑄0) / 2 ] × 100
(3,000− 2,800)
= [ (3,000 + 2800) / 2 ] × 100
(∆𝑄/𝑄) = 6. 9 %

(𝑃1− 𝑃0)
(∆𝑃/𝑃) = [ (𝑃1 + 𝑃0) / 2 ] × 100
(60− 70)
= [ (60 + 70) / 2 ] × 100

(∆𝑃/𝑃) = − 15. 4 %

PED = (∆𝑄/𝑄) ÷ (∆𝑃/𝑃)

6.9
PED = −15.4

PED = 0.45. The elasticity of demand of price drop from B to A is 0.45, inelastic.
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