Week 3_Lec 5_
Demand
By demand, we mean the quantity of any commodity that ‘buyers are willing and have
the ability to buy.’ Both the conditions must be satisfied together before goods can be
demanded.
Example: One who wishes to purchase a laptop, he must have enough money or
resources to do so.
Demand Function
Demand function is a mathematical function showing relationship between the quantity
demanded of a commodity and the factors influencing demand.
Dx = f (Px, Py, T, Y, A, Pp, Ep, U)
In the above equation,
Dx = Quantity demanded of a commodity
Px = Price of the commodity
Py = Price of related goods
T = Tastes and preferences of consumer
Y = Income level
A = Advertising and promotional activities
Pp = Population (Size of the market)
Ep = Consumer’s expectations about future prices
U = Specific factors affecting demand for a commodity such as seasonal changes,
taxation policy, availability of credit facilities, etc.
Effective demand
This means demand that is backed up with a willingness and ability to pay.
The law of Demand/The theory of demand
At higher prices, a lower quantity will be demanded than at lower prices, ceteris
paribus. At lower prices, a higher quantity will be demanded than at higher prices,
ceteris paribus. Basically, when the price is high demand is low and vice versa. Ceteris
paribus means 'all other things being equal'.
Demand schedule
A table which contains values for the price of a good and the quantity that would be
demanded at that price. If the data from the table is charted, it is known as a demand
curve.
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Demand Schedule
Quantity
Price
Demanded
5 10
4 17
3 26
2 38
1 53
The demand curve for this example is obtained by plotting the data:
Demand curve
A graph showing the demand for a product at different price points.
The demand curve is the graph depicting the relationship between the price of a certain
commodity, and the amount of it that consumers are willing and able to purchase at that
given price. It is a graphic representation of a demand schedule.
The determinants of demand
It is fairly obvious that the price of a good is a pretty strong determinant of its demand,
but there are many other things that will affect demand too.
• Customer preference: Changing preferences will affect your demand for a product
regardless of its price.
• Prices of related goods
o Complements - an increase in the price of a complement reduces demand,
shifting the demand curve to the left.
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o Substitutes - an increase in the price of a substitute product increases
demand, shifting the demand curve to the right.
• Income - an increase in income shifts the demand curve of normal goods to the
right.
• Number of potential buyers - an increase in population or market size shifts the
demand curve to the right.
• Expectations of a price change - a news report predicting higher prices in the
future can increase the current demand as customers increase the quantity they
purchase in anticipation of the price change.
Advertising: positive affect on the individual demand
Population. Quite obviously, a significant rise in the number of people in a given
area or country will affect the demand for a whole host of goods and services. Note
that a change in the structure of the population (we have an ageing population) will
increase the demand for some goods but reduce the demand for others.
Interest rates and credit conditions. If interest rates are relatively low then it is
cheaper to borrow money that can then be spent.
Movements along a demand curve(change in quantity demanded)
A movement refers to a change along a curve. The movement implies that the demand
relationship remains consistent. 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 the quantity demanded is caused only by a change in price, and vice versa.
Shifts of a demand curve(change in demand)
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A shift in the demand curve occurs if one of the 'other' (i.e. non-price) determinants of
demand change. This means that for a given price level the quantity demanded will
change. This could be due to a rise in real incomes (assuming the good is normal), a rise
in the price of a substitute good, a fall in the price of a complement, etc.
For instance, if the price for a bottle of beer was $2 and the quantity of beer demanded
increased from Q1 to Q2, then there would be a shift in the demand for beer. Shifts in the
demand curve imply that the original demand relationship has changed, meaning that
quantity demand is affected by a factor other than price. A shift in the demand
relationship would occur if, for instance, beer suddenly became the only type of alcohol
available for consumption.
Exceptions to Law of Demand
The instances where law of demand is not applicable are as follows-
1. There are certain goods which are purchased mainly for their snob appeal, such
as, diamonds, air conditioners, luxury cars, antique paintings, etc. These goods are
used as status symbols to display one’s wealth. The more expensive these goods
become, more valuable will be they as status symbols and more will be there
demand. Thus, such goods are purchased more at higher price and are purchased
less at lower prices. Such goods are called as conspicuous goods.
2. The law of demand is also not applicable in case of giffen goods. Giffen goods
are those inferior goods, whose income effect is stronger than substitution effect.
These are consumed by poor households as a necessity. For instance, potatoes,
animal fat oil, low quality rice, etc. An increase in price of such good increases its
demand and a decrease in price of such good decreases its demand.
3. The law of demand does not apply in case of expectations of change in price of
the commodity, i.e, in case of speculation. Consumers tend to purchase less or
tend to postpone the purchase if they expect a fall in price of commodity in future.
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Similarly, they tend to purchase more at high price expecting the prices to
increase in future.
Supply
How much of a given product the sellers, or firms, or producers are prepared to supply to
the market at any given price.
Effective supply
Effective supply is defined as the willingness and ability of producers to supply goods
and services on to a market at a given price in a given period of time.
A table can be constructed of price and quantity supplied based on observed data. Such a
table is called a supply schedule, as shown in the following example:
Law of supply
Ceteris paribus, if price goes up, quantity supply goes up. And if price goes down,
quantity supply goes down. so there is positive relationship between price and quantity
supply
Supply Schedule
Quantity
Price
Supplied
1 12
2 28
3 42
4 52
5 60
By graphing this data, one obtains the supply curve as shown below:
Supply Curve
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The convention of the supply curve is to display quantity supplied on the x-axis as the
independent variable and price on the y-axis as the dependent variable.
The law of supply states that the higher the price, the larger the quantity supplied, all
other things constant. The law of supply is demonstrated by the upward slope of the
supply curve.
Law of supply
At higher prices a larger quantity will generally be supplied than at lower prices, ceteris
paribus, and at lower prices a smaller quantity will generally be supplied than at higher
prices, ceteris paribus. So this time we have higher supply at higher prices and vice versa.
Again, in is important to assume that 'all other things remain constant'.
The determinants of supply
There are many things that affect supply as well as the price of the good in question.
Notice that nearly all of these factors affect the firms' costs.
1. Prices of other factors of production. An increase in the price of, say, hops, will
increase the costs of a brewing firm and so for any given price the firm will not be
able to brew as much beer. Hence, the firm's supply curve will shift to the left.
The same would be true for changes in wage costs or fuel costs.
2. Technology. The supply curve drawn above assumes a 'constant' state of
technology. But as we know, there can be improvements in technology that tend
to reduce firms' unit costs. These reduced costs mean that more can be produced
at a given price, so the supply curve would shift to the right.
3. Indirect taxes and subsidies. When the chancellor announces an increase in
petrol tax (again!), it is the firm who actually pays the tax. Granted, we end up
paying the tax indirectly when the price of petrol goes up, but the actual tax bill
goes to the firm. This again, therefore, represents an increase in the cost to the
firm and the supply curve will shift to the left. The opposite is true for subsidies
as they are handouts by the government to firms. Now the firm can make more
units of output at any given price, so the supply curve shifts to the right.
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4. Labour productivity. This is defined as the output per worker (or per man-hour).
If labour productivity rises, then output per worker rises. If you assume that the
workers have not been given a pay rise then the firm's unit costs must have fallen.
Again, this will lead to a shift to the right of the supply curve.
5. Price expectations. Just as consumers delay purchases if they think the price will
fall in the future, firms will delay supply in they think prices will rise in the
future. It's the same point but the other way round.
6. Entry and exit of firms to and from an industry. If new entrants are attracted
into an industry, perhaps because of high profit levels (much more on this in the
topic 'Market structure'), then the supply in that industry will rise at all price
levels and the supply curve will shift to the right. If firms leave the industry then
the supply curve will shift to the left.
Movements along a supply curve
A movement along a supply curve only occurs when the price changes, ceteris paribus.
In other words, the price changes but the other non-price determinants remain constant.
The diagram below shows that a price rise will cause an extension up the supply curve,
from point p4 to p3, whilst a price fall will cause a contraction back down the supply
curve.
Shifts in the Supply Curve
While changes in price result in movement along the supply curve, changes in other
relevant factors cause a shift in supply, that is, a shift of the supply curve to the left or
right. Such a shift results in a change in quantity supplied for a given price level. If the
change causes an increase in the quantity supplied at each price, the supply curve would
shift to the right:
Supply Curve Shift
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There are several factors that may cause a shift in a good's supply curve. Some supply-
shifting factors include:
• Prices of other goods - the supply of one good may decrease if the price of
another good increases, causing producers to reallocate resources to produce
larger quantities of the more profitable good.
• Number of sellers - more sellers result in more supply, shifting the supply curve
to the right.
• Prices of relevant inputs - if the cost of resources used to produce a good
increases, sellers will be less inclined to supply the same quantity at a given price,
and the supply curve will shift to the left.
• Technology - technological advances that increase production efficiency shift the
supply curve to the right.
• Expectations - if sellers expect prices to increase, they may decrease the quantity
currently supplied at a given price in order to be able to supply more when the
price increases, resulting in a supply curve shift to the left.
The equilibrium price
The demand curve represents the actions, at any price level, of the buyers (or consumers).
The supply curve represents the actions, at any price level, of the sellers (or firms, or
producers). To find out what the price level will actually be, we need to see what
happens when we combine the demand and supply curves.
The price mechanism
This is the mechanism through which the price is determined in a market system.
Basically, the price will adjust until supply equals demand, at which point we have the
equilibrium price.
The definition of 'equilibrium' is 'a state of physical balance', or put more simply, 'a
state of rest'. As you will see in the following diagrams, any given market is only 'at rest'
when supply equals demand, which is where the two curves cross.
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In the diagram above, let us assume that the price is P2 temporarily. At this price, demand
is quite low (Q3) but firms wish to supply quite a lot (Q2). We have excess supply equal
to Q2 - Q3. Firms find that they have a glut of unsold goods. This is not a 'state of rest'.
The price would fall until firms reached a position where they no longer experienced
excess supply. This occurs where supply equals demand, price P1, quantity Q1.
Now let us assume that the price is P3 temporarily. Now we have a situation when the
price is relatively low, so the demand for the product (Q4) is much higher than the
amount firms wish to supply (Q5). We have excess demand equal to Q4 - Q5. Now firms
find that they sell their stock very easily and there are customers queuing at the door
wanting more!
Consumer surplus
Consumer surplus is officially defined as the welfare, or benefit, a consumer derives
from the purchase of a good or service. It is a 'surplus' because it measures, in a sense, the
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extra 'benefit' they receive because the price they actually pay is less than the price they
were willing to pay.
In the diagram above, the equilibrium price is P1 and the equilibrium quantity is Q1. The
demand curve shows the value that consumers place on the product in question. If the
price is high then there are not many consumers who value the product so highly. When
the price is low numerous consumers are prepared to buy the product. Imagine that you
are a consumer that is prepared to pay P2 for the product in question. Luckily for you, the
market price is only P1, so the difference between the two prices (P2 - P1, or A minus B)
is, in a sense, an intangible benefit that you receive. If you went to a newsagent, fully
prepared to pay 80p for an ice cream, but for whatever reason the price was only 50p,
then, in a way, you have received a benefit of 30p.
The total consumer surplus in this market is represented by the triangle P1EC (under the
demand curve, above the equilibrium price and to the right of the y-axis). It can be seen;
therefore, that if the price rises, for whatever reason, then total consumer surplus will fall,
and if the price falls then total consumer surplus will rise.
Producer surplus
This concept is similar but refers to producer welfare rather than consumer welfare.
Producer surplus is, effectively, producer profit (much more detail in the 'Costs and
revenues' topic).
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As we know, the supply curve represents what the producers are willing and able to
supply. It is also their marginal cost curve. If a producer is just prepared to supply the
Q2th unit, then the cost of producing that unit must be the distance CQ2. But the market
price is P1, so the revenue he gains from selling that unit is represented by the distance
BQ2. Profit is revenue minus cost, so the producer profit (or producer surplus) is the
distance BC.
if one extends this analysis to all units supplied, the total producer surplus is represented
by the triangle P1AE (Above the supply curve, below the market price and to the left of
the y-axis.)
Application of supply and demand theories
In the field of software engineering, the application of supply and demand theories is
often observable in areas like job market trends, salaries, software product pricing, and
resource allocation. Here are a few recent examples where supply and demand dynamics
play out realistically:
1. Demand for Cloud Engineers and Shortage of Talent
• Demand: With the increasing shift to cloud infrastructure (AWS, Azure, Google
Cloud), companies are heavily investing in cloud computing. Demand for cloud
engineers with expertise in building, deploying, and managing cloud-based
systems has skyrocketed. Businesses from startups to enterprise companies are
competing for top talent in the cloud domain.
• Supply: The supply of skilled cloud engineers has not kept pace with demand.
While cloud computing has become a primary focus in tech education and
certification programs (e.g., AWS Certified Solutions Architect), the specialized
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skills required are still limited. As a result, the job market has seen a shortage of
qualified candidates.
• Outcome: Companies are offering significantly higher salaries, bonuses, and
attractive benefits to secure cloud talent. The shortage of qualified engineers
drives up wages and creates a competitive hiring environment. Some companies
may resort to outsourcing or contract workers to fill the gap, which increases
demand for these types of workers as well.
2. High Demand for AI and Machine Learning Engineers
• Demand: With the explosion of generative AI, natural language processing, and
machine learning applications (like OpenAI's ChatGPT, Google's Bard, etc.), the
demand for AI and ML engineers has surged. Organizations want to integrate AI
to optimize processes, automate tasks, and create cutting-edge products.
• Supply: There is a significant gap in the number of professionals with advanced
degrees and expertise in AI, machine learning, and deep learning. Universities and
coding bootcamps have ramped up AI-focused curricula, but the number of
candidates with the expertise needed to design and implement complex AI
systems is still limited.
• Outcome: The supply-demand imbalance has driven up salaries for AI/ML
engineers, with reports showing annual salaries exceeding $150,000 in the U.S.
Companies also offer perks such as remote work, stock options, and career
development opportunities to attract and retain AI talent. This phenomenon has
also led to an increase in AI bootcamps, online courses, and certifications aimed
at upskilling workers to meet the demand.
3. Shortage of Cybersecurity Professionals
• Demand: As cyberattacks and data breaches become more frequent and
sophisticated, the demand for cybersecurity professionals has grown
exponentially. Companies, especially those in industries like finance, healthcare,
and e-commerce, need cybersecurity experts to protect sensitive data and
infrastructure.
• Supply: Despite the high demand, there is a significant shortage of qualified
cybersecurity professionals. According to reports from organizations like (ISC)²,
the global cybersecurity workforce gap is estimated to be in the millions.
• Outcome: The scarcity of qualified candidates has driven up salaries, and
companies are offering hefty signing bonuses and work-from-home options to
attract and retain talent. Additionally, there is a growing market for cybersecurity
tools and platforms to help businesses manage their security needs with fewer
specialists, which further illustrates the supply-demand imbalance in the talent
market.
4. Remote Work and Global Talent Pools
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• Demand: The demand for remote software engineers, particularly for roles in
frontend development, backend development, and full-stack engineering, has
surged during and after the COVID-19 pandemic. Many companies have adopted
remote-first or hybrid models, leading them to tap into global talent pools.
• Supply: While the supply of software engineers globally has increased, the
competition for the best talent is fierce. Engineers from regions with lower costs
of living are competing with those in higher-cost regions like North America and
Western Europe, which has created a global talent market.
• Outcome: Companies that offer competitive salaries and benefits can access a
broader, more diverse talent pool, often hiring from countries with lower labor
costs. At the same time, the increased supply of remote workers from regions like
India, Eastern Europe, and Southeast Asia has created downward pressure on
wages in certain geographies, but companies in high-demand regions (e.g., Silicon
Valley) still offer premium salaries to attract the best remote workers.
5. Software as a Service (SaaS) Pricing and Competition
• Demand: As businesses increasingly adopt SaaS products for everything from
project management (e.g., Jira, Trello) to customer relationship management
(CRM) (e.g., Salesforce), the demand for SaaS solutions continues to grow.
• Supply: The number of SaaS providers has also grown dramatically, making it a
highly competitive market. Many new startups are entering the SaaS space,
offering innovative solutions or targeting niche markets, which increases supply.
• Outcome: In response to high competition, some SaaS providers lower their
prices or offer freemium models to attract customers. Conversely, highly
demanded SaaS platforms with unique features or strong brand recognition (e.g.,
Salesforce, Microsoft 365) can command premium prices due to their strong
market position and limited substitutes. The balance between the demand for SaaS
tools and the availability of choices allows customers to weigh cost against
features and service levels.
6. Talent in Software Development and Frameworks
• Demand: As businesses increasingly move toward modern, flexible web
applications, there is a growing demand for developers skilled in modern
frameworks like React, Angular, Vue.js, and backend technologies like Node.js
and Django.
• Supply: While there is an abundance of generalist developers, developers with
specific expertise in these modern frameworks and technologies are harder to
find. The rapid evolution of web development tools and libraries means that
developers need to continually update their skills, creating a supply-demand
imbalance for highly specialized developers.
• Outcome: Companies often face challenges in hiring developers proficient in the
latest frameworks and technologies. To address this, they may offer training
programs to upskill their existing workforce or provide higher salaries and
benefits to attract talent with the desired expertise.
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PRICE CEILING:
A legally established maximum price that is imposed on a market BELOW the price that
otherwise would be achieved in equilibrium. A price ceiling is placed on a market with
the goal of keeping the price low, presumably based on the notion that the equilibrium
price is too high. If imposed on a competitive market free of market failures, a price
ceiling creates a shortage, or excess demand.
A price ceiling places an upward limit on the price of good. Buyers and sellers can
exchange the good at prices less than the ceiling, but not greater. The primary goal of a
price ceiling is to keep the price of a good low and thus more affordable to the buyers.
PRICE FLOOR:
A legally established minimum price that is imposed on a market ABOVE the price that
otherwise would be achieved in equilibrium. A price floor is placed on a market with the
goal of keeping the price high, presumably based on the notion that the equilibrium price
is too low. If imposed on a competitive market free of market failures, a price floor
creates a surplus, or excess supply.
A price floor places a downward limit on the price of good. Buyers and sellers can
exchange the good at prices more than the floor, but not less. The primary goal of a price
floor is to keep the price of a good high and thus generate more revenue to the sellers.
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