Ateneo de Davao University

Senior High School

APPLIED ECONOMICS
TOPIC 4 – LAWS OF SUPPLY AND DEMAND

The level of real national income depends not only on an increasing total demand but also
on increasing supply, that is, on the ability of the producers to satisfy the demand for goods and
services.
In the Philippines, the increase in labor resources is still the single biggest contributor to
the increase in the supply of goods. The increase in this factor of production has been the result
of high population growth. History has proven that high population growth ultimately
accompanied high rates per capita land that population declined only after a country had reached
a high level of economic growth and not before it.
On the other hand, our land resources are still waiting to be tapped to increase our supply
of goods. The most difficult resource supply to increase its capital depends on the level of savings
and foreign exchange available.

OVERVIEW

Many individuals do not understand how the prices of goods and services are determined.
Many think that prices are determined by the government. This is true in some basic goods and
services like rice, gasoline, sugar, or rent of an apartment. In a market economy like ours, prices
of goods and services are determined by the interaction between demand and supply of goods
and services. The government does not interfere.
It is a common fact that supply also affects the prices of goods and services in the market. An
understanding of the law of supply will give the individual an insight into why there are scarcity
and surplus of goods and services in the market.

MEANING OF DEMAND AND SUPPLY

Demand means the desire for a particular good backed up by sufficient purchasing power.
The term demand signifies the ability or the willingness to buy a particular commodity at a given
point in time.

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 In economics, demand does not mean mere need or desire, which is not backed up by the
ability to pay or no purchasing power. This kind of demand is called potential demand. The
demand, which is backed up by the ability to pay, is called effective demand. In our discussion of
demand, we will always assume the effective demand. Demand then refers to the actual
purchase of a good or service.

Supply, on the other hand, is the quantity of a commodity that is in the market and
available for purchase at a particular price. In other words, supply is the number of goods and
services available for sale at given prices at each time and place. Supply implies the ability and
willingness of sellers to sell.

DEMAND AND SUPPLY SCHEDULE

A market is a place where buyers and sellers interact with each other, and that exchange
takes place among them. In the market, different buyers and sellers will buy or sell different
quantities of a commodity. Because of this, different behaviors between buyers and sellers exist,
thus, a demand/supply schedule also must exist.

A demand schedule reflects the quantities of goods and services demanded by a

consumer or an aggregate of consumers at any given price. To understand this fully, let us analyze
a hypothetical demand schedule for beef in the market as shown in Table 1.

The supply schedule shows the different quantities that are offered for sale at various
prices. The supply schedule may reflect the individual schedule of only one producer or the
market schedule showing the aggregate supply of a group of sellers or producers. Table 2 gives
you an idea of a supply schedule.
Table 1 Table 2
Hypothetical Demand for Hypothetical Supply of
Beef in the Market Rice in the Market
Price of Beef QD Price of Rice QS
(Per Kilo) in Kilos (Per Sack) (50kilos/Sack)
P300 20 P3000 300
250 40 P2500 250
200 60 P2000 200
150 80 P1500 150
100 100 P1000 100
50 120 P500 50

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 In Table 1, It is shown that if the price is low an individual would tend to buy more and
vice versa if the price is high. In the given example, at a price of P300.00, the quantity demanded
by the consumers is 20 kilos while a decrease in price to P50.00 increases the quantity demanded
of the consumers to 120 kilos.

While in Table 2, indicates that if the price is high the seller offers more supply in the
market and vice versa if the price is low. In the given example, at a price of P3000 pesos, the
quantity supplied is high compared to a lower price of P500 decreases the quantity supplied from
300 to 50 sacks.

THE LAW OF DEMAND AND SUPPLY

The law of demand may be stated as "the quantity of a commodity which buyers will buy at a
given time and place will vary inversely with the price.” This means that as price increases,
quantity demanded decreases, and as price decreases, quantity demanded increases other things
are constant. Such general tendencies of consumers can be explained for two reasons.
1. Income effect - At lower prices, an individual has greater purchasing power. This means
he can buy more goods and services. But at higher prices, naturally, he can buy less.
2. Substitution effect - Consumers tend to buy goods at lower prices. In case the price of a
product that they are buying increases, they look for substitutes whose prices are lower.
Thus, the demand for higher-priced goods will decrease.

The law of supply states that the quantity offered for sale will vary directly with price. This means
that as price increases quantity supplied also increases; and as price decreases, quantity supplied
also decreases. This direct relationship between price and quantity supplied is the law of supply.
Producers are willing and able to produce and offer more goods at a higher price than at a lower
price. Sellers offer more goods at higher prices because they make more profits. Such behavior
of sellers or producers is a natural inclination. No businessman is willing to produce goods if he
makes no profit.

DEMAND AND SUPPLY SCHEDULE

The demand schedule shown in Table 1 can also be understood through a graphical illustration
known as the demand curve. In many instances, it is more convenient to express the relation
between prices and quantity demanded using a demand curve.

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Figure 1 shows the translation of Table 1 into a graphical illustration.

The supply schedule as shown in Table 2 can also be illustrated in the graphical form
known as the supply curve. This is shown in Figure 2.

In Figure 1, the price is presented on the vertical axis and the quantity demanded on the
horizontal axis. The points can be connected in a continuous curve. We label our demand curve
with D, which means demand, to indicate that it is the entire demand schedule.

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 It can be noted that the demand curve is sloping down. It shows that price and quantity
demanded are inversely proportional producing negative relationships. This inverse relationship
between prices and quantity demanded depicts the law of demand.

In Figure 2, it can be noted that the supply curve has an upward slope. It shows that price
and quantity supplied are proportional to each other. This kind of relationship depicts the law of
supply. We label our supply curve with S to indicate the entire supply schedule.

Note: The points in each demand /supply curve show their relationship with price.

DETERMINANTS OF DEMAND
Hereunder are the determinants of demand also known as a non-price factor that also affects a
buyer's willingness or ability to buy a good. These are:

1. Income People buy more goods and services when their income
increases, but will buy less if their income decreases, thus,
affecting the demand for goods and services. Changes in the
income of people will change their demand for goods and
services. An increase in income will either increase or decrease
demand depending upon the kind of commodity.

2. Population More people mean more demand for goods and services. That is
why; we can observe that there are more buyers in the city stores
than in the barrio stores. Conversely, less population means less
demand for goods and services. Business is poor in rural areas
compared to business in urban areas.

3. Taste and Demand for goods and services increases when people like or
Preferences prefer them. Such tastes or preferences are greatly influenced by
advertisement or fashion. On the other hand, if a certain product
is out of fashion, the demand for it decreases.

4. Price When people expect the prices of goods, especially basic

Expectations commodities like rice, soap, cooking oil or sugar to increase
tomorrow or next week, they will buy more of these goods. In the
same manner, they decrease their demand for each product if
they expect the price to decline tomorrow or in a few days. The
reason for such a consumer's behavior is to economize. This is a

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 general tendency of buyers.

5. Prices of Related When the price of a certain good increases, people tend to buy
Goods substitute products. For example, if the price of Colgate
increases, consumers buy less of Colgate and more of the close
substitute like Close-up or Hapee. This means the demand for
Colgate decreases while the demand for substitutes increases.
This means, if the price of one good increases, the demand for
the other good increases. For substitutes then, P and QD are
directly related.

But for complimentary products (those that go together) like bow and arrow or sugar and
coffee, it is different. If the price of sugar increases, the price of coffee increases. But, if the
demand for sugar decreases, the demand for coffee also decreases. Conversely, if the price of
sugar decreases, the demand for coffee increases. P and QD are said to be inversely proportional.

DETERMINANTS OF SUPPLY
Just like demand, supply has also its determinants. These are as follows:

1. Technology This refers to techniques or methods of production. Modem

technology which uses modern machines increases the supply
of goods. In contrast, traditional technology which uses
animals and people is very slow in producing goods. Also,
technology reduces the cost of production, and this
encourages the producers to increase their supply.

2. Cost of When we speak of the cost of production, we take into

Production Production consideration the price of raw materials which are
needed together with the cost of labor. As the price of raw
materials or the salaries of laborers increases, it means a
higher cost of production. The higher cost of production
decreases supply because the viability or profitability of the
business decreases. Generally, businessmen are not willing to
offer more goods if they are not sure of profit.

3. Number of More sellers or more factories mean an increase in supply. On

Sellers the other hand, fewer sellers or factories mean less supply.

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 4. Taxes and Certain taxes increase the cost of production. Higher taxes
Subsidies discourage production because it reduces the earnings of
businessmen. That is why the government extends tax
exemptions to some new and necessary industries to stimulate
their growth. Similarly, tax incentives are granted to foreign
investors to increase foreign investment in the Philippines. This
will result in more goods.
In the case of subsidies, there are financial grants or financial
assistance to producers. Subsidies reduce the cost of
production. This induces businessmen to produce more.

5. Weather Production of goods also depends on weather conditions. A

businessman will produce more sweaters during the cold
season, more umbrellas during the rainy season and light
clothing materials and walking shorts during summer.

THE CETERIS PARIBUS ASSUMPTION

The law of demand states that as price increases, quantity demanded decreases, and as
price decreases, quantity demanded increases. Such theory is true if we apply the Ceteris Paribus
assumption wherein it assumes that "all other things equal or constant." This means, that the
determinants of demand are constant and are not considered factors that will affect demand in
the market. Thus, the law of demand, using the Ceteris Paribus, can be restated as "assuming
that the determinants of demand are constant, price and quantity demanded are inversely
proportional to each other."

However, if the determinants of demand are considered major factors or greatly affect
the demand in the market, then, the Ceteris Paribus assumption is dropped.

The law of supply is only correct if we apply the assumption of ceteris paribus. This means
the law of supply is valid if the determinants of supply like the cost of production, technology,
number of sellers, and so forth, are held constant.

CHANGES IN DEMAND AND SUPPLY

Changes in demand refer to the shift of the demand curve which is brought about by the
changes in the determinants of, demand, like income, population, price expectation, and so forth.
For instance, an increase in population also increases the demand for goods and services, or a

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decrease in income also reduces demand. In a graph, an increase in demand shifts the demand
curve to the right while a decrease in demand shifts the demand curve to the left as shown in
Figure 3.

Changes in supply pertain to a shift of the supply curve brought by changes in the
determinants of supply. Through graphical presentation, an increase in supply shifts the supply
curve to the right, while a decrease in supply shifts the supply curve to the left. Figure 4 illustrates
the changes in supply.

CHANGES IN QUANTITY DEMANDED/QUANTITY SUPPLIED

Changes in the quantity demanded indicate the movement from one point to another
point. This means the demand curve does not change its position like that of the demand curve
in the changes in demand. The change in quantity demanded is brought about by changes in
prices. Whenever there is a price change, there is a corresponding change in the quantity
demanded. The change in quantity demanded is, graphically illustrated in Figure 5. For example,
a change in price from 200 to 150 will correspondingly change the quantity demand from 60 to
80, and vice-versa.

Figure 5. Change in Quantity Demanded

Changes in quantity supplied to show the movements from one point to another point
in a constant supply curve. A change in quantity supplied is brought about by a change in price.
For example, if the price decreases from P400 to P300, there is a corresponding decrease in
quantity supplied from 200 to 150, and vice-versa as shown in Figure 6.

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 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 by the original supply
relationship. In other words, a movement occurs when a change in quantity supplied is caused
only by a change in price, and vice versa.

Note: The movements within the demand and supply curves are the effects of the changes in
their respective prices.

Figure 6. Change in Quantity Supplied

EQUILIBRIUM OF DEMAND AND SUPPLY

Alfred Marshall, a British economist, introduced a kind of pricing scheme by combining

the law of demand and the law of supply. With this combination, an equilibrium price and
equilibrium quantity are formulated. This is known as market equilibrium.

In the market, supply and demand interact freely. Supply is represented by producers or
sellers while demand is represented by the buyers. In the process of interaction between buyers
and sellers, an equilibrium price and equilibrium quantity or market equilibrium are established.
The market equilibrium comes at that price and quantity where the supply and demand forces
are in balance. This is the situation where quantity supplied, and quantity demanded are equal.
This means that the amount that buyers want to pay is just equal to the amount that sellers want
to sell. In Table 3, the equilibrium price is P8.00; the market price in which both sellers' and
buyers' decisions are mutually consistent.

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 Table 3
Supply and Demand Schedules Indicating the Equilibrium Price and Equilibrium Quantity
Quantity Price Quantity Shortage/
Supplied Demanded Surplus
(Php)

3 3 24 Shortage

6 6 20 Shortage

9 9 16 Shortage

12 8 12 Equilibrium

15 15 8 Surplus

18 18 4 Surplus

Let us work through the supply and demand schedules in Table 3 to see how supply and
demand determine market equilibrium. To find the market price and quantity, we find a price at
which the amount desired to be bought and sold just matches. If we try a price of P9.00, a
producer would like to sell 9 units while consumers want to buy 16 units. Here, we see a shortage
of 7 units of supply. The quantity demanded exceeds the quantity supplied. At a price of PI5.00,
a quick look shows that the quantity supplied which is 15 units exceeds the quantity demanded
which is 8 units. Accordingly, there is a surplus of 7 items of supply.
We could try other processes, but we can easily see that the equilibrium price is P8.00. At
P8.00, consumers' desired demand of 12 units is equal to the desired supply which is also 12
units. This denotes that supply and demand orders are filled, and consumers and suppliers are
satisfied. Whenever there is a balance of demand and supply irrespective of price, we can
positively state that there is an equilibrium.

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In Figure 7, an illustration through a graph of demand and supply can be seen.

Fig. 7 Equilibrium price and equilibrium quantity are established by the interaction
between demand and supply.

Above the equilibrium price is a SURPLUS and below the equilibrium price is a SHORTAGE.

In the process of interaction between buyers and sellers, prices tend to move towards the
equilibrium price.

Note: The equilibrium price (Pe) and the equilibrium quantity (Qe) are determined by the
meeting point between demand and supply curves.

EFFECTS OF EQUILIBRIUM OF A SHIFT IN SUPPLY AND DEMAND

The point of equilibrium is subject to change. This is due to a shift of either the supply
curve alone, or the demand curve alone, or both. The shifting of either the demand or supply
curves is caused by changes in their respective determinants. Let us assume that the demand
curve is constant, and the supply curve shifted to the right, which was brought about by the
producer's use of modem technology. This is illustrated in Figure 8 where the supply curves, SI
shifted to S2.

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 Figure 8. The shift in the supply curve changes the equilibrium price and equilibrium quantity.

The supply curve shifts to the right to indicate an increase in supply brought about by the
adoption of modern technology. Note that the market price has been reduced from P5.00 to
P4.00 with demand being constant. However, the quantity of demand increased from 8 to 10.
In like manner, a shift of the demand curve with the supply curve as constant will cause a
change in the equilibrium point as shown in Figure 9.

Figure 9. The shift in the demand curve changes equilibrium.

THE LAW OF DEMAND AND SUPPLY

The law of supply and demand states that when supply is greater than demand, price
decreases. When demand is greater than supply, price increases. When supply is equal to
demand, the price remains constant. This is the market equilibrium.

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REFERENCES AND RESOURCES
Cengage Asia. (2016). Applied Economics: An Introduction. Abiva Publishing House.
Economics Online. (n.d.). Demand shifts to the right [Graph]. Retrieved from
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R.png
Economics Online. (n.d.). Falling Cost [Graph]. Retrieved from
https://www.economicsonline.co.uk/How%20markets%20work%20graphs/Supply-to-
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Leaño, R. D., Jr. (2016). Applied Economics for Senior High School. Manila: MINDSHAPERS.
Manapat, C. L. (2018). Applied Economics for Senior High School. Quezon City: C&E Publishing.

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