Chapter 2: DEMAND, SUPPLY AND MARKET EQUILIBRIUM

DEMAND – reflects consumer’s desire for a commodity.

Quantity Demanded (Qd)- the various quantities of goods or services that the consumers are
willing and able to buy or to take out of the market.

The Law of Demand states that as the price increases, the quantity demanded decreases; and
as the price decreases, the quantity demanded increases, ceteris paribus.

Validity of the Law of Demand- it is only true if the assumption of ceteris paribus applied or
other determinants remain constant; that is, there is no change and movement in other varia-
bles.

Types of Demand Relation

1. Generalized Demand Function- a demand relationship showing how quantity de-
manded (Qd) of the product is related to other variables that affect demand.

There are seven principal variables that influence the quantity demanded of a good or service
and the relationship with Qd:
a. Price of the good or service (P)
P Qd :P Qd
b. Income (I)
I Qd : P Qd
c. Price related of goods (Pr)
Substitute goods- Py Qd :P Qd
Complementary goods- Py Qd : Py Qd
d. Price expectation (Pe)
Pr Qd : Pr Qd
e. Taste and Preferences (T)
T Qd : T Qd
f. Number of consumer in the market (N)
N Qd : N Qd
g. Range of Available Good (R)
R Qd :R Qd

Qd= a – bP + cI ± dPr +e T + fPe + gN – iR

2. Ordinary Demand Function- a demand relationship showing how quantity demanded
(Qd) and the price (P) of the product are related to each other when all other variables
affecting demand are held constant at specific values.

As an equation, a demand function can be express as:

Qd= a – bP

A demand schedule is the relationship between the quantity of a good demanded and the
price of that good. Other factors that may affect the quantity demanded, such as the price of
other goods, are held constant in drawing up the demand schedule.

Quantity demanded for com-

Price of X (P)
modity (Qd)
10 9
20 8
30 7
40 6
50 5
60 4
70 3
80 2

The demand schedule for a commodity shows the different quantities demanded when only
price changes and other factors affecting the quantity demanded are held constant.
A demand curve is a plotted demand schedule. Typically demand curve is downward slop-
ing. A movement along a given demand curve is the change in the quantity demanded due to
the changes in the price of the product when all other factors are held constant. A change in
the demand refers to the shift in the entire demand schedule due to the changes in some fac-
tors that were held constant.

Price
100
80
60
40
20
0
Quantity
0 1 2 3 4 5 6 7 8 9Demanded
SUPPLY- the amount of a commodity available for sale

Quantity Supplied (Qs)- the various quantities of goods or services that the producers are
willing and able to sell or to put into the market at a particular place, price and time.

The Law of Supply states that as the price increases, the quantity supplied also increases, and
as the price decreases, the quantity supplied also decreases, ceteris paribus.

Types of Supply Relation

1. Generalized Supply Function- a supply relationship showing how quantity supplied
(Qs) of the product is related to product price (P) and five other variables that affect
supply.

There are ten principal variables that influence the quantity supplied of a good or service.
Their relationship with Qs is expressed as follows:

a. Price of the good or service (P)

P Qs : P Qs
b. Cost of Inputs (C)
C Qs : C Qs
c. Price of Related Goods (Pr)
Substitute goods- Py Qs : Py Qs
Complementary goods- Py Qs : Py Qs
d. Level of Available Technology (Te)
Te Qs : Te Qs
e. Expected Price of the Good in Some Future Period (Pe)
Pe Qs : Pe Qs
f. Number of Sellers (Se)
Se Qs : Se Qs
g. Taxes (Tx)
Tx Qs : Tx Qs
h. Subsidies (Sb)
Sb Qs : Sb Qs
i. Availability of Inputs (A)
A Qs : A Qs
j. Weather/Season (W)
W Qs :W Qs

Qs= a + bP - cC ± dPr + eTe - fPe + gSe – hTx + iSb + jW + kA

2. Ordinary Supply Function- This functions shows the relationship between price (P)
and quantity supplied (Qs) when all others variables affecting quantity supplied are
held constant. This is sometimes called supply function or simply supply.

As an equation, a demand function can be express as:

Qs = a + bP

A supply schedule is the listing of the different quantities of goods and services that sellers
will sell given the various alternative prices. Market supply is the horizontal summation of all
individual supply of the consumers in the market.

Quantity supplied for

Price of X (P)
commodity (Qs)
10 1
20 2
30 3
40 4
50 5
60 6
70 7
80 8

A supply curve is a plotted supply schedule. A movement along a given supply curve is the
change in the quantity supplied due to the changes in the price of the product when all other
factors are held constant. Change in the supply refers to the shift in the entire supply schedule
due to the changes in some factors that were held constant.

Price
100

Supply
60
40
20
0
Quantity
0 1 2 3 4 5 6 7 8
Supplied
MARKET EQUILIBRIUM is a situation in which at the prevailing price, consumers can buy
all of a good they wish to buy and producers can sell of a good they wish to sell.

Price Demand Supply

Equilibrium
Price

Quantity
Equilibrium
Quantity

Equilibrium Quantity- the amount of a good bought and sold in the market at a prevailing
equilibrium price.

Shortage (excess demand)- exists when quantity demanded exceeds quantity supplied.
Surplus (excess supply)- exists when quantity supplied exceeds quantity demanded.

Quantity Demanded for Quantity Supplied for

Price of X (P)
commodity X (Qd) commodity X (Qs)
10 9 1
20 8 2
30 7 3
40 6 4
50 5 5
60 4 6
70 3 7
80 2 8

Price
100
90 Demand
Supply
80
70 Surplus
Equilibrium 60
Market
Price 50
Equilibrium
40
30 Shortage
20
10
0 Quantity
1 2 3 4 5 6 7 8

Equilibrium
Quantity
Sample Computation for Qd and Qs with identifying Market Equilibrium:

P Qd Qs State of Market
Shortage
0 1200 450
-750
Shortage
10 1000 500
-500
Shortage
20 800 550
-250
Equilibrium
30 600 600
0
Surplus
40 400 650
250
Surplus
50 200 700
500
Surplus
60 0 750
750

Demand: Qd = 1200 – 20 P
Supply: Qs = 450 – 5 P

Find the equilibrium price and quantity:

Demand = Supply
Qd = Qs
1200 – 20 P = 450 + 5 P
1200 – 450 = 20 P + 5 P
750 = 25 P
30 = P The equilibrium price is ₱30.

The equilibrium quantity can be obtained using either the demand or supply equations.

Demand Supply

Qd = 1200 – 20 (30) Qs = 450 + 5 (30) Therefore, the

= 1200 – 600 = 450 + 150 equilibrium quantity is
= 600 = 600 600 units.
Econ 24/29

Changes in Market Equilibrium- consequently, demand and supply curves shifts. Because of
the changes in the variables affecting both supply and demand, equilibrium price (Pe) and
equilibrium quantity (Qe) change. Using demand and supply, managers may take either a
qualitative or a quantitative forecast.

Price
S1

4 S2
3
2 D2

D1 Quantity
20 30 35

Changes in the demand (supply is constant)

here’s an increase in demand because of an increase in income. The shortage causes
the price to rise to new equilibrium where Qd=Qs. The new equilibrium, where D2 intersects
S1 occurs when Pe= 4 and Qe= 30 units. Therefore, the increase in demand (supply constant)
increases both the equilibrium price and quantity.

Changes in the supply (demand is constant)

Let now price decrease to S2, we now return to S1 where Pe=3 and Qe=20 units. An in-
crease in the number of firms causes the supply curve S1 to shift to the right S2. The new equi-
librium, where D1 intersects S2 occurs when Pe=2 and Qe= 35 units. Therefore, the increase in
supply (demand constant) equilibrium price falls and equilibrium quantity rises.

Price

S1
3
3.5
D2

D1 Quantity
20 50

Simultaneous shift in both Demand and Supply curves

In situation involving both a shift in the demand along with a shift in the supply, it is
possible to predict either the direction in which P change, or the direction in which Q chang-
es, but not both. In the case of the graph above, where both D and S increases, Pe falls, Qe ris-
es.
Econ 24/29
Chapter 3: ELASTICITY OF DEMAND AND SUPPLY

In economics the word elasticity means responsiveness. It is a tool of economists in measuring

the reaction of a function.

Elasticity- the responsiveness of demand/ supply to a change in its determinant.

Price elasticity of demand or the degree of consumer’s responsiveness or reaction of quantity de-
manded to a change in price is measured by:

a. Point elasticity- the coefficient of price elasticity of demand at one point along the de-
mand curve.

ΔQ −
%ΔQx
=
%Δ Δ −

b. Arc Elasticity- the coefficient of price elasticity of demand at one point along the de-
mand curve.

+
− 2
= +
−
2

Values and Types of Elasticity

/E/ = 1 Unitary Elastic, that is when %ΔQ = %ΔP
P

Qd

/E/ > 1 Elastic, that is when %ΔQ > %ΔP

P

Qd

/E/ < 1 Inelastic, that is when %ΔQ < %ΔP

P

Qd
/E/ = 0 Perfectly Inelastic
P
Econ 24/29

Qd
/E/ = ∞ Perfectly Elastic
P

Qd

Commodities and their Elasticities

We already learned that the more essential a good is to the consumer, the more inelas-
tic will be the demand for the good. The use of a necessity a good is, the more elastic is the
demand for it.
Tax Burden
When the good is essential, the buyer shoulder a bigger portion of the tax burden be-
cause they are will to buy it and the producer can afford to pass on.

Income Elasticity measures the consumer’s responsiveness or reaction to changes in his in-
come. The coefficient of income elasticity of demand measures product’s percentage change
in demand as a ratio of the percentage change in income which caused the shift in the de-
mand curve.

ΔQ −
%ΔQ
= ΔI −
%Δ

The absolute value of the coefficient of income elasticity is also a measure of how responsive
demand is to change in income. As income increases, the coefficient of:

>1 means demand is elastic and the good is superior;

<1 means demand is inelastic and the good is inferior.

Based on Engels Law, when income increases the percentage that is spent for food tends to
decrease. When income increases, the increase goes mostly to the purchase of luxury items,
education, travel and leisure. Moreover, superior goods will eventually become inferior as in-
come continues to increase to give way to new superior goods.
Econ 24/29
Cross Elasticity of Demand
The coefficient of cross elasticity of demand measures the percentage change in the
demand of good x which is shift of the demand curve in response to a percentage change in
the price of Good Y, thus:
ΔQx −
%ΔQx
=
%Δ ΔPy −

Good X and Y may be related in two ways, first as substitutes, and second as comple-
mentary. If the coefficient EC is positive, this means commodities X and Y are substitutes.
And if the coefficient EC is negative, this means commodities X and Y are complementary.

Price elasticity of supply measure the percentage change in the quantity supplied of a com-
modity compared to a percentage change in the price of such a commodity. Goods which are
relatively easy to manufacture tend to have elastic supplies; whereas goods which are difficult
to produce have inelastic supplies. Just as in the demand curve, the supply curve is elastic if
ES is > 1, inelastic, if curve ES < 1 and unitary elastic when ES=1.
Projecting the Future
Important decisions about what and how many goods to produce depend very much
on the entrepreneur’s estimate of future demand. Thus, it is very important that the entrepre-
neur knows some forecasting techniques.
There are different methods of making a forecast:

1. The Average Arithmetic of Growth Rate Method

Historical Sales Figures of Company X
1996-2004

Years Sales(M) % Growth Rate

1996 23.2 -
1997 24.1 3.9
1998 40.3 67.22
1999 30.2 (25.06)
2000 35.8 18.54
2001 15.6 (56.42)
2002 24.9 59.62
2003 25.8 3.61
2004 52.7 104.26
175.67%
Econ 24/29

Average Growth Rate= 175.67

8
= 21.96%

Projected Values:

2005: 52.7 x 21.96% = 11.57

+52.70
64.7M

2006: 64.7 x 21.96% = 14.11

+64.27
78.38M

2. Trend Line Using the Least Squares Method

Historical Sales Figures of Company X
1996-2004

Years X Sales(Y) XY X2
1996 -4 23.2 -92.8 16
1997 -3 24.1 -72.3 9
1998 -2 40.3 -80.6 4
1999 -1 30.2 -30.2 1
2000 0 35.8 0 0
2001 1 15.6 15.6 1
2002 2 24.9 49.8 4
2003 3 25.8 77.4 9
2004 4 52.7 210.8 16
0 272.60 77.7 60

Yt=a + bx
Where:

a= , b=
Substitute:

a= 272.6 = 30.29 , b= 77.7 = 1.30 Y’05=30.29 + 1.30(5)

9 60 2005= 36.79
Yt=30.29 + 1.30X Y’06=30.29 + 1.30(6)
2006= 38.09