QSM406-

PRINCIPLES OF
ECONOMICS
2.0 DEMAND AND SUPPLY
Week 3

2.0 Demand and Supply 1

2.0 DEMAND AND SUPPLY

2.1 The Market Structure

2.2 Demand
2.2.1 The Law of Demand

2.2.2 Demand Curves

2.2.3 Change in Quantity
Demanded versus Change
in Demand
2.2.4 Factors That Shift the Demand Curve
2.0 Demand and Supply 2
2.1 Market Structure
Perfect Monopolistic Oligopoly Monopoly
competition competition

The firms is a The firm has Depends on The firm is a

price taker some control reactions of rivals price maker
over price to price change

Very many Many sellers Few sellers One seller

sellers

Homogeneous Differentiated Differentiated or Unique product

product e.g. product e.g. undifferentiated no close
vegetables, restaurants, product e.g. substitute e.g.
fruits soap, shampoo, cement, steel, electric, water,
detergents cars, telephone,
companies

No No High High
barriers barriers barriers barriers
to entry to entry to entry to entry

Fig. A: Summary of Market Structures

2.0 Demand and Supply 3

2.2 Demand

Demand means the willingness and ability of buyers to

pay for goods and services.

Quantity demanded is the amount consumers are

willing and able to buy at a given price over a given
period (e.g. a week, or month or a year).

How, other things remaining the same, does the

quantity demanded of a good change as its price
change?

2.0 Demand and Supply 4

2.2 Demand

2.2.1 The Law of Demand

The law of demand states that, other things remaining the same:

As the price of a good rises, the quantity demanded per period falls.
As the price of a good falls, the quantity demanded per period rises.

Simply put, the law of demand states that the price of a good and the quantity
demanded of the good are inversely related, cateris paribus.

P Qd ; P Qd

The law of demand applies when other things are held constant such as price
of other goods and the income level.

2.0 Demand and Supply 5

2.2 Demand

Why does a higher price reduce the quantity demanded,

and more when the price fall?

2.0 Demand and Supply 6

2.2 Demand

The Income Effect of a price rise. With a higher price and

unchanged income, people will feel poorer. The purchasing
power of their income has fallen i.e. they can now buy less
than before with the same income. The good whose price
has risen will be one of the goods that people buy less.

The Substitution Effect of a price rise. The good will now

be dearer relative to other goods. People will buy less of
that good and more of its substitute.

Similarly, when the price of a good falls, the quantity

demanded will rise. People can afford to buy more of this
good (the income effect), and they will switch to or from
alternative goods (the substitution effect).

2.0 Demand and Supply 7

2.2 Demand

Market demand is the sum of the individual

demand for a good from each consumer in the
market. If more people enter the market and they
have the ability to pay for items on sale, then
demand at each price level will rise.

A market demand schedule shows the different

total quantities of a good that consumers are
willing and able to buy at various prices over a
given period of time. To obtain the market
demand schedule for the good, simply add up the
quantities demanded at each price by all
consumers.

2.0 Demand and Supply 8

2.2 Demand
Prices Buyer A Buyer B Buyer C Total quantity
($/kg)

1.00 2 1 1 4

0.80 4 8 2 14

0.60 6 9 3 18

0.80 8 10 4 22

0.20 10 11 5 26

Table 2

Table 2 shows the demand schedule for 3 buyers. The

market demand at each price is the sum of the 3
individuals.

2.0 Demand and Supply 9

2.2 Demand
A market demand curve shows the relationship
between the price of a good and the quantity of the
good demanded by all the consumers over a period of
time (e.g. weekly or annually), while all the other
factors that affect how much consumers want to buy
are held constant.

The graph in Fig. 2 shows the demand curves that

correspond to these demand schedules.

A downward sloping demand curve is the graphical

2.0 Demand and Supply 10
representation of the inverse relationship between
price and quantity demanded.
2.2 Demand
2.2.2 Demand Curves
$ Fig. 2 Market Demand
D Fig 2
Curve
1.00 a Point a shows that at $
1.00/kg, 4 items are demanded
each month. When the price
b
0.40
D
falls to $0.40, we move down
the curve to point b, this
shows the quantity demanded
0 4 Quantities 22
has now risen to 22 items per
month.
The market demand curves generally slope downwards from
left the right: the lower the price of a product, the more is a
person likely to buy.
2.0 Demand and Supply 11
2.2 Demand
A CHANGE IN QUANTITY DEMANDED
Fig. 3
is the movement from one point to P
another point on the same demand
Decrease in quantity
curve caused by a change in the price a
demanded
of the good itself when other things
b
remain the same.
c
Increase in
Movement along the Demand Curve quantity demanded Q
Changes in the price of the good itself
cause a movement along the demand
curve.
The effect of a change in price is shown by a movement along the
demand curve; for example from point b to point a in Fig. 3 when the
price of the item rises from 40 to $1.00/kg.
For example, a tax that raises the price of cigarettes results in a
movement along the demand curve.

2.0 Demand and Supply 12

 2.2 Demand
A CHANGE IN DEMAND is about a change or a shift in the entire
demand curve (rightwards or leftwards). It occurs when any factor
that influences consumers buying decisions, other than the price of
the good itself, changes.

An increase in demand means that people are willing and able to

buy more units of the good at each price. The demand curve shifts
to the right.

A decrease in demand means that people are willing and able to

buy less of a good at each price. The demand curve shifts to the
left.

2.0 Demand and Supply 13

 2.2 Demand
Shifts in the Demand Curve
(Increase or Decrease in Demand)
Changes in any of the factors other
than price cause the demand curve
to shift.
Any change that raises the quantity
that buyers wish to purchase at a
given price shifts the demand curve
to the right.
Any change that lowers the quantity
that buyers wish to purchase at a
given price shifts the demand curve
to the left. A policy to discourage
smoking shifts the demand curve to
2.0 Demand and Supply
the left.
Fig. 4
P
D1
D0
Q0 Q1
If income rises, the demand for the
item increases, then the curve shifts
to the right. At each price, more will
be demanded than before.
In Fig. 4 at a price of P, a quantity
of Q0 was originally demanded. But
now, after the increase in demand,
quantity Q1 is demanded.
14
2.2 Demand
Table 4: Factors Leading To a Movement along and a Shift in
Demand Curve The Law Of Demand
(A movement along the demand curve)
The quantity of chocolate bars demanded
Decreases if: Increases if:
The price rises The price falls

Changes In Demand
(A shift of the demand curve)
The demand for chocolate bars
Decreases (shift to the left) if: Increases (shifts to the right) if:
A change in tastes away from the A change in tastes towards the product
product
A competitor has a successful There is a successful advertising
advertising campaign campaign
The price of a substitute falls The price of a substitute rises
The price of a complement rises The price of a complement falls
Income falls (choc is a normal good)* Income rises (choc is a normal good)*
Income rises (item is an inferior good)
Expected future income falls Expected future income rises
The population decreases The population increases
2.0 Demand and Supply 15