Chapter 2 - Demand and Supply

Principles of Economics second edition
Oxford Fajar Sdn. Bhd. (008974-T) 2010
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Ch. 2: 1
CHAPTER
DEMAND AND SUPPLY

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Ch. 2: 2
DEFINITION OF DEMAND
Demand is defined as the ability and

willingness to buy specific quantities of
goods in a given period of time at a particular
price, ceteris paribus.

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Ch. 2: 3
CLASSIFICATION OF GOODS AND

SERVICES
FREE GOODS
Free goods are goods that
have no production cost.
PUBLIC GOODS
Public goods are goods that
are for common use and will
benefit everyone.
ECONOMIC GOODS AND SERVICES

Economic goods are goods of value that can be seen and
touched.
Economic services are intangible things (with value) that
cannot been seen or touched.
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Ch. 2: 4
LAW OF DEMAND
Law of demand states that the higher the

price of a good, the lower is the quantity
demanded for that good and the lower the
price, the higher is the quantity
demanded, ceteris paribus.
P Qdd
P Qdd
NEGATIVE RELATIONSHIP
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Ch. 2: 5
DEMAND SCHEDULE AND CURVE
Demand Schedule
Price
Quantity
Demand Curve
12
10
10
DD
0
2

10
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Ch. 2: 6
INDIVIDUAL AND MARKET

DEMAND
INDIVIDUAL DEMAND
The relationship between the quantity of a good
demanded by a single individual and its price.
MARKET DEMAND
The relationship between the total quantity of a
good demanded by adding all the quantities
demanded by all consumers in the market and
its price.

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Ch. 2: 7
Consumers
income
Tastes and
trends
Price of
related goods
Supply of
money in
circulation
Level of taxation

Population or
number of
buyers
DETERMINANTS
OF DEMAND
Festive
seasons and
climate
Expectation
about future
prices
Advertisement
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Ch. 2: 8
CHANGES IN QUANTITY DEMANDED

VS. CHANGES IN DEMAND
CHANGES IN QUANTITY
DEMANDED
CHANGES IN DEMAND
Price
Price
D1
DD
Quantity
D0
Quantity
Movement along DD curve

Price changes and other factors
are constant
Upward movement Decrease in
quantity demanded (Contraction)

Downward movement Increase
in quantity demanded (Expansion)
Shift in the demand curve

Occurs when there are changes in
other factors but price remains
constant
Increase in Demand (D0 D1)
Decrease in Demand (D1 D0)
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Ch. 2: 9
EXCEPTIONAL DEMAND
Exceptional Demand is the opposite of the
Law of Demand where as price increases,
demand will also increase and vice versa.
GIFFEN GOODS
SPECULATION
EMERGENCIES
STATUS SYMBOL GOODS
HIGHLY-PRICED GOODS
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Ch. 2: 10
INTER-RELATED DEMAND
CROSS DEMAND
The demand for a good is also affected by the price of

its substitute or complementary goods. Cross demand
can be divided into two: Joint demand and
competitive demand.
DERIVED DEMAND
Derived demand is the demand for a good which
is derived from other goods.

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Ch. 2: 11
CROSS DEMAND: JOINT DEMAND

VS COMPETITIVE DEMAND
Cross Demand
Positive relationship exists

between substitute goods
Price of pizza
Price of pizza
DD
Negative relationship exists
between complement
goods
P2
P1
P2
P1
DD
Q1
Q2
Joint Demand

Quantity of soft drinks
Q1
Q2
Quantity of
soft drinks
Competitive Demand
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Ch. 2: 12
PRICE ELASTICITY OF DEMAND
DEFINITION:
Measures the
sensitivity/responsiveness of
the quantity demanded due to a
change in its price.

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Ch. 2: 13
PRICE ELASTICITY OF DEMAND (cont.)
FORMULA:
d
% Quantity Demanded
% Price
d

Q 2 Q1 x
Q1
P1
P2 P1
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Ch. 2: 14
DEGREE OF ELASTICITY
Price (RM)
d =0
d < 1
Perfectly Inelastic Demand

Demand
A conditionInelastic
in which the quantity
demanded does
not changeofaschange
the price
changes.
A large percentage
in the
price of a good
will only affect a small percentage of change in the
quantity
demanded.
Elastic
Demand
d =
d = 1
A small percentage of change in the

price of a good
will leadElastic
to larger
Unitary
percentage of change in quantity
Demand
demanded.
Perfectly
Elastic
A condition in which
Demand
percentage
changes in price
equals to percentage
A condition in which a small
changes in quantity
percentage of change in
demanded.
price leads to an infinite
percentage of change in the
quantity demanded.
d > 1
Quantity Demanded
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Ch. 2: 15
Existence of
substitutes
Frequently
purchased
products
Complementary
goods

Proportion of the
expenditure on a
product
DETERMINANTS
OF PRICE
ELASTICITY OF
DEMAND
Habits
Nature of
goods
Income level
Time
dimension
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Ch. 2: 16
RELATIONSHIP TO TOTAL
REVENUE
Total Revenue (TR) = Price (P) x Quantity (Q)
The information on price elasticity of demand will be useful
for the seller to adjust their selling price since it will affect
the total revenue.
Price
DEMAND IS ELASTIC
RM30
Total Revenue
RM20 x 10 = RM200
RM20
If seller increases price to RM30

New Total Revenue
= RM30 x 5 = RM150
TR = RM50
D
5

10
Quantity Demanded
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Ch. 2: 17
REVENUE (cont.)
Price
DEMAND IS INELASTIC
Total Revenue
RM2
RM1 x 15 = RM15
RM1
New Total Revenue

= RM2 x 10 = RM20
TR = RM5
D
10
15

Quantity Demanded
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Ch. 2: 18
REVENUE (cont.)
DEMAND IS UNITARY ELASTIC
Price
Total Revenue
RM1 x 20 = RM20
RM2

New Total Revenue
= RM2 x 10 = RM20
RM1
TR = 0
D
10

20
Quantity Demanded
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Ch. 2: 19
INCOME ELASTICITY OF DEMAND
DEFINITION:
Measures the sensitivity/responsiveness
of the quantity demanded due to a
change in income.

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Ch. 2: 20
INCOME ELASTICITY OF DEMAND (cont.)
FORMULA:
Y
% Quantity Demanded
% Income
d

Q 2 Q1 x
Q1
Y1
Y2 Y1
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Ch. 2: 21
RESPONSES OF INCOME
ELASTICITY
Elastic Income
Income
-Type of good: Luxury goods such as antique

furniture and diamonds
y =0
Inelastic Income
-Type of good: Normal goods such as food
and clothing
Negative Income Elasticity

-Type of good: Giffen/ Inferior goods such
as used car and low grade potatoes
Zero Income Elasticity
0 < y < 1
y > 1
-Type of good: Necessity Goods such as rice

and vegetables
y< 0
Quantity Demanded

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Ch. 2: 22
CROSS ELASTICITY OF DEMAND
DEFINITION:
Measures the sensitivity/responsiveness of
the quantity demanded of one product due to
a change in the price of a related product.

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Ch. 2: 23
INCOME ELASTICITY OF DEMAND
FORMULA:
X = % Quantity Demanded of good X
% Price of good Y

Qx2 Qx1 x
Py1
Qx1
Py2 Py1
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Ch. 2: 24
RESPONSES OF CROSS
ELASTICITY
Price of Good X
Positive Cross Elasticity
x =0
-Good X and Y are substitute goods
Negative Cross Elasticity

-Good X and Y are complementary goods
Zero Cross Elasticity

-Good X and Y have no relationship
x > 0
x < 0
Quantity Demanded
of Good Y

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Ch. 2: 25
DEFINITION OF SUPPLY
Supply is defined as the ability and

willingness to sell or produce a particular
product and services in a given period of
time at a particular price, ceteris paribus.

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Ch. 2: 26
LAW OF SUPPLY
Law of supply states that the higher the
price of a good, the greater is the quantity
supplied for that good and the lower the
price of a good, the lower is the quantity
supplied, ceteris paribus.
P Qss
P Qss
POSITIVE RELATIONSHIP

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Ch. 2: 27
SUPPLY SCHEDULE AND CURVE
Supply Schedule
Supply Curve
Price
Quantity
12
10
10
Supply

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Ch. 2: 28
INDIVIDUAL AND MARKET SUPPLY
INDIVIDUAL SUPPLY
The relationship between the quantity of a product
supplied by a single seller and its price.
MARKET SUPPLY
The relationship between the total quantity of a
product supplied by adding all the quantities
supplied by all sellers in the market and its price.

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Ch. 2: 29
Cost of
production
Expected
future price
Price of
related goods
DETERMINANTS
OF SUPPLY
Improvement in
infrastructure

Government
Policies
Technological
advancement
Number of
sellers
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Ch. 2: 30
CHANGE IN QUANTITY SUPPLIED

VS. CHANGE IN SUPPLY
CHANGE IN QUANTITY SUPPLIED
CHANGE IN SUPPLY
Price
Price
s0
s1
SS
Quantity
Quantity
Movement along supply curve

Price changes and other factors are
constant
Downward movement Decrease in
quantity supplied (Contraction)
Upward movement Increase in
quantity supplied (Expansion)
Shift in the supply curve

Occurs when there are changes in
other factors but the price remains
constant
Increase in Supply (S0 S1)
Decrease in Supply (S1 S0)
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Ch. 2: 31
EXCEPTIONAL SUPPLY
Exceptional Supply is the opposite of the Law of
Supply where as price increases, the quantity supplied
decreases and vice versa
Wage Rate
20
Income Effect
(Exceptional Supply
Curve)
15
10
Substitution Effect

Labour
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Ch. 2: 32
PRICE ELASTICITY OF SUPPLY
DEFINITION:
Measures the sensitivity/responsiveness of
the quantity supplied due to a change in the
price of a product or service.

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Ch. 2: 33
PRICE ELASTICITY OF SUPPLY (cont.)
FORMULA:
ss
= % Quantity Supplied
% Price
SS

Q 2 Q1 x
Q1
P1
P2 P1
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Ch. 2: 34
DEGREE OF ELASTICITY
Elastic Supply
A small percentage of change in the price of a good will lead to
larger percentage of change in the quantity supplied.
Price (RM)
Inelastic Supply
ss =0
ss < 1
ss = 1
A large percentage of change in the price of a good

will only affect a small percentage of change of the
quantity supplied.
Unitary Elastic Supply

Percentage change in price equals the percentage
change in the quantity supplied.
Perfectly Elastic Supply
ss =
An almost zero percentage of change in price

brings a very large percentage of change in the
quantity supplied.
Perfectly Inelastic Supply
ss > 1
A percentage of change in price has no effect on

the percentage of change in the quantity supplied.
Quantity Demanded
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Ch. 2: 35
Time Period
Technology
improvements
DETERMINANTS
OF PRICE
ELASTICITY OF
SUPPLY
Perishability

Availability and
mobility of
factors of
production
Nature of the
market
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Ch. 2: 36

Chapter 2 - Demand and Supply

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Principles of Economics second edition

Oxford Fajar Sdn. Bhd. (008974-T) 2010

All Rights Reserved

DEMAND AND SUPPLY

Principles of Economics second edition

All Rights Reserved

Demand is defined as the ability and

Principles of Economics second edition

All Rights Reserved

CLASSIFICATION OF GOODS AND

ECONOMIC GOODS AND SERVICES

All Rights Reserved

Law of demand states that the higher the

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DEMAND SCHEDULE AND CURVE

Principles of Economics second edition

All Rights Reserved

INDIVIDUAL AND MARKET

Principles of Economics second edition

All Rights Reserved

Principles of Economics second edition

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CHANGES IN QUANTITY DEMANDED

Movement along DD curve

quantity demanded (Contraction)

Shift in the demand curve

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The demand for a good is also affected by the price of

Principles of Economics second edition

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CROSS DEMAND: JOINT DEMAND

Positive relationship exists

Principles of Economics second edition

Quantity of soft drinks

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PRICE ELASTICITY OF DEMAND

Principles of Economics second edition

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PRICE ELASTICITY OF DEMAND (cont.)

Principles of Economics second edition

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Perfectly Inelastic Demand

A small percentage of change in the

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Principles of Economics second edition

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If seller increases price to RM30

Principles of Economics second edition

New Total Revenue

Principles of Economics second edition

DEMAND IS UNITARY ELASTIC

If seller increases price to RM2

Principles of Economics second edition

INCOME ELASTICITY OF DEMAND

Principles of Economics second edition

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INCOME ELASTICITY OF DEMAND (cont.)

Principles of Economics second edition

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-Type of good: Luxury goods such as antique

Negative Income Elasticity

Zero Income Elasticity

-Type of good: Necessity Goods such as rice

Principles of Economics second edition