antity demanded falls, when the alls the quantity demanded rises’.

Quantity Demanded: The amount of a good consumers choose to buy at a particular price.

Demand Schedule: A table showing the relationship between the price of a good and the quantity
demanded per period of time, other things being equal.

Demand Curve: A diagram showing the relationship between the price of a good and the quantity
demanded per period of time, assuming other things to be equal.

The demand curve is drawn on the assumption that other things equal, price and quantity demanded are
inversely related.

Demand Schedule Demand Curve

Price (per pound) Quantity Demanded (millions of pounds per month)
$ 5.00 6
$ 4.50 8
$ 4.00 10
$ 3.50 12
$ 3.00 14

Demand curve:
According to the law of demand
quantity demand is negatively related
to price which explain why the demand
curve slopes downwards.

Shifts in the Demand Curves

The amount of a good that consumer are willing to buy depends on more than the price of that good. Other
relevant factors include, which are also referred to as the cetrus paribus factors.

1) Income of the consumers

2) Number of consumers
3) Price of other goods
4) Fashion, taste and habits
5) Expectations regarding the future price of the good.

Whenever one of the variables mentioned above change in the result is a new demand curve – a shift in
demand.

i) Income of the Consumers

Generally an increase in income increases the demand for a good, as consumers can afford to buy more of a
the good.

• Normal Good: A good for which demand increases in response to a higher income.

• Inferior Good: A good for which demand falls in response to a higher income. An increase in
income increases the demand for normal goods (e.g fresh bread), which reducing the demand for
inferior goods (e.g Stale bread)

An increase in income
A decrease in income decreases demand for normal goods, while increasing demand for inferior goods.

A decrease in income

ii) Number of Consumers:

Greater the number of consumers in the market, higher will be the demand for a commodity at its
given price and vice versa.

Increase in the no. of consumers A decrease in the no. of consumers

iii) Price of other goods

There are two types of goods.

Substitute Goods: Goods that are suitable/ substitutable in consumption. Two goods are suitable
when an increase in the price of one good increases demand for the other.

Complementary Goods: Goods that are consumed together. These goods are complements when
an increase in the price of one good reduces demand for the other.

An increase in the price of beef (a substitute) shifts demand for fish outward (A). In contract when tennis
balls increase in price, tennis becomes less popular which reduces demand for tennis racquets (B).

(A) Substitutes (B) Complements

iv) Fashion, taste and habits

When published reports convince consumers that they should eat more fish and cut their
consumption of meat, beef, demand for fish increases and demand for beef falls.
Price of fish Price of beef

D2 D1
D1 D2

Quantity of fish Quantity of beef

v) Expectations regarding future price and market conditions can influence demand today.
Speculation about increase in price of coffee tomorrow, might lead coffee drinkers to stock up on their
coffee supplies today.

* Point to remember

A change in a goods own price leads its a movement along a given demand curve (a change in
quantity demanded), a change in any other variable which would be the citrus paribus factors
(excluding Price) results in a new demand curve (a shift / change in the demand curve).
Elasticity of Demand

Elasticity is a measure of responsiveness. The degree to which quantity demanded (q.d) responds to change
in the products own price is known as responsiveness of demand.

Assume the price of a good rises by 10%, according to the ‘Law of Demand” the q.d for the good should
fall. The answer to how much in value should q.d fall, is answered by the concept of price elasticity of
demand.

Price Elasticity of Demand is defined as the percentage change in q.d divided by the percentage change in
price
Elasticity is denoted by the Greek symbol n.

If a 10% price increase leads to a 1% decrease in q.d then price e.o.d is

n = % change in q.d / % change in p
= (-1)/10 = - .10

• Consider the following demand curve for McDonald’s Quarter Produces.

$2.20 B

$ 2.00 C

$1.80 A
qd/per week
800 1,000 1,200

At price of $1.80, 1,200 is the q.d. per week. When price rises to $ 2.20 q.d. for quarter powders falls to
800 burgers per week. Given these figures, what is the price e.o.d.?

Movement from point A to B

Suppose we take P1 = $1.80 and Q1=1200 as our reference point (point A on the demand curve) then an
increase in price of quarter pounders from $1.80 to $2.20 constitutes a price change of 22%.

%age change in price is (p2 – p1) / p1 = (2.20 – 1.80)/ 1.80 = .22 or 22 %.

Similarly, a reduction in the number of quarter ponders purchased from 1,200 to 800 constitutes a change in
q.d of 33%

%age change in q.d is (q2 – q1) / q1 = (800 – 1200)/ 1200 = - .33 or 33 %.

Based on these numbers, the e.o.d is delta q/delta p = -33/2 = -1.5

Someone could take P2=2.20 and Q2= 800 as reference point and compute the elasticity by considering a
movement from point B to A, and compute the elasticity by considering a movement from B to point A. In
this case, the change in price is 18%.

%age change in price is (p2 – p1) / p1 = (1.80 – 2.20)/ 2.20 = - .18 or 18 %

And q.d as to be 50%

%age change in q.d is (q2 – q1) / q1 = 1200 – 800)/ 800 = .50 or 50 %.

According to these numbers, p.e.o.d is equal to delta Q / delta P = 50 / -18 = - 2.8

Note that this value is different to our prior calculation of -1.5.

To avoid this difference, we specify a reference point. We split elasticity into two parts: delta q/ delta p
(rate of the change in quantity brought about by a change in price. And p1/q1 related to the midpoint of
price & q.d. on the demand cure before any change.

n= (change in q.d) / (change in p) x (p1/q1)

Given average price of $ 2.00

Given average q.d of 1,000

The price elasticity over the entire demand curve would be;

(Change in q/ Change in p) x (p1/ q1)

= (q2 – q1) / (p2 – p1) x (p1 / q1)

= (1200 – 800) / 1.80 – 2.20) x (2 / 1000)
= (400) / (-0.4) x ( 2/ 1000)
= - 2 which is n

Economists often label the demand for a good on the basis of its elasticity.
When Ed>1, demand is said to be relatively elastic.
With an elastic demand curve the change in q.d is greater than the change in price.

When Ed<1, demand is termed as relatively inelastic meaning that the change in q.d is less than the change
in price.

When Ed=1, demand is unitary elastic. A price change of 1% will bring about a 1% change in q.d.

Perfectly Elastic Demand: ‘A demand that is infinitely responsive to price, represented by a horizontal
demand curve.
p

p1 D
 qd

Quantity demanded is so responsive to price that consumers purchase all that is offered at P1, but purchase
nothing when price rises above P1.

Perfectly Inelastic Demand.

A demand that is totally unresponsive to price changes. It is represented by a vertical demand curve.
p

Q.D
Q1

Consumers want to purchase Q1, regardless of price.

Unitary Elastic Demand:
A demand that is completely responsive to price

Other Elasticities

Quantity demanded depends on a good’s own price but on other factors too, for example income and prices
of other goods.

Income Elasticity of Demand:

What happens when income rises? For normal goods demand increases – so that at any given price a
higher quantity is now demanded.

For inferior goods demand falls – consumers reduce purchase of inferior goods by substituting preferred
goods.

The question of whether demand for a goods rises or falls, is addressed by the concept of Income Elasticity
of Demand.

ny= (% change in q.d) / (% change in income)

• Income e.o.d for normal good is positive

• Income e.o.d for inferior good is negative

Normal goods are further sub-classified into luxury and necessity goods.
Luxury goods are ones whose income e.o.d exceeds 1.

Necessities are goods whose income e.o.d is less that 1. Example of necessity goods are food, electricity,
cigarettes.

Necessities are on the top priority list. When income is low, necessities use up a major share of the
income. As income rises consumers spend fewer additional money on necessities, and a larger share on the
consumption of luxuries.

Cross Elasticity of Demand.

‘The responsiveness of demand for any product to change in the price of another product is called cross
e.o.d.’

How sensitive is the q.d. of one good due to the price change of another good. Answer is provided by cross
e.o.d.

nx,y= %age change in q.d of good x / %age change in price of good y

The value for cross elasticity of demand can range from – infinity to = infinity

The value of cross e.o.d indicates the relationship between two goods.

• When cross e.o.d is positive, good are substitutes. When price of one good falls, consumers buy
more of it at the expense of the other good. So the q.d of the other good falls.

• When cross e.o.d. is negative, the goods are complimentary goods (e.g. cameras and film).
Consumers want more not only of the good whose price has fallen, but also of the other good.

• When cross e.o.d is zero, the goods are indpendent goods (e.g. pencils and footballs). The q.d of
footballs does not depend on the price of pencils.

Good Original New % Change

Camera
Quantity 100 95 -5%
Price £1 £ 1.1 10%

Film
Quantity 200 140 -30%
Price £5 £6 20%

nx,y= %age change in q.d of good x / %age change in price of good y

= (5%) / (20%)
= - 0.25; so the consumers demand less of both goods in question.
As nxy is negative we see that the goods are complementary goods.

Good Original New % Change

Fish
Quantity 100 95 -5 %
Price £1 £ 1.10 10%
 Meat
Quantity 100 110 10%
Price £1 £ .90 -10%

nx,y= %age change in q.d of good x / %age change in price of good y

= (-5%) / (-10%)
= - 0.50.
Good are substitutes as cross e.o.d is positive; consumer demand more of good y at the expense of good x
(as they are substitutes)
Supply

As demand curves describe the behavior of buyers, supply curves summarize the behavior of sellers by
describing the trades they are willing to make at various prices.

Suppose your college offers you a job painting dormitory rooms for $ 100 per room. You can choose on
the number of rooms you want to paint. Your answers form your supply schedule.

A seller’s supply schedule for a good is a table showing many hypothetical prices of the good and the
seller’s quantity supplied at each price.

Price for Room Rooms painted per week

$ 80 0
$ 100 1
$ 120 2
$ 140 3
$ 160 4

‘A supply curve for a good is a graph of the supply schedule’.

A seller’s quantity supplied of a good at some price is the amount of the good he or she would sell during
some time period if he or she could sell as much as they desired at that price.

* Notice that the quantity supplied describes what sellers want to do, it is unrelated to the amount that
buyers want to buy.

LAW OF SUPPLY

‘Other things being constant, an increase in price increases quantity supplied and a decrease in price
decreases quantity supplied.’

• The supply curve shows how price changes affects the quantity supplied, holding certain conditions
constant.

• When the price of the good rises, holding constant other conditions, quantity supplied usually rises.

• Market supply curves slopes upwards because each seller’s supply curve slopes upwards and because
more potential sellers become actual sellers when the price rises.

• When economists refer to the supply curve for a good, they mean the market supply curve.
Changes in Supply

A change in supply means a change in the number of quantity supplied in the supply schedule, which
implies a shift in the supply curve.

An increase (or rise) in supply is an increase in the quantity supplied at each possible price and thus the
supply curve shifts to the right

A decrease (or fall) in supply is a decrease in the quantity supplied at each possible price and thus the
supply curve shifts to the left.

Note * ‘A change in price changes q.s, but it does not change the supply.’

‘A change in conditions other than price can shift the supply of a good.’

CHANGES IN CONDITIONS CAUSING CHANGES IN SUPPLY

INCREASE IN SUPPLY DECREASE IN SUPPLY

i. Prices of inputs: Increases in the prices of inputs can decrease supply by reducing the profit
margin. Similarly a fall in the input prices raises the incentive to produce and sell the goods, thus
increasing supply.

ii. Technology: If an advancement in technology lowers the cost of producing a good, it increases
the incentives to produce and sell it. In a way, advancement in technology increases supply.

iii. Number of sellers: Market supply increases when the number of potential seller rises. Market
supply decreases when the number of potential sellers falls.
iv. Expectation regarding the future price: An increase in the expected price of a good in the future
will decrease supply today and vice versa.

v. Price of other Goods A price change can change the supplies of other goods e.g if a producer can
use a machinery to make either shirts or dresses, a rise in the cost of dresses raises the opportunity
cost of producing shirts. Therefore a rise in dress prices decreases the supply of shirts. A rise in
the dress prices decreases the supply of shirts.

A different example involves goods that are jointly produced, an increase in the price of leather can
increase the supply of beef because leather and beef are produced jointly from cattle.

Effects on supply of changes in conditions.

Changes in condition to that increase supply of a Changes in conditions that decrease the supply of a
good good
1. Fall in price of input Rise in price of input
2. Improvement in technology that lowers cost of Decreases in available technology
production.
3. Fall in price of a good that sellers could produce Rise in price of a good that sellers could produce
themselves, a rise in the price of jointly produced themselves, and a fall in price in the case of jointly
goods. produced goods.
4. Increase in adjustment time following a rise in price. Increase in adjustment time following a fall in price.
5. Increase in the numbers of sellers. Decrease in the number of sellers.
Equilibrium of Demand and Supply

• Demand curves summarize the behavior of buyers.

• Supply curves summarize the behavior of sellers.
• An equilibrium is a situation that has no tendency to change unless some underlying condition
changes.
• A market equilibrium is a situation described by a combination of price & quantity traded, in which the
quantity supplied equals the quantity demanded. That price is the equilibrium price and the quantity is
the equilibrium quantity. Economist also use the term market-clearing for market equilibrium. They
say that the equilibrium price ‘clears the market’.

Market Equilibrium

• A market equilibrium appears on the graph as a point where the ‘S’ and ‘D’ curves intersect: point A in
figure.
• The equilibrium price is P1.
• The equilibrium quantity Q1 shows the amount of the good bought and sold.
• Buyers buy Q1 units of the good from sellers, and pay P1 dollars for each unit.
• Total spending on the good is the area of the shaded area. This area equals the quantity that people
buy, Q1 multiplied by the price per unit P1.

At any price other than p1, quantity demanded does not equal quantity supplied and hence the market is not
in equilibrium. This is a disequilibrium situation.

Disequilibrium is the absence of equilibrium; it occurs when the quantity demanded and the quantity
supplied are not equal at the current price.

There are two kinds of disequilibriums.

i) Excess Demand or Shortage:

Suppose that the price is p0, below the equilibrium price p1. At price p0, the quantity demanded exceeds
the quantity supplied, buyers want to buy more than sellers want to sell. There is a shortage of the good.

Excess demand or a shortage is a situation in which the quantity demanded exceeds the quantity supplied.

• A shortage occurs wen the price of a good is below its equilibrium price. The size of the shortage, or
the amount of excess demand, equals the quantity demanded minus the quantity supplied.
• A shortage creates pressure for the price to rise. Some buyers cannot buy the good and stores run out
of it.
• Sellers have an incentive to raise the price because enough buyers are willing to pay the higher price.
• The price tends to rise until it reaches the equilibrium price P1 where the quantity demanded equals the
quantity supplied.

If the price is below the equilibrium price, there is a shortage and the price tends to rise towards
equilibrium.
ii) Excess supply or surplus:

• The second type of disequilibrium involves excess supply.

• Suppose price is P2, above the equilibrium price of P1.

• At price P2, the quantity supplied is more than the quantity demanded.
• Buyers want to buy less then seller want to sell. There is a surplus of the good.

Excess supply, or a surplus is a situation in which the quantity supplied exceeds the quantity demanded.

Supplies creates pressure for the price to fall sellers have extra units that they cannot sell, and they would
rather sell the goods at a lower price then not sell them at all.

• Sellers reduce the price to complete for customers, the price tends to fall until it reaches the
equilibrium price P1, where the quantity supplied equals the quantity demanded.

If the price is above the equilibrium price, there is a surplus and the price tends to fall towards the
equilibrium price.

Summary of Equilibrium

• At the equilibrium price, there is neither a shortage nor a surplus, so the price shows no tendency to
change, unless demand or supply changes.

Remember that some change in conditions cause changes in demand while other changes in conditions
cause changes in supply.

Consumers Surplus

The difference between the total value consumers place on all units consumed of a commodity and the
payment they must make to purchase that amount of the commodity.
 • You’re thirsty and you would pay $3.00 for a soft drink. A vendor machine offers them for 75c
each. You have no choice but to buy the drink from the machine. You buy one and you are not
thirsty enough for a second. Your consumer surplus from the first drink is $2.25.

• If you were less thirsty the maximum amount you would be willing to spend on a drink might only
be $1.90. In this case your consumer surplus would be $1.15.

• If the highest price you are willing to pay would be 80c then your consumer surplus would be 5c.

The height of the market demand curve shows consumers willingness to pay consumers purchase goods at
the equilibrium market price. The difference between the price actually (ie. paid equilibrium price) and the
maximum price consumers would actually be willing to spend is consumer surplus.

Consumer surplus measures the benefit consumers get when they buy the good at the equilibrium price.
Total consumer surplus is the area under the demand curve and above equilibrium price line.
p

Consumer Surplus

q.d
q0

The area under the demand curve shows the total value that consumer place or all the units consumed. The
total value consumer place on consuming q0 units at price p is captured by both the and
area. However consumer surplus is denoted by the shaded area.

We know that consumer surplus means the benefits consumers get when they buy the good at its
equilibrium price. The consumer surplus on each unit purchased is the vertical distance between the
demand curve and a line showing the equilibrium points. Adding these vertical distances on all the units
purchased gives the area that curves total consumer surplus and also the total spending on the product.

The vertical line at the quantity of 1 unit shows consumer surplus on the first unit purchased (3.00 - .75=
$ 2.25). The vertical line at the quantity of the 10 units shows consumer surplus (1.90 - 0.75= $ 1.15)

‘Confusion about consumer surplus’

Consumer surplus does not measure the happiness or enjoyment that consumers get from goods. It
measures the total benefit to consumers based on their tastes or values and on their ability to pay. The
consumer surplus measurement reflects the distribution of income and wealth across people.
Why are important goods like air and water inexpensive, while less important goods like diamonds very
expensive. To understand this dilemma we must be clear about the fact that the equilibrium price is not a
measure of the importance of a good. The equilibrium price is greatly influenced by the supply of the
commodity in question.

The consumer surplus that people get from water exceeds the consumer surplus they get from diamonds.
Water is essential for human despite the price of water being much less than the price of diamonds.