Demand and Supply

Analysis

Learning Outcomes
Conceptual Understanding of Demand,

Demand Curve and Law of Demand.

To Understand effects of determinants of
demand on Demand Function.
To Understand causes of change in Demand.

Demand
Demand: effective desire
Demand is that desire which backed by willingness and ability to
buy a particular commodity.
Amount of the commodity which consumers are willing to buy
per unit of time, at that price.
Things necessary for demand:
Time
Price of the commodity
Amount (or quantity) of the commodity consumers are willing
to purchase at the price

Types of Demand
Direct and Derived Demand

Direct demand is for the goods as they are such as Consumer

goods
Derived demand is for the goods which are demanded to
produce some other commodities; e.g. Capital goods

Recurring and Replacement Demand

Recurring demand is for goods which are consumed at frequent

intervals such as food items, clothes.
Durables are purchased to be used for a long period of time

Wear and tear over time needs replacement

Complementary and Competing Demand

Some goods are jointly demanded hence are complementary in

nature, e.g. software and hardware, car and petrol.
Some goods compete with each other for demand because they
are substitutes to each other, e.g. soft drinks and juices.

Determinants of Demand
Price of the product

Single most important determinant

Negative effect on demand
Higher the price-lower the demand

Income of the consumer

Normal goods: demand increases with increase in consumers

income
Inferior goods: demand falls as income rises

Price of related goods

Substitutes
If the price of a commodity increases, demand for its
substitute rises.
Complements
If the price of a commodity increases, quantity demanded of
its complement falls.

Determinants of Demand
Contd

Tastes and preferences

Very significant in case of consumer goods
Expectation of future price changes

Gives rise to tendency of hoarding of durable

goods

Population
Size,
composition and distribution
population will influence demand
Advertising

of

Very important in case of competitive markets

Demand Function
Interdependence between demand for a product and its

determinants can be shown in a mathematical functional

form
Dx = f(Px, Y, Py, T, A, N)

Independent variables: Px, Y, Py, T, A, N

Dependent variable: Dx
Px: Price of x
Y: Income of consumer
Py: Price of other commodity
T: Taste and preference of consumer
A: Advertisement
N: Macro variable like inflation, population growth, economic
growth

Law of Demand
A special case of demand function which shows relation between
price and demand of the commodity
Dx = f(Px)
Other things remaining constant, when the price of a commodity
rises, the demand for that commodity falls or when the price of a
commodity falls, the demand for that commodity rises.
Price bears a negative relationship with demand
Reasons

Substitution Effect : When the price of a commodity falls (rises), its

substitutes become more (less) expensive assuming their price has
not changed.
Income Effect: When the price of a particular commodity falls, the
consumers real income rises, hence the purchasing power of the
individual rises.
Law of Diminishing Marginal Utility: as a person consumes
successive units of a commodity, the utility derived from every next
unit (marginal unit) falls.

Demand Schedule and Individual

Demand Curve

Price (Rs
per cup)

Demand
(000
cups)

15

50

20

40

25

30

30

20

35

10

e
35
Price of Coffee

Point on
Demand
Curve

30

25

20

15
O

10

20

40 50
30
Quantity of coffee

Change in Demand
Price

Shift in demand curve from D0 to D1

More is demanded at same

D1
D2

D0

Q2

Q1

Quantity

price (Q1>Q)
Increase in demand caused by:
A rise in the price of a substitute
A fall in the price of a
complement
A rise in income
A
redistribution of income
towards those who favour the
commodity
A change in tastes that favours
the commodity
Shift in demand curve from D0 to D2
Less is demanded at each price
(Q2<Q)

Exceptions to the Law of Demand

Law of demand may not operate due to the following
reasons:
Giffen Goods
Snob Appeal
Future Expectation of Prices (Panic buying)
Addiction
Neutral goods

Life saving drugs

Salt

Amount of income spent

Match box

Market Demand
Market: interaction between sellers and buyers of a

good (or service) at a mutually agreed upon price.

Market demand

Aggregate of individual demands for a commodity at a

particular price per unit of time.
Sum total of the quantities of a commodity that all
buyers in the market are willing to buy at a given price
and at a particular point of time (ceteris paribus)

Market demand curve: horizontal summation of

individual demand curves

Demand for Big Macs

Leader in fast food chain business with 31000 restaurants in 118 countries.
Closest competitor Burger King had 12000 restaurants in 61 countries.
In US, Mc Donalds has 14000 outlets compared with Burger Kings 7000.
Burger market share is 47% compared to Burger Kings 14% and Wendys 13%.

After three decades of double digit gains, domestic sales at Mc Donalds have grown slowly
since 1980s

Why?

Higher prices
Changing tastes
Increased competition from other fast food chains
Obesity issues in the US

Strategies adopted to increase demand

Introduced new items on its menu
Cutting prices
In 1990, introduced value menu with small hamburgers selling for as little as 59
cents( down from 89 cents) and a combination of burger, french fries and softdrinks for as
much as half off
Indian strategies to increase demand
Efforts to position as affordable by introducing low priced products as ice cream cone at
Rs7 and Economeals at low prices.
Gradually launched Mc Swirl vanilla icecream in cones, topped with cadbury chocolate at
Rs 12 and cone sales increased by 15%
Happy price menu

Customised Indian menu with no pork products.

Reformulated products giving spices favoured by Indians.
Maharaja Mac favoured by middle and rich class consumers.

Supply
Indicates the quantities of a good or service that the

seller is willing and able to provide at a price, at a given

point of time, other things remaining the same.
Supply of a product X (Sx) depends upon:

Price of the product (Px)

Cost of production (C)

State of technology (T)
Government policy regarding taxes and subsidies (G)
Other factors like number of firms (N)
Hence the supply function is given as:
Sx = (Px, C, T, G, N)

Law of Supply
Law of Supply states that other things remaining the same, the
higher the price of a commodity the greater is the quantity supplied.
Price of the product is revenue to the supplier; therefore higher price
means greater revenue to the supplier and hence greater is the
incentive to supply.

Supply bears a positive relation to the price of the commodity.

Supply Schedule

Supply Curve

Point on
Supply
Curve

Price
(Rs. Per
cup)

Supply (000
cups per
month)

15

10

20

20

25

30

30

45

35

60

Price of Coffee

35

30
25

20

15
0

a
10

20

30 40 50 60
Quantity of Coffee

Change in Supply

Price

S2
S0
S1

Q2

Q0

Q1

Quantity

Shift in the supply curve from

S0 to S1
More is supplied at each
price (Q1>Q0)
Increase in supply caused by:
Improvements
in
the
technology
Fall in the price of inputs
Shift in the supply curve from
S0 to S2
Less is supplied at each
price (Q2<Q0)
Decrease in supply caused by:
A rise in the price of inputs
Change in government
policy (VAT)

Market Equilibrium

Equilibrium occurs at the price where the quantity demanded and

the quantity supplied are equal to each other.
At point E demand is equal to supply hence 25 is equilibrium price

Price

25

D
O

30

Quantity

Demand
(000 cups/
month)

Price
(Rs)

Supply
(000 cups/
month)

15

10

50

20

15

40

25

30

30

30

45

15

35

70

10

Market Equilibrium

For prices below the equilibrium, Quantity demanded exceeds

quantity supplied (D>S)
Price pulled upward

For prices above the equilibrium, Quantity demanded is less than

quantity supplied (D<S)
Price pulled downward.

At point E demand is equal to supply hence 25 is equilibrium price.

Price
S
30
25

20
D
O

30

Quantity

Price
(Rs)

Supply
(000 cups/
month)

Demand
(000 cups/
month)

15

10

50

20

15

40

25

30

30

30

45

15

35

70

10

Changes in Market Equilibrium

(Shifts in Supply Curve)
The original point of equilibrium is

at E, the point of intersection of

curves D1 and S1, at price P and
quantity Q
An increase in supply shifts the
supply curve to S2
Price falls to P2 and quantity rises

to Q2, taking the new equilibrium to

E2

A decrease in supply shifts the

supply curve to S0. Price rises to

P0 and quantity falls to Q0 taking
the new equilibrium to E0

Thus an increase in supply raises

quantity but lowers price, while a

decrease in supply lowers quantity
but raises price; demand being
unchanged

Price

S0
S1

D1
P0
P
P2

S2

E0
E
S0

E2

S1
S2

D1
Q0 Q Q2

Quantity

Changes in Market Equilibrium

(Shifts in Demand Curve)
The original point of equilibrium is at
Price
D2
S1

D1
D0
E

P
P*

D2
D0
Q* Q

Q1

D1
Quantity

Price rises to P1 and quantity rises to

Q1 taking the new equilibrium to E1

A decrease in demand shifts the

demand curve to D0

E2
S1

E1

P1

E, the point of intersection of curves

D1 and S1, at price P and quantity Q
An increase in demand shifts the
demand curve to D2

Price falls to P* and quantity falls to

Q* taking the new equilibrium to E2.

Thus, an increase in demand

raises both price and quantity, while
a decrease in demand lowers both
price and quantity; when supply
remains same.

Change in Both Demand and Supply

Initial equilibrium is at E1, with price

Price

D2

D2

D1

P2
P1

E1
S1

S2
Q1

quantity combination (P1, Q1).

An increase in both demand and
supply takes place;
demand curve shifts to the right
S1
from D1 D1 to D2 D2
S2
supply curve also shifts to the
right from S1 S1 to S2 S2.
E2
The new equilibrium is at E2, and
E0
price quantity is (P2, Q2).
An increase in both supply and
D
demand will cause the sales to rise,
D2 2
D1
but
the price will increase if increase
Q2
Quantity
in D>S (as at E2 )
No change in price if increase in
D=increase in S (as at E0 )

 The government announces a price hike in petrol and diesal in the

month of September. Resultantly, the cost of transportation of

vegetables rises leading to a rise in price of vegetables. Draw a
diagram showing the impact of these changes on demand for
vegetables.
Shirt manufacturers of Jalandhar are facing declining sales due to stiff
competition from imported Chinese garments. Thus, demand falls due
to the presence of a better substitute in the market. The manufacturers
call a meeting to solve the problem. They decide to cut production of
shirts thus offering lesser quantity for sale at the same price. However,
the fall in demand is lesser than the fall in supply. Show these changes
with the help of diagram depicting market equilibrium.
The growers of a local Indian variety of bananas are facing competition
from imported bananas from Argentina and Brazil. This has led to a fall
in demand for Indian variety over the last two years. The banana
growers call a meeting and cut production. However, fall in demand is
less than fall in supply. Show these changes.

Summary
Demand is defined as the desire to acquire a commodity to satisfy

human wants, which is backed by ability to pay the price.

Categories of demand are made on the basis of the nature of
commodity demanded (consumer goods and capital goods); time unit
for which it is demanded (short run and long run); relation between
two goods (substitutes and complements), etc.
The law of demand states that the consumers will buy more of the
commodity when prices are high and less when prices are low,
provided all the other factors of demand remains constant.
Demand for a product X (Dx) is a function of price of the commodity X
(Px), income of the consumer (Y), price of related (substitutes or
complements) commodities (Po), tastes and preference of the
consumer (T), advertising (A), future expectations (Ef), population
and economic growth (N).
A change in quantity demanded denotes movements along the
demand curve due to a change in price, while a change in demand
denotes a rightwards or leftward shift of the demand curve due to a
change in the other determinants of demand other than price.

Summary
Supply is defined as the willingness to produce and sell the commodity by

production units or firms.

The law of supply states that firms will sell more of the commodity when
prices are high and less of the commodity when prices are low provided all the
other factors of supply remains constant.
Supply of a product X (Sx) is a function of price of the product (Px), cost of
production (C), state of technology (T), Government policy regarding taxes
and subsidies (G), other factors like number of firms (N).
Change in quantity supplied refers to movements along the same supply
curve due to change in the price of the commodity. However when change in
supply is associated with change in the factors like costs of production,
technology, etc. it causes a shift of the supply curve upwards or downwards
Market equilibrium occurs where demand and supply are equal. This
equilibrium determines the price in the market through the forces of demand
and supply. Comparative statics is the process of comparison between two
equilibrium situations.
An increase in both supply and demand will cause the sales to rise, but the
effect on price can be positive, negative or equal to zero, depending on the
extent of the shifts in the demand and supply curves.