CHAPTER III:

SUPPLY, DEMAND AND THE MARKET PROCESS

Most economic goods and services in the market get allocated Prices. Economics is also
called Price Theory, especially Micro. The market forces of supply and demand describe
how the prices systems work, and help us understand how the market allocates scarce
resources.
Consumer Choice and the Law of Demand
The inverse relation between price and quantity demanded. The law of demand reflect
that as consumers, we like low prices because we want to get as much satisfaction
from our limited income, so we choose to maximize our purchasing power. Available
substitutes dramatically influence our behaviour as consumers. Part of the reason why
we buy less at higher price is the availability of substitutes.
When only few substitutes are available, consumers are not as responsive/sensitive to
price changes. And if there are lots of good substitutes, consumers become very
responsive or sensitive to changes in the prices of goods or commodities. Availability of
goods, close substitutes determine consumer responsiveness to price changes.
When consumers are very price sensitive, when there are lots of good substitutes, the
demand curve is flat; the demand is elastic to price changes. And when consumers are
not very sensitive to prices and there are no available substitutes; the demand curve is
steep; the demand is inelastic. The steepness/flatness of a demand curve reflects how
sensitive consumers are to prices of different goods/services.T
The law of demand tells us that Price Increases result in a reduction in quantity
demanded. Elasticity is a more precise measure that tells us how quantity demanded
will fall with a price increase.

Consumer Surplus
This means the maximum price you would pay is the market price
SHIFTS CHANGES IN DEMAND VS. CHANGES IN QUANTITY DEMANDED
The demand curve isolates the effect that price has on Qd (Law of Demand), holding
everything constant, ceteris paribus.
Rule: A change in price leads to a change in quantity demanded (movement along the
demand curve); a change in any other variable leads to a change in demand (shift in
the entire demand curve).
Increase in demand: Demand curve shifts to the right.
Decrease in Demand: Demand curve shifts to the left.
What Causes Demand For X To Shift?
1. A rise I consumers income will increase (decrease) demand.
2. An increase (decrease) in the number of consumers in the market would increase
(decrease) demand. If the price of substitutes product y goes up (down) demand
for x increases (decreases).
3. If the price of Product y that is a complement for x goes down (up), demand for
x increases.
4. Expectations about future price influence our decision to buy now or later. The
demand curve reflects our willingness to buy now or later.
5. Demographic changes that are either favourable to a market will increase
demand.
6. Changes in consumer Tastes/Preference.

LAW OF SUPPLY
There is a direct / positive relation between price and the quantity supplied by firms. At
a higher price, the producer has a greater incentive to supply goods and services.
The Law of Supply represents two things:
1. The minimum price necessary to induced producers to supply a specific Q
2. The valuation (opportunity cost) of the resources used in production.

ELASTIC AND INELASTIC SUPPLY CURVES

From the law of supply, we know that as increase in price will lead to an increase in the
quantity supplied. The degree of elasticity tell us how much quantity supplied will
increase, measure the responsiveness of suppliers to price changes.

SHIFTS (CHANGES) IN SUPPLY VS. CHANGES IN QUANTITY SUPPLIED

Supply curve summarize the willingness of producers to offer a product at different
prices. We distinguish between a change in quantity supplied and a shift change in
supply.
CHANGE IN QUANTITY SUPPLIED
The movement along a supply curve. A change in supply causes the entire supply curve
to shift.
Increase in Supply: Supply curve shifts to the right.
Decrease in Supply: Supply curve shifts to the left.

Factors that will Shift Supply

1. Changes in Resources (Input) Prices If resource prices fall, the supply
curve shifts out (increases). If resource prices rise, the supply curve shifts back
(decreases).
2. Change in Technology Every after new technology is introduced; the old
one becomes very cheap. Like lower resource prices, technological improvements
discovery of new, lower cost production reduce the OPP COST of production,
and increase Supply.
3. Nature and Politics can Affect Supply This has something to do with the
intertwined relationships of politics and our environment.
4. Changes in Taxes Affect Supply Taxes on producers increase the cost of
production, and will decrease the Supply, shifting it to the left. Lower prices will
increase supply and shift supply to the right.
5. Changes in the number of firms in the market if the number of firms
increases, supply increases. If the number of firms decreases, supply decreases.
When profits or returns are above average in an industry, the number of firms in
that industry will increase. When profits or returns are below average, the
number of firms in that industry will decrease.
Anything that lowers the cost of production or increases the number of firms will
increase Supply. Anything that raises the cost of production or decreases the number of
firms will decrease supply.
If Price goes up (down), the quantity Supplied will increase (decrease).

MARKET PRICES AND THE INTERACTION OF SUPPLY AND DEMAND

Market An abstract concept describing trade that takes place according to the laws
of supply and demand.
Equilibrium - When the conflicting forces of Supply and demand are in balance, the
market is in equilibrium. It is the natural state that the market is always moving
towards.
Equilibrium = Market-clearing = ( Qd = Qs ). No shortages, No surplus.
Equilibrium emphasizes market efficiency.
MARKET ADJUSTMENT TO CHANGES IN SUPPLY AND DEMAND
A decrease in demand has the opposite effect because when a consumer feels that the
goods produced today wont last for a week, he will buy more today as its price is
expected to go up. If households have enough stocks and no buyers are in the market,
this will result in lower prices and a reduction in quantity supplied. Changes in demand
transmit information from consumers to producers, and help coordinate economic
activity through the price system.

CHAPTER IV: SUPPLY AND DEMAND APPLICATIONS

SUPPLY
Supply is the quantity of goods available for sale. It is not the number of goods that are
produced. It should be goods that are available for sale.
Factors that determine supply:
1. Technology - these refers to techniques or methods of production.
2. Cost of Production- I f the price of raw materials or services of laborers
increase, it means higher cost of production and vice-versa.
3. Number of sellers- more sellers or more factories means an increase in supply.
4. Prices of other goods- Changes in the prices of goods have effects in the
supply of such goods. Decrease in the price of goods may likely encourage the
producers to produce more of this give him more profit.
5. Price expectations- this infuences sellers to hoard their goods; however, it is
classified to affect supply.
VALIDITY IF THE LAW OF SUPPLY
The law of supply is valid if the assumption of ceteris paribus is applied. Literally from
the French, all else equal or all other things remain constant. The Law of supply is
correct of the non-price determinants of supply are held constant. That is, there is no
change in technology, cost of production, number of sellers and so forth.
Change in Quantity
A change in quantity supplied occurs because of a change in price only.

Change in Supply
A change in supply happens when a supplier of a given commodity/good or service has
altered their output. This is brought about by several factors like technology, change in
number of competitors or number of sellers.

THE MARKET DEMAND AND SUPPLY FOR A COMMODITY

The market or aggregate demand for a commodity gives the alternative amount of the
commodity demanded per time period, at various alternative prices, by all individuals in
the market.
The market supply of a commodity is the sum total of the amount of the commodity
supplied per time period at various prices by all the producers of the commodity in the
market. It is an aggregate supply.