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Price-Demand And Price-Supply

Equations From Basic Assumptions.

V.I.G.Menon 1
Chief Consultant, Yahovan Centre for Excellence,12/403,W Block, Anna

Nagar West Extension, Chennai,India-600101,Email:v.i.g.menon@gmail.com,

Phone: : :+91984 0600251, +919962952559.Author is grateful to Giri Menon

for his Valuable Suggestions.


Abstract

The dependence of demand or supply on price is established in the form

equations from simple assumptions. Also this dependence is explored in the

Matrix form ,as well as using the mean of the parameters Price,Wage ,Supply

and Demand Quantities for a community as a market. The paper thus explores

the conditions under which the standard demand/supply relations hold with

respect to price.Analysis of the wage,price,demand graph shows expected

trends.And the improvised approach to understanding the elasticities of

demand based on the basic equations show that for goods with –ve price

elasticities of demand ,income elasticities of demand is positive,and vice versa


Introduction
The dependence of price on demand or supply is the most basic relation that supports

the micro economic thought everywhere. In the following we discuss why this “Natural

Law” holds.

Price-Demand Dependency
We assume a buyer with a fixed wage Wb for any given period of the wage cycle,

buying Qi amounts of a good at price Pi. Figue 1 Gives the Matrix where the rows 1

to B are the buyers and Columns 1 to S are the sellers .If all the wage/income of this

buyer for this period is spent on N goods and services, we can write

Wb = ∑ Pi *Qi …………………………………………… (1)

,where summation is done from i =1 to i = N.

If we assume that as long as Wb , is constant for the individual “b”, then we get

∑ Pi *Qi = Constant. …………………………………………… (2)

Now if we assume that the consumption profile ( Pi *Qi /∑ Pi *Qi ) is a constant Ki

for each i, then we have

Pi *Qi = ( Pi *Qi /∑ Pi *Qi ) = K i*Wb …………………………………………… (3)


Where K i = Pi *Qi /∑ Pi *Qi in equation (3) is the percentage or fraction of “b”s

income Wb spent on item “i”.This equation tells us that if individuals spend generally

fixed ratios of their wages on various goods, then demand Qi depends inversely with

price.

That is , the Quantity Qi demanded at wage Wb is indirectly proportional to the

price Pi,which is what we wanted to derive

Price-Supply Dependency
Similarly, now consider a supplier who is supplying “M” number of goods to the

market, including the goods that are bought by the buyer above. His total wage or

income Ws from the trade can be represented as

Ws = ∑ PJ QJ …………………………………………… (4)

where J is summed from 1 to M.

If we assume that the supply profile ( PJ *QJ/∑ PJ*QJ ) is a constant K J for J

then as above we can write

PJ QJ = ( PJ QJ/∑ PJQJ ) = K J Ws …………………………………………… (5)

Where , QJ is the total quantity of “J” sold in the market by him at price PJ , K J

is the percentage or fraction of suppplier’s income Ws received on item “J”


and so we have,

.Since PiQi represents the total paid by the buyer for the Quantity Qi of “ith” product

at price Pi ,this amount will go to the seller as a fraction of his income.

For the same item where buyer’s item i = J th item for the seller ,we write

(PiQi / PJQJ ) = K iWb/K JWs ,,we can also note K iWb/K JWs = C ,where C is the

fraction of the income generated due to product J for the supplier “s” by the buyer b”.

Or, QJ = [(1/ C ) * (Qi / PJ ) ]*Pi …………………………………………… (6)

QJ = C* Pi …………………………………………………… (7)

Where “constant “ C = [(1/ C ) * (Qi / PJ ) ] showing that the Quantity Supplied,

QJ is proportional to the purchase price Pi which is the supply-price relation we

wanted to establish,under the assumption of constant consumption and supply price

profiles for the product i=J (not necessarily Pi =Pj the equillibrium price)

As the terms involving buyer or supplier are not entering here, these equations are

independent of any buyer “b” or supplier “s”.


Generalised Results

Figure shows a community of buyers purchasing varying quantities of

products and services ,each according to their wages Wb.

For any buyer “b” and similarly for any supplier “s”, we can rewrite the above

equations as in Matrix representations,

Wb = ∑ Pi *Qi = P.Q …………………………………………… (8)

which represents the “Matrix product” of P with Q,treating P as 1X N

and Q as NX1 Matrices.

Let us,for clarity,choose to write P.Q for buyer “b” as P b.Q b and for supplier

“s” as P s.Q s noting that

Wb = P b.Q b …………………………………………… (9)

for the buyer and

Ws = P s.Q s …………………………………………… (10)

for the supplier.

Summing for all buyers “b” from b = 1 to B and for all suppliers “s” from s = 1 to

S, we have (see Figures)


K B*W = ∑ K bWb = ∑ P b.Q b = (∑ P b).(∑Q b) = P B*Q B,
B ……………… (11)

for all the buyers and

K S*W S = ∑K SWs = ∑ P s.Q s = (∑ P s).(∑Q s) = P S*Q S ………………… (12)

for all the suppliers,where (∑ P B) = P B ,etc.,

P B*Q B, and P S*Q S represent Matrices whose elements P ij.Q kl are as shown in

the figures 2 & 3 above. K B*W B and K S*W S are single column matrices

So that we can write,

(13)
(14)

Generalised Matrix Laws

We again start with

KB WB = P BQ B …………………………………………… (13)

KS WS = P SQ S …………………………………………… (14)

Both these look exactly like our single buyer case except that these are Matrix

Equations.

Assuming as in the previous case that Consumption Profiles will be same when the

wage rates are fixed, we have

(P -1 B )* KS WS = QB ……………………………………………

(15)
Which tells us that the demand matrix Q B is inversely dependent on the price

matrix P B.

This is our Generalised Price-Demand Law in Matrix form involving many

goods ,buyers and suppliers.

Now Multiplying KS WS = P SQ S in equation (14) by the inverse of KB WB

we have

(KB WB ) -1 * KS WS =( P B Q B ) -1
* P S Q S …………………………………

(16)

ie.,

C =( P B Q B ) -1 * P S Q S …………………………………

(17)

Where C is a constant Matrix, Or,


( P B )*( Q B ) * P -1 S * C* = Q S …………………………………

(18)

Which again shows that the Demand Matrix Q S is proportional to

Price matrix P B, under the assumption that ( Q B ) * P -1 S is a constant.

This is our Generalised Supply-Price Law in Matrix form involving many

goods , buyers and suppliers.

The Matrix relations will enable us to study the system using linear equations and linear

programming

Derivation Based On Mean of the Parameters

For a community of average wage rate is W is consuming an average Quanity Qi of

the ith Commodity at an average price Pi ,

Then, as in the individual case equations (1) to (7) ,we have

Ki W = Pi*Qi, ………………………………… (18)


where Ki is the average fraction of the wage spent on the ith product .

This again leads us to the conclusion that if mean wage W is

constant and the mean fraction of the wage spent on the ith

product is fixed,then demand Qi for this product in this

community depends inversely on its price Pi.

Similarly it is easy to see that

QJ = C* Pi ………………………………… (19)

that is, the Mean Quantity QJ of item “J “ supplied is proportional to the Mean

Purchase Price Pi for the same commodity (where generally, ith commodity bought by

buyer is same as the Jth commodity supplied- pl note that for enumeration, the i th

product bought by the buyer need not be the same as the ith product supplied by the

supplier)

Wage and Price

Relation between the individual,(or mean), wage, price and demand is seen by plotting
Ref
P = K.W/Q,with K =1,and Q on the X,W on the Y and P on the Z axes, using the

online 3D plotter .

The results are very encouraging .Apart from showing the expected price-demand

dependence,on its red edge,the green edge of the 3D “sheet” shows that as wage level

increases ,price level also increases Ref.


http://www.livephysics.com/ptools/online-3d-function-grapher.php?

ymin=1&xmin=0&zmin=0&ymax=5&xmax=5&zmax=15&f=y*x^-1

Calculation Of Price Elasticities

a) Price Elasticity Of demand ED is given by

(∆Q/Q) dlnQ ……………… (20)


ED = (∆P/P) = dlnP
for infinitesimal changes in Q & P .

From equation (3) dlnQ/dlnP can be worked out as follows

PdQ + QdP = KdW, dividing both sides by PQ,

dQ/Q + dP/P = K(dW/PQ) = K(dW/KW) ,since PQ = KW,

ie, dlnQ + dlnP = dlnW, dividing by dlnQ gives,

( dlnQ/dlnP) + 1 = (dlnW/dlP)

( dlnQ/dlnP) = (dlnW/dlnP) – 1 ……………………………… (21)

Multiplying both sides of Equation (21) by ( dlnP/dlnQ) ,gets us

1 = (dlnW/dlnQ) + ( dlnP/dlnQ), that is,

1 = (dlnW/dlnQ) + [1/(dlnQ/dlnP)] ……………………………… (22)

Representing (dlnW/dlnQ) as α and (dlnQ/dlnP) as β, we write Equation (22) as

α + 1/β = 1
( dlnW/dlnQ) = 1 - [1/(dlnQ/dlnP)] ……………………………… (23)

ie,

α = 1 - 1/β ……………………………… (23)

Which shows how wage ( income) elasticity of demand ( dlnW/dlnQ) is related to

Price elasticity of demand.Thus we see that increase of β increases α.The relation

between price elasticity of demand and income elasticity of demand are explored in

the graph ref,showing that for goods with –ve price elasticities of demand ,income

elasticities of demand is positive, such that as wage increases, the demand increases for

goods with –ve elasticity .

Results and Discussions

Under the assumptions of constant income for the buyer and the supplier, as well as

constant consumption and supply profiles for the buyer and the supplier respectively,

it is found that the Classical price-demand as well as the price-supply relations hold

exactly with respect to an individual or a community (ie market).Such relations can be

expressed in Matrix form as well as through Mean of Price, Quantity Wage and the

associated Constants.

Graphical analysis of the equations in 2D shows the expected pattern, and the 3D

graph involving, wage, price and demand equation shows that the Quantity demanded
increases with wage. Analysis of price elasticities show that for goods with –ve price

elasticities of demand ,income elasticities of demand is positive.


Fig.1:The Matrix Shows Suppliers 1 to S ,each supplying products 1 to S for the Market
comprising Of Buyers 1 to B. The Column total for ,say buyer “i” ∑PiQJ for any product “i” for

all “J” ,gives his total budget to spend which may be a fraction Ki of his wage Wi,as given by KiWi.

Along the column, Pi remains same,but QJ varies for all buyers for the same product at the same

price Pi .The Row total Gives the income or revenue for each product to Supplier, where CJWJ is

income of Supplier from all buyers for product J sold in this market =∑PiQJ for any J for all “i” .

Notes On The Transaction Accounting Notation in Fig 1.


Products are assumed to be numbered from “I” =1 to N

Supplies are assumed to be numbered from “I” =1 to S

Buyers are assumed to be numbered from “I” =1 to B

Quantities are assumed to be numbered from “I” =1 to M

Value of any transaction is given by Price multiplied by Quantity,ie,P*Q

Price Matrix is [ P] which is a 1X N row matrix

Quantity Matrix is [ Q] which is a MX 1 Column matrix

Transaction Value Matrix or Transaction Matrix [T] = [PQ] is an NXM


matrix

The sum of the rows of [T] is given by ∑PiQJ ,where PiQJ =0


for i ≠ J.
b
P1 Represents the price of “item” “1” bought by any buyer “b”

S
Q1b Represents the Quantity of “item” “1” bought by any buyer “b” from
supplier “S”.

b
PS1 *SQ1b This product of bP1 with SQ1b represents the total amount
transacted by any buyer “b” for “item” “1” supplied by any supplier “S”
at price bP1 for quantity SQ1b

b
PSn *SQnb This product of bP1 with SQ1b represents the total amount
transacted by any buyer “b” for “item” “n” supplied by any supplier “S”
at price bPn for quantity SQnb

bW represents the Wage of any buyer “b”

b
K represents the fraction of the budget allocation by “b”
bWS represents the fraction of the revenue of any supplier S due to any buyer “b”

b
KS represents the fraction of the budget allocation by “b” for supplier “S”.
b
KSn represents the fraction of the budget allocation by “b” for supplier “S”

due to a product “n”.


b
KSn * bWS gives budget allocation of “any” buyer “b” for “any” product
“n” offered by “any” supplier “S” obtained by multiplying bKSn with bWS

∑ bKSn * bWS = bKS * bWS gives total budget allocation of “any” buyer “b” for all
n=1 to N
products 1 to N offered by “any” supplier “S”.

∑ bKS * bWS = KS * WS gives total budget allocation of all buyers “1 to B” for all
b=1 to B
products 1 to N offered by “any” supplier “S”.

∑ KS * WS = K * W gives total budget allocation of all buyers “1 to B” for all


S=1 to S
products 1 to N offered by suppliers 1 to “S”.

∑ bKS * bWS = bK * bW gives total income of all suppliers “1 to S ” for all products
S=1 to S
1 to N bought by any buyer “b” .

Transaction Account for Fig1.


De
ma
nd

Quantity

Fig 2:Sample Price-Deamand graph calculated from Equation (3) using online graph

plotter (http://graph-plotter.cours-de-math.eu/) setting X axis for Price and Y-axis for

Quantity , K=5,W = 1000, and X (that is ,Price) set to change from 100 to 500 units
Su
ppl
y

Price

Fig3.Sample Price-supply graph calculated from Equation (7) using online graph plotter (http://graph-

plotter.cours-de-math.eu/) setting X axis for Price and Y-axis for Quantity , K=5,W = 1000, and X (that is

,Price) set to change from 10 to 50 units.


Fig.4.Apart from showing the expected price-demand dependence,the 3D “sheet”

plotted based on equation (3) shows that as wage level increases ,price level also

increases Ref. http://www.livephysics.com/ptools/online-3d-function-grapher.php?

ymin=1&xmin=0&zmin=0&ymax=5&xmax=5&zmax=15&f=y*x^-1
α

Fig.5.Plot for income elasticity of demand α as a function of price elasticity of

demand β as in equation (23). As the values of β is varies from -5 to + 5, the values of

α take a hyperbolic shift from –ve to + ve range as can be seen.(plotted using

plotter at (http://graph-plotter.cours-de-math.eu/)