BASIC PRINCIPLES OF DEMAND AND SUPPLY

The Law of Demand

The Market (1)

A market is an interaction between buyers and

sellers of trading or exchange. It is where the
consumer buys and the seller sells. The goods
market is the most common type of market
because it is where we buy consumers goods.
The labor market is where workers offer
services and look for jobs, and where employers
look for workers to hire. There is also the
financial market which includes the stock
market where securities of corporations are
traded.
The Market (2)

The market is important because it is where

a person who has excess goods can
dispose them to those who need them. This
interaction should lead to an implicit
agreement between buyers and sellers on
volume and price. In a purely competitive
market (similar products), the agreed price
between a buyer and seller is also the
market price or price for all.
DEMAND (1)

• Demand is the willingness of a consumer to buy a

commodity at a given price
• A demand schedule shows the various quantities
the consumer is willing to buy at various prices.
• A demand function shows how the quantity
demanded of a good depends on its
determinants, the most important of which is the
price of the good itself, thus the equation
Qd = f(P)
Hypothetical Demand Schedule of Martha
for Vinegar (in bottles) Qd = 6 – P/2
Price per Bottle Number of bottles

PHP 0 6

2 5

4 4

6 3

8 2

10 1
The demand curve is a graphical illustration of
the demand schedule, with the price measured
on the vertical axis (Y) and the quantity
demanded measured on the horizontal axis (X).
The values are plotted on the graph and are
represented as connected dots to derive the
demand curve. The demand curve slopes
downward indicating the negative relationship
between the two variables which are price and
quantity.
• The downward slope of the curve
indicates that as the price of
vinegar increases, the demand
for this good decreases. The
negative slope of the demand
curve is due to income and
substitution effects.
• Income effect is felt when a change in the
price of a good changes consumer’s real
income or purchasing power, which is the
capacity to buy with a given income. In other
words, purchasing power is the volume of
goods and services one can buy with his/her
income. If a good becomes more expensive,
real income decreases and the consumer can
only buy less goods and services with the
same amount of money income. The
opposite holds with a decrease in the price of
a good and increase in real income.
• Substitution effect is felt when a change in
the price of a good changes demand due to
alternative consumption of substitute goods.
For example, lower price encourages
consumption away from higher-priced
substitutes on top of buying more with the
budget (income effect). Conversely, higher
price of a product encourages the
consumption of its cheaper substitutes further
discouraging demand for the former already
limited by less purchasing power (income
effect)
The Law of Demand
Using the assumption “ceteris paribus,” which
means all other related variables except those
that are being studied at the moment and are
held constant, there is an inverse relationship
between the price of a good and the quantity
demanded for that good. As price increases,
the quantity demanded for that product
decreases. The low price of that good
motivates the consumer to buy more. When
price increases, the quantity demanded for the
good decreases.
Non-Price Determinants of Demand (1)

• If the ceteris paribus assumption is

dropped, non-price variables that also
affect demand are now allowed to
influence demand. These non-price
determinants can cause an upward or
downward change in the entire demand for
the product and this change is referred to
as shift of the demand curve.
Non-Price Determinants of Demand (2)

• The demand function will now read:

D=f(P, T, Y, E, PR, NC), which states that
demand for a good is a function of Price (P),
Taste (T), Income (Y), Expectations (E), Price of
Related Goods (PR), and Number of
Consumers.
• Factors other than the price of the product
are the non-price factors of demand.
Non-Price Determinants of Demand (3)

• If consumer income decreases, the capacity to

buy decreases and the demand will also
decrease even when price does remain the
same. The opposite will happen when income
increases.
• Improved taste for a product will cause a
consumer to buy more of that good even if its
price does not change.
Non-Price Determinants of Demand (4)

• Another non-price determinant is consumer’s

expectations of future price and income.
Consumers tend to anticipate changes in the
price of a good.
• Prices of related goods as substitutes or
complements also determine demand.
Substitute goods are those that are used in
place of each other. Complements are goods
that are used together.
Non-Price Determinants of Demand (5)

• The number of consumers is also

an important determinant that
will affect market demand for a
good. The higher the population,
the more consumers and the
higher will be the demand for
good.
Shifts of the Demand Curve
• A change in the price of a good causes the
quantity demanded for that good to
change (the demand curve will simply
move from one point to another on that
curve).
• If the change in demand is caused by a
non-price determinant, this will involve a
change in the entire demand curve.