SUPPLY AND DEMAND

Demand

Definition

Desire refers to people's willingness to own a good. Demand is the amount of a good that consumers are willing and able to buy at a given price.

Utility

Utility is the satisfaction people get from consuming (using) a good or a service. Utility varies from person to person. Some people get more satisfaction from eating chips than others. Even the same person can gain greater satisfaction by eating chips when hungry than when he has lost his appetite.

Factors Influencing Demand

The amount of a good demanded depends on:

• the price of the good;

• the income of consumers;

• the demand for alternative goods which could be used (substitutes);

• the demand for goods used at the same time (complements);

• whether people like the good (consumer taste).

The demand curve labelled DD in the figure below shows the amount of a good one or more consumers are willing and able to buy at different prices.

Movements Along and Shifts in Demand Curves

A change in price never shifts the demand curve for that good. In the figure below an increase in price results in a movement up the demand curve. The fall in the quantity demanded from Q₁ to Q₂ is sometimes called a contraction in demand.

A demand curve shifts only if there is a change in income, in taste or in the demand for substitutes or complements. In the diagram below a decrease in demand has shifted the demand curve to the left. The new demand curve is D1 D1.

Supply

Factors Influencing Supply

Supply is the amount of a good producers are willing and able to sell at a given price. Supply depends on:

• the price of the good;

• the cost of making the good;

• the supply of alternative goods the producer could make with the same resources (competitive supply);

• the supply of goods actually produced at the same time (joint supply);

• unexpected events that affect supply.

The supply curve labelled SS in the figure below shows the amount of a good one or more producers are prepared to sell at different prices.

Movements Along and Shifts in Supply Curves

A change in price never shifts the supply curve for that good. In the diagram below an increase in price results in a movement up the supply curve. The increase in quantity supplied from Q₁ to Q₂ is sometimes called an expansion in supply.

A supply curve shifts only if there is:

• a change in costs;

• a change in the number of goods in competitive or joint supply; or

• some unforeseen event which affects production.

In the diagram below an increase in supply shifts the supply curve to the right.

Market Price

At prices above the equilibrium (P*)  there is excess supply while at prices below the equilibrium (P*) there is excess demand. The effect of excess supply is to force the price down, while excess demand creates shortages and forces the price up. The price where the amount consumers want to buy equals the amount producers are prepared to sell is the equilibrium market price. All these situations are shown in the diagram below:

Indirect Taxes and Subsidies

In the figure below an indirect tax  has been added to SS. This has the effect of shifting the supply curve up vertically by the amount of the tax. Note in the diagram below that price does not increase by the full amount of the tax. This suggests that part of the tax is paid by the firm.

In this figure a subsidy has been given to the firm. This has the effect of making firms willing to supply more at each price and so shifts the supply curve downwards. The shift is equivalent to the value of the subsidy. Note that price falls by less than the full amount of the subsidy. This suggests that the firm keeps part of the subsidy.

Elasticity

Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of demand to a given change in price and is found using the equation:

PED = Percentage change in quantity demanded/Percentage change in price

or

PED = P/Q x Q/P

where P = the original price

Q = the original quantity

and = 'the change in'

See Table 7.1

Table 7.1 Features of price elasticity of demand

FeatureÂ	Elastic goodsÂ	Inelastic goodsÂ
PED valueÂ	Greater than 1Â	Less than 1Â
A rise in price meansÂ	A larger fall in demandÂ	A smaller fall in demandÂ
Slope of demand curveÂ	FlatÂ	SteepÂ
Number of substitutesÂ	ManyÂ	FewÂ
Type of goodÂ	LuxuryÂ	NecessityÂ
Price of goodÂ	ExpensiveÂ	CheapÂ
ExampleÂ	Maestro carsÂ	PetrolÂ

Price Elasticity of Supply

Price elasticity of supply (PES) measures the responsiveness of supply to a given change in price.

PES = Percentage change in quantity supplied/Percentage change in price

or PES = P/Q x Q/P

See Table 7.2

Table 7.2 Features of elasticity of supply

FeatureÂ	Elastic goodsÂ	Inelastic goodsÂ
PES valueÂ	Greater than 1Â	Less than 1Â
A rise in price meansÂ	A larger rise in supplyÂ	A smaller rise in supplyÂ
Slope of supply curveÂ	FlatÂ	SteepÂ
The good is producedÂ	RapidlyÂ	SlowlyÂ
The time period isÂ	MonthsÂ	DaysÂ
The firm hasÂ	Large stocksÂ	Limited stocksÂ
ExampleÂ	ScrewsÂ	BeefÂ

Income Elasticity of Demand

Income elasticity of demand (YED) measures the responsiveness of demand to a given change in income:

YED = Percentage change in quantity demanded/Percentage change in income

If YED is negative then the good is inferior. People use an increase in income to buy less of this good and more of a superior substitute.

If YED is positive then the good is normal. Consumers use an increase in income to buy more of the good.

Cross Elasticity of Demand

Cross elasticity of demand (XED) measures the responsiveness of demand for one good (z) to a given change in the price of a second good (w):

XED = Percentage change in quantity demanded of good z/Percentage change in the price of good w

If XED is positive then the two goods are substitutes. If XED is negative then the two goods are complements.

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