Brief theory of Demand & Supply, Slides of Economics

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MICRO

ECONOMICS

UNIT 2

LAW OF DEMAND

 (^) Demand is an economic concept that relates to a consumer's desire to purchase goods and services and willingness to pay a specific price for them. An increase in the price of a good or service tends to decrease the quantity demanded. Likewise, a decrease in the price of a good or service will increase the quantity demanded.  (^) Law of demand is studied from the perspective of the consumer.  (^) Demand is closely related to the concept of supply. While consumers try to pay the lowest prices they can for goods and services, suppliers try to maximize profits.  (^) Demand helps fuel profits and the economy. That's why it's an important concept.  (^) Some factors affecting demand include appeal of a good/service, the availability of competing goods, the availability of financing, and the perceived availability of a good or service.

DEFINITION OF THE LAW OF DEMAND

According to Prof. Marshall, “ The law of demand states that amount demanded increases with fall in price and diminishes when price increases.” According to Benham, “ Usually a larger quantity of commodity will demand at a lower price than a higher price.” According to Ferguson, “According to the law of demand, the quantity demanded varies inversely with price.” For example, when the price of 1 kg of mangoes goes down from Rs.80 to Rs. 50, the quantity demanded will go up. Many people who were not able to buy at Rs.80, are now able to purchase at Rs 50. Similarly, if Starbucks raises the price of coffee from Rs 700 to Rs. 1000, the quantity demanded will be decreased. Fewer people will buy their coffee, rather they prefer to make their own at home because of the increased price.

DEMAND CURVE (Graph)

 The demand curve depicts that the price of a good

and the quantity demanded have an inverse

relationship. When the price of a good rises, there

will be less demand for that good, and conversely,

when the price decreases, there will be more

demand for that good.

When applying this economic principle in microeconomics

and macroeconomics, economists assume that only the

price changes and all other variables that can affect

demand (such as the consumer’s income or preferences)

remain constant. And that we take into consideration

large number of buyers and sellers. And all products are

homogeneous in nature.

Demand Curve normally slopes downward, indicating negative or inverse relationship between price of a commodity and its quantity demanded. Let's consider change in price as △P = P2−P Let's assume the change in quantity demanded as △Q = Q2−Q Slope of Demand Curve = P2−P1/Q2−Q1 = △P/△Q Hence , by this you can find the slope of a demand curve

The Concept of demand curve includes: [a] Individual Demand Curve [b] Market Demand Curve [a] Individual Demand Curve – Is a curve showing different quantities of a commodity that one particular buyer is ready to buy at different possible prices of that commodity at a given point of time. [b] Market Demand Curve - Is the horizontal summation of the individual demand curve. It shows various quantities of a commodity that all buyers in the market are ready to buy at different possible prices of the commodity at a given point of time.

DETERMINANTS (factors) OF DEMAND #1 – The Prices of Goods or Services When the price of goods and services rises, the quantity demanded falls. When the price of goods and services falls, the quantity demanded will increase. It is also called the Law of Demand If demand does not change even in the price change, that is called inelastic demand. On the other hand, elastic demand is called if the quantity demanded changes more than the price change.

#2 – Price of Substitute/Complementary Goods & Services Substitute goods are goods that satisfy the same needs. For example, groundnut oil-sunflower oil and tea-coffee are substitutes. Hence, a rise in groundnut oil price can increase the demand for sunflower oil and vice-versa. Complementary goods are those goods consumed together. For example, car and diesel or tea and sugar. #3 – Buyers’ Tastes and Preferences The demand for any product can change based on buyers’ tastes and preferences; brand advertising plays a vital role in changing buyers’ tastes and preferences. For example, earlier, people thought chocolates were mainly for kids. But the advertising industry has changed this concept by showing that chocolates are for everyone from kids to very older adults. Likewise, they always come up with new trends in the market that influence the customers and ultimately impact the demand for those products.

DEMAND FUNCTION The demand function for a commodity describes the relationship between quantities of the commodity which consumers demand during a specific period and the factors which influence its demand. In mathematical symbol, it can be expressed as: Dx = f (Y, Px, Ps, Pc, T; Ep; Ey; N, D) (Y – Consumer Income, Px - Price of the commodity x, Ps - Price of its substitute, Pc - Price of its complimentary commodity, T - Taste and Preference of Consumers, Ep - Consumer’s expectation about future price of commodity, Ey - Consumer's expected increase in future income, N - Number of consumers, D - Distribution of consumers)

REASON FOR DOWNWARD DEMAND CURVE

REASON FOR LAW OF DEMAND

1. Law of Diminishing Marginal Utility

2. Substitution Effect

3. Consumer Income Effect

4. New Consumer Group

5. Different uses of the commodities

Price Change Exception: The issue of price change in the market is another exception to

the law of Demand. There might be a situation when the Price of a product or service

increases and is subjected to future growth. So, the customers may buy more of it to avoid

further cost increment. Eventually, there are times when the Price of a product is about to

decrease. Consumers may temporarily stop the purchase to avail of the future benefits of

price decrement. Ex - Massive rise in the price of onions where people were buying it more

due to the worry of the further cost increase.

Essential Goods: The Demand for essential goods stays intact even if there’s a price rise.

People can’t stop purchasing the products of regular necessities. For example, if the cost of

salt increases, consumers won't be able to afford it. It is the complete opposite of the law of

Demand in Economics. Another example is Medicines/Medical Treatments.

Luxury Goods: A significant exception to the law is the Demand for luxury goods. In such

cases, even if the price increases, the consumer won't stop consumption. Cigarettes and

alcohol typically come in this category.

LAW OF SUPPLY The law of supply is a fundamental concept in microeconomics that governs supply at a given price. The law of supply states that ‘when the market price of a good increases, suppliers will increase the supply of that good. And when the price decreases, the quantity they will supply decreases’. When employing the law of supply concept, economists assume that only the price changes and all other variables that can affect supply (like consumer mindset or materials cost) remain constant. Because businesses seek to increase revenue, when they expect to receive a higher price for something, they will produce more of it. Meanwhile, if prices fall, suppliers are disincentivized from producing as much. Supply in a market can be depicted as an upward-sloping supply curve that shows how the quantity supplied will respond to various prices over a period of time. Law of supply is studied from the supplier’s perspective.

HOW THE LAW OF SUPPLY WORKS

The law of supply works in three major steps:

1. The price of a good increases. Suppliers may change the selling price of a product

based on any number of determinants, including quality, demand, cost of production,

consumer income and mindset, taxes, and even supply and demand.

2. Suppliers see more incentive to sell. When the price of the product rises, suppliers

see more incentive to sell higher quantities of the good. They may increase the

gathering of materials, divert resources from other markets, or make other changes in

their business structure to increase the production of a particular good or service.

3. The supply increases. After a certain period of time in the supply schedule, the

fresh supply of goods will hit the market, increasing the number of goods supplied to

the market. Thus, when the price increases, the supply increases.

What Factors Affect Supply? Supply is influenced by prices and consumer demand. In addition, the number of suppliers available, the level of competition, the state of technology, and the presence of government support or restriction will play important roles. For certain products like agricultural commodities, supply is also impacted by things like weather and crop yields. Some examples of Law of Supply  (^) When college students learn that computer engineering jobs pay more than English professor jobs, the supply of students with majors in computer engineering will increase.  (^) When consumers start paying more for cupcakes than for donuts, bakeries will increase their output of cupcakes and reduce their output of donuts in order to increase their profits.  (^) When your employer pays time and a half for overtime, the number of hours you are willing to supply for work increases