CHAPTER 2 : DEMAND &

SUPPLY THEORIES1. Demand

a) Law of ddb) Determinants of ddc) Changes in dd vs changes in qt

demandedd) Elasticity of dd : P, cross, Ye) Determinants of P elasticity of dd

2. Supplya) Law of ssb) Determinants of ssc) Changes in ss vs changes in qt ssd) Elasticity of sse) Determinants of P elasticity of ss

DEFINITION

• dd – ability & willingness to buy specific qt of goods in a given period at particular P, ceteris paribus

• ss – qt of g & s that will be offered for sale at a given P over a period of time in a given market, ceteris paribus

LAW OF DD VS SS

• LAW OF DD – other things being equal – higher P of goods, lower qt dd

– negative r/ship – downward sloping

• LAW OF SS – other things being equal – higher P of goods, higher qt

ss – positive r/ship – upward sloping

P

Q

dd

ss

DETERMINANTS OF DD

i. Income – normal vs inferior goodsii. P of related goods – complementary vs

substituteiii. Tastes & preferencesiv. Govt policies – eg : T, Subsidies, IRv. Populationvi. P expectationvii. seasons

DETERMINANTS OF SS

i. No of sellersii. P of related goods – complementary

vs substituteiii. Cost of factor of prodniv. Govt policies – eg : import T,

Subsidies,v. Techno developmentvi. Length of time

CHANGES IN DD (SS) VS CHANGES IN QT DD (SS)

• Changes in dd (ss) - refer to shift of curve - caused by other than P

• Changes in qt dd (ss) - refer to movement along the curve - caused by changes in P, ceteris

paribus

Downward movement vs Upward movementExpansion vs contraction

CHANGES IN DD (SS) VS CHANGES IN QT DD (SS)

P

Q

dd

P

Q

ss

Q1 Q0 Q2

P0

P2

P1

P0

P2

P1

Q1 Q0 Q2

P

Q

dd1

dd0

dd2

P

Q

ss0ss2

ss1

P0

Q1 Q0 Q2

P0

Q1 Q0 Q2

ELASTICITY OF DD

Def : sensitivity / responsive to ∆ that can effect dd

Elasticity of ddi. P : when P ∆, how much qt dd ∆ii. Y : when Y ∆, how much qt dd ∆iii. cross E : what will happen to dd of x when

Py ∆

i) Price Elasticity Of dd

Degrees of P E• dd is elastic : E > 1 (∆Q > ∆P)• dd is inelastic : E < 1 (∆Q < ∆P)• dd is unitary elastic : E = 1 (∆Q = ∆P)• dd is perfectly elastic : E = ∞ (P unchanged but

Q∆)• dd is perfectly inelastic : E = 0 (P∆ but Q

unchanged)

Formula = ( – % ∆ in Qx / % ∆ in P) = ( – ∆ in Qx / Q0 ) x ( Px0 / ∆ in Px )

Determinants Of P E Of dd

i. Substitutabilityii. Relative importance of the goods in

the budgetiii. Time dimension (SR vs LR)iv. Status of goods (luxury vs

necessity)v. Income levelvi. Habits

P E vs Total Revenue

TR = P x Q

TR ↑↓ when P ∆ therefore will affect E of dd

Eg :• If dd elastic, when P ↓, TR ↑• If dd inelastic, when P ↓, TR ↓• If dd unitary, if P ∆, TR unchange

ii) Y Elasticity Of dd

Degrees of Y E• YE is +ve (0 – 1) : when Y ↑ 1%, dd ↑• YE > 1 : when Y ↑ 1%, dd ↑ > 1%• YE < 0 : when Y ↑ 1%, dd ↓• YE = 0 : when Y ↓, no effect on dd

Formula = ( – % ∆ in Qx / % ∆ in Y) = ( – ∆ in Qx / Q0 ) x ( Y0 / ∆ in Y )

iii) Cross Elasticity Of dd

- Responsiveness of dd for product x to a change in P of related product (product y)

Degrees of Cross E• Positive : when Px ↑, dd y ↑ (-ve r/ship)• Negative : when Px↑, dd y ↓ (+ve r/ship)• Cross Price E = 0 (no r/ship)

Formula = ( – % ∆ in Qx / % ∆ in Py) = ( – ∆ in Qx / Q0 ) x ( Py0 / ∆ in Py )

ELASTICITY OF SUPPLY

- Responsiveness of qt ss to a ∆ in P

Degrees of E ss• E ss > 1 (fairly elastic) : %∆in qt ss > % ∆ in P• E ss < 1 (fairly inelastic) : %∆in qt ss < % ∆ in P• E ss = 1 (unitary elastic) : %∆in qt ss = % ∆ in P• E ss = 0 (perfectly inelastic) : %∆in qt ss = 0, P∆• E ss = ∞ (perfectly elastic) : %∆in qt ss is

infinitely large, P unchanged

Formula = (% ∆ in Qx / % ∆ in P) = (∆ in Qx / Q0 ) x ( Px0 / ∆ in Px )

Determinants Of E Of Ss

i. Timeii. Nature of the goodsiii. Cost & feasibility of storageiv. Substitutability of factors or inputs

usedv. Perishability