THEORY THEORY OF OF

DEMAND AND DEMAND AND SUPPLYSUPPLY

INTRODUCTIONINTRODUCTIONIn In microeconomicsmicroeconomics,,  supply and demandsupply and demand is an  is an 

economic modeleconomic model of  of price determinationprice determination in a  in a marketmarket. It concludes that in a . It concludes that in a competitive marketcompetitive market

, the , the unit priceunit price for a particular  for a particular goodgood, or other , or other traded item such as labor or liquid financial traded item such as labor or liquid financial

assets, will vary until it settles at a point where assets, will vary until it settles at a point where the quantity demanded (at the current price) will the quantity demanded (at the current price) will equal the quantity supplied (at the current price), equal the quantity supplied (at the current price),

resulting in an resulting in an economic equilibriumeconomic equilibrium for price  for price and quantity transacted.and quantity transacted.

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Supply and DemandSupply and Demand

Supply -Supply - which is how much of something which is how much of something you haveyou have

Demand -Demand - which is how much of something which is how much of something people want people want

DETERMINANTSDETERMINANTS OF OF

DEMAND AND DEMAND AND SUPPLYSUPPLY

Determinants of Demand Determinants of Demand ::

change in consumer tasteschange in consumer tastes change in the number of buyerschange in the number of buyers change in consumer incomeschange in consumer incomes change in the prices of change in the prices of

complementary and substitute goodscomplementary and substitute goods change in consumer expectationschange in consumer expectations

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Determinants of Supply :Determinants of Supply : change in input priceschange in input prices change in technologychange in technology change in taxes and subsidieschange in taxes and subsidies change in the prices of other goodschange in the prices of other goods change in producer expectationschange in producer expectations change in the number of supplierschange in the number of suppliers

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LAW OF DEMANDLAW OF DEMAND

If the price is increases, the quantity If the price is increases, the quantity demanded will decreases and vice demanded will decreases and vice versa.versa.

Demand CurveDemand Curve

The demand curve has a negative slope, consistent The demand curve has a negative slope, consistent with the law of demand.with the law of demand.

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Assumptions of the law of Assumptions of the law of DemandDemand

There is no change in income of consumers.There is no change in income of consumers. There is no change in the price of product.There is no change in the price of product. There is no change in quality of product.There is no change in quality of product. There is no substitute of the commodity.There is no substitute of the commodity. The prices of related commodities remain the The prices of related commodities remain the

same.same. There is no change in customs.There is no change in customs. There is no change in taste and preference of There is no change in taste and preference of

consumers.consumers. The size of population remains the same.The size of population remains the same. The climate and weather conditions are same.The climate and weather conditions are same. The tax rates and other fiscal measures The tax rates and other fiscal measures

remain the same.remain the same.

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Exceptions Exceptions to the to the

Law of DemandLaw of Demand

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Inferior goodsInferior goods

The law of demand does not apply in The law of demand does not apply in case of inferior goods. When price of case of inferior goods. When price of inferior commodity decreases and its inferior commodity decreases and its demand also decrease and amount demand also decrease and amount

so saved in spent on superior so saved in spent on superior commodity. The wheat and rice are commodity. The wheat and rice are superior food grains while maize is superior food grains while maize is

inferior food grain.inferior food grain.

Demonstration effectDemonstration effect

The law of demand does not apply in The law of demand does not apply in case of diamond and jewelry. There case of diamond and jewelry. There is more demand when prices are is more demand when prices are high. There is less demand due to high. There is less demand due to low prices. The rich people like to low prices. The rich people like to demonstrate such items that only demonstrate such items that only they have such commodities.they have such commodities.

Ignorance of consumersIgnorance of consumers  The consumer usually judge the quality The consumer usually judge the quality

of a commodity from its price. A low of a commodity from its price. A low priced commodity is considered as priced commodity is considered as inferior and less quantity is inferior and less quantity is purchased. A high priced commodity purchased. A high priced commodity is treated as superior and more is treated as superior and more quantity is purchased. The law of quantity is purchased. The law of demand does not apply in this case.demand does not apply in this case.

Less supplyLess supply

The law of demand does not work The law of demand does not work when there is less supply of when there is less supply of commodity. The people buy more for commodity. The people buy more for stock purpose even at high price. stock purpose even at high price. They think that commodity will They think that commodity will become short.become short.

DepressionDepression

The law of demand does not work The law of demand does not work during period of depression. The during period of depression. The prices of commodities are low but prices of commodities are low but there is increase in demand. it is due there is increase in demand. it is due to low purchasing power of people.to low purchasing power of people.

SpeculationSpeculation

The law does not apply in case The law does not apply in case of speculation. The speculators start of speculation. The speculators start buying share just to raise the price. buying share just to raise the price. Then they start selling large quantity Then they start selling large quantity of shares to avoid losses.of shares to avoid losses.

Out of fashionOut of fashion    The law of demand is not applicable in The law of demand is not applicable in

case of goods out of fashion. The case of goods out of fashion. The decrease in prices cannot raise the decrease in prices cannot raise the demand of such goods. The quantity demand of such goods. The quantity purchased is less even though there purchased is less even though there is falls in prices.is falls in prices.

LAW OF SUPPLYLAW OF SUPPLY

The supply of the commodity The supply of the commodity increases with the increases in increases with the increases in prise and vice versa.prise and vice versa.

Supply CurveSupply Curve

The supply curve has a positive slope, The supply curve has a positive slope, consistent with the law of supply.consistent with the law of supply.

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AssumptionsAssumptionsof of

Law of SupplyLaw of Supply

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No change in cost of productionNo change in cost of production

It assumed that there is no change in It assumed that there is no change in cost of production because of the profit cost of production because of the profit decreases with the increase in cost of decreases with the increase in cost of production and it causes the decrease production and it causes the decrease in supply. If price of a commodity in supply. If price of a commodity decreases and cost of production also decreases and cost of production also decreases, at the same time, the decreases, at the same time, the quantity supplied does not decrease quantity supplied does not decrease and profit remains constant.and profit remains constant.

No change in technologNo change in technolog

It is also assumed that technique of It is also assumed that technique of production does not change. If production does not change. If better methods of production are better methods of production are invented, profit increases at the invented, profit increases at the previous price. The sellers increase previous price. The sellers increase supply and law of supply does not supply and law of supply does not operate.operate.

No change in climateNo change in climate

It is also assumed that there is no It is also assumed that there is no change in climatic situation. For change in climatic situation. For example, at any place flood or example, at any place flood or earth quake occurred. The supply earth quake occurred. The supply of goods decreases at that place at of goods decreases at that place at previously prevailing price.previously prevailing price.

No change in prices of No change in prices of substitutessubstitutes

If the prices of substitutes of a If the prices of substitutes of a commodity fall then the tendency of commodity fall then the tendency of consumers diverts to substitutes consumers diverts to substitutes therefore, the supply of a commodity therefore, the supply of a commodity falls without any change in price.falls without any change in price.

No change in natural resourcesNo change in natural resources

If the quantity of natural resources If the quantity of natural resources (minerals, gas, coal, oil etc) (minerals, gas, coal, oil etc) increases, the cost of production increases, the cost of production decreases. It causes to increase in decreases. It causes to increase in quantity supplied.quantity supplied.

No change in price of capital No change in price of capital goodsgoods

The capital goods are raw material, The capital goods are raw material, machinery, tools etc. The cost of machinery, tools etc. The cost of production increases due to increase production increases due to increase in prices of capital goods. It can lead in prices of capital goods. It can lead to decrease in quantity supplied.to decrease in quantity supplied.

No change in political situationNo change in political situationThe amount of investment is affected The amount of investment is affected

by the change in political situation of by the change in political situation of a country. The production of goods a country. The production of goods decreases due to decrease in decreases due to decrease in investment.investment.

No change in tax policyNo change in tax policy

It is also assumed that the taxation It is also assumed that the taxation policy of government does not policy of government does not change. The increase in taxes effects change. The increase in taxes effects the investment and production and the investment and production and supply of goods decreases.supply of goods decreases.

Exception Exception of of

Law of SupplyLaw of Supply

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Expectations regarding future prices Expectations regarding future prices :: When the sellers expect the prices to rise in When the sellers expect the prices to rise in the future then they may adopt wait and the future then they may adopt wait and watch policy and withhold their supply of watch policy and withhold their supply of goods. Even though the price may be higher goods. Even though the price may be higher the sellers may want to supply the goods the sellers may want to supply the goods when the prices rise even more which would when the prices rise even more which would fetch them good returns. Also if the sellers fetch them good returns. Also if the sellers expect the prices to fall in the coming days expect the prices to fall in the coming days then they may sell off their goods at existing then they may sell off their goods at existing lower prices in order to avoid losses.lower prices in order to avoid losses.

Farm produce Farm produce :: In case of farm In case of farm products it is nothing but a play of products it is nothing but a play of climate.  Such products may not climate.  Such products may not obey the law of supply as they may obey the law of supply as they may not react to changes in prices due to not react to changes in prices due to heavy dependency on weather heavy dependency on weather conditions.conditions.

Perishable commodities :  Perishable commodities :  The The commodities fall in different classes and not commodities fall in different classes and not all of them can be stored for a longer period all of them can be stored for a longer period of time. Certain commodities have very short of time. Certain commodities have very short shelf life and they need to be made available shelf life and they need to be made available in the market before they perish. The common in the market before they perish. The common examples of perishable goods are fruits, sea examples of perishable goods are fruits, sea produce, flowers, meat, vegetables and so on. produce, flowers, meat, vegetables and so on. So for such goods the sellers cannot simply So for such goods the sellers cannot simply wait for a longer time and supply these in the wait for a longer time and supply these in the market even when the prices are not rising.market even when the prices are not rising.

Out of fashion goods :Out of fashion goods :  When goods When goods are in fashion then the sellers can are in fashion then the sellers can command a high price. But there are command a high price. But there are certain goods that go out of fashion certain goods that go out of fashion and are no longer in vogue. Such goods and are no longer in vogue. Such goods are supplied by the sellers at low are supplied by the sellers at low prices in order to clear these goods.prices in order to clear these goods.

Economic Slowdown Economic Slowdown :: The businesses The businesses pass through different phases and the pass through different phases and the sellers have to adapt to these changes. sellers have to adapt to these changes. During the low economic phases the During the low economic phases the sellers may not have advantage of high sellers may not have advantage of high prices and hence during such tough prices and hence during such tough times goods are sold even when they do times goods are sold even when they do not witness price rise in order to recover not witness price rise in order to recover their costs. So the law of supply is not their costs. So the law of supply is not applicable in this case.applicable in this case.

Change in business Change in business :: It may happen It may happen that the seller may plan to enter into an that the seller may plan to enter into an entirely new area of business by exiting entirely new area of business by exiting the current one. So when the present the current one. So when the present business is on the verge of closure then business is on the verge of closure then the seller may sell the goods at lower the seller may sell the goods at lower prices simply to clear them off. So here prices simply to clear them off. So here too the law of supply is not followed.too the law of supply is not followed.

Immediate requirement of funds Immediate requirement of funds :: The seller may face a time when he The seller may face a time when he is in immediate need of funds. At is in immediate need of funds. At such situation he may supply the such situation he may supply the goods in the market even at lower goods in the market even at lower prices.prices.

Supply of labour Supply of labour :: Another fine example Another fine example of the exception to the law of supply is the of the exception to the law of supply is the labour supply. The workers are interested in labour supply. The workers are interested in high wages till a certain point. Once that high wages till a certain point. Once that point is achieved they may like to devote point is achieved they may like to devote their time to leisure activities. So after a their time to leisure activities. So after a particular point the workers may no longer particular point the workers may no longer be interested in higher wages.  This simply be interested in higher wages.  This simply means that initially the supply of labour is means that initially the supply of labour is directly related to the wages but after a directly related to the wages but after a certain level the relation between wages certain level the relation between wages and supply of labour turns inversely related.and supply of labour turns inversely related.

EquilibriumEquilibrium In economics, an In economics, an equilibriumequilibrium is a is a

situation in which: situation in which: there is no inherent tendency to there is no inherent tendency to

change, change, quantity demanded equals quantity quantity demanded equals quantity

supplied, and supplied, and the market just clears.the market just clears.

EquilibriumEquilibrium

Equilibrium occurs at a price of $3 and a quantity of Equilibrium occurs at a price of $3 and a quantity of 30 units.30 units.

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Elasticity of DemandElasticity of Demand

The elasticity of demand (Ed), also referred to as The elasticity of demand (Ed), also referred to as the price elasticity of demand, measures how the price elasticity of demand, measures how responsive demand is to changes in a price of a responsive demand is to changes in a price of a given good. More precisely, it is the percent given good. More precisely, it is the percent change in quantity demanded relative to a one change in quantity demanded relative to a one percent change in price, holding all else constant percent change in price, holding all else constant ((ceteris paribusceteris paribus). Demand of goods can be ). Demand of goods can be classified as either perfectly elastic, elastic, classified as either perfectly elastic, elastic, unitary elastic, inelastic, or perfectly inelastic unitary elastic, inelastic, or perfectly inelastic based on the elasticity of demand. This table based on the elasticity of demand. This table shows the values of elasticity of demand that shows the values of elasticity of demand that correspond to the different categories.correspond to the different categories.

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The graph illustrates the demand The graph illustrates the demand curves and places along the demand curves and places along the demand curve that correspond to the table. curve that correspond to the table. The elasticity of demand changes as The elasticity of demand changes as one moves along the demand curve. one moves along the demand curve. This is an important concept - the This is an important concept - the elasticity of demand for a good elasticity of demand for a good changes as you evaluate it at changes as you evaluate it at different price points. These charts different price points. These charts are for illustration only. To determine are for illustration only. To determine if a demand is elastic at a given price, if a demand is elastic at a given price, you have to evaluate it with the you have to evaluate it with the methods we're about to discuss.methods we're about to discuss.

Where Dq = Percentage change in Where Dq = Percentage change in demand,demand,

dP = Pencentage change in dP = Pencentage change in price.price.

https://en.wikipedia.org/wiki/Price_elasticity_of_demand

Types of Elasticity Of Types of Elasticity Of DemandDemand

Price Elasticity of DemandPrice Elasticity of Demand Income Elasticity of DemandIncome Elasticity of Demand Cross Elasticity of DemandCross Elasticity of Demand Promotional Elasticity of Promotional Elasticity of

DemandDemand

UTILITY –UTILITY – CARDINAL AND ORDINAL CARDINAL AND ORDINAL APPROACHESAPPROACHES Cardinal Utility is the idea that economic Cardinal Utility is the idea that economic

welfare can be directly observable. For welfare can be directly observable. For example, people may be able to express the example, people may be able to express the utility that consumption gives for certain utility that consumption gives for certain goods. This is important for welfare economics goods. This is important for welfare economics which tries to put values on consumption. For which tries to put values on consumption. For example, allocative efficiency is said to occur example, allocative efficiency is said to occur when MC = Marginal Utility.when MC = Marginal Utility.

One way to try and put values on goods utility One way to try and put values on goods utility is to offer choices for consumers. This is a is to offer choices for consumers. This is a rough guide to the utility given to a good.rough guide to the utility given to a good.

Ordinal Utility. In ordinal utility the utility Ordinal Utility. In ordinal utility the utility derived from a good is not observablederived from a good is not observable