Module-2: Market Forces of Demand & Supply

● The concept of demand, its determinant

● Law of demand, its exception
● Demand function
● The concept of supply, its determinant
● Law of supply
● Supply function
● Demand and supply taken together: equilibrium
 The Concept of Demand

Demand = Willingness + Ability + Readiness

Readiness
to
Purchasing Buy at
Desire to Prevailing
Power
buy a Price
good

- Demand for a good may be defined as the quantity of the good that
will be bought at a particular price & during a given period of time

- Demand is always defined with respect to price and time

 Determinants of Demand

- The factors that affect demand for a good

1) Price of the good

2) Income of the consumer:

- Normal goods: the goods for which demand increases with the
increase in income.
E.g. clothing, automobile, furniture etc.
- Inferior goods: the goods for which demand decreases with increase
in the income of consumers.
E.g. vanaspati ghee, bus-rides, millets etc.
 Determinants of Demand

- The factors that affect demand for a good

3) Price of related goods: The related goods are of two types;

a) Substitutes: Similar goods that satisfy same type of want

E.g. Tea-coffee, Thums up-coca cola, Colgate-Pepsodent etc.

- Two goods are said to be substitutes if increase in price of one good

increases the demand of the other good
 Determinants of Demand

3) Price of related goods: The related goods are of two types;

b) Complementary good: the goods whose demand is linked to each

other as they are jointly consumed.

E.g. Car-petrol, bread-butter, tea-sugar, torch-battery, shoe-polish,

printer-ink cartridge, pencil-eraser etc.

- Two goods are said to be complements of each other if an increase

in price of one good decreases the demand of the other good
 Determinants of Demand

4) Tastes of the consumers:

- Likes or dislikes of consumer for the good

- Change in tastes of the consumer in favour of a good may be due to
fashion will increase its demand

5) Advertisement by the producer:

- Advertisement of good by producer on TV, Newspaper, radio may
induce the people to buy that good
 Determinants of Demand

Price
Tastes of
Price
related
goods

Income
Demand
Advertisement
for a good

Seasonal
Number
factors
Of Packaging
Buyers
 Determinants of Demand

Determinants of demand can be expressed by the following function;

Where,
P = Price of the good
I = Income of the consumer
Pr = Prices of related goods
T = Tastes
A = Advertisement
 Law of Demand

- Law of demand describes the functional relationship between

quantity demanded of a commodity & its price

● Assumptions of the law of demand

( Assumptions are the conditions which are necessary to hold the law
true means if these conditions are not fulfilled, the law does not operate)

1) Income of the consumer does not change

2) Prices of the related goods do not change
3) Tastes of the consumer for the good does not change
4) There should not be any change in the quality of the product.
 Law of Demand

● Statement of the law:

“ Other things being equal, if the price of a
commodity falls, the quantity demanded of it will rise, if the price of
the commodity rises, its quantity demanded will decline”

- According to the law of demand there is an inverse relationship

between the quantity demanded of a commodity and its price

Quantity demanded of good x

= Price of the good x

 Law of Demand

● Demand curve & Illustration of Law of Demand:

Price of Good X Quantity demanded

of Good X
D
1 50

2 40

3 30

4 20
D
5 10
 Law of Demand

● Reasons behind the downward slope of the demand curve:

1) Income effect:
- Decrease in price of a good increases the real income (purchasing
power) of the consumer & it induces him to buy more of it

2) Substitution effect:
- When price of a commodity falls it becomes relatively cheaper as
compared to the other commodities

Example: Tea & Coffee

 Law of Demand

● Exceptions to the law of demand:

1) Veblen effect: (Goods having prestigious value)

- Associated with the name of the economist Thorstein Veblen

- He put forth the concept of conspicuous consumption
(Consumption of the articles of distinction)
- For the upper strata of the society, higher the price of goods,
greater will be the utility & prestige value associated with the
good
 Law of Demand
● Exceptions to the law of demand:

2) Small commodities:

- Those commodities on which you spend a very small portion of

your income
- E.g. Match-box, needle in the sewing machines, chocolate etc.
- Increase in price of such commodities won’t affect their demand
much

3) Necessities:
- Compulsory goods which are used for the consumption purposes
- E.g. salt, wheat, rice, LPG, electricity etc.
 Law of Demand

● Exceptions to the law of demand:

4) Ignorance of the consumers regarding quality-price relationship

- Perception of the consumers to decide quality of the good

according to its price

5) Expectations of the consumers regarding future price

 Law of Demand

● Exceptions to the law of demand:

5) Giffen Goods: (Giffen Paradox)

- Associated with the name of a Scottish Statistician Robert Giffen

- There are certain goods which show a positive relationship
between price and demand
- Characteristics of Giifen Goods:
1) Giffen goods are basically ‘a special type’ of inferior goods
2) They are staple in the poor community
3) These goods have a very few substitutes if any
 Law of Demand
● Exceptions to the law of demand:

5) Giffen Goods: (Giffen Paradox)

- Behaviour of low paid british workers

- Diet of those people mainly consisted of two food items
1) Bread (basic staple food) that offers high calories at low cost
2) Meat- fancy good that offers few calories as compared to its price

- Giffen observed that when the price of bread is increasing its

demand is also increasing
 Shifts in the Demand Curve

- When only the price of the commodity changes we move along the
same demand curve

C
D

E
 Shifts in the Demand Curve

- When any affecting the demand other than the price changes, the
entire demand curve shifts.
Increase in demand
Decrease in demand 1) Change in the income of consumer
2) Change in the price of related good
3) Change Tastes of the consumer
4) Advertisement
5) Number of buyers in the market etc.

-Increase in demand→ Demand curve shifts to the right

Decrease in demand→ Demand curve shifts to the left
 The Concept of Supply

- The supply of a commodity is the amount of that commodity that the

firms are willing and able to offer for sell at a particular price during
a given period of time

➔ How much of a commodity the firms will be willing to offer for sale
depends on the profit that they expect

➔ How much of a commodity the firms are able to produce depends

upon the resources available to them and the technology that they
employ for producing the good
 Determinants of Supply

- The factors affecting supply of a good

1) Price of the good:

2) Input prices:
- Supply of a good is negatively related to the input prices
- Example: Production of Ice cream

Cream
Sugar
Ice Cream Flavours
Labours
Ice Cream Machine
 Determinants of Supply

- The factors affecting supply of a good

3) Technology:
- The use of advanced technology increases the production and
reduces the cost of production

4) Expectations of the sellers:

5) Number of sellers in the market:

 Determinants of Supply

Determinants of supply can be represented by the following

function:

Where,
= Supply of a good x T = Technology of production

= Price of good x N = Number of sellers

= Prices of inputs

= Expectations of sellers regarding the future price

 Law of Supply

- Establishes a functional relationship between quantity supplied of a

good and its price

- Assumptions

1) The prices of inputs do not change

2) The technology does not change
3) Number of sellers in the market do not change
 Law of Supply

● Statement of the law:

“Other things remaining the same, as the price
of a commodity increases, the quantity supplied of it increases and if
the price of the commodity falls, the quantity supplied of that
commodity will decline”

- There is a direct and positive relationship between quantity supplied

of a commodity and its price

= Quantity supplied of x

= Price of good x
 Law of Supply

● Illustration of the law:

Price of Ice Cream Quantity Supplied

Cone of Ice Cream Cone

2.5
0 0

0.5 0
1.5
1 10

1.5 20
0.5
2 30

2.5 40

3 50
 Law of Supply

● Exceptions to the law of supply:

1) Auction Sale: In the case of auction sale the supply is limited and it
doesn’t increase with the increase in price

2) Stock Clearance Sale: Selling of large quantity of goods at heavily

discounted price

3) Perishable goods: example- vegetables

4) Fear of being out of fashion

● Movement along the supply curve Vs Shifts in the supply curve:

Movement along the supply curve

- When only price of a good changes we move along the same supply
curve
Price of Banana
(₹/dozen)

Quantity of Banana
 Law of Supply

Shifts in the supply curve

- The supply curve of a commodity will shift if there is change in the
non-price factors affecting the supply of the commodity

Ex. Decrease in the input

Prices shifts supply
Price of Banana

curve to the right

(₹/dozen)

20
(Increase in supply)

8 12
Quantity of Banana
 Shifts in the supply curve
- The supply curve of a commodity will shift if there is change in the
non-price factors affecting the supply of the commodity

Ex. Increase in the input

prices shifts the
supply curve to the left
Price of Banana

30 (Decrease in supply)
(₹/dozen)

8 12

Quantity of Banana
 Shifts in the supply curve

- The supply curve of a commodity will shift if there is change in the

non-price factors affecting the supply of the commodity

- Supply curve shifts to the right → Increase in the supply

- Supply curve shifts to the left → Decrease in the supply
 Demand and Supply Taken Together : Equilibrium

- The forces of demand and supply togetherly determine the price of

any commodity in the market and its quantity bought and sold in the
market

- If we plot both the demand and supply curves of a good in a single

graph we’ll get a point at which both these curves intersect each
other - Point of equilibrium

- Equilibrium→ various forces are in balance

Demand and Supply Taken Together : Equilibrium
 Demand and Supply Taken Together : Equilibrium

- Equilibrium in the marker: a situation in which the market price has

reached the level at which the quantity supplied equals the quantity
demanded

- The price at this equilibrium is called as equilibrium price and the

quantity at this equilibrium is called as equilibrium quantity.

- The equilibrium price is also called as ‘market clearing price’

because at this price everyone in the market is satisfied.
 Demand and Supply Taken Together : Equilibrium

- There is always a tendency of the actions of buyers and sellers to

naturally move towards the equilibrium of demand and supply.

- This can be explained with the help of following two cases;

1. When the market price is above the equilibrium price

2. When the market price is below the equilibrium price

 Demand and Supply Taken Together : Equilibrium

1. When the market price is above the equilibrium price

Price of
Ice-Cream

Quantity Supplied of the Ice-Cream

 Demand and Supply Taken Together : Equilibrium

2. When the market price is below the equilibrium price

Price of
Ice-Cream

Quantity Supplied of the Ice-Cream