PRINCIPLES OF

MICROECONOMICS
Lecturer: Mr Felix Maluleke
 Learning Unit: 3a

DEMAND, SUPPLY AND PRICES

(chapter 4)
 Learning Outcomes
❑ Identify the most important determinants of the quantity demanded
❑ Show how demand can be expressed in words, numbers, graphs and equations.
❑ Explain the difference between demand and quantity demanded
❑ Differentiate between a movement along a demand curve and a shift of a demand
curve
❑ Explain the determinants of the quantity supplied
❑ Distinguish between a movement along a supply curve and a shift of a supply curve
❑ Explain how the equilibrium price and quantity are determined
❑ Distinguish between the consumer surplus and the producer surplus.

This chapter lays the foundation for the rest of your course!!!!
 DEMAND ANALYSED
Define Demand: The quantities of goods and/or services that the potential
buyers are willing and able to buy.
• Demand must not be confused with wants. We have many unlimited wants and we
do not have the means to satisfy them all.
• Demand is only effective if the consumer is able and willing to pay for the good or
service concerned.
• Demand is a flow concepts measured over a period of time e.g. day, week, month or
year.
• Demand can be expressed in words, schedules (or numbers). Curves (or graphs),
and equations (or symbols). 𝑄𝑑 = 𝑓(𝑃𝑥 , 𝑃𝑔 , 𝑌, 𝑇, 𝑁, … )
 DEMAND ANALYSED
Define Demand: The quantities of goods and/or services that the potential
buyers are willing and able to buy.
 INDIVIDUAL DEMAND AND MARKET DEMAND
Determinants of demand (for both Individual and Market demand):
• The price of the product 𝑷𝒙 : The lower the price of a product, the greater the
quantity that will be demanded ceteris paribus.
• The price of related products 𝑷𝒈 : distinguish between:
❖ Substitutes: Are goods which can be used instead of the good in question, e.g. butter and
margarine.
❖ Complements: Are goods that are used jointly, e.g. DVD player and DVDs.
• The income of consumers (Y): the higher the income the more of a product a
consumer can buy.
• The taste or preferences of consumers (T): the more a consumer likes a
product/good/service. The more s/he will plan to buy. If a product goes out of fashion
the demand for that product will decrease.
• The size of the household (N): the larger the household the more they will plan to
buy.
• Other factors that affect demand: expected future price of the product and income
distribution are tow additional factors that can have an influence on demand.
 THE LAW OF DEMAND
The law of demand: States that other things being equal (i.e. ceteris paribus) the higher the
price of a good, the lower is the quantity demanded.
 The Relationship between Price and Quantity Demanded
The relationship between quantity demanded and price can be illustrated
in various ways:
❖ One possibility is to use a demand schedule.
➢ A Demand Schedule: is a table which lists the quantities demanded at different
prices when all other influences on planned purchases are held constant.
➢ The information in the demand schedule can also be illustrated graphically by
drawing a demand curve.
o The points on the demand curve correspond to the different possibilities indicated in the
demand schedule.
 The Relationship between Price and Quantity Demanded
Demand Schedule: Demand Curve:
Anne Smith’s demand schedule for Tomatoes Anne Smith’s weekly demand for tomatoes

Px
Possibility Price of Tomatoes Quantity demanded

Price of Tomatoes (rand per kg)

(R/kg) (kg per week)
D
A 1 6 e
5
B 2 5 d
C 3 4 4
c
D 4 3 3
b
e 5 2 2
a
Each point indicates the quantity of tomatoes demanded at 1
that price. By joining the points we obtain the demand curve D Qd
DD. The demand curve indicates the relationship between 1 2 4 0
the quantity of tomatoes demanded weekly and the price of 3 5 6
tomatoes, on the assumption that all other things remain Quantity of tomatoes demanded
equal. (kg per week )
The higher the price, the smaller the quantity of tomatoes The demand curve is a simple and useful way of
demanded. As I have already mentioned, this inverse (or indicating the relationship between the quantity
negative) relationship between price and quantity demanded demanded and the price of good or service, on the
is called the law of demand. assumption that all other determinants are constant
(i.e. ceteris paribus)
Plot the demand curve from the information provided
Demand Schedule:

Price (R) Quantity demanded (Units)

2 80

4 60

6 40

8 20
 Solution
Demand Curve
Px

D
d
8
c
Price of (R)

6
b
4
a
2

D
Qd
0 20 40 60 80
Quantity of demanded
 Expression of the individual demand and law of demand
Later in the chapter we will examine what happens if any of the other determinants do
change.
❖ Using words. Demand refers to the entire relationship between the quantity demanded and the
price of a good or services, on the assumption that all other influences are held constant. The
higher the price of the good, the lower the quantity demanded, ceteris paribus.
❖ Using numbers: the demand schedule. The demand schedule is a table which shows the
quantities of a good demanded at each possible price, ceteris paribus.
❖ Using graphs: the demand curve. The demand curve is a line which indicates the quantity
demanded of a good at each price, ceteris paribus. The negative slope of the demand curve
clearly indicates that the quantity demanded increase as the price decreases.
❖ Using symbols: the demand equation. The demand equation is a shorthand way of expressing
the relationship between the quantity of a good demanded and its price, ceteris paribus.
➢ 𝑄𝑑 = 𝑓(𝑃𝑥 , Pഥg , Y
ഥ, T
ഥ, N
ഥ, … )
➢ 𝑄𝑑 = 𝑓 𝑃𝑥 𝑐𝑒𝑡𝑒𝑟𝑖𝑠 𝑝𝑎𝑟𝑖𝑏𝑢𝑠
This equations (which are actually two ways of expressing the same thing) are often reduced to
𝑄𝑑 = 𝑓(𝑃𝑥 )
 Market demand
➢ Market demand: In a market we have to take into account the plans of all consumers.
❖ The market demand curve is obtained by adding the relevant individual demand curves
horizontally. It is an aggregate of all individual demand curves for a good/service and is
referred to as the horizontal summation of individual demands (refer to the textbooks if this
is not clear to you).
❖ The same factors that determine individual demand will also influence market demand,
namely: price of the specific goods, price of substitutes and complements; tastes of
consumers; income of consumers, size of the population or household and other factors.
➢ Market demand schedule
Table 4-2 Deriving the market demand schedule from individual demand schedule
Price of tomatoes Price of Tomatoes (R/kg) Total Quantity demanded
(R/Kg) Anne Helen Purvi (kg per week)

1 6 4 5 15
2 5 3 4 12
3 4 2 3 9
4 3 1 2 6
5 2 0 1 3
 Solution
(a) Demand Curve
Px Px (b)

D
5 H P A 5

Price of tomatoes
Price of tomatoes

4 4

(rand per kg)

(rand per kg)

3 3

2 2

1 1

D Qd
Qd
0 1 2 3 4 5 0 3 6 9 12 15
Quantity of tomatoes (kg) Quantity of tomatoes (kg)
per week per week
The market demand curve is obtained by adding the individual demand curves horizontally. In (a)
Annes’s demand curve is labelled A, Helen’s H and Purvi’s P. In (b) these three demand curves have
been added to obtain a market demand curve DD.
 What are factors that can cause a movement along a demand
curve (a change in the quantity demanded)
• If the price of the product changes, we obtain the change in the quantity
demanded by comparing the relevant points on the unchanged demand curve, that
is, by moving along the curve.
• This is how we determine a change in the quantity demanded.
• The market demand curve shows the relationship between the price of the product
(𝑃𝑥 ) and the quantity demanded (𝑄𝑑 ), 𝑐𝑒𝑡𝑒𝑟𝑖𝑠 𝑝𝑎𝑟𝑖𝑏𝑢𝑠.
• To find out what happens to 𝑄𝑑 if 𝑃𝑥 changes, we simply compare the relevant points
on the given demand curve, since the demand curve shows the relationship between
price and quantity demanded, on the assumption that all other influences of demand
are constant.
• This relationship can be illustrated by the following equation: 𝑄𝑑 = 𝑓(𝑃𝑥 , Pഥg , Y
ഥ, T
ഥ, N
ഥ, … )
 A movement along a demand curve
Px (b) Demand Curve Px

Price of tomatoes (rand per kg)

D D e
5 5
Price of tomatoes

4 d
4
(rand per kg)

3 3 c
b
2 2
1 a
1
D
D Qd Qd
0 3 6 9 12 15 0 3 6 9 12 15
Quantity of tomatoes (kg) per week Quantity of tomatoes (kg) per week

The demand curves are the same. A fall in the price of tomatoes from R4,00 per kg to R3,00 per kg
increases the quantity demanded from 6 kg to 9 kg. This is represented by a movement along the
demand curve (as price changes)
 What are factors that can cause a shift of the demand curve (a
change in demand)
• A change in any of the determinants of demand.
• Other than price of the product will shift the demand curve.
• Changes in the other determinants of demand are reflected only as shifts of the curve
itself.
• When this happens, we describe it as a change in demand.
• The difference between a:
❖ Change in the Quantity Demanded: is illustrated by a movement along a given demand curve.
❖ Change in Demand: is illustrated by shift of the whole demand curve.
• Let us examine changes in the determinants of demand, which causes the demand
curve to shift:
❖ Substitutes: A good that can be used in place of other good to satisfy a certain want, e.g. butter
and margarine.
❖ Complements: Goods that are used together to satisfy a want, e.g. Cd players and CDs.
 A shift of the demand curve (Substitute Effect)
NB: Please make sure you understand the relationship between substitutes:
• Consider the following case where the price of butter decrease and notice the effect
on the demand for margarine, ceteris paribus.
P SUBSTITUTES: effects of a decrease in the price of butterP D
D on the demand for substitute, margarine: D1
P

P1

0 0 Q
Q Q1 Q
Butter Margarine

The price of butter decreases and as a result the quantity of butter demanded
increases, people are now consuming more butter. Consequently the demand for
margarine will decrease (D line shifts to the left).
 A shift of the demand curve (Complements)
• If the price of the complement of a good changes as a result of a change in in supply,
the demand for the good will also change.

P D1
P
D
D
P1

0 0 Q
Q1 Q Q
Quantity of CD Players Quantity of CDs

A decrease in the price of a complementary product (CD players) increases the demand for the product
concerned (CDs) and this is illustrated by rightward shift of the demand curve.
 SUPPLY ANALYSED
Define Supply: Supply refers to the quantity of a good that producers are willing
to sell at a given price given that any other factors that might affect the quantity
supplied are held constant (Pindyck and Rubinfeld (2013:22).
• In other words, supply is more than just having the resources and technology to
produce something.
• The quantity supplied may be more or less than the quantity sold during a specific
period.
• Note there is no guarantee that the quantity supplied would actually be sold.
• Like demand supply is a flow concept. Which is measured over a period of time
(day, month, week or year)
• It revolves around planned quantities that producers plan to sell at each price (Mohr
et al, 2015: 65).
• Supply can be expressed in words, schedules (or numbers). Curves (or graphs), and
equations (or symbols). 𝑄𝑠 = 𝑓(𝑃𝑥 , 𝑃𝑔 , 𝑃𝑓 , 𝑃𝑒 , 𝑇𝑦 , … )
 THE LAW OF SUPPLY
• In a similar fashion in which the law of demand is used to illustrate the linear relationship
between the rice of a product and the quantities of a product demanded;
• the law of supply is also used to show the relationship between the price of a product and
quantity supplied (Mohr et al, 2015:68).
• The law of supply states that all other things held constant (ceteris paribus), the higher the
price of a good, the greater is the quantity supplied.
• On the other hand, the lower the price of a good, the smaller the quantity supplied (Parkin,
2014).
 Why Does a Higher Price Increase the Quantity Supplied
• This is because as the price of any good increases, the firms are attracted to
enter the market.
• The higher the price, the more firms are able and willing to produce and sell
(Pindyck and Rubinfeld (2013:22).
• This is because a higher price may enable current firms to generate profits
and expand their production in the process (Mohr et al, 2015: 65).
 Relationship between Price and Quantity Supplied
The relationship between price and quantity supplied can be explained by using the following
supply schedule and supply curve:
Points Price (R/kg) Quantity supplied (kg per year)
A 1 500
B 2 1000
C 3 1500
D 4 2000
E 5 2500

Explaining the information depicted in the Supply Schedule above, results in a supply curve
which is graphically explained in the curve below.
 Relationship between Price and Quantity Supplied
The supply curve depicting the supply of tomatoes:

As depicted by the graph above, the supply curve has an upward slope indicating that as price
increases, the quantity supplied also increases. In other words, the higher the price, the more
firms are able and willing to produce and sell (Pindyck and Rubinfeld (2013:22)
 Individual and Market Supply
• The Individual supply curve shows the relationship between price and the
quantity supplied by an individual firms.
• Moving from individual supply to market supply, the individual supplied are
added together horizontally, to obtain the market supply curve it (Parkin,
2014).
• This is also obtained the same way the market demand curve is obtained.
• The market supply curve shows the relationship between the price of the
product and the quantities supplied (by all the firms) during a particular
period. (Mohr et al, 2015: 65).
 A change in quantity supplied versus a change in supply
• Similar concepts that are applied in the case of demand are also used in the in
explaining the difference between a change in quantity supplied and a change
in supply. A Movement Along the Supply Curve
• Price of the good in question results in a change in quantity supplied, and
subsequently a movement along the supply curve.
As shown in the graph suppose the
price of a good increase from P1 to P2,
the quantity supplied will increase from
Q1 to Q2 (Parkin, 2014). This is shown
by a movement along.
 A change in quantity supplied versus a change in supply
• In case any other determinants of the quantity supplied changes, then the whole supply relationship changes.
Graphically this is indicated by:
A Shift of the Supply Curve
• A shift of the supply curve as a result of a change in any factor other than the price of the product is called a
change in supply.
According to the graph, SS is the main supply
Curve. A change in any of the determinants of
the quantity supplied other than the price of
the product will lead to a change in supply, this
is shown by a shift of the supply curve.

Any reduction caused by any factor will shift

the supply curve to the left, to S1S1 and vice
versa, any increase in supply will shift supply
curve to the right. S2S2. The differences in the
QS at price P1.
 Determinants of Supply
• Ceteris paribus, supply can be influenced by a combination of a number of other variables
besides price.
• The quantity that producers are willing to sell depends not only on the price they receive
but also on their production costs such as wages, interest charges and the costs of raw
materials and so forth (Pindyck and Rubinfeld (2013:23).
• The determinants of supply at a given point in time are therefore
enumerated below:
• the price of a product in question
• Figure 4.6 A change in supply
• the prices of other alternative products in the market
• prices of factors of production and other inputs
• expected future price of the product in question
• the state of technology in the economy
 Market Supply
• 𝑄𝑠 = 𝑓(𝑃𝑥 , 𝑃𝑔 , 𝑃𝑓 , 𝑃𝑒 , 𝑇𝑦 , 𝑁 … )
• To move from individual supply to market supply, the individual suppliers are added
together (horizontally) to derive a market supply curve.
• The same factors that determine the individual quantities supplied also determine market
supply. However, a few additional factors determine market supply; number of firms in the
market (N) and some other factors such as government policy, natural disaster, joint
products, by-products, productivity.
 Market Equilibrium
• As mentioned before, if the prices of a good rises, the quantity demanded decreases and
the quantity supplied increases.
• This prompts us to superimpose the supply curve and the demand curve,
• this culminates in a situation called equilibrium which depicts a state of balance between
forces of supply and demand.
• After a series of explanations, we arrive at a conclusion that prices coordinate the plans of
buyers and sellers and achieve equilibrium (Mohr et al, 2015: 65).
 Function of prices in a market economy
• Prices serve two important functions in a market economy.
1) Rational function: Prices serve to ration scare suppliers of goods and services to those who can afford
them (who place a high value on them)
2) Allocative function: in markets with excess demand, prices increase. Profit opportunities increase which
means there is a higher need for factors of production towards those activities. The opposite occurs
when there is an excess supply. This is the driving force behind Adam Smith’s “invisible hand”
• Note: markets reflects the plans of those who are able to participate as consumers and
suppliers.
• Those who lack the purchasing power or command over the factors of production are not
able to signal their wants or plans via the market.
• IN MARKETS ONLY MONEY VOTES COUNT.
 What is Equilibrium?
• Equilibrium is an economic situation in which the quantity supplied and the quantity
demanded are equal,
• a point at which there is neither excess demand nor excess supply (Pindyck and Rubinfeld
(2013:23).
• In other words, at that point, the opposing forces of supply or demand balances each other.
(Parkin, 2014).
• This implies that the market is in equilibrium when the quantity demanded is equal to the
quantity supplied, that is, when the plans of the households’ buyers coincide with the plans
of the firms or sellers (Mohr et al, 2015:75).
 Equilibrium, Excess demand and Excess Supply
• The next step is to use demand and supply schedules and curves to explain equilibrium and disequilibrium in
the market for a consumer good (tomatoes).
• When the quantity demanded is greater than the quantity supplied, there is excess demand (Market shortage)
at that particular price.
• When the quantity supplied is greater than the demanded, there is excess supply (Market surplus) at that
particular price (Parkin, 2014).
Price of tomatoes Quantity demanded Quantity supplied (kg) Excess supply or demand (kg) Pressure on price
(R/kg) (kg)
1 360 0 360 (Excess Demand) Upward
2 320 50 270 (Excess Demand) Upward
3 280 100 180 (Excess Demand) Upward
4 240 150 90 (Excess Demand) Upward
5 200 200 0 None
6 160 250 90 ( Excess Supply) Downward
7 120 300 180 (Excess Supply) Downward
8 80 350 270 (Excess Supply) Downward
 Equilibrium, Excess demand and Excess Supply
• Demand, Supply and Equilibrium

The graph above, the demand Curve DD intersects the supply curve SS at a price of R5 per Kg- this is the
equilibrium price. The equilibrium quantity is 200 kg. At a price of R2 the quantity demanded is 320 kg and the
quantity supplied 50 kg. The excess demand of 270 kg is indicated by bc. At a price of R 7 per kg the quantity
demanded is 120 kg and 300 kg are supplied. The excess supply of 180 kg is indicated by df.
 Consumer Surplus and Producer Surplus
• It is important that we understand the consumer surplus and the producer
surplus so as to know the reason why some consumers are paying less than the
maximum they are willing to pay, while certain suppliers are receiving more
than the minimum they were willing to accept (Parkin, 2014).
 Consumer Surplus and Producer Surplus
• Consumer Surplus
• Consumer surplus refers to the difference between the total amount of money that
consumers are willing and able to pay for a good or service and the total amount that they
actually do pay when they buy the good in question.
• The difference between what consumer pay for and the value that they receive from buying
a particular good, indicated by the maximum amount they are willing to pay. This is what
we call consumer surplus.
• It is indicated by the area below the demand curve but above the price in the graph below:
 Consumer Surplus and Producer Surplus
• Producer Surplus
• Producer surplus refers to an economic measure of the difference between the amount a
producer of a good receives for selling the good in the market and the minimum amount the
producer is willing to accept for the good in question.
• The producer surplus involves the idea of producers being willing to supply units of the
product at less than the market price.
 Consumer Surplus and Producer Surplus
• Consumer surplus and producer surplus at market equilibrium
• Total surplus refers to the total addition or sum of consumer surplus and producer surplus. Total surplus is
maximized in perfect competition because free-market equilibrium is reached.
 Important Concepts
Demand: Demand therefore refers to the quantities of goods and services that
prospective buyers are willing and able to purchase during a given period of time
The Law of Demand: The law of demand states that the higher the price of a
good, the lower the quantity demanded, ceteris paribus. On the other hand, the
lower the price of a good, the higher the quantity demand, ceteris paribus
Substitute good: A substitute is a good that can be interchangeably used in place
of another good to satisfy the same or similar need.
Complementary goods: A complement is a good that can be used in conjunction
with another good to satisfy a certain human need.
Supply: It refers to the quantity of a good that producers are willing to sell at a
given price given that any other factors that might affect the quantity supplied
are held constant.
 Important Concepts
The Law of Supply: The law of supply states that all other things held constant
(ceteris paribus), the higher the price of a good, the greater is the quantity
supplied. On the other hand, the lower the price of a good, the smaller the
quantity supplied.
Equilibrium: Equilibrium is an economic situation in which the quantity supplied
and the quantity demanded are equal, a point at which there is neither excess
demand nor excess supply.
Consumer Surplus: The difference between what consumer pay and the value
that they receive, indicated by the maximum amount they are willing to pay.
Producer Surplus: Producer surplus is the difference between the amount a
producer of a good receives and the minimum amount the producer is willing to
accept for the good.
Important Concepts
END OF LEARNING
UNIT Four