FACULTY OF BUSINESS AND MANAGEMENT

BBEK1103
PRINCIPLES OF MICROECONOMICS

SEMESTER JANUARY 2011

Market is a situation where potential buyers (consumers) and potential sellers (producers) of a
goods or service come together for the purpose of exchange. Activities of both producers and
consumers determine the level of demand and supply. The concept of demand and supply is the
basic concept in market economy. The price system will determine how resources, goods and
services are distributed. It is depends on anyone who has wants and willing to pay will obtain
what is required.
Demand is refer to total quantity of goods required and able to be purchased by consumers at
various price levels in a particular period of time. Market demand refers to the total quantities of
a product that all households would want to buy at each price level. Price elasticity of demand is
a measurement on responsiveness of demand quantity towards a price change. Generally,
elasticity can be pictured in the shape of demand curve. The range of price elasticity at different
point on a downward sloping straight line demand curve is illustrated in Figure 1.

Price
P

0.5P

0.5Q

Quantity

Figure 1: Ranges of price elasticity

Elasticity of demand price can be determined by the followings factors.

i)
ii)
iii)
iv)

The number of substitute goods

Budget ratio
Time
The number of uses of goods

Nowadays fuel is one of the main materials (input) in many sectors. It is almost become a
necessity of our life. In general, demand for fuel is inelastic since there are almost no other
substitute goods can be replaced it. When demand is inelastic, an increase in price will still result
1

in a fall in quantity demanded, but in total expenditure will rise. Figure 2 illustrate area X
(expenditure gained) is greater than area Y (expenditure lost). Therefore, price change gives a
more significant effect compared to quantity change.

Price

Expenditure rises
when price rises
PB
PA

B
X

A
Y
Quantity
QB QA

Figure 2: Inelastic demand for fuel market

When a war breaks out in a country which is main fuel producer in the world, it will result fuel
supply disruption in the world and fuel price increase. In economic analysis, demand does not
solely mean for quantity. It is also refers to relationship between quantity and price which can be
shown graphically as a demand curve and demand table. See illustration below, Figure 3 and
Table 1. When price increase, demand quantity decrease, and when price decreases, demand
quantity increases. This inverse relationship we call it as Law of Demand. A demand curve show
quantity demanded will change in response to a change in price. Movement along demand curve
indicates the changes of demanded quantity caused by the goods price change.
There are several factors influence the total market demand for a goods. The determinants of
demand includes
i)
ii)
iii)
iv)
v)
vi)

Price of the goods

Consumer income
Price of related goods
Taste and fashion
Expectation
The distribution of income amongst buyers or households

Table 1: Demand table

2

Price (RM)
10
20
30
40
50
60

Demanded Quantity (Litre)

600
500
400
300
200
100

Price
D
60
50
40
30
20
10
Quantity
100 200 300 400 500 600

Figure 3: Demand curve

A supply curve is show quantity of a goods that existing supplier (existing producers) are willing
to produce for the market at a given price. It is upward sloping curve from left to right, the
greater the quantities will be supplied at higher price. Figure 4 is the supply curve derived from
Table 2. Table 2 shows the quantity of goods that willing to produce by the producer at different
price level.
Table 2: Supply Table
Price (RM)
10
20
30
40
50
60

Quantity Supplied (Litre)

100
200
300
400
500
600

Price
S
60
50
40

30
20
10
100 200 300 400

500 600

Quantity

Figure 4: Supply Curve

What is market equilibrium?

Market equilibrium is where the point of intersection between demand and supply curve. At the
point of market equilibrium, we will able to know the particular quantity (known as equilibrium
quantity, Qe) and price (equilibrium price, Pe) where buyer and seller are willing to pay and sell.
With understanding of demand and supply, we can show how the decisions of buyers of goods or
services interact with the decisions of sellers to determine the equilibrium (McConnell, Brue&
Flynn, 2009).
According to McConnell, the market equilibrium is the base point in which the supply and
demand of the product quantity (McConnell, 2009). This can be illustrated by drawing demand
curve and supply curve on the same graph (Figure 5). Market equilibrium will achieve when
there is no surplus and shortages. Figures 5 illustrates the condition when market equilibrium,
surplus and shortages.
Price
Surplus

Market supply

Pe

Shortage
Qe

Market demand
Quantity

Figure 5: Market equilibrium, surplus and shortages

If the quantity produce at a given price exceeds the quantity that consumers demand, there will
be an excess of supply.

When change in the price of goods relates to a commodity will shift the position of demand
curve. A change in the price of one goods will not necessarily change the demand for another
goods. For example we would not expect an increase in the price of bread to affect the demand
4

for car. However, if both of the goods in the market demand are inter-connected and there are no
other substitute goods, then the demand sensitivity of cars towards the price change of fuel is
high.
Substitute goods are goods that are alternative to each other. Meaning to say an increase in the
demand for one is likely to cause a decrease in the demand for another. Consumers may switch
demand from one goods to another rival goods. Example of substitute goods and services are:i)
ii)
iii)

Rival brands of the same commodity, likes Coca-cola and Pepsi-cola

Butter or margarine
Bus rides and train rides

Complementary goods are goods that can be consume together, so that an increase in the demand
for one is likely to cause an increase in the demand for the other and vice versa. Examples of
complements are:i)
ii)
iii)

Fuel with cars

Cups with saucers
Pen with ink

For instance, an example of complementary goods likes fuel and car. The fuel price increase in
the market due to supply disruption in the world. Lets say the price of fuel increase from P1 to
P2. This will cause quantity demand for petrol decrease. Refer demand curve for fuel which
illustrated in Figure 6(a).
Consequences after the increase of fuel price, it will have direct impact towards car market.
Consumers will reduce demand for cars; see Figure 6 (b) illustrated below. In other words, the
change in fuel price will cause consumers make changes to the fuel consumption they willing to
be purchased. Demand for cars decrease as consumers have a mindset that fuel price too high,
given that fuel and car are complementary goods.
In car market demand will shift left due to reason expensive fuel price discourage people from
buying car (Figure 6b). Therefore demand quantity for car market will decrease. When increase
fuel prices, it is not only will affect car market. It will also cause other sectors increase in cost of
production. Hence, costs of living such as foods and clothing also rise due to increase fuel price.
This will then push inflation upwards, and later is interest rate rise!

Price

Price

D1

D
P2
P1

Do

B
A

P1

A
Do
5

D
D1
Q2

Quantity

Q1

Q2

(a) Demand curve for fuel

Q1

Quantity

(b) Demand curve for car

Figure 6: Change in the price of complementary goods

On the other hand, demand for public transport and bikes market will increase as there is not
much other alternative to substitute fuel.
The effect of one form of government intervention in market is indirect tax imposed on certain
goods. When government tax imposed on cars, this will increase cost to seller, hence the tax will
shift the supply curve to the left. Consumer has to pay the price includes the tax. For example in
Figure 7:
(a) S0 is the supply curve before impose tax
(b) S1 is the supply curve including the cost of tax
(c) Q0 is the demand quantity before impose tax
(d) Q1 is the demand quantity after impose tax
Price
S1
S0
P2
P0
P1

B
C

Q1

D
Q0

Quantity

Figure 7: the effect of tax towards market equilibrium

From graph above (Figure 7) we can see when supply curve from S0 to S1, the market
equilibrium from A move to B. Quantity demand has fall from Q0 to Q1 and price pay by
consumer has increase from P0 to P2. The amount of tax collected by government is depicted by
area P1P2BE and amount borne by consumer is the area P0P2BC. The amount of tax borne by the
seller is P1P0CE.

In general, the greater the elasticity of the demand and supply, the greater will be the effect of a
tax in reducing the quantity sold in and the produced for the market. It can be appreciated from
Figures 8 that the consumer bears greater proportion of the tax burden when the demand curve be
more elastic.
Price

Price
D

S1
B

Tax

S1
S0

D
B

S0

Tax

Q1 Q2
(a) Inelasticity demand

Quantity

F
Q1

Q2

Quantity

(b) Elasticity demand

Figure 8: Elasticity of demand curve after government imposed tax

Point A in both diagrams is the initial equilibrium point and point B is the market equilibrium
after tax is imposed. From Figure 8(a) we can see when the demand is inelasticity, the bigger the
tax burden that has to be borne by consumers in area CHBE.
Refer to Figure 8 (b) where the elasticity demand for car is elastic, the seller has to bear more
taxes imposed (area EFGH) as we compare with consumer (area CHBE).
In summary, when elasticity of demand or supply becomes lesser, the quantity will get decrease
from Q2 to Q1. This may lead to significant rises in the unit costs of production when companies
reduce quantities in production after government imposed tax.
In view of fuel is an important resources to many sectors, government should not impose tax to
burden both supplier and consumers. The impacts of increase price in fuel and follow by adverse
consequences on the car market; this will make the country produce goods and services in an
uncompetitive situation when compete with oversea market with foreign firm which are not
subject to the same tax.
Reference
Munzarina Ahmad Samidi, Norehan Abdullah, Jamal Ali and Zalina Mohd Mohaideen (2009).
Principles of Microeconomics. Meteor Doc. Sdn Bhd.

British Library Cataloguing-in-Publication Data (1998). The Organisational Framework. BPP

Publishing Limited.
Ivan Png and Dale Lehman (2007). Managerial Economics. Blackwell Publishing.
Hairun. Supply and Demand: How Market Work. 5/3/2011.
http://www.ukm.my/hairun/Ecn3100/DD,%20SS,%20elasticity.pdf
SparkNotes. Equilibrium. 5/3/2011.
http://www.sparknotes.com/economics/micro/supplydemand/equilibrium/section1.rhtml
Wikipedia. Supply and Demand. 6/3/2011. http://en.wikipedia.org/wiki/Supply_and_demand
Robert Schenk. Price Elasticity. 7/3/2011. http://ingrimayne.com/econ/elasticity/Elastic1.html
Mohsensaberi (7/4/2010). Market Equilibrium. 7/3/2011
http://www.oppapers.com/essays/Market-Equilibrium/350643

Note: 1,789 words excluding references.