Demand, Supply,

Equilibrium and Elasticity

(Price Theory or Market
Mechanism)

Market
A set of arrangements by which buyers and sellers are in
contact to exchange goods and services.
Various types of markets
Physical (Buyers , sellers and goods and services in
physical presence or contact)
Intermediate (share market)
Super (prices are fixed)
Electronic (www.) and Tele (Video/phone/fax)
Auction (ascending, descending, sealed bid),
Differentiated (customer, product, quality)
Homogenious (same type of goods and same price)
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geographical (regional, city, rural, estate) etc.

Various types of products:

Normal products (If the quantity demanded
rises as incomes rise and falls when incomes
fall)
Inferior products (If the quantity demanded
fall as incomes rise and rises when incomes
fall)
Giffen products (A special case of the inferior
product arises when as price rises, more of
the good in question is bought resulting
upward slopping demand curve)
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Veblen products (A special case of giffen

luxury product: prices goes down people will
buy more prices goes up people will buy
more jewellery market -conspicuous
consumption).
Independent/dependent products (goods
which can/not consume independently)
Substitution Product (instead of one good we
can use other good).
Complementary Products (without the help of
other goods we can not use them).

Definition for a Demand

Purchasing power and will to spend based
necessity. It is the quantity of a good buyers
wish to purchase at each conceivable price. The
willingness to pay a sum of money for a given
amount of a specific good or service.
Ex-ante Demand (intended or expected) and
Ex-post Demand (actual demand/existing
demand)
Consumer Demand (individual demand) and
Market Demand (summation of individuals
demand)
Speculative demand (due to expectations)

Consumer demand curve (this relates to the

amount the consumer is willing to buy to each
conceivable price for a product)

Market demand curve is generally derived by

summing the individual demand curves of
consumers horizontally. Shape of the curve
depends on the market structure)

Factors Influencing the Individual Demand

Price of the product
income of the buyer
taste
habits and preferences
prices of complementary and
substitutes
consumer expectations
advertisement effect, etc
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Factors Influencing the Market Demand

price of the product
distribution of income and wealth
communitys common habits and
preferences
living standards and spending habits
growth of population
age and sex composition
future expectation
tax structure
inventions and innovations
fashions
weather
customs, advertisement, etc

Demand equation:

Qd =f( P ), Qd = a - bP, b =AQd/AP (slope)

Demand function:
Qd =f

(P: price of the good is concerned

Pj: Prices of substitution and complementary goods
Y: Income
T: taste
Ex: expectations
Ad: advertisements
G: government influence
W: weather

.n).

Demand Schedule (behavior of buyers at every price)

Price($)
0
10
20
30
40
50

Demand ( units)
200
160
120
80
40
0

Demand Curve (the relationship between price and

quantity demanded, holding other factors constant).
P
50
25
0

100

200

Qd

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Analysis of demand function: (Analyse

the Qd with respect to change in all the
factors which affect for demand)
Qd = f (P:price of the good is concerned,
Pj:
prices
of
substitution
and
complementary goods, Y:income, T: taste,
Ex: expectations, Ad: advertisements,
G: government influence, W: weather n)

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(X

and Y are substitutes)

1. Price of substitution good (X) goes

up then quantity demanded from
the good is concerned (Y) goes up.
(relation +)
2. Price of substitution good (X) goes
down then quantity demanded from
the good is concerned (Y) goes
down. (relation +)
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(A and B are complementary goods)

1.

Price of complementary good (A) goes up then

quantity demanded from the good is concerned (B)
goes down. (relation -)

2.

Price of complementary good (A) goes down then

quantity demanded from the good is concerned (B)
goes up. (relation -)

3.

Price of independent good goes up or down then

quantity demanded from the good is concerned
does not have any impact. (relation 0)
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4. Income (disposable Yd = Y-T) goes up then

demand for normal good goes up (relation +).
Income goes down then demand for normal good
goes down (relation +).
5. Income goes down then demand for inferior good
goes up. Income goes up then demand for inferior
good goes down.
Angels Law
As income rises the proportion of expenditure on all
necessities (foods) declines and luxuries increase
(non-necessities).

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4. Consumers taste goes up (due to advertising

campaign) then demand for normal good goes
up. Taste goes down then demand for normal
good goes down (relation +)

5. Expectations, advertisements, weather go up

(down) then demand for normal good goes up
(down), G: government influence (tax negative
elasticity- and subsidy positive).

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The inverse relationship (negative) between price

and quantity demanded depends on the
substitution effect of price changes.
X and Y are substitutes. Price of X goes up then
consumers shift from X to Y. Price of X goes down t
hen consumers shift from Y to X.
income effect of price changes
If consumers real income goes up then they will
demand more and if their real income goes down th
ey will demand less.
This can be shown through
Marginal utility approach.
Indifference curve approach.
This will be discussed in your fourth lecture.

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Unusual upward slopping demand curve

Giffen goods (If prices fall while income is rising consumers buy
less giffen goods because they go for superior goods. If prices
increase while income is dropping they buy more giffen goods
because they can not afford superior goods).
Articles of snob appeal or Conspicuous consumption (People
buy as status symbol of prestigious/expensive or unique goods diamonds, antiques and Rolls-Royces). The influence of
conspicuous prices upon consumption is referred as veblen effect.

Speculation (If prices are going up people expect future price

rises and then buy more - shares and some commodities).
Consumers psychological bias (upper market behaviour and
brand loyality).
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Network Externalities in Market Demand

The bandwagon or demonstration
effect (demand generated due to
others pursuation, imitation or
stimulation) - consumers are
motivated to follow the crowd.
.

The snob or veblen effect (persons

desire to own unique high priced
good)
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Change and shift in demand: Change means movement

(up - expansion or down - contraction) along the
demand curve due to change in own price. Shift [left:
decrease or right: increase] in demand curve due to
changes in other factors except price.
P

Qd = f(P)

Qd = f(Pj, T, Y..n)

D1

P1
P1

P2

D2

Q1

Q2

Qd

Movement along the demand

Q1

Q Q2

Shift in demand

Qd
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Definition for a supply (the amount which supplier willing

sell and it is the quantity of a good supplier wish to sell
at each conceivable price over a specific time period)
Supply equation:
Qs = f(P), Qs = a + b P,
b = AQs/AP (slope) and supply function:
Qd = f(P): price of the good is concerned
Pj: prices of substitution and complementary goods
T: technology
PI: price of inputs
Ex: Business expectations, Sn: Number of suppliers
G: government influence, W: weathern.

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Supply Schedule ( behavior of suppliers at every price)

Price($)

Supply ( units)

10

20

40

30

80

40

120

50

160

Market supply and individual supply

Market supply is the summation/aggregation of individuals supply curve
for a specific product.
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Supply Curve
(the relationship between price and quantity supplied,
holding other factors constant).
If prices are low less supply, if prices are high more
supply. Positive relationship between price and the
quantity supplied.
P

Qs
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Analysis supply function:

Qd = f (P: price of the good is concerned,
Pj: prices of substitution and
complementary goods, T: technology, PI:
price of input, Ex: expectations, G:
government influence, W: weather, etc )

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Change and shift in supply: Change means movement

(up extension or down - contraction) along the
supply curve due to change in own price. Shift (left:
decrease or right: increase) in supply curve due to
changes in other factors except prices.
Qs = f (Pj, Tec..n)
Qs =f (p)
P

S1

P1

P2

P1

S2

Q1

Q2

Qs

Q1

Q Q2

Qs
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Equilibrium Price and Quantity

Equilibrium price equalizes quantity supplied to the
quantity demanded and it clears the market. Above
this price excess demand and below this price excess
supply.
Price

Qd

Qs

10

160

20

120

40

30

80

80

40

40

120

50

160

(Qd > Qs) Excess demand

Equilibrium (Qd = Qs)
(Qs > Qd) Excess supply

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P
(30)p

S
Floor price

Equilibrium price
Ceiling price

Qd,Qs(80)

Qd, Qs

Price Controls (government interference to market to

forbid the adjustment of prices to clear the market)
Floor prices (minimum prices above the equilibrium
price)
Ceiling prices (maximum prices below the equilibrium
price).
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Comparative Static Analysis (response of price and quantity to

changes in demand and supply)
1. Shift in demand curve to both directions while supply curve
stable.

D1

P
D

D2

D shift to right

P3

B
A

P2

D shift to left

P1

P Qd = B

P Qd = C

Qd
Q1

Q2 Q3

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2. Shift in supply curve to both directions while

demand curve stable.
P

S2
D

S
S1 S shift to right

P3

C
A

P2

P1

P Qd
S shift to left
P Qd

Q1

Q2 Q3

=B

=C

Qd
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3. Both supply and demand curves shift into both

directions in same %.
P

P3
P2

D
D2

S2

D1

S1

P Q

P1

Q1

Q2 Q3

Qd
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4. Supply and demand curves shift into both directions in

different %.

4.1 Demand 5% up and supply 10% up

P
D

D1

S
S

D 5% S 10% (right)
P Qd = B

P2

A
B

P1

Q1

Q2

Qd
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4.2 Demand 10% up supply 5% up

P

S
D1

D
5%

10 %

P2
P1

S1

D 10%

S 5% (right)

=B

Qd

B
A

Q1

Q2

Qd

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4.3 Demand 5% down supply 10% down

P

S1
D1

%
10

5%

P2
P1

Q1

D 5% S 10% (left)
P

Qd

= B

Q2

Qd
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4.4 Demand 10% down and supply 5% down

S1
D

5%

D 10% S 5% (left)

D1

10%

P2
P1

P Qd = B

Q1

Q2

Qd
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Consumer Surplus and Producer Surplus

a

S
Consumer surplus

x
Producer surplus

D
q3
o
oaxq3 -opxq3 = pax
The difference between the total amount of money an
individual would be prepared to pay for a given quantity of
a good and the amount actually paid. This concept is usefu
l to public policy making, pricing, tax and welfare decisions
. Producer surplus = OPX
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For business firm this concept shows a

possible source of additional
Income (possibility of price discrimination).
For government to tax policies.
Using this concept, we can place a monetary
value on activities that do not appear to have
a market price.

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