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CHAPTER 2
DEMAND AND SUPPLY
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Demand (DD) & Supply (SS)
Concept of DD & SS based on workings of a freemkt economy.
In a mkt economy, resources are allocated via the
price mechanism (invisible hand) where dd & sschanges bring abt price changes to bring abt mktequilibrium.
Consumers have freedom to decide & choosewhat gds to buy to maximise satisfaction basedon their ability & willingness to pay.
Producers have freedom to engage in any prod tomaximise profits.
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THEORYOF DEMAND
Demand behavior of buyers in the mkt.
DD defined as total amount of g&s bought
(Qd) by consumers at various price (P) levelsat given time period.
Effective dd dd measured by willingess to
buy & ability to pay by consumers
DD shows the relationship bet. P & Qd = DD
curve.
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LAWOF DEMAND
Law of DD states that ceterius paribus (cp) i.e.
other things remain constant/unchanged, the
P, Qd; P, Qd.
P & Qd shows inverse/negative relationship.
DD curve is downward sloping from left to
right.
Draw dd curve to show Law of DD
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LAWOF DEMAND
Why downward sloping? 2 effects to explain that
a lower price, consumers demand buy more.
1. Substitution effect (SE) when Px relative to other
gds, consumers switch or substitute with cheaper
gds (Gd X), Qdx.
2. Law of Diminishing Marginal Utility (LDMU) as
more of Gd X is consumed, less & less satisfaction is
derived, consumers Qdx, thus to get consumers to
buy more of Gd X, Px must be .
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DETERMINANTS OF DEMAND
1. Movement along dd curve caused by changes
in the price of good X. C.p., when
Px, Qdx = movt upwards along dd curve =contraction of dd (pt A to B)
Px, Qdx = movt downwards along dd curve =
extension of dd (pt A to C)
Draw dd curve movt.
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DETERMINANTS OF DEMAND
2. DDx is a function of Px and other factors (c.p.
factors)
Dx = (Px, Pr, Ps, Y, T, anticipated P & Y) Change in c.p. factors bring abt shifts in DD
curve
Increase in DD = shift in dd curve to the right Decrease in DD = shift in dd curve to the left
Draw shift in dd curve
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Changes in DD = shifts in DD
Dx = (Px, Pc, Ps, Y, T, anticipated P & Y)
1. Change in price of related gds:
Pc = change in price of complementary gds Ps = change in price of substitutes
2. Change in income level
3. Change in taste & preferences4. Anticipated change in future price and
income
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Changes in DD = shifts in DD
1. Change in price of related gds:
a. Ps = change in price of substitutes
Substitutes are gds that can replace thefunctions of another gd e.g. butter & margarine
(close substitutes) or meat & fish
Pbutter Dmargarine (consumers subsitute
butter with margarine increase in DD) Pbeef Dchicken (decrease in DD)
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Changes in DD = shifts in DD
b. Pc = change in price of complementary gds
Complementary gds are gds that are demanded
together or jointly used or joint demand e.g. car
with petrol, pen with ink, tea with sugar
Ppetrol D car (increase in DD)
Psugar D coffee (decrease in DD)
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Changes in DD = shifts in DD
2. Change in income (Y) level
c.p. generally as Y, DD (increase in DD)
Y DD depends on type of gds: Y, DD = Normal gds
Y, DD = inferior gds
Y
, no DD = common gds Y, largeDD = luxury gds
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Changes in DD = shifts in DD
3. Change in taste & preferences
Consumer taste & preferences change over time
E
.g. change in preference towards organic food increase in DD
E.g. change in preference influenced by
advertisement increase in DD for beauty
products
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Changes in DD = shifts in DD
4. Anticipated change in future price and income
Consumers anticipate future changes in price
and income E.g. consumers predict price of sugar to
increase in the future such as during festive
season, bring forward current purchases
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Individual DD and Market DD
Mkt DD = sum or aggregate of dd of individual
buyers in the mkt
E.g. mkt dd for cars = sum of each car sold &bought (sum of Qd) at different price levels in
the mkt
Draw mkt dd curve
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THEORYOF SUPPLY
Behavior of producers/sellers in the market
Definition of Supply (SS):
Various quantities of goods sold/offered for sale at
various price levels at a given time period C.p. supply shows the relationship between quantity
supplied (Qs) and price (P)
Law of Supply:
P, Qs & vice versa
Direct/positive relationship between P & Qs
Draw SS curve
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DETERMINANTS OF SS
Why P leads toQs ? Or Why ss curve is
upward sloping?
3 reasons:
Increase price means higher revenue, leads to higher
profits, firms are motivated to increase prod - Qs
P means profits long run new firms are attracted
to enter the industry to compete leads to Qs
Increase prod leads to increase cost of prod due to Law
of Diminishing Returns
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Determinants of SS
Change in Qs caused by change in price of gd
itself, c.p. = movement along ss curve
P, Qs = extension of ss (pt A to B)
P, Qs = contraction of ss (pt A to C)
Draw movt of SS curve
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Determinants of SS
Change in Supply caused by change in c.p. factors =shift of ss curve to the right or left
C.p. factors e.g. change in cost of prod, priceprediction, number of producers & change in price of
related goods e.g. Cost of prod, ss & vice versa
number of producers, SS vice versa. cost of prod, SS = decrease in ss (ss curve shifts to the
left) number of producers, SS = increase in ss (ss curve
shifts to the right)
Draw shifts in ss curve
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Determinants of SS
SSx = {Priceof Gd X itself, cost of prod (C), Price of relatedgds (Pr), number of producers (Pd), anticipated pricechanges (Pa)}
Change in cost of prod (cop) due to:
increase in cost of resources e.g. in wage cost, increase inrental or increase in cost of raw materials
Change in technology e.g. technological progress lowerscop
Taxation by govt increase cop
Subsidies lower copLeads to changes in ss shift of ss to the right/left
Draw diagrams
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Determinants of SS
Change in price of related goods:
1. Substitutes in ss prod of chillies vs prod ofgreen vegetables
E.g. price of chillies producers prod green vegeswitch to prod of chillies
2. Complements in ss (joint ss) two gds jointlyprod e.g. petroleum & natural gas
E.g. price of oil producers prod pump outmore oil and prod of crude oil & at the sametime, more natural gas is prod because jointly ss
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Determinants of SS
3. Anticipated price changes:
e.g. if producers predict P of gds in the future,
increase prod & vice versa
4. Number of producers in the mkt
e.g. new entrants into the mkt will increase ss &
vice versa
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Individual SS & Mkt SS
Mkt ss = sum of Qs by all sellers at various
price levels in the mkt
Draw derivation of mkt ss
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