Lecture Theory of Demand

Wendell Long
W. Long(2012) 1
The Law of Demand
The law of demand generalises that
other things equal, consumers will
buy more of a product (increase
quantity) as the price declines during
a particular period of time.


W. Long(2012) 2
Demand Schedule: The Market Demand
for fresh pigeon peas in Tabular Form
Price ($/can) Quantity of bags/month
0 12
1 10
2 8
3 6
4 4
5 2
6 0
W. Long(2012) 3
Graph: The Demand Curve for
Fresh Pigeon Peas Change in
Quantity Demanded

0 2 4 6 8 10 12






1






2






3





4





5





6



P
r
i
c
e

(
$
/
b
a
g
)

Quantity (bags / month)
expansio
n
contractio
n
W. Long(2012) 4
Demand Function
The equation of the market demand curve can be
expressed as follows:
P = b mQd (eq. 1) ; whereby P ~ price, b ~
intercept on the Y axis, - m ~ the slope and Q ~
quantity demanded
This expression was obtained from the equation of
a straight line: Y = c + mX ; (+m) now becomes (
m) because the demand curve is negatively sloped
Thus via substitution we get:
P = 6 - Q d (eq.2) ; whereby was
obtained from the demand curve from points A & B,
the rise is P = -1 (4 - 5) and the run is Q = 2 ;
thus the slope of the demand curve is = =

d
Q
P
W. Long(2012) 5
Determinants of Demand:
Factors Causing a Change in
Demand
We have already seen that changes in
price causes changes in quantity
demanded (movement along the
demand curve); however, the following
factors causes a change in demand
(shift of the demand curve):
W. Long(2012) 6
Determinants of Demand:
Factors Causing a Change in
Demand (contd)
Price of other goods
Taste , habits and customs
Changes in population
Seasonal factors
Distribution of income
Advertising
Income
Government policies
W. Long(2012) 7
Demand Schedule: The Market
Demand for fresh pigeon peas
An Increase in Income
Price ($/can) Quantity of
bags/month
Quantity of
bags/month
with an
increase in
income
Quantity of
bags/month
with a
decrease in
income
0 12 14 10
1 10 12 8
2 8 10 6
3 6 8 4
4 4 6 2
5 2 4 0
6 0 2
W. Long(2012) 8
Change in Demand

Price/bag
Quantity
(bags/ month)
W. Long(2012) 9
Exceptions to the Law of
Demand
Snob Goods: those goods as price
increases the more it is demanded
Speculative Demand: If the price the
good is expected to increase
consumers may demand more eg
Investment in stock
Giffen Goods
W. Long(2012) 10
Exceptions to the law of
demand

Price
Quantity
Price
Quantity
Snob/speculative
Good
Giffen Good
D
D
9
3
0 2 4 6 8 10 12
8
W. Long(2012) 11

Theory of Supply & Equilibrium
W. Long(2012) 12
Law of Supply
The law of supply generalises that
other things equal, producers will sell
more of a product as the price rises
(increased quantity) during a
particular period.
Note that the analysis for supply is the
opposite of demandthis is because
we are examining two opposite ends
of the market i.e. consumers
(demand) and producers (supply).

W. Long(2012) 13
Supply Schedule: The supply of soft
drinks
Price/bottle Quantity (# of bottles)
0 0
1 100
2 200
3 300
4 400
5 500
6 600
7 700
W. Long(2012) 14
The supply curve: soft drinks
Change in Quantity Supplied (a movement)
0




1




2




3




4




5




6




7

100 200 300 400 500 600 700
S
A
B
Expansion
Contraction
Q
P
Quantity Supplied (bottles)
P
r
i
c
e
/
b
o
t
t
l
e

W. Long(2012) 15
Supply Function
The equation of the supply curve can be expressed
as follows:
P = b + mQs (eq. 1) ; whereby P ~ price, b ~
intercept on the Y axis, + m ~ the slope and Q ~
quantity demanded
This expression was obtained from the equation of
a straight line: Y = c + mX ; (+m) as the supply
curve is positively sloped
Thus via substitution we get:
P = 0 + Qs (eq.2) ; whereby was obtained
from the demand curve from points A & B, the rise
is P = +1 (5 - 4) and the run is Q = 100; thus the
slope of the demand curve is = =

100
1

S
Q
P
100
1
W. Long(2012) 16
Determinants of Supply (factors
that cause a change in Supply)
A change in quantity supplied refers
to a movement along the supply
curve caused by a change in price (as
illustrated in figure 1 below.)
A change in supply refers to a shift in
the supply curve caused by a change
in a factor (determinants) other than
price (as seen in figure 2.)
W. Long(2012) 17
Determinants of Supply (factors
that cause a change in Supply) contd
Price of factors of production
Price of other commodities (resource
switching)
Technology
Taste of producers
Entry and exit from the industry
Exogenous Factors (e.g. weather
conditions)
W. Long(2012) 18
Determinants of Supply:
Schedule
Changes in the supply of bottle water
as illustrated in the table below:
Price/bottle Quantity (# of
bottles)
Increase in
Supply
Decrease in
Supply
0 0 0 0
1 100 150 50
2 200 250 150
3 300 350 250
4 400 450 350
5 500 550 450
6 600 650 550
7 700 750 650
W. Long(2012) 19
Change in Supply: Graph
Shift to the left & right of the supply
curve
0






1






2






4






5






6






7





100 200 300 400 500 600 700 800
S

S1
S2
Increase supply
(rightward)
Decrease
in
supply(left
ward)
Quantity Supplied (bottles)
P
r
i
c
e
/
b
o
t
t
l
e

W. Long(2012) 20
The Market: equilibrium
Equilibrium occurs when the total quantity
of goods consumers plan to purchase
(demand) exactly equals the quantity the
producers plan to sell (supply).
When this happens the market is said to be
in equilibrium or a state of rest. The
condition of equilibrium applies to both price
and quantity. The equilibrium price or the
market clearing price is the price at which
quantity demanded equals quantity
supplied and the quantity itself is known as
the equilibrium quantity or equilibrium
output.

W. Long(2012) 21
Table Showing Equilibrium:

Market price/bottle
of soft drink
Market demand (#
of soft drinks)
Market supply (# of
soft drinks)
1 700 100
2 600 200
3 500 300
4 400 400
5 300 500
6 200 600
7 100 700
W. Long(2012) 22
Equilibrium Price & Quantity
The market for soft drinks
0 100 200 300 400 500 600 700





1



2




3



4




5




6




7

S
D
Quantity demanded & supplied
P
r
i
c
e
s
/
b
o
t
t
l
e

Surplus
Shortage
Equilibrium price & quantity
W. Long(2012) 23
Changes in equilibrium: an
increase in demand
An increase in demand gives a higher
price and a greater quantity.
P1
P
Q1 Q
P
r
i
c
e

Quantity D/d & S/s
D
D1
S
E
E1
W. Long(2012) 24
Changes in equilibrium: an
increase in Supply
An increase in supply will cause a reduction in
price and a increase in quantity demanded and
supply
S
S1
D
P
P1
Q Q1
P
r
i
c
e

Quantity D/d & S/s
W. Long(2012) 25
Activity: The Eight Scenarios
Give the change in equilibrium price and/or
equilibrium quantity as a result of each of the
following:
1. Increase in demand with supply remaining
constant
2. Decrease in demand with supply remaining
constant
3. Increase in supply with demand remaining
constant
4. Decrease in supply with demand remaining
constant
5. Increase in both demand and supply
6. Decrease in both demand and supply
7. Increase in demand and decrease in supply
8. Decrease in demand and increase in supply
W. Long (2012)