Economics 2nd Chapter Notes PDF

# Chap # 2 ## Demand and Supply ### Demand - The ability and willingness to buy specific quantities of goods in a given period of time at a particular price, *ceteris paribus*. - *Ceteris Paribus* means holding other factors constant while some other factors change. ### Classification of goods an...

# Chap # 2 ## Demand and Supply ### Demand - The ability and willingness to buy specific quantities of goods in a given period of time at a particular price, *ceteris paribus*. - *Ceteris Paribus* means holding other factors constant while some other factors change. ### Classification of goods and services 1. **Free Goods** - Gifts of nature or goods that have no production cost, e.g. water, air, sunlight 2. **Public Goods** - Goods that have a common use, and are of benefit to everyone, e.g. Public Clinic, Schools 3. **Economic Goods** - Goods that involve a production cost and things of value that can be seen or touched, e.g. books, clothes, houses 4. **Economic Services** - Intangible things (with value) that cannot be seen or touched, e.g. Medical care, Legal Services ### Law of Demand - As the price of a good or service increases, the quantity demanded of it decreases, *ceteris paribus* (all other things being equal). ### Assumptions: 1. Tastes and preferences of consumers remain unchanged. 2. Consumers' income remains the same. 3. Price of related goods (complementary or substitutes) should remain unchanged. 4. Goods should not have any prestige value. - Based on the law of demand, a negative relationship exists between price and the quantity demanded. - P↑ Qoo ↓ - P↓ Qoo ↑ ### Demand Schedule and Demand curve - The demand schedule for a product is a list of the quantity that a buyer is willing to buy at different prices at one particular time. | Price | Quantity | |:---:|:---:| | 5 | 2 | | 4 | 4 | | 3 | 6 | | 2 | 8 | | 1 | 10 | - The demand curve is a line or graph showing inverse relationships between price and demand of a product. - The demand curve must slope downwards due to the inverse Relationship (according to the law of demand). ### Individual Demand and Market Demand - **Individual demand** is the relationship between the quantity of a product demanded by a single individual and its price. - **Market Demand** is the relationship between the total quantity demanded by all buyers in the market and its prices | Price | Individual 1 | Individual 2 | Market Demand | |:---:|:---:|:---:|:---:| | 5 | 2 | 4 | 6 | | 4 | 4 | 5 | 9 | | 3 | 6 | 6 | 12 | | 2 | 8 | 7 | 15 | | 1 | 10 | 8 | 18 | - When Individual demand curves for different individuals are added up, we get the Market Demand Curve. ### Determinants of Demand - Determinants of demand refer to the factors that influence the demand for a good or service. #### Internal Factors 1. **Price of goods** - Price of the product depends on the cost of production. The higher the price, the lower the demand. 2. **Service policies or terms of payments** - Better cutomer service and terms of payments (by credit instead of cash) will increase sales. 3. **Profit Margin** - A higher profit margin will lead to an increase in the price of the product and reduce its demand. #### External Factors (Related) 1. **Price of Goods**- The demand for a product is also affected by a change in the price of related goods. ##### Two Categories of Related Goods 1. **Substitute Goods** - Those goods or services that can be used in place of another product or service. Demand for a product will increase if the price of a substitute product rises. - P↑ Qold ↑ DD↑ 2. **Complementary Goods** - A product that is used in conjunction with another product, e.g. pen and ink. The price of complementary goods affects the demand for the product in the opposite direction to the price change. - Pen↑ Qdd ↓ DDink ↓ #### Determinants of Demand Related to Consumers 1. **Consumers' Income** - When income increases, consumers demand for more goods and services will increase. - Goods that increase in demand as income increases are **Normal Goods** e.g. cars, shirts. - Goods that decrease in demand as income increases are **Inferior Goods** e.g. low grade rice, low grade potatoes. 2. **Consumer preferences** - If the product is fashionable, the demand for it will increase. If outdated, the demand will decrease. 3. **Population** - A larger population with higher growth rate creates greater demand for goods and services. 4. **Expectations about future prices** - The higher the expected future price of a product, the higher the current demand for that product, e.g. increase in petrol prices. 5. **Advertisements** - Advertised goods normally have a higher demand because of awareness. 6. **Festive seasons and climate** - During different festive seasons, different products will be high in demand. 7. **Level of taxation** - The higher the taxes, the lower the purchasing power of consumers 8. **Supply of money in circulation** - The larger the supply of money in circulation, the greater the demand for goods and services, because consumers have more money to spend. ### Changes in Quantity Demanded vs Changes in Demand - **Changes in QD** occurs when the price of product changes and there is movement along the demand curve, *ceteris paribus*. - **Changes in Demand** occurs when other factors change, but the price of a product remains constant, the demand curve will shift. - **Determinants of demand changes**: - When the population or number of buyers increases, the demand curve will shift from D0 to D1. ##### Changes in Quantity Demanded vs Changes in Demand: - **Changes in QD** - Movement along the demand curve occurs when the price of a product changes and there are movements along the demand curve. - Other factors constant. - Upward movement- decrease in QD - Downward movement- increase in QD -**Changes in Demand** - Shift in the demand curve occurs when changes in other factors: Population, income, price of a product, etc. - Price of a product remains constant. - Increase in Demand (D0 – D1). ### Exceptional Demand - Against the law of demand. - Where as the price increases, the quantity demanded will also increase. - The demand curve is positively sloped. ##### Instances of Exceptional Demand - **Giffen Goods** - Giffen goods or inferior foods are normally consumed by those in the lower income group, e.g. potatoes. - **Status Symbol Goods** - Goods or products that people buy to display their wealth, status or prestige. - **Speculations** - If the price of a product is increasing and is expected to increase further in the near future, the consumer will buy more of the product even at the higher price. - **Emergencies** - During emergencies such as war, people will buy more goods even though the prices of those goods are high. - **Highly Priced Goods** - Consumers may perceive highly priced goods as superior products. As such they will buy more when the price is high and less when the price is low. ### Interrelated Demand - Demand for two or more goods that are connected. #### Two Categories of Cross Goods 1. **Joint Demand**- Applies for the complementary goods when an increase in the price of a complement good decreases the demand for the good. - e.g. Pizza and soft drinks 2. **Competitive Demand** - Applies for the substitute goods when an increase in the price of a substitute good increases the demand for the good. - e.g. Pizza and spaghetti. ### Types of Demand: 1. **Derived Demand** : The demand for a good that is dependent on the demand for another related good. For e.g. When the demand for houses increases, the demand for construction workers, carpenters and building materials also increases. 2. **Composite Demand** : Composite demand is the demand for a good that has multiple uses, e.g. Milk can be used for making butter, cheese, and yogurt. # Supply - The ability and willingness to sell or produce particular goods and services within a given period of time at a particular price, *ceteris paribus*. ### Law of Supply - The law of supply states that the higher the price of a product, the greater the quantity supplied of that product. The lower the price of a product, the lower quantity supplied, *ceteris paribus*. - **e.g.** If the price of chicken increases, the quantity of chicken supplied will increase, since the seller will sell more to earn more profit. ### Assumptions 1. **Cost of production** remains constant. 2. **Number of sellers** remains the same. 3. **Price of related goods** (complementary or substitute) does not change. 4. **Availability of other inputs** remains unchanged. - Based on the law of supply, a positive relationship exists between price and the quantity supplied. - P↑ Qss ↑ - P↓ Qss ↓ ### Supply Schedule and Supply Curve - **The supply schedule** is a list of the quantity supplied at each different price, *ceteris paribus*. | Price (RM) | Quantity (unit) | |:---:|:---:| | 5 | 10 | | 4 | 8 | | 3 | 6 | | 2 | 4 | | 1 | 2 | - **The supply curve** is a line or graph showing the direct relationship between the quantities supplied of a good and its price. - The supply curve must slope upwards. ### Individual Supply and Market Supply - **Individual supply** is the relationship between the quantity of a product supplied by a single seller and its price. - **Market supply** is the relationship between the total quantity of a product supplied by all sellers in the market and its prices. | Price | Seller A | Seller B | Market Supply | |:---:|:---:|:---:|:---:| | 5 | 10 | 8 | 18 | | 4 | 8 | 7 | 15 | | 3 | 6 | 6 | 12 | | 2 | 4 | 5 | 9 | | 1 | 2 | 4 | 6 | - When Individual supply curves for different sellers are added up, we get the Market Supply Curve. ### Determinants of Supply - Determinants of supply refer to the factors that influence the supply of a good or service 1. **Price of related goods** - The supply of a product can be influenced by the price of related goods. - **Substitute goods** - The supply of a product will decrease when there is an increase in the price of a substitute product. - P↑ Qss ↓ SS↓ - **Complementary goods** - An increase in the price of a product will increase the supply of a complimentary product. - Pen↑ Qss ↑ SS↑ 2. **Cost of Production** - When the cost of production increases, the quantity supplied will decrease and vice versa. 3. **Expectations about future prices** - The higher the expected future price of a product, the smaller the current supply of the product. ### Factors that Influence the Changes in Supply: 1. **Technological Advancement-** New technologies that enable producers to use fewer factors of production will lower the cost of production and increase supply. 2. **Number of sellers**- The larger the number of firms supplying a product, the larger the quantity supplied for the product. 3. **Government policies** - **Taxes** - Decrease the supply. - **Subsidies** - Increase the supply. Encourage producers. 4. **Improvements in infrastructure**- Improvements in infrastructure such as transportation (fast movement of goods) increase the supply ### Change in Quantity Supplied vs Changes in Supply - **Change in QS** occurs when the price of product changes and there is movement along the supply curve, *ceteris paribus*. - **Changes in QSupply** occurs when other factors change but the price of a product remains constant, the supply curve will shift. ##### Change in Quantity Supplied vs Changes in Supply: - **Change in QS** - Movement along the curve occurs when the price of a product changes and there are movements along the demand curve. - Other factors remain constant. - **Changes in Supply** - Shift in the supply curve occurs when there are changes in other factors, technology, etc - Price of a product remains constant. - Increase in supply (S1 – S3). ### Exceptional Supply: - Against the law of supply. - Where as the price increases, the quantity supplied decreases. - The curve is negatively sloped. #### Instance of Exceptional Supply: - **Supply of Labour** - The supply of labour is known as Backward Bending. - The supply of labour curve does not slope upwards throughout its entire length, but begins to bend back on itself at one point (Backward bending) - **Substitution effect** - The higher the wage rate, people increase their work hours. - **Income effect**- An increase in income will reduce the labour supplied. ### Joint Supply - We have discussed joint demand, now joint supply. - Joint supply where an increase in the supply of a good brings too an increase in the supply of other related goods. - **e.g.** Sheep can be used for meat, wool and sheep skin. Supply of sheep increases, the supply of wool also increases.