DEMAND AND SUPPLY

Dr Alka Chadha
IIM Trichy
Demand
• Quantity of a good or service that buyer will purchase at
every possible price
• Demand Curve shows the amount of a good that
consumers are willing to buy at each possible price during
a given time period, holding other things constant.
• Demand for a good or a service is determined by the
willingness and ability to pay for that good or service at a
given point of time.
Willingness to pay
Utility (Benefit) : total satisfaction received from consuming
a good or service

Utility depends on a consumer’s Tastes & Preferences

Everything else remaining same, if WTP Demand

Marketing strategies are designed to WTP

Ability to pay
Ability to consume depends on:
• Price of the good
• Income
• Price of other related goods

Everything else remaining same:

If Ability Demand
Law of demand
The law of demand states that, ceteris paribus or other
things being equal, the quantity demanded of a good
increases when its price decreases.

Qd= f(P, T, M, P’)

Quantity demanded varies inversely with price.

Demand curve slopes downward.

Substitution effect and income effect.

Demand schedule
Price (Rs/kg) Quantity demanded (thousand kgs)

A 150 8

B 120 14

C 90 20

D 60 26

E 30 32
Quantity Demanded, Demand, Market Demand
• “My demand for apples is five kilograms”
• Five kilograms is the quantity demanded at a certain price
instead of demand. Demand refers to the entire demand
schedule or demand curve for the individual, not any
specific quantity.
• Change in quantity demanded refers to movement along
the demand curve when own price changes, while change
in demand refers to shift of the demand curve when other
factors change.
• Market Demand: sum of individual demands of all
consumers in the market. We will generally refer to market
demand when we talk about demand.
Factors that shift the demand curve
• Changes in consumer income:
Normal good: Demand increases as income increases.
Inferior good: Demand decreases as income increases.
• Changes in the price of related goods:
Substitutes: Goods that can serve as alternatives to a
given good.
Complements: Goods that are used in conjunction with
each other.
• Changes in tastes and preferences
• Changes in consumer expectation
• Changes in the number or composition of consumers
Supply
• Quantity of a good or service that producer will sell at
every possible price
• Supply Curve shows the amount of a good that producers
are willing to offer for sale at each possible price during a
given time period, holding other things constant.
• Supply for a good or a service is determined by the
willingness and ability to offer for sale that good or service
at a given point of time.
Willingness and Ability to sell
• As price rises, producers are willing to offer more for sale.
• As price rises, willingness to sell increases because it
becomes more profitable to produce the given good than
other uses of the resources available.
• As price rises, ability to sell also increases because the
higher price covers the higher marginal cost that results
from producing more output.
Law of supply
The law of supply states that, ceteris paribus or other
things being equal, the quantity supplied of a good
increases when its price increases.

Qs= f(P, T, R, P’)

Quantity supplied varies directly with price.

Supply curve is upward-sloping.

Supply schedule
Price (Rs/kg) Quantity supplied (thousand kgs)

A 150 28

B 120 24

C 90 20

D 60 16

E 30 12
Quantity Supplied, Supply, Market Supply
• Quantity supplied refers to at a particular amount offered
for sale at a particular price as reflected by a point on the
given supply curve.
• Supply refers to the entire supply schedule or supply
curve for the individual, not any specific quantity.
• Change in quantity supplied refers to movement along the
supply curve when own price changes, while change in
supply refers to shift of the supply curve when other
factors change.
• Market Supply: sum of individual supplies of all producers
in the market. We will generally refer to market supply
when we talk about supply.
Factors that shift the supply curve
• Changes in technology
• Changes in the price of resources/inputs
• Changes in the price of alternative goods
• Changes in producer expectation
• Changes in the number of producers
• Changes in government regulations
Market equilibrium
Price Quantity demanded Quantity supplied
(Rs/kg) (thousand kgs) (thousand kgs)

150 8 28

120 14 24

90 20 20

60 26 16

30 32 12
Equilibrium Price and Quantity
At price P*, the quantity demanded is equal to the quantity
supplied.
P S

P*

Q* Q
If price is too high…
This results in excess supply or surplus for the
good equal to 24-14=10 thousand kgs

P
120 S

90

14 20 24 Q
If price is too low…
This results in excess demand or shortage for the
good equal to 12-2=10

P
S

90
60
D

16 20 26 Q
Inverse Demand Function
• Price as a function of quantity demanded.
• Example:
Demand Function
Qx = 50 – 2Px
Inverse Demand Function:
2Px = 50 – Qx
Px = 25 – 0.5Qx
Inverse Supply Function
• Price as a function of quantity supplied.
• Example:
Supply Function
• Qx = 10 + 2Px
Inverse Supply Function:
• Px = -5 + 0.5Qx
Market Equilibrium
• Find the price that clears the market
Qs = Qd
• Steady-state: When the market is in equilibrium, the
quantity demanded is the same as the quantity supplied
for the prevailing market price.
• This price at which demand is equal to supply is called
market clearing price.
Comparative Static Analysis
• Comparative static analysis examines how a change in an
exogenous variable will affect the level of an endogenous
variable in the model.
• Use this graphical tool to show how the equilibrium price
and quantity will change when a determinant of supply or
demand changes.
Demand Shift
• There is an increase in the price of pears due to an attack
by locusts.
• What would happen to the apple market?
♦Demand increases
• What happens to the equilibrium price and quantity?
Increase in Demand
Equilibrium is at a higher price and higher quantity.

P S

P2 E2

P1 E1
E D’
D

Q1 Q2 Q
Supply Shift
• The benign weather brought a bumper crop.
• What would happen to the market?
♦ Supply increases
• What happens to the equilibrium price and quantity?
Increase in Supply
Equilibrium is at a lower price and higher quantity.

P S

S’
P1 E E1
P2 E2

Q1 Q2 Q
Simultaneous Shifts in Demand and Supply
• Managers may encounter events that lead to
simultaneous shifts in both demand and supply.
• A tragic example:
♦In late 1990s, an earthquake hit Kobe, Japan.
♦The earthquake damaged Japan’s sake wine industry.
♦People drank to relieve the stress caused by the
earthquake.
• What happened to the market?
Demand Increase and Supply Decrease
Equilibrium is at a higher price but effect on quantity is uncertain.

P S’

S
P2

P1

D D’

Q1 Q