|
|

|
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2 


2 In formulating demand theory, the agents are

all assumed to be adult individuals who earn
income,
2 and
2 They spend this income purchasing various
goods and services.
2 In economics, it is generally assumed that
each individual consumer seeks maximum
!
! 
, or 

.

2 The consumer µmaximizes utility¶ within the

limits set by his or her available resources.
Ô 
2  The amount of a
product that consumers wish to purchase.

2    ?ctual

purchase of a commodity.
2 £uantity demanded is a @ !
@ Ñuantity.

2 £uantity demanded is a .

!"#

2 ? 
  has a time dimension: it is so
much per unit of time.

2 ? !

  has no time dimension: it is
just so much.
Ô $
 
2 The Ñuantity of each product demanded by
each individual consumer is influenced by
five main variables:

 1. The price of the product

 2. The prices of other products
 3. The consumer¶s income and wealth
 4. The consumer¶s tastes
 5. Various individual-specific or
environmental factors
2 This can be conveniently summarized in a
:

2 Ñdn = D (pn, p1, «.,pn-1,Y,S)

2 The term Ñdn stands for the Ñuantity that the
consumer demands of some product, which
we call product n.
2 The term pn stands for the price of this
product.
2 p1, «.,pn-1 is a short hand notation for the
prices of all other products.
2 Y denotes consumer¶s income.
2 The term S stands for a host of factors that
vary from individual to individual , such as

 age,
 number of children,

 place of residence,

and
 other assets.
2 There are also some environmental factors
affecting demand patterns, such as

2 The state of weather and

2 The time of the year.
|
2 ? basic economic hypothesis is that the lower
the price of a product, the larger the Ñuantity
that will be demanded, other things being
eÑual.

2 This negative relationship between the price

of a product and the Ñuantity demanded is
sometimes referred to as the #
.
2 This law might be true.

2 ? major reason for this is that there is usually

more than one product that will satisfy any
given desire or need.

2 It can be determined what happens when

income, tastes, population, and the prices of
all other products are held constant and the
price of only one product is varied.
2 èirst, let the price of the product rise.

2 The product then becomes a more expensive

way of satisfying a want.

2 Some consumers will stop buying it

altogether.
2 *thers will buy smaller amounts.

2 Still others may continue to buy the same

amount.

2 But no rational consumer will buy more of it.

2 ?s many consumers will switch wholly, or
partially, to other products to satisfy the same
want, less will be bought of the product
whose price has risen.

2 Second, let the price of the product fall.

2 This makes the product a cheaper method of

satisfying any given want.
2 uonsumers will buy more of it and less of
other similar products whose prices have not
fallen.

2 These other products have become

expensive relative to the product in Ñuestion.
Ô   

2 %

2 ?   is one way of showing

the relationship between Ñuantity demanded
and price.

2 It is a numerical tabulation that shows the

Ñuantity that will be demanded at some
selected prices.
2 The data from the demand schedule of an
individual consumer can be plotted with price
on the vertical axis and Ñuantity on the
horizontal axis.

2 The smooth curve drawn through these

points is called the demand curve.
2 It shows the Ñuantity that a consumer would
like to buy at every possible price.

2 Its negative slope indicates that the Ñuantity

demanded increases as the price falls.

2 ?! 

 @
@
@
!
! 
  



!
2 Ô  @
@
!!
 




!
  


@
@ @ @
 .

2 Economists often speak of the conditions of

demand in a particular market as µgiven¶ or as
µknown¶.
2 Xhen they do so they are referring not just to
the particular Ñuantity that is being demanded
at the moment but to the whole demand
curve.

2 The whole demand curve remains in one

place so long as all variables other than the
price of the product itself remain unchanged.
Ô !
2 To explain market behaviour, the total
demand of all consumers has to be known.

2 To obtain a market demand schedule, the

Ñuantities demanded by each consumer at a
particular price are summed to obtain the
total Ñuantity demanded at that price.
2 The process is repeated for each price to
obtain a schedule of total, or market, demand
at all possible prices.

2 ? graph of this schedule is called the



@
@
.
2 The market demand curve is thus the
horizontal sum of the demand curves of 
the individuals who buy in the market.

2 In practice, knowledge of market demand is

usually derived by observing total Ñuantities
of sales directly.
2 The derivation of market demand curves by
summing individual curves is a theoretical
operation.

2 It is done to understand the relation between

curves for individual consumers and market
curves.
2 The total Ñuantity demanded depends on the

 price of the product being sold,

 the prices of all other products,
 the incomes of the individuals buying in that
market,
and
 on their tastes.
2 The market demand curve relates the total
Ñuantity demanded to the product¶s own
price, on the assumption that
2 all other prices,
2 total income,
and
2 all other environmental factors
are held constant.
  
2 The demand schedule and the demand curve
are constructed on the assumption of 

!

! (other things held constant).

2  # 

  & 
' # # 
 &##.
2 ?ny change that increases the Ñuantity of a
product that consumers wish to buy at each
price will shift the demand curve to the right.

2 ?ny change that decreases the Ñuantity that

consumers wish to buy at each price will shift
the demand curve to the left.
 &  
2 The demand curves have negative slopes
because the lower a product¶s price, the
cheaper it becomes relative to other products
that can satisfy the same needs.

2 Those other products are called '.

2 ? product becomes cheaper relative to its
substitutes if its own price falls.

2 This also happens if the substitutes¶ price

rises.

2 ? rise in the price of a product¶s substitute

shifts the demand curve for the product to the
right.

2 More will be purchased at each price.

2 ÷roducts that tend to be used jointly with
each other are called  .

2 èor example:
2 uars and petrol
2 Electric cookers and electricity etc.
2 uomplements tend to be consumed together.

2 Hence, a fall in the price of either will

increase the demand for both.

2 ? fall in the price of one product that is

complementary to a second product will shift
the second product¶s demand curve to the
right.

2 More will be purchased at each price.

 &
2 If consumers receive more income, they can
be expected to purchase more of most
products even though product prices remain
the same.

2 ? product whose demand increases when

income increases is called a &.
2 ? rise in consumers¶ incomes shifts the
demand curves for normal products to the
right.

2 This indicates that more will be demanded at

each possible price.
2 èor a few products, called &, a
rise in consumers¶ income leads them to
reduce their purchases.

2 This is because, they can switch to a more

expensive, but superior, substitute.
2 ? rise in income will shift the demand for
inferior goods to the left.

2 This indicates that less will be demanded at

each price.
Ô '
2 Suppose total income and all other
determinants of demand are held constant
while the distribution of income changes.

2 Then the demand for normal goods

 will rise for consumers gaining income
and
 fall for consumers losing income.
2 If both gainers and losers buy a good in
similar proportions, these changes will tend to
cancel out.

2 However, this will not always be the case.

2 Xhen the distribution of income changes,
demands will rise for those goods favoured
by those gaining income

and

2 fall for those goods favoured by those losing

income.
 

2 uhanges in the characteristics of the

individuals who make up the market will
cause demand curves to shift.
 
2 Demand for some products is different at
different times of the year.

2 Some of this is due to weather.

2 *ther variations may be due to traditions

associated with annual festivals.
2 èrom the point of view of theory of demand,
these are exogenous forces.

2 In other words, these are things that lie

outside the theory, affecting demand,
sometimes greatly, but not themselves being
explained by the theory.
 &
2 If there is a change in tastes in favour of a
product, more will be demanded at each
price.

2 This will cause the demand curve to shift to

the right.
2 In contrast, if there is a change in tastes
away from a product, less will be demanded
at each price.

2 This will cause the entire demand curve to

shift to the left.
÷rice
D
D2 D0 1

£uantity

("Ô|
| )

2 ? shift in the demand curve from D0 to D1
indicates an increase in demand.

2 ? shift from D0 to D2 indicates a decrease in

demand.

&
 
2 Shifts of curves are different from movements
along curves.

2 | refers to one  demand curve.

2 & refers to a !
in the

whole curve, that is, a change in the amount
that will be bought at
price.
2   
#    
& *

2   
#    
*
2 ?ny one point on a demand curve represents
a specific amount being bought at a specified
price.

2 It represents, therefore, a particular Ñuantity

demanded.

2 ? movement along a demand curve is

referred to as a  & $
.
2 #
+, 
$*

2   
+, $
*
 

2 The suppliers in a market are the .

2 The firms are in business to make the goods

and services that consumers want to buy.
"%
2 ?ccording to economic theory, firms have
several attributes.

2 è
!t, each firm is assumed to make
consistent decisions.

2 › @, firms hire workers and invest capital

and entrepreneurial talent to produce goods
and services that consumers wish to buy.
2 Ô
@, firms are assumed to make their
decisions with a single goal in mind: to make
as much profit as possible.

2 In other words, they are driven by the goal of

ë
 

.
Ô  
2 The amount of a product that firms are able
and willing to offer for sale is called the
$ .

2 Supply is a desired flow: how much firms are

 to sell per period of time, not how
much they actually sell.
Ô $
   
2 Three major determinants of the Ñuantity
supplied in a particular market are:

 1. The price of the product

 2. The prices of inputs to production
 3. The state of technology
2 This list can be summarized in a  


2 Ñsn = S (pn, è1,«.,èm),

2 where Ñsn is the Ñuantity supplied of product
n;
2 pn is the price of that product;
2 è1,«.,èm represent prices of all inputs into
production;
2 and the state of technology determines the
form of the function S.
  
2 It has to be known how Ñuantity supplied
varies with a product¶s own price, all other
things being held constant.

2 The focus is therefore, only on the ceteris

paribus relation,
2 Ñsn = S (pn)
2 u

!
!, the Ñuantity of any product
that firms will produce and offer for sale is
positively related to the product¶s own price,
rising when price rises and falling when price
falls.

2 The basic reason behind this relationship is

the way in which costs behave as output
changes.
2 The cost of increasing output by another one
unit tends to be higher the higher is the
existing rate of output.

2 The firm will not find it profitable to increase

output if it cannot at least cover the additional
costs that are incurred.
2 ?s the price of the product rises, the firm can
cover the rising costs of more and more
additional units of output.

2 ?s a result, higher and higher prices are

needed to induce firms to make successive
increases in output.
2 The result is a positive association between
market price and the firm¶s output.

2 The ! ëë!
  records the Ñuantity all

producers wish to produce and sell at a
number of alternative prices, rather than the
Ñuantities consumers wish to buy.
2 The ! ëë
 relates the Ñuantity of a
commodity supplied to the price of the
commodity.

2 In other words, it shows the Ñuantity

produced and offered for sale at each price.

2 Its positive slope indicates that Ñuantity

supplied increases as price increases.
÷rice
S

*
£uantity
 
   
2 ? shift in the supply curve means that, at
each price, a different Ñuantity is supplied.

2 If there is an increase in Ñuantity supplied,

there is a rightward shift in the supply curve.

2 ? decrease in the Ñuantity supplied at each

price causes a leftward shift.
2 X   & 
'+    %#
,   
 #& 
 #    
# *
2 The major possible causes of such shift are
as follows:

2  
2 ?ll things that a firm uses to produce its
outputs are called the firm¶s inputs.
2 *ther things being eÑual, the higher the price
of any input used to make a product, the less
will be the profit from making that product.
2 Thus, the higher the price of any input used
by a firm, the lower will be the amount that
the firm will produce and offer for sale at any
given price of the product.

2 ? rise in the price of any input shifts the

supply curve to the left.

2 This indicates that less will be supplied at any

given price.
2 ? fall in the price of inputs shifts the supply
curve to the right.
2 Ô &

2 ?t any time, what is produced and how it is

produced depend on the technologies in use.

2 *ver time, knowledge and production

technologies change.

2 The Ñuantities of individual products that can

be supplied also change.
2 ? technological change that decreases costs will
increase the profits earned at any given price of
the product.

2 Increased profitability leads to increased

production.

2 This change shifts the supply curve to the right,

indicating an increased willingness to produce the
product and offer it for sale at each possible price.

& 
 
2   refers to a particular
Ñuantity actually supplied at a particular price
of the product.

2   refers to the whole relation between

price and Ñuantity supplied.
2 Thus, 

!

!
! ëë
refers to shifts in the supply curve.

2 u

 
! ëë means a
movement from one point on the supply
curve to another point on the same curve.
Ô |
2 Ô  !

2 ? market may be defined as an area over

which buyers and sellers negotiate the
exchange of some product or related group of
products.

2 Therefore, it must be possible for buyers and

sellers to communicate with each other and
to make meaningful deals over the whole
market.
Ô & 
!
2 Both the demand and supply curves can be
shown on a single graph.

2 Let us consider the following diagram.

| $'


S
÷rice D

* £uantity
2 The eÑuilibrium price corresponds to the
intersection of the demand and supply
curves.

2 ÷oint E indicates the eÑuilibrium.

2 ?t prices above eÑuilibrium there is excess
supply and downward pressure on price.

2 ?t prices below eÑuilibrium there is excess

demand and upward pressure on price.

2 The pressures on price are represented by

the vertical arrows.
2 The amount by which the Ñuantity demanded
exceeds the Ñuantity supplied is called the
-.

2 It is defined as Ñuantity demanded
!

Ñuantity supplied (Ñd ± Ñs).
2 Xhen Ñuantity supplied exceeds the Ñuantity
demanded, there is negative excess demand
(Ñd ± Ñs)<0.

2 Negative excess demand is usually referred

to as - .

2 It measures the amount by which supply

exceeds demand (Ñs ± Ñd).
 & # $
$$
 
2 Xhenever there is excess demand,
consumers are unable to buy all they wish to
buy.

2 Xhenever there is excess supply, firms are

unable to sell all they wish to sell.

2 In both cases, some agents will not be able to

do what they would like to do.
2 There is a key driving force in markets which
may be referred to as the # 
..

2 This law predicts what will happen to the

market price when there is either excess
demand or excess supply.
2 X  - !
#*

2 X -  !

#*
2 If there is excess supply, it means that
producers cannot sell all that they wish to sell
at the current price.

2 They may then begin to offer to sell at lower

prices, for example, through clearance sales
or discounts.
2 If purchasers observe the glut of unsold
output they may begin to offer lower prices.

2 èor either or both of these reasons, the price

in the market will fall.
2 If, at the current price, consumers are unable
to buy as much as they would like to buy,
they may offer higher prices in an effort to get
more of the available supply for themselves.

2 Suppliers are unable to produce a greater

Ñuantity of the product in the short run.

2 But they can ask higher prices for the

Ñuantities that they are producing.
2 They will make more profit if they do so.

2 èor either or both of these reasons, prices will

rise.
2 This law of price adjustment makes
considerable sense and conforms with the
common experiences of how markets work.

2 Shortages of any product tend to lead to price

rises
while
2 gluts tend to lead to price falls.
2 This means that the market will exhibit
!

.

2 Xhenever the current price is not the one

that eÑuates demand and supply, the law of
price adjustment ensures that the price will
move towards the market-clearing price
rather than away from it.
2 Thus, it is not enough that there exists a price
for which demand is eÑual to supply.

2 Stability of the market also reÑuires some

mechanism to return the price to the market-
clearing level whenever it is away from that
point.
2 The combination of a negatively sloped
demand curve and a positively sloped supply
curve with the law of price adjustment will
guarantee a stable market, so long as any
market in this product exists.
Ô $' 
2 *nce supply and demand are eÑual, there is
no tendency for the price to change because
suppliers are just able to sell all that they
want
2 ?nd demanders are just able to buy all that
they want.

2 Nobody has any incentive to change the

price.
2 The price where the supply and demand
curves intersect, is the price towards which
the actual market price will tend.

2 It is called the $' : the price at

which Ñuantity demanded eÑuals Ñuantity
supplied.
2 The amount that is bought and sold at the
eÑuilibrium price is called the $'
$.

2 The term µeÑuilibrium¶ means a state of

balance.

2 It occurs when desired purchases eÑual

desired sales and
2 there are no forces tending to make anything
change.
2 Xhen Ñuantity demanded eÑuals Ñuantity
supplied, we say that the market is in
$'.

2 Xhen Ñuantity demanded does not eÑual

Ñuantity supplied, we say that the market is in
$'.
Ô  
 
2 ? Ñuestion arises how a shift in either
demand or supply curve affects price and
Ñuantity.

2 The answers to this Ñuestion constitute the

predictions of supply and demand theory.
2 The purpose is to see what happens when an
initial position of eÑuilibrium is upset by some
shift in either the demand or supply curve,
and a new eÑuilibrium position is then
established.
2 To discover the effects of the demand and
supply shifts, the method that is used, is
known as  .

2 ?fter starting from a position of eÑuilibrium,

the change to be studied is introduced.

2 The new eÑuilibrium position is determined

and compared with the original one.
2 The differences between the two positions of
eÑuilibrium must result from the change that
was introduced, for everything else has been
held constant.
2 The predictions of supply and demand theory
are:

2 1.   +

& #  ,
'  
$'  $'
$'& *
2 D*  +#
  ,
'  $'  $'
$'& *

2 /*   +& #

   ,
 $'  
$'$'& *
2 r*   +
#   ,
 $' 
 $'$
'& *


2 1. Lipsey & uhrystal. Y
!, *xford

University ÷ress.

2 2. Dominick Salvatore. p  
 
Y
!  Y
McGraw-
Hill, Inc.