# Supply and Demand: Theory (Part I)

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1 Supply and Demand: Theory (Part I) Ch 3, Economics 9 th Ed, R.A. Arnold Market Ch. 2 discussed about production and trade. After production the producers (sellers) sell the goods to buyers in a market. In Ch. 3 we study the market. Market: A place where buyers and sellers meet to trade (e.g. NSU cafeteria, NSU bookstore, bikroy.com) Buyers demand goods And sellers supply the goods Hence, any market has a demand side and a supply side The first part of the chapter focuses on the demand side of a market 1

2 Demand 1) The willingness and ability of buyers to purchase different quantities of good 2) At different prices 3) During a specific period of time e.g. a buyer may purchase 2 cups of coffee per day when price of coffee is 20tk per cup. But (s)he may consume 3 cups per day when coffee is 15tk per cup. Note: in the above example, different quantities of a good (2 and 3 cups of coffee) are being purchased at different prices (20tk and 15tk) during a specific time period (per day). Law of Demand Four ways to represent the law: 1. In words: As the price (P) of a good rises, the quantity demanded (Q d ) of the good falls, and as the price of a good falls, quantity demanded of the good rises, ceteris paribus 2. In symbols: if, P then Q d and if, P then Q d, ceteris paribus 2

3 3. Demand schedule: The numerical tabulation of the quantity demanded of a good at different prices (numerical representation of the law of DD) 4. Demand curve: The graphical representation of the law of demand. Plotted/drawn using the demand schedule. Why are P and Q d inversely related? We need a theory to explain this Explaining The Inverse Relationship Two theories that explains the inverse relationship: 1) Substitution [assuming: substitutes (alternatives) exist] - people substitute lower priced goods for higher priced goods e.g. if coffee becomes more expensive, we will buy more tea. Hence quantity demanded (Qd) of coffee will fall, assuming ceteris paribus (e.g. Price of tea remains unchanged). 2) Law of diminishing marginal utility - individuals obtain less utility/satisfaction from additional units of a good e.g. First plate of biriyani gives us more satisfaction (utility) than the second plate. Utility from first plate > utility from second plate - hence, we buy larger quantity of goods at lower prices e.g. two plates of biriyani will only be bought if the price of biriyani is low. At a high price we are likely to buy only one plate. Remember: when, benefit > cost we will buy the biriyani. Benefit (utility) from second plate is low. Think of a situation where you were affected by the law of diminishing marginal utility. It affects us everyday. 3

4 Individual Demand Curve AND Market Demand Curve Individual Demand Curve: Price quantity combinations of a particular good for a single buyer Market Demand Curve: Price quantity combinations of a particular good for all buyers The market demand curve can be obtained by adding the individual demand curves. Change In Quantity Demanded VS A Change in Demand Quantity Demanded (Qd) Demand!!! i.e. they are not the same thing Quantity Demanded: The number of units of a good that individuals are willing and able to buy at a particular price. E.g. when price of coffee is 20 tk the quantity demanded of coffee is 2 cups Change in quantity demandedoccurs when there is a change in price (represented by movement along the curve) Whereas, change in demand occurs when a factor* other than price changes the quantity demanded (results in a shift in the demand curve) If, Demand Demand curve shifts right if, Demand shifts left * discussion of the factors start from slide 10 4

5 Factors Affecting Demand 1) Income (Y): The effect of changes in income on demand depends upon the good we are considering. If the good under consideration is a normal good (X) then if income increases, the demand for X (DX) would increase (ceteris paribus). E.g. if our income goes up we might demand more cars in case of an inferior good (Y) e.g. local bus rides if income then D Y (vice versa) if the good is a neutral good e.g. toothpaste then the changes in income has no affect on the demand for that good Think of the goods you consume on a daily basis. How would a change in your income/pocket money affect the demand for these goods? Then you can determine what type of good they are: normal, neutral or inferior. 5

6 2) Preferences: (Affected by information) - Change in preferences in favour of the good increases demand of the good (C. Paribus) - Change in preferences away from the good decreases demand for the good (C. Paribus) e.g. scientists have found out fish oil is good for our brain and hearts. This information may change the preference in favour of fish. Demand for fish will increase (C. Paribus) 3) Prices of related goods (substitutes and complements) If, P(coke) then D(pepsi) (C.P.) coke and pepsi are substitutes If, P(milk) then D(coffee) (C.P.) milk and coffee are complements Substitute goods satisfy similar needs and wants (tea and coffee) Complements are consumed together (pen and paper; milk and coffee) 6

7 4) Number of buyers If, number of buyers then Demand Number of buyers might increase due to a higher birth rate, increased migration, etc 5)Expectations of future prices If, buyers expect the P to in the future, then D (now) If, buyers expect the P to in the future, then D (now) During Ramadan price of food items increase. So buyers are likely to buy food items earlier and store them for consumption during Ramadan. As you may have seen already Much of economics is formalizing (applying) common sense - Anonymous 7

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