Fundamentals of Economics Allocation of Resources: Demand and Supply

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  • Willingness or ability to pay a given price for goods or services
  • Amount demanded at each price – Quantity Demanded
  • Quantity demanded decrease as price rises – law of demand (inverse relation)
Economics: Demand
  • As the price of a good or service falls, more customers are able to pay, so they are more likely to buy the product.
  • As the price of a good or service falls, the customer՚s β€˜real’ income rises (i.e.. with the same amount of income, the customer is able to buy more products at lower prices) .
  • The market demand curve refers to the sum of all individual demand for a product. For instance, a cinema charges $ 10 for its movie tickets and the demand from male customers totals 600 per week while 400 females purchase tickets at that price per week. The market demand for cinema tickets at $ 10 per ticket is therefore 1000 tickets per week.

Determinants of Demand (MISC)

  • Price
  • Income
  • Habit, Fashion – Luxury goods from France popular in China
  • Substitutes – used instead of others (tea or coffee)
  • Complements – demanded jointed (tea and sugar)
  • Advertisement – persuade people
  • Government policies – rules and regulations
  • State of Economy – impacts spending patterns (2013, financial crisis with unemployment of more than 26 % in Greece & Spain – highest in EU)

Demand for specific goods – weather, size of population and buying habits

Contraction and Extension of Demand

Contraction and Expansion of Demand
  • A price rise will cause a decrease (contraction) in the quantity demanded of the product, whereas a reduction in price will cause an increase (expansion) in the quantity demanded,
  • A movement along the demand curve is caused by price changes only. A change in all other (non-price) factors that affect demand, such as income levels, will cause a shift in demand. An increase in demand (rather than an increase in the quantity demanded) is represented by a rightward shift of the demand curve.
  • Increase in demand – other than price – behavioral shift, liking – hike in BMW sales in China
  • Decrease in demand – financial problems and unemployment


  • Willingness or ability to produce at a given price
  • Higher the price of product, higher its supply tends to be
  • Higher the price, firms will supply more
  • Price increases then quantity rises
  • Existing firms can earn higher profits if they supply more.
  • New firms will be able to join the marker if the higher price allows them to cover the production costs
  • Total supply is sum of individual supply

Determinants of Supply

  • Cost of production - If the price of raw materials and the cost of other factors of production fall, then the supply curve will shift to the right. Increase in supply at each level if cost falls
  • Taxes – adds to the cost and reduces supply
  • Subsidies – encourage output by reducing cost
  • Technological progress – automation implies greater output at each price
  • Price & Profitability - if the market price of corn falls while the price of rapeseed increases, then farmers are likely to reduce their supply of corn and raise their supply of rapeseed
  • Time – if less time to increase output, supply would decrease
  • Weather

Contraction and Expansion of Supply

Contraction and Expansion of Supply
  • A price rise will cause an increase (expansion) in the quantity supplied of a product, while a price fall will cause a decrease (contraction) in the quantity supplied Rightward shift in supply curve indicates increase in supply (rather than increase in quantity supplied)
  • Japan՚s tsunami in March 2011, the country՚s worst natural disaster, reduced the supply of major manufacturers such as Sony, Panasonic, Toyota and Honda (World bank estimated cost of disaster at $ 235 billion)

Market Equilibrium or Market Clearing Price

Demand is Equal to Supply

Demand is Equal to Supply
  • There is neither excess quantity demanded, nor excess quantity supplied at the equilibrium price
  • Changes in a non-price factor that affects demand or supply will tend to cause a change in the equilibrium price and therefore quantity traded
  • government sales tax imposed on tobacco will shift the supply curve for cigarettes to the left
  • Favorable weather will shift the curve towards the right
  • If price is set too high (above the market-clearing price) , then supply > demand – surplus production leads to excess supply (as price is higher than market equilibrium)
  • In order for firms to get rid of their excess supply, they will need to reduce price. This is a key reason why leftover stocks of Christmas cards are reduced in price after 25 December and why unsold summer clothes go on sale during the autumn.
  • In contrast, if SP is low – demand > supply – creates shortage in market caused by excess demand (shortage occurs as price is lower than market equilibrium)
  • When Apple launched its iPhone 5 in Hong Kong in late 2012, demand outstripped supply so much that the price of the smartphone increased from H K $ 5588 to almost HK $ 8000 - an increase of 43 %

✍ Manishika