Demand and Supply

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Movements, Shifts, and their Determinants

Table of contents

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What is Demand and Supply?

Movements along the Demand Curve

Movements along the Supply Curve

Shifts in Demand and its Non-Price Determinants

Shifts in Supply and its Non-Price Determinants

Market Equilibrium and the Price Mechanism

What is Demand and Supply?

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Definitions

Supply

Quantity of goods and/or services that firms are willing and able to produce at various price points during a specific time period, ceteris paribus (everything else being equal).

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The Law of Supply states that as the price of a good or service increases, the quantity supplied* for that good or service increases, ceteris paribus.

Quantity of goods and/or services that consumers are willing and able to purchase at various price points during a specific time period, ceteris paribus (everything else being equal).

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The Law of Demand states that as the price of a good or service decreases, the quantity demanded* for that good or service increases, ceteris paribus.

Demand

*It is important to distinguish between quantity demanded/supplied and demand/supply as increases/decreases in quantity demanded/supplied refer to movements along the curves, while increases/decreases in demand/supply refer to shifts in the curves.

Demand and Supply Curves

Important: Components of the Graphs

• Diagram Label (at the top)
• Quantity (Q) (x-axis)
• Price (P) (y-axis)
• Curves and their Respective Labels (Beside the curves)

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Demand Curve: Downward sloping due to the Law of Demand

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Supply Curve: Upward sloping due to the Law of Supply

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Equilibrium (point A) at Price P₁ and Quantity Q₁

Movements along the Demand Curve

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Movements along the Demand Curve

• Caused by a change in prices
• Simple increase/decrease in quantity demanded

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Example (shown on the right)

• If a decrease in the price of T-shirts occur (P₁ → P₂) then the quantity of T-shirts demanded increases (Q₁ → Q₂), ceteris paribus.
• This is due to the Law of Demand. As prices fall, consumers are more willing and able to purchase T-shirts at a lower price.
• Lower prices are more enticing to consumers as they are utility maximizers, hence they tend to spend more if prices are lower.
• We say that there is a movement from point A to B.

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Why is it important to mention “ceteris paribus”?

→ It helps isolate a variable, ensuring that a change in a dependent variable (in this case, quantity demanded) only changes due to a change in an independent variable (in this case, price)

Movements along the Supply Curve

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Movements along the Supply Curve

• Similar to demand, this is caused by a change in prices
• Simple increase/decrease in quantity supplied

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Example (shown on the right)

• If an increase in the price of Coconuts occur (P₁ → P₂) then the quantity of Coconuts supplied increases (Q₁ → Q₂), ceteris paribus.
• This is due to the Law of Supply. As prices rise, firms are more willing and able to produce Coconuts at a higher price.
• A higher price means greater funding for firms. Not to mention, it is more enticing for firms, as profit seekers, to produce more at a higher price.
• We say that there is a movement from A to B.

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Shifts in the Demand Curve and its Non-Price Determinants

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Some Examples of Shifts in Demand

• An increase in the demand of gasoline due to an expected rise in prices

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• A decrease in the demand for car wheels due to a decrease in the demand for cars

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• An increase in the demand for avocados due to social media influence

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• A decrease in the demand for mooncakes after the Mid-Autumn festival

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Notice the use of the word “Demand” instead of “Quantity Demanded” to indicate that a shift in the demand curve has occurred, rather than a movement.

What do shifts look like?

• When shifts in the demand curve occur, the entire demand curve moves leftwards or rightwards, from D₁ to D₂

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Increases in Demand (Rightward Shifts)

• When there is an increase in demand (not quantity demanded), the demand curve shifts rightwards (see Figure 1).
• Notice how when a rightward shift occurs, the price P₁ is able to purchase a greater quantity of goods (Q₁ → Q₂)

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Decreases in Demand (Leftward Shifts)

• Likewise, when there is an decrease in demand, the demand curve shifts leftwards (see Figure 2).
• The price P₁ in Figure 2 is able to purchase a lesser quantity of goods (Q₁ → Q₂) when a leftward shift occurs

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Figure 1: Rightward Shift

Figure 2: Leftward Shift

Non-Price Determinants

Factors which affect demand other than the price of the good itself

Changes in Income

When the demand of a good or service changes due to a change in income

Depending on how they change with regards to income, goods can be classified as:

• Normal (when demand increases as income increases, or decreases when income decreases) or
• Inferior (when demand decreases as income increases, or increases when income decreases), ceteris paribus..

Phones, for example, are considered normal goods as people tend to purchase more of them as their income increases, ceteris paribus.

Taxi services, on the other hand, are considered inferior goods as people tend to avail less of them as their income increases, ceteris paribus.

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Changes in the Price of Related Goods

When the demand of a good or service changes due to a change in the price of another good

Depending on how they change with regards to another good, a group of goods can be classified as:

• Substitutes: When one good can be substituted for another
• If the price of a good increases and its quantity demanded decreases (movement), the demand for a substitute good may increase (shift) as people purchase the cheaper good instead, ceteris paribus. The converse is also true.
• Example: If the price of Coca-Cola increases and its quantity demanded decreases, the demand for Pepsi may increase as well, ceteris paribus.
• Complementary: When one good and another good can be bought/consumed together
• When the price of a good increases and its quantity demanded decreases, the demand for a complementary good may decrease as well, ceteris paribus.
• Example: If the price of iPad Pros decrease and its quantity demanded increases, the demand for Apple Pencils may increase as well, ceteris paribus.
• Unrelated: When two or more goods don’t have any relation to each other

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Diagrams for Prices of Related Goods

Case 1: Substitute Goods

Diagrams for Prices of Related Goods

Case 2: Complementary Goods

Changes in Tastes and Preferences

When the demand or popularity for a good or service changes due to changes in people’s preferences brought about by things such as social media, advertisement campaigns, events, fashion, etc., ceteris paribus.

Masks, for example, experienced a change in their demand during the COVID-19 pandemic as they were required to be worn everywhere.

Another example would be the demand for rainbow foods which decreased over time as people’s tastes changed.

Future Expectations

When the demand for a good or service increases or decreases due to expectations by consumers.

Expectations about Future Prices:

• The demand for a good or service may change depending on the expectations consumers have on its price. As utility maximizers, consumers will tend to spend more now if they expect prices to increase in the future. Conversely, they will tend to spend less if they expect it to decrease in the future.
• Example: During the pandemic, people expected the prices of toilet papers and water to increase. Hence, many tended to hoard these items.

Expectations about the Economy:

• Demand for goods may also change depending on consumer confidence. If, for example, the economy undergoes a recession, consumers will tend to spend less in order to hold on to their money.
• Example: During the pandemic, many people lost their jobs due to many businesses closing down. As a result, demand for many goods, besides essential ones, decreased as people tended to buy less of them.

Changes in the Number of Consumers

When the demand for a good or service changes due to a change in the number of consumers participating.

Demographic Changes

• Changes that occur due to a change in the size, structure, or distribution of certain groups within a population
• Example: As more children are born in countries such as India and the Philippines, the demand for toys and other childcare products increases, ceteris paribus.

Government Policies

• The government may choose to enact policies in order to artificially decrease or increase the demand for a particular good, ceteris paribus.
• Example: In the Philippines, there is an excise tax on cigarettes in order to discourage their consumption.

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Seasonal Changes

When the demand for a good or service changes due to the time of the year, ceteris paribus.

Hot chocolate, for example, tends to become more popular during the winter months as the weather gets colder.

Another example would be school supplies, whose demand increases significantly when schools are about to start classes again, hence the “Back to School” sales.

Exercise

Refer back to slide 11 and identify the non-price determinants affecting the demand.

Exercise Answers

• An increase in the demand of gasoline due to an expected rise in prices
• This is an example of future expectations affecting the demand for gasoline. Since consumers expect prices to rise, they tend to consume more while the prices are lower.

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• A decrease in the demand for car wheels due to an increase in the price of cars
• Car wheels and cars are complementary goods as they are to be consumed together. Hence, this is an example of how changes in the price of related goods affects the demand of a particular good.

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• An increase in the demand for avocados due to social media influence
• This is an example of a change in tastes and preferences influenced by social media.

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• A decrease in the demand for mooncakes after the Mid-Autumn festival
• This is an example of seasonal changes. After the Mid-Autumn festival, mooncakes won’t be as relevant.

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Shifts in the Supply Curve and its Non-Price Determinants

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Some Examples of Shifts in Supply

• An increase in the supply of car parts due to new, more efficient machinery.

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• An increase in the supply of books due to government subsidies promoting education.

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• A decrease in the supply of paper due to numerous paper companies closing during the pandemic

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• A decrease in the price of noodles causing a decrease in the supply of bread

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Similar to earlier, notice the use of the word “Supply” instead of “Quantity Supplied” to indicate that a shift in the supply curve has occurred, rather than a movement.

What do shifts look like?

• Similar to shifts in demand curves, shifts in the supply curve involve the entire curve moving leftward or rightward, from S₁ to S₂

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Increases in Supply (Rightward Shifts)

• When there is an increase in supply (not quantity supplied), the supply curve shifts rightwards (see Figure 1).
• Notice how when a rightward shift occurs, the a greater amount of goods (Q₁ → Q₂) could be supplied at price P₁

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Decreases in Demand (Leftward Shifts)

• Likewise, when there is an decrease in demand, the supply curve shifts leftwards (see Figure 2).
• If this occurs, firms aren’t able to supply as much at the price P₁, hence they are only able to supply at quantity Q₂ instead of the usual Q₁

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Figure 1: Rightward Shift

Figure 2: Leftward Shift

Non-Price Determinants (Of Supply)

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Changes in the Costs of Production

These refer to the changes in the costs for Factors of Production, which are Land, Labour, Capital, and Entrepreneurship.

Costs of Land: This refers to the ability for land to be able to output at an optimum level. For example, if the land becomes unfit to grow crops, it’ll become more expensive to source ingredients such as wheat for bread, decreasing the supply of products which depend on these ingredients, ceteris paribus.

Costs of Labour: Labour costs money as workers demand pay for their efforts. If, for example, there is an increase in minimum wage or workers unionize to demand higher wages, then the cost of production will increase, decreasing supply, ceteris paribus.

Costs of Capital: This can refer to maintenance costs. As time passes, machines used for the production of goods eventually wear down. Sooner or later, the costs of running a machine will outweigh the revenue it produces, hence a decrease shift in supply will occur as firms spend money to maintain it, ceteris paribus.

Costs of Entrepreneurship: This involves costs of running a business in general. If it becomes less costly to run or create a business, then the cost for this factor of production would decrease, increasing the supply, ceteris paribus.

Changes in Technology

Similar to how changes in the costs of production (specifically Capital) affect supply, changes in technology can make it more efficient and economical for firms to produce a certain good. In other words, it may help increase productivity, thus increasing supply, ceteris paribus.

A good example of this would be the nobel prize-winning Haber-Bosch process which greatly helped in the production of ammonia through the use nitrogen and hydrogen with an iron catalyst, thus increasing the supply of ammonia.

Future Expectations

Similar to demand, the supply for a good or service increases or decreases due to expectations by firms.

Expectations about Future Prices:

• Firms are profit-maximizers, meaning they prefer to make maximum profit for minimum effort. With this in mind, firms may choose to withhold or to push out supply depending on what their expectations are for prices. If they expect prices to increase in the near future, they may choose to withhold (decrease) supply so that they may be able to sell it at a higher price on a later date. Conversely, if they expect prices to drop, they may choose to push out (increase) supply to avoid losing revenue later on.

Expectations about the Economy:

• Just like how demand has consumer confidence, supply has business confidence. If firms are confident that the economy will grow, then they will anticipate a future increase in demand. Hence, they will increase supply to meet this possible future increase in demand. Likewise, if they aren’t confident in the economy, they will do the opposite, decreasing supply to meet the possible decrease in demand.

Changes in the Number of Firms

Simply put, more firms means more supply and less firms means less supply, ceteris paribus.

For example, if the number of pizzerias increase, then the supply for pizza would increase as well, ceteris paribus.

Changes in the Prices of Related Goods

When certain goods and services are related to each other, changes in the price of one may lead to a change in the supply of another. However, it is important to identify the relationship between these two products.

Joint Supply: A “joint supply” occurs when two or more goods can be produced from the same product such that it is impossible to produce more of one good without increasing the supply of the other, also called a by-product.

• An example of joint supply would be sheep’s wool and sheep’s milk. If, for example, prices rise for sheep’s wool which increase the quantity supplied of wool, there would, consequently, be an increase in the supply of sheep’s milk as well, ceteris paribus, as farmers would need to have more sheep anyway to meet the demands for wool. These sheep could then be used to supply milk as well.

Competitive Supply: A “competitive supply” occurs when two goods are made from similar resources and similar processes. What differentiates this from joint supply is that producing more of one good means producing less of the other good, ceteris paribus, as firms allocate more resources to producing the more profitable, higher priced good.

• If, for example, the prices for neodymium magnet spheres were to increase, consequently increasing their supply, firms will choose to prioritize the production of these spheres rather than magnet cubes.

Diagrams for Prices of Related Goods

Case 1: Joint Supply

Diagrams for Prices of Related Goods

Case 2: Competitive Supply

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Changes Made by Government Intervention

In order to change supply, the government may choose to enact various policies such as:

Indirect Taxes: The government may choose to apply an indirect tax, or an additional fee to be paid to the government, for the production of a particular good. This causes a leftward shift in the supply curve as it becomes more expensive for firms to supply goods and services, hence lowering the supply.

Subsidies: The government may also choose to promote the production of a particular good through the use of subsidies. These subsidies help boost firm’s production of goods or services, assuming they use it to further enhance their productivity. Hence, this causes a rightward shift in the supply curve.

Other Forms of Regulation: Lastly, the government may choose to pass laws to directly affect the supply of a particular good or service depending on what they want to achieve.

Diagrams for Government Intervention

Case 1: Indirect Tax

Diagrams for Government Intervention

Case 1: Subsidy

Exercise (again)

Refer back to slide 25 and identify the non-price determinants affecting the demand.

Exercise Answers

• An increase in the supply of car parts due to new, more efficient machinery.
• This is an example of technological changes increasing the supply of car parts.

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• An increase in the supply of books due to government subsidies promoting education.
• This is an example of government intervention in the form of subsidies increasing the supply of books.

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• A decrease in the supply of paper due to numerous paper companies closing during the pandemic
• This shows how the number of firms in a market affects the supply of a good, which is paper in this case. Less firms mean less supply.

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• A decrease in the price of noodles causing an increase in the supply of bread
• This is an example of how the prices of related goods affect the supply of another good. In this case, we see it’s a kind of competitive supply. Both noodles and bread are made from flour which comes from wheat. Hence, if the price of noodles decreases, its quantity supplied decreases, meaning that the supply of bread will increase, ceteris paribus.

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Market Equilibrium and the Price Mechanism

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Market Equilibrium

The point of intersection between the supply and demand curves, where quantity demanded is equal to quantity supplied.

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Q₁ is referred to as the equilibrium quantity and P₁ is referred to as the equilibrium price.

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We say that the market is at equilibrium at point A.

Disequilibrium

Refers to when the market isn’t at an equilibrium point.

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Excess Demand (Shortage):

• A shortage occurs when there is excess demand. At this point, firms are unable and unwilling to supply enough goods at a given price point to meet with the demands of consumers.
• (Refer to Figure 1) We say that there is a shortage at P₂ since quantity supplied Q_s is less than quantity demanded Q_d.

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Excess Supply (Surplus):

• A surplus, on the other hand, occurs when there is excess supply. At this point, most consumers are unable and unwilling to consume a good or service at a given price point causing an excess in supply.
• (Refer to Figure 2) We say that there is a surplus at P₃ since Q_s > Q_d.

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Figure 1: Shortage

Figure 2: Surplus

How is disequilibrium combated? (Demand)

Consider Figure 1, where a shift in demand occurs causing a disequilibrium at the old equilibrium price P₁ since the quantity demanded at P₁ is greater than quantity supplied.

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Now look at Figure 2. To combat the disequilibrium caused by the shift in demand from D₁ to D₂, the price increases from P₁ to P₂, increasing the quantity supplied and decreasing the quantity demanded to meet at a new equilibrium point B.

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Figure 1: Shortage

Figure 2: Equilibrium

How is disequilibrium combated? (Demand)

If the opposite were to occur, where demand shifts leftwards, a surplus would be created initially. The old equilibrium price P₁ causes an excess in supply as less consumers are willing to purchase goods at price P₁.

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Hence, the market will decrease prices to P₂ to decrease supply and increase demand sufficiently to meet at a new equilibrium point.

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How is disequilibrium combated? (Supply)

Supply, on the other hand, works very similarly to demand.

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Consider Figure 1, where a rightward shift in the supply curve from S₁ to S₂ occurs, creating a surplus at P₁.

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Similar to how disequilibrium is combated in demand, prices will decrease to entice more consumers to consume the good and to decrease the quantity supplied to meet at a new equilibrium point B.

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Figure 1: Surplus

Figure 2: Equilibrium

How is disequilibrium combated? (Supply)

If a leftward shift in the supply curve occurs (again from S₁ to S₂), there would be a temporary shortage as the old price P₁ would produce a greater quantity demanded than quantity supplied.

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To counter this, prices will increase from P₁ to P₂ to help supply and demand equalize to a new equilibrium point B.

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Price Mechanism

What we discussed gave insight to the concept of Price Mechanism.

Price mechanism creates a negative feedback loop whenever a market reaches a state of disequilibrium such as when demand and/or supply curves shift rightwards or leftwards, creating surpluses and/or shortages along the way. Price mechanism (shown on the right) helps bring the market back to equilibrium, assuming no government intervention is made.

Price mechanism may act as a signal to consumers and producers on what to consume and produce. Rising prices signal consumers to consume less whilst falling prices signal consumers to consume more. Similarly, rising prices signal firms to produce more whilst falling prices signal firms to produce less.

Price mechanism may also act as a form of incentive. If consumers and firms would like to maximize utility or maximize profits, they must follow the signals of the price mechanism.

Lastly, the price mechanism can function as a rationing function. When a shortage occurs, prices rise, making some products inaccessible to some people. This helps ration goods, deciding who gets what in an economy.

Thanks!

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