Copperbelt University

Directorate of Distance Education and Open Learning

Master in Business Administration (Finance)

Assignment 2

By

Ignatius Kasela Zulu

Lecturer: Dr. Nicholas Odongo

16th November 2020

What is Demand?

Demand refers to the willingness and ability of consumers to purchase a given quantity of a

Note that in this definition consumers are prepared to buy a good or service both because they
are willing (i.e., they have a preference for it) and they are able (i.e., they have the income to
support this preference).

Holding all other factors constant, an increase in the price of a good or service will decrease the
quantity demanded, and vice versa. This inverse relationship between price and the quantity
demanded is called the law of demand. There may be instances in which consumers behave in
an “irrational” manner by buying more as the price rises and less as the price falls because they
associate price with quality. But in the economic analysis of demand, it is assumed buyers do
not associate price with quality and will therefore follow the law of demand.

All other things being constant, supply is the quantity of goods or services that people are ready
to sell at various prices within some given time period

Notice that the only difference between this definition and that of demand is that in this case the
word sell is used instead of buy. Just as in the case of demand, supply is based on an assumed
length of time within which price and the other factors can affect the quantity supplied. Recall
that the law of demand states that the quantity demanded is related inversely to price, other
factors held constant. In contrast, the law of supply states that quantity supplied is related
directly to price, other factors held constant. Thus, any schedule of numbers representing a
relationship between price and quantity supplied would show a decrease in the quantity
supplied as price falls.

On a graph where quantity is on the X-axis and price on the Y-axis, a supply curve slopes
upward from left to right.  This upward sloping curve reflects the notion that a producer is willing
to produce more of a product as the price it can get for that product increases. That is classic
profit maximization.While price is the most important element influencing supply, other factors
have an influence as well. 

2. List the key nonprice factors that influence demand and supply.

Factors that can cause demand to change are called nonprice determinants of demand.
Following is a list of these determinants and a brief elaboration of their impact on demand:

1. Tastes and preferences. Why do people buy things? Economists use a general-purpose
category in their list of nonprice determinants called tastes and preferences to account for the
personal likes and dislikes of consumers for various goods and services. These tastes and
preferences may themselves be affected by other factors. Advertising, promotions, and even
government reports can have profound effects on demand via their impacts on people’s tastes
and preferences for a particular good or service.

2. Income. As people’s incomes rise, it is reasonable to expect their demand for a product to
increase, and vice versa.

3. Prices of related products. A good or service can be related to another by being a substitute
or by being a complement. If the price of a substitute product changes, we expect the demand
for the good under consideration to change in the same direction as the change in the
substitute’s price.

4. Future expectations. If enough buyers expect the price of a good or service to rise (fall) in the
future, it may cause the current demand to increase (decrease).

5. Number of buyers. The impact of the number of buyers on demand should be apparent; as
far as sellers are concerned, the more the merrier.

Just as there are nonprice determinants of demand, there are nonprice determinants of
supply.We briefly discuss each factor to understand why this is expected to occur:

1. Costs and technology. The two factors of costs and technology can be treated as one
because they are so closely related. In any event, unit cost reductions, whether from
technological innovations or simply management decisions, will result in an increase in market
supply. Increases in the unit cost of production will have the opposite effect.

2. Prices of other goods or services offered by the seller. From the consumer’s standpoint, any
good or service has other goods or services related to it either as substitutes or as
complements. From the producer’s standpoint, there can also be substitutes or complements for
a particular good or service offered in the market. If the sellers were already selling two (or
more) products, the change in market conditions would prompt them to reallocate their
resources toward the more profitable products. (Given this possibility, it may be more
appropriate to say that the sellers consider pizza and hot dogs as “competing” products rather
than as “substitute” products.)

3. Future expectations. This factor has a similar impact on sellers as on buyers; the only
difference is the direction of the change. For example, if sellers anticipate a rise in price, they
may choose to hold back the current supply to take advantage of the higher future price, thus
decreasing market supply. As we discuss in the “Market Demand” section, an expected rise in
price will increase the current demand for a product.

4. Number of sellers. Clearly, the number of sellers has a direct impact on supply. The more
sellers, the greater the market supply.

5. Weather conditions. Bad weather (e.g., floods, droughts, unusual seasonal temperatures) will
reduce the supply of an agricultural commodity. Good weather will have the opposite effect
3. In defining demand and supply, why do you think economists focus on price while holding
constant other factors that might have an impact on the behavior of buyers and sellers?

Changes in production capacity shift the supply curve and changes in tastes shift the demand
curve. These are effectively quantity changes that subsequently affect prices. This makes
quantity the independent variable and price the dependent variable.
The reason is that consumers are willing and able to buy more of a good the lower the price of
the good and will buy less of a good the higher the price of the good. Price and quantity
demanded are negatively (inversely) related because when the price of a good rises,
consumers tend to shift from that good to other goods that are now relatively cheaper.
Conversely, when the price of a good falls, consumers tend to purchase more of that good and
less of other goods that are now relatively more expensive. Price and quantity demanded are
inversely related when all other factors are held constant. This relation between price and
quantity demanded is so important that we discuss it in more detail later.

4. Define comparative statics analysis. How does it compare with sensitivity analysis or what-if
analysis used in finance, accounting, and statistics?

Comparative static analysis is a tool that can be used to analyze a system of equations. The use of
comparative static analysis on an economic model can provide valuable information about how an
economic system works. Sensitivity analysis is a way to predict the outcome of a decision if a
situation turns out to be different compared to the key prediction(s).

The model of market demand, supply, and equilibrium price and quantity can be used to
analyze the market. The particular method of analysis we use is called comparative statics
analysis. Comparative static analysis is a tool that can be used to analyze a system of equations. The
use of comparative static analysis on an economic model can provide valuable information about how
an economic system works. Sensitivity analysis is a way to predict the outcome of a decision if a
situation turns out to be different compared to the key prediction(s). For example, if we were
doing a what-if analysis of a company’s cash flow, we would start with a given pro forma income
statement adjusted to provide the cash flow for a given period of time. We would then conduct
sensitivity analysis by supposing certain factors changed, such as revenue, cost, or the rate of
depreciation. We would then inspect how changes in these factors would change the cash flow
of the firm over time. In the same manner, economists conduct a what-if analysis of their
models. The term statics alludes to the theoretically stable point of equilibrium, and comparative
refers to the comparison of the various points of equilibrium.

5. Define the rationing function of price. Why is it necessary for price to serve this function in
the market economy?

Rationing function of price features raising the price higher so that less of the consumable will
be purchased and used by the consumers and more will be conserved or rationed
The distribution or allocation of a limited commodity using markets and prices. Rationing is
needed due to the scarcity problem. Because wants and needs are unlimited, but resources are
limited, available commodities must be rationed out to competing uses. Markets ration
commodities by limiting the purchase only to those buyers willing and able to pay the price

Rationing function of price. The increase or decrease in price to clear the market of any
shortage or surplus. This is considered to be a short-run function because both buyers and
sellers are expected to respond only to price changes.

When the market price changes to eliminate the imbalance between quantities supplied and
demanded, it is serving what economists call the rationing function of price. The term rationing
is often associated with shortages, but we define it to also include a surplus situation.

6. Define the guiding or allocating function of price.

Guiding function of price. Also referred to as the allocating function of price, the movement of
resources into or out of markets as a result of changes in the equilibrium market price. This is
considered to be a long-run function. On the supply side of the market, sellers may enter or
leave the market or may vary all their factors of production. On the demand side, consumers
may change their tastes or preferences or find long-lasting alternatives to a particular good or
service. (p. 50)

The comparative statics analysis presented earlier required only that you consider the response
of equilibrium price and quantity to a given change in supply or demand. This response was
dubbed the “rationing function” of price. Let us consider what might happen as a result of this
change in market price. To illustrate this, we examine the market for hot dogs, a presumed
substitute for pizza. After this “long-run” adjustment is made, equilibrium price and quantity may
return to the levels at which they were before the initial changes in demand took place (i.e., P3
in each market may be close to or equal to P1).

But the main point is that Q3 is considerably less than Q1 in the hot dog market and
considerably more than Q1 in the pizza market. These differences represent the shifting of
resources out of the hot dog market and into the pizza market. Several centuries ago, Adam
Smith referred to this shifting of resources into and out of markets in response to price changes
as P P2 Q Q Q3 Q2 1 Hot dogs D2 D1 S2 S1 "Long-run" shift P P2 P3, P1 P3, P1 Q Q Q1 (a)
(b) "Long-run" shift Figure 3.7 Short-Run and Long-Run Changes in Supply (in Response to an
Initial Change in Demand)

Services the “invisible hand.”2 Another way to express these shifts in supply is that they
represent a response to “price signals” sent to the owners of the factors of production. In any
event, when resources have been shifted out of the market for hot dogs and into the market for
pizza, price is fulfilling its guiding or allocating function. Defined in a more formal manner, the
guiding or allocating function of price is the movement of resources into or out of markets in
response to a change in the equilibrium price of a good or service.
7. Discuss the differences between the short run and the long run from the perspective of
producers and from the perspective of consumers.

Long run. A time period in which new sellers may enter a market or sellers already in a market
may leave. This time period is sufficient for both old and new sellers to vary all their factors of
production. From the standpoint of consumers, the long run provides time enough to respond to
price changes by actually changing their tastes or preferences or their use of alternative goods
and services. For example, suppose bad weather in Brazil results in an increase in the price of
coffee. In the short run, people are expected to buy less coffee because of the higher price.
However, in the long run, they may buy even less coffee because the higher price will have
prompted them to drink more tea on a regular basis. (p. 50).

Short run. A time period in which only those sellers already in the market may respond to a
change in market price by using more or less of their variable resources. From the standpoint of
consumers, the short run is a period in which they respond only to price changes. As a result of
a change in price, consumers may change their tastes or preferences or their use of alternative
goods or services. However, in economic analysis, these related changes are considered long-
run phenomena. (p. 50).

The preceding example illustrates a basic distinction made in economic analysis between the
“short run” and the “long run.” This distinction has nothing to do directly with a specific calendar
time. Instead, it refers to the amount of time it takes for sellers and buyers to react to changes in
the market equilibrium price. The following descriptions of the short run and the long run helps
readers distinguish the two time periods:

1. Short run a. Period of time in which sellers already in the market respond to a change in
equilibrium price by adjusting the amount of certain resources, which economists call variable
inputs. Examples of such inputs are labor hours and raw materials. A shortrun adjustment by
sellers can be envisioned as a movement along a particular supply curve. b. Period of time in
which buyers already in the market respond to changes in equilibrium price by adjusting the
quantity demanded for a particular good or service. A short-run adjustment by buyers can be
envisioned as a movement along a particular demand curve.

2. Long run a. Period of time in which new sellers may enter a market or the original sellers may
exit from a market. This period is long enough for existing sellers to either increase or decrease
their fixed factors of production. Examples of fixed factors include property, plant, and
equipment. A long-run adjustment by sellers can be seen graphically as a shift in a given supply
curve. b. Period of time in which buyers may react to a change in equilibrium price by changing
their tastes and preferences or buying patterns. (The Wall Street Journal and other sources of
business news may refer to this as a “structural change” in demand.) A long-run adjustment by
buyers can be seen graphically as a shift in a given demand curve. Another good way of
distinguishing the short run from the long run is to note that the rationing function of price is a
short-run phenomenon, whereas the guiding function is a long-run phenomenon.
 1. Define demand. Define supply.in your answers; explain the difference between demand
and quantity demanded and between supply and quantity supplied.

Ans: Demand: Demand is how much consumers are prepared to buy at the market price. An
economic principle that describes a consumer's desire and willingness to pay a price for a
specific good or service. Holding all other factors constant, the price of a good or service
increases as its demand increases and vice versa
Supply: Supply is what producers are prepared to sell at a certain price. The supply of a good
or service is defined as quantities of a good or service that people are ready to sell at various
prices within some given time period, other factors besides price held constant.
Demand is the total amount of demand at all possible prices; while quantity demanded
is the demand at a particular price.
Supply is the amount of a product offered for sale at all possible prices that can succeed
in a market; while quantity supplied is the amount that producers are willing and able to supply
are a certain price.

2. List the key non price factors that influence demand and supply.
Ans: Non-price determinants of demand
• Tastes and preferences
• Income
• Prices of related products
• Future expectations
• Number of buyers
Non-price determinants of supply
• Costs and technology
• Prices of other goods or services offered by the seller
• Future expectations
• Number of sellers
• Weather conditions
3. In defining demand and supply, why do you think economists focus on price while
holding constant other factors that might have an impact on the behavior of buyers and
sellers
Ans: The reason is that consumers are willing and able to buy more of a good the lower the
price of the good and will buy less of a good the higher the price of the good. Price and
quantity demanded are negatively (inversely) related because when the price of a good
rises, consumers tend to shift from that good to other goods that are now relatively
cheaper. Conversely, when the price of a good falls, consumers tend to purchase more of
that good and less of other goods that are now relatively more expensive. Price and
quantity demanded are inversely related when all other factors are held constant. This
relation between price and quantity demanded is so important that we discuss it in more
detail later.

4. Define comparative static analysis. How does it compare with sensitivity analysis or
what if analysis used in finance, accounting and statistics.
Ans: Comparative static analysis is a tool that can be used to analyze a system of equations. The
use of comparative static analysis on an economic model can provide valuable information about
how an economic system works.
Sensitivity analysis is a way to predict the outcome of a decision if a situation turns out to
be different compared to the key prediction(s).

5. Define rationing function of price, why is it necessary for price to serve this function in
the market economy
Ans: Rationing function of price features raising the price higher so that less of the
consumable will be purchased and used by the consumers and more will be conserved or
rationed
The distribution or allocation of a limited commodity using markets and prices. Rationing is
needed due to the scarcity problem. Because wants and needs are unlimited, but resources
are limited, available commodities must be rationed out to competing uses. Markets ration
commodities by limiting the purchase only to those buyers willing and able to pay the price

6. Define guiding or allocating function of price.

7. Discuss the difference between short run and the long run from the perspective of
producers and from the perspective of consumers.
Ans: The short run is a period of time in which the quantity of at least one input is fixed and
the quantities of the other inputs can be varied. The long run is a period of time in which
the quantities of all inputs can be varied.
  Sellers already in the market respond to a change in equilibrium price by adjusting
variable inputs.
 Buyers already in the market respond to changes in equilibrium price by adjusting
the quantity demanded for the good or service.
 Existing sellers may exit from a market
 Existing sellers may adjust fixed factors of production
 Buyers may react to a change in equilibrium price by changing their tastes and
preferences or buying preferences

8. Explain the difference between shortage and scarcity. In answering this question, you
should consider short run and long run in economics.
Ans: Scarcity is a term used to mean unavailability of resources. It takes a long time to
recover from it. Shortage is used to show, the unavailability of something which was
formerly available. It takes a business or an organization a short time to recover from it.

9. Why do you think it is important for managers to understand the mechanics of supply
and demand both in the short run and in the long run? Give examples of companies
whose business was either helped or hurt by changes in supply or demand in the
markets in which they were working.
Ans: For mangers, it is important to understand the two as they have to understand the
machinery, labor and raw materials needed. It is important for them to know this statistics
in order to help them plan in advance during the two periods to ensure there is no shortage
or surplus in production. The knowledge of the mechanics also helps in general planning of
the production in order to take care of the market in terms of demand and supply.
E.g. Diamond industry, Gasoline industry
10. If Congress levies an additional tax on luxury items, the prices of these items will rise.
However, this will cause demand to decrease, and as a result the prices will fall down,
perhaps even to their original levels.” Do you agree or disagree with this statement?
Please explain.
Ans: I disagree with the statement as, only a small group of the society can afford luxury
items. More than a need it is a status symbol, so people to maintain the status for sure will
afford to buy luxury items even if the gov’t increases the taxes.

11. Overheard at the water cooler in the corporate headquarters of a large manufacturing
concern: “The competition is really threatening us with their new product line. I think we
should consider offering discounts on our current line in order to stimulate demand.” In this
statement, is the term demand being used in a manner consistent with economic theory?
Explain. Illustrate your answer using a line drawn to represent the demand for this firm’s
product line.
Ans: Yes, the term demand is used in consistent with economic theory because it refers to
the supply of the product as a result of the competition this company is facing in the market.
And the company is applying the laws of economics to bounce back by stimulating the demand.
 12. Briefly list and elaborate on the factors that will be affecting the demand for the
following products in the next several years. Do you think these factors will cause the
demand to increase or decrease?
A. Convenience food- Busier life styles, two-income families, single-parent households will
continue to cause demand for convenience foods to increase.
B. Products purchased on the Internet: Demand is already increasing drastically for goods
purchased on the Internet and is posed to Explode in the next five years.
C. Fax machines: Will decline as usage of internal fax modems and e-mail attachments
continue to rise.
D. Film and cameras: May decrease as digital cameras become less expensive and in
greater demand.

E. videos rented from retail outlets : Pay-per-view and satellite TV programs will continue
to erode video rental demand
F. Pay-per-view television programming: Pay-per-view should increase as broader band
connections to the home make this form of Entertainment cheaper and easier to use.
G. airline travel within the United States; airline travel within Europe : Longer term trends
point in an upward direction
H. gasoline: It is difficult to tell, but if demand for SUV’s and trucks continues to rise, there
will also be a Steady increase in demand

13. -Briefly list and elaborate on the factors that will be affecting the supply of the following
products in the next several years. Do you think these factors will cause the supply to
increase or decrease?

a) Crude oil: Discovery of new sources of oil: supply increases. (2) Invention of new long-
lasting battery for electric car: supply decreases—particularly in the long run as
companies shift their
Resources from oil production to battery production. (3) Mergers or acquisitions (as have been
going on in the late 90s with BP and Amoco as well as Exxon and Mobil):—these mergers may
cause supply to increase or decrease depending on the intentions of the larger companies that
have even more power over supply.
b) Beef: (1) Cattle ranching declines as it becomes harder to earn a good return in the
market for beef (in this case it is actually supply decreasing in response to demand
falling in the long run).(2) Increase in beef imports from countries such as Argentina
(recently the U.S. government allowed the importation of Argentine beef into the
country) —supply increases
c) Computer memory chips: Increase in the building of new manufacturing facilities in
Asian countries such as Taiwan—supply increases.
d) Hotel rooms: Mergers and acquisitions in the hotel industry (could increase or
decrease number of rooms— would probably increase number of rooms as the larger
companies try to expand their market share by building new hotels
e) Fast food outlets in emerging markets: U.S. or European based multinationals such as
McDonald’s and Burger King build new restaurants in an attempt to expand their
global businesses—supply increases
f) Credit cards issued by financial institutions: New co-branded cards are offered by
financial institutions—supply increases
g) Laptop computers: More manufacturing, assembly and distribution capacity by key
companies such as Dell, Compaq, IBM and Gateway 2000—supply increases.
h) PC servers: More PC companies such as Dell and Compaq 2000 enter the server
market or increase their resources in this product segment in an attempt to offset the
shrinking profit margins in the PC business --supply increases.