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TOPIC TWO A
DEMAND AND SUPPLY ANALYSIS:
 Demand Analysis: Definition of demand; law of demand exceptions of the law, Determinants of
demand, Individual and market demand curve. Supply Analysis: Definition of supply, law of
supply, exceptions, Determinants of supply, Market supply.
 Concept of equilibrium: Determination of market equilibrium price and quantity; Effects of
Changes in supply and demand and the effect they have on equilibrium price and quantity. Price
controls: Minimum (Price ceiling) and maximum price (Price Floors) controls, effects of a tax and
subsidies, effects of price decontrol.
 ……………………………………………………………
The topic is divided into two parts
PART ONE: DEMAND AND SUPPLY ANALYSIS

A market is nothing more or less than the locus of exchange; it is not necessarily a place, but simply
buyers and sellers coming together for transactions. A set up where two or more parties engage in
exchange of goods, services and information is called a market. Ideally a market is a place where two
or more parties are involved in buying and selling.

Types of Markets

1. Physical Markets - Physical market is a set up where buyers can physically meet the sellers and
purchase the desired merchandise from them in exchange of money. Shopping malls, department
stores, retail stores are examples of physical markets.
2. Non Physical Markets/Virtual markets - In such markets, buyers purchase goods and services
through internet. In such a market the buyers and sellers do not meet or interact physically, instead
the transaction is done through internet. Examples - Rediff shopping, eBay etc.
3. Auction Market - In an auction market the seller sells his goods to one who is the highest
bidder.
4. Black Market - A black market is a setup where illegal goods like drugs and weapons are sold.
5. Knowledge Market - Knowledge market is a setup which deals in the exchange of information and
knowledge based products.
6. Financial Market - Market dealing with the exchange of liquid assets (money) is called a financial
market.
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A) DEMAND ANALYSIS

Demand refers to the willingness of the consumers to want something at a particular price at a given
time

The demand schedule (demand curve) reflects the law of demand it is a downward sloping function
and is a schedule of the quantity demanded at each and every price.

Demand Schedule: Shows relationship of price and quantity demanded of good X

Price of X 200 180 160 140 120 100

Quantity of X 2 4 6 8 10 14

A demand curve is a graph depicting the relationship between the price of a certain commodity (the y-
axis) and the quantity of that commodity that is demanded at that price (the x-axis).

Demand curves generally have a negative gradient indicating the inverse relationship between quantity
demanded and price.

NOTE: The demand curve is downward sloping from left to right. Also both the demand schedule and
demand curve reflects the law of demand. The lower the price, the higher the quantity demanded
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In the first diagram as the price decreases from p0 to p1, the quantity increases from q0 to q1 and vice
versa

In the second diagram as the price decreases from PA to PB, the quantity increases from QA to QB and
vice versa

The Law of Demand: states that the quantity demanded will drop as the price rises, or the quantity
demanded will rise as the price of the good falls, when all other things being equal. ie, This
relationship between quantity and price will follow the demand curve as long as the determinants of
demand don't change.
(This is because of the law of demand: for most goods, the quantity demanded falls if the price rises. Certain
unusual situations do not follow this law. These include Veblen goods, Giffen goods, and speculative bubbles
where buyers are attracted to a commodity if its price rises).

Mathematically, a demand function – which is an algebraic formulation – can also be used to show
the relationship between demand and price.

The standard function is a linear one where Qd = a – bP

Where Qd=Linear Demand Curve

a_ factors influencing demand besides prices

b=slope of the demand curve

P= price

example the demand function is Qd = 1600 – 20p.

The graph of the demand curve uses the inverse demand function in which price is expressed as a
function of quantity. The standard form of the demand equation can be converted to the inverse
equation by solving for P:

P: Q/b –a/b

Three categories of demand curves

 Individual Demand Curve: the relationship between the quantity of a product a single
consumer is willing to buy and its price.
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 Market Demand Curve: the relationship between the quantity of a product that all consumers in
the market are willing to buy and its price. The market demand curve can be obtained by
adding up the individual demand curves of individual consumers in the industry horizontally.
 Firm Demand Curve: (A firm demand curve may also be referred to as the demand curve of the
market to which the firm is exposed.) It refers to the relationship between the number of
customers willing to buy a certain product from the enterprise and its price.

Relationship Between an Individual Demand Curve and the Market Demand curve

The market demand curve shows the quantity of a good all consumers in a market will buy at every
different price. A market demand schedule for a product indicates that there is an inverse relationship
between price and quantity demanded.

The slope of the market industry demand curve is greater than the slope of the individual demand
curve; the slope of the enterprise demand curve is less than the slope of the industry demand curve.
The slope of a firm's demand curve is less than the slope of the industry's demand curve.

For example, suppose that there were just two consumers in the market for good X, Consumer 1 and
Consumer 2. These two consumers have different individual demand curves corresponding to their
different preferences for good X. The two individual demand curves are depicted in Figure , along with
the market demand curve for good X.

The market demand curve for good X is found by summing together the quantities that both consumers
demand at each price. For example, at a price of $1, Consumer 1 demands 2 units while Consumer 2
demands 1 unit; so, the market demand is 2 + 1 = 3 units of good X. In more general settings, where
there are more than two consumers in the market for some good, the same principle continues to
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apply; the market demand curve would be the horizontal summation of all the market participants'
individual demand curves.

Explanations of Why Demand Curves Slope Downwards:

a) Diminishing marginal utility: One of the earliest explanations of the inverse relationship between
price and quantity demanded is the law of diminishing marginal utility. This law suggests that as
more of a product is consumed the marginal (additional) benefit to the consumer falls, hence
consumers are prepared to pay less. This can be explained as follows: Most benefit is generated by
the first unit of a good consumed because it satisfies most of the immediate need or desire. A
second unit consumed would generate less utility – perhaps even zero, given that the consumer has
less need or less desire. With less benefit derived, the rational consumer is prepared to pay rather
less for the second, and subsequent, units, given that the marginal utility falls.
b) The income effect: The income can also be used to explain why the demand curve slopes
downwards. If we assume that money income is fixed, the income effect suggests that, as the price
of a good falls, real income – that is, what consumers can buy with their money income – rises and
consumers increase their demand. Therefore, at a lower price, consumers can buy more from the
same money income, and, ceteris paribus, demand will rise. Conversely, a rise in price will reduce
real income and force consumers to cut back on their demand.
c) The substitution effect: In addition, as the price of one good falls, it becomes relatively less
expensive. Therefore, assuming other alternative products stay at the same price, at lower prices the
good appears cheaper, and consumers will switch from the expensive alternative to the relatively
cheaper one.

EXCEPTIONS OF THE LAW OF DEMAND: It is possible to identify some exceptions to the

normal rules regarding the relationship between price and current demand.

a. Giffen Goods: is a special variety of inferior good. Sir Robert Giffen of Scotland observed in the
19th century (1840s) that poor people spent the major portion of their income on a staple item, viz.,
potato. If the price of this good rises they will become so poor that they will be found to spend less
on other items and buy more potatoes in order to get a minimum diet and keep themselves alive.

For such goods, the demand curve will be upward sloping. It will look like the supply curve of a
commodity. Note that this is a very exceptional case and potatoes that we consume today should be
considered as ‘normal good’ rather than Giffen good.
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A rise in the price of such a staple food will not result in a typical substitution effect, given there are
no close substitutes. If the real incomes of the poor increase they would tend to reallocate some of this
income to luxuries, and if real incomes decrease they would buy more of the staple good, meaning it is
an inferior good. Assuming that the money incomes of the poor are constant in the short run, a rise in
price of the staple food will reduce real income and lead to an inverse income effect.

However, most inferior goods will have substitutes, hence despite the inverse income effect, a rise in
price will trigger a substitution effect, and demand will fall.

b. Snob Appeal or Veblen Good: People sometimes buy certain commodities like diamonds at high
prices not due to their intrinsic worth but for a different reason. The basic object is to display their
riches to the other members of the community to which they themselves belong.

This is known as ‘snob appeal’, which induces people to purchase items of conspicuous consumption.
Such a commodity is also known as Veblen good (named after the economist Veblen) whose demand
rises (fails) when its price rises (falls).

c. Possibility of Future Rise in Prices (Speculative Demand): If a consumer anticipates that the price of
a commodity will rise in future he will purchase more of that commodity now. The consumer will
purchase more even if current price is high.

In a speculative market (such as the stock market), a rise in the price of a commodity (such as, share)
creates an impression among buyers that its price will rise further. So people start buying more of a
share when its price rises.

d. Using Price as an Index of Quality: Most consumers do not have the capacity or technical
knowledge to examine the physical properties of a product (such as, reliability, durability, economy,
etc.,) as in the case of an item such as a motor car or a VCR. So, in the absence of other information,
price is taken as an index of quality. Thus, a high-priced car is more valued than a low-priced one.

A costly book is often considered to be more useful by a student than a cheaper title. In such cases, the
demand curve may be upward sloping. This argument is not a new one. This applies to our previous
case where we referred to commodities having snob appeal. So this point really reinforces the previous
one.

e. Highly Essential Good: Finally, in case of certain highly essential items such as life- saving drugs,
people buy a fixed quantity at all possible price. Heart patients will buy the same quantity of medicine
whether price is high or low. Their response to price change is almost nil.
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In cases of such commodities, the demand curve is likely to be a vertical straight

FACTORS AFFECTING DEMAND OF A PRODUCT OR DETERMINANTS OF DEMAND

1. Price of the Given Commodity: It is the most important factor affecting demand for the given
commodity. Generally, there exists an inverse relationship between price and quantity demanded. It
means, as price increases, quantity demanded falls due to decrease in the satisfaction level of
consumers. For example, if price of given commodity (say, tea) increases, its quantity demanded will
fall as satisfaction derived from tea will fall due to rise in its price. Demand (D) is a function of price
(P) and can be expressed as: D = f (P). The inverse relationship between price and demand, known
as ‘Law of Demand’.

2. Price of Related Goods: Demand for the given commodity is also affected by change in prices of the
related goods. Related goods are of two types:

(i) Substitute Goods: Substitute goods are those goods which can be used in place of one another for
satisfaction of a particular want, like tea and coffee. An increase in the price of substitute leads to an
increase in the demand for given commodity and vice-versa. For example, if price of a substitute good
(say, coffee) increases, then demand for given commodity (say, tea) will rise as tea will become
relatively cheaper in comparison to coffee. So, demand for a given commodity is directly affected by
change in price of substitute goods.

(ii) Complementary Goods: Complementary goods are those goods which are used together to satisfy a
particular want, pen and ink. Petrol and use car. An increase in the price of complementary good leads
to a decrease in the demand for given commodity and vice-versa. For example, if price of a
complementary good (say, sugar) increases, then demand for given commodity (say, tea) will fall as it
will be relatively costlier to use both the goods together. So, demand for a given commodity is
inversely affected by change in price of complementary goods.

3. Income of the Consumer: Demand for a commodity is also affected by income of the consumer.
However, the effect of change in income on demand depends on the nature of the commodity under
consideration.

(i) If the given commodity is a normal good, then an increase in income leads to rise in its demand,
while a decrease in income reduces the demand.
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(ii). If the given commodity is an inferior good, then an increase in income reduces the demand, while
a decrease in income leads to rise in demand.

4. Tastes and Preferences: Tastes and preferences of the consumer directly influence the demand for a
commodity. They include changes in fashion, customs, habits, etc. If a commodity is in fashion or is
preferred by the consumers, then demand for such a commodity rises. On the other hand, demand for a
commodity falls, if the consumers have no taste for that commodity.

5. Expectation of Change in the Price in Future: If the price of a certain commodity is expected to
increase in near future, then people will buy more of that commodity than what they normally buy.
There exists a direct relationship between expectation of change in the prices in future and change in
demand in the current period. For example, if the price of petrol is expected to rise in future, its
present demand will increase.

6. Advertisement Expenditure: Advertisement expenditure made by a firm to promote the sales of its
product is an important factor determining demand for a product, especially of the product of the firm
which gives advertisements. The purpose of advertisement is to influence the consumers in favour of a
product. Advertisements are given in various media such as newspapers, radio, and television.
Advertisements for goods are repeated several times so that consumers are convinced about their
superior quality.

7. The Number of Consumers in the Market: The market demand for a good is obtained by adding up
the individual demands of the present as well as prospective consumers of a good at various possible
prices. The greater the number of consumers of a good, the greater the market demand for it. Now, the
question arises on what factors the number of consumers for a good depends. If the consumers
substitute one good for another, then the number of consumers for the good which has been substituted
by the other will decline and for the good which has been used in place of the others, the number of
consumers will increase. Besides, when the seller of a good succeeds in finding out new markets for
his good and as a result the market for his good expands the number of consumers for that good will
increase.

Another important cause for the increase in the number of consumers is the growth in population. For
instance, in India the demand for many essential goods, especially food grains, has increased because
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of the increase in the population of the country and the resultant increase in the number of consumers
for them.

CHANGES IN DEMAND VERSUS CHANGES IN QUANTITY DEMANDED

A)Changes in demand (shifts in the demand curve). This is indicated by a shift in demand curve either
to the right or to the left due to all other factors affecting demand other than price of the
commodity. If demand increases, the entire curve will move to the right. That means larger
quantities will be demanded at every price. If the entire curve shifts to the left, it means total
demand has dropped for all price levels.
Diagram

An increase in demand is shown by the shift of the demand curve to the right from D to D2, notice that
at each price there is a greater quantity demanded along D2 (the dotted line) than was demanded with
D (the solid line). Note this is due to the factors determine demand being favorable, eg, an increase in
price of the commodity

A decrease in demand, means a shift of the demand curve to the left. Suppose original demand curve
was D2, then a change in demand shifts the demand curve to D. at the same price quantity demanded
decreases from D2 to D. Note this is due to the factors determine demand being unfavorable, eg, a
decrease in price of the commodity

EXERCISE

Price(Px) Quantity Demanded New Quantity Demand

(Qd) (Qd1)
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140 10 15
135 12 17
130 14 19
125 17 23
120 20 27
115 24 33
110 30 40
105 37 48
100 45 59

Draw the demand curve. Hence draw the shift in demand

B) Changes in Quantity Demanded (movement along a demand curve): This is indicated by a
movement along the demand curve either to the right or to the left. Due to changes to changes in the
price of the commodity only.
Diagram

Let original price be 10.

When price increases from 10 to 12, then there is a movement along the demand curve to the left,
quantity demanded decreases from 65 to 40, and this is referred to as a contraction of demand
When price decreases from 10 to 7, then there is a movement along the demand curve to the right,
and quantity demanded increases from 55 60 75, and this is referred to as an extension of demand
B) SUPPLY ANALYSIS

Definition” Supply refers to the quantity that producers are willing to supply at any moment at a given
price

Supply schedule- is a table showing the relationship between price of a commodity and the quantity
supplied
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Price of X 300 280 250 200 180 130

Quantity of X 15 12 10 8 6 2

Supply curve is nothing more than a schedule of the quantities at each and every price.

There is a positive relation between price and quantity on a supply curve. The supply curve slopes
upwards from left to right, ie, as the price increases then more is supplied or as the price decreases
then less is supplied. This means that the higher the price, the higher the quantity supplied. From the seller's
perspective, the opportunity cost of each additional unit that they sell tends to be higher and higher.
Producers supply more at a higher price because the higher selling price justifies the higher opportunity cost
of each additional unit sold.

Market Supply Curve: As explained, the market supply curve represents a combination of individual supply
curves. The market supply curve is most accurate in a perfectly competitive market, which is a market that
includes a large number of companies producing the same product.

Why is supply curve generally upward sloping?

Generally, a higher price encourages firms to produce more. This is for two reasons.

 A higher price makes the good more profitable to produce.

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 In the short term, the cost of production (marginal cost) is affected by the law of diminishing marginal
returns. Increasing output with capital fixed leads to a point where marginal costs rise rapidly, so the
firm needs a higher price to compensate for the higher cost of production

The law of supply: States that when price of a commodity increases the supply of the commodity also
increase or When the price of the commodity decreases the supply of the commodity decreases when
all other things are held constant. Thus there is a direct relationship between price of the commodity
and its supply

Supply curve equation is of the form Qs = a + bP or Qs=200 + 500P

Market Supply Schedule:

Refers to a supply schedule that represents the different quantities of a product that all the suppliers in
the market are willing to supply at different prices. Market supply schedule can be drawn by
aggregating the individual supply schedules of all individual suppliers in the market.

Table-9 shows the market supply schedule of a product supplied by three suppliers. A, B, and C:

PLOT THESE

Exception to Law of Supply:

According to the law of supply, if the price of a product rises, then the supply of the product also rises
and vice versa. However, there are certain conditions where the law of supply is not applicable. These
conditions are known as exceptions to law of supply. In such cases, the supply of a product falls with
the increase in price of a product at a particular point of time.
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a) Backward sloping curve:The exception of law of supply is represented on the regressive supply
cure or backward sloping curve. It is also known as exceptional supply curve, which is shown in
Figure-16:

In Figure-16, SMS1 is the exceptional supply curve for labor. In this case, wages are regarded
as the price of labor. It can be interpreted from the graph that as the wages of a worker
increases, its quantity supplied that is working hours decreases, which is an exception to the law
of supply.

b) Speculation: Refers to the fact that the supply of a product decreases instead of increasing in
present when there is an expected increase in the price of the product. In such a case, sellers
would not supply the whole quantity of the product and would wait for the increase in price in
future to earn high profits. This case is an exception to law of demand.
c) Agricultural Products: Imply that law of supply is not valid in case of agricultural products
as the supply of these products depends on particular seasons or climatic conditions. Thus, the
supply of these products cannot be increased after a certain limit in spite of rise in their prices.

d) Changes in Other Situations: Refers to the fact that law of supply ignores other factors (except
price) that can influence the supply of a product. These factors can be natural factors, transportation
conditions, and government policies.

Factors Affecting or Determining The Supply Of A Commodity

1. Price: Refers to the main factor that influences the supply of a product to a greater extent. Unlike
demand, there is a direct relationship between the price of a product and its supply. If the price of a
product increases, then the supply of the product also increases and vice versa. Change in supply with
respect to the change in price is termed as the variation in supply of a product. Speculation about
future price can also affect the supply of a product. If the price of a product is about to rise in future,
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the supply of the product would decrease in the present market because of the profit expected by a
seller in future. However, the fall in the price of a product in future would increase the supply of
product in the present market.

2. Cost of Production: Implies that the supply of a product would decrease with increase in the cost
of production and vice versa. The supply of a product and cost of production are inversely related to
each other. For example, a seller would supply less quantity of a product in the market, when the cost
of production exceeds the market price of the product. In such a case the seller would wait for the rise
in price in future. The cost of production rises due to several factors, such as loss of fertility of land,
high wage rates of labor, and increase in the prices of raw material, transport cost, and tax rate.

3. Natural Conditions: Implies that climatic conditions directly affect the supply of certain products.
For example, the supply of agricultural products increases when the climate is favorable. However,
the supply of these products decreases at the time of drought. Some of the crops are climate specific
and their growth purely depends on climatic conditions.

4. Technology: Refers to one of the important determinant of supply. A better and advanced
technology increases the production of a product, which results in the increase in the supply of the
product. For example, the production of fertilizers and good quality seeds increases the production of
crops. This further increase the supply of food grains in the market.

5. Transport Conditions: Refer to the fact that better transport facilities increase the supply of
products. Transport is always a constraint to the supply of products, as the products are not available
on time due to poor transport facilities. Therefore, even if the price of a product increases, the supply
would not increase.

6. Factor Prices and their Availability: Act as one of the major determinant of supply. The inputs,
such as raw material, lobour, equipment, and machines, required at the time of production are termed
as factors. If the factors are available in sufficient quantity and at lower price, then there would be
increase in production. This would increase the supply of a product in the market. For example,
availability of cheap labor and raw material nearby the manufacturing plant of an organization would
help in reducing the labor and transportation costs. Consequently, the production and supply of the
product would increase
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7. Government’s Policies: Implies that the different policies of government, such as fiscal policy and
industrial policy, has a greater impact on the supply of a product. For example, increase in tax on
excise duties would decrease the supply of a product. On the other hand, if the tax rate is low, then the
supply of a product would increase.
8. Prices of Related Goods: Refer to fact that the prices of substitutes and complementary goods also
affect the supply of a product. For example, if the price of wheat increases, then farmers would tend to
grow more wheat than other crops. This would decrease the supply of rice in the market

Changes in Supply Versus changes in Quantity Supply

a) Changes in supply: Indicated by a shift of the supply curves either to the right or to the left.
Changes in one or more of the non-price determinants of supply cause the supply curve to shift. A
shift to the left of the supply curve is called a decrease in supply; a shift to the right is called an
increase in supply

Diagram

A shift to the right from s1 to s2 is caused by the factors affection supply being favorable, eg, a
reduction in government taxes, better technology, better communication means etc

While a shift to the left is caused by the factors affection supply being unfavorable, eg, an increase in
government taxes. Poor technology and poor communication means, etc

b) Changes in quantity supplied: occurs due to changes in the price of the commodity only,

Diagram
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Changes in price cause changes in quantity supplied, starting with the original price 16, quantity
supplied is 55.

When price increases from 16 to 22, then there is an upward movement and supply increases from 55
to 75. This is referred to as an extension in supply

When price decreases from 16 to 12, then there is a downward movement and supply decreases from
55 to 40. This is referred to as a contraction in supply

………………………………………………………………………
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PART TWO : MARKET EQUILIBRIUM:

Definition of market equilibrium – A situation where for a particular good supply = demand. When the market
is in equilibrium, there is no tendency for prices to change. We say the market-clearing price has been
achieved. Equilibrium price is also called market clearing price because at this price the exact quantity that
producers take to market will be bought by consumers, and there will be nothing ‘left over’. This is efficient
because there is neither an excess of supply and wasted output, nor a shortage – the market clears
efficiently. This is a central feature of the price mechanism, and one of its significant benefits.
As indicated in the diagram this occurs where supply equals demand (supply curve intersects demand
curve). An equilibrium implies that there is no force that will cause further changes in price, hence
quantity exchanged in the market.
Diagram

Where the supply and demand curves intersect, equilibrium price is determined (Pe) and
equilibrium quantity is determined (Qe)
The graph of a market in equilibrium can also be expressed using a series of equations. Both the
demand and supply curve can be expressed as equations.

In the case of excess supply, sellers will be left holding excess stocks, and price will adjust downwards
and supply will be reduced.
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In the case of excess demand, sellers will quickly run down their stocks, which will trigger a rise in
price and increased supply.

THUS If the market is working effectively, with information passing quickly between buyer and seller
(in this case, between students and a college canteen), the market will quickly readjust, and the excess
demand and supply will be eliminated. The more efficiently the market works, the quicker it will
readjust to create a stable equilibrium price.

Equilibrium price is also called market clearing price because at this price the exact quantity that
producers take to market will be bought by consumers, and there will be nothing ‘left over’. This is
efficient because there is neither an excess of supply and wasted output, nor a shortage – the market
clears efficiently. This is a central feature of the price mechanism, and one of its significant benefits.

Disequilibrium: in a market setting, disequilibrium occurs when quantity supplied is not equal to the
quantity demanded; when a market is experiencing a disequilibrium, there will be either a shortage or
a surplus. Whenever markets experience imbalances—creating disequilibrium prices, surpluses, and
shortages—market forces drive prices toward equilibrium.

EXERCISE: Use the table below to plot and determine the (i) Equilibrium point. (ii) Equilibrium price
and quantity

Price (per Quantity demanded Quantity supplied

gallon) (millions of gallons) (millions of gallons)
$1.00 800 500
$1.20 700 550
$1.40 600 600
$1.60 550 640
$1.80 500 680
$2.00 460 700
$2.20 420 720
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MATHEMATICALLY: Determination of equilibrium price and quantity

Remember at equilibrium ( Dd=Qs)

Example 1: Let us suppose we have two simple demand and supply equations

 Qd = 20 – 2P and Qs = -10 + 2P determine the equilibrium price and quantity

ANSEWR: At equilibrium QS = Qd , we put the two equations together

 20-2P = -10 + 2P
 20+10= 4P
 30/4=P THUS P = 7.5

To find Q, we just put this value of P into one of the equations

 Q = 20 – (2×7.5) THUS Q= 5

Example 2: Suppose that the demand for soda is given by the following equation: Qd=16–2P, where
Qd is the amount of soda that consumers want to buy (i.e., quantity demanded), and P is the price of
soda. Suppose the supply of soda is Qs=2+5P
Given the equilibrium condition as Qd = Qs, The determine the equilibrium price and quantity

Example 3: The following equations describe the market for wheat

QS = 1944 + 207P and QD = 3244 - 283P
(i) Calculate equilibrium price and quantity
(ii) If the price is set at 5 will there be a shortage or a surplus, Explain

EFFECTS OF CHANGES IN SUPPLY AND DEMAND CONDITIONS ON THE

EQUILIBRIUM PRICE AND QUANTITY

Changes in the underlying factors that affect demand and supply will cause shifts in the position of the
demand or supply curve at every price. Whenever this happens, the original equilibrium price will no
longer equate demand with supply, and price will adjust to bring about a return to equilibrium.

The changes are better understood using graphs to demonstrate what happens in a market when there
are changes in non-price determinants of supply and demand.
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a) Changes in demand conditions while supply conditions are held constant. These changes are either a
rise or a fall in demand
(i)A rise in demand is indicated by a shift of the demand curve to the right form D to D1

Effect are, a new equilibrium point where D1 = S, Price increases from P to P1, and quantity
increases from Q to Q1

(ii) A fall in Demand is indicated by a shift of the demand curve to the left form D to D1

Effect, a new equilibrium point where D1 = S, Price decreases from P to P1, and quantity
decreases from Q to Q1

b). Changes in supply conditions while demand conditions are held constant. These are either a rise or
a fall in supply

(i) Supply rises is indicated by a shifts the supply curve to the right, which reduces price and increases
output.
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Effects are: Read the diagram

(ii)Supply falls is indicated by a shift in supply curve to the left, which increases price

Effects are: read them from the graph

the same time.

c) Changes in both demand and supply conditions in the market.
Suppose, there is a large rise in the demand for mangoes because of a rise in per capita income of
the people. Followed by an unexpected bumper crop of mangoes.
What will be the final effect of such changes on the equilibrium price?
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The answer can be found from both the following diagrams.

However, although both the quantity demanded and quantity supplied increase in each case, in Fig.
(a) the market price falls and in Fig. (b) it rises.
Thus, when multiple shifts in demand and supply curves are considered price may rise or fall depending on
the two magnitudes of changes. a change in demand and a change in supply.
EXERCISE
A change in both demand and supply condition may lead to four possibilities
- (i)Demand rises and at the same time supply rises (simultaneously and proportionately)
- (ii) Demand Fall and at the same time supply falls (simultaneously and proportionately)
- (iii) Supply rises and at the same time demand falls (simultaneously and proportionately)
- (iv) Supply fall and at the same time demand increases (simultaneously and proportionately)

GOVERNMENT AND PRICE CONTROLS.

National and local governments sometimes implement price controls, legal minimum or legal
maximum prices for specific goods or services, to attempt managing the economy by direct
intervention. Price controls can be price ceilings or price floors.
 A price ceiling is the legal maximum price for a good or service,
 while a price floor is the legal minimum price.

Although both a price ceiling and a price floor can be imposed, the government usually only selects
either a ceiling or a floor for particular goods or services.

When prices are established by a free market, then there is a balance between supply and demand.
The quantity supplied at the market price equals the quantity demanded at that price. So, the
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government imposition of price controls causes either excess supply or excess demand, since the
legal price often differs greatly from the market price. Indeed, the government imposes price
controls to solve a problem perceived to be created by the market price. For instance, rent control is
imposed to make rent more affordable for tenants.
(i) Price ceiling: Always set below the equilibrium price set by the market forces
Some countries set price ceilings on basic necessities like cooking oil, sugar or flour. Consider the
market for corn flour information below.

Note that the demand(Qd) is greater than supply (Qs) which means that there is an excess demand for
this commodity that is not being satisfied by suppliers at this artificially low price. The distance
between Qs and Qd is called a shortage.
Price ceiling in a long run can cause adverse effect on market and create huge market inefficiencies.
Some effects of price ceiling are

i) Shortage: if price ceiling is set below the existing market price, the market undergoes problem of
shortage. When price ceiling is set below the market price, producers will begin to slow or stop their
production process causing less supply of commodity in the market. On the other hand, demand of
the consumers for such commodity increases with the fall in price. And with this imbalance between
supply and demand of the commodity, shortage is created in the market

ii) Government rationing and queuing: When there is extreme shortage in the market, government
begins rationing distribution to restrict the demand of the consumers. As a result, consumers won’t be
able to utilize as much goods as they need. Government rationing also results in consumers needing to
stay in queue for great deal of times, and this can be troublesome to elderly, disabled and other people
who cannot afford to stay in line for a long time.
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iii). Black market: Shortage of commodities encourages black market. Sellers begin trading
commodities to relatives and friends, and they start charging other people prices multiple times higher
than that of price ceiling.

iv) Degradation of quality: Producers won’t be able to generate desirable profit when government set
price ceiling. During such condition, many producers may use raw materials of comparatively lesser
quality in order to maintain same or almost same revenue as before.

a) Price floor (i.e., the minimum you can charge for a product). For a price floor to be effective, it

must be set above the competitive equilibrium price

Notice that at the floor price, Supply (Qs) is greater than demand (Qd), the distance between Qd and
Qs is the amount of the surplus. Minimum wages are the best-known examples of price floors.

Effect of price floor

ii) In case of producer surplus, producers would have reduced the price to increase consumers’
demands and clear off the stock. But since it is illegal to do so, producers cannot do anything. So,
government has to intervene and buy the surplus inventories. Government may sell these inventories
in situation when there is scarcity of those commodities, or it can also distribute to the poor people
and public entities.
iii) Minimum wage and unemployment: if minimum wage is set above market price, employers
may distribute more work among few workers and terminate rest of the workers in order to not to pay
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more wage to more workers. Setting price floor will obviously help few workers in getting higher
wage. But at the same time, other workers will also have to lose their jobs, creating unemployment.

TAXES: Another way that the government interferes with the equilibrium price set in the market is
through taxes. The effect of the tax is to shift the supply curve to the left form S to ST . A tax increases
the price of the commodity by the amount of the tax, however both the consumer and the seller share
the tax. referred as the incidence of a tax.

A tax causes the supply curve to shift to the left or inward so that reductions in supply correspond to
existing prices, reflecting the fact that businesses can now produce less for the same amount of money.

 Effect on Price: One of the most immediate and clear effects of tax on supply and demand
involves an increase in the price of consumer goods. This occurs because businesses must pay
more for the products they buy, including machinery, office furnishings and computer
equipment. The higher cost of doing business translates into higher prices for new products.

 Impact on Demand: While tax affects supply directly, it only has an indirect effect on
consumer demand. Besides altering the equilibrium price, which takes demand into account,
tax also impacts consumers' buying power. When tax rate is high, consumers spend more
money on taxes and have less to spend on additional goods.

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