DEMAND AND

SUPPLY
 Learning Objectives

 Concept of demand
 Law of demand
 Exceptions to law of demand
 The demand function
 Other factors impacting the demand
 Market demand and its determinants
 Change in demand and change in quantity
demanded
 Learning Objectives

 Concept of supply
 Law of supply
 Other factors determining supply
 Change in quantity supplied and change in supply
 Determination of equilibrium
 Demand

It is defined as the quantity demanded by an individual for a

product at a price per unit of time.

Features
• Demand depends on the utility of the commodity
• It is always related to the price
• It is in a desired quantity
• It is affective demand i.e it is always backed by the ability to
pay
• It is for the final products
 DEMAND FUNCTION
• It states the relationship between the demand for a
product (the dependent variable) and its determinants
(the independent variables).
• Demand Function:
• Linear demand function:
– A function is said to be linear if ΔD/ΔP (reciprocal of the
slope of demand curve) is constant and the resulting
function is a linear demand curve.Dx= aPx-b
• Non-linear demand function:
– A function is said to be non-linear or curvilinear if the
slope of the demand curve, ΔP/ΔD changes all along the
curve.Dx= a-bPx(where b=ΔD/ΔP)
 Multi-variate or Dynamic Demand
Function: Long-Term Demand Function
• A demand function of this kind is called a multi-variate or dynamic
demand function.
• Consider this statement: the demand (Dx) for a commodity X,
depends on its price (Px), consumer’s money income M, price of its
substitute Y, (Py), price of complementary goods (Pc) and
consumer’s taste (T) and advertisement expenditure (A).
• This statement can be expressed in a functional form as,
Dx = f (Px, M, Py, Pc, T, A)
• If the relationship between Dx and the quantifiable independent
variables, Px, M, Py, Pc and A is of linear form, the estimable form of
the demand function is expressed as
Dx = a – bPx + cM + dPy – gPc + jA ...(7.8)
where ‘a’ is a constant term and constants b, c, d, e, g and j are the
coefficients of relation between Dx and the respective independent
variables8.
 Law of Demand

According to the law of demand, when other factors are constant, there is
an inverse relationship between price and demand. In other words, the
demand for something increases as its price false. Conversely, demand
reduces when the price increases.

We can understand this inverse relationship using the following individual

demand schedule:
Price Demand

5 100

4 200

3 300

2 400

1 500
 Law of Demand
From the demand schedule we have seen above, we can derive the following
demand curve:

This graph also shows the demand curve falling as the price reduces. The
downward sloping of this curve explains the law of demand.
 Reason for the downward
slope of demand curve
Causes for Downward Sloping of Demand Curves
The following are some of the causes explaining why demand curves always
slope downwards:
1) The law of diminishing the marginal utility
According to this principle, the marginal utility of a commodity reduces
when the quantity of goods is more. Consequently, when the quantity is
more, the prices will fall and demand will increase. Hence, consumers will
demand more goods when prices are less. This is why the demand curve
slopes downwards.
2) Substitution effect
Consumers often classify various commodities as substitutes. For example,
many Indian consumers may substitute coffee and tea with each other for
various reasons. When the price of coffee rises, consumers may switch to
buying tea more as it will become relatively cheaper.
Economists refer to this as the substitution effect. Hence, if the price of tea
reduces, its demand will increase and the demand curve will be downward
sloping.
 Reason for the downward slope of
demand curve
3) Income effect
According to this principle, the real income of people increases
when the prices of commodities reduce. This happens because
they spend less in case of falling prices and end up with more 
money. With more money, they will, in turn, purchase more and
more. Therefore, the demand increases as prices fall.
 Exceptions to law of demand

Exceptions to the Law of Demand

Veblen Goods
The theory of Veblen goods belongs to the next category of
exceptions to the law of Demand. Thorstein Veblen was the one to
highlight this concept. Veblen goods are the ones whose demand
increases with their Price. They become more valuable with their
price rise. These are the goods people consider to be more useful
with an increase in Price. Like a high-priced gold necklace, it's
more desirable to the customer than the one with lower costs.
Luxury Goods
A significant exception to the law is the Demand for luxury goods. In such
cases, even if the price increases, the consumer won't stop consumption.
Cigarettes and alcohol typically come in this category.
 Exceptions to law of demand
Price Change Exception
The issue of price change in the market is another exception to the law of
Demand. There might be a situation when the Price of a product or service
increases and is subjected to future growth. So, the customers may buy
more of it to avoid further cost increment. Eventually, there are times when
the Price of a product is about to decrease. Consumers may temporarily
stop the purchase to avail of the future benefits of price decrement.
Recently, there has been a massive rise in the price of onions. People were
buying it more due to the worry of the further cost increase.
Necessary Goods
Let us understand what are the exceptions to the law of demand in the
case of necessary items. The Demand for essential goods stays intact even
if there’s a price rise. People can’t stop purchasing the products of regular
necessities. For example, if the cost of salt increases, consumers won't be
able to afford it. It is the complete opposite of the law of Demand in
Economics.
 Exceptions to law of demand

Income Change
The change in income of a consumer or a family also determines the
Demand for a particular product. If a family's income increases, they may
choose to buy a specific product in more quantity, no matter the Price.
Again, if the family's income decreases, they can select to reduce product
consumption to an extent. It opposes the law of Demand. 
 Market Demand

It is defined as the sum of the individual demands

for a product at a price per unit of time.
Adding up the individual demand at different
prices.
 Summing up the individual demand
functions
DEMAND FUNCTION
DETERMINANTS OF MARKET DEMAND

Following are the factors that determine the market demand for a
product:
• Price of the product,
• Price of the related goods—substitutes, complements and
supplements,
• Level of consumers’ income,
• Consumers’ taste and preferences,
• Advertisement of the product,
• Consumers’ expectations about future price and supply
position,
• Demonstration effect and ‘bandwagon effect’,
• Consumer-credit facility,
• Population of the country (for the goods of mass
consumption),
• Distribution pattern of national income, etc.
Movement in Demand Curve

Movement along the demand curve depicts the change in both the factors
i.e. the price and quantity demanded, from one point to another. Other
things remain unchanged when there is a change in the quantity demanded
due to the change in the price of the product or service, results in the
movement of the demand curve. The movement along the curve can be in
any of the two directions:

•Upward Movement: Indicates contraction of demand, in essence, a fall

in demand is observed due to price rise.
•Downward Movement: It shows expansion in demand, i.e. demand for
the product or service goes up because of the fall in prices.
Hence, more quantity of a good is demanded at low prices, while when the
prices are high, the demand tends to decrease.
Movement in demand curve
 Shift in demand

A shift in the demand curve displays changes in demand at each possible

price, owing to change in one or more non-price determinants such as the
price of related goods, income, taste & preferences and expectations of the
consumer. Whenever there is a shift in the demand curve, there is a shift in the
equilibrium point also. The demand curve shifts in any of the two sides:

•Rightward Shift: It represents an increase in demand, due to the favourable

change in non-price variables, at the same price.
•Leftward Shift: This is an indicator of a decrease in demand when the price
remains constant but owing to unfavourable changes in determinants other
than price.
SHIFT IN DEMAND
MOVEMENT IN DEMAND VS SHIFT IN DEMAND

BASIS FOR COMPARISON MOVEMENT IN DEMAND CURVE SHIFT IN DEMAND CURVE

Meaning Movement in the demand The shift in the demand curve
curve is when the commodity is when, the price of the
experience change in both the commodity remains constant,
quantity demanded and price, but there is a change in
causing the curve to move in a quantity demanded due to
specific direction. some other factors, causing
the curve to shift to a
particular side.

What is it? Change along the curve. Change in the position of the
curve.
Determinant Price Non-price
Indicates Change in Quantity Demanded Change in Demand

Result Demand Curve will move Demand Curve will shift

upward or downward. rightward or leftward.
 Supply

The concept of supply can be understood following the below-given

explanation:
1.The quantity of a commodity which a firm is willing to sell at a
particular price
2.Follows the ‘supply curve’
Higher the price, the greater the incentive for the firm to sell more.
 Determinants of Supply
The following are the determinants of the supply:
1.Cost of production – if it increases, supply decreases. The shifts in the supply
curve:
1. If the cost of production increases, the quantity supplied will reduce and
the supply curve will shift leftwards
2. If the cost of production decreases, the quantity supplied will increase.
The supply curve will shift rightwards.
2.Taxes – If taxes increase, supply will reduce, and the supply curve will shift
leftwards.
1. The impact of the increase in the cost of production and increase in
taxes will be the same After the global financial crisis of 2008, the
government reduced taxes to boost supply.
2. This shifted the supply curve rightwards.
3.Goals of Firms – Profit is not always the only goal of the firm
1. The goal may be sales maximization or social welfare
2. In this case, the supply increases, and the supply curve shifts rightwards
3. Supply may also increase due to good rainfall leading to increase in Agri
supply
 Market equilibrium

Market equilibrium is a stage where Quantity demanded = quantity

supply

Equilibrium point = point of intersection of demand and supply

curves

•Markets comprise of two groups – buyers and sellers

Buyers want lower prices to maximize their satisfaction
Sellers want higher profits
•Thus reducing the price below the equilibrium will lead to a
shortage. Hence price will automatically go up, in the interest of
both the groups till equilibrium is restored
 Market equilibrium

Increasing the price above the equilibrium will lead to over-supply

Suppliers will reduce the price to sell all the stock and thus
equilibrium will be rerstored

Consumer’s equilibrium is the situation where a consumer spends

his income on various commodities in such a manner that he gets
maximum satisfaction
Producer’s equilibrium is the situation where a firm produces that
level of output which provides its maximum profits
 Market equilibrium

When Demand Changes

Increase in demand and decrease in demand plays a crucial role in
determining the price of a product. Here is a detailed discussion regarding
that –
•Demand Increase
When supply remains constant, but the demand surges, it tends to shift the
demand curve rightwards. If the demand for a product steadily rises, it
ultimately affects the equilibrium price. Therefore, this price rise also
increases competition among buyers, which also hikes the price of a
product.
 Market equilibrium

On the flip side, this rise in price serves as an incentive to the

manufacturers. They will then increase production and supply that will
result in falling demand. A point to note here is that this process stays
operational until a new equilibrium is set. Resultantly, there is a hike in
both the equilibrium price and quantity.
•Demand Decrease
Similarly, if the supply remains constant, and demand for a product
plummets, the demand curve will shift towards the left. In a situation like
this, a condition of excess supply occurs at the equilibrium level. This
situation leads to a competition between sellers, who want to sell their
products due to this fall of prices.

Alternatively, once a product’s prices go down its market demand

increases. This demand then leads to an increase in supply and
manufacturing. This process then continues till a new equilibrium is in
place. Resultantly, there is a reduction in the equilibrium price as well as
quantity.
Market equilibrium

When Supply Changes

Supply-demand curve also observes a shift when there is any alteration in
the supply of a product. Here are two phenomena regarding that –
•Increase in Supply
When demand remains constant with a change in supply, it tilts the supply
curve towards right. Therefore, when the supply of a product rises its
demand at the equilibrium level also increases. This situation leads to a
competition among sellers, which results in a drop in prices of a product.

Moreover, this lowering of prices also increases the demand for a product
in the market, which also affects its production. This process continues till a
new equilibrium is found, and at that point, the price of a product
decreases and its quantity increases.
 Market equilibrium

•Decrease in Supply
Similarly, when the demand of a product remains constant, but its supply
plunges, it shifts the supply curve towards left. This reduction of supply
creates an excess demand at the equilibrium level, which results in an
increase in the price.

Contrarily, this price hike will be accompanied by a lowering of demand and

excess supply. This process will also carry on until a new equilibrium is
found. Thus, the equilibrium price of a product will rise, but its quantity will
fall.