PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 1
CHAPTER
2
THEORY OF DEMAND,
SUPPLY, AND
ELASTICITY
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 2
LEARNING OUTCOME
After reading this chapter, student should be able to :
q
q
q
q
Explain the meaning of demand, law of demand and
market demand
Construct a demand schedule and demand curve
Distinguish between a change in quantity demand and a
change in demand
Distinguish between exceptional and inter-related
demand
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 3
LEARNING OUTCOME
q
q
q
q
Explain the meaning of supply, law of supply and
market supply
Construct a supply schedule and supply curve
Distinguish between a change in quantity supply and a
change in supply
Distinguish between exceptional and inter-related
supply
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 4
DEFINITION OF DEMAND
Demand is defined as the ability and willingness
to buy specific quantities of goods
in a given period of time
at a particular price, ceteris paribus.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 5
CLASSIFICATION OF GOODS
AND SERVICES
q Free goods are goods that have no production
cost.
q Public goods are goods that are for common
use and will benefit everyone.
q Economic goods are goods of value that can
be seen and touched. Economic services are
intangible things (with value) that cannot been
seen or touched.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 6
LAW OF DEMAND
Law of demand states that the higher the price
of a good, the lower is the quantity demanded
for that good and the lower the price, the higher
is the quantity demanded, ceteris paribus.
P ­ Qdd ¯
P ¯ Qdd ­
NEGATIVE RELATIONSHIP
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 7
8
DEMAND SCHEDULE AND
DEMAND CURVE
q Demand schedule:
− A table that shows the relationship between the
price of a good and the quantity demanded
q Demand curve
− A graph of the relationship between the price of a
good and the quantity demanded
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 8
DEMAND SCHEDULE AND
CURVE
Demand Schedule
Demand Curve
Price
Quantity
5
2
4
4
3
6
2
8
1
10
5
4
3
DD
2
1
0
2
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
4
6
8
10
All Rights Reserved
2– 9
EXAMPLE 1A: SOFIA’S DEMAND
FOR MUFFINS
Sofia’s demand
schedule for muffins
−
Notice that Sofia’s
preferences obey
the law of demand.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
Price
of
muffins
Quantity
of muffins
demanded
$0.00
16
1.00
14
2.00
12
3.00
10
4.00
8
5.00
6
6.00
4
All Rights Reserved
2– 10
EXAMPLE 1B: SOFIA’S D
SCHEDULE AND D CURVE
Price of
Muffins
Quantity
Price
of muffins
of
demande
muffins
d
DSofia
$6.00
$5.00
$4.00
A decrease
in price…
$3.00
$2.00
$1.00
$0.00
0
5
10
15
Quantity of
Muffins
$0.00
16
1.00
14
2.00
12
3.00
10
4.00
8
5.00
6
6.00
4
… increases the quantity of muffins demanded.
All Rights Reserved
PRINCIPLES
OF ECONOMICS
Third Edition
Mankiw,
Principles
of
Economics,
10th
Edition.
©
2024
Cengage.
All
Rights
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
2– 11
INDIVIDUAL AND MARKET
DEMAND
INDIVIDUAL DEMAND
The relationship between the quantity
of a good demanded by a single individual
and its price.
MARKET DEMAND
The relationship between the total quantity
of a good demanded by adding all the quantities demanded
by all consumers in the market and its price.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 12
Consumers’
income
Tastes and
trends
Price of
related goods
Supply of
money in
circulation
Level of taxation
Population or
number of
buyers
DETERMINANTS
OF DEMAND
Festive
seasons and
climate
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
Expectation
about future
prices
Advertisement
All Rights Reserved
2– 13
DETERMINANTS OF DEMAND INTERNAL FACTOR
q Price of goods
§ The price of the product depends of the cost of
production, which in turn will determine the
quantity that will be purchased by the consumer.
§ The higher the price the lower the demand.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 14
DETERMINANTS OF DEMAND EXTERNAL FACTOR
q Price of related goods
§ Substitute goods - A change in the price of a
substitute product affects the demand for the
product in the same direction. E.g.: tea vs coffee
§ Complementary goods – The change in the price
of complementary product affects the demand for
the product in the opposite direction. E.g.: pen vs
ink
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 15
DETERMINANTS OF DEMAND EXTERNAL FACTOR
q Consumers’ income
§ When income increase, consumers’ demand for
more goods and services will increase. Goods
that increase in demand as income increases are
normal goods such as cars, shirts, and books.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 16
DETERMINANTS OF DEMAND EXTERNAL FACTOR
q Tastes and preferences
§ If a product becomes more fashionable, the
demand for it will increase and if the same
product becomes outdated, the demand for it will
fall.
q Population or number of buyers
§ A larger population with a high rate of growth
creates a greater demand for goods and services.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 17
DETERMINANTS OF DEMAND EXTERNAL FACTOR
q Advertisements
§ Advertised goods are normally have a higher
demand because of awareness. Consumers will
only buy goods and services when they are
aware of the existence of those products.
q Festive season and climate
§ During festive seasons, different products will be
in high demand.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 18
DETERMINANTS OF DEMAND EXTERNAL FACTOR
q Level of taxation
§ The higher the tax, the lower the purchasing
power of consumers, and vice versa. This will
lead to decrease in the demand.
q Supply of money in circulation
§ The larger the supply of money in circulation, the
greater the demand for goods and services,
because consumer have more money to spend.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 19
CHANGES IN QUANTITY DEMANDED
VS. CHANGES IN DEMAND
CHANGES IN QUANTITY DEMANDED
CHANGES IN DEMAND
Price
Price
D1
DD
v
v
v
v
D0
Quantity
Movement along DD curve
Price changes and other factors are
constant
Upward movement ´ Decrease in
quantity demanded (Contraction)
Downward movement ´ Increase in
quantity demanded (Expansion)
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
Quantity
v
v
v
v
Shift in the demand curve
Occurs when there are changes in
other factors but price remains
constant
Increase in Demand (D0 à D1)
Decrease in Demand (D1 à D0)
All Rights Reserved
2– 20
SHIFT VS. MOVEMENT ALONG
CURVE
q Change in demand:
– A shift in the demand curve
– Occurs when a non-price determinant of demand
changes (like income or number of buyers)
q Change in the quantity demanded:
– A movement along a fixed demand curve
– Occurs when the price changes
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 21
EXAMPLE 1E: DEMAND CURVE
SHIFTS
D1
P
Suppose the number of
buyers increases.
D2
$6.00
• Then, at each P, Qd
will increase (by 5 in
this example).
• The demand curve
shifts to the right
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
5
10
15
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
20
25
30
Q
All Rights Reserved
2– 22
SUMMARY: VARIABLES THAT
INFLUENCE BUYERS
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 23
EXCEPTIONAL DEMAND
Exceptional Demand is the opposite of the Law of Demand
where as price increases, demand will also increase and vice versa.
GIFFEN GOODS
SPECULATION
EMERGENCIES
STATUS SYMBOL GOODS
HIGHLY-PRICED GOODS
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 24
INTER-RELATED DEMAND
CROSS DEMAND
The demand for a good is also affected by the price of
its substitute or complementary goods. Cross demand can be
divided into two: Joint demand and competitive demand.
DERIVED DEMAND
Derived demand is the demand for a good
which is derived from other goods.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 25
CROSS DEMAND: JOINT DEMAND
VS. COMPETITIVE DEMAND
Cross Demand
Positive relationship exists
between substitute goods
Price of pizza
Price of pizza
DD
Negative relationship exists
between complement
goods
P2
P2
P1
P1
DD
Q2
Q1
Quantity of soft drinks
Joint Demand
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
Q1
Q2
Quantity of
spaghetti
Competitive Demand
All Rights Reserved
2– 26
DERIVED DEMAND
Cross Demand
Positive relationship exists
between substitute goods
Wage
Pricerate
of pizza
(RM per hour)
Price (RM’000)
of pizza
S0DD
S0
Negative relationship exists
between complement
goods
P21
P
P0
P1
D1
WR
P21
D1
WR
P10
D0DD
Q1
QQ0 2
Q1 QuantityQuantity
of soft drinks
Demand
Joint Demand
and supply for house
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
D0
Q01
Q02
Quantity
Quantity
of of
softworkers
drinks
Demand
Competitive
and supply
Demand
for carpenters
All Rights Reserved
2– 27
INTERRELATED DEMAND
COMPOSITE DEMAND
Composite demand is demand for a good
that has multiple uses
For example: oil can be used for petrol,
kerosene and diesel
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 28
COMPOSITE DEMAND
Price
Price
S1
S0
S0
P1
P1
P0
P0
D1
D0
Q0
Q1 Quantity
Demand and supply for petrol
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
D0
Q1
Q0
Quantity of
workers
Demand and supply for diesel
All Rights Reserved
2– 29
DEFINITION OF SUPPLY
Supply is defined as the ability and willingness
to sell or produce a particular product
and services in a given period of time
at a particular price, ceteris paribus.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 30
LAW OF SUPPLY
Law of supply states that the higher the price
of a good, the greater is the quantity supplied
for that good and the lower the price of a good,
the lower is the quantity supplied, ceteris paribus.
P ­ Qss ­
P ¯ Qss ¯
POSITIVE RELATIONSHIP
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 31
SUPPLY SCHEDULE AND
CURVE
Supply Schedule
Supply Curve
Price
Quantity
12
5
10
10
4
8
8
3
6
6
2
4
4
1
2
2
Supply
0
1
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
2
3
4
5
All Rights Reserved
2– 32
INDIVIDUAL AND MARKET
SUPPLY
INDIVIDUAL SUPPLY
The relationship between the quantity of a product
supplied by a single seller and its price.
MARKET SUPPLY
The relationship between the total quantity
of a product supplied by adding all the
quantities supplied by all sellers
in the market and its price.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 33
Price of related
goods
Improvement in
infrastructure
Proportion of the
Cost
of production
expenditure
on a
product
Expected
future price
Technological
advancement
DETERMINANTS
OF SUPPLY
Government
Policies
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
Number of
sellers
All Rights Reserved
2– 34
DETERMINANTS OF SUPPLY –
EXTERNAL FACTORS
q Price of related goods
§ Substitute goods – Supply of a product will
decrease when there is an increase in the price of
substitute product. E.g.: Pepsi vs Cola Cola
§ Complementary goods – An increase in the price
of a product will increase the supply of a
complementary product. E.g.: pen vs ink
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 35
DETERMINANTS OF SUPPLY –
EXTERNAL FACTORS
q Cost of production
§ Supply will change in response to the factors of
production: labor, capital. When the cost of
production increase, the quantity supplied will
decrease and vice versa.
q Expectation about future price
§ The higher the expected future price of a product,
the smaller the current supply of a product, and
vice versa.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 36
DETERMINANTS OF SUPPLY –
EXTERNAL FACTORS
q Technological advancement
§ New technologies that enable producers to use
fewer factors of production will lower the cost of
production and increase the supply.
q Number of sellers
§ The larger the number of firms supplying a
product, the larger the quantity supplied for the
product, and vice versa.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 37
DETERMINANTS OF SUPPLY –
EXTERNAL FACTORS
q Government policies
§ Tax – decrease the supply
§ Subsidies – increase the supply
q Improvement in infrastructure
§ Improvements in the infrastructure such as
transportation and communication will facilitate
free and fast movement of goods and services
within the country. This increase the supply of a
product.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 38
CHANGE IN QUANTITY SUPPLIED
VS. CHANGE IN SUPPLY
CHANGE IN SUPPLY
CHANGE IN QUANTITY SUPPLIED
Price
Price
s0
s1
SS
Quantity
Quantity
v Movement along supply curve
v Shift in the supply curve
v Price changes and other factors are
v Occurs when there are changes in
constant
v Downward movement ´ Decrease in
quantity supplied (Contraction)
v Upward movement ´ Increase in
quantity supplied (Expansion)
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
other factors but the price remains
constant
v Increase in Supply (S0 à S1)
v Decrease in Supply (S1 à S0)
All Rights Reserved
2– 39
ACTIVE LEARNING 2A: DECREASE
IN P OF APPLE JUICE
Price of
apple
juice
Move down along the
supply curve to a lower
P and lower Q.
q
S curve does not shift.
S
1
P1
P2
q
A
B
Q2 Q1
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
Quantity of
apple juice
All Rights Reserved
2– 40
ACTIVE LEARNING 2B:
TECHNOLOGICAL ADVANCE
P1
Better technology
reduces production
costs
q At each price, QS
increases.
q The supply curve
shifts to the right
q
Price of
apple
juice
S
S2
1
A
Q1
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
Q2
Quantity of
apple juice
All Rights Reserved
2– 41
EXCEPTIONAL SUPPLY
q Exceptional Supply is the opposite of the Law of
Supply where as price increases, the quantity
supplied decreases and vice versa.
q Normally, this happens in the supply of labor
and known as the “Backward Bending Supply
Curve”.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 42
EXCEPTIONAL SUPPLY
q Supply of labor is defined as the number of
hours or days a particular type of labor is
offered for hire at different wage rates. The
higher wage rate, the longer the supply of labor
hours.
q However, there may be exceptions to this rule
(which known as the exceptional supply). The
supply can be affected by the work-leisure ratio
as illustrated in the next figure.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 43
EXCEPTIONAL SUPPLY
Exceptional Supply is the opposite of the Law of
Supply where as price increases, the quantity supplied
decreases and vice versa
Wage Rate
20
Income Effect
(Exceptional Supply
Curve)
15
10
Substitution Effect
5
0
1
2
3
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
4
5
6
Labour
All Rights Reserved
2– 44
EXCEPTIONAL SUPPLY
q A labor will spend 24 hours of his day either on
work or leisure. His non-working hours (earning
income) will be considered his leisure time. The
opportunity of working is to forgo the hours of
leisure.
q An increase in wage rate may encourage
substitution of this leisure for work and
encourages the worker to put in additional work
hours (known as substitution effect).
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 45
EXCEPTIONAL SUPPLY
q Supply of labor will shift upwards to the right.
q However, after certain number of hours,
workers will be unwilling to substitute their
leisure for work. Although higher wage rates
may be offered, workers will view their leisure
as important.
q This is called the income effect of an increase
in the wage rate.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 46
INTERRELATED SUPPLY
JOINT SUPPLY
Increase in the supply of one good
brings to an increase in the supply
of another related goods.
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 47
INTERRELATED SUPPLY
Example: Sheep can be used for meat,
wool, and sheepskin, whereas cows for
milk, beef and dairy products. If the
supply of sheep increases, the supply for
meat and wool increase, and vice versa
PRINCIPLES OF ECONOMICS Third Edition
© Oxford Fajar Sdn. Bhd. (008974-T), 2013
All Rights Reserved
2– 48