ICT-ED INSTITUTE OF SCIENCE AND TECHNOLOGY LIPA

Mercedes Bldg. P. Torres St. Lipa City, Batangas 4217

(043) 757-4445 / (043) 757-5944

SHS DEPARTMENT
12 - ABM
Learning Module
In
APPLIED ECONOMICS
(SY. 2020-2021)

Instructor:
Jojie R. De Ramos

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 WEEK 6
LESSON 4

The Tools of Applied Economics: Demand and Supply

Before we can apply the tools of economics, we must first know and understand them. In this section, we review the
basic principles of economics that form the foundation for its application. We begin by studying how the economy works. Who
decides what to produce, how to produce, and who gets what's produced? The answers to these questions depend on how
the economy is organized. In a command economy, economic decisions are made by the government, such as the communist
countries of Cuba and North Korea. In a laissez-faire (pronounced as les-ay-fair which is French for "allow to do") economy,
economic decisions are made by the market without government intervention. The market is simply a group of buyers and
sellers interacting with one another. Whenever we hear the term "market" we often associate it with a place to shop or do
business such as a wet market or a supermarket. But there need not be a specific place or location for a market to exist.
When we speak of the market for cellphones in the Philippines, we do not mean that there is one specific place where
cellphones are bought and sold, we simply mean that there are buyers and sellers of cellphones in the Philippines who may
be dispersed all throughout the country. Nowadays, there are few purely command and no purely laissez-faire economies.
Most countries have mixed economies containing elements of both systems. We examine how markets allocate scarce
resources using the model of supply and demand."

Demand

The quantity demanded of a good is the amount of a good that buyers are willing and able to buy. The law of demand
says that when prices rise, quantity demanded decreases; and when prices fall, quantity demanded increases. People can
buy more, and more people can buy, goods and services when prices are low than when they are high. This is because
consumers want to maximize the use of their money. A demand schedule is a table that lists the quantity demanded of a good
at different prices. Below is a demand schedule for mangoes.

As the price of mangoes increase, the quantity demanded decreases, following the law of demand. We can plot this
demand schedule onto a graph, with price on the vertical axis and quantity on the horizontal axis. We can connect the points
on the graph to form a downward sloping line known as a demand curve or simply demand. The downward slope of the curve
reflects the inverse relationship between price and quantity demanded the higher the price, the lower is the quantity
demanded, and vice versa.

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 Table 1. Demand for
Mangoes
Quantity Demand curve – as
140
Price Demanded the price of a good
120 (‘000 kgs) increases from 20 to
100 20 21 120 the demand
40 18 decreases from 21
PRICE

80 60 15 to 6
60
80 12
100 9
40 120 6

20
D

0
5 10 15 20 25 30 35
Demand for Mangoes

Supply

Our discussion of supply is analogous to that of demand, but here we take the sellers' point of view. The quantity
supplied of a good is the amount of the good that sellers are willing and able to sell. The law of supply says that when prices
rise, quantity supplied increases; and when prices fall, quantity supplied decreases. Sellers sell more, and more sellers want
to sell, when prices are high than when they are low. This is because the goal of the seller is to maximize their net benefit by
maximizing profit. A supply schedule is a table that lists the quantity supplied of a good at different prices. Below is the supply
schedule for mangoes.

Table 2. Demand for Supply Curve – as

120 Mangoes the price of a good
Quantity
Price Demanded
increases from 20 to
100
(‘000 kgs) 120 the supply
PRICE

80 0 0 increases from 5 to
20 5
60 40 10
30
60 15
40 80 20
100 25
20 120 30

0
5 10 15 20 25 30
Supply for Mangoes

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 As the price of mangoes increase, the quantity supplied increases following the law of supply. We can plot this supply
schedule onto a graph, with price on the vertical axis and quantity on the horizontal axis. When we connect the points on the
graph, we form an upward sloping line known as the supply curve or simply supply. The upward slope of the curve reflects
the direct relationship between price and quantity supplied: the higher the price, the higher is the quantity supplied, and vice
versa.

Prices of Basic Commodities

When we put the supply and demand curves on one and the same graph, they will intersect at one point called
equilibrium. The price and quantity at equilibrium are called the equilibrium price and the equilibrium quantity, respectively.

In the graph below, the supply and demand curves intersect at a single point called the equilibrium point (E), which
corresponds to an equilibrium price (PE) of Php 60 per kilo, and an equilibrium quantity (QE) of 15 000 kilos, Notice that at the
equilibrium point, the buying price is exactly equal to the selling price, and the quantity demanded is exactly equal to the
quantity supplied. Suppose the price of mangoes is at Php 100 per kilo which is above the equilibrium price of Php 60 per
kilo. At that price the quantity demanded of mangoes is 9 000 kilos, less than the quantity supplied of 25 000 kilos. This results
in a surplus of 16 000 kilos mangoes. Sellers would find that they have excess mangoes on their hands. Rather than leave
them to rot, sellers lower their prices to encourage sales. As the price goes down more and more buyers buy, while less and
less sellers sell mangoes. The price continues to go down until it reaches equilibrium.

P Equilibrium
140

120

100

80
E
PE 60

40

20

0
5 10 15 20 25 30 35 Q
QE

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 Now, suppose the price of mangoes is at Php 20 per kilo, which is below the equilibrium price of Php 60 per kilo. At
that price the quantity demanded of mangoes is 21 000 kilos, greater than the quantity supplied of 5 000 kilos. This results in
a shortage of 16 000 kilos of mangoes. Sellers would find that they are running out of stock and start raising their prices to
increase profits. As the price increases, less and less buyers buy, while more and more sellers sell mangoes. The price
continues to increase until it reaches equilibrium.

This is how markets allocate scarce resources. The prices adjust to equalize supply and demand, thereby eliminating
surpluses and shortages. High prices act as an incentive for sellers to sell more and buyers to buy less, while low prices act
as an incentive for sellers to sell less and buyers to buy more.

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 When a typhoon ravages a town, prices of basic commodities such as food, normally go up due to shortages resulting
from the destruction. The higher prices motivate traders from nearby towns to deliver those goods to the ravaged town.
Although prices may be higher in the short-term, they will eventually come down when supply arrives. This is the "magic" of
the markets. When there is a shortage of a commodity, the government need not tell sellers to sell more or buyers to buy less.
Prices rise so sellers automatically sell more, and buyers automatically buy less. Similarly, when there is a surplus, prices fall
so sellers automatically sell less and buyers automatically buy more.

The 18th century classical economist Adam Smith observed that markets operated as if led by an "invisible hand"
The invisible hand refers to self-interest. In maximizing their own net benefit, the actions of buyers and sellers benefit society
as a whole. This is especially true of the sellers, who can only sell and thereby profit if they offer something of value to the
buyers. In the succeeding chapters, we will apply the tools of supply and demand to other sectors of the economy

Given the numerous complaints about high prices and low wages, why doesn't the government just raise wages and
reduce the prices of basic commodities? That way, workers earn more and buy cheaper goods with their money, right? Well
not exactly. Price controls are the limits on price that governments set so that prices do not go above or below a certain level.
A price floor is a legal minimum price a good must sell. If the price floor is below the equilibrium price then it has no effect on
the market. But if the price floor is set above the equilibrium price, then we say that it is binding and the quantity demanded
is less than quantity supplied resulting in a surplus.

A price ceiling is a legal maximum price at which a good must sell. If the price ceiling is above the equilibrium price
then it has no effect on the market. However, if the price ceiling is set below the equilibrium price then it is binding and the
quantity demanded is greater than the quantity supplied resulting in a shortage. When price controls are imposed, prices are
unable to adjust to equilibrium so that markets are unable to allocate resources efficiently.

S
Price Floor S

Price Ceiling
D D

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 Governments impose price controls for the benefit of society. Price ceilings such as price caps are imposed to protect
consumers, while price floors such as the minimum wage, are imposed to protect producers. Despite these noble intentions
however, price controls may be harmful as price ceilings lead to shortages and price floors result in surpluses, thereby
distorting the market's allocation of resources.

Factors that Affect the Demand Curve

When the price changes, there is a movement along a fixed demand curve. When the price of mangoes increases
from Php 40 per kilo to Php 60 per kilo, there is a movement upwards and to the left along the demand curve so that quantity
demand decreases from 18 000 kilos to 15 000 kilos. However, when factors other than price affect the demand, the entire
demand curve can shift, to the left if the effect is to decrease demand, and to the right if the effect is to increase demand.
These other factors include (1) the number of buyers, (2) tastes, (3) the income of buyers, (4) the prices of related goods, and
(5) expectations.

When the number of buyers increases, the quantity demanded at each and every price rises, shifting the demand
curve to the right. Conversely, when the number of buyers decreases, the quantity demanded at each and every price falls,
shifting the demand curve to the left. Here we make a ceteris paribus assumption, that is, we hold all other factors constant
Suppose the entry of tourists increases the number of buyers of mangoes, raising the quantity demanded of mangoes at each
and every price by 5 000 kilos. It would be as if the entire demand curve had shifted to the right by 5 000 kilos.

When the demand curve shifts to the right while the supply curve remains fixed, the equilibrium point changes such
that both the equilibrium price and equilibrium quantity are higher.

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 A change in tastes in favor of mangoes would increase the number of buyers and shift the demand curve to the right,
while a change in tastes away from mangoes would reduce the number of buyers and shift the demand curve to the left

The income of buyers also affects demand. Normally, an increase in the incomes of buyers increases the demand
for goods and services, and vice versa. This is because higher incomes mean people can buy more, and more people can
buy, goods and services. That is why goods whose demand increases as the income of buyers increases and whose demand
decreases as the income of buyers decreases, are known as normal goods. Most goods are normal goods. However, there
is another type of goods where the opposite is true: its demand decreases when the income of buyers increases, and its
demand increases when the income of buyers decreases. These are known as inferior goods. Inferior goods are often goods
and services that people buy to save money. An example of an inferior good is salted fish or tuyo which is generally cheaper
compared to meat and vegetables, When incomes fall, people shift from eating meat to eating tuyo to save money, thereby
increasing the demand for tuyo. Conversely, when incomes rise, people can afford to eat better, more expensive dishes, and
so consume less tuyo. Another example of an inferior good is jeepney rides, which is a cheaper form of transportation
compared to riding taxis or owning a car. When incomes rise, people may prefer to ride taxis which are more expensive but
more convenient and comfortable, or buy a car of their own thereby reducing the demand for jeepney rides. When incomes
fall, people would rather ride the jeepney to save money thereby increasing the demand for jeepney rides.

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 The price of related goods can also affect demand. Goods can be related in two ways. They can be substitutes, where
one good can be used in place of another, or complements, where one good is used together with another. Coffee and tea
are substitutes because both of them are often taken at breakfast. If the price of coffee increases, the quantity of demanded
of tea increases. This is because the increase in price of coffee made it less attractive to buyers relative to tea. Conversely,
if the price of coffee decreases, the quantity demanded of tea decreases. On the other hand, coffee and cream are
complements because they often go together. We put cream in coffee to make it taste better. If the price of coffee increases,
the quantity demanded of cream decreases. This is because the higher price reduces the demand for coffee. If less coffee is
consumed, less cream is needed to put into the coffee.

Finally, buyers' expectations of future prices and events also affect demand. If gasoline prices are expected to go up
tomorrow, demand for gasoline will go up today. People would want to buy gasoline before prices go up, to save money.
Conversely, if gasoline prices are expected to go down tomorrow, demand for gasoline would go down today as motorists
wait for prices to decrease before filling up.

Factors that Affect the Supply Curve

When the price changes, there is a movement along a fixed supply curve. When the price of mangoes increases from
Php 40 per kilo to Php 60 per kilo, there is a movement upwards and to the right along the supply curve so that quantity
supplied increases from 10 000 kilos to 15 000 kilos. However, when factors other than price affect the supply, the entire
supply curve can shift, to the left if the effect is to decrease supply, and to the right if the effect is to increase supply. These
other factors include (1) the number of sellers, (2) input prices, (3) technology, and (4) expectations.

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 When the number of sellers increases, the quantity supplied at each and every price rises, shifting the supply curve
to the right. Conversely, when the number of sellers decreases, the quantity supplied at each and every price falls, shifting
the supply curve to the left. Suppose Indian mangoes are imported into the Philippines increasing the number of sellers of
mangoes, raising the quantity supplied at each and every price by 5 000 kilos. It would be as if the entire supply curve had
shifted to the right by 5 000 kilos.

When the supply curve shifts to the right while the demand curve remains fixed, the equilibrium point changes such
that the equilibrium price is lower but equilibrium quantity is higher.

Another factor that shifts the supply curve are input prices which refer to the cost of inputs or anything that goes into
the product such as raw materials and direct labor. A decrease in input prices raises profitability, which encourages more
sellers to sell, shifting the supply curve to the right Conversely, an increase in input prices reduces profitability, which
discourages sellers from selling thereby lowering supply and shifting the supply curve to the left. Meanwhile, technology shifts
the supply curve in only one direction: to the right. This is because technology always moves forward, never backward. Thus,
advances in production technology lower the cost of production, raising profitability which encourages more sellers to sell,
shifting the supply curve to the right.

THE TOOLS OF APPLIED ECONOMICS Demand And Supply

 The expectations of sellers also affect supply. If sellers of expect the price of mangoes to go up tomorrow, they will
sell less today and wait for higher prices tomorrow to increase their profits. This is known as hoarding, conversely, if sellers
expect prices to go down tomorrow, they will sell more today.

Activity 4.

The market for pizza has the following demand and supply schedule (*per slice)

QUANTITY QUANTITY
PRICE
DEMANDED SUPPLIED
400 135 26
500 104 53
600 81 81
700 68 98
800 53 110
900 39 121

1. Graph to scale the demand and supply curves.

2. What is the equilibrium price and equilibrium quantity?

3. If the market for pizza shifted to the following demand and supply (*per slice)

QUANTITY QUANTITY
DEMANDED SUPPLIED
140 31
109 58
86 86
73 103
58 115
44 126

3.1 Graph to scale the shift in demand curve.

3.2 Graph to scale the shift in supply curve.

3.3 Graph to scale the new demand and supply curves.

3.4 What is the new equilibrium price and equilibrium quantity?

THE TOOLS OF APPLIED ECONOMICS Demand And Supply