Demand and Supply 25
Demand and Supply 25
Demand and Supply 25
PRICE goes
SUPPLY goes
up
Then…
up
Part 2. As PRICE decreases, SUPPLY decreases
SUPPLY goes
PRICE goes
down
down
Then…
Law of supply
• According to the law of supply, suppliers will offer more of a good at a
higher price
• Think about this: If I am a seller and people are willing to pay more for
what I am selling how will I behave?
Exceptions to the law of supply
Change in business
It may happen that the seller may plan to enter into an entirely
new business by exiting the current one then the seller may sell
his goods at lower prices to clear them off
Monopoly
When a small number of producers control the supply of goods in
the market then the law of supply may not operate. For example,
in the case of monopoly (single seller) may not necessarily offer
a larger quantity supplied even though the price of goods is
higher. Market control by the monopoly allows it to set the
market price based on demand in the market.
Exceptions to the law of supply
Perishable Goods
In cases of perishable goods, the supplier would offer to sell
more quantities at lower prices to avoid losses due to damage to
the product
Legislation Restricting Quantity
Suppliers cannot offer to sell more quantities at higher prices
where the government has put some regulations on the quantity
of the good to be produced or the price ceiling at which the good
is to be sold in the market
Elasticity of supply
• Elasticity of supply measures the sensitivity or responsiveness of
quantity supplied to a change in price of the commodity.
• Price elasticity of supply measures the responsiveness to the supply
of a good or service after a change in its market price
Elasticity of supply
• If the price of a Ukwaju ice cream increases by 10%, and the supply
increases by 20%
= 20/10 = 2
Interpretation of Elasticity of supply
• Perfectly Inelastic Supply ( Es = 0)
• A service or commodity has a perfectly inelastic supply if a
given quantity of it can be supplied whatever might be the
price. The elasticity of supply for such a service or commodity is
ZERO.
• This indicates that supply of a commodity is not sensitive to
price changes. The same quantity of supply will be supplied at
any alternative prices
Interpretation of Elasticity of supply
•…
Interpretation of Elasticity of supply
Perfectly elastic supply ( Es = ∞ )
• The PES for perfectly elastic supply is infinite, where
the quantity supplied is unlimited at a given price, but
no quantity can be supplied at any other price
• Perfectly elastic indicates that a percentage change in
price causes an infinite change in quantity supplied.
Interpretation of Elasticity of supply
Interpretation of Elasticity of supply
Inelastic Supply ( Es<1)
Inelastic supply indicates that supply is not very sensitive to price
changes. A percentage change in price results into a less
percentage change in quantity supplied
Interpretation of Elasticity of supply
Interpretation of Elasticity of supply
Elastic supply (Es > 1 )
A percentage change in price causes a higher percentage change
in quantity supplied. In general quantity supplied is sensitive to
price changes
Interpretation of Elasticity of supply
Price determination
Ways of price determination
i. Price mechanism: the price is determined by the free interaction of
demand and supply where (Qd=Qs)
ii. Sale auction; price is determined through bidding therefore it is
determined by the highest bidder
iii. Haggling the price is determined through bargaining
iv. Government controls; the government may set minimum or maximum
price
i. Price ceiling (maximum price) is the price set by the government below the
equilibrium price. It aims at protecting consumers against excessive high prices
ii. Price floor (minimum price) is the price set by the government above the
equilibrium price. It aims at motivating producers after realizing that the current
price is low
Price determination
i. Price mechanism
• The price of a product is determined by the law of supply and
demand.
• The equilibrium price of a good is the price at which quantity
supplied equals quantity demanded ( Qd=Qs)
• The price in the market is determined by the free intersection of
the forces of demand and supply and as above the price will be
determined at a point where Qd=Qs
• Graphically, the supply and demand curves intersect at the
equilibrium price
Price determination
Qs=Qd
Price determination
Given the table below determine the equilibrium price and
quantity
Price determination
Given the following demand and supply functions calculate
the equilibrium price and quantity
Qs = 100 + 1P and
Qd = 400 - 5P
Qs=Qd
Therefore: 100 + 1P = 400 - 5P
P= 50
Q= 150
Price determination
ii. Government Price controls
Government price controls; the government may set minimum or
maximum price
i. Price ceiling (maximum price) is the price set by the
government below the equilibrium price. It aims at
protecting consumers against excessive high prices
ii. Price floor (minimum price) is the price set by the
government above the equilibrium price. It aims at
motivating producers after realizing that the current price
is low
Price ceiling vs price floor
Price ceiling vs price floor
• Price ceilings prevent a price from rising above a certain level.
• When a price ceiling is set below the equilibrium price, quantity
demanded will exceed quantity supplied, and excess demand or
shortages will result.
• Price floors prevent a price from falling below a certain level.
• When a price floor is set above the equilibrium price, quantity
supplied will exceed quantity demanded, and excess supply or
surpluses will result.
• When government laws regulate prices instead of letting market
forces determine prices, it is known as price control.
Price ceiling vs price floor
Review questions
1. The estimates suggest the following price elasticities of demand:
0.6 for physician’s service, 4.0 for foreign travel and 1.2 for banking
services. Interpret the given coefficients
2. Explain the factors influencing the price elasticity of demand and
supply
3. Distinguish between the change in quantity demanded from the
change in demand
4. With examples explain the assumptions to the law of demand
5. Explain the determinants of demand and supply