UNIT 4: DEMAND AND SUPPLY
All societies necessarily make economic choices. Society needs to make choices
about what should be produced, how those goods and services should be produced, and
who is allowed to consume those goods and services.
The terms supply and demand do not mean the amount of goods and services
actually sold and bought; in any sale the amount sold is equal to the amount bought,
and such supply and demand, therefore, are always equal.
Supply is a fundamental economic concept that describes the total amount of a
specific good or service that is available to consumers.
Demand is an economic concept that relates to a consumer's desire to purchase
goods and services and willingness to pay a specific price for them.
Demand is comprised of three things.
•Desire
•Ability to pay
•Willingness to pay
It may seem obvious that in any sale transaction the price satisfies both the buyer
and the seller, matching supply with demand. The interactions between supply,
demand, and price in a (more or less) free marketplace have been observed for
thousands of years.
The Law of Demand states that, if all other factors remain equal, the higher the
price of a good, the less people will demand that good. In other words, the higher the
price, the lower the quantity demanded.
The law of supply relates price changes for a product with the quantity supplied.
In contrast with the law of demand the law of supply relationship is direct, not inverse.
The higher the price, the higher the quantity supplied. Lower prices mean reduced
supply, all else held equal.
The market price is the price at which buyers are willing to buy the same number
of goods that sellers are willing to sell. This point is called market equilibrium.
Because supply and demand can shift and change, equilibrium in a standard market is
also fluid, responding to changes in either market force.
A very important concept in understanding supply and demand theory is elasticity.
There are three main factors that influence elasticity of supply and demand:
1.The availability of substitutes. This is probably the most important factor
influencing the elasticity of a good or service. In general, the more substitutes, the
more elastic the demand will be.
2.Amount of income available to spend on the good. This factor affecting
demand elasticity refers to the total a person can spend on a particular good or service.
3.Time. The third influential factor is time. For example, if the price of cigarettes
goes up $2 per pack, a smoker with very few available substitutes will most likely
continue buying his or her daily cigarettes. This means that tobacco is inelastic because
the change in price will not have a significant influence on the quantity demanded.
If elasticity is greater than or equal to one, the curve is considered to be elastic. If
it is less than one, the curve is said to be inelastic.
Elasticity varies among products because some products may be more essential to
the consumer. Products that are necessities are more insensitive to price changes
because consumers would continue buying these products despite price increases.
Conversely, a price increase of a good or service that is considered less of a necessity
will deter more consumers because the opportunity cost of buying the product will
become too high.
