Introduction To Supply and Demand in Economics
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Published: Mon, 23 Jul 2018
Introduction to Demand & Supply
According to one of the microeconomic textbook from Oxford demand & supply is the basis of economic of pricing that the prices are determined using the demand and supply concept. In other words, the demand and supply system is to show the dependence of demand and supply on price.
This session is the description of what is demand in economics. Joseph and Kamil (1996) stated that demand is the rate at which consumers want to buy a product. There is difference between demand and want, according to Oxford microeconomics textbook (2008, p.28) want is meant to have a desire or a wish for something while demand is the desire or need of customers for goods and services which they want to buy or use. When the product price that is high in the market, the demand will be low. When the product price is low in the market then the demand will be high as many consumers will be able to purchase the product if the product price is low.
- Law of Demand
Law of demand is to explain that when higher the price of a good, the lower is the quantity demanded for that good. When the price is lower down, the quantity demanded is higher. Besides that, law of demand also explains there will be a negative or an inverse relationship between price and quantity demanded.
Oxford microeconomics textbook (2008, p.28) stated that every individual and society practices the law of demand. Peoples will always buy more goods when the goods of the price is reduced. For example people will definitely buy more goods in a mega sales confirm to the normal season of the sale. This statement can clearly relates to on October 2, 2014 government increased the petrol and diesel price by 20 cent per liter as in line with the federal government’s subsidy rationalization policy. The new retail price of RON95 will be RM2.30 and diesel will be RM2.20 per liter. When government increase the petrol and diesel price by 20 cent, definitely there are a lot of Malaysian consumers struggle with the price of it.
- Determinants of Demand
Determinants of demand can be defined as when there is changes in price, quantity demanded will change. It is a movement along the same demand curve and when the factors other than price changes, demand curve will shift. Below are the information of the determinants of demand.
- Income: Income is define as the rise of the individual’s income will lead to an increase of demand it is because income of a consumer can influence the purchasing decision of an individual. Rise of income will lead individual demand for more goods and services such as houses, cars and others. But when there is income unfavorable, definitely it will lead individuals to decrease their demand.
- Tastes and fashions: Changes in tastes and fashions of consumers can change significantly the demand for goods and services.
- Population or number of buyers: Demand of goods and services are all depends on the size of the population of buyers in the market. If there is a large population with a high rate of growth creates greater demand for the goods and services.
- Expectation: The event that consumer expect in the future will also give a impact on the demand it is because the higher the expected future price of a good, the current demand for that good will be higher and vice versa.
- Advertisement: Goods that have advertisement are normally goods with high demand. It needed the advertisement to create the awareness and attract the consumer to buy the goods and services when they are aware of the existence of the goods.
- Price of related goods: This to explain that demand for a good is affected by the changes in price of related goods. There are two categories which are substitute goods and complementary goods.
– Substitute goods: Substitute goods is define as the goods can be replace by another goods. For example, coffee and tea, chicken and pork and many others goods that can find a similar replacement.
– Complementary goods: Complementary goods are those goods that are used in conjunction with another good
Matt Johnson (2014) define supply as the total quantity of a product or service that the marketplace can offer. The quantity supplied is the amount of a product or service that the suppliers will be supply willingly with a given price. According to Oxford microeconomics textbook (2008, p.40) supply is defined as the ability and willingness to sell a specific quantities of the goods in a given period of time at particular price, everything else held constant.
- Law of Supply
Under Oxford microeconomics textbook (2008, p.41) stated “Other things being equal, law of supply states that higher the price of a good, higher is the quantity supplied for that good and lower the price, lower the quantity supplied.” It is stated that the law of supply is a positive or a direct relationship between the price and the quantity that is supplied. Goods that sold by the seller will want to gain more profit, that’s why goods are normally sell more at a higher price.
- Determinants of Supply
Determinants of supply can be define as when there is factors and price of the good is constant, there will be change in supply. Below are the factors and how it can shift the supply curve.
- Cost of production: The change of supply will response to the factor of production such as labour, capital or land. The resource for production increased therefore cost of production will increase as well, thus it reduce the supply of the good.
- Price of related goods: Supply will be influenced by the prices of related goods such as substitute goods and complementary goods. When there is price increase of the substitute goods in product, the supply of the goods will decrease and vice versa.
- Expectation of seller: When the seller are expecting a higher price of the good in future, the supply will be smaller as for the goods and vice versa.
- Technological advancement: The technologies improvement have been the most important influence on the supply due to the innovations in technologies enable the producers to use fewer factors of product that will lower down the cost of product and therefore the supply will increase.
- Number of sellers: If the firms of supplying goods is growing large, then the larger the supply of the goods and vice versa.
- Government policies: Supply of the good will be affected if there is any implementation rules by various government policies such as taxes and subsidies. When the government imposed sales tax definitely it will caused higher cost of product and thus the supply will decrease.
Government increased the price of petrol and diesel increased
This is the case study that shows on 2nd October 2014, government have increased the price of petrol and diesel to 20 cents per liter as in line with the federal government’s subsidy rationalization policy. The new retail price of RON95 will be RM2.30 and diesel for RM2.20 per liter. The assignment will now explains how does the changes will affect the demand and supply on Malaysian consumers.
The demand of petrol
As law of demand already explained determinants of demand can be define as when there is changes in price, quantity demanded will change. When government increase the price of petrol and diesel, definitely the demand towards petrol will decrease as it determinates the income of consumers is affected. Petrol price plays a big role towards the market, when price of petrol increase which means the market or society will be facing the increasing of inflation. Inflation occurs when petrol price increase it is because production line will need to increase their prices as well to cover up the petrol cost by delivering the products.
According to a statement from DAP Malaysia, “The government must realize that allowing the increase of fuel prices will create two- prong negative impacts. Firstly, it will cost more for car users and this will definitely affect a large section of the consumers, as a big population of Malaysian society owns a car. Furthermore, the price hike in fuel will have cascading effects and lead to increase of prices of other goods and services and thus contributing to inflation in our economy.Secondly, the higher cost of fuel will increase the overall operating cost of doing business in Malaysia.”
- The supply of petrol
Supply of petrol will not be a problem in Malaysia although the government increased the price of petrol. People will still need to have petrol for their cars. Therefore the supply of petrol will remain stable as there is a statement from the PKR secretary general ”Because the people are still paying prices higher than the market prices for unsubsidized fuel.”
- The demand and supply curve for petrol
The graph above is the demand and supply curve of the petrol as the demand of petrol will decrease as government do not make any changes for the petrol price. Kindly refer below for the symbol terms.
S = Supply
D = Demand
P 0 & 1 = Price equilibrium
Q 0 & 1 = Quantities demanded
The demand of diesel
Government also increase the diesel price for 20 cent per liter, the total amount of diesel is now RM2.20. The demand of diesel is same with the demand of petrol, price increase and demand will decrease eventually. The only thing that affected by the price of diesel is the production from the manufacturers as they will need to increase the price of production to cover up the production cost.
- The supply of diesel
The supply of diesel will be maintain the same as the supply of petrol, government will not face problem in Malaysia although the government increased the price of diesel. Manufacturers will still needed diesel for production cost, therefore the total damage will only bare by consumers.
- The demand and supply curve for diesel
The graph above is the demand and supply curve of the petrol as the demand of diesel will decrease as government do not make any changes for the diesel price. Kindly refer below for the symbol terms.
S = Supply
D = Demand
P 0 & 1 = Price equilibrium
Q 0 & 1 = Quantities demanded
Conclusion for price of increasing petrol and diesel
After the knowing of the effect of increasing petrol and diesel, Malaysia government should consider decreasing the price to a reasonable price where consumers are able to afford the price. Price of petrol and diesel increase will cause the inflation rate increase in Malaysia. Malaysia is needed to be remained competitive in the eyes of foreign investors.
Introduction to Elasticity
Elasticity in economics is important because it is a important concept to be mastered in order to apply the concept to the households, businesses and researchers as it is vital and very applicable in the daily life. Elasticity is the measurement of the magnitude of responsiveness of any variable such as quantity demanded or quantity supplied to the change to the determinants factor such as price and income. According to Oxford microeconomics textbook (2008, p.87) the value of elasticity can be measure by the graph below:
- Types of elasticity
Below are the table of the types of elasticity:
- Price Elasticity of Demand
The price of elasticity of demand is to measure on how much the quantity demanded of a good responds to a change in price of the good. According to Economics Online, price elasticity of demand shows the relationship between price and quantity demanded and provides a precise calculation of the effect of a change in price on the quantity demanded.
To calculate the price elasticity of demand between two points on a demand curve, we will need a formula to calculate. Refer the graph below for the formula of calculating price elasticity of demand.
There are also 5 types of the demand curve exist in price elasticity of demand that shown in Oxford microeconomics textbook (2008, p.89).
- Perfectly Inelastic Demand: Elasticity = 0 which defines as regardless of the price, the quantity of demand will remain the same.
- Inelastic Demand = <1 which defines as the quantity demanded will move proportionately less than the price
- Unit Elastic Demand = 1 which defines as the quantity demanded moves the same amount as the price moves.
- Elastic Demand > 1 which defines the quantity demanded moves proportionately more than the price.
- Perfectly Elastic = Infinity which defines when there is a small change in the price will lead to the huge change of the quantity demanded/
- Price Elasticity of Supply
The price elasticity of supply is the measurement on how much the quantity that supplied for the good responds to a change in the price of the good that computed as the percentage change in quantity that is supplied divided by the percentage of changes in price.
To calculate the price elasticity of supply between two points on a supply curve, we will need a formula to calculate. Refer the graph below for the formula of calculating price elasticity of supply.
Price elasticity of supply =
There are also 5 types of the supply curve exist in price elasticity of supply that shown in Oxford microeconomics textbook (2008, p.95).
- Elastic > 1 defines as the quantity supplied moves proportionately more than the price.
- Inelastic < 1 defines as the quantity supplied moves proportionately less than the price.
- Unit Elastic = 1 defines as the quantity supplied moves at the same amount as the price moves.
- Perfectly inelastic = 0 define as the regardless of the price, the quantity of the supply will remain the same
- Perfectly elastic = infinity define as when there is a small change in the price will lead to the huge changes in the quantity supplied.
- Cross Elasticity of Supply
Cross elasticity of supply is the measurement on how much the quantity demanded of a good responds to a change in the price of another good where it will computed as the percentage change in quantity demanded of goods A divided by the percentage change in the price of goods B.
Below is the formula of cross price elasticity
Cross price elasticity of demand =
According to the statement of economics export (Mike Mofatt, 2015) “The cross-price elasticity of demand is used to see how sensitive the demand for a good is to a price change of another good”. The high positive of the cross price elasticity will let us know that if the price of the good goes up and the demand for the other good goes up as well. A negative tells us just the opposite, that an increase in the price of one good causes a drop in the demand for the other good. A small value (either negative or positive) tells us that there is little relation between the two goods.
Below are the interpretation of the degree of elasticity:
- Goods 1 & 2 < 0 = Goods 1 & 2 are complimentary goods
Definition: Both goods are require to be paired up and related
Example: Pizza & Coke, A good pizza store that serves great pizza will generates demand for the drinks as well.
- Goods 1 & 2 > 0 = Goods 1 & 2 are substitute goods
Definition: They are substitutes goods when there is price increase on the good and cause the demand increase for the good of others.
Example: Replacing an iPhone 6 with a Samsung Note 4 will be better than replacing the iPhone 6 with a Samsung tablet.
- Goods 1 & 2 = 0 = Goods are not related goods
Definition: The price of the good will not affect the demand for another good.
Example: Ferrari, even if the price increase it will not related to the demand for another good. It has its own target market.
- Income Elasticity of Demand
Income elasticity of demand is define as the measurement of how much the quantity demanded of the good responds to the changes of consumer income and computed as the percentage of change in quantity demanded divided by the percentage change in income.
Below is the calculation of income elasticity
Income elasticity of demand =
According to the statement of economics export (Mike Mofatt, 2015) “Income elasticity of demand is used to see how sensitive the demand for a good is to an income change.” When there is high income elasticity, it will be sensitive to the demand for a good is to income changes. A very high income elasticity shows that the consumer’s income goes up and consumers will buy a great deal more of that good. A very low price elasticity implies just the opposite, that changes in a consumer’s income has little influence on demand.
Below are the interpretation of the coefficient of income elasticity:
Coefficient of Income Elasticity
Degree of Elasticity
Types of Good
Ey = 0
Ey > 0
0 < Ey < 1
Ey < 0
Table 1: Oxford microeconomics (2008, p.94)
Conclusion for elasticity
With all the research that has been done, elasticity do play a important role in economics with the measurement of responsiveness towards one determinant to the change in one of the determinant’s factor.
Conclusion and recommendation
With the research of doing this assignment I get to learn about the characteristics of useful economics information such as demand & supply, law of demand & supply, determinants of demand & supply. Each of the characteristic of the economics information also will determine the usefulness.
Through this assignment, I have know about the information of elasticity. There are four types of elasticity such as price elasticity of demand, price elasticity of supply, cross price elasticity & income elasticity. I also learnt to how to draw different types of demand curve.
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