Demand and Supply, Laws, Schedules and Market Equilibrium for SS 1

Theory of Demand and Supply

Performance Objectives

By the end of the lesson, students should be able to:

1. define demand and supply;
2. construct and interpret demand and supply schedules;
3. draw and label demand and supply curves, showing the relationship between price and quantity;
4. state the laws of demand and supply with the aid of diagrams and explain factors that affect demand and supply;
5. using a given set of data, determine the equilibrium price and quantity of a given product.

Understanding Demand

Demand in economics refers to the quantity of a good or service that consumers are willing and able to purchase at various prices over a specific period.

It is not just about wanting a product; it also includes the ability to pay for it. For example, a student may want a new smartphone, but if they do not have the money to buy it, their desire does not count as effective demand.

Demand Schedule

A demand schedule is a table that shows the different quantities of a good or service that consumers are willing and able to buy at different possible prices over a specific period.

It helps to illustrate the relationship between the price of a product and the quantity demanded by consumers. Consider the demand for yam in a local market:

This schedule shows that as the price of yam decreases, the quantity demanded by consumers increases. For instance, at ₦1,000 per tuber, consumers demand 100 tubers, but at ₦600 per tuber, they demand 250 tubers.

Law of Demand

The law of demand states that, all other factors remaining constant (ceteris paribus), the higher the price of a commodity, the lower the quantity demanded, and the lower the price, the higher the quantity demanded.

This means there is an inverse relationship between the price of a good and the quantity demanded. Consumers generally buy more of a product when its price is low and less when its price is high.

Demand Curve

A demand curve is a graphical representation of the demand schedule, showing the inverse relationship between the price of a good and the quantity demanded.

The demand curve typically slopes downwards from left to right. This downward slope illustrates the law of demand. Using the yam demand schedule, a demand curve can be drawn:

Factors Affecting Demand

Several factors can influence the quantity of a good or service that consumers are willing and able to buy. These factors cause a shift in the entire demand curve, either to the left (decrease in demand) or to the right (increase in demand).

1. Income of Consumers: For most goods (normal goods), an increase in consumer income leads to an increase in demand. For example, if people earn more, they might buy more clothes or go out to eat more often. For inferior goods, an increase in income leads to a decrease in demand.
2. Taste and Preference: Changes in consumer tastes or preferences can significantly affect demand. If a product becomes fashionable or popular, its demand increases. If it goes out of fashion, demand decreases.
3. Price of Related Goods:
   1. Substitutes: These are goods that can be used in place of each other. If the price of a substitute good increases, the demand for the original good will increase. For example, if the price of rice increases, consumers might buy more yam.
   2. Complements: These are goods that are consumed together. If the price of a complementary good increases, the demand for the original good will decrease. For example, if the price of fuel increases, the demand for cars might decrease.
4. Population Size: An increase in the population generally leads to an increase in the overall demand for most goods and services, as there are more consumers.
5. Expectation of Future Prices: If consumers expect the price of a good to increase in the future, they might buy more of it now, leading to an increase in current demand. Conversely, if they expect prices to fall, current demand might decrease.
6. Government Policy: Government policies like taxes or subsidies can indirectly affect demand by influencing prices or consumer income.

Understanding Supply

Supply in economics refers to the quantity of a good or service that producers are willing and able to offer for sale at various prices over a specific period.

It is not just about having a product; it also includes the willingness and ability of producers to sell it at different prices. For example, a farmer may have a large harvest of maize, but they will only supply it to the market if the price is favourable enough to cover their costs and make a profit.

Supply Schedule

A supply schedule is a table that shows the different quantities of a good or service that producers are willing and able to sell at different possible prices over a specific period.

It helps to illustrate the relationship between the price of a product and the quantity supplied by producers. Consider the supply of yam in a local market:

This schedule shows that as the price of yam increases, the quantity supplied by producers also increases. For instance, at ₦600 per tuber, producers supply 100 tubers, but at ₦1,000 per tuber, they supply 250 tubers.

Law of Supply

The law of supply states that, all other factors remaining constant (ceteris paribus), the higher the price of a commodity, the higher the quantity supplied, and the lower the price, the lower the quantity supplied.

This means there is a direct relationship between the price of a good and the quantity supplied. Producers generally offer more of a product for sale when its price is high, as this increases their potential profit.

Supply Curve

A supply curve is a graphical representation of the supply schedule, showing the direct relationship between the price of a good and the quantity supplied.

The supply curve typically slopes upwards from left to right. This upward slope illustrates the law of supply. Using the yam supply schedule, a supply curve can be drawn:

Factors Affecting Supply

Several factors can influence the quantity of a good or service that producers are willing and able to sell. These factors cause a shift in the entire supply curve, either to the left (decrease in supply) or to the right (increase in supply).

1. Cost of Production: If the cost of producing a good (e.g., raw materials, labour, rent) increases, producers will supply less at each price, as their profit margins shrink. Conversely, a decrease in production costs leads to an increase in supply.
2. Technology: Improvements in technology can make production more efficient, reducing costs and increasing the quantity supplied. For example, new farming techniques can lead to a larger harvest.
3. Government Policy:
   1. Taxes: An increase in taxes on production or sales can increase costs for producers, leading to a decrease in supply.
   2. Subsidies: Government subsidies (financial aid) can reduce production costs, encouraging producers to supply more.
4. Natural Factors: For agricultural products, natural factors like weather conditions (rainfall, drought) significantly affect supply. Favourable weather leads to increased supply, while adverse weather reduces it.
5. Price of Other Goods: Producers might shift resources to produce goods that are more profitable. If the price of another good that can be produced with similar resources increases, the supply of the original good might decrease.
6. Number of Producers: An increase in the number of firms or producers in the market will generally lead to an increase in the total supply of a good.
7. Expectation of Future Prices: If producers expect the price of their product to increase in the future, they might hold back some of their current supply to sell it later at a higher price, leading to a decrease in current supply.

Market Equilibrium

Market equilibrium is a state in the market where the quantity demanded by consumers is exactly equal to the quantity supplied by producers at a particular price.

At this point, there is no tendency for the price to change, as the market is balanced. The price at which this occurs is called the equilibrium price, and the corresponding quantity is the equilibrium quantity.

Determining Equilibrium Price and Quantity

Equilibrium can be determined by combining the demand and supply schedules or by plotting both curves on the same graph.

Using Demand and Supply Schedules

Let us combine the demand and supply schedules for yam:

From the table, the equilibrium occurs at a price of ₦800, where both the quantity demanded and the quantity supplied are 150 tubers.

1. Surplus: When the price is above the equilibrium price (e.g., ₦1,000 or ₦900), the quantity supplied is greater than the quantity demanded. This creates a surplus of goods in the market, which puts downward pressure on prices as producers try to sell off excess stock.
2. Shortage: When the price is below the equilibrium price (e.g., ₦700 or ₦600), the quantity demanded is greater than the quantity supplied. This creates a shortage of goods, which puts upward pressure on prices as consumers compete for limited supply.

Using Demand and Supply Curves

When the demand and supply curves are plotted on the same graph, the point where they intersect represents the market equilibrium.

In the diagram, the demand curve (D) and the supply curve (S) intersect at point E. At this point:

1. The equilibrium price (P_e) is ₦800.
2. The equilibrium quantity (Q_e) is 150 tubers.

At any price above ₦800, there would be a surplus, causing prices to fall towards equilibrium. At any price below ₦800, there would be a shortage, causing prices to rise towards equilibrium. The market naturally adjusts to reach this equilibrium point.