CHAPTER 2: Market

Learning Objectives: This chapter discusses the demand and supply concepts in the market. At
the end of this chapter, the readers will be able to understand the law of demand and
supply, distinguish the difference between change in quantity demanded from change in
demand and the change quantity supplied from change in supply, identify the determinants
of demand and supply, identify the equilibrium price and equilibrium quantity and analyze
the effects of the changes of demand and supply to equilibrium price and equilibrium
quantity.

Market is a place where the buyers and sellers meet. There are two actors involved in the
market. These are the (1) buyers also known as the demanders and the (2) sellers also known
as the suppliers. Hence, this topic will be divided into parts, demand side and supply side, before
discussing the market equilibrium. Elasticity will be explained on the last part of this chapter.

2.1 Demand

Demand shows various amount of goods that consumers are willing and able to buy at a
specific period of time (day, week, month or year). This can be represented as demand schedule
or demand table, demand curve and demand function.

2.1.1 Demand Schedule

Quantity The table shows that as the price increases, the quantity
Price
Demanded demanded decreases. This is called the law of
0 100 demand.
5 90
10 80 Take note that demand is different from quantity
15 70 demanded. Demand refers to the whole schedule while
20 60 quantity demanded refers to the specific amount of good
25 50 at a given price (i.e at price 10 quantity demanded is 80).

Based on the above demand schedule, quantity demanded will be changed when price
changed, leaving demand unchanged. Demand can change based on the change of its
determinants known as determinants of demand. A change in demand can be easily shown using
the demand curve.

There are three explanations of the inverse relationship of price and quantity demanded:

1. The law of demand is consistent with Common Sense. People ordinarily do buy more of a
product at a low price than at a high price. Price is an obstacle that deters consumers from
buying. The higher that obstacle, the less of a product they will buy; the lower the price
obstacle, the more they will buy. The fact that businesses have “sales” is evidence of their
belief in the law of demand.

2. In any specific time period, each buyer of a product will derive less satisfaction (or benefit, or
utility) from each successive unit of the product consumed. The second Big Mac will yield less
satisfaction to the consumer than the first, and the third still less than the second. That is,
consumption is subject to Diminishing Marginal Utility. And because successive units of a
 particular product yield less and less marginal utility, consumers will buy additional units only
if the price of those units is progressively reduced.

3. We can also explain the law of demand in terms of income and substitution effects. The
income effect indicates that a lower price increases the purchasing power of a buyer’s money
income, enabling the buyer to purchase more of the product than before. A higher price has
the opposite effect. The substitution effect suggests that at a lower price, buyers have the
incentive to substitute what is now a less expensive product for similar products that are now
relatively more expensive. The product whose price has fallen is now “a better deal” relative
to the other products.

For example, a decline in the price of chicken will increase the purchasing power of
consumer incomes, enabling people to buy more chicken (the income effect). At a lower price,
chicken is relatively more attractive, and consumers tend to substitute it for pork, lamb, beef, and
fish (the substitution effect). The income and substitution effects combine to make consumers
able and willing to buy more of a product at a low price than at a high price.

2.1.2 Demand Curve

Transforming the above demand schedule to demand curve:

Because of the inverse relationship of price and quantity demanded, demand curve is a
downward sloping curve. Consider the following determinants of demand:

1. Tastes or preferences. If consumers have favorable response regarding the good,

demand will increase making demand curve shifts to the right. On the other hand,
unfavorable response of consumers on the good will decrease demand and will shift
demand curve to the left.
2. Number of Buyers. An increase in the number of buyers will increase in demand and
make the demand curve shift to the right. Otherwise to the left.
3. Income. There are two kinds of goods under income, normal good or superior good
and inferior good. As income increase demand for normal good also increase. This
means a positive relationship between income and normal goods. On the other hand,

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 as income increase demand for inferior good will decrease. Thus, there is a negative
or inverse relationship of income and inferior good.
4. Price of Related Goods. Substitute goods and complementary goods are considered
as related goods. When there is an increase of price of a particular good and the
demand of its related good increased, the goods are considered as substitute goods.
On the other hand, when there is an increase of price of a particular good and the
demand of its related good decreased, these goods are complementary goods.
5. Expectation. Consumer’s expectations on the change of price because of weather,
tradition and culture. In example, if there will be a super typhoon tomorrow today’s
demand will increase because consumers are expecting higher price of goods after
typhoon and decrease of supply of goods.

These determinants are also known as non-price determinants. The effect of the change
of these determinants causes the movement of one curve to another demand curve which is
called change in demand.

Any movement from one point to another point along the same demand curve due to the
change in price of the commodity itself, holding other determinants constant, is called change in
quantity demanded.

2.1.3 Demand Function

Another representation of demand is a function. Considering the given demand schedule,

we can derive its demand function:

Qd = a – bP
∆𝑄𝑑
where Qd = Quantity Demanded, a = intercept (at price 0), b = slope ( ∆𝑃
), and P = price.

The negative slope represents the negative relationship of price and quantity demanded.
Intercept is the maximum amount of goods that the consumers are willing and able to buy at price
0. Thus,

Qd = 100 – 2P
∆𝑄𝑑
b = ∆𝑃
90−100 −10
= 5−0 = 5
b=-2
To check: substitute the P with the given prices from the table.

Qd = 100 – 2(0) = 100 – 0 = 100

Qd = 100 – 2(5) = 100 – 10 = 90
Qd = 100 – 2(10) = 100 – 20 = 80
Qd = 100 – 2(15) = 100 – 30 = 70
Qd = 100 – 2(20) = 100 – 40 = 60
Qd = 100 – 2(25) = 100 – 50 = 50

This function is applicable to linear equation where the slope is constant or equal. In this
function, the slope is -2.

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2.2 Supply
Supply shows various amount of goods that suppliers are willing and able to sell or make
available in the market at a specific period of time (day, week, month or year). This can be
represented as supply schedule or supply table, supply curve and supply function.

2.2.1 Supply Schedule

Quantity The table shows that as the price increases, the quantity
Price
Supplied supplied also increases. This is called the law of supply.
0 60
Take note that supply is different from quantity supplied. Supply
5 70 refers to the whole schedule while quantity supplied refers to
10 80 the specific amount of good at a given price (i.e., at price 10
15 90 quantity supplied is 80).
20 100
25 110

Based on the supply schedule, quantity supplied can be changed when price changed
leaving supply unchanged. Supply can change based on the change of its determinants known
as determinants of supply. A change in supply can be easily shown using the supply curve.

2.2.2 Supply Curve

The positive or direct relationship of price and quantity supplied shows an upward sloping
curve of supply curve.

Increase in supply will shift the supply curve to the right (S0 to S1). Decrease in supply will
shift the supply curve to the left (S0 to S2). If quantity supplied can be changed through the change
in price, supply can be changed through the change of its determinants. There are six (6)
determinants of supply:

1. Resource Price. This refers to the prices of resources used in the production like
wages for labor and rent for capital. When there is an increase in the resource price,
cost of production will increase that could lead to a decrease in supply. On the other
hand, lower resource price leads to lower cost of production that will increase supply.

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 2. Technology. Upgrading the firm’s production by using advance technology from
manual production can decrease the cost of production. Instead of paying laborers
with wages, the firms can make efficient production by using machineries. This leads
to an increase in supply,
3. Number of Sellers. An increase in the number of suppliers will also increase supply.
4. Taxes and Subsidies. Taxes are part of the cost of production while subsidies are
help of the government to the firms. Taxes are mandatory payment of the firms. All
firms should pay taxes but only firms can avail for subsidies. Subsidies are given for
those who have an important role in the society and the government cannot give up
its functions (i.eg production of the farmers). When the government imposed higher
tax to the firms, cost of production will increase then supply will decrease. When
subsidies like fertilizer and free irrigation were given to the farmers, cost of production
decreased that could lead to an increase in supply.
5. Price of other goods. These goods are not necessarily be related goods or
complementary goods, but these two goods were production using same equipment
and materials. Wherein it is easy to shift production from one good to another when
the price of one good changed. Example: Suppose there are two balls, ball for
basketball and a ball for volleyball. Then let us say, a firm is producing basketball, but
the price of volleyball increased. A firm will choose to produce volleyball because of
higher price therefore the supply of basketball will decrease. It is easy to shift a
production because the two balls have almost the same materials and using the same
equipment in production.
6. Expectation. The suppliers are expecting for a change in price in the future. When
the firms expected that the price of their goods will increase in the future, the present
supply of their goods will decrease.

These determinants are also known as non-price determinants. The movement of one
curve to another demand curve caused by the change in non-price determinants is called change
in supply. On the other hand, any movement of one point to another point along the same supply
curve due to the change in the price of the good itself is called a change in quantity supplied.

2.2.3 Supply Function

Supply function is another representation of supply. Given the above supply schedule, we
can derive its supply function:

Qs = c + dP
∆𝑄𝑑
where Qs = Quantity Supplied, c = intercept (at price 0), d = slope ( ∆𝑃 ), and P = price.
The positive slope (d) represents direct or positive relationship of price and quantity
supplied. The intercept (c) is the maximum amount of goods that the suppliers are willing and
able to make available in the market at price 0. Thus,

Qs = 60 + 2P
∆𝑄𝑑
b = ∆𝑃
70−60
=
5−0
10
= 5
b=2

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 To check: substitute the P with the given prices from the table.

Qs = 60 + 2(0) = 60 + 0 = 60
Qs = 60 + 2(5) = 60 + 10 = 70
Qs = 60 + 2(10) = 60 + 20 = 80
Qs = 60 + 2(15) = 60 + 30 = 90
Qs = 60 + 2(20) = 60 + 40 = 100
Qs = 60 + 2(25) = 60 + 50 = 110

This function is applicable to linear equation where the slope is constant or equal. In this
function, the slope is 2.

2.3 Market Equilibrium

Since demand and supply are represented by three models, market equilibrium can also
be determined using the three representations by combining the two. Equilibrium means balance
or equal, therefore, market equilibrium exists when quantity demanded is equal to quantity
supplied.

2.3.1 Table or Schedule

Using the demand schedule and supply schedule above, market equilibrium is at price 10
where Qd = Qs of 80. Price 10 is called the Equilibrium Price (Pe) while quantity 80 is called the
Equilibrium Quantity (Qe).

There are two problems faced by the market when market equilibrium is not present. At
prices below equilibrium price (0 and 5), quantity demanded is greater than quantity supplied thus,
shortage is present. On the other hand, surplus occurs at prices above equilibrium price (15, 20
& 25) where quantity demanded is less than quantity supplied. To compute how much the
shortage and surplus is in the market, subtract quantity supplied to quantity demanded (Qs – Qd).

Example:

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 1) At price 5, Qs is equal to 70 and Qd is equal to 90.

Qs – Qd: 70 – 90 = -20

Negative sign represents shortage. Thus, there is shortage of 20 units.

2) At price 20, Qs is equal to 100 and Qd is equal to 60.

Qs – Qd: 100 – 60 = 40

Positive sign represents surplus. Thus, there is a surplus of 40 units.

2.3.2 Curve or Graph

Plotting the given schedules of demand and supply into one graph,

Upper portion of the graph shows surplus while the lower portion represents shortage. The
interaction of demand curve and supply curve represents the market equilibrium (ME). The above
diagram also shows that equilibrium price is 10 and equilibrium quantity is 80.

2.3.3 Function

Using the derived demand function Qd = 100 – 2P and supply function Qs = 60 + 2P, we
can derive equilibrium price and equilibrium quantity. Following the condition of market
equilibrium, Qd = Qs;

Qd = Qs
a – bP = c + dP
100 – 2P = 60 + 2P

Combine like terms:

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 100 – 60 = 2P + 2P
40 = 4P

Divide both sides by 4

10 = P; thus, 10 is the equilibrium price.

To calculate the equilibrium quantity, substitute P as 10 in the functions.

Qd = Qs
a – bP = c + dP
100 – 2P = 60 + 2P
100 – 2(10) = 60 + 2(10)
100 – 20 = 60 + 20
80 = 80; thus, 80 is the equilibrium quantity.

2.4 Government Control on Price

There are cases that even though equilibrium price is present, consumers cannot afford
to buy goods because it is expensive for them and sellers cannot sell the goods because it is
cheap on their part. Government intervention on price is needed to help both consumers and
sellers.

Price ceiling is imposed to help the consumers to buy goods. It is the maximum legal
price that can be charged by the sellers to the consumers. Prices above the price ceiling are
considered illegal. An effective price ceiling can be found below the equilibrium price but may
result to shortage.

On the other hand, price floor is imposed to help the sellers when they consider the price
of goods low for them to recover their costs. It is the minimum legal price that the sellers can
charge on goods. Prices below the price floor are considered illegal. An effective price floor can
be found above the equilibrium price but may result to surplus.

For example, during calamities the production of agricultural products will be affected.
Given an equilibrium price in the market, sellers are not willing to sell their goods because the
given price is not enough for them to recover their costs in producing the goods. In order to help
them, the government will increase the price goods which is called price floor. It is a legal action
by the government to protect the sellers from losing income.

When sellers are charging illegal prices, they are considered as black markets. If price
ceiling is present in the market, black markets operate at the higher price. On the other hand,
black markets operate at the lower price during price floor.

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