Demand, Supply and Equilibrium

Prices
 Learning outcomes
▪ At the end of the course, students will:

✓ Explain why managers should study consumer demand and

producer supply of goods or services
✓ Identify and explain the factors that influence consumer demand
and producer supply of goods or services.
✓ Distinguish between movement along the demand and supply
curves and shift of the demand and supply curves.
✓ Determine the market equilibrium price and quantity of a good
or service graphically and mathematically.
✓ Analyse the effect of non-price factors on the equilibrium price
and quantities of goods or services.

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 Why Should Managers Study Supply
and Demand?
• Managers need to study demand and supply to:
– develop their own competitive strategies and
to respond to the actions of their
competitors.
– understand how the environment or
structure of the market that their firms
operate in impact demand and supply.
– understand how public policy will impact
supply and demand of their products.
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 Demand
▪ Demand is the number (quantity) of units of a good or service
that (consumers) buyers are willing and able to buy at various
prices, in a given period of time (ceteris paribus) when other
factors, like, buyers incomes, tastes and preferences and the
prices of goods related in consumption are held constant.

▪ It is the functional relationship between the price of a good or

service and the quantity demanded by consumers in a given
period of time, all other things held constant.

▪ Demand incorporates a consumer’s willingness and ability to

purchase a product/service.

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 Demand schedule

▪ The relationship between price and quantity can be

represented in:

• Tabular form – demand schedule

• Graphical form – demand curve
• Mathematical form – demand function

▪ Demand schedule is the tabular representation of

quantity demanded and price of a good or service.

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 Example of Demand Schedule
Price per unit Quantity
(GHS) demanded
(units)
9 2
7 3
5 5
3 6
1 10

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Example of Demand Curve (Line)
▪ The demand curve is a graphical relationship between the
price of a good or service and the quantity demanded by
consumers in a given period of time, all things held
constant.

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 Demand Function

Dq = f (P, I, T, W, Pr, Pop, E, R,

Pf… )
• Dq = f (P)
• P = f(Dq) inverse demand
function
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 Non-price Factors Influencing Demand
▪ Managers need to understand the factors that influence
consumer demand for their product/service.

▪ Although the price of a product is usually important, other

factors may equally play a significant role.

▪ In developing a competitive strategy, managers need to

determine which factors they can influence and how to
handle the factors that are beyond their control.

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▪ Many other factors in addition to price influence
the quantity of a product that consumers
demand:
– Tastes and preferences
– Income level of consumer
– Prices of goods related in consumption
– Future expectations
– Number of potential consumers
– Weather
– Religion
– etc

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Tastes and Preferences
▪ Tastes and preferences are how potential consumers
feel about a good or service and how well a good or
service meets a consumer’s desire.

▪ If tastes and preferences are in favour of a good,

demand for it is high.

▪ Tastes and preferences vary by age, sex, race, marital

status, level of education, etc.

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Income level of consumer
▪ A person’s income level affects demand because demand
incorporates both willingness and ability to pay for the good.

▪ If an increase (decrease) in income causes a person to buy

more (less) corn flakes, then for that person, corn flakes is said
to be a normal good.

▪ If an increase (decrease) in income causes a person to buy less

(more) gari, then for that person, gari is an inferior good.

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▪ Income in action:
✓Firms selling normal goods, like, jewellery,
automobiles and clothing experience
increases in sales when the general economy
is booming.

✓Firms selling inferior goods, like,

hamburger, used clothing and generic bleach
experience increases in sales when the
general economy is in recession.

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Prices of Related Goods
• Prices of related goods will also affect the demand for a
good or service.
• This however depends on whether the goods or services
are substitutes or complements.
– Products or services are substitute goods for each other if one can be
used in place of another.
✓ An increase (decrease) in the price of good Y causes consumers to
increase (decrease) their demand for good X
– Complementary goods are products or services that consumers use
together.
✓ If an increase (decrease) in the price of good Y causes consumers to
decrease (increase) their demand for good X

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▪ Prices of related goods in action:
✓By 2006 the abundance and relatively low prices
of cell phones, iPods, and laptop computers
resulted in many teens and young adults no longer
purchasing wristwatches.
• These all serve as substitutes for watches.

✓As prices of personal computers have dropped

over time, there has been an increased demand for
printers and printer cartridges by consumers.
• Personal computers and printers are complementary
products.

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Future Expectations

▪ Expectations about future prices also play a role in

influencing current demand for a product.

▪ If consumers expect prices to be lower in the future, they

may have less current demand than if they did not have
those expectations.

▪ If prices are expected to increase, consumers may demand

more of the good at present than they would without these
expectations.

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Number of Potential Consumers
▪ The number of consumers in the marketplace
influences the consumer demand for a product.

▪ A firm’s marketing strategy is typically based on

finding new groups of consumers who will purchase
the product.

▪ In many cases, a country’s exports may be the source

of this increased demand.

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 Demand Function
▪ The number of consumers in the marketplace influences the
demand for a product. Written in a functional form as:
Qxd = f(Px, T, I, Py, Pz, EXP, N,…)
where
- Qxd = quantity of good x demanded
- Px = price of good x
- T = variables representing tastes and preferences
- I = income
- Py = price of related good y
- Pz = price of related good z
- EXP = expected future prices
- N = number of consumers

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▪ Given the mathematical linear demand function:

▪ QD = 10 – 50Pc + 0.2I + 0.5T +0.1P

▪ If I = 100, T = 40 and P = 100, then

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 The Law of Demand
▪ Demand curves are generally portrayed as downward sloping,
suggesting an inverse or negative relationship between the
price of the good and the quantity demanded, all else equal.
– When the price of a good rises, quantity demanded falls, all else equal.
• The law states: The higher the price, the lower the quantity
demanded and vice versa

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 Individual vs. Market Demand
▪ Each consumer has his/her own individual demand function.

▪ However, managers are usually more interested in the

market demand function:
✓ It shows the quantity demanded of the good or service by all consumers
in the market at any given price
✓ It is the horizontal sum of individual demand curves.
✓ The market demand function is influenced by the prices of related
goods as well as by the taste and preferences, income and future
expectations of all consumers in the market.
✓ It can also change because more consumers enter the market.

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▪ Individual and market demand schedule:
Price (GH¢) Qd1 Qd2 Qd3 Market demand

10 1 2 2 5
9 2 4 5 11
8 3 6 8 17
7 4 8 11 23
6 5 10 14 29
5 6 12 17 35
4 7 14 20 41
3 8 16 23 47
2 9 18 26 53
1 10 20 29 59

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▪ Diagram of individual and market demand function

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Demand Curve Shift vs. Movement Along
a Demand Curve

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• A change/shift in demand is caused by any
of the other factors influencing demand
apart from price of the good/service. There
is a bodily shift of the demand curve, either
to the left or right depending on the
direction of change of the factor . Here
price of the good has not changed but
other factor(s) has changed
• A change in quantity demanded is caused
by changes in the price of the good itself.
There is movement along the same demand
curve. 25
 Supply
• We now examine producer decisions to supply
various goods and services.

• Market supply is the number of units of a good or

service that businesses are willing and able to
produce for sale at a given price in a time period (
when other factors, like, resource prices, technology
and prices of goods related in production are held
constant).

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▪ The supply curve is the functional relationship
between the price of a good or service and the quantity
supplied by producers in a given time period, all else
held constant.

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 Non-price Factors Influencing Supply
▪ In the consideration of supply, managers must
examine the factors that influence the supply of
their product in developing a competitive strategy.

▪ Finding ways to increase productivity and lower

production costs is particularly important in
gaining a strategic advantage in a competitive
market where managers have little power/control
over price.
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▪ Although supply focuses on the influence of price on the
quantity of a good or service supplied, many other factors
influence producer supply decision.

▪ These factors generally relate to the cost of production:

– Technology
– Input prices
– Prices of goods related in production
– Future expectations
– Number of producers

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Technology
▪ The state of technology, or the body of knowledge
about how to combine the inputs of production,
affects what output producers will supply because
technology influences how the good or service is
actually produced, which, in turn, affects the costs of
production.

▪ Change in technology allows companies to produce at

a lower cost, keeping more of them in business.

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Input Prices
▪ Input prices are the prices of all the inputs or
factors of production—labour, capital, land,
and raw materials—used to produce the given
product.

▪ These input prices affect the costs of

production and, therefore, the prices at which
producers are willing to supply different
amounts of output.

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• Input prices in action:

– For broiler chickens, feed costs represent 70 to 75

percent of the costs of growing a chicken to a
marketable size.

– Thus, changes in feed costs are so important that

market analysts often use them as a proxy to
forecast broiler prices and returns to broiler
processors.

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Prices of Related Goods
▪ The prices of other goods related in production can
also affect the supply of a particular good.

✓ Two goods are substitutes in production if the same inputs can be

used to produce either of the goods, such as land for different
agricultural crops.

✓ Two goods are complementary in production if the production of

one is a by-product of the production of the other.

o as more oil and gas are produced, the supply of sulfur, which is a
by-product also increase.

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Future Expectations
▪ Future expectations can also play a role on the supply side
of the market.

▪ If producers expect prices to increase in the future, they

may supply less output now than without those
expectations.

▪ The opposite could happen if producers expect prices to

decrease in the future.

▪ Expectations may not always be correct.

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Number of Producers
▪ The number of producers influences the
total supply of a product at any given
price.

▪ The number of producers may increase

because of perceived profitability in a
given industry or because of changes in
laws or regulations such as trade barriers.
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 The Law of Supply
▪ Supply curves are generally portrayed as upward sloping,
suggesting a direct or positive relationship between the price
of the good and the quantity supplied, all else equal.

o When the price of a good rises the quantity supplied rises, all else
equal.

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 Individual vs. Market Supply
▪ Each producer has his/her own individual supply
function.
▪ However, managers are usually more interested in the
market supply function:
✓ It shows the quantity supplied of the good or service by all
producers in the market at any given price.
✓ It is the horizontal sum of individual supply curves.
✓ The market supply function is influenced by the input
prices, technology, prices of goods related in production as
well as future expectations of all producers in the market.

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▪ Individual and market supply schedule:

Price (GH¢) Qs1 Qs2 Qs3 Market supply

10 14 24 22 60
9 13 22 20 55
8 12 20 18 50
7 11 18 16 45
6 10 16 14 40
5 9 14 12 35
4 8 12 10 30
3 7 10 8 25
2 6 8 6 20
1 5 6 4 15

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 Expressing Supply function
• The functional form of the supply curve is
expressed as:
Qxs = f(Px, T, I, Py, EXP, N, …)
where
- Qxd = quantity of good x supplied
- Px = price of good x
- T = Technology
- Py = price of related good y
- EXP = expected future prices
- N = number of producers
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▪ A mathematical example of supply function:

▪ Suppose that W = 4, T = 20 and N = 40

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Supply Curve Shift vs. Movement
Along a Supply Curve

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 Market Equilibrium
▪ In a competitive market, the interaction of demand and
supply determines the equilibrium price.
✓ the price that will actually exist in the market or toward which
the market is moving.

▪ The market equilibrium price and quantity is that price for

which quantity supplied is equal to quantity demanded.

▪ At any other price, there will be an imbalance between

quantity demanded and quantity supplied.

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Equilibrium Graphically
▪ Market equilibrium occurs at that price where quantity
demanded by consumers equals the quantity supplied by
producers.

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Equilibrium in Tabular Form
▪ Market Equilibrium Price and Quantity:
Price (GH¢) Market demand Market supply
10 5 60
9 11 55
8 17 50
7 23 45
6 29 40
5 35 35
4 41 30
3 47 25
2 53 20
1 59 15

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 Mathematical Equilibrium
▪ Given the following demand and supply functions:

a. Find the equilibrium price and quantity

b. What happens when the price is fixed at GH¢1.00?

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 Surplus Disequilibrium

▪ At prices where the quantity supplied exceeds the quantity

demanded there exists a surplus in that market at that price.

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 Shortage Disequilibrium

• At prices where the quantity demanded exceeds the quantity

supplied there exists a shortage in that market at that price.

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Changes in Equilibrium – Demand Induced
▪ When non-price demand factors change, the demand curve
shifts and produces a change in equilibrium price and quantity.

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 Changes in Equilibrium – Supply Induced
▪ When non-price supply factors change, the supply curve shifts
and produces a change in the equilibrium price and quantity.

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 Changes in Equilibrium – Changes in
Demand and Supply
▪ When non-price factors change, the supply and demand curves
may both shift and produce a change in the equilibrium price
and quantity.

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 Application – Price legislation
▪ Maximum price legislation/price ceiling
• Reason:
– Protect consumers

▪ The effects:
– Shortage
– Rationing
– Development of parallel markets

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 Application – Price legislation
▪ Minimum price legislation/price floor
▪ Reason:
▪ To protect some producers
▪ To reduce consumption of
certain goods
▪ Effect
– Surplus
– Parallel markets

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 Application – Taxation and Subsidies
▪ Managers must analyze the impact of
government policy such as tax and subsidy on
the market equilibrium price and quantity of
their product.
▪ Suppose government imposes per unit tax (t)
on a product, this will affect the supply
function and ultimately increase the market
price of the product and reduce equilibrium
quantity.
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▪ Given the demand and supply functions respectively as:
Qd =a - bp and Qs = c+ dp

Substitute the per unit tax (t) into the supply function (subtract t
from P in the ss function) to obtain a new supply function as
Qst = c + d(p –t)
Qst = c + dp - dt

Therefore, the new equilibrium price after the per unit tax can be
obtained as:
Qd = Qst
a – bp = c + d(p – t)
a – c + dt = dp + bp
a – c + dt = p(d + b)
p = (a – c + dt)/(d + b)

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Tutorial Questions
▪ Q1. A mobile phone selling company faces the following demand function.
Qd = 50 - 3P
The firm’s accountant believe that the supply function of the company is
given by: Qs = 2P
Where P denotes price of a mobile phone in GH¢ and Qd and Qs are
the quantities demanded and supplied respectively.
▪ Requirement:
a. Determine the equilibrium price and quantity in the market for the company.
b. Determine the total revenue for the company if the equilibrium quantity is
sold.
c. Calculate the total surplus in the market
d. If the government now decides to impose a tax of GH¢2 per unit on the
quantity supplied and the company adjusts the supply function to include tax,
i. .

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i.Determine the new equilibrium price
and quantity in the market for the
company
ii.What portion of the tax revenue is paid
by consumers?
iii.What portion of the tax revenue is paid
by producers?
iv.What is the total tax revenue to
government?

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v. Determine the deadweight loss.
vi. Present graphically the results of the above
questions.

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Practice Question (2)
▪ The inverse demand and supply functions for Peak Milk in Accra are as follows:
P = 100 – Q and Q = 1/3P – 20/3
where P is the price of a tin of Peak milk.
Requirement:
a. Sketch the demand and supply functions on one graph.
b. Compute the market-clearing price and quantity for peak milk.
c. Compute the consumers’ surplus and total surplus in this market.
d. Suppose the cost of milking a cow rises such that at every quantity, cost rises by
GH¢20.00. How will that affect the equilibrium price and quantity for peak milk?
e. If the Regional Minister of Great Accra argues that the free-market price for peak milk
is too high for the ordinary person to pay. What’s the effect of a price ceiling at
GH¢74.00
f. Another Regional Minister contends that the equilibrium price is rather too low for peak
milk producers to earn a fair return. If his contention is accepted, what will be the effect
of a price floor of GH¢86.00.
g. What will be the cost to the government of the price floor in (f) above?

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Practice Question (3)
▪ A research firm recently provided a firm’s Marketing Manager
with the estimate of the demand and supply functions for its
product X as:

Where Px is the price of commodity X; PM is the price of

commodity M = ¢15; PN is the price of commodity N =
¢50.00; Y is the income = ¢40,000.00; A is the advertising
expenditure = ¢10,000.00; PL is the average price of unskilled
labour = ¢80

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▪ Requirements:
a.Find the equilibrium price and quantity for
the product X.
b.Graph both demand and supply for product
X
c.Which product in the demand function is a
substitute for product X? Explain.
d.If income falls by ¢5,000, find the new
equilibrium price and quantity. Will
equilibrium price and quantity increase or
decrease? Explain
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 Practice Questions (4) - Assignment
▪ Consider the following statement:
It has been a tough year in the poultry business, with supply outpacing
demand and feed-grain prices rising substantially. But producers are
hoping all that changes when the summer cook-out season starts
The seasonal upswing in chicken consumption, along with the anticipated
jump in spot-market poultry prices, could bring some relief to producers
whose profit margins have been slashed by surging corn and soybean-
meal costs.

Rising feed-grain prices, accelerated by the diversion of corn to make

ethanol, have pushed up the cost of producing a live chicken by as much
as 65 percent over the past two years.
Three factors make analyst more optimistic: Companies are cutting
production, weekly egg-set numbers are declining (egg sets are fertile
eggs placed in incubators), and prices are responding positively to the
decreasing supply.

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 The production slowdown is a response to the surge in feed-grain prices last
fall.

Profit margins for producers will not improve unless spot-market prices for
chicken move up fast enough to cover costs paid for corn and soybean meal to
feed chicken flocks.

Production cutbacks and season demand have helped fuel a 20-cent increase in
boneless, skinless breast-meat prices to $1.80 by summer 2008.

Requirements:
a. Use demand and supply analysis to illustrate the changes in chicken
prices described in the above article.
b. Describe what has happened in the corn and soybean-meal markets and
how that has influenced the chicken market.

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