CAIIB ABM Demand and Supply – The True Banker

Demand Schedule

The amount of a commodity people buy depends on its price.
The higher the price of an article, other things held constant, the fewer units consumers are willing to buy.
The lower is its market price, the more units of it are bought.
Other things remaining constant, there is a definite relationship between the market price of a good and
the quantity demanded of that good.
The relationship between price and quantity bought is called the demand schedule, or the demand curve.
The quantity demanded increases with the fall in price.

The Demand Curve

The graphical representation of the demand schedule is the demand curve.
The quantity demanded is plotted on the horizontal axis (X axis) and the price is plotted on the vertical axis (Y axis).
The quantity demanded and price are inversely related.
Demand curve slopes downward, going from northwest to southeast. This important property is called the law of downward-sloping demand.
Law of downward-sloping demand: When the price of a commodity is raised (and other things being constant), buyers tend to buy less of the commodity. Similarly, when the price is lowered, other things being constant, quantity demanded increases.
Quantity demand tends to fall as price rises for two reasons. First reason is the substitution effect. When price of a commodity rises, the consumer tries to substitute it with another similar product e.g. Tea and Coffee. Second reason is the income effect when a higher price reduces quantity demanded. When price goes up, one finds himself somewhat poorer than before as effectively real income goes down.

Market Demand

Market demand represents the sum total of all individual demands.
The market demand curve is found by adding together the quantities demanded by all individuals at each price.
The market demand curve also obeys the law of downward-slopping demand. If prices drop, the lower prices attract new customers through the substitution effect. In addition, a price reduction will induce extra purchases of goods by existing consumers though both the income and the substitution effects. Conversely, a rise in the price of a good will cause some of us to but less.

Forces behind the Market Demand Curve

The average income of consumers is a key determinant of demand. As people’s income rises, individuals tend to buy more of almost everything, even if prices do not change. Automobiles purchases tend to rise sharply with higher levels of income.
The size of the market – population: clearly affects the market demand curve. More the population, more is the demand.
The prices and availability of related goods: Demand is affected by availability of substitute products like apples and oatmeal, pens and pencils, small cars and large cars, or oil and natural gas. Demand for good A tends to be low if the price of substitute product B is low.
Individual and social tastes: Subjective elements like tastes or preferences also affect demand. Tastes represent a variety of cultural and historical influences. They may reflect genuine psychological or physiological needs (for liquids, love, or excitement). They may also contain a large element of tradition or religion (eating beef is popular in America but taboo in India, while curried jellyfish is a delicacy in Japan but not liked by many Americans.)
Special influences: The demand for umbrellas is high in rainy Mumbai but low in sunny Delhi; the demand for air conditioners will rise in hot weather. Further, expectations about future economic conditions, particularly prices, may have an important impact on demand.

Shift in Demand

When there is a change in demand for reasons other than price, it is called Shift in demand curve.
Demand curve shifts because factors other than the good’s price also change.
The net effect on demand due to changes in underlying influences is called an increase in demand.
An increase in the demand is indicated by rightward shift in the demand curve and a decrease in demand is indicated by leftward shift in demand curve.
The shift in demand means more or less number of commodity will be bought at every price.

The Supply Schedule

The supply side of a market involves the terms on which businesses produce and sell their products.
The supply schedule relates the quantity supplied of a good to its market price, other things being constant.
In considering supply, the other things that are held constant include input prices, prices of related goods and government policies.
The supply schedule (or supply curve) for a commodity shows the relationship between its market price and the amount of that commodity that producers are willing to produce and sell, other things being constant.
Higher the price more supply is expected and lower the price lower would be the supply.

The supply Curve

The supply curve is an upward sloping curve for an individual commodity indicating that as the price of the commodity increases more of it will be produced.
One important reason for the upward slope is ‘the law of diminishing returns’.

Force Behind The Supply Curve

One major factor indicating the forces determining the supply curve, is that producers supply commodities for profit and not for fun or charity.
Cost of Production: One major element underlying the supply curve is the cost of production. When production costs for a good are low relative to the market price, it is profitable for producers to supply a great deal. When production costs are high relative to price, firms produce little, switch over the production of other products, or may simply go out of business. But production costs are not the only ingredient that goes into the supply curve.
Input costs: Production costs are primarily determined by the price of inputs and technological advances. The prices of inputs such as labour, energy or machinery obviously have a very important influence on the cost of producing a given level of output.
Technological advances: Another important determinant of production costs is technological advances, which consist of changes that lower the quantity of inputs needed to produce the same quantity of Such technological advances include scientific breakthroughs, better application of existing technology, reorganization of the flow of work.
Price of related goods: Supply is also influenced by the prices of related-goods, particularly goods that are alternative outputs of the production process. If the price of one production substitute rises, the supply of another substitute will decrease.
Government policy also has an important influence on the supply curve. Environmental and health considerations determine that technologies can be used, while taxes and minimum-wage laws can significantly raise input prices.
Special factors:. The weather exerts an important influence on farming and on the agro-industry. The computer industry has been marked by a keen spirit of innovation, which has led to a continuous flow of newer products. Market structure will affect supply, and expectations about future prices often have an important impact upon supply decisions.

Shift in Supply

When changes in factors other than a good’s own price affect the quantity supplied, it is called as shifts in supply. Supply increases (or decreases) when the amount supplied increases (or decreases) at each market price.

Equilibrium of Supply and Demand

Supply and demand interacts to produce an equilibrium price and quantity or market equilibrium. .
The market equilibrium comes at that price and quantity where the forces of supply and demand are in balance. At the equilibrium price, the amount that buyers want to buy is just equal to the amount that sellers want to sell.
It is called equilibrium because when the forces of supply and demand are in balance, there is no reason for price to rise or fall, as long as other things remain unchanged.
A market equilibrium comes at the price at which quantity demanded equals quantity supplied. At that equilibrium, there is no tendency for the price to rise or fall.
The equilibrium price is also called the market-clearing price. This denotes that all supply and demand orders are filled, the books are ‘cleared’ of orders and demander’s and suppliers are satisfied.

Equilibrium with Supply and Demand Curves

The market equilibrium is for the price at which quantity demanded equals quantity supplied. The equilibrium price comes at the intersection of the supply and demand curves.
The equilibrium price and quantity come where the amount willingly supplied equals the amount willingly demanded. In a competitive market, this equilibrium is found at the intersection of the supply and demand curves. There are no shortages or surpluses at the equilibrium price.

Effect of a Shift in Supply or Demand

The supply-and-demand curves can be used to ascertain the equilibrium price and quantity.
It can also be used to predict the impact of changes in economic conditions on prices and quantities.
For example, if due to bad weather the price of wheat increases which is a key ingredient of bread. That shifts the supply curve for bread to the left. But, the demand curve for bread does not shift because people’s sandwich demand is largely unaffected by farming weather. However, if prices do not change, then due to increase in price of input, bakers will produce less bread at the old price. So quantity demanded exceeds quantity supplied. The price of bread therefore rises, encouraging production and thereby raising quantity supplied, while simultaneously discouraging consumption and lowering quantity demanded. The price continues to rise until, at the new equilibrium price, the amount demanded and supplied are once again equal.
The supply-and-demand curves can also be used to examine how changes in demand affect the market equilibrium. For example, with a sharp increase in family incomes, everyone wants to eat more bread resulting in a ‘demand shift’ rightward. The demand shift produces a shortage of bread at the old price. Prices are raised until supply and demand come back into balance at a higher price.