2 Theory of demand and supply In a market economy, individual consumers make plans of consumption

You will learn about the various factors that can shift a supply or demand curve up or down, the concepts of equilibrium and market adjustment, and the signaling and rationing functions of prices. The graphical representation of supply schedule is called supply curve. In a graph, price of a product is represented on Y-axis and quantity supplied is represented on X-axis. Supply curve can be of two types, individual supply curve and market supply curve. Individual supply curve is the graphical representation of individual supply schedule, whereas market supply curve is the representation of market supply schedule. Both individual and market schedules denotes an INVERSE functional relationship between price and quantity demanded.

The law assumes independence of utility schedules of goods. It means that utility derived from one good is not affected by the quantity purchased of other goods. In reality, however, many goods are related to each other by being substitutes or complements to each other. In such cases, the marginal utility derived from a given good depends not only upon its own quantity, but also upon the quantity of the related good. The law makes a questionable assumption that the consumer is able to accurately determine the marginal utility schedules of all the goods.

Understand the Relationship Between Demand And Supply

Here, the question emerges that why law of supply behave in this fashion and not otherwise. Assumes that the price of a product changes, but the change in the cost of production is constant. This is because if the cost of production rises with increase in price, then sellers would not supply more due to the reduction in their profit margin. Therefore, law of supply would be applicable only when the cost of production remains constant.

We know that price is a dominant factor in determining the supply of a commodity. As price of the commodity increases, there is more supply of that commodity in the market and vice versa. It is for this reason that marginal utility of a good tends to increase if there is an unduly long interval between the consumption of two units of a good. Marginal utility of a good may also increase, if the want of the consumer is intensified by consuming a very small quantity of it . By dividing this total utility by the number of units of X, that is n, the resultant is Average utility of these units of X to the consumer.

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For instance, if the price of bike is Rs50,000 and at this price, Consumer A demands 2 bikes and Consumer B demands 1 bike then the market demand for the bike will be 3 . Likewise by adding up the individual demand for a commodity at different price levels, we can ascertain the market demand for the commodity. With a change in the price of the good, the consumer changes the quantity purchased by him. Normally, the consumer buys more of a good when its price falls and reduces the quantity when its price increases.

• The price system works in a market economy only if there is free choice within the market.
• In several cases, the consumer does not possess sufficient information regarding the prices of goods he is interested in.
• If there is no speculation about products, then the economy is assumed to be at balance and people are satisfied with the available products and do not require any change.
• According to the law of supply, if the price of a product rises, then the supply of the product also rises and vice versa.

It means that a rise in price of a commodity brings about fall in its demand and vice versa. In the figure above, consumption reflects supply and not by the quantity demanded. For example, consumption of ripe mangoes during peak harvest season. The vertical supply curve implies that elasticity of supply is zero and an horizontal supply curve parallel to the quantity axis implies that elasticity of supply is infinite. If the price of Burger increases by some extent and quantity of burger demanded falls to some extent this means that demand is elastic.

ASSUMPTIONS TO THE LAW OF SUPPLY

During the Great Depression, factories sat idle and workers were laid off because there was insufficient demand for those products. In this scenario, supply would be reduced while demand would be increased, resulting in a higher price. When consumers begin to pay more for cupcakes than for donuts, bakeries will increase their cupcake output while decreasing their donut output in order to increase their profits. As a result, the typical response will not apply to Giffen goods, and the price increase will continue to push demand.

• As the income increases, the demand for comforts and luxuries also increases.
• In Figure-16, SMS1 is the exceptional supply curve for labor.
• Now we imagine that coffee becomes expensive and now it is selling at Rs. 200 per kgs.
• He will purchase the commodity up to the point where MU derived from the purchase of additional unit of Commodity is equal to its price.
• For example, if we take the case of a chocolate bar, then it will be observed that after consuming one chocolate bar your sweet tooth has been satisfied.
• If the price of a supplement, such as charcoal for grilling corn, rises, demand will shift to the left .

The necessity of a good is defined a good having an income elasticity of demand less than 1. If demand is inelastic and the prices increase, the consumer will suffer because an inelastic demand means that he has to buy in any condition. This is very important https://1investing.in/ as well as confusing for a student with no economics background. The cross elasticity can indicate whether the two products are substitutive or complementary . The lavish spending does not decrease because people spend to attain or maintain a social status.

What is ‘Law of Supply’

Market supply schedule can be drawn by aggregating the individual supply schedules of all individual suppliers in the market. Refers to a supply schedule that represents the different quantities of a product supplied by an individual seller at different prices. When the goods and services are in fashion then the sellers can supply them at reasonable and higher prices.

A demand curve for any commodity can be drawn by plotting each combination of price and demand on a graph. If consumers expect rise in the price of a commodity in near future, the current demand for the commodity will increase and vice versa. Therefore, knowledge about tastes and preferences is important in production planning, designing new products and services to suit the changing tastes and preferences of the consumers. The equilibrium price is determined by the intersection between demand and supply therefore, it is also called as the MARKET EQUILIBRIUM. Tastes and preferences of consumers generally change over time due to fashion, advertisements, habits, age, family composition, etc.

There are no changes in the price of substitute goods. Flipkart acquires mobile marketing firm AppiterateThe financial details of the deal were not disclosed. In line with its ‘Mobile First’ focus, this acquisition strengthens Flipkart’s presence. There is no change in the fashion of the commodity etc. Changes in weather conditions also influence household’s demand.E.g.

It is challenging to increase the agricultural produce at a certain level as land is a limited resource. It shows that if the prices of land increase, the supply may not get increased. The commodity of products is measurable and accessible in small units. The supply will remain limited even if their prices are high for goods having social distinction.

Notes

Assumes that there is no speculation about prices in future, which otherwise can affect the supply of a product. If there is no speculation about products, then the economy is assumed to be at balance and people are satisfied with the available products and do not require any change. Assumes that there is no change in the technique of production. This is because the advanced technique would reduce the cost of production and make the seller supply more at a lower price. Similarly, if the price of the product decreases, the supplier would decrease the supply of the product in market as he/she would wait for rise in the price of the product in future.

Despite the problem at the quantification level, we should consider the impact of quantity demanded on the prices qualitatively and through model projections. This implies that consumption is solely dependent on the supply and will remain the same irrespective of the shift in the demand curve. Thus, the price is the variable that brings the fortune 500 means equilibrium. If demand is elastic and the price increase, the consumer will less suffer because he will either decrease the consumption or shift to other products. However if supply increases due to other factors than price it is called “increase in supply” and if it falls due to other factors than price, it is called “ decrease in supply”.

• A fall in the price of one commodity would cause the demand of the complimentary commodity to rise.
• Each good obeys the law of DMU, and its marginal utility schedule is known.
• Assumes that the policies of the government remain constant.
• From individual demand schedules one may draw the market demand schedule.