CHAPTER 4: DEMAND, SUPPLY AND PRICES
4.1 INTRODUCTION
In Chapter 3, we studied the interdependence between households and firms in a mixed economy.
We now look at this interaction in more depth by focusing on the process by which these role-players
interact in goods markets: Firms supply their products to be sold, and households in turn display
different levels of demand for these goods. This interaction of demand and supply is what determines
the prices and quantities traded in the goods market in a market economy.
FIGURE 4-1 The interaction between households and firms
4.2 DEMAND
Demand refers to the quantities of a good or service that potential buyers are willing and able to
buy.
In other words, for demand to exist (in an economic sense):
1. There must be an intention to buy
2. There must be the means to buy
When these characteristics are present, we say that there is effective demand.
These two characteristics are what make a demand different from wants, needs or claims – do not
confuse these concepts!
Demand is also a flow concept – meaning that it is measured over a period of time.
Note, furthermore, that demand relates to the plans of households, firms and other
participants in the economy – not to events that have already occurred.
This means that quantity demanded may differ from the quantity actually bought.
In this chapter, we will take a microeconomic approach to demand – meaning that we focus
on the demand for particular goods and services, as opposed to total demand for all goods
and services in the economy.
Let us look at the determinants and properties of demand.
LECTURE NOTES | ECON 112 CHAPTER 4
, Market demand
In the examples below, we will consider the demand for tomatoes in a particular market. Market
demand consists of the combined demand of all the households in a particular market.
The quantity of tomatoes that households plan to purchase in a given period is determined by:
1. The price of the product. The lower the price of tomatoes, the more tomatoes households
will be willing to buy, ceteris paribus.
2. The price of related products. The price of complements (things that are used along with
tomatoes – such as bread and salad leaves) as well as the price of substitutes (things that are
used instead of tomatoes – such as avocadoes) will also influence demand.
3. The income of consumers. Normally, the higher the household’s income, the more tomatoes
they can afford (and plan) to buy.
4. The taste (preferences) of consumers. Taste can have a positive or negative impact. If people
do not like tomatoes, they will not demand as many, and vice versa.
5. The number of households. The more households there are, and the greater the number of
people per household, the greater the quantity of tomatoes that will be demanded.
Note that demand decisions are independent of the supply situation. While the availability (supply) of
a product such as tomatoes can influence the actual outcome in the market, consumers’ plans are
based on information they have available (such as the price of tomatoes, instead of how the price of
tomatoes was determined).
We can summarise the above discussion as follows:
The quantity of a good demanded in a particular period depends on (or is a function of) the price of
the good, the prices of related goods, the income of the households, consumers’ taste, the number
of consumers and any other possible influence.
We will now zoom in on one determinant of demand in particular: The price of the product.
The tendency we see for quantities demanded to increase when prices decrease (and vice versa) is so
strong that economists have formulated the following law of demand:
Other things being equal (ceteris paribus), the higher the price of a good, the lower the quantity
demanded.
Let us stick to the example of tomatoes we have been using (as a consumer, you can imagine different
products you regularly use, too – what do you notice in your own purchasing behaviour when the price
of different goods changes?)
We can illustrate this relationship graphically, as shown in Figure 4-2.
LECTURE NOTES | ECON 112 CHAPTER 4
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