Module 3-Market Forces (Demand and Supply) PDF

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St. Joseph CollegeACCOUNTANCY DEPARTMENT####### ECON 1: MANAGERIAL ECONOMICSCredits: 3 units AY: 2021- Section: A, B, C & D Instructor: Jhonel M. Añavesa, MPA, MDM, PhDMODULE 3 - Market Forces: Demand andSupplyLesson 1: Review on Law of DemandCourse Code: Econ 1 (Managerial Economics) Module Cod...

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St. Joseph College ACCOUNTANCY DEPARTMENT ECON 1: MANAGERIAL ECONOMICS Credits: 3 units AY: 2021-2022 Section: A, B, C & D Instructor: Jhonel M. Añavesa, MPA, MDM, PhD

MODULE 3 - Market Forces: Demand and Supply Lesson 1: Review on Law of Demand Course Code: Module Code: Lesson Code:

Econ 1 (Managerial Economics) 3.0 (Market Forces: Demand and Supply) 3.1 (Review on Law of Demand)

I. LESSON OBJECTIVES: At the end of this lesson, the student should be able to: 1. 2. 3. 4. 5. 6.

define the meaning of a market and its two basic components; explain the basic concept of “The Law of Demand”; enumerate and discuss the non-price determinants or factors affecting demand. differentiate a change in quantity demanded versus a change in demand; illustrate and explain the shifting of demand curves; and discuss the fundamental concept of the demand function.Identify supply sources.

II. DISCUSSION PROPER: What do we mean when we say market? How important is the market in the economy? Why is it that prices in the market change over time? Take for example, prior to the current COVID-19 Pandemic, the average price of a disposable mask is only around P4.50 apiece. And during the pandemic the price of each disposable mask is around P20.00 or more. This is just one of the many examples that we can associate today in the current market situation in relation to price changes of various commodities in the market. Another example, during Typhon Sendong, many places in Mindanao were affected by such a tragic calamity that one of the biggest problem encountered at that time was the availability of drinking water. Many sellers took advantage of the event. The usual price of a regular sized bottled water was around P15.00. But when the calamity struck, it bloated to P100.00 each.

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So the question here is: what makes it possible for prices to change drastically? This is why we need to further study how markets work in consideration of price changes. A typical marketplace is defined as a venue where people meet to conduct transactions like buying and selling. A market plays an important role in the society because it provides goods and services needed by the consumer with easy accessibility and it also gives opportunity for producers to generate profit or income. This transaction may happen physically or digitally just like in our modern society today where people may wish to buy or sell products online. The primary reason for most consumers who patronize online transactions more is the degree of convenience. There is no need for them to go to a physical place. Moreover, the current COVID-19 Pandemic pushes people to do transactions online for safety reasons. A market is a mechanism that facilitates the overall transactions between buyers and sellers to determine prices and quantities in a market-driven economy. There are several kinds of markets that exist in our economy. The most common is the goods market. When we say goods market, it refers to a market for outputs, whether goods or services. This includes the food we eat, the gadgets we use, and the movies we watch. We also have the labor market (which is a factor market) where human physical effort is bought and sold. For example: companies that need people to work for them act as the buyers of this labor and those who will apply for a job are considered the sellers of this labor. Another is the Financial market or money market where people basically purchase or sell financial assets. Regardless of the kind of market, one thing they share in common is that they all respond to prices. To understand how the market determines prices, we need to ask what causes these price changes. As mentioned above, markets function if there is a buyer who is willing to pay for a particular good as well as a seller who is then willing to sell that particular good also. Therefore, a market comprises of two important agents: the buyer which constitutes the demand side and the seller which constitutes the supply side. Demand and supply are also known as the market forces that influence the prices in the market, considering other factors held constant.

The Demand Side of the Market Basically demand is one of the market forces that deals with the amount or quantity that consumers are very much willing to purchase. According to McConnell, Brue, and Flynn “Demand is a schedule or a curve that shows the various amounts of a 2

product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time. Demand shows the quantities of a product that will be purchased at various possible prices, other things equal” (p. 79). A demand schedule is used to clearly depict the individual demand as to the relationship between quantity purchased and the price of the commodity considering other factors held constant.

Looking at the table presented above, we can see that there is an inverse relationship between the price and the quantity demanded of product X. As the price increases, the quantity demanded for product X decreases. A graphical representation of this table is presented below.

In order to come up with the figure presented above, we have to plot table 1 where each point shows the combinations of prices and quantity demand for product X. The connection of these points will depict a demand curve. This downward sloping curve represents the indirect or inverse relationship between the prices and the quantity demanded for product X. With this, it goes to show that considering other factors held constant, increasing the price will tend to decrease its quantity demanded until it reaches zero. This common market phenomenon falls under one of the basic laws of economics and it is known as the Law of Demand. This law means that when prices of a particular product rises (ceteris paribus or other things held constant) consumers tend to purchase less. On the other hand, when the prices drop (ceteris paribus) quantity demanded rises. There are two important reasons to remember why quantity demanded tends to fall as price increases:

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1. The Substitution Effect – this will happen because a particular good becomes more expensive when price increases. Consumer may find a way to buy other commodities in which can also give them the same functionality but at a much cheaper price than the previous commodity. Instead of buying X they will probably buy product Y. 2. The Income Effect – as discussed above, a higher price will generally decrease the quantity demanded for a good. It occurs because consumers become poorer than before. Their purchasing power cannot compensate for the higher price of the good. Since other factors such as income are held constant, a consumer will purchase less of the product. The Market Demand As we mentioned earlier, the market comprises of a wide range of sellers and buyers. Let us assume that the hypothetical demand schedule in table 1 refers to only one consumer. Let us now consider the presence of more than one buyer in the market. We will just assume that there are only three buyers in the market namely Raymundo, Anthony, and Daryl in order for us to easily identify the overall quantity demanded at each given price of our product. In each given price we just simply add the quantities demanded by each buyer (as seen in table 2). We can then plot each price and the total quantities demanded as a single point on the market demand curve (see figure 3).

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We can see in figure 3 the overall market demand of our given product at each corresponding price. These are just hypothetical figures to simplify our discussion on what a market demand is. So far, we have only considered that the quantity demanded is determined only by the good’s own price. However, in other circumstances, there are also other factors that can affect the degree of purchases. We refer to these as the non-price determinants or factors affecting demand. Considering such non-price determinants, it will result in a change in demand and the demand curve will shift either to the right or to the left (considering own prices held constant).

The Non-Price Determinants or Factors 1. Tastes or Preferences A desirable taste or preference of a buyer for a particular product means greater demand for that product. This will result in a rightward shift of our demand curve. On the other hand, if it is unfavorable on part of the consumer then it will result in a lesser demand and the demand curve will shift to the left. For example, video gamers may choose smart gaming phones than console platforms because handheld devices are easier to carry and more accessible. 2. Population or market size If the population of an area increases, ceteris paribus, it will likely mean that demand will also increase. For example, the Balik Probinsya Program of the Philippine government may result in an increase of the population of a particular locality. The demand for consumer goods may then increase due to the additional number of people that will possibly purchase products in that locality. 3. Prices of Related Commodities There are two basic classifications of related goods in economics. These are: a. Substitute Goods – these are goods that can act as the best alternative or a replacement for another good which perform similar functions based on a consumer’s perception. If two products (A and B) are considered as substitutes an increase in the price of product (A) will increase the demand for product B. On the other hand, if the price of product A will decrease then the demand for product B will decrease as well. For example: If you cannot afford to hire a grab car to reach your destination then you may take the MRT or the bus instead. b. Complementary Goods – these are goods that go along or is used together with other commodities. For example: Some coffee drinkers are not used to drinking black coffee (coffee w/o sugar). If the price of sugar rises, ceteris paribus, it is highly probable that there will be a lesser demand for coffee. Another example is when the price of a computer console drops, it results in an increase in the demand for computer games.

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Any change in the price of both substitutes and complements may influence the level of demand for certain goods in the market. 4. Expectations Change in buyers’ expectations may lead to a shift in demand. Expectations among buyers may vary for several reasons. It may be triggered by certain circumstances such as expected price increase in the future or an expected decrease in the supply of a particular product. This usually leads to panic buying where consumers urgently go to the market to buy more of the products because they fear that prices may increase in the next days or that supplies might become inadequate. A very noticeable example is when in many parts of the world people rushed to stores and bought alcohol, face masks, or even the toilet papers in the midst of the COVID-19 pandemic. 5. Consumer’s Income For very obvious reasons, income is one of the most important key factors influencing demand. If one’s income increases, ceteris paribus, this results in an increase in demand since this individual can afford to buy more of the product. On the other hand, those whose incomes decrease, ceteris paribus, will tend to buy less of the product.

Change in Quantity Demanded Vs Change in Demand To make sense of the dynamics of market demand, the terms change in quantity demanded and change in demand should not be used interchangeably because these are two different concepts. When we say change in quantity demanded, it refers to a change in the quantity purchased due to the increase or decrease in the price of a product. This can be described as a movement from any point of our demand curve, along the curve, to another point on the curve. The cause of such a change is an increase or decrease in the price of the product under consideration. In such a case, it is incorrect to say that the demand increased or decreased. Rather, it is more appropriate to say that there was an increase or decrease in the quantity demanded.

Figure 4

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In the graph shown above, we can say that from point B to C, the quantity demanded of the considered good has gone up from 2 to 3 units as the price of the good went down from P250 to P200. We can also say that from point D to A, the quantity demanded of the considered good has gone down from 4 to 1 unit as the price of the good doubled from P150 to P300. Changes in demand on the other hand, are caused by the non-price factors affecting demand. An increase in demand will shift the demand curve to the right. A decrease in demand will shift the demand curve to the left. This is a result of other (aside from the price of the commodity), influencing the market demand. Let us take an example: a change in the income of buyers, ceteris paribus, will lead to a change in the market demand. An increase in income will definitely allow buyers to purchase more of the said product. Therefore, any increase in consumer income will shift our demand curve to the right while a decrease in consumer income will result in the shift of our demand curve to the left. (See Figure 2).

Figure 5 As mentioned above, an increase in income, ceteris paribus, will result to an increase in demand. This will result in a rightward shift of our demand curve from Do to D1. On the other hand, if income decreases, our demand curve will shift to the left from Do to D2. This is how income can change the level of demand in the market. Aside from income, we can also consider that population, tastes and preferences, prices of related commodities, and expectations will result in a change in demand. For figure 3, take for instance a particular situation in which people were repatriated to their respected places because of the current COVID-19 pandemic. These repatriated individuals will add to the current population of their places of origin. This increased population, ceteris paribus, will result in greater demand for particular products and our demand curve will shift to the right (from D0 to D1). Interestingly, this will result in a lesser demand in the areas from which people were repatriated from. These areas’ demand curves will then shift to the left (from D0 to D2).

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Figure 6 So far, we represented changes in quantity demanded and changes in demand through graphs. However, economists also use mathematical equations such as the demand function, to explain the relationships between demand and price as well as the non-price factors. The Demand Function The demand function shows the relationship between the quantity demanded of a product and the price of that product as well as the non-price factors. Below is the general demand equation. This is usually expressed as a linear equation:

Example using the demand function with only price as the major consideration of our demand; Let us take this linear function Qd = 60 – 10P, where Qd represents our quantity demanded and P is the price of the given product. According to this equation, if the price increases by one peso the quantity demanded will drop by 10 units. And if the price of the given product goes down to zero, the quantity demanded of our product is at 60 units.

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Table 3

Let us now try to consider other factors aside from the price of the product and come up with a multivariable linear demand equation. Example: If the demand for rice is influenced by 2 corresponding factors other than the existing price of rice (i.e. the price of corn, and the salary or income of our buyers), then the demand function for rice will be: Qd = 5 – 2(PRice) 4(PCorn) 0.0003Y (Yearly Income) This simple linear equation shows that any increase in the price of rice will decrease the amount or quantity that consumers will purchase. (note: rice is multiplied by a negative value -2(PRice) which shows the inverse relationship between the price of rice and the quantity demanded). On the other hand, if the price of corn increases as well as the income of consumers, these will result in to an increase in demand for rice. (note: corn is classically known as a substitute for rice and income is one of the factors that can influence demand in a directly proportional manner, which is why both are multiplied by a positive value) Now, what will happen to the demand function if the price of corn in the market is P50 per kilo and the yearly income of the consumer is P30,000. So What then is our new demand function for rice? Qd = 5 – 2P + 200 + 9

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= 5 – 2P + 209 Qd = 214 – 2P Interpreting the equation above, if the price of rice were zero, then the number or amount of rice demanded per kilo would be 214. What if the price of rice changes from P0.00 to P35.00 per kilo? This will result in in quantity demanded dropping to 144 units. Let us consider another scenario: what if the price of corn increases from P50.00 per kilo to P100.00 per kilo. What is our new demand equation for rice? The answer is Qd = 414 – 2P When we study and identify real market conditions, it is important to consider all the relevant variables associated with the market to come up with the best model for explaining economic behavior.

III. EVALUATION: In your Canvas Accounts, take the following to assess your learning in this module. - Assignment (analysis of your own proposed shop)

IV. REFERENCES Medina, Roberto G. (2003) Principles of Economics – Rex Bookstore Inc. Pagoso, C., Dinio, R., Villasis, G., (2006) Introductory to Macroeconomics – Revised Edition – Rex Bookstore, Inc. Samuleson, P. and Nardhaus, W. (1998) Economics – 16th Ed. McGraw – Hill Companies, Inc. McConnell, Bruce, Flynn, (2009). Economics, Principles, Problems, and Policies 18th Ed., McGraw-Hill Irwin, Inc. 2009

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Lesson 2: Review on Law of Supply Course Code: Module Code: Lesson Code:

Econ 1 (Managerial Economics) 3.0 (Market Forces: Demand and Supply) 3.2 (Review on Law of Supply)

I. LESSON OBJECTIVES: At the end of this lesson, the student should be able to: 1. 2. 3. 4.

Define economics; understand the law of supply; explain the relationship of price and quantity supplied through graph and equation; understand the determinants or factors affecting supply; and Identify supply sources.

II. DISCUSSION PROPER: The previous topics have established the law of demand and the factors behind changes in quantity demanded and shifts in demand curve. However, to fully understand the market system, it is also essential to understand the law of supply. The law of demand represents the consumers’ side while law of supply represents the producers’ side. In determining the supply of the goods and services in the market, what do you think are the considerations of the producers? What is the relationship between price and quantity supplied? Let these questions be your guide in understanding the law of supply as you read more of this module. The notion of supply and demand has been of one of the core concepts in studying economics. The interaction of the two is essential in understanding the movement of prices in the market. Since demand was discussed in the previous modules, the focus of this module will be the concept of supply. “Supply describes the behavior of the firms that are producing and selling goods and services.” (Bello et al., 2009). It also points out the relationship between price and the amount or quantity of goods and services that producers are willing and able to sell at that price, holding all other factors constant. Further, the law of supply states that the higher the price, the higher the quantity of goods and/or services that will be produced. In the same way, the lower the price, the lower the quantity of goods and/or services that will be produced (Bello et al., 2009). Thus, there is a direct relationship between price and quantity supplied of a good. In the same way, if production cost is less than the market is willing to pay for a product, production will be seen as profitable and when ...