Demand and Supply Flashcards
What is the law of demand?
It states that when ‘the price of a good rises, the quantity demanded of that good falls and vice versa, provided that all other factors that can affect demand remain constant.
What are the two reasons for the law of demand?
- The purchasing power of people’s real income tends to fall when the price goes up
- this reduces the amount that individuals can buy with the money they have making them feel poorer (INCOME EFFECT)
- When the price of a good rises, people would switch to a cheaper substitute of that good, reducing the quantity demanded for the good (SUBSTITUTION EFFECT)
How can the law of demand be illustrated?
- On a demand curve (price on Y-axis and quantity demanded on X-axis)
- The curve is downward sloping
- It can be of an individual consumer or the sum of the demands of consumers in the market
What happens to the demand curve when the price of a good changes?
A movement along the demand curve occurs, leading to CHANGE IN THE QUANTITY DEMANDED.
When factors affecting demand other than the price of the good (e.g. income of individuals/ price of other goods etc.) changes, they cause the DEMAND CURVE TO SHIFT, leading to CHANGE IN DEMAND
- Rightward shift = increase in demand
- Leftward shift = decrease in demand
What is the law of supply?
When the price of a good rises, the quantity supplied of that good rises and vice versa, provided that all other factors that can affect supply remain constant.
What are the two reasons for the law of supply?
- Higher prices make it more profitable for producers
- Prolonged high price will encourage more producers to enter the market thus increasing the market supply
How can the law of supply be illustrated?
- On a supply curve (price on the Y-axis and quantity supplied on the X-axis)
- The curve is upward sloping
- It can be of an individual producer, or the sum of the supply from producers in the market
What happens to the supply curve when there is a change in the price of a good?
A movement along the supply curve.
While a change in factors influencing supply other than the price of that good (e.g. cost of production, random shocks etc.) will lead to a shift of the supply curve
- rightward shift = increase in supply
- leftward shift = decrease in supply
What is the equilibrium point?
This is the point where the quantity demanded and quantity supplied are equal.
Thus there is no shortage or surplus.
At this point the price is referred to as equilibrium price and the DEMAND AND SUPPLY FUNCTIONS are equal.
What is elasticity of demand?
This is the degree of responsiveness of the quantity demanded of a good due to a change in a factor affecting the quantity demanded of the good
When is it Elastic?
If the change in the factor influencing demand leads to a larger proportionate change in the quantity demanded
When is it Unitary?
If the change in the factor influencing demand leads to the same proportionate change in the quantity demanded
When is it Inelastic?
If the change in the factor influencing demand leads to a smaller proportionate change in the quantity demanded
What is Price Elasticity?
The degree of responsiveness of the quantity demanded of a good due to a change in the price of that good.
Mathematically, it is the percentage change in the quantity demanded of a good due to the percentage change in its price.
What is the formula for Price Elasticity?
Pe =
changeQ/Q ÷
changeP/P)
- It is elastic if the value of Pe is greater than 1
- It is unitary if the value of Pe is equal to 1
- It is inelastic if the value of Pe is less than 1.
