6. What do demand and supply depend on? Formulate the law of demand and the law of supply. Explain the concept of elasticity.

Demand is a consumer’s willingness and ability to buy a product or service at a particular time and place.

The law of demand describes the relationship between prices and the quantity of goods and services that would be purchased at each price. It says that all else being equal, more items will be sold at a lower price than at a higher price.

Demand behaves these way for some of the following reasons.

• More people can afford to buy an item at a lower price than at a higher price.

• At a lower price some people will substitute ice cream cones for other items (such as candy bars or soft drinks), thereby increasing the demand.

• At a higher price some people will substitute other items for ice creams.

• Economists describe this effect diminishing marginal utility. “Utility” refers to the usefulness of something. Thus “diminishing marginal utility” is the economist’s way of describing the point reached when the last item consumed will be less satisfying than the one before.

Elasticity of Demand.

For example lets compare cola and milk. If, for example, the price of milk and cola were to triple, people would buy less cola and milk. But the decrease in milk sales would be far less than the decrease in cola sales. This is because people can do without cola more easily than they can do without milk. The quantity of milk purchased is less sensitive to changes in price than is the quantity of cola. Demand for cola is more elastic than the demand for milk. Elasticity describes how much a change in price affects the quantity demanded.

When the demand for an item is inelastic, a change in price will have a relatively small effect on the quantity demanded. When the demand for an item is elastic, a small change in price will have a relatively large effect on the quantity demanded.

Elasticity can also be measured by the "revenue test." If after price increase, total revenue falls, the demand will be described as elastic. If after price increase, total revenue increases, the demand will be described as inelastic.

Why the Demand for Some Goods and Services Is Inelastic. The demand for some goods and services will be inelastic for one or more of the following reasons:

• They are necessities.

• It is difficult to find substitutes.

• They are relatively inexpensive.

• It is difficult to delay a purchase. When your car is running out of gas, it is not always possible to shop for the best deal.

Substitutes. When two goods satisfy similar needs, they are described as substitutes. Black and brown shoes are close substitutes. If the price of black shoes goes up, then people will tend to substi­tute brown shoes for black shoes, and the demand for brown shoes will be raised.

Complementary goods. Goods that are often consumed together, like peanut butter and jelly, are complements. If the price of peanut butter should increase, the quantity of peanut butter consumed will decrease. Since peanut butter and jelly are consumed together, the quantity of jelly demanded at each and every price will also decline, and the demand curve for jelly will shift in.

factors that might affect the curve:

• Change in the environment. It is a much hotter month than usual.

• Change in the item’s usefulness. The Surgeon General of the United States issues a report that states ice cream is good for you and enhances your attractiveness.

• Change in income. Allowances are raised as an economic boom sweeps your community.

• Change in the price of a substitute product. The price of candy decreases.

• Change in the price or availability of complemen­tary products.

• Change in styles, taste, habits, etc.

Supply

The law of supply states that sellers will offer more of a product at a higher price and less at a lower price.

The higher the price, the greater the incentive to produce and sell the product.

Any or all of the following changes are likely to affect the quantities supplied.

• Changes in the cost of production.

• Other profit opportunities. If the price of a product they have not been producing (but could if they chose to) increases, many will shift their output to that product.

• Future expectations. If producers expect prices to increase in the future, they may increase their production now to be in position to profit later.

The price at which supply exactly equals demand is known as the market price, or the point of equilibrium.