Theory of Demand and Supply – concepts, curves, equilibrium & elasticity

1. Introduction

The demand‑supply framework is the backbone of micro‑economic analysis. It tells us how much of a good or service buyers are willing to purchase at each price (demand) and how much producers are willing to offer (supply). The interaction determines the market price and quantity exchanged.

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2. Demand

2.1 Definition & Law of Demand

Demand = quantity of a good that consumers are willing and able to buy at various prices, ceteris paribus.
Law of Demand: All else equal, a rise in price leads to a lower quantity demanded; a fall in price leads to a higher quantity demanded.

2.2 Determinants of Demand

2.3 Demand Schedule & Curve

A demand schedule lists price‑quantity pairs. Plotting price on the vertical axis and quantity on the horizontal axis yields the demand curve, typically downward‑sloping.

2.4 Worked Example – Budget Line & Consumer Equilibrium

A consumer has Rs 16,000 income. Prices: $P_x=$ Rs 1,600 for good x, $P_y=$ Rs 800 for good y.

Budget line equation:
$$P_{x}x+P_{y}y=I\Rightarrow 1600x+800y=16000$$

Solve for y:
$$y=\frac{16000-1600x}{800}=20-2x$$

Plotting gives a straight line with intercepts (0,20) and (10,0).

Assume the consumer’s indifference curves are convex and the highest attainable curve touches the budget line at x = 4, y = 12. This point satisfies the marginal rate of substitution (MRS) = price ratio:

$$\frac{M{U}_x}{M{U}_y}=\frac{P_x}{P_y}=\frac{1600}{800}=2$$

Thus the equilibrium consumption bundle is $(x^{\ast },y^{\ast })=(4,12)$.

2.5 Price Elasticity of Demand (PED)

$$E_d=\frac{\%\Delta Q_d}{\%\Delta P}$$

• Elastic demand $|E_d|>1$ → quantity changes proportionally more than price.
• Inelastic demand $|E_d|<1$ → quantity changes proportionally less.
• Unit‑elastic $|E_d|=1$.

Interpretation of components for $Q_d=a-bP$:

• $a$ = intercept (maximum quantity demanded when price = 0).
• $-b$ = slope (rate at which quantity falls as price rises).

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3. Supply

3.1 Definition & Law of Supply

Supply = quantity of a good that producers are willing and able to sell at various prices, ceteris paribus.
Law of Supply: Higher price induces producers to supply more; lower price induces less.

3.2 Determinants of Supply

3.3 Supply Schedule & Curve

A supply schedule lists price‑quantity pairs for producers. Plotting yields an upward‑sloping supply curve.

2.4 Worked Example – Deriving Linear Supply

Given table:

Assume linear form $Q_s=a+bP$.

Using two points (0,100) and (40,500):

$$b=\frac{500-100}{40-0}=\frac{400}{40}=10$$

$$a=Q_s-bP=100-10(0)=100$$

Thus supply function: $\boxed{Q_s=100+10P}$.

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4. Market Equilibrium

4.1 Equilibrium Condition

$$Q_d(P^{\ast })=Q_s(P^{\ast })=Q^{\ast }$$

The price $P^{\ast }$ and quantity $Q^{\ast }$ where the two curves intersect are equilibrium.

4.2 Graphical Determination

4.3 Comparative Statics – Shifts

4.4 Worked Example – Table Completion & Equilibrium

Given:

Compute:

• For $P=6$: $Q_d=100-5(6)=70$; $Q_s=30+5(6)=60$.
• For $P=7$: $Q_d=65$; $Q_s=65$ → Equilibrium at (7,65).
• Continue similarly.

Graph shows demand curve crossing supply at $P=7$, $Q=65$.

4.5 Relation of Revenue & Elasticity

• Total Revenue (TR) = $P\times Q$.
• Marginal Revenue (MR) = change in TR for one extra unit sold.

When demand is elastic, a price cut raises TR (MR positive). When demand is inelastic, a price cut lowers TR (MR negative).

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5. Government Interventions

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6. Real‑World Applications

6.1 Daraz Order Queue

Daraz’s daily order processing can be modelled as a supply curve of delivery slots. When a flash sale drops the price of a popular gadget, the demand curve shifts right, creating a temporary shortage of delivery slots (queue length increases). Daraz responds by adding extra delivery trucks – a rightward shift of the supply curve – restoring equilibrium.

6.2 eSewa Transaction Fees

eSewa charges a fixed transaction fee of Rs 10 per payment. If the fee is increased, the effective price of using eSewa rises for merchants, shifting the demand for eSewa services left (fewer merchants choose it). Conversely, a promotional waiver shifts demand right, increasing transaction volume.

6.3 Ncell Data Packages

Ncell offers a 2 GB data pack at Rs 500. When a competitor (NTC) launches a 2 GB pack at Rs 450, Ncell’s demand curve for its pack shifts left. Ncell may respond by lowering price (moving along its demand curve) or improving network speed (shifting its demand curve right again).

6.4 Kathmandu Traffic Routes (Supply Constraint)

During peak hours, the supply of road capacity on the Ring Road falls due to congestion, effectively shifting the supply curve left. Drivers’ willingness to pay higher travel time costs shifts the demand curve right, leading to higher “price” (travel time) and lower “quantity” (vehicles that can move smoothly). Traffic‑management policies (e.g., dedicated bus lanes) act as a supply‑enhancing measure.

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7. Comparison Table – Demand vs. Supply

| Aspect                | Demand                              | Supply                              |
|-----------------------|-------------------------------------|-------------------------------------|
| Typical slope         | Negative (downward)                 | Positive (upward)                   |
| Primary driver        | Consumer preferences & income      | Producer costs & technology         |
| Shift rightward when  | Income rises (normal good)          | Input costs fall or tech improves    |
| Shift leftward when   | Income falls (inferior) or price of substitutes falls | Input costs rise or taxes increase |
| Elasticity measure    | Price Elasticity of Demand (PED)   | Price Elasticity of Supply (PES)    |
| Market signal         | Willingness to pay                  | Willingness to produce               |

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8. Advantages & Limitations of the Demand‑Supply Model

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9. Worked Example – Loan Interest (Application of Elasticity)

A Nepali bank offers a loan at 12 % annual interest. Empirical study shows the interest‑rate elasticity of loan demand is $-0.4$ (inelastic).

If the bank raises the rate to 13 % (increase of $\frac{1}{12}=8.33\%$), the expected change in loan quantity is:

$$\%\Delta Q=E_d\times \%\Delta P=(-0.4)\times 8.33\%=-3.33\%$$

Thus loan volume falls by only 3.33 %, indicating the bank can increase revenue by raising rates, a typical outcome for inelastic demand.

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10. Real‑World Images

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11. Exam tip

• Memorise the four determinants of both demand and supply; exam questions often ask you to identify the shift direction.
• Practice converting tables to linear equations (use two points to find intercept and slope).
• When a question provides a demand (or supply) function, always write the equilibrium condition $Q_d=Q_s$ and solve for $P^{\ast }$ first, then compute $Q^{\ast }$.
• For elasticity, use the midpoint formula:
  $$E=\frac{(Q_2-Q_1)}{(Q_2+Q_1)/2}/\frac{(P_2-P_1)}{(P_2+P_1)/2}$$
  This avoids sign errors and is the method marked in TU/PU exams.
• In graph‑based questions, label axes, intercepts, equilibrium point, and indicate the direction of any shift with an arrow. Clear, neat sketches earn full marks even if the curve is not perfectly to scale.