Chapter 3, Problem 3.4SC

To determine

The law of demand and supply and study the movement along or shift of a demand curve.

Concept Introduction:

Law of Demand- The neo-classical economist, Alfred Marshall propounded the law of demand which establishes an inverse relationship between the quantity demanded and its price. The law states that as the price of a commodity falls the demand increases and vice versa, assuming ceteris paribus. The assumption implies that all other variables that can affect demand like income, prices of substitutes and complements, tastes and preferences of the consumers etc should be constant.

Extension and contraction of demand- An change in the quantity demanded due to a change in the price, given the ceterus paribus condition, is shown by a movement along the same demand curve. This is known as the extension or contraction of demand.

Increase or Decrease of demand- A change in the demand due to exogenous factors or the factors assumed constant by the law of demand, like income or prices of other related goods, is not captured by the demand curve which establishes a relationship between the price and quantity demanded. This change in demand is termed as the increase or decrease in the demand and causes the demand curve to shift outward or inward.

Law of Supply- The law establishes a direct relationship between the price and quantity supplied assuming ceteris paribus. The assumption implies that all other variables that affect supply like input prices, technology and factor productivity, taxes and subsidies, expectations of future relative prices, number of industries etc are held constant.

Supply Curve- The supply curve is upward sloping to the right given the direct relationship between price taken on the Y-Axis and quantity supplied on the X-Axis.