APPLIED ECONOMICS

GRADE 11 ( GAS )
PREPARED BY: ANNABELLE L. MANCO

UNIT 1: ECONOMICS AND REAL- WORLD CHALLENGES

MODULE 3:
THE LAW OF DEMAND AND SUPPLY AND THE MARKET EQUILIBRIUM

PRICES OF BASIC COMMODITIES

Why is a kilogram of fruit sold in the public market is cheaper than a kilogram of the same fruit sold at the
supermarket? You will find the answer to this question in this section as you learn how prices of goods and services are
set in the market and the factors that affect the determination of the market price.
What is a commodity? This term as used in economics pertains the homogenous good that commands a price.
Examples would be grains such as rice, corn, and wheat; utilities such as electricity; and other product that are normally
produced in bulk such as oil, sugar, etc. A commodity is characterized by its uniformity across the market. Regardless of
the producer of the good, the output will have more or less the same attributes. For instance, it is hard to distinguish rice
grains that were harvested by a farmer in Isabela from rice grains that were produced by a farmer in Davao. This is in
contrast of branded products, which can be highly differentiated. For instance, one brand of hand soap may differ from
another in terms of size, scent, ingredients, and packaging. It is these distinctions that influence the price of the product.
Additionally, commodities are often used as a raw materials or inputs to produce another good (secondary
products). For example, wheat is used to make bread and beer, while crude oi is refined to produce petroleum, which in
turn is processed further to create ink, fue, paint, plastic, among other things. Because of their raw materials, commodities
are generated in significant quantities.

ACTIVITY 1:
Identify which of the following goods are commodities (C ) and which are secondary products
( S ). Write C or S on the blank.

1. sugar ________ 2. Coffee _________ 3. plastic ________ 4.Rubbervcement________5. flour_______

6. diesel fuel _______ 7. timber _________ 8. textile _______ 9. corn _________ 10. gravel _________

Given the characteristics of a commodity, its price is dictated by the quantity available in the market, taken as a
whole. For instance, assume that the supply of rice in the country largely comes from Central Luzon. If a strong typhoon
hits and damages the rice crops in the region, expect the domestic supply of rice to fall. This will in turn cause the price of
rice to surge. The price adjustment will likely impact not just the area hit by calamity, but also the rest of the country. In
the case of highly differentiated products, one brand will most likely be priced higher due to its perceived effectiveness or
quality rather than the volume available in the market. Thus, a chocolate cake from Bacolod may be priced higher than a
similarly sized chocolate from Cebu.
On a global scale, local prices of imported goods are also influenced by events in the exporting country.
Essentially, a local producer imports a good for three main reasons: (1) the good is not available locally, (2) the cost of
importing is cheaper than procuring the same good locally, and (3) the quality of the imported good is better than a similar
good sold locally. Being an importer, however, means that you take whatever is the prevailing market price of the
imported good. Consider the crude oil for example. Crude oil is a commodity that the Philippines imports. Apart from not
being available domestically, it is cheaper to import it from countries that are in the business of extracting and refining
crude oil into various usable forms. The Middle East and member countries of the Organization of the Petroleum
Exporting Countries ( OPEC) having an abundant supply of it are the major supplies globally. In the event that these
countries run into trouble that would limit the supply or increase their production costs, the price of oil will go up. The
Philippines, being an importer, would have to pay this higher price.

DEMAND
Recall that in the pervious modules you learned that economics is about efficient allocation of available ( and
limited ) resources. Consider what limited resource means: firms can run out of

capital ; individuals, too, can have their income depleted. This characteristic is known technically as the resource
constraint. This compels firms, governments, and household consumers to find the best trade off with the opportunity
cost. For example, firms have to decide on how much of a certain product to manufacture and how many resources such
as labor to utilize. In the same way, governments ave to decide on how much to spend on rebuilding a highway or how
often to do repairs on public infrastructure.
THE LAW OF DEMAND
Now, consider the micro or the individual level. Under the same assumption that resources are limited, consumers
must choose how much of a good they will buy. Consumer utility refers to a person’s willingness and ability to consume
a good in reaction to price changes. Consumer utility forms the basis of the law of demand.
The law of demand states that as the price of a good goes up ( P ), the quantity demanded of that good goes
down ( Q d ) , all other things remaining constant ( ceteris paribus ). This means that consumers tend to buy more
of a certain good at lower prices. Conversely, as this good becomes more expensive, consumers will tend to buy less.
The opposite relationship of price and quantity demanded is best explained through a demand curve. A demand
curve illustrates the linear attribute of the law of demand. Points along the curve correspond to quantity demanded at
varying price levels. Figure 3.1 shows an example.
Take a look at figure 3.1. assume that this is the demand curve for apples. At point A where the price of apple is
30. 00 per price, quantity demanded is 1. At point B where the price of apple is 10.00 per price, quantity
demanded is 3 pieces. Given the cetires paribus assumption, which means there are no changes in other factors, the law of
demand asserts that you will be willing to buy more apples when the price of an apple is cheaper.

Demand Curve

Quantity ( pieces )
Fig. 3.1 At point A, with a higher price of 30.00, the quantity demanded is 1 while at point B, with a lower price of
10.00, the quantity demanded is 3.
The inverse relationship between price and quantity demanded is represented by the downward- sloping demand
curve. Inverse refers to the direction of change for the two variables --- price and quantity. When variable 1 rises, the
opposite happens to variable 2. More specifically, when the price increases (( P ), the quantity demanded decreases ( Q d
), and vice versa.
The downward- sloping demand curve implies a negative slope. Remember that the slope of a linear function is
rise over run given two points on the curve. Think of the change in the y- axis to represent the “ rise “, while the change in
the x- axis corresponds to the “run”. Knowing that the price ( P ) represents the y- axis in your demand curve diagram and
quantity demanded ( Qd ) corresponds to the x- axis, it can be inferred that the slope of the demand curve equals change in
P over change in Qd. This relationship is summarized in equation 3.1.[ the Greek letter delta ( ) means “change” in a
variable.]
DETERMINANTS OF DEMAND
So far, you have learned that price influences the quantity demanded of a product. But aside from price, what
other factors affect the amount of good a consumer is willing to purchase? In this section, you will study other
contributing factors of demand.

ACTIVITY 2
Have you ever imagined winning the lottery? If you come across a huge amount of money, what do you plan on spending
it on?
INCOME
In the earlier discussion of price and quantity demanded, there was the ceteris paribus assumption. All other
variables apart from price and quantity demanded are presumed to be constant. But what happens if another factor such as
consumers’ income changes?
The extra spending money by a consumer is referred to in economics as disposable income. When an employee gets a
raise, how much of it can he or she actually take home? DISPOSABLE INCOME refers to the net amount after taxes
and other mandatory contributions have been deducted. This additional money is what drives a consumer’s desire to buy
or purchase more of good.
Typically, as consumers’ income rises ( ), quantity demanded of goods also increases ( ). This is known as
the income effect. Goods that display this attribute are identified as normal goods. Clothes can be an example of normal
goods.
 One contradiction to the income effect is the case of inferior goods. Goods that exhibit a decline ( ) in quantity
demanded as consumer income rises ( ) are called inferior goods.
Inferior goods are often of poorer quality than normal gods. This drives consumers to substitute the inferior good
for a better product when their income level improves. An example would be buying vegetables instead of meat or
choosing a cheaper variety of fish rather than prime cuts of meat.
In terms of elasticity, there are two further categories of normal goods------- luxury and necessity. Remember that
elasticity is a measure of responsiveness of one variable to a change in one another variable. In this case, income
elasticity relates to the change in quantity demanded in response to an adjustment in income.
Luxury goods exhibit an increase in demand more than the proportionate increase in income. Expensive designer
bags and one- of - a- kind jewelry are examples of luxury goods.
Necessity goods, on the other hand, show an increase in demand that is less than the proportionate increase in
income. Food staples such as rice or bread and utilities such as electricity are examples of necessity goods.
One contradiction to the law of demand is the case of Veblen goods, named after Thorstein Veblen, an American
economist who came up with the idea. The Veblen effect is the propensity of a good, identified as Veblen Good, to
increase in demand when its price soars to the point of being extremely overpriced. Like luxury goods, owning Veblen
goods conveys high status. But in contrast to luxury goods, Veblen goods are not driven by an increase in income. Rather,
the appeal comes from their expensiveness and exclusivity. The more expensive they get, the higher the demand. For
example, a luxury brand’s most exclusive and most expensive limited edition line is commonly a Veblen good. Often,
only a handful of people in the world can afford such goods.

SUBSTITUTES
Goods that meet the same requirements or fulfil the same needs as another good are called substitutes. Assume
that good B is a substitute for good A. As the price of good A increases, the quantity demanded of its substitute also
increases. The idea behind substitutes is basically having alternatives. When a good becomes more expensive, its
alternatives become relatively cheaper and generally more appealing. This is known as the substitution effect.
An example of a good service with substitute is local transportation. How do you actually go tto school? Do you take a
bus, ride a jeepney? Perhaps you do not commute but rather go by or maybe you walk. This means that you have several
options to get to school. Specifically, if you normally ride the bus but there is a bus fare hike increasing the fare from
12.00 to 15.00 for the minimum distance, then you might decide to take a cheaper option such as riding a
jeep, which costs a minimum of 7.00.

COMPLEMENTARY GOODS
Another factor that influences the quantity demanded of a product is the presence of a complementary good for
this product. Complementary goods are generally consumed or used together.
Classic examples of complementary goods are coffee and creame. When coffee becomes more expensive, there
will be less demand for coffee. It follows that demand for creamer will also drop, since creamer is not ordinarily
consumed on its own.

ACTIVITY 3
Check your understanding of the different types of economic goods. Classify the goods in column I by choosing the letter
of the correct answer in column II. Write the letters of the answer on the blank. ( note: answers may repeat )
COLUMN I COLUMN II
_______ 1. Car and gas a. substitutes
_______ 2. Lemon and calamansi b. normal goods
_______ 3. Canned goods c. complementary goods
_______ 4. Organic food d. inferior goods
_______ 5. Designer bags e. luxury goods
_______ 6. Generic supermarket products
_______ 7. Whole wheat pasta
_______ 8. Printer and ink cartridges
_______ 9. Margarine and butter
_______ 10. Vintage sports car