Introduction to Economics

MADDA WALABU UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ECONOMICS

Course Code= Econ 1012

Credit=3hrs

Course instructor name: Genemo F.

CHAPTER TWO
UNIT OBJECTIVES

After completing this Unit, you will be able to:

 explain the concept of demand and Supply
 differentiate between individual demand and market
demand and Supply of a commodity;
 discuss the factors affecting demand and Supply
 state the law of demand ,supply and establish
relationship between price and quantity demanded,
Supplied
 construct an individual demand and Supply curve
 interpret the shape of individual demand and Supply
curve
 Define elasticity of Demand and Supply
 Market Equilibrium
2.1.Theory Of Demand

The Theory of demand is concerned with the

influence that potential buyers exert on price. The
behavior of potential buyers in a market is called
Demand and the amount of a commodity that buyers
are willing and able to purchase at a certain price in a
given period of time, keeping all other influences
constant, is called quantity demanded.

Demand exists only if someone is willing and able

to pay for a good-that is, exchange dollars for a good
or service in the marketplace.
 Quantity demanded is a flow concept and
does not refer only to the quantity of a
commodity consumers buy.
 The quantity demanded of a commodity
must, therefore, be understood with respect to a
time period (day, week, month, year, etc…).
 Hence, the quantity demanded of a commodity is
the various quantities of the commodity, which
buyers are willing and able to purchase at each
specific price, over a given period of time.
2.1.The Law Of Demand
•The law of demand gives the relationship between price
of a commodity and its quantity demanded, when all
factors other than price of the commodity remain
unchanged.
•The law of demand is given as, “If price of a
commodity falls, its quantity demanded increases
and if price of the commodity rises, its quantity
demanded falls, other things remaining constant.”
•The law of demand means that, other factors
determining the demand remaining constant, price of a
commodity and its quantity demanded are inversely
•

Dx
2.1.2.Demand Schedule
• Demand schedule :- A list showing the quantities
of a good that consumers would choose to
purchase at different prices, with all other
variables
Combinations held constant
A B C D E
• Table 2.1 Individual household demand for orange per week
Price per kg 5 4 3 2 1

Quantity demand/week 5 7 9 11 13
2.1. 3.Demand Curve
The demand curve :shows the
relationship between the price of a
Good and the Quantity demanded
in the market, holding constant all
other variables that influence
demand.
Each point on the curve shows the
total quantity that buyers would
choose to buy at a specific price.
Demand function
• Demand function is a
mathematical relationship between
price and quantity demanded, all
other things remaining the same. A
typical demand function is given by:
Qd=f(P)
• where Qd is quantity demanded and
P is price of the commodity, in our
Market Demand:

Market Demand: The market

demand schedule, curve or
function is derived by horizontally
adding the quantity demanded for
the product by all buyers at each
price.
Individual and market demand for a commodity
Individual demand Market
Price demand
Consumer-
1 Consumer-2 Consumer-3

8 0 0 0 0

5 3 5 1 9

3 5 7 2 14

0 7 9 4 20
Determinants Of Demand
• The demand for a product is influenced
by many factors. Some of these factors
are:
a) Price of the product
b) Taste or preference of consumers
c) Income of the consumers
d) Price of related goods
e) Consumers expectation of income and
price
f) Number of buyers in the market
2.1.4. Determinants Of Demand

a)The price of own commodity (PA)

 If the price of a commodity rises, ceteris paribus, the quantity
demanded of that commodity falls; if the price of a
commodity declines, all other factors being kept constant, the
quantity demanded of that commodity increases.

b) The price of substitutes (PS)

 Any two or more commodities that satisfy similar needs or
desires are known as substitute commodities or
substitutes.
 When two commodities are substitutes, an increase in the price
of one good causes an increase in the demand for another
c) The Price of Complements (PC)
 Complementary goods (complements) are any
two or more goods, which go together
 When commodities are complements, a decrease
in the price of one commodity causes an increase
in the demand for another good and an increase
in the price of a commodity results in a decrease
in the demand for the other.
 Example Film and camera, tea and sugar,
gasoline and automobiles are good examples of
d ) Change in household income and
Wealth (I)
• More generally, an increase in consumer’s money income
increases the demand for most goods whereas a fall in
consumer’s income tends to reduce the demand for these
goods.
• Commodities whose demand goes up when income is
higher and whose demand goes down when income is
lower are called superior goods (normal goods).
• On the other hand, commodities whose demand declines
when income rises and whose demand goes up as income
decreases are called inferior goods (example; used
e) Consumer's tastes and Preferences (T)
• A change in consumer’s tastes and preferences is more likely
prompted by advertising or fashion changes. For instance,
the demand for fashioned goods increases, but with the
passage of time, such goods would be less preferred.

f) Consumer’s expectation about future price

change (E)
• People may have expectation about future price changes
and these may affect their decisions at present. For instance,
if they anticipate price for a given product to increase in the
future, they buy more of the product now to avert higher
prices in the future.
Elasticity of Demand

• Elasticity is a tool that is used to describe the relationship

between two variables. It is defined as The percentage
change in a dependent variable “caused” by a
percentage change in an independent variable.

Demand can be classified as elastic, inelastic or

unitary.
• An elastic demand is one in which the change in quantity
demanded due to a change in price is large.
• An inelastic demand is one in which the change in quantity
demanded due to a change in price is small.
Income Elasticity of Demand (E1)
Income elasticity of demand measures the responsiveness of
quantity demanded of a commodity for an individual
consumer to the change in the income of the consumer.

The income elasticity of demand (E1) is expressed as a

percentage change in quantity demanded of a commodity
divided by a percentage change in income, ceteris paribus.
• Mathematically,
Income elasticity = Percentage change in quantity demanded
Of demand (EI) Percentage change in income
EI = % change in Q
% change in I
•
•
 For most goods a rise in income leads to increase
in demand and the income elasticity of demand
for these goods will be positive. These types of
goods are said to be normal goods. For inferior
goods, demand (consumption) decreases in
response to an increase in income.
 Thus, the income elasticity of demand for inferior
goods is negative. This is so because when the
income of the consumer increases, he/she
substitutes the superior goods for the inferior
ones.
 On the whole, the income elasticity of demand for
most commodities varies as income changes
depending on the nature of the commodity.
 If the income elasticity of demand (EI) is

negative, the commodity is inferior.

 If the income elasticity of demand (EI) is

positive, the commodity is normal (either luxury

or necessity).
 A normal good is usually a luxury if EI > 1, and a

necessity if 0<EI<1.
2.2 Theory of Supply

•In the theory of supply, supply is the relationship

between the price of an item and the quantity
supplied by sellers, given all other influences
whereas quantity supplied (the amount of a
commodity sold in the market) refers to the quantity
of a particular commodity that a firm (seller) is
willing and able to offer for sale at alternative prices,
during a given period of time.
•Thus, like demand, supply is a relationship but not a
2.2.1. Law Of Supply

 The Law of supply expresses the

functional relationship between
the price of a commodity and its
quantity supplied, provided that
other factors remain the same.
Assumptions of the Law of Supply
• Law of supply depends on the basic assumption, ‘other things being

equal (ceteris paribus)’. By other things we mean factors other than

price which affect the supply of a commodity. For example, price of

related goods, price of factors of production, objectives of firm,

production technique etc. For the law, to operate there should be no

change in any of these other determinants. We may summarize

The assumptions of the law of supply as follows:

• There should be no change in the prices of related goods,
• There should be no change in the prices of factors of
production,
• There should be no change in the goals of the firm
• There should be no change in the state of technology,
Supply Schedule
• A supply schedule is a tabular statement that states the
different quantities of a commodity offered for sale at
different prices.

There are two types Of Supply schedules

i Individual supply schedule.

ii Market supply schedule.

• i. Individual supply schedule is a tabular statement
which shows the different quantities of a commodity offered
for sale by an individual firm at different prices per time
period.
• ii. Market supply schedule is a tabular statement which
Supply Curve

• A supply curve conveys the same

information as a supply schedule. But it shows
the information graphically rather than in a
tabular form.
There are two types Of Supply curves
i Individual supply curve.
ii Market supply curve.
• i. Individual supply curve refers to
the curve which expresses graphically
the relationship between different
quantities of a commodity supplied by
an individual firm at different prices
per time period.

• ii. Market supply schedule is found by

adding horizontally the individual
supply curves.
Determinants Of Supply
a) The price of the commodity itself (PA)
• If the price of a commodity goes up, ceteris paribus, the
quantity supplied of the commodity increases, and if the price
of the commodity falls, all other factors being held constant, the
quantity supplied of the commodity declines.
b) The Price of Substitutes (PS)
• An increase in the price of a product reduces the supply of its
substitutes and an increase in the price of substitutes reduces
the supply of a commodity under consideration, keeping all other
factors constant.
• In a similar manner, a fall in the price of a commodity raises the
supply of its substitutes and a decrease in the price of substitutes
c) The price of Complements (Pc)
• A rise in the price of complements increases the supply of an alternative good

and a fall in the price of complements reduces the supply of the alternative good,

keeping other factors constant.

• For instance, when the price of car rises, the price of petrol being unaltered, the

supply of petrol rises and a fall in the price of car, the price of petrol being the

same, would cause the supply of petrol to decline.

d) The cost of production (C)

• A producer’s willingness to supply a commodity depends on two considerations:

the price of the commodity and the cost of production.

• The cost of production is determined and conditioned by the prices of relevant

e) Seller’s expectation about future price change
(E)
• What motivate business people for production are
not only the current prices but also the anticipated
future prices.
• Businesses plan their production on what they
expect prices to be.
• In general, expectation of future price rise induces
business firms to produce more and hence future
supply will increase.
• But, if business people anticipate the price of a
Elasticity of Supply (Es)

 The price elasticity of supply measures the

responsiveness of quantity supplied of a commodity to

changes in the price of the commodity, other things
being constant.
 More specifically, the price elasticity of supply (Es)
at any given point on the supply curve can be
expressed as a given percentage change in the
quantity supplied of a commodity as a result of a given
percentage change in the price of the commodity,
ceteris paribus.
• The coefficient of the price elasticity of supply may vary from
zero to infinity, which can be categorized and interpreted as
follows:
• i) If the price elasticity of supply is greater than one, supply is
price elastic (Es>1). This means that for any price change, there
will be a more than proportionate change in quantity supplied of
a commodity.
• Example: a) If a 3% change in the price of a commodity brings
about a 4% change in quantity supplied of the commodity,
supply is price elastic
(Es = = 1.33).
b) If a 2% increase in the price of a certain product triggers a 3%
increase in the quantity supplied of the commodity, ceteris
• ii) If the price elasticity of supply is less than unity, supply
is price inelastic (Es<1). This implies that for any price
change, there will be a less than proportionate change in
the quantity supplied of the commodity, everything being
equal.
Example:
a) If a 4% change in the price of a commodity causes a 3%
change in the quantity supplied of the commodity, supply is
price inelastic (Es = 0.75).

b) If a 5% decline in the price of a commodity is

accompanied by a 4% decrease in the quantity supplied of
• iii) If the price elasticity of supply is exactly unity,
supply is unitary elastic (Es = 1). This means a given
percentage change in the price of a commodity would
cause a proportionate change in the quantity
supplied of the commodity. Any straight-line supply
curve passing through the origin has unitary elasticity
throughout its length, regardless of its slope. Thus,
for a unitary elastic supply curve, Es = 1.
•Example:
a) If a 3% change in the price of a commodity is
accompanied by a 3% change in the quantity
supplied of the commodity, supply is unitary elastic.
b) If a 6% drop in the price of a commodity causes a 6%
decline in the quantity supplied of the commodity,
supply is unitary elastic.
• iV) If the price elasticity of supply is exactly zero,
supply is perfectly inelastic (Es = 0). This means
quantity supplied does not respond to price change
and the supply curve will be vertical drawn parallel to
Determinants Of Price Elasticity Of Supply
•The price elasticity of supply is affected by a number of important factors,
are:
i) Length of production period
•The price elasticity of supply is influenced by the length of time which is
required to adjust supply to price change. The time period can be momentary,
short-run or long run.
•

•In the momentary time, supply is perfectly inelastic. This means that quantity
supplied is limited to the quantities already available in the market and it
cannot be increased whatever price is offered.
ii) Availability of factors of production
•

•If factors of production such as labour, land, capital etc are available in large
and desired quantities, supply is relatively elastic. But, if factors of production
iii) Factor substitution
•If there are more substitutes of factors of production (example,
tractors for farming oxen), then supply is more elastic. This
means whenever there is a slight change in the price of a factor
input, it can be substituted for others making supply quite
elastic. If there are less or no substitutes of factor of production,
however, supply is price inelastic.
•

iv) Number of sellers in the market

•The market supply will be more elastic when there are a large
number of firms (sellers) in the market. However, with a small
number of sellers in the market, supply is price inelastic.

V) Accumulation of stock
•

•If warehouses exist to accumulate stock, supply is more elastic

whereas in the absence of warehouses, supply is price inelastic.
2.3. Market Equilibrium

• Market equilibrium refers to a situation in which the

quantity demanded of a commodity equals the quantity
supplied of the commodity.

• Equilibrium Price The price at which the quantity

demanded of a commodity equals quantity supplied is known as
‘equilibrium price’.

• Equilibrium Quantity The equilibrium price is the price at

which the consumers are willing to purchase the same quantity
of a commodity which producers are willing to sell. The amount
that is bought and sold at equilibrium price is called the
Market equilibrium
• Numerical example: Given market
demand: Qd= 100-2P, and market
supply: P =( Qs /2) + 10
a)Calculate the market equilibrium price
and quantity
b)Determine, whether there is surplus or
shortage at P= 25 and P= 35.
Solution:
a)At equilibrium, Qd= Qs 100 – 2P = 2P – 20
4P =120
P = 30, and Q = 40
b) Qd (at P = 25) = 100-2(25) =50 and
Qs(at P = 25 ) = 2(25) -20 =30
Therefore, there is a shortage of: 50 -30
=20 units
Qd ( at P=35) = 100-2(35) = 30 and Qs (at
p = 35) = 2(35)-20 = 50, a surplus of 20
units