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DEMAND AND SUPPLY

Demand does not mean wants or needs. In Economics, demand refers to that quantity of a commodity
which the consumer is willing and able to pay for at a particular price within a given period of time. Effective
demand must therefore be backed by the willingness and ability to pay for a commodity.
Demand schedule and curve
A demand schedule is a table or a list showing the various quantity of a commodity which the consumer is
willing and able to pay for at each given price, within a given period of time, while a demand curve is a
graphical representation of the data in the demand schedule. Note that there is the Individual demand
schedule and the Market or composite demand schedule which is obtained by adding the individual
schedules.
Example of a demand schedule and curve

Price (Frs) Qty dded (Kgs)

90 120
80 250
60 380
50 450
40 600
20 730
10 840

From the above table and curve, we observe that the higher the price, the lower the quantity demanded
and vice versa. This is the first law of demand and supply which states that more will be demanded at a
lower than at a higher price.
Why does the normal demand curve slope downward from left to right? (Why is more demanded at
a lower than at a higher price.
There are three main reasons;
1.Due to the law of diminishing marginal utility. It states that as successive units of a commodity are
consumed, the additional satisfaction derived from consuming an additional unit of the commodity falls.
Therefore the consumer will be prepared to pay for any additional unit only if the price falls. The price which
we pay for a commodity reflects the satisfaction derived from it. The more the satisfaction, the more we will
be willing to pay higher and the lesser the satisfaction, the lesser we are willing to pay. Since more and
more units consumed gives us lower and lower satisfaction, so too will the consumer be willing to pay for
more units only if the price falls. For example, consider the table below showing the marginal utility which a
consumer derives from consuming successive units of a commodity.
No of units or qty Marginal Price (Frs)
Utility (utils)
1 16 16
2 12 12
3 8 8
4 5 5
5 3 3
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If each utility is valued at1 franc, then for the first unit where the marginal utility is 16, he will be willing to
pay 16 Frs. For the second unit where the marginal utility is 12, he will be willing to pay 12 Frs and so on.
This shows that price falls as number of units or quantity consumed increases, leading to a downward
sloping demand curve. The demand curve can be easily derived from the marginal utility as shown.

2. Due to the income effect of a change in price. The income effect deals with changes in consumer’s
real income; that is; what money income can buy or the purchasing power. When the price of a good falls,
the consumer’s real income increases and he will be able to buy more. When price increases, his real
income falls and he is able to buy less.
3. Due to the substitution effect of a change in price. The substitution effect requires that cheaper
goods should be substituted or preferred for dearer ones. When the price of a good falls, the good
becomes relatively cheaper and it is substituted or preferred for a dearer good. When price increases, the
good becomes relatively expensive and more cheaper goods are substituted or preferred for it.
Therefore the are two separate effects which is pushing a consumer to buy more when price falls; firstly
because his real income has increased (Income effect) and secondly because the good has become
relatively cheaper and more preferable to a dearer good (Substitution effect).
Exceptional demand curves (Abnormal or Regressive demand)
Even though the normal demand curve slopes downward from left to right, there are certain exceptional
cases where more is instead demanded at a higher price and less demanded at a lower price, making the
demand curve to instead slope upward from left to right. These include
1.Goods of ostentation (Veblen goods). These are goods which consumers buy not because of their
intrinsic or real values, but mainly because of the prestige attached to owning such goods. They are
prestigious goods of snob appeal which consumers buy mainly because they want to display or show off
their wealth. Some consumers tend to derive more satisfaction when they buy certain expensive goods
which others admire. Examples of such goods include Jewelleries, Sports cars, sophisticated mobile
phones etc. for such goods, when their price increase, the consumers buy more to display or show off their
wealth. The regression or abnormality is at the top but at low prices, such goods behave normally as shown.
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When the price is P, the quantity demanded is Q and when price increases to P1, quantity demanded also
increases to Q1showing that both the price and quantity are rising.
2. Giffen goods. These are goods which consumers consider to be of low quality to other goods. For such
goods when their price falls, the consumer’s real income will increase but the consumer will prefer to use
the increase in real income to buy more superior goods. Examples include staple food stuff like sweet
potatoes, cassava, second handed dresses etc. The regression or abnormality is at the bottom but at high
prices such goods will behave normally as shown.

When the price is P, the quantity demanded is Q and when price falls to P1, quantity demanded also falls to
Q1, showing that both price and quantity demanded are falling.
3. Expectation of future increase in price. When the price of a good is increasing and the consumer is
expecting a further increase in price in the future, he will tend to buy more at the moment. This is because
he wants to avoid buying at the high prices later. Likewise when the price of a good is falling and the
consumer is expecting a further fall in price in the future, he will tend to buy less at the moment. This is
because he wants to wait for the price to eventually fall so as to benefit.
Change In Quantity Demanded And Change In Demand
A change in quantity demanded is a movement along the same demand curve and it is due exclusively to
changes in price.

When price increases from P to P1, quantity demanded falls from Q to Q1, also known as a contraction in
demand, and when price falls from P1 to P, quantity demanded increases from Q1 to Q, also known as an
extention in demand.
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A change in demand on the other hand is a complete shift or displacement of the whole demand curve
either to the right which represents an increase in demand or to the left which represents a decrease in
demand. It is not due to price changes but it is due to changes in those factors influencing demand.

Factors influencing demand (Determinants of demand ).

Changes in income. When income increases, the demand for goods and services will increase shifting the
curve to the right and when income falls, demand will fall shifting the curve to the left. (use numerical
examples to illustrate.
2. Changes in taste and fashion. Taste and fashion changes daily, which affects demand. When a
commodity is in fashion, or when consumer's taste and liking for the commodity increases, the demand will
increase. If the fashion dies out, or when consumer's taste and liking for the commodity falls, the demand
will fall.
3. Changes in the price of other commodities. This depends on whether the goods are substitutes or
compliments. For substitutes such as butter and margarine, an increase in the price of one of the goods for
example butter will make consumers to shift to the substitute margarine leading to an increase in the
demand for margarine. Therefore with substitutes, increase in the price of one good will lead to increase in
the demand for the other good and fall in the price of one good leads to fall in the demand for the other
good.
For complimentary goods such as cars and petrol, an increase in the price of cars for example will lead to
a fall in its quantity demanded. As such, the demand for the compliment petrol will fall, since they are used
together. Hence for complimentary goods, increase in the price of one good leads to a fall in the demand
for the other good and vice versa.
4. Seasonal changes. The demand for certain goods are seasonal depending on changes in weather and
climate, festival periods etc. For example the demand for umbrellas is high during the rainy than in the dry
season. Demand turns to be very high during festival periods like Christmas.
5. Changes in government's policy on taxation. When the government increase direct taxes, the citizen's
disposable income will fall, leading to a fall in demand. If direct taxes are reduced, disposal income will
increase which will increase demand.
6. Availability of credit facilities such as hire purchase and credit sales. When these facilities are available,
demand turns to increase especially for durable consumer goods like cars and TVs.
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7. Changes in technology. Advancement in technology usually brings in new products leading to a fall in
the demand for the old ones. For example the demands for flat TV screens have been rising due to
advancement in technology in this direction.
8. Changes in population size and structure. Generally when population size increases, the demand for
goods and services will increase and vice versa. Changes in population structure also affect demand. Eg if
the population is ageing, or declining, it will lead to increase in demand for things needed by the old such
as walking sticks, hats etc while a young or growing population will increase the demand for things needed
by the young like fashionable dresses.
9. Advertisement. When the is a successful advertisement campaign carried out for a commodity, its
demand will increase. This is because advertisement creates awareness of the existence of a product in
the market and it motivates consumers to buy more.
SUPPLY
Supply does not mean the existing stock or amount available or what has been produced. In economics
supply refers to that quantity of a commodity which a producer is prepared to bring forth into the market at a
particular price within a given period of time.
A supply schedule is a table or a list showing the various quantities of a commodity which the producer is
prepared to supply at each given price within a given period of time, while a supply curve is a graphical
representation of the data in the supply schedule. Note that there is the individual supply schedule and the
market or composite supply schedule which is obtained by adding the individual schedules. Example of a
supply schedule and curve.

Price (frs) QtySS (kgs)

90 860
80 720
60 500
40 350
20 180
10 75
From the above table and curve, we observe that the higher the price, the higher the quantity supplied and
vice versa. This is the second law of demand and supply or simply the law of supply which states that more
will be supplied at a higher than at a lower price. More is supplied at a higher than at a lower price because
at a higher price, producers tend to make more profits as such they will be motivated to supply more.
EXCEPTIONAL SUPPLY CURVE
The supply curve of labour is an exceptional supply curve after the target income has been attained. The
supply of labour is the number of hours an individual is prepared to put in for work at a given wage rate,
while the price of labour is the wage rate. As wage rates increase, an individual will be prepared to put in
more hours of work up to when he attains his target income. The supply of labour is therefore normal up to
this point. After the target income, if the is any further increase in wage rate, the individual will now prefer to
reduce the number of hours put in for work and use the extra time gained for leisure. The supply of labour
therefore becomes regressive after the target income as shown.
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As wage rate increase from W1 up to the target income Wt, the number of hours supplied for work
increases from h1 to ht. This is because the individual's preference for work is stronger than his preference
for leisure when he has not attained his target income. After the target income, if there is any further
increase in wage rate for example to W2, the individual will now prefer to reduce the number of hours put in
for work to h2 and use the extra time gained for leisure. This is because individuals tend to have a strong
preference for leisure than work once they attain their target income.
CHANGE IN QUANTITY SUPPLIED AND CHANGE IN SUPPLY.
A change in quantity supplied is a movement along the same supply curve and it is due exclusively to
changes in price.

When price increase from P to P1, quantity supplied increases from Q to Q1 ( Also known as an extension
in supply). When price falls from P1 to P, quantity supplied also falls from Q1 to Q (Also known as a
contraction in supply). Qty DD (Kgs)
A change in supply on the other hand is a complete shift or displacement of the whole supply curve either
to the right which indicates an increase in supply or to the left which is a decrease in supply. It is not due to
price changes but it is due to factors influencing supply.
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Factors influencing supply (Determinants of supply)

1. Changes in the cost of raw materials and other factors of production. When the cost of raw materials like
fuel, fertilizers, and other factors of production increases, production cost will increase leading to a fall in
supply. This shifts the supply curve to the left. When these costs reduce, supply will increase shifting the
curve to the right. Note that cost of other factors include wages, interest and, rents.
2. Changes in weather and climatic conditions. The supply of certain products are seasonal depending on
changes in weather and climatic conditions. If the weather is favorable for producing a crop, the supply will
increase. If the weather is unfavorable like a prolonged drought or excessive rainfall, the supply will
decrease.
3. Changes in technology. The use of Advance techniques of production leads to increase in supply. This
is because when technology increases, per unit cost falls and output per man hour (productivity) increases.
For example Del monte has been able to increase the supply of bananas from Cameroon due to the use of
Advance methods of production.
4. Changes in the quality of raw materials. The use of high quality raw materials in production will lead to
increase in supply. For example if high quality yam seedlings are used in planting, the yield and
consequently output will increase.
5. Indirect taxes and subsidies. When the government impose or increase indirect taxes on producers,
production cost will increase leading to a fall in supply. If subsides are granted, production cost falls
leading to an increase in supply.
6. Changes in the prices of other commodities. This depends on whether the goods are in joint or
competitive supply. Goods are said to be in joint supply if they are produced together. One cannot be
produced without the other. For example Palm oil and palm kernel, plywood and saw dust, beef and hides.
An increase in the price of one of the goods for example palm oil will lead to an increase in its supply. As a
result, the supply of the other good palm kernel will increase since they are produced together. As such
when goods are in joint supply, increase in the price of one will lead to increase in the supply of the other.
Fall in price of one good leads to fall in the supply of the other.
Goods are in competitive supply if they are produced from the same raw materials. The producers
compete for the raw materials to supply the good. For example corn beer and corn fufu. If the price of corn
beer increases, its quantity supplied will increase. As a result, the supply of the other good corn fufu will fall,
since the raw materials have been used for beer production. As such when goods are in competitive
supply, increase in the price of one will lead to fall in the supply of the other and vice versa.
7. Expectations of future changes in price. When producers are expecting the price of a good to rise in the
future, they will turn to produce more at the moment hoping to benefit from the eventual price increase. Like
wise when they expect a future fall in price, they will reduce supply.
THE EQUILIBRIUM OR MARKET PRICE
It is that price where quantity demanded equates the quantity supplied. This is the third law of demand and
supply. The equilibrium or market price can be seen by bringing together the market demand and supply
schedules and curves.
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From the above table and curve, we observe that the equilibrium or market price is 40 frs because it is at
this price where quantity demanded equals the quantity supplied which is 500kgs. For any other price, the
will be forces at work that will tend to bring the price back to the equilibrium.
For any price above the equilibrium price, the quantity supplied will be more than the quantity demanded.
This creates surpluses which causes price to fall. Price falls until the equilibrium is attained. This also
creates a BUYERS MARKET situation since buyers will have an upper hand to bargain for price decrease.
For any price below the equilibrium, the quantity demanded will be greater than the quantity supplied. This
creates shortages in the market, causing price to increase. Price increase until the equilibrium is attained.
This equally creates a SELLERS MARKET situation since sellers will have an upper hand to bargain for
price increase.
The equilibrium price and quantity can also be determined from the demand and supply functions. The
demand/ Supply function is the functional relationship that exist between the quantity demanded/supplied
and all factors that affect this quantity demanded/supplied.
CHANGES IN THE EQUILIBRIUM OR MARKET PRICE.
This can be brought about by changes in the market demand and supply.
A) EFFECTS OF CHANGES IN MARKET DEMAND WHEN SUPPLY IS CONSTANT.
The initial demand and supply are DD and SS and the initial equilibrium price and quantity is Pe and Qe
respectively.

An increase in demand will shift the demand curve to the right from DD to D 1D1. This leads to a ride in the
equilibrium price from Pe to Pe1. The increase in demand creates shortages which causes price to increase.
When price increase, quantity supplied falls.
A decrease in supply will shift the Supply curve to the left from DD to D 2 D2. This leads to a fall in the
equilibrium price from Pe to Pe2. The decrease in demand creates surpluses which causes price to fall.
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When price falls, quantity supplied also falls. The fourth law of demand and supply thus states that
everything being equal, an increase in demand will raise price and increase the quantity supplied while a
decrease in demand will reduce price and reduce the quantity supplied.
B) EFFECTS OF CHANGES IN SUPPLY WHEN DEMAND IS CONSTANT.

The initial demand and supply are DD and SS and the initial equilibrium price and quantity are Pe and Qe
respectively. An increase in supply will shift the Supply curve to the right from SS to S1S1. This leads to a
fall in the equilibrium price from Pe to Pe1. The increase in supply creates surpluses which causes price to
fall. When price falls, quantity demanded increases.
A decrease in supply will shift the Supply curve to the left from SS to S2S2. This leads to a rise in the
equilibrium price from Pe to Pe2. The decrease in supply creates shortages which causes price to increase.
When price increase, quantity demanded falls. The firth law of demand and supply thus states that
everything being equal, an increase in supply will reduce price and increase the quantity demanded while a
decrease in supply will raise price and reduce the quantity demanded.
Question.
Study the diagram below showing changes in the demand and supply of butter locally produced in
Cameroon. DD and SS are the original demand and supply respectively.

Each time begining from the initial equilibrium point e, determine the new equilibrium if
1.The is an increase in consumer's income while the government impose an indirect tax on butter
producers.
2.The is a successful advertisement campaign for margerine while a new technique of producing butter is
introduced.
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3. Butter is discovered to cause a disease called BeriBeri while there is a severe drought which decimates
cattle herds.
4. Consumer's taste and liking for butter reduces.
ELASTICITY OF DEMAND. Elasticity measures the extent to which a dependent variable will change due
to changes in an independent variable. There are three types of elasticity of demand; that is price, income
and cross.
PRICE ELASTICITY OF DEMAND. It is the degree of responsiveness of changes in the quantity
demanded of a good due to changes in price. It is calculated as follows;
Ped=% change in quantity demanded
. .............................
% change in price
Price (frs) Qty dd(kgs)
50 250
40 300
35 500
20 550
a) Calculate the elasticity of demand (i) When price increase from 40frs to 50frs (ii) When price drops
from 50frs to 40 frs.
b) Calculate the arc elasticity of demand when price increase from 40frs to 50frs
Arc elasticity of demand. The above elasticities are point elasticities because they measure the
elasticity from one point of the demand curve to another. Arc elasticity measures the elasticity at
the midpoint.
Formular for Arc ed

POSITIVE AND NEGATIVE PRICE ELASTICITY OF DEMAND

Price elasticity of demand is said to be positive when the price of a good and it's quantity demanded are
moving in the same direction. Increase in price leads to increase in quantity demanded and fall in price
leads to fall in quantity demanded. This is the case of exceptional demand like goods of ostentation, Giffen
goods and expectations of future price changes.
Price elasticity of demand is said to be negative when the price of a good and its quantity demanded are
moving in opposite directions. Increase in price leads to fall in quantity demanded and fall in price leads to
increase in quantity demanded. This is the case of a normal good. A normal good can therefore be defined
as a good with a negative price elasticity of demand or a good whose quantity demanded falls as price
increases.
VARIOUS ASPECTS OF PRICE ELASTICITY OF DEMAND
1. Inelastic demand. This is when a percentage or proportionate change in price leads to a less than
proportionate change in the quantity demanded. Quantity demanded does not react much to changes in
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price. A large increase in price from P to P1 leads to a small drop in quantity demanded from Q to Q1 and a
large drop in price from P1 to P leads to a small increase in quantity demanded from Q1 to Q.

2. Perfectly inelastic demand. This is when a proportionate change in price leads to no percentage or
proportionate change in quantity demanded. Quantity demanded does not react to changes in price. No
matter how price change, quantity demanded remains the same. A large increase in price from P to P1 or a
small drop in price from P1 to P leaves quantity demanded constant at Q.

3. Elastic demand. This is when a percentage or proportionate change in price leads to a more than
proportionate change in the quantity demanded. Quantity demanded does not react much to changes in
price. A small increase in price from P to P1 leads to a large drop in quantity demanded from Q to Q1 and a
small drop in price from P1 to P leads to a large increase in quantity demanded from Q1 to Q.

4. Perfectly elastic demand. This is when price renains constant no matter how quantity demanded
Changes. An infinite quantity can be demanded at a constant price.

5. Unitary elasticity of demand. This is when a proportionate change in price leads to the same
proportionate change in quantity demanded. Quantity demanded reacts by the same extend as the change
in price. For example if price increase by 50%, quantity demanded will drop by 50%
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Factors influencing elasticity of demand.

1. Habits. When consumers have formed a habit in the consumption of a commodity, the demand will be
inelastic. Examples of habit forming commodities include alcohol, cigarettes, etc. The formation of habits
therefore reduce elasticity of demand or make the elasticity of demand to be low since demand becomes
inelastic. When the are no habits formed, demand becomes elastic to the consumer. This makes the
elasticity of demand to increase or to be high.
2. The availability of close substitutes. When a commodity has close substitutes, its demand becomes
elastic. If the is any small increase in price, consumers will shift to the substitutes leading to a large drop in
the quantity demanded. The availability of close substitutes therfore increase elasticity of demand or make
the elasticity of demand to be high. When the are no close substitutes, elasticity of demand will reduce or
will be low since demand becomes more inelastic.
3. The degree of necessity or luxury. If a good is considered to be a necessity to the consumer, its demand
will be inelastic. No matter how the price change, quantity demanded will not be affected much since
consumers cannot do without the good. On the other hand if a good is considered to be a luxury to the
consumer, its demand becomes elastic since consumers can do without the good. A small increase in
price will affect much the consumption by the individual. Necessities therefore reduce elasticity of demand
while luxuries increase elasticity.
4. The proportion of income spent on the commodity. When consumers spend a very large proportion of
their income on a commodity, the demand becomes elastic. When the proportion of income spent on the
commodity is very small, the demand becomes inelastic. For example consumers tend to spend a very
small proportion of their income on commodities like matches, salt, cigarettes etc making their demand to
be inelastic apart from the fact that they are habit forming goods or goods of basic necessities.
The relationship between elasticity of demand, price and total revenue.
If demand is in elastic, price and total revenue will be changing in the same direction. Increases in price
leads to increase in total revenue and fall in price leads to fall in total revenue.
If demand is elastic, price and total revenue change in opposite directions. Increase in price leads to fall in
total revenue and fall in price leads to increase in total revenue.
If demand has unitary elasticity, any change in price leaves total revenue unchanged. This is because
when price increases say by 50 %, quantity will also fall by 50 % hence the will be no net change in total
revenue.
The Elasticity of demand along a straight line downward sloping demand curve.
The elasticity of demand along a straight line downward sloping demand curve is not constant. The
elasticity turns to reduce as we move down the curve.
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When price falls from 100 to 90 frs, quantity increase from 0 to 10. This gives an elasticity of infinity. When
price falls from 90 to 80 frs, quantity increase from 10 to 20 giving an elasticity of 9. When price falls from
80 to 70 frs quantity increases from 20 to 30 giving an elasticity of 4. At a very low price drop from 20 to 10
frs, quantity increase from 80 to 90 giving an elasticity of 1/4. This shows that the elasticity turns to reduce
as we move down the curve as shown

At high prices the demand will be elastic. At the midpoint it will be unitary and at low prices it will be
inelastic. At the extreme point down when the will be no further change in quantity, it will be 0 ie perfectly
inelastic.
Demand turns to be more elastic at high prices and more inelastic at low prices for two reasons.
Firstly at high prices, consumers are more sensitive to price changes than at low prices. They are more
reactional to price changes when prices are high than when they are low.
Secondly at low prices, consumers tend to spend a small proportion of their income on a commodity than
at high prices making the demand to be more inelastic.
Importance of the concept of elasticity of demand.
The concept of elasticity of demand is important not only to the producer but also to the government.
A) Importance to the producer( or business man or firm).
1. It enables him to know when to increase or reduce price in an attempt to increase his sales or turn over.
If demand is inelastic, he can increase sales by increasing prices but if demand is elastic, he can only
increase his sales if he cuts down his price.
2 . It enables the producer to be able to know how to share the tax burden between him and the consumer.
If demand is inelastic, he can shift most of the burden to the consumers in the form of higher prices. But if
demand is elastic he will have to bear most of the burden because any attempt to raise the market price in
trying to shift the burden to the consumers will lead to a large drop in quantity demanded.
3. It enables the producer to succeed in price discrimination. For price discrimination to be successful, the
elasticity of demand should be different in the different markets. The demand should be inelastic in the
market where he charges a high price and elastic in the market where he charges a low price. Therefore
the producer must carefully understand the nature of the elasticity of demand in the different markets if he
must succeed to price discriminate.
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4. It enables the producer to know how to react to changes in prices. If demand is inelastic an prices are
increasing, he should increase production and if prices are falling, he should reduce production.
On the other hand if demand is elastic and prices are increasing, he should instead reduce production
since consumers will buy less if prices are decreasing with demand being elastic, he should increase
production since consumers will buy more.
B) Importance to the government.
1. It enables the government to be able to know which goods to tax more in an attempt to raise tax revenue.
The government should tax more those goods that have an inelastic demand to raise more revenue since
consumers will still buy.
2. It enables the government to know which goods she can discourage their consumption with the use of
indirect taxes. She can only succeed to discourage the consumption of those goods having an elastic
demand with the use of indirect taxes. For goods having an inelastic demand, she cannot succeed to
discourage their consumption through indirect taxes since consumers will still buy the goods. Hence for
such goods with inelastic demand, the government have to look for other means to discourage their
consumption like banning. .
3. It enables the government to succeed in her devaluation policies. For a devaluation to successfully
eliminate deficits in the B.O.P, the demand for exports and imports should be elastic. This is known as the
Marshall Lerner condition for a successful devaluation which requires that the sum of the elasticity of
demand for exports and imports should be greater than I. As such the government should carefully study
the nature of the elasticity of demand for her exports and imports before attempting a devaluation.
4. It also enables the government to be able to succeed in price discrimination when supplying certain merit
and other essential goods to the citizens. .
Income elasticity of demand.
It is the degree of responsiveness of changes in quantity demanded of a good due to changes in income. It
is calculated as follows

% change in qtydd
Yed= ................................
% change in income

NB. The same calculations as in price elasticity. The only difference is that in the place of price it becomes
income.
Income elasticity of demand is said to be positive when income and quantity demanded are moving in the
same direction. Increases in income leads to increase in quantity demanded and fall in income leads to fall
in quantity demanded. This is the case of normal and Ostentatious goods.
Income elasticity of demand is said to be negative when income and quantity demanded are changing in
opposite directions. Increase in income leads to fall in quantity demanded and fall in income leads to
increase in quantity demanded. This is the case of inferior goods. An inferior good can therefore be
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defined as a good with a negative income elasticity of demand. Or a good whose quantity demanded falls
as income increases and vice versa.
The concept of income elasticity of demand is important to the producer for him to know how to react to
changes in income. For goods with positive income elasticity of demand, that is normal and Ostentatious
goods, when income is increasing, the producers should increase production since consumers will buy
more. When income is falling, the producers should reduce production since consumers will buy less.
For goods with negative income elasticity of demand that is inferior goods, when income is increasing, the
producer should reduce production since consumers will buy less. When income is falling, the producers
should increase production since consumers will buy more.
Cross elasticity of demand.
It is the degree of responsiveness of changes in the quantity demanded of one good due to changes in the
price of another good. It measures the extent to which price change in one good can affect the quantity
demanded of another good. It is calculated as follows
%Chg in Qd of gd A
Ced=...............................
% Chg in P of gd B

Where A and B are two different goods.

Cross elasticity of demand is said to be positive when the price of one good and the quantity demanded of
another good are changing in the same direction. Increases in price of one good leads to increase in the
quantity demanded of the other and fall in the price of one good leads to fall in the quantity demanded of
the other. This is the case of substitutes. For example if the price of butter increases, it's quantity
demanded will fall. Consumers will shift to the substitute margarine leading to an increase in the quantity of
margarine consumed.
Cross elasticity of demand is said to be negative when the price of one good and the quantity demanded of
another are changing in opposite directions. Increase in price of one good leads to a fall in the quantity
demanded of the other and vice versa. This is the case of complimentary goods. For example if the price
of cars increase, its quantity demanded will fall. As a result the quantity of the compliment petrol will fall
since they are consumed together.
The concept of cross elasticity of demand is important to the producer for him to know when to increase or
reduce production in response to changes in prices of other goods.
For goods with positive cross elasticity of demand, when the price of one good increases. Producers of the
substitute should increase production since consumers will buy more. If price falls, producers of the
substitute should reduce production since consumers will buy less.
For goods with negative cross elasticity of demand, when price increases, producers of the compliment
should reduce production since consumers will buy less. When price falls, producers of the compliment
should increase production since consumers will buy more.
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Questions.
Q1. The elasticity of demand of a good is 1/4. If the price increases from 500frs to 600frs. Calculate the
percentage change in the quantity demanded of the good.
2. The elasticity of demand of a good is 2. When the price is 50frs, the quantity demanded is 400 kg. What
will be the new quantity demanded if the price increases to 70 frs.
3. A 10% fall in the demand for a good was provoked by a 12% rise in income. This suggests that the
good is
A) Normal B) Giffen C) Ostentatious D) inferior.
4. What relationship exist between good X and Y if a 20% fall in the demand for good X was caused by a
15% fall in the price of good Y
A) Substitutes B) Compliments C) joint supply D) Competitive supply
5. The cross elasticity of demand for pear to
A) plums =3/5
(B) Apples=4/5 (C)mangoe=1/4
(D) Orange=2/5
Which of the above fruits is the best substitute for pear following their elasticity behavior
6. A 10 % rise in the price of good A leads to a 20 % fall in its quantity. As a result the demand for good B
falls by 25%.
i ) Calculate the price elasticity of good A.
ii) What relationship exist between good A and B
iii) Calculate their cross elasticity of demad

ELASTICITY OF SUPPLY
It is the degree of responsiveness of changes in the quantity supplied of a good due to changes in price. It
is calculated as follows;
Pes= % change in quantity supplied
. .............................
% change in price
VARIOUS ASPECTS OF ELASTICITY OF SUPPLY
1. Inelastic Supply. This is when a percentage or proportionate change in price leads to a less than
proportionate change in the quantity supplied. Quantity supplied does not react much to changes in price. A
large increase in price from P to P1 leads to a small increase in quantity supplied from Q to Q1 and a large
drop in price from P1 to P leads to a small drop in quantity supplied from Q1 to Q.
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2. Perfectly inelastic Supply. This is when a proportionate change in price leads to no percentage or
proportionate change in quantity supplied. Quantity supplied does not react to changes in price. No matter
how price increase or falls, quantity supplied remains the same. A large increase in price from P to P1 or a
large drop in price from P1 to P leaves quantity supplied constant at Q.

3. Elastic Supply. This is when a percentage or proportionate change in price leads to a more than
proportionate change in the quantity supplied. Quantity supplied does not react much to changes in price. A
small increase in price from P to P1 leads to a large increase in quantity supplied from Q to Q1 and a small
drop in price from P1 to P leads to a large drop in quantity supplied from Q1 to Q.

4. Perfectly elastic Supply. This is when price renains constant no matter how quantity supplied Changes.
An infinite quantity can be supplied at a constant price.

5. Unitary elasticity of Supply. This is when a proportionate change in price leads to the same proportionate
change in quantity supplied. Quantity supplied reacts by the same extend as the change in price. For
example if price increase by 50%, quantity supplied will increase by 50%.
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FACTORS INFLUENCING SUPPLY

1. Time. This is one of the most important factors influencing elasticity of supply. When it takes a very short
time to increase the supply of a commodity, the supply will be elastic. When the time taken is very long,
supply will be inelastic. For example it takes a very long time to increase the supply of coffee and cocoa
than vegetables making the supply of vegetables to be more elastic and that of coffee and cocoa to be
more inelastic. This also explains generally why agricultural products tend to have a more inelastic supply
compared to industrial products.
2. The availability of stocks. Stocks do not constitute supply but they affect the elasticity of supply; that is
the extent to which supply can be increased in the market. When stocks are available, the supply in the
market can be easily increased by releasing from the stocks. This makes supply to be more elastic. When
the are no stocks, supply becomes inelastic. The existence of stocks will therefore increase elasticity of
supply or make the elasticity of supply to be high since supply becomes more elastic. The absence of
stocks reduce elasticity of supply or make the elasticity of supply to below, since supply becomes inelastic.
3. The existence of idle resources. When firms have idle resources (that is excess capacity, spare
capacities, or unused productive capacities), supply can be easily increased in the market by making use
of the idle resources. This makes supply to be more elastic. When the are no idle resources supply
becomes inelastic. The existence of idle resources therefore increase elasticity of supply.
4. The expansion capacity of the firm. Some firms can easily increase their production capacity within a
very short period of time. This makes the supply to be more elastic. Others cannot easily increase their
productive capacities making their supply to be inelastic. For example , it is difficult to expand the
productive capacity of firms like gold mining firms, hydro electricity generation etc, making the supply of
these industries to be very inelastic.
5. The number of producers involved in the production of the commodity. If they are many, the supply will
be easily increased making it to be more elastic. If the numbers of producers are few, supply will not be
easily increased making it to be inelastic.
6. The distance to the market. When the distance from the production point to the market is very short, the
supply in the market can be easily increased making it to be elastic. When this distance is very long,
supply will not be easily increased making it to be inelastic.
7. Factor mobility. When factors of production are highly mobile from one firm to another within the industry,
the supply of the industry as a whole can be easily increased, making the supply to be elastic. When the is
high degree of immobility of factors within the industry, the supply will not be easily increased, making it to
be inelastic.
DEMAND AND SUPPLY (TIME ANALYSIS)
In demand and supply analysis, ther are three main time period; that is the momentary, the short
run and the long run period.
The momentary period. This is the period of time during which supply is restricted to the quantities
actually available in the market at the moment; that is the supply in the market at the moment. The
momentary supply of vegetables for instance will represent the number of bundles of vegetables that were
delivered early in the morning in the market. In the momentary period, supply is fixed or constant and the
 19

supply curve is perfectly inelastic. If the is any increase in demand in the momentary period, price will
increase by the full extent of the increase in demand while quantity supplied remains constant as shown.

The momentary supply curve is the perfectly inelastic supply curve S. If demand increase from D1 to D2,
price will increase by the full extent of the increase in demand from P1 to P2, while the quantity supplied
remains constant at Q.
THE SHORT RUN PERIOD. This is the period of time during which supply can be increased by increasing
only the variable factors of production while the fixed factors remain constant. More of the vegetables can
be supplied in the short run by increasing only variable factors such as labour and fertiliser while the fixed
factor such as land remain constant. In the short run supply will no longer be perfectly inelastic since supply
can be increased by increasing the variable factors. The supply will be fairly elastic. If the increase in
demand remained up to the short run, price will fall as compared to the momentary period while quantity
demanded increases as shown.

The short run supply curve is th fairly elastic supply curve S1S1. If demand increase from D1 to D2, the
short run equilibrium price will fall from P2 to P3 while the quantity demanded increases from Q to Q1
THE LONG RUN PERIOD. This is the period of time during which supply can be increased by increasing
both the fixed and variable factors of production. More of the vegetables can be supplied in the long run by
increasing not only the variable factors such as labour and fertiliser but also the fixed factor such as land. In
the long run there will therefore be an increase in the entire size or scale of production leading to an
increase in supply. This leads to a complete shift of the whole supply curve to the right. The supply
becomes more elastic in the long run since supply can be increased more, by increasing both the fixed and
variable factors of production. If the increase in demand remain permanent up to the long run, the will be a
further fall in price and a further increase in the quantity demanded as shown.
 20

In the long run when supply increase from S1S1 to S2S2, the will be a further fall in price from P3 to P4 and
a further increase in quantity demanded from Q1 to Q2.
THE EFFECT OF INDIRECT TAXES AND SUBSIDIES ON THE EQUILIBRUIM PRICE AND QUANTITY
A) THE EFFECT OF AN INDIRECT TAX. An indirect tax will increase production cost leading to a fall in
supply. The effect will be a rise in price and a fall in the quantity demanded. For example you are given the
table below showing the demand and supply of a commodity.

Price(frs) Quantity SS (kgs) Quantity DD (kgs) New Qty SS New Qty SS after
after tax Sub
120 2250 250 1750 -
110 2000 500 1500 -
100 1750 750 1250 2250
90 1500 1000 1000 2000
80 1250 1250 750 1750
70 1000 1500 500 1500
60 750 1750 250 1250
50 500 2000 - 1000
40 250 2250 - 750

The new quantity supplied after tax is obtained as follows. Since the tax is 20 frs, at the price of 120 frs, if
the government takes 20frs as tax, the producer will be left with 100frs. As such the supply of 120frs will
now become the supply of 100frs which is 1750kgs. The supply of 110 frs will now become the supply of 90
frs. The supply of 100 frs now becomes the supply of 80 frs and so on. From the table, the new equilibrium
price increase to 90 frs while the quantity demanded falls to 1000kg.

The indirect tax shifts the supply curve to the left from SS to S1S1. The perpendicular distance between the
two supply curves gives the tax per unit which is 20 frs or the distance AC or FE.
 21

The consumers share of the tax per unit is the increase in the market price from 80 frs to 90 frs or the
distance AB or FE. The total tax burden to the consumers is their tax per unit times the equilibrium quantity
they buy after the tax which is 10X1000=10,000frs or the shaded area ABEF.
The producers tax per unit is the fall in their supply price from 80 frs to 70frs which is 10 frs or the distance
BC or ED. This is because even though the producers now sell at 90 frs, the government takes 20 frs as
tax and they are left with 70 frs, given a net loss or sacrifice of 10 frs compared to the 80 frs they were
selling and receiving before the tax. The total tax burden to the producers is equally their tax per unit times
the final equilibrium quantity; that is 10 X1000=10,000frs or the area BCDE.
Note that the total tax revenue generated by the government is the tax per unit times the final equilibrium
quantity; that is 20 X1000=20,000 frs or the consumers share plus the producers share. This is equally the
whole area ACDF.
THE EFFECT OF A SUBSIDY. A subsidy reduces production cost leading to an increase in supply. The
effect will be a fall in price and an increase in the quantity demanded. For example suppose that in the
above table instead of a tax, a subsidy of 20 frs per unit was granted to the producers. What will be the new
equilibrium price and quantity.
The table for the new quantity supplied after the subsidy is easily obtained as follows. Since the subsidy is
20 frs, the supply of 40frs becomes the supply of 60 frs whichsis750kgs. The supply of 50 frs becomes the
supply of 70 frs which is1000kg and so on. The new equilibrium price falls to 70 frs while the quantity
demanded increases to 1500 kgs.

The subsidy shifts the supply curve to the right from SS to S1S1. The perpendicular distance between the
two supply curves gives the subsidy per unit which is 20 frs or the distance AC or FE.
The consumers benefit of the subsidy per unit is the fall in the market price from 80 frs to 70 frs or the
distance BC or DE. The total subsidy benefit to the consumers is their subsidy per unit times the equilibrium
quantity they buy after the subsidy which is 10X1500=15,000frs or the shaded area BCDE.
The producers subsidy per unit is the increase in their supply price from 80 frs to 90frs which is 10 frs or the
distance AB or EF. This is because even though the producers now sell at 70 frs, the government subsidies
20 frs and they end up with 90 frs, given a net increase or benefit of 10 frs compared to the 80 frs they were
selling and receiving before the subsidy. The total subsidy to benefit to the producers is equally their
subsidy per unit times the final equilibrium quantity; that is 10 X1500=15,000frs or the area ABEF
Note that the subsidy granted by the government is the subsidy per unit times the final equilibrium quantity;
that is 20 X1500=30,000 frs or the consumers benefit plus the producers benefit. This is equally the whole
area ACDF.
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THE RELATIONSHIP BETWEEN ELASTICITY OF DEMAND AND THE BURDEN OF AN INDIRECT TAX
TO THE PRODUCER AND THE CONSUMER.
The burden of an indirect tax to the producer or the consumer depends on the elasticity of demand of the
good.
If the demand is inelastic, most of the burden will be borne by the consumers. The producers will shift most
of the burden to the consumers in the form of high prices. Since demand is inelastic the market price can
be raised substantially in trying to shift the burden to the consumers.

If demand is perfectly inelastic, all the burden will be borne by the consumers. The producers will shift the
entire burden to the consumers by raising the market price by the full amount of the tax.

If demand is elastic, most of the burden will be borne by the producers. The producer will be unable to raise
the market price substantially in trying to pass the burden to the consumers. Due to the elastic nature of
demand, any small increase in price will lead to a very large drop in the quantity demanded.

If demand is perfectly elastic, all the burden will be borne by the producer. Any attempt to raise the market
price will lead to no quantity demanded since demand is perfectly elastic. As such the producer will have to
bear all the burden.
 23

If demand has unitary elasticity or if the elasticity of demand equal the elasticity of supply, the burden will
be shared equally between the producers and the consumers.

NB. Consumers share of the tax= Es x Tax

ED +Es

Producers share of the tax= Ed x Tax

ED +Es

DRAW DIAGRAMS TO SHOW HOW A SUBSIDY BENEFIT TO CONSUMER OR PRODUCER DEPENDS

ON ELASTICITY OF DEMAND
 24

MAXIMUM AND MINIMUM PRICES

A)MAXIMUM PRICES (PRICE CEILING). This is a price set by the government to protect the interest of
consumers. When the equilibrium price in the market is too high for the consumers, the government usually
intervene with a maximum price policy to protect them. The will be no effect if the maximum price is set
above nor even at the equilibrium price because the equilibrium price itself is already to high for the
consumers. It is always set below the equilibrium as shown.

ECONOMIC EFFECTS OF A MAXIMUM PRICE

POSITIVE EFFECTS.
1.It creates excess demand which encourages firms to expand production.
2.To produce more, the firms will have to carry out more investments which increases economic growth.
3.To produce more, the firms will have to employ more. As such it reduces unemployment.
4. The will be more tax revenue generated due to more production,.
NEGATIVE EFFECTS
1.It creates excess demand over supply leading to shortages
2. Due to shortages, the government may be forced to carry out rationing which may lead to under
consumption of the good for some individuals.
3. Black marketing will occur. This is a situation where goods are sold at prices higher than the official price
set by the government. The black market prices rise far above the equilibrium.,
4.Queues will develop where consumers tend to form long lines in front of shops waiting for long boring
hours in an attempt to buy a scarce product.
5. The will be the use of waiting list and the policy of first come first serve.
6. Selling under the counter and other forms of preferential treatment will occur.
MINIMUM PRICE (PRICE FLOOR). This is a price set by the government usually above the equilibrium
price to protect the interest of producers. When the equilibrium price in the market becomes too low such
 25

that producers are discouraged, the government usually comes in with a minimum price policy to
encourage them. The will be no effect if the minimum price is set below nor even at the equilibrium price
because the equilibrium price itself is already too low for the produces. It is always set above the
equilibrium as shown.

ECONOMIC EFFECTS OF A MINIMUM PRICE

POSITIVE EFFECTS.
1.It encourages firms to expand production due to the increase in prices which motivates the producers to
produce more..To produce more, the firms will have to carry out more investments which increases
economic growth. To produce more, the firms will have to employ more. As such it reduces unemployment..
The will be more tax revenue generated due to more production.

NEGATIVE EFFECTS.

1.It creates excess supply over demand which the government is force to buy. This increases cost to the
government.
2. The imposition of a minimum price on basic raw materials like cocoa and coffee will lead to increase in
production, leading to cost push inflation.
3. It could lead to excess production which may result to dumping.
4.It may cause storage difficulties especially for perishable goods due to excess production.
5.Producers may tend to form clubs or selling syndicates where they sell at prices far above the minimum.
Exercise. You are given the table below showing the demand and supply of a commodity.

Price(frs) Qty DD (Kgs) Qty SS (Kgs)

45 200 1800
40 400 1600
35 600 1400
30 800 1200
25 1000 1000
20 1200 800
15 1400 600
10 1600 400
5 1800 200
 26

a,What will be the economic effect of the government impose a maximum price of (i)30frs (ii) 15frs
b).At the maximum price of 15frs what will be the likely black market price
b).Suppose that the government imposes a minimum price of 40 frs and undertakes to buy any excess
unsold at that price;
i)How much will it cost the government to buy of the excess.
ii)What is the maximum price at which the government can resell the excess assuming that the market
demand and supply remains unchanged.
iii)What then will be the net loss of such an operation to the government.