Kwame Nkrumah University of

Science & Technology, Kumasi, Ghana

ECON 151:
ELEMENTS OF ECONOMICS

E. BUABENG
Department of Economics
KNUST
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

LECTURE ONE
INTRODUCING ECONOMICS
 Kwame Nkrumah University of
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COURSE OUTLINE
1. Introducing Economics
2. Supply and Demand
3. Government Intervention in the Market
4. Background to demand
5. Background to Supply
6. Profit Maximization under Perfect
Competition
7. Profit Maximization under and Monopoly
 Kwame Nkrumah University of
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Welcome to economics lectures

 The things you learn in this class will probably help
you see the world in a different way.
 Economics is not just about money, as you may
have incorrectly assumed.
 On the contrary, as you will learn in this course,
economics is about how society distributes scarce
resources.
 Since almost anything in the world is a scarce
resource, from fossil fuels to nice guys, or nice
ladies, we can apply the rules of economics to
pretty much anything.
 Kwame Nkrumah University of
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Welcome to economics lectures

 My main goal is to show you the way economists
think and how to use this analytical system to
answer questions related not only to these and other
important human issues, but to anything you end up
doing with your life after this class.

 After all, as you will quickly find out, I believe that

everything is economics!
 Kwame Nkrumah University of
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Definition of Economics
Economics is the study of how economic agents
choose to allocate scarce resources and how those
choices affect society.
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Economic Agents and Economic Resources

 An economic agent is an individual or a group that
makes choices.
 An economic agent can be an individual like:
 Consumer
 Boss
 Kid, student, lecturer, ….
 Parent
 Thief
 Prostitute, carpenter, etc.
 Kwame Nkrumah University of
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Economic Agents and Economic Resources

 An economic agent can be a group like:
 A household
a government
an army
a firm,
a university (KNUST)
a political party (NPP, NDC)
a labor union, a sports team, a street gang, students union..
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Resource and resource allocation

An important concept of interest in the study of
economics is the issues of scarcity of resources.

Scarce resources are things that people want, where

the quantity that people want exceeds the quantity that
is available
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Resource and resource allocation

Scarcity is the situation of having unlimited
wants in a world of limited resources.
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Positive Economics and Normative Economics

As indicated, economics is all about Peoples’ choice…
Understanding people’s choices is practically useful for
two key reasons.
Economic analysis:
1.Describes what people actually do (positive
economics).

2.Recommends what people ought to do (normative

economics).
 Kwame Nkrumah University of
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Positive Economics and Normative Economics

– Positive Statement
Positive statement is a statement of fact. It may be right or
wrong, but its accuracy can be tested by appealing to the facts.
Eg. Ghana’s economy is bigger than that of USA; KNUST is
older than UDS

– Normative Statement

Normative statement is a statement based on an individual’s

value judgement. Eg. It is inappropriate for university
students to pay fees. The price of the Bible/Quran to should
be very low; government ought to scrap sitting allowances
for parliamentarians
 Kwame Nkrumah University of
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Positive Economics and Normative Economics

 positive economics: An approach to economics
that seeks to understand behavior and the
operation of systems without making
judgments. It describes what exists and how it
works.

 normative economics An approach to

economics that analyzes outcomes of economic
behavior, evaluates them as good or bad, and
may prescribe courses of action. Also called
policy economics.
 Kwame Nkrumah University of
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Positive Economics
 ….Describes what people actually do
 ….Descriptions of what people actually do are
objective statements about the world….
 Such factual statements can be confirmed or tested
with data.
 Kwame Nkrumah University of
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Normative Economics
 .....analysis that prescribes what an individual or
society ought to do.
 advises individuals and society on their choices.
 Normative economics is almost always dependent on
subjective judgments, which means that normative
analysis depends at least in part on
personal feelings
tastes,
or opinions.
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Positive Economics and Normative Economics

 Positive Economics
 *******Some people took more than one
and not everyone got a piece

Normative economics
********Each student should just take one
so that everyone gets a piece
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Trial Question
 Which of the following is an example of a normative
economic statement?
 A) A cut in the tax rate will lead to an increase in
consumption.
 B) Relaxation of import duties will encourage imports.
 C) An increase in subsidies to farmers will boost
agricultural production.
 D) An increase in social security benefits will increase
the welfare of all economic agents.
 Ans: D
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Trial Question
 Which of the following is an example of a normative
economic statement?
 A) An increase in government expenditure will lead to
an increase in well-being.
 B) An increase in the money supply will lead to an
increase in the inflation rate.
 C) An increase in income is accompanied by an
increase in savings.
 D) An increase in income is accompanied by an
increase in consumption.
 Answer: A
 Q Which one of the following is a
normative statement?
A. Unemployment is higher 20% 20% 20% 20% 20%

this year than last.

B. Unemployment will rise.
C. Economists predict that
unemployment will rise.
D. Raising taxes will cause
unemployment to rise.
E. The government should cut A. B. C. D. E.
taxes and therefore reduce
unemployment.
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Normative analysis and Public Policy

 Since policies normally affect some people
positively and others negatively, its evaluation
involves normative analysis…

 Deciding whether the costs experienced by the

losers are justified by the benefits experienced by
the winners is partly an ethical judgment.
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Normative analysis and Public Policy

 For instance to protect the environment, some
forests must be left untouched and this policy will
not be welcomed by farmers who need the land to
farm on.

 Example is the Amazon issues in Brazil

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The Scope of Economics

Microeconomics Macroeconomics
The study of how The study of the whole
individuals, firms, and
governments make choices…
economy
Studies Economic Agents Studies economic
aggregates
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The Scope of Economics: Macroeconomic issues

 Macroeconomics is concerned with the economy
as a whole.
 Growth
 Employment or unemployment
 Inflation
 balance of payments problems
 cyclical fluctuations
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The Scope of Economics: Microeconomic issues

 Microeconomic is concerned with individual
economic agent choices.
– Choices
Choice refers to the act of choosing from
among alternatives of goods and services.

The three main categories of choice are

• What to produce
• How to produce and
• For whom to prod
 Examples of microeconomic and
macroeconomic concerns
Production Prices Income Employment

Microeconomics Production/Output Price of Individual Distribution of Employment by

in Individual Goods and Services Income and Wealth Individual
Industries and Businesses &
Businesses Price of medical care Wages in the auto Industries
Price of gasoline industry Jobs in the steel
How much steel Food prices Minimum wages industry
How many offices Apartment rents Executive salaries Number of
How many cars Poverty employees in a firm

Macroeconomics National Aggregate Price National Income Employment and

Production/Output Level Total wages and Unemployment in
salaries the Economy
Total Industrial Consumer prices
Output Producer Prices Total corporate profits Total number of jobs
Gross Domestic Rate of Inflation Unemployment rate
Product
Growth of Output
25 of 33
 Q Which one of the following is
a microeconomic issue?
A. The government spends 20% 20% 20% 20% 20%

more than it receives in

tax revenue.
B. House prices rise more
rapidly.
C. Unemployment rises.
D. The Bank of England
raises interest rates. A. B. C. D. E.

E. Imports exceed exports.

 Kwame Nkrumah University of
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Key Ideas: The Three Principles of Economics

1. Optimization = making the best choice possible
with given information.

2. Equilibrium = a situation in which nobody would

benefit by changing his or her own behavior.

3. Empiricism = using data to figure out answers to

interesting questions

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Optimization Trade-offs and Budget Constraints

An economic agent faces a trade-off when the
agent needs to give up one thing to get something
else.

That is trade-offs arise when some benefits must

be given up in order to gain others
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Optimization Trade-offs and Budget Constraints

 Economists use budget constraints to describe
trade-offs.

 A budget constraint is the set of things that a

person can choose to do (or buy) without
breaking her budget.
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Optimization Trade-offs and Budget Constraints

Examples…
Assume that Christabel has GH¢20 which she can use
to buy kenkey and fish. Assume that the price of
kenkey is GH¢1 and the price of fish is GH¢2.
Her budget constraint can be written as:

GH¢1 GH¢2
GH¢20
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Optimization Trade-offs and Budget Constraints

Suppose that you have 5 free hours in a day (once we
take away necessities like sleeping, eating, bathing,
attending classes, doing problem sets, and studying for
exams).

Think of these 5 free hours as your budget of free time.

Then your budget constraint would be:

5 hours = Hours on social media + Hours working at

part-time job.
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Opportunity Cost
The other important tool in the analysis of optimization
is Opportunity Cost..
Opportunity cost is the best alternative use of a resource.
It is defined as the next best alternative forgone.
Opportunity cost is what an optimizer is effectively
giving up when she undertakes an activity.

*****The concept of opportunity cost applies to all

resources****
Budget Hours Surfing Social Hours at Part-Time
Media Job
5 hours 0 hours 5 hours
5 hours 1 hours 4 hours
5 hours 2 hours 3 hours
5 hours 3 hours 2 hours
5 hours 4 hours 1 hours
5 hours 5 hours 0 hours
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Cost Benefit Analysis

 Cost-benefit analysis is a calculation that adds
up costs and benefits using a common unit of
measurement, like Ghana Cedis.

 It is used to identify the alternative that has the

greatest net benefit, which is equivalent to
benefits minus costs.
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Cost Benefit Analysis: Example

Should I cook or Buy Food: (Assuming same
Quality).

Assume a plate of fried rice and chicken cost 15

Ghana Cedis…..

An agent who wants to optimize will calculate

the alternative to buying, like ingredients, time,
gas, etc, and put monetary value on it…….
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Cost Benefit Analysis

COSTS BENEFITS
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The Second Principle of Economics: Equilibrium

 A situation in which no one benefits by changing
his/her behavior.

 Thus equilibrium is the special situation in which

everyone is optimizing in the society, so nobody would
benefit personally by changing his or her own
behavior.
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What Does Equilibrium Really Mean?

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Equilibrium: An Illustration
 To illustrate the concept of equilibrium, consider the
length of the regular checkout lines at a supermarket.

 If any line has a shorter wait than the others, optimizers

will choose that line.

 If any line has a longer wait than the others, optimizers

will avoid that line. So the short lines will attract
shoppers, and the long lines will drive them away. And
it’s not just the length of the lines that matters.
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Equilibrium: An Illustration
 You pick your line by estimating which line will
move the fastest, which incorporates everything
that you can see, including the number of items
in each person’s shopping cart.

 Economists say that “in equilibrium” all of the

checkout lines will have roughly the same wait
time.
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Equilibrium: The Free Rider Problem

The Free Rider Problem exists when an individual
or group is able to enjoy the benefits of a situation
without incurring the costs
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Equilibrium: The Free Rider Problem

1. Group needs to decide what is fair.

2. Some sort of pressure needs to be put on the

free rider to get him to conform

Markets have no mechanism for deciding what is

fair
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The Third Principle of Economics: Empiricism

 Economists test their ideas with data.
 We call such evidence-based analysis, empirical
analysis or empiricism.

 Economists use data to determine whether our

theories about human behavior—like
optimization and equilibrium—match up with
actual human behavior.
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Why Study Economics?

1. To Learn a Way of Thinking

 In order to do this, we must understand Three

fundamental concepts:

 Opportunity cost
 Marginalism
 Efficient markets
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Why Study Economics?

2. To Understand Society

 The study of economics is an essential part of

the study of society. One thing that is very
important about our modern society is the
industrial revolution
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Why Study Economics?

3. To Understand Global Affairs

 An understanding of economics is essential to

an understanding of global affairs. The fracas
between USA and china concerning exchange
rates could only be understood if one is well
vexed in the subject of economics.
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Why Study Economics?

4. To Be an Informed Citizen

 To be an informed citizen requires a basic

understanding of economics.
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Economic Policy
Criteria for judging economic outcomes:
1. Efficiency
2. Equity
3. Growth
4. Stability
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Economic Policy
Efficiency: An efficient economy is one that
produces what people want at the least possible
cost.

equity means Fairness. This is highly normative

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Economic Policy
economic growth: An increase in the total output
of an economy

Stability: A condition in which national output is

growing steadily, with low inflation and full
employment of resources.
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The Economic Problem:

Scarcity and Choice
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The Problem of Scarcity

 There is a central economic problem that
everyone faces. This central economic problem
is the problem of scarcity.

 Scarcity is the excess of human wants over what

can actually be produced to fulfill these wants.

 The resources or factors of production are

limited but human needs or wants are unlimited
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The Problem of Scarcity

 The the reason for scarcity is thus:

 Human wants are virtually unlimited, whereas

the resources available to satisfy these wants are
limited.

 Because of scarcity, various choices have to be

made between alternatives.
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The Problem of Scarcity

 One thing you must understand is that we do not
all face the problem of scarcity to the same
degree. For instance, a poor person unable to
afford enough to eat or a decent place to live
will hardly see it as a ‘problem’ that a rich
person cannot afford a second BMW.
 But given that people, both rich and poor, want
more than they can have, this makes them
behave in certain ways.

 Economics studies that behaviour.

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The Problem of Scarcity

In short, Economics studies anything to do with

the process of satisfying human wants using
available resources.
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The Ten facts of Economics

1. PEOPLE FACE TRADEOFFS (there is nothing
like free lunch)

 Individuals as well as societies face tradeoff….. For

something to be done, we must always sacrifice
something.
 For individual…. Learn or club, education or work.
 For societies…. “Guns and butter.”
 One tradeoff society faces is between efficiency
and equity.
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The Ten facts of Economics

2. THE COST OF SOMETHING IS WHAT
YOU GIVE UP TO GET IT

 Because people face tradeoffs, making decisions

requires comparing the costs and benefits of alternative
courses of action.

 In many cases, however, the cost of some action is not

as obvious as it might first appear. For university
education, the benefit is intellectual enrichment but the
cost goes beyond fee and time spent in school
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The Ten facts of Economics

3. RATIONAL PEOPLE THINK AT THE
MARGIN

4. PEOPLE RESPOND TO INCENTIVES….

Because people make decisions by comparing
costs and benefits, their behavior may change
when the costs or benefits change.
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The Ten facts of Economics

5. TRADE CAN MAKE EVERYONE BETTER
OFF

6. MARKETS ARE USUALLY A GOOD WAY

TO ORGANIZE ECONOMIC ACTIVITY

7. GOVERNMENTS CAN SOMETIMES

IMPROVE MARKET OUTCOMES
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The Ten facts of Economics

8. A COUNTRY’S STANDARD OF LIVING
DEPENDS ON ITS ABILITY TO PRODUCE
GOODS AND SERVICES

9. PRICES RISE WHEN THE GOVERNMENT

PRINTS TOO MUCH MONEY

10. SOCIETY FACES A SHORT-RUN TRADEOFF

BETWEEN INFLATION AND UNEMPLOYMENT
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What do Economists Study?

–Production and consumption

 Production has to do with the transformation of

inputs into outputs by firms in order to earn
profit (or meet some other objective).

 Consumption is the act of using goods and

services to satisfy wants. This will normally
involve purchasing the goods and services.
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Factors of production
 As indicated, Production is the process by which
resources are transformed into useful forms.
 For firms to produce, they need resources or factors of
production.
 Resources, or inputs, refer to anything provided by nature
or previous generations that can be used directly or
indirectly to satisfy human wants.

 There are three factors of production:

• Capital resources……… Capital
• Human resources..... Labour
• Natural resources….Land
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Factors of production
Labour
 Labour refers to all forms of human input, both
physical and mental that goes into current
production. The reward for labour is Wages

Land and raw materials

 Inputs into production that are provided by nature:
e.g. unimproved land and mineral deposits in the
ground. The reward for land is Rent
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Factors of production
Capital
 All inputs into production that have themselves
been produced: e.g. factories, machines and tools.
The reward for capital is Interest
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Three basic questions must be answered in order

to understand an economic system
 The mechanics of decision making in a larger economy
are more complex, but the type of decisions that must
be made are nearly identical.

 All societies must decide:

– What will be produced?
– How will it be produced?
– Who will get what is produced?
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The production possibility curve

– The curve shows all the combinations of the
two goods that can be produced with all the
nation’s resources fully and efficiently
employed.
 The production possibility curve
8
A
7 B

6
C
D
Capital Goods

3 E
2

0
F
0 1 2 3 4 5 6 7 8

Consumer Goods
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The production possibility curve

The production possibility frontier curve has a
negative slope that indicates the trade-off that a
society faces between two goods.
The slope of the ppf is also called the marginal rate of
transformation (MRT).
The marginal rate of transformation describes
numerically the rate at which output of one good can be
transformed (by re-allocation of production resources)
into output of the other
The production possibility curve

• Points inside of the

curve are inefficient.

• At point H, resources are

either unemployed, or are
used inefficiently.
The production possibility curve

• Points outside the PPF are

unattainable.

• Point F is desirable
because it yields more of
both goods, but it is not
attainable given the
amount of resources
available in the economy.
The production possibility curve
• Points on the PPF
represent full and
efficient allocation of
resources.

• Point C is one of the

possible combinations of
goods produced when
resources are fully and
efficiently employed.
The production possibility curve
• A move along the curve
illustrates the concept
of opportunity cost.
• In order to increase the
production of capital
goods, the amount of
consumer goods will
have to decrease.
The production possibility curve
• The concave shape of the
production possibility
frontier curve reflects the
law of increasing
opportunity cost.

• As we increase the
production of one good,
we sacrifice
progressively more of
the other.
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Economic Growth
The outward shift of the PPF represent economic
growth
Economic growth is an increase in the total output
of the economy. It occurs when a society acquires
new resources, or when it learns to produce more
using existing resources.
The main sources of economic growth are capital
accumulation and technological advances.
Food Economic Growth

Now

O
Clothing
 Economic Growth

Future
Food

Now

O
Clothing
Economic Growth
• To increase the
production of one good
without decreasing the
production of the other,
the PPF curve must
shift outward.

• From point D, the

economy can choose any
combination of output
between F and G.
 Which of the following would shift the
Q
p.p. curve outwards?
A. An increase in the population 20% 20% 20% 20% 20%

of working age
B. A reduction in
unemployment
C. A reduction in VAT
D. An increase in the general
level of prices
A. B. C. D. E.
E. A reduction in expenditure on
education
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Economic Systems
An economic system refers to the particular way in
which economic activities takes place in an
economy.
In other words, an economic system refers to the
particular set of institutional arrangement or
mechanism by which ownership and use of
resources in an economy are determined.
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Economic Systems
There are basically three classifications of economic
systems. These are;
Centrally planned or command economy
Free-market economy
Mixed economy
 Classifying economic systems

Mid 1980s

N. Korea China UK Hong

Cuba Poland France USA Kong
Totally Totally
planned free-market
economy economy
N. Korea Cuba China Poland France USA
UK China
(Hong
Kong)

Late 2000s
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Economic Systems: The command economy

A command economy is an economy
where all economic decisions are taken by
the central authorities.
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Features of a command economy

 The state plans the output of each industry
and firm.
 It plans the distribution of output between
consumers.
 It plans the allocation of resources between
current consumption and investment for the
future.
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Advantages of a command economy

 high investment, high growth
 stable growth
 social goals pursued
 low unemployment
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Problems of a command economy

 problems of gathering information
 expensive to administer
 inappropriate incentives
 shortages and surpluses
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The free-market economy

 A free market economy is an economy
where all economic decisions are taken by
individual households and firms and with
no government intervention.
 demand and supply decisions
 the price mechanism
 the interdependence of markets
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Advantages of a free-market economy

 transmits information between buyers and
sellers
 no need for costly bureaucracy
 incentives to be efficient
 competitive markets responsive to
consumers
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Problems of a free-market economy

 Competition may be limited: problem of
market power
 Inequality
 The environment and other social goals
may be ignored
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The mixed economy

 An economy where economic decisions are
made partly by the government and partly
through the market.
 Because of the problems of both free-
market and command economies, all real-
world economies are a mixture of the two
systems.
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Methods of Economic Studies:

Theories and Models
 Model: A formal statement of a theory,
usually a mathematical statement of a
presumed relationship between two or more
variables.
 Examples are Demand Models, Consumption
Model. etc. it is an abstraction of reality
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Methods of Economic Studies:

Theories and Models
 Variable: A measure that can change from
time to time or from observation to
observation. For Example, Price, income,
Quantity of Yam, Etc.
 Ockham’s razor The principle that
irrelevant detail should be cut away
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

The Principles of All Else Equal: Ceteris

Paribus
 Ceteris paribus, or all else equal: A device used
to analyze the relationship between two variables
while the values of other variables are held
unchanged.
 Using the device of ceteris paribus is one part of
the process of abstraction. In formulating
economic theory, the concept helps us simplify
reality to focus on the relationships that interest
us.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

DEMAND AND SUPPLY

ANALYSIS

Dr Elliot Boateng
Department of Economics
College of Humanities and Social Sciences

[email protected] // +233 (0) 204833853

 THE CIRCULAR FLOW
INPUT MARKETS AND OUTPUT MARKETS:
THE CIRCULAR FLOW
Market Equilibrium
CHAPTER 3: Demand, Supply, and

FIGURE 3.1 The Circular Flow of Economic Activity

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 46
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Demand
➢ Demand is the quantity of a good or service that
consumers are willing and able to buy at various
prices in a given period of time.

➢ Though there are several factors that determine a

consumer’s decision to buy a commodity, we
define demand as a relationship between quantity
and price.
➢ Price determines the relative value of a commodity
and thus the most important determinant of demand
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Demand Schedule, Demand Curve

and Demand Function
The negative relationship between price
and quantity demanded can be presented
by a
➢ demand schedule,
➢ demand curve and
➢ demand function.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Demand Schedule
A demand schedule is a table showing how
much of a given product a household would be
willing to buy at different prices.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Demand Schedule
Price Per Unit Quantity of Potatoes
20 700
40 500
60 350
80 200
100 100
120 50
140 10
160 0
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Demand Curve
The demand curve is a graph showing the
relationship between price of a good and
quantity of the good demanded over a given
time period.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Demand Curve
➢ According to convention, the demand curve
is drawn with price on the vertical axis and
quantity on the horizontal axis.

➢ A demand curve shows the relationship

between price and quantity demanded only;
all (other) factors affecting demand are
assumed to remain unchanged along a
demand curve.
 Demand Curve for potatoes (monthly)
E Point Price Market demand
100 (pence per kg) (tonnes 000s)
A 20 700
D
Price (pence per kg)

80 B 40 500
C 60 350
C D 80 200
60 E 100 100

B
40

A
20
Demand

0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

The Law of Demand

The law of demand states that:

➢ There is a an inverse relationship between

quantity demanded of a commodity and its price.
Thus:
➢ “Other things unchanged, as price rises, the
quantity demanded decreases, and as price falls,
the quantity demanded increases”
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Exceptions to the law of

demand
Generally, the amount demanded of good increases
with a decrease in price of the good and vice versa.
In some cases, however, this may not be true. Such
situations are:

➢ Giffen Goods

➢ Commodities which are used as status symbols

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Reasons behind the law of

demand
Relationship between demand and price can
be explained by:

➢ The Income Effect

➢ The Substitution Effect

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Income and Substitution Effects

Income Effect:
When the price of a commodity rises, the
consumer would feel poorer as real income
falls and thus would buy less and vice versa.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Income and Substitution Effects

Substitution Effect:
When the price of a commodity rises, the good
would now cost more than its alternatives or
substitutes and thus consumers would switch
to the alternatives. The opposite is true for a
fall in price
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Three Properties of the Demand Curve

➢ First, the demand curve is negatively
sloped which reflects the law of demand.

❖ An increase in price is likely to lead to a

decrease in quantity demanded, and a
decrease in price is likely to lead to an
increase in quantity demanded.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Three Properties of the Demand Curve

➢ They intersect the price (Y) axis, a result of
limited incomes and wealth. That is As long as
households have limited incomes and wealth, all
demand curves will intersect the price axis.

❖ For any commodity, there is always a price

above which a household will not or cannot pay.
Even if the good or service is very important, all
households are ultimately constrained, or limited,
by income and wealth.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Three Properties of the Demand Curve

➢ The third property is that demand curves intersect
the quantity axis is a matter of common sense.
Demand in a given period of time is limited, if
only by time, even at a zero price. In other words
They intersect the quantity (X-) axis, a result of
time limitations and diminishing marginal utility.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

The Demand Function

➢ simple demand functions
Qd = a – bP
➢ more complex demand functions
Qd = a – bP + cY + dPs – ePc

could be linear or non-linear functions

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Other determinants of demand

➢ tastes
➢ number and price of related goods
➢ income
➢ distribution of income
➢ expectations
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Changes in Demand versus Changes in

Quantity Demanded
A change in price, ceteris paribus, results in a
change in quantity demanded; that is a movement
along the curve.

A change in demand (curve) results from changes

in factors other than price. Such changes cause
shifts of the demand curve.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Factors causing changes (shifts) in demand

(curve):
➢ Changes in income
➢ Taste
➢ prices of related goods (substitutes or complementary
goods)
➢ expectations about future prices,
➢ number of buyers
➢ Other non-self-price factors
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Change in Quantity Demanded

P
A
20

10 B

100 200 Q
 An increase in demanded
Possible causes of a rise in demand
• Tastes shift towards this product
• Rise in price of substitute goods
• Fall in price of complementary goods
• Rise in income
P • Expectations of a rise in price
Price

D0 D1

O Q0 Q1
Quantity
 A decrease in demanded
Possible causes of a fall in demand
• Tastes shift against this product
• Fall in price of substitute goods
• Rise in price of complementary goods
• Fall in income
P • Expectations of a fall in price
Price

D1 D0

O Q0 Q1
Quantity
 Q Which way will the market demand
for petrol shift if the price of cars rises?

A. Right

B. Left

C. No shift (movement
along the curve)
 Q Which way will the market demand for
petrol shift if petrol becomes more expensive

A. Right

B. Left

C. No shift (movement
along the curve)
 Q The effect on the margarine market of a
reduction in butter prices would be to:

A. increase the price of

margarine by an identical
amount.
B. leave the demand for
margarine unaffected.
C. decrease the demand for
margarine at all prices.
D. increase the demand for
margarine at all prices.
E. shift the supply of
margarine to the left.
 Demand curve for equation: Qd = 10 000 – 200P
50

40

P 30

20

10

D
0
0 2 4 6 8 10
Q (000s)
 Demand curve for equation: Qd = 10 000 – 200P
50

P Qd (000s)

40
5 9

P 30

20

10

D
0
0 2 4 6 8 10
Q (000s)
 Demand curve for equation: Qd = 10 000 – 200P
50

P Qd (000s)

40
5 9
10 8

P 30

20

10

D
0
0 2 4 6 8 10
Q (000s)
 Demand curve for equation: Qd = 10 000 – 200P
50

P Qd (000s)
5 9
40
10 8
15 7

P 30

20

10

D
0
0 2 4 6 8 10
Q (000s)
 Demand curve for equation: Qd = 10 000 – 200P
50

P Qd (000s)

40
5 9
10 8
15 7
20 6
P 30

20

10

D
0
0 2 4 6 8 10
Q (000s)
Market Demand Verses Individual
Demand

Market demand: Sum of individual

Demands for the particular good
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Market Demand
➢ Market demand is the sum of all the quantities of
a good or service demanded per period by all the
households buying in the market for that good or
service.

➢ It is obtained by adding up all the quantity

demanded by each of the household at each price
level.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price Qty by A Qty by B Qty by C Market

Demand
2 5 6 14 25
4 4 4 10 18
6 2 3 7 12
8 1 2 5 8
10 0 1 4 5
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Supply
➢ Definition: Supply is the amount of a
particular product that a firm/seller
would be willing and able to offer for
sale at various prices during a given
time period.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

The law of Supply

➢ The law of supply postulates a positive
relationship between price and quantity
of a good supplied:

➢ It States that: “An increase in market

price will lead to an increase in quantity
supplied, and a decrease in market price
will lead to a decrease in quantity
supplied, all other things being equal”.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Reasons Behind the Law of Supply

➢ As firms increase production beyond a point,
the production cost rises more rapidly and
thus firms would only increase production
and supply if they can get higher price for
the commodity.
➢ Higher prices make the production of a
commodity more profitable. This means that
as price rises, firms would produce more to
take advantage of the higher price to
increase profits.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Reasons Behind the Law of Supply

➢ Increase in price encourage new entrants into
the market to take advantage of higher
potential profits thereby increasing market
supply.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Supply Schedule, Supply Curve, and Supply

Function
➢ The relationship between price and quantity
supplied of a commodity can be expressed
in three way. These are:
➢ supply Schedule,
➢ Supply Curve, and
➢ Supply Function
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Supply Schedule
❑ Supply schedule is a table which shows
how much one or more firms will be willing
to supply at various prices.
❑ The supply schedule shows in tabular form
the quantity of goods that a supplier would
be willing and able to sell at various prices
under the existing circumstances.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price of Total supply

potatoes (tonnes: 000s)
(pence per kg)

a 20 100

b 40 200

c 60 350

d 80 530

e 100 700
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Supply Curve
➢ The supply curve is a graph that shows the amount
of some good that producers are willing and able to
sell at various prices, assuming all determinants of
supply other than the price of the good in question,
remain the same.

➢ The supply curve usually slopes upward, since

higher prices give producers an incentive to supply
more in the hope of making greater revenue.
 Market supply of potatoes (monthly)
100
Supply
P Q
80
a 20 100
Price (pence per kg)

60

40

a
20

0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 Market supply of potatoes (monthly)
100
Supply
P Q
80
a 20 100
Price (pence per kg)

b 40 200
60

b
40

a
20

0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 Market supply of potatoes (monthly)
100
Supply
P Q
80
a 20 100
Price (pence per kg)

b 40 200
c c 60 350
60

b
40

a
20

0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 Market supply of potatoes (monthly)
100
Supply
d P Q
80
a 20 100
Price (pence per kg)

b 40 200
c c 60 350
60
d 80 530

b
40

a
20

0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 Market supply of potatoes (monthly)
100 e
Supply
d P Q
80
a 20 100
Price (pence per kg)

b 40 200
c c 60 350
60
d 80 530
e 100 700
b
40

a
20

0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Supply Function
➢ The mathematical expression of the
relationship between quantity of a good that
firms are willing to sell and the price level.
➢ simple supply functions
Qs = a + bP
➢ more complex supply functions
Qs = a + bP + cC + dPs – ePj
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Other determinants of supply

➢ costs of production
➢ Price of related goods (Substitute in production;
joint products or complement in production)
➢ nature and other random shocks (natural factors
➢ Technology
➢ Producers expectations of future price change
➢ Producers expectations of future price change
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Change in Quantity Supplied vs. Change in

Supply
Change in quantity supplied – is a movement
along the same supply curve, due solely to a
change in price, i.e., all other factors held
constant.

Change in supply – is a shift in the entire

supply curve (either to the left or to the right) as
a result of changes in other factors affecting
supply.
 Shifts in the supply curve
P
Possible causes of a rise in supply S0 S1
• Fall in costs of production
• Reduced profitability of alternative
products that could be supplied
• Increased profitability of goods in
joint supply
• Favourable weather conditions
• Expectations of a fall in price Increase

O Q
 Shifts in the supply curve
P
S2 S0 S1

Decrease Increase

O Q
 Q Which way will the market supply
of bread shift if the price of flour falls?

33% 33% 33%

A. Right

B. Left

C. No shift (movement
along the curve)

A. B. C.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Supply and Demand

Price and output

determination
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Market Equilibrium
➢ Market equilibrium is that state in which
the quantity that firms want to supply
equals the quantity that consumers want to
buy.
➢ The price that clears the market is called
the equilibrium price and the quantity (sold
and bought) is called the equilibrium
quantity.
 Market for Fufu
Quantity
Price Per Plate Demanded Quantity Supplied
0 8 0
0.50 7 1
1.00 6 2
1.50 5 3
2.00 4 4
2.50 3 5
3.00 2 6
3.50 1 7
4.00 0 8
 Equilibrium price and output:
Price of Potatoes Total Market Demand Total Market Supply
(pence per kilo) (Tonnes: 000s) (Tonnes: 000s)

20 700 (A) 100 (a)

40 500 (B) 200 (b)

60 350 (C) 350 (c)

80 200 (D) 530 (d)

100 100 (E) 700 (e)

 The determination of market equilibrium
(potatoes: monthly)
E e
100
Supply
D d
80
Price (pence per kg)

Cc
60

40
b B

a A
20

Demand
0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 The determination of market equilibrium
(potatoes: monthly)
E e
100
Supply
D d
80
Price (pence per kg)

Cc
60

b SHORTAGE B
40
(300 000)
a A
20

Demand
0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 The determination of market equilibrium
(potatoes: monthly)
E e
100
Supply

80
D SURPLUS d
Price (pence per kg)

(330 000)
Cc
60

b B
40

a A
20

Demand
0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
 The determination of market equilibrium
(potatoes: monthly)
E e
100
Supply
D d
80
Price (pence per kg)

60

b B
40

a A
20

Demand
0
0 100 200 300 Qe 400 500 600 700 800
Quantity (tonnes: 000s)
Suppose 𝑄𝑑 = 10 − 𝑝 and 𝑄𝑠 = −2 + 𝑝
: Find the equilibrium price and quantity

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Changes In Equilibrium
➢ When supply and demand curves shift, the
equilibrium price and quantity change.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Changes in Deamand
➢ If any of the determinants of demand
changes (other than price), the whole of the
demand curve shifts.
➢ This will mean a movement along the
supply curve and the new demand curve.
 P
Effect of an increase in demand
S

Initial equilibrium
at point g
g
Pe1

D1
O Q e1 Q
 P
Effect of an increase in demand
S

g
Pe1

D1
O Q e1 Q
 Effect of an increase in demand
P
S

g
Pe1

D2
D1
O Q e1 Q
 Effect of an increase in demand
P
S

i New equilibrium at
Pe2 point i

g h
Pe1

D2
D1
O Q e1 Q e2 Q
Price and output determination
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Effects of shifts in the supply curve

➢ Just like the demand , if there is a change in
the determinants of supply (other than price)
the whole supply curve shifts.

➢ This causes movement along demand curve

and new supply curve.

➢ Assume that there is increase in taxes, this

will cause a decrease in supply as shown
below:
 Effect of a shift in the supply curve
P

S1

g Initial equilibrium
Pe1 at point g

D
O Q e1 Q
 Effect of a shift in the supply curve
P

S1

g
Pe1

D
O Q e1 Q
 Effect of a shift in the supply curve
P
S2

S1

g
Pe1

D
O Q e1 Q
 Effect of a shift in the supply curve
P
S2

S1

k
Pe3

j g New equilibrium at
Pe1 point k

D
O Q e3 Q e1 Q
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Change in both demand and supply

➢Here we observe a simultaneous change
in both demand and supply

➢The relative magnitudes of change in

supply and demand determine the outcome
of market equilibrium.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Change in both demand and supply

➢Let us assume that there is an increase in
demand and a decrease in supply

➢Let us say Government increases the

salaries of Teachers and Teachers are
important consumers of Yam. At the say
time, bad rainfall pattern decreases the
amount of yam supplied.
Increase in Demand And a Decrease in Supply
P
S4 S3
S2
S1

Pe1 e1

D2
D1
O Q e1 Q
 Increase in both Demand And Supply
P
S0
S1

e4
e1 e
Pe1 3
e
2

D4
D3
D2
D1
O Q e1 Q
The relative magnitudes of increase in supply and demand
determine the outcome of market equilibrium.
Q The diagram shows the market for cocoa. Equilibrium
is currently at point x. To which equilibrium point
(1, 2, 3, 4, 5, 6, 7 or 8) will the market move if there is
a rise in the cost of producing cocoa?

1. The market for Cocoa

S2 12% 12% 12% 12% 12% 12% 12% 12%

2. S0
S1
3. 1
8 2
4.
Price

7 x 3

5. 6
5
4

6. D1

7. D2
D0

8. Quantity
1 2 3 4 5 6 7 8
Q The diagram shows the market for cocoa. Equilibrium
is currently at point x. To which equilibrium point
(1, 2, 3, 4, 5, 6, 7 or 8) will the market move if there is
a fall in wages in the chocolate industry?

1. The market for Cocoa

S2 12% 12% 12% 12% 12% 12% 12% 12%

2. S0
S1
3. 1
8 2
4.
Price

7 x 3

5. 6
5
4

6. D1

7. D2
D0

8. Quantity
1 2 3 4 5 6 7 8
Q The diagram shows the market for cocoa. Equilibrium
is currently at point x. To which equilibrium point
(1, 2, 3, 4, 5, 6, 7 or 8) will the market move if there is
speculation that the price of cocoa will fall?

1. The market for Cocoa

S2 12% 12% 12% 12% 12% 12% 12% 12%

2. S0
S1
3. 1
8 2
4.
Price

7 x 3

5. 6
5
4

6. D1

7. D2
D0

8. Quantity
1 2 3 4 5 6 7 8
Q The diagram shows the market for cocoa. Equilibrium
is currently at point x. To which equilibrium point (1, 2, 3,
4, 5, 6, 7 or 8) will the market move if there is increased
demand for chocolate and a new tax on cocoa?

1. The market for Cocoa

S2 12% 12% 12% 12% 12% 12% 12% 12%

2. S0
S1
3. 1
8 2
4.
Price

7 x 3

5. 6
5
4

6. D1

7. D2
D0

8. Quantity
1 2 3 4 5 6 7 8
 Q If it is observed that the price and quantity of a
product sold both fall, we can conclude that:
A. demand has shifted to the right, but we
cannot draw any conclusions about
supply without more information.
B. demand has shifted to the left, but we 20% 20% 20% 20% 20%
cannot draw any conclusions about
supply without more information.
C. supply has shifted to the right, but we
cannot draw any conclusions about
demand without more information.
D. supply has shifted to the left, but we
cannot draw any conclusions about
demand without more information.
E. We cannot draw any conclusions about
shifts in either curve without more
information. A. B. C. D. E.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

The Control of Prices

➢ The free working of the market will always
establish equilibrium price and quantity.

➢ At the equilibrium, there will be no shortage

or surplus.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

The Control of Prices

➢ However, the equilibrium price and quantity
may not be the most desirable. Government
may therefore enter the market and fix a
price that may be above or below the
equilibrium price.

➢ There are two kinds:

I. Minimum Price control, or Price Floor
II. Maximum Price control, or price ceiling
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Minimum Price Control

➢ Minimum Price or price Floor establishes a
minimum legal price below which the
commodity cannot be sold.
➢ When a minimum price is established, it
means that the price is not allowed to fall
below that level.
➢ Example: Minimum wage
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Reasons for Minimum Price Control

➢ To protect producers income

➢ To create surplus in periods of excess

production which can be stored in
preparation for future shortages

➢ To protect workers income in the case of

minimum wage
 Minimum price: price floor
P
S

Pe

O Q
 Minimum price: price floor
P
S

surplus
minimum
price

Pe

O Qd Qs Q
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Dealing with resulting surpluses

➢ Government could buy the surplus and sell it
later or sell it abroad

➢ Supply could be artificially lowered by

government restrictions

➢ Demand could be raised by advertisement,

finding alternative uses, or by reducing
consumption especially imports
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Maximum Price Control

➢ A price ceiling establishes a maximum price
that sellers are legally permitted to charge.
➢ Sellers are not allowed to sell above the
maximum price
➢ Example: Rent, Fuel prices in Ghana

➢ Maximum prices are set to protect

consumers especially for essential
commodities.
 Maximum price: price ceiling
P
S

Pe

O Q
 Maximum price: price ceiling
P
S

Pe

maximum
price
shortage

O Qs Qd Q
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Effects of Maximum Price Control

➢ Shortage
➢ Underground markets (Parallel or Black
Market).
➢ Quantity produced may fall worsening the
shortage
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Dealing with the Shortages

➢ Government can encourage supply
➢ Direct production by government
➢ Discourage demand
➢ Encourage production of alternative goods
➢ Controlling people’s income
Effect of price control on underground-market prices
P
S No underground market

Pe
Price ceiling

Pg

D
O Qs Qd Q
Effect of price control on underground-market prices
P
S
Pb
If operators in
underground markets buy
all the supplies at Pg, the
black market equilibrium
Pe price will be Pb.

Pg

D
O Qs Qd Q
Q Which one of the following controls would
involve setting a minimum price rather than a
maximum price of a good (or factor)?
20% 20% 20% 20% 20%
A. Controls on rents to protect
tenants on low incomes.
B. Controls on wages to protect
workers on low incomes.
C. Controls on basic food prices to
protect consumers on low
incomes.
D. Controls on transport fares to
protect passengers on low
incomes.
E. None of the above.
A. B. C. D. E.
 Q If the government raises the minimum wage
(relative to other wage rates):
A. unemployment would fall. 20% 20% 20% 20% 20%

B. wage rates in higher-paid

jobs would fall.
C. the demand for workers at
the minimum wage would
rise.
D. the supply of workers at the
minimum wage would rise.
E. there would be a smaller
disequilibrium at the
minimum wage than before. A. B. C. D. E.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Question:
The market for text books is currently in
equilibrium. The following are some changes
that may take place in the market for textbooks.
For each of the following, indicate what will
happen to either the demand for or the supply of
textbooks by listing which curve is affected and
then the terms: "shift right or "shift left" and
show it graphically. (NOTE: START FROM
THE INITIAL EQUILIBRIUM)
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Question (Con’t)
i. An increase in student enrolment at
universities across the country
ii. A decrease in the price of ink used to print
textbooks
iii. A drop in income (textbooks are a normal
good).
iv. An improvement in the technology used to
print textbooks
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

LECTURE TWO ENDS

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Elasticity
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Introduction
 As pointed out earlier, when the price of a good
rises (or falls), quantity demanded falls (rises).
 Economists would like to know by how much
quantity demanded falls or rises in response to a
price change
 In other words, we would like to know how
responsive demand is to price changes.
 For instance, consumers’ response to a change in
the price of oil would differ from that of Voltic
Mineral Water.
 Market demand and Price Change

c b
Price

P2

a
P1 D'

D
O Q3 Q2 Q1 Quantity
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Elasticity
 Elasticity is the economic measure of the response of
one variable to a change in another
 Elasticity of demand measures the degree of
responsiveness of quantity demanded to changes in the
determinants of demand.
 Since not all the factors that affect demand can be
measured quantitatively, we will discuss three types of
demand elasticity:
 Price Elasticity of Demand
 Income Elasticity of Demand and
 Cross-Price Elasticity of demand
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price Elasticity of demand

 Price elasticity of demand measures the degree of
responsiveness of quantity demanded to changes
in the commodity’s own price.

 Elasticity compares the size of the change in

quantity demanded to that price.

 Since quantity and price are measured in different

units, the only sensible way to measure elasticity
is to use proportionate or percentage changes.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Measurement of Price Elasticity:

Or
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Measurement of Price Elasticity:

Percentage change in quantity is given as:

------(1)

Percentage change in Price is given as:

-------(2)
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price Elasticity of demand

 Dividing equation (1) by equation (2) implies:

 Solving this will yield an alternative method.

 This is given as:
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price Elasticity of demand: Example

 Assume that the price of Yam decreases from
GH¢5 to GH¢4 per tuber and this causes the
quantity demanded to increase from 5 tubers per
day to 10 tubers. What is the price elasticity of
demand?

 From this information,

, ,
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price Elasticity of demand: Example

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price Elasticity of demand: Example

Percentage change in quantity is given as:

Percentage change in Price is given as:

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation of Elasticity Figures

 Since demand curves are generally downward
sloping, it implies that percentage change in price
and that of quantity would have opposite signs.
 That is, a percentage increase in price would be
accompanied by a percentage decrease in price
and vice versa.
 Either way, the price elasticity of demand is
always negative. In this class, I would ignore the
negative sign and interpret the absolute values.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation of Elasticity Figures

 If PED = 0, then demand is Perfectly inelastic.

 This means that demand does not respond at all to

changes in price. That is, no matter the price,
quantity demanded is the same.

 The demand curve is thus vertical as shown

below:
 Perfectly inelastic demand (PÎD = 0)
P D

P2
b

P1 a

O Q1 Q
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation of Elasticity Figures

 If PED = ∞, then demand is Perfectly Elastic.

 This means that demand responds to a small

change in price. That is, a small change in price
brings about infinitely large change in quantity
demanded.

 This is shown by a horizontal demand curve

 Infinitely elastic demand (PÎD = ¥)
P

a b
P1 D

O Q1 Q2 Q
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation of Elasticity Figures

 If PED>1, then demand is fairly Elastic.
 This is where a change in price causes
proportionately larger change in the quantity
demanded. In this case, the value of elasticity will
be greater than 1 since we are dividing a larger
figure by a smaller figure.

 This is shown by a relatively flatter demand curve

Elastic demand between two points
P

b
5
a
4
D

0 10 20 Q
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation of Elasticity Figures

 If 0<PED<1, then demand is fairly Inelastic.
 This is where a change in price causes
proportionately smaller change in the quantity
demanded. In this case, the value of elasticity
will be less than 1 since we are dividing a
smaller figure by a larger figure.

 This is shown by a relatively steeper demand

curve
 Inelastic demand between two points
P

8
c

a
4

0 15 20 Q
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation of Elasticity Figures

 If PED =1, then demand is said to be unitary
Elastic.
 This is where price and quantity demanded change
by the same proportion. In this case, the value of
elasticity will be 1 since we are dividing a figure by
itself.
 The demand curve is a rectangular hyperbola:
 Unitary Elastic
P

po c

p1 a

0 Q0 Q1 Q
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Summary of Price Elasticity of Demand

 Fairly Elastic Demand - Ed will be > 1

 Fairly Inelastic Demand - Ed will be < 1

 Unitary Elastic Demand - Ed will be = 1

 Perfectly Inelastic Demand - Ed will be = 0

 Perfectly Elastic Demand - Ed will be = 

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Determinants of price elasticity of demand

 number and closeness of substitute goods

 Number of uses of the commodity

 the proportion of income spent on the good

 The number of new buyers

 time
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price elasticity of demand and consumer

expenditure
 Total Revenue (expenditure) = P x Q

 A price increase has two effects on revenue:

 Higher P means more revenue on each unit
you sell.
 But you sell fewer units (lower Q), due to
Law of Demand.
 Which of these two effects is bigger?
It depends on the price elasticity of demand.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Determinants of price elasticity of demand

If demand is elastic, then

price elasticity of demand > 1

% change in Q > % change in P

 The fall in revenue from lower Q is greater

than the increase in revenue from higher P,
so revenue falls.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Determinants of price elasticity of demand

If demand is inelastic, then

price elasticity of demand < 1

% change in Q < % change in P

 The fall in revenue from lower Q is smaller

than the increase in revenue from higher P,
so revenue rises.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Determinants of price elasticity of demand

If demand is Unitary elastic, then

price elasticity of demand = 1

% change in Q = % change in P

 The fall in revenue from lower Q is the

same as the increase in revenue from higher
P, so revenue remains the same.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Determinants of price elasticity of demand

 Arc Elasticity
 Arc elasticity measures elasticity between two point
on the demand curve.

 We Q/averageQ ÷ P/average P

 Or
 Measuring elasticity using the arc method
10

m
8

n
6

P (£)

2 Demand

0
0 10 20 30 40 50
Q (000s)
 Measuring elasticity using the arc method
10
Q P
Ped =  mid P
mid Q
m
8

7 P = –2
n
6
Q = 10
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
 Measuring elasticity using the arc method
10
Q P
Ped =  mid P
mid Q
m
8 10 -2
=
15
 7
7 P = –2
n
6
Q = 10
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
 Measuring elasticity using the arc method
10
Q P
Ped =  mid P
mid Q
m
8 10 -2
=
15
 7
7 P = –2 = 10/15 x -7/2
n
6
Q = 10
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
 Measuring elasticity using the arc method
10
Q P
Ped =  mid P
mid Q
m
8 10 -2
=
15
 7
7 P = –2 = 10/15 x -7/2
n
6 = -70/30
Q = 10
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
 Measuring elasticity using the arc method
10
Q P
Ped =  mid P
mid Q
m
8 10 -2
=
15
 7
7 P = –2 = 10/15 x -7/2
n
6 = -70/30
Q = 10 = -7/3 = -2.33
P (£) Mid P
4

2 Demand

0
0 10 15 20 30 40 50
Mid Q Q (000s)
Q If the price of good X rises from £9 to £11 and
as a result quantity demanded falls from 100
units to 60 units, what is the price elasticity of
demand between these prices?
20% 20% 20% 20% 20%

A. 2/–80 = –0.025
B. –80/2 = –40
C. 0.2/–0.5 = –0.4
D. –0.5/0.2 = –2.5
E. –1
A. B. C. D. E.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price elasticity of supply

Measure the degree of responsiveness of quantity
supplied to changes in the price of the commodity.
For point elasticity,

Or
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Price elasticity of supply

For Arc Elasticity:

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Determinants of Price elasticity of supply

 The more easily sellers can change the quantity
they produce, the greater the price elasticity of
supply.

 For many goods, price elasticity of supply

is greater in the long run than in the short run,
because firms can build new factories,
or new firms may be able to enter the market.
 Q In which one of the following cases is
good X likely to have a more
price-elastic supply than good Y?
A. It is more costly to shift from
producing X to another product
than from Y to another product.
B. The supply of Y is considered
over a longer period of time
than X.
C. X is a minor by-product of Y.
D. Consumers find it easier to find
alternatives to Y than to X.
E. The cost of producing extra units
increases more rapidly in the
case of Y than in the case of X.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Income Elasticity of Demand

 Measure the degree of responsiveness of quantity
demanded to changes in the income of the
consumer
For point elasticity,

Or
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Income Elasticity of Demand

For Arc Elasticity:

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation of Income Elasticity

Figures
 If the value is negative then the good is an inferior
good
 If the value is positive, then the commodity is a
normal good
 For normal goods, if the value is grater than one,
then it is said to be a luxury
 If it is positive but less than one, then it is a
necessity
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Determinants of Income Elasticity

 degree of necessity

 proportion of income spent on the good

 Q The data in the table refer to the income
elasticities of demand for various commodities.
Which one is a normal good and income inelastic?
Wine and spirits 2.60
Travel abroad 1.14
Dairy produce 0.53
Bread and cereals –0.50
Coal –2.02

A. Wine and Spirits

B. Travel Abroad
C. Dairy Produce
D. Bread and cereals
E. Coal
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Cross-Price Elasticity of Demand

 Measure the degree of responsiveness of quantity
demanded of one commodity to changes in the
price of another commodity.

Or
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Cross-Price Elasticity of Demand

For Arc Elasticity:

 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation
 If the value is positive, then the two goods are
substitutes implying that percentage increase
in the price of one good lead to an increase in
the demand for the other good, and vice versa
all things equal
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Interpretation
 If the value is negative, then the two goods
are complements implying that percentage
increase in the price of one good leads to a
decrease in the demand for the other good,
and vice versa, all things equal

 If the value is zero, then the two goods are

said to be unrelated
 Q If a rise in the price of good X results
in the amount of money spent on
good Y remaining the same, then

A. X and Y are perfect substitutes. 20% 20% 20% 20% 20%

B. X and Y are perfect complements.

C. the cross-price elasticity of
demand for Y with respect to X
is infinite.
D. the cross-price elasticity of
demand for Y with respect to X
is 1.
E. the cross-price elasticity of
demand for Y with respect to X
is Zero. A. B. C. D. E.