Makko billi secondary school grade 10 economics unit 2

Unit Introduction
Market is a place, condition, or mechanism, which brings together both buyers (demanders) and sellers
(suppliers) in order to exchange their goods and services.
All situations which link potential buyers with potential sellers are markets. Thus, the market means the
system in which sellers and buyers of a commodity interact to settle its price and the quantity to be bought and
sold.
Unit Objectives
After completing this unit, students will be able to:
 Explain the theory of demand.
 Describe the theory of supply
 Identify factors that affect demand and supply
 Distinguish between individual and market demand
 Distinguish between individual and market supply
 Demonstrate market equilibrium both graphically and mathematically
 Evaluate the effect of changes in demand and supply on equilibrium price and quantity.
 Define elasticity
 Calculate and interpret the different types of elasticity
2.1. Theory of Demand
Definition:
 Demand means the ability and willingness to buy a specific quantity of a commodity at the prevailing
price in a given period of time.
 Demand for a commodity implies a desire to acquire it, along with the willingness and ability to pay for
it. Thus, Demand = Willingness to buy + Ability to pay.
 It refers to the amount of commodity which an individual buyer is willing and able to buy at a given price
and during a given period of time.
 Demand for a commodity is the amount of it that a consumer is willing to buy at various given prices and
a given moment of time
 We may say demand refers to an effective desire.
A desire becomes an effective desire or demand only when it is backed by the following three factors:
 ability to pay for the good desired,
 willingness to pay the price of the good desired, and
 availability of the good itself
The Demand Schedule, Demand Function and the Demand Curve
 Demand Schedule is a table showing different quantities of commodity that consumer is willing to buy at
different level of prices, during a given period of time.
 Demand expresses the nature of functional relationship between the price of a commodity and its
quantity demanded. Qd=f(P)=a-bP ;whereas ‘d‘ is quantity demanded, ‘P’ is price, ‘a’ is constant, ‘b’
coefficient of price,
 A demand curve is a curve that represents the relationship between the quantity of the good chosen by a
consumer and the price of the good.
 The independent variable (price) is measured along the vertical axis, and dependent variable (quantity) is
measured along the horizontal axis.
 The demand curve shows the quantity demanded by the consumer at each price.
Table2.1 Amina’s demand. The Demand Schedule shows the quantity demanded at each price

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Makko billi secondary school grade 10 economics unit 2

Demand Schedule
A demand schedule is a tabular statement that states the different quantities of a commodity that would be
demanded at different prices.
Demand schedules are of two types:
 Individual demand schedule.
 Market demand schedule
Individual demand schedule
 A tabular statement which shows the quantity of a commodity demanded by an individual household at
various alternate prices per time period.
Table2.2. Individual Demand Schedule

The above demand schedule shows the different quantities of mangoes demanded by an individual at
different prices. At Birr10 per kg consumer demands 4 kg mangoes but at Birr 22 per kg consumer
demands 1 kg mangoes.
Market demand schedule
 A tabular statement which shows the different quantities of a commodity demanded by different
households or consumers in a market at various alternate prices per time period.
 The below table demand schedule shows the different quantities of mangoes demanded by different
consumers at different prices. At Birr 10 per kg X demands 4 kg whereas Y demands 6 kg, so market
demand at Birr 10 per kg is 10 kg.
 But at Birr 22 per kg X demands 1 kg whereas Y demands 2 kg, so market demand at Birr 22 per kg is 3
kg.
Table 2.3. Market Demand Schedule

if individual demand schedules were expressed as demand curves, the market demand curve would
be derived by taking the horizontal summationof individual demand curves.
umerical Example: Suppose the individual demand function of a product is given
by: QI= 50 - 5P and there are about 100 identical buyers in the market. Then the market demand function is
given by:
⇒Qm= (50 – 5P) 100
⇒Market Demand (Qm) = 5000-500P
Statement of the Law:
The law of demand states that, other things being equal, at a higher price consumers will purchase less of
a commodity, and at a lower price, consumers will purchase more of it.
Or a rise in the price of goods leads to a fall in quantity demanded and vice versa, assuming all other
determinants of demand are kept constant.
Assumptions of the Law of Demand
 Law of demand depends on the basic assumption of other things being equal (ceteris paribus). By other
things we mean factors other than price which affect the demand for a commodity.

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Makko billi secondary school grade 10 economics unit 2
We may summarize the assumptions of the law of demand as follows:
 There should be no change in prices of related goods,
 Tastes and preferences of the consumer should remain constant,
 There should be no change in the income of the consumers,
 The size of the population should remain constant,
 Distribution of income and wealth should be equal,
 There should be perfect competition in the market.
Factors affecting demand
 Determinants of demand are factors that cause the consumer to increase or decrease their demand for a
particular commodity.
 Demand is a multi-variety function in a sense that it is determined by many factors/variables.
 There are various factors affecting the demand for a commodity.
Some of these are:
Price of the good:
 The price of a commodity is an important determinant of demand.
 Price and demand are inversely related.
 The higher the price, the lower the demand and vice versa
Price of related goods:
 The price of related goods like substitutes and complementary goods also affect the demand.
 Substitute goods are goods that can be used in place of each other to satisfy a given want.
(For example, coffee and tea, pens and pencils, butter and oil, etc.).
 Complementary goods are goods used together to satisfy a given want.
(For example, tea and sugar, phone and sim-card, cars and petrol, gun and bullet etc.)
In the case of substitutes, rise in the price of one commodity leads to an increase in the demand for its
substitute. In the case of complementary goods, a fall in the price of one commodity leads to a rise in
demand for both the goods
Consumer income:
 Directly related to demand. A change in the consumer’s income significantly influences his demand for
most commodities.
If the consumers’ income increases, demand will be greater.
Taste and habits:
 These are very effective factors affecting demand for a commodity.
When there is a change in the consumer’s taste, habits, or preferences, their demand will change.
Population:
 If the size of the population is greater, demand for goods will be greater.
 The market demand for a commodity substantially changes when there is a change in the total
population.
Season:
 The demand for a commodity is also affected by the season.
 For hand, demand for cotton clothes increases in hot seasons.
Consumer’s future price expectation:
 If a consumer expects prices to rise in the future, he may buy more at the current price, and thus his/her
demand rises.
Changes in quantity demanded and changes in demand
 Other things being equal, it designates the movement from one point to another point from one price
quantity combination to another on a fixed demand schedule or demand curve.
 The cause of such a change is an increase or decrease in the price of the product being considered.
 Downward movement along the demand curve is called an extension of demand, while the upward
movement is a contraction of demand.

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Makko billi secondary school grade 10 economics unit 2

Note
A change in the demand schedule, or more graphically, a shift in the location of the demand curve, is
called a change in demand. An increase in demand causes the demand curve to shift upward to the right;
whereas, a decrease in demand causes the demand curve to shift downward to the left.
In other words, while an increase in demand is explained by an outward shift of the demand curve, a
decrease in demand is explained by an inward shift of the demand curve.
Theory of Supply
Supply of a commodity
 Refers to various quantities of it which producers are willing and able to offer for sale at a particular time
at various corresponding prices.
 Supply function: is a statement that states the relationship between the quantity supplied (as a dependent
variable) and its determinants (say price, as independent variable).
 Suppose that a single producer’s supply function for commodity X is given as: QX=F(PX)=a+bP, ceteris
paribus.
The slope of a supply curve:
 The Law of supply expresses the direct relationship between the prices of a commodity and its quantity
supplied.
 Price and supply are positively related.
 The slope of the supply curve is positive.
Changes in quantity supplied and changes in supply
A change in quantity supplied
 Price of goods increases, the quantity supplied increases.
Change in supply
 Change refers to a shift in the position of the supply curve caused by a change in something other than
the commodity’s own price.
 A shift in the supply curve may be caused by change in the prices of other goods, a change in the prices
of factors of production, a change in production technique or a change in the goals of the producer.

Factors affecting supply

 The economist’s assumption is that price is the most significant determinant of the quantity supplied of
any product.
These other factors include
The cost of factors of production:
 The cost depends on the price of factors. An increase in factor cost increases the cost of production, and
reduces supply.
The state of technology:
 Using advanced technology increases the productivity of the organization and increases its supply.
External factors:
 External factors like this influence the supply.
 If there is a flood, this reduces the supply of various agricultural products.
Tax and subsidies:
 An increase in government subsidies results in more production and higher supplies.

Transport:
 Better transport facilities will increase the supply.

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Makko billi secondary school grade 10 economics unit 2
The price of other goods:
 If the price of other goods is more than the price of commodity ‘X’, then the supply of commodity ‘X’
will be increased.
Market Equilibrium
 That is, equilibrium occurs when the quantity demanded by the buyers equals the quantity supplied by the
sellers in a particular market, so that the market clears.
 It is a condition that once it is achieved, tends to persist because economic agents have no incentive to
change their behavior.

Market equilibrium
The concepts of excess demand and excess supply
 Excess demand occurs when the quantity demanded is greater than the quantity supplied, which
leads to a shortage in the market.
 Excess supply occurs when the quantity supplied exceeds the quantity demanded, resulting in market
surplus.

Excess demand and Excess Supply

Example: If the market demand and supply functions of wheat are given as Qd= 80 – 3P and
Qs = 9P -40, respectively. What are the market clearing price in Birr/kg and the corresponding quantity
in kg?
Effects of change in demand and supply on equilibrium quantity and price
 demand might change because of fluctuations in consumer tastes or incomes, changes in consumer
expectations, or variations in the prices of related goods. Supply might change in response to
changes in resource prices, technology, etc.

Changes in Demand:
 Suppose that supply is constant and increases in demand, leads to a rise in both the equilibrium price and
quantity; and also if there is demand fall it leads to decrease in both the equilibrium price and quantity
demanded.
Change in Supply:
 Let’s suppose demand is constant but supply increases (decreases).
 This will affect the equilibrium by lowering (rising) the new market- clearing price and rising (lowering)
the new equilibrium quantity.

Factors Shifting Demand Curve (assume Supply remains constant)

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Makko billi secondary school grade 10 economics unit 2

Factors that shift the Supply Curve (assume demand remains constant)

Elasticities of Demand and Supply

Elasticity of demand
 The measure of the responsiveness of demand for a commodity to changes in any of its determinants,
such as the price of the commodity, price of related goods, and consumers’ income.
Accordingly, there are three basic elasticities:
I. Price elasticity of demand,
II. Cross-price elasticity of demand &
III. Income elasticity of demand
Price elasticity of demand
 A measure of the degree of responsiveness (or sensitiveness) of consumers to changes in the price of the
commodity itself.
 It may be defined as the ratio of the percentage change in quantity demanded to the percentage change
in price.

 Price elasticity of demand is of two types:

Point elasticity and arc elasticity of demand.
Point elasticity of demand:
 Measures elasticity at a (given) point or for a very small change in price.

 Arc elasticity refers to price elasticity over a distance on the demand curve.
 Arc elasticity measures the average responsiveness of consumer demand to changes in price over a range
of extended prices.

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Makko billi secondary school grade 10 economics unit 2

Interpreting Price Elasticity of Demand Values

Price Elastic Demand:
 Said to be relatively elastic if a specific percentage change in price results in a larger percentage change
in quantity demanded.
 Then, will be greater than 1.
Price Inelastic Demand:
 If a given percentage change in price is accompanied by a relatively smaller change in the quantity of the
good or service, then demand is said to be relatively price inelastic.
For example, if a 10% increase in a product’s price is accompanied by only a 2% decrease
in the quantity demanded, the price elasticity of demand will be
EPD= 0.02/0.1 = 0.2< 1
Unitary Elastic: When a percentage change in price and the accompanying percentage change in quantity
demand are equal, the case separating elastic and inelastic demands is said to be unitary elastic.
Perfectly Inelastic:
 A situation in which the quantity demanded of a certain product is invariable relative to the change in the
price. The elasticity coefficient is equal to zero (EPD =0).

Perfectly Elastic:
 Denotes that a 1% change in price results in an infinite change in quantity demanded.
 The consumer can buy all possible quantities at the given price and nothing else at other prices.

Summary of Price Elasticity of Demand

The price elasticity of demand depends on the following factors:

Nature of the commodity, Availability of close substitutes,
People with high incomes ,Durability of a commodity,
Proportion of income spent on the commodity, Time,
Urgency of demand / postponement of purchase,
Product purchase frequency or recurrence of demand
Cross Elasticity of Demand
 Cross elasticity measures the responsiveness of the quantity demanded of a commodity due to changes in
the price of another commodity.

Income Elasticity of Demand

 Income (I) Elasticity of Demand measures the percentage change in the amount of a commodity
purchased per unit time resulting from a given percentage change in a consumer’s income.

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Makko billi secondary school grade 10 economics unit 2

Elasticity of supply
 Price elasticity of supply measures the degree of responsiveness or reaction of producers to price
changes.
 The greater the reaction, the greater the elasticity.

 Determinants of the price elasticity of supply: There are factors which determine the price elasticity of
supply. The main factors are:
Expectation of future prices:
 If producers expect a rise in the price of a commodity in the future, they will likely hoard the commodity
to take advantage of the rise in future prices
 The supply will, therefore, be less elastic
 If they expect a fall in future prices, they will release the goods from their stocks.
 The supply will be more elastic.
Production period:
 The amount of time available to producers for responding to changes in product price is the main
determinant of price elasticity of supply.
Generally, supply is relatively elastic to price changes in the long-run and relatively inelastic in the short-
run. The reason why supply is elastic for a longer period is that suppliers might produce good substitutes.
Time for adjustment is important because most production activities cannot be changed in scale
overnight.
Factor substitution:
 If there are greater substitutes for factors of production, supply is more elastic. Whenever there is a slight
change in the price of a factor input, it can be substituted for others, making supply quite elastic.
With no substitutes, supply becomes inelastic.
Number of sellers:
 The market’s supply will be more elastic when there are large numbers of firms serving the market. With
a smaller number of firms/sellers, supply becomes inelastic.

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