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 iii

MODERN MICROECONOMICS:
(A Practical Arithmetical Approach)

"T. A. Ngerebo-a (Ph.D)

Department of banking & Finance
R~vers State University of Science and
.. _ Technology, Port Harcourt.
 /

iv
Published in Nigeria by Springfield Publishers Ltd.

T. A. Ngerebo-a (Ph.D)
© Copyright 2006

ISBN: 978-8084-79-6

All Rights Reserved

This book may not be reproduced in part or in full, or stored

in a retrieval system or transmitted in any form or by any
means, electronic, mechanical, photocopying, recording or
otherwise (except for brief quotations in critical articles or This b
reviews) without the prior written permission of the copyright "short-cu
owner.

This book is sold subject to the condition that it should not by

way of trade or otherwise be lent, resold, hired out or
otherwise circulated without the copyright owner's consent,
in any form of binding or cover than that in which it is
published and this condition being imposed on the
subsequent purchaser.

Typeset & ~rinted By:

SABCOS PUBLISHERS
96A Azikiwe Street
Port Harcourt.
08039466191,08032331709
 iv
~ d.

DEPICATION
·c1es or
~.........ight
This book is dedicated to everybody who is against
"short-cut" to affluence and higher qualification .

. sent,
h it is
n the
 vi
described

PREFACE
There are as many books in economics, and more
specifically microeconomics, as the definitions of
economics. Most of these books are restatements of the
philosophical write-ups of the originators of the various who mus
topics in economics. With the consistent increase in the David A. -~--­
standard. of examination questions and the deepening Pastor bu: h _
need for· the application or relevance of the various B. A. Fuba:-
issues in microeconomics there appears to be a gap
between the growing objectives of the study of
microeconomics and the available books. Moreover,
most of the existing textbooks on microeconomics have
little practical examples.
This book is written with just one singular aim of
bridging explored gap. This is why the book is written T.A.
with the simplest language and very close practical
illustrations so that the high and the low in academics
and other spheres of life can read, understand and
apply the ideas discussed therein. Specifically the book
had been written to meet the demands of secondary
school students, undergraduate and graduate students
in Management Sciences and Social Sciences,
businessmen, and everybody with some sort of
inquisitive mind. it is because of these special features
that this book has been limited to just seven chapters
that are mostly the core areas of microeconomics at
whatever level of study. This seven chapter book is best
 vii
VI
described as a "must-own-one by every ~reader"
especially as it foresees the situation where the lecturer,
instructor, or teacher will not be around.
~ more
n s of The author benefited immensely from the criticisms,
-- of th e suggestions and contributions of many persons some of
who must be mentioned. One of such persons is Rev.
David A. Adedeji who had not only been my Senior
Pastor but had been an investment advisor. Professors
B. A. Fubara, A. I.7\hiauzu, J . K. Onoh and A. N . Gbosi
- a gap as well as Doctors S.- N. ~madi , D. W. -Maclayton, D. I.
. d y of Hafl:1ilton and -P. U: C. Agundti aie deservedly
:-eover, acknowledged. I am also;indebted .o all my students in
s h ave Rivers State University of Science and technology.
Finally, I am eternally grateful to my wife, my son and
my beloved mother for their invaluabl~ supports.
alID of
...,.-ritten T. A. NGEREBO, Ph.D

/
 viii

TABL& 0,. C01'TENT8

DEDICATION v
PREFACE vi
1 INTRODUCTION 1
2. DEMAND AND SUPPLY ANALYSIS 25
3. ELASTICITY OF DEMAND AND SUPPLY 64
4. THEORY OF DEMAND BEHAVIOUR 119
-
5. THEORY OF PRODUCTION 169
6. COSTS ANALYSIS 199
7. MARKETING ANALYSIS 218
8. REFERENCES 248
INDEX 249
subjecL ~
into differ-._,
(1 980 &="-
 viii

25
64 CHAPTER ONE
19 INTRODUCTION
69 (
\

·99 \
21 8 1.0 DEFINITION
248 There seems to be as many ways of defining the subject
249 called Economics as there are the various aspects of the
subject. However, these definitions have been divid~d
into different groups. For example, Stonier and Hague
(1980) grouped the definitions into the three parts Lof
economics - Descriptive, Analytical and Applied
economics. The most common grouping of the
definitions is the one done by Fraser ( 1982) adopted by
Jhingan (1982) by which the def nitions are grouped
into wealth (or classical) and welfare (Neoclassical).
However, some other economists have criticized the
definitions, ending up in single aU-e,mbracing ·,
definitions. One of the latter group of economists is
Samuelson (1980) who defined economics as the study
of how people and society end up choosing, with or
 Modem A/11·meco11omics: A practical Arithmetical Approach
without money, to employ scarce productive resources
1hnt could have alternative uses to produce
commodities and distribute them for consumption, now
or in the future, among various persons and groups.
Some other definitions are as follows irrespective of
the camp:
1) Economics is an enquiry into the nature
and causes of the wealth of nations (Adam
Smith, 1776).
2) !tis the practical science of the production
and distribution of wealth (J. S. Mill).
3) It is the science that treats phenomena
from the standpoint of price (H. J.
Davenport)
4) It is the body of knowledge which relates to
wealth, (J.E. Carrnes).
5) It is the study of the laws which govern
Wealth (J.B. Say).
6) The study of how to increase total
production in order to raise the standard of
living (A. C. Pigou).
7) It is the study of mankind in the ordinary
business oflife (Alfred Marshall).
8) It is the science which studies human
behaviour as a relationship between ends
and scarce means,_which have alternative
.......- -
Introduction 3
uses (Lord Robbins).
9) It is the study of those activities, which,
with or without money, involve exchange
transactions among people (Rowart).
10) It is the science dealing with production,
distribution and consumption of wealth
(Concise Dictionary).
11) It is the social science that studies
human behaviour in his effort to make a
living.
12) It is the study of the general principles of
administration of resources, whether of
an individual, a household, a business or
a state, including the examination of the
ways in which was le arises in all such
administration.
13) It is a social science concerned with the
proper use and allocation of resources
for the achievement and maintenance of
growth with stability in an economy.
14) It is the study of the general causes on
which the material welfare of human
beings depend (E. Canaan).
The above definitions have certain things in common,
such as human beings (man and society), satisfaction of
needs or wants, wealth, and use of resources. Another
 Introduction 5
4 Modern Microeconomics: A practical Arithmetical Approach

on certain criteria. Two of these criteria are:

pecu~iar thing with the definitions is that the more (a) On the basis of economic analysis and
recent the definition the more comprehensive and more utilization.
refined it is. It will therefore not be out of place to define (b) On the basis of entity in excha!lge
economics as the use of man in the study of exchanges
and satisfaction of needs. The subject uses man as its Figure 1.1 shows these divisions
Economics
tool and analyses the behaviours at different times with .
regards to different needs and different alternating
means of satisfying the needs. Since human behaviours
are not always predictable but assumed to be personal
or connected with cultural value system in relation to
various reasons of exchange and exchange processes, Entity in' Exchange Economic Analysis/
Utilizaiton
economics reasonably can be considered as an ART
rather than SCIENCE. But because economists can
apply the scientific method of solving problems with the
aid of principles and functional relationships of
variables, economics can be a SCIENCE.
I
Micro-
economics
Macro-
economics
Positive
Economics
Normative
Economics
Whether science, social science or art, economics is the
study of exchanges with the ultimate aim of satisfying
the needs of human beings. The exchanges can be with Figure 1.1 Divisions of Economics
or without money. This position is against the assertion On the basis of economic analysiB and utilization, we
that modern exchanges are monitized. Barter, the mean how the economist views or investigates
exchange of goods for goods, or goods for services still phenomenon around him, the essence of such
exists and has the sa:r:ne aim as monitized exchanges i.e. investigations and the way the outcome of such
satisfaction of needs. investigation or analysis is utilized in an e(fort to proffer
solution(s) to the basic economic questions
And the study uses man as the most important tool.
surrounding the phenomenon. In this regard, the
1.1 DIVISIONS OF ECONOMICS economist either analyzes the causes and effects, or the

l~conomics can be divided into several arms depending

6 Modern.Microeconomics: A practic.al Arithmetical Approach
causes and justification of the outcome of th
phenomen_pn. The former consideration is known as
positive economics while the latter is known as
-----
normative economics.
Positive Economics: This is the science of economics.
~
It is the description of the economy and the study of
what causes ~hat. It is free from value judgement about
the results o(actions (good or bad). That is, it involves
I
the study of what, does happen. It also involves making
predictions,
- I
for example, predictions about prices,
demand, supply, etc. Here, the concern is the accuracy
of economic theories, descriptions, forecasts and
predictions. ~For instance, if government imposes high
excise duty on liquor, economists may predict a fall in
the demand and the retrenchment of labour force.
Positive analysis is about the accuracy of this
prediction.
Normative Economics: This is the study of whether a n
outcome or policy or action is good or bad, desirable or
not, and what, how or whether to change things to
achieve the best possible outcome. It is concerned with
value judgement, or the study of what should happen.
For instance, if the imposition of high tax on liquor is
just, or can it achieve the aims, etc?
Exchanges can take place on single unit levels or at a
broad all-units levels. When the consideration or the
study of the human being's needs, the process of
Introduction 7
't isfying the needs and the effects of such process is on
ill individual person, household, firm or market basis,
I lie study is said to be MICRO hence
MICROECONOMICS . In most microeconomic analysis,
1 11 uses and effects are taken on single exclusive basis
I 1olding other causes and effects constant. This is t~e
11•oson why the most outstanding assumption iQ 1/"
1
111icroeconomics is ALL OTHER THINGS BEING EQUAL 1r
md the basic theory is the determination of relative
prices with the aid of demand and supply analysis,
Inking the determinants and consequences one at a
time .
Microeconomics is the branch of economics or modern
1·conomic theory concerned with price theory. It is the
:-i lu dy or theory of the small (one unit), of behaviour of
<'Onsumers, producers and markets. Microeconomics
1•xplains the composition or allocation of total
production, while income theory explains the level of
tota l production and why the level rises and falls.
Microeconomics= Theory of Value or Price Theory
Advantages of microeconomics:
1) It provides an understanding of the
operation of the economy in simplified
forms .
2) It furnishes the analytical tool for economic
policies affecting prices and production.
 8 Modern Microeconomics: A practical Arithmetical Approach
3). Its methods of analysis are applied to
certain problems . continually faced by
business enterprises. Its main
contributions to improved decision-
making in business. are,. in demand
analysis, cost analysis, and in methods of
calculating p rices . This is known as
MANAGERIAL ECONOMICS.
On the oth er han d , when the stu dy of the determinants
a n d resultant effects of exchanges aimed at the
satisfaction of needs , is done on a general ba sis (say the
whole economy, the whole markets, the whole
households or the entire individuals), then we say that
the study is MACRO hence MACROECONOMICS. In
macroeconomics, such issues as flow of income,
em pfoymen t level/movement, price movements, foreign
trade implications, production capacity utilization and
the improvement of the overall standard of living are
studied For ex:ample, if the quantity demanded of a
~bmmodity (Q 0 ) is influenced by the price of the
commodity (Px) price of other commodities ,· habit (h),
,1ihcome (Y), population (Pop), climate (C), etc.,
' 'm acroeconomics will study this relationships au at the
same time . But, microeconomics will study, ·this
relationship one at a time. That is, for macroeconomics,
th e relationship can be, mathematically stated as :
Qo =a+ biPx+ b2Po+ b3Y + bsPop + b6C + U.
/11troductio11 9
But for microeconomic analysis this will be as follows:
Q 0 =a+ b1Px; Qo =a+ b 2Po; Qo =a+ b3h; Qo= a+ b4Y
Inspite of the divisions, microeconomics is the basis of
macroeconomics and will need carefulness and
diligence to understand/explain the boundary between
the two divisions. Such distinction could exist
reasonably depending on the type of economic system
under consideration. And every other form of economic
study can easily be classifi~d into these four areas. That
is, these four areas or divisions form the basis for any
other form of economics. The other forms of economics
include Development Economics , Public Sector
Economics, Environmental Econ.omics, Regiona l
Economics, Petroleum Economics, Mathematica l
Economics, Monetary Economics and International
Economics.
1.2 TYPES OF ECONOMIC SYSTEM
An economic system refers to ways by which people
within a geographic area accept to use the resources a t
their disposal in the production and distribution of
goods and services for the sntisfaction of their
needs/wants. It therefore consist::; of the laws, habitH,
ways of handling of the national resources and t h< ·
institutions involved in the creation of utility. Economic
system therefore refers to the ways commodities un
rationed to Consumers (whether primary, intermediut<
or u ltimate) in the process of allocating resources . And
 \,
Io Modem Microeconomics: A practical Arithmetical Approach
I I 1< • 111dhod of r~tioning are solely dependent on the
1111q•,1litude of private individual participation or
i1dl11t·nce. Other forms of rationing include:
(i) Ratic:ming by queuing
(ii) Rationingbyneeds
(iii) Rationing.by political criteria
Al various times nations have adopted different
<'co11omic systems such as capitalist, socialist and
111ixed economy.
1.2.1 Capitalist Economic System
C't1 pitalist economic system, simply called capitalism, is
tl:-io known as free-market economy (LAISSEZ-FAIRE
1i;c 'O NOMY). It is the national economic system whereby
1•co11omic activities are undertaken mostly by private
111cliv iduals with the aim of making private profits. The
<~ lfrctive forces for exchange are the forces of demand
11 id ~mpply by which resources are allocated to the most
p1 <'Hsing and priced areas of production and the price
yM l <' m is the mechanism by which demand and supply
1111 < r·s work.
r..r1tures of Capitalist Economies
1) It is based on the mechanism of price
system. That is, resources are rationed or
allocated by price or the willingness of any
individual to pay for the resources, such
that the higher the individual's willingness
Introduction 11
and capability to acquire the resources, the
better the quantity and satisfaction to tha t
individual.
2) It is based on unhindered and fre
competition. It is because of this feature
that capitalism is considered to be a
PERFECT COMPETITIVE MARKET system
and hence LAISSEZ- FAIRE ECONOMY,
3) For pure competition to be in existence,
properties, enterprises and ownership of
factors of production must be privately
owned.
4) Since production processes are controlled
and owned privately, consumers and
producers have the right to choose freely,
5,) Since consumers are free to make choice
and factors of production and production
processes are privately owned, again
because not every person will own all h
desires/needs there is definitely bound 1o
be imbalance in the ownership of
properties This means that some will have
more while others will have littl<•,
depending on capabilities and willingness.
6) The reason for · private ownership ol
properties and freedom of choice is to ma kc
 12 Modern Microeconomics: A pract{ca/ Arithmetical Approach
private profit.
1.2.2 Socialist Economic System
Sometimes called Leftist Economic System, socialist
economic system is the opposite extreme of a capitalist
economic system. The sodalist economic system (or
socialism) is the system whereby the properties,
production proc~sses and factors of production as well
as the choices of consumption are done by the entire
people (state) and state agencies. By this, every
economic activity is planned a n d decided upon by a few
powerful persons at the helm of the affairs of the state.
This is why this type of. economy is called command
economy.
1.2 .3 Mixed Economy
Like the name implies, this has a combination of some of
the characteristics, of both the capitalist and socialist
economic systems:, To certain extent, it is a midway
between the two extremes of capitalist and socialist
economies. Most of the countries run mixed economies.
_,,-
Features
(a) The operation of state-owned and privately
owned properties, production processes
and factors of production.
(b) Control and regulation are mostly the
responsibility of the state. These are done
through laws and policies.
Introduction 13
(c) Price mechanism exists in certain aspect of
the economic life of the state.
(d) Certain pure activities (though with some
effects on the citizens and national pride)
are untouchable by private sector
operators.
(e) Economic decision-making is shared
between private individuals/economic
agents and government.
The level of mixture however depends on the extent of
economic, sociar'and political development of the state.
In reality, more mixed economies exist than the
capitalist and socialist systems. Even the United States
of America and China or Cuba can not be satisfactorily
described as capitalist and/ or socialist respectively.
However, as the cost of running private sector
businesses becomes high, the tendency is to have a
moderated capitalist economy. And the focus of t h is
book is moderated capitalist or market economy.
Economists have concluded that there are certain basic
concepts and tools that are characteristic of thi H
m oderated capitalist economic system.
-7
1.3 BASIC CONCEPTS AND TOOLS
Whether in the moderated capitalism or mix<:< I
economy, economic decisions are m ade by t he invi Hihl«
 14 Modern Microeconomics: A practical Arithmetical Approach
hand because not an the things desired can be obtained
as and when desired. These things that are desired can
be for consumption or for the production of items for
consumption. Consumption means the use of a product
for the satisfaction of a want, and not used for
production. Commodities or products (goods and
services) used for the · production of consumable
products are called factors of production. These factors
of production (or factor inputs) are land, labour, capital
and entrepreneur.
Land means the physical land, buildings on the land
and the natural resources deposited by God on or
beneath the land. It is that factor input which cannot be
increased but can be improved, and therefore is
perfectly immobile according to classical economists. It
is therefore, one of the two natural factors of production.
Labour mean the human resources used (employed) for
the production process, other than the employer. It is
the second natural factor of production. Every human
being is a labour until the person desires to be self-
employed (working for and through other human
beings).
I
Capital means money, monetary instruments, and
other acquired means of production e.g. plant,
machinery, equipment, tools, etc. It is one of the two
man-made factors of production and serves as the
physical link or lubricant in the transformation process.
Introduction 15
Entrepreneur refers to the initiator of the production
process together with his intelligence, risk-taking
ability, etc. It is the second of the two man-made factors
of production.
Production therefore is the p"r ocess of changing the
forms of the factor inputs to .~-~o'nsumable products.
However, this production proce~;s and the products to
be produced are decided by the desires of the people
(economy). As stated above, since not all desires could
be met as and when desired, there is bound to be
rationing. Again, because certain products will be
highly desired than others, the factor inputs will be
moved to the production of the highly desired products.
This processes leads to the .concepts of desires, wants,
needs, demand, scarcity, scale of preference, choice and
opportunity cost.
Desires, want, and needs are closely related. The
difference between them is that each is relative to the
other and actually depends on the amount of resources
available to attain it as well as the capability to realize
them.
Desire ordinarily refers to some thing aspired to by a
person ideally to make life meaningful and comfortable.
For example, everyone aspires to the top such as being
the most-powerful man or president of the world. To
some, this is a utopia. Given the capability and capacity,
 16 Modern Microeconomics: A practical Arithmetical Approach
/11troJ11ctim1 17
one can reduce the aspiration to the President of a
continent (e.g. President of African Union). This looks means of acquiring these wants are limited. This short-
more attainable and could be classified as want. supply or relative non-availability of these means is
referred to as ecarci~. A scarce resource is one for
Again, a little lower is being the president of a country,
Which the demand at a zero price level is more than
which is very attainable. Most people can go for this
available supply. Since the means of satisfying the
depending on the choice areas and others factors like
unlimited wants are scarce, there is the need to arrange
necessity. This level could be referred to as need.
the wants/needs in the order of the most pressing, or
Finally, once a person actually commits resources to the
most desired (i.e. prioritizing). This arrangement in the
realization of this need, it becomes a demand. This is
order of priorities is called ecale of ,refereace (i.e. a
why desire > ne,e ds > wants > demand. Because demand
table showing the list of wants in the order of
(the ability or willingness to satisfy wants) is less than
importance). The process of arranging the wants such
wants, resources (used for demand) are said to be
that some will be satisfied in preference to others is
scarce. That is, materials and human resources are less
known as clloice maid•&· The less preferred want in
than want. The · test of SCARCITY is PRICE. Only
the making of a choice is known as the .,,.rtuait~
commodities that are not scarce command no price.
coat forgone, while the preferred or chosen want is
And, resources have alternative uses, e.g. consumer's
known as Opportuait~ Beaeftt QI'. dlda. These
resources (money and time): Consumer's choice
allocates his amount of money and time among
concepts are very cardinal to economics, whether for
competing ends, or purposes. F<;>r firms, the resources consumption or production or both, and whether in
are labour, material and equipment while for micro, macro or managerial-economics.
government, the budgets are used to allocate resources. From the above discussions so far, one can wonder how
this art or science called economics will study, analy
Want simply means the whole of needs desired
reasonably by an individual, household or firm that may and conclude on events, and what ways (teola) will be
not be backed by the ability to pay (purchasing power) employed. Economists use three (3) ways (tools) in their
and includes both pressing, purchasable and non- study, analysis and·conclusions, these are: -
p ressing desires. When a pressing need is backed by
(i) Verbal analysis (tool)
purchasing power, it is known as demand. There are
(ii) Mathematical analysis (tool)
infinite qu antities of desire and/or for wants but the
(iii) Graphical or geometrical analysis (tool).
 18 Modern Microeconomics: A practical Arithmetical Approach
Introduction 19
.,J\~~~~i.lt;0·1-;·m-1,\A \\\~l~\lt·r•·,..

V~rbal tools refer ~o statement 9f p_roblems, drawing of problems are .also known as t,he functions of any
hypotheses,
.
testing of the hypotheses and drawing
~. ~.
economy. It is therefore the de~ire ~nd the mechanics
•, I I .. - ,·, . I "· ]

cqp.~lusions on behavioural patter:ns

_._ . . . of e,conomic events .
for answering. these questions"' that f? rm goals of
and individuals, in words. irresp~ctive of the level of economics.
com:plexity. , Some of the basic problems are:
In mathematical . analysis, · algebraic symbols and 1) What to produce and - how much to be
rri'athematical equations ·are used in the . process .of produced? This question-:afises because of
drawing co'hclusion. This is the most applicable,, out of unlimi~ed wants even though not all wants
the three tools because there is hardly an economic case are most pressing and affordable . To solve
that will or cannot be tackled mathematically. this p ronlem, resour ces must be mobilized
With graphical or geometric tools , the economists use properly . .This proper ,. mobilizat,ion is
graphs, figures and drawings to analyze cases. Such known as Resource Allocation. ·In the
graphs, figures . and drawings .include pie chart, bar capitalist iand mix~g economy, price
chart, tree diagrams and various other forms of graph. $Y$tem ii .,. -q.sed ., for.~ proper resource
This.,is -,common with complex ,cases that .ipvolye more ,allo~'}tion, · whil~ ." J n . ,centrally planned
than two variables ; . -~ .. ~'...:_ economy (Socia)ist-
/ o ' I ~
'
·economy)
~.
it is the
• ... r ' • '

responsibility of the central government.

l .4 BASIC ECONOMIC PR'oBi..EMS ~

'
" 2) "How to produce the' -products that have \
With the scarce resolJrces and.the need to scaie wants
been concluded' to be produced as in ( 1)
for choice-making and satisfaction, certain economic
above? This '.'means that ·one· out of th e
questions are asked fro·t n time tb time-: These questions
existing technical methbds- of production
govern" the·, economic behaviours -of· individuals
must be adopted. A dedsi·o n or solution to
households; firms. and, soc_iety, and are known as ·the
basic: economic problems. At other times, .these this problem is by choosit1g:the production
questions form·the very essence of econoini.e s ,. whether process that has tlie lowest marginal COSl 8
capitalist, socialist or mixed . The difference being in the ·but with the highest output with the aid of
way or the level of response thf economy offers in production theory. ~ '·
·•· -~11 -~---V -·Xiii!°"I-~ .. , ~~.;:i,.~ ,,.. _
solving these problems., This is why the basic economic
' 3) For ,whom . tp;_ , b~ pr<?,d':lce~~ ,:!Pe beauty of

20 Modem Microeconomics: A practical Arithmetirnl Approach
the capitalist economy is its automatic
movement of resources from the
production of lowly demanded to highly
demanded products such that factors like
population, climate, etc., that determine
demand are considered in production
decisions.
4) When to produce? This is important in
order to avoid unnecessary stock-pilling.
' . .
5) Are the resources efficiently used? That is,
are the production and . distribution
systems efficient? This problem is tackled
with the aid o~ ls<?·quant-I~mcost Analysis
(for production efficiency) and Indifference
. ~urve Analysis (for distribution efficiency).
Another way to solve this problem is the
use of the Production Possibility Frontier
analysis. The Production Possibility
Frontier is the downward sloping curve
that gives the most efficient combination of
products produced such that at full-
employment, .increase in the output of a
product will result in the decrease in the
output of another production (opportunity
cost). And any combination that falls
outside the frontier (curve) does not show
efficient allocation of resources.
/11troductio11 21
6) Are the resources properly utilized or
employed? This means whether the
resources (human and inanimate) are fully
utilized or not? If not, is economy below
full-employment or at a level after
attainment of employment?
7) How is the economy performing? That is
whether the economy experi~nces the
multiplication of the consumer and
producer goods and services, and at what
rate (increasing, constant or decreasing).
By this consideration also, answers on the
growth or. development of the economy are
provided. These answers are provided by
the economic theory of growth and
development .
All these problems/questions are necessarily observed
under two types of economic issues - positive economics
(what it is) and normative economics (what it ought to
be). And only question 1-5 are treated ·in this course
(microeconomics) while questions 6-7 are studied
under macroeconomics.
1.5 GOAUJOFECONOMICS
Attempts to proffer answers to economic questions
posed in paragraph 1.4 above lead to the study of
economic policies in both the public and private sectors
 Modern Microeconomics: A p~actfcal Arith111etirnl .4pproach
- -~.

22
lntrod11ctio11 23
l· ~rtr !7.J.-rJ\:~::· ,..,?..' ;,· ;J.;- :;~; 3 ..-:~ -~;.. ..,. . .~- ·f ..).'/._ .;:;:_~~
of the economy. Such studies an~ in modern times
f ·JL,; ' . ' . {' ·i :7h' ·1 lJN~JytP.LOY~p. PE.l}~ON, 'Yeul~:Lsimply mean
centr<;;d :ap;mnd "why?" and. "what should be 'done?"
:; ~ " ·-1~ ·nds.u~ a ., P~f,S.9c!b tga~;.i ts:~.f.lV.a:il~hl~>·J gualified and
1
' ?!/ ' •Ii:.• '\; ; I ; 1 ,

'(he es;?ePc. e is. to initiate policies that 'c an take care of

> "1i
•! \ ~· •• n ~ < ' I Iii 1 '
. if oapabJ.e )q; w.ork·~ an,q ~genµin~ly searching
the historical flaws identified with the economic actions
' - ,; ~.ll - ~j ~ '~ 1
,,/'y , ' :• , ' • 1
for one. l;mtJjnds nqne at a parJ.icular point
~,I. ...._ ,_,,,..,_ •• ' -~ ·',;. . . . . . . . . . . ,,

taken hitherto and ·have been . studied. Consequent

~.n time. This is why economists claim that
upon such initiati~~s, i ~ . bett~r set of policies is ,_. ' ' 1\ one ofthe' charactehstics ' bfD'EPRESSION is ~ '~
developed to deal with the economic problems, " th'e ~ 'existence~. 'o f ,very ' 7hign'' lncidence ol
irrespective" of wliith ' sector· is more emphasized (no unemployment over long p·e riod of tim('.
'r -·~ , · . . · {~ ~··· . "-"" ··~ · •
a
matter · t fre emp1J;i:\8Jsis ~ on'' LAISSE'Z FAIRE or I·~
While a . decline ./in ·production for short
~EYNESI:A!NISM). Tli~ devel0p'ed policies are bound to period di' time, 's ay two dr mof~ quarters 01
satisfy certai.rf'' major ·desired expectations or goals. everl <i.year is an i~dicationofRECESSION.
Satisfaction here rn@aris the ability to either reduce the . ..
--economic problems or solving the problems as well as 2) Stability of priGes of goqps and services,
maximizing 1 the ~ benefits. embedded' in the economic and exchange rate of the national currency.
activities: Economic policies and analysis or study
~~ ·11 i ,,,.. should reduce the incidence of high pric<·
Some of the major economic g9~~s,,are: . fluctuations (up and down). A rapidly
• 1 The maintenance -~f h 'i'g h and acceptable changing price index is inimical to
· i?~i/ ~"=~~~do '!fi'~· 18-veP of .:efhpl6yinen1]! \ 0fii.i tesources. Thi's
1
• ' ' !\, • ....,
planning and execution. That i:
0~.m:;i;o.rzn!:¥~v ~· meahs q fl'..a_va hot ":-611'11.J' 1ucwill Jhe < huma:n
0

~ ,. ., .. . ~·
economists try to develop policies that tl l't'
iJ•)I ,.;1:2vo .1B "' ·~resources be'·.uti1iz«2d ;:;but·e very other agent aimed at checking inflation and deflatio11
·rt {)f (pfodlictio-n ""'.shcJu:ld ~ be .:w.e ll ·employed. outside the tolerable limits of the economy
s·~. - There "should":-n ot l)e· ~{:'- situation wher'e
people that are up to .wor;king age ·an.,cLare 3) The equitable distribution of income, sw h
that not plenty people leave below povc1 ty
willing to wqFk s~o-lfld. n9t J?~ ~.mP!Qyed,Jor
example . Also land · that · is fit · for a
~' """-.4' .. ' ,...._. ·; ',J; I ~
line while just a few control the resourc1••
·•particulartfc>tm ofprodd&tiop shoulq not -We or wealth in the economy.
'!\'• m~u.te'J '!°JrlJw-asted : feir f wha'tever · ·socio..: political
4) To ensure efficiency in production. 'l'h1
e10.t~~a e':!J:whreas~ . Ji®tv·crit r:th(s , . col!l'sitl:eration,~- an : means more than adequate returns fro1n
all agents engaged in product ion
24
Modern Mic:roec·m~omics: A practiC'O/ Arithmetical Appmaclt
Demand and supply Analysis
Production is said to be efficient when the
output is more than proportionate input.
Output could mean quantity or quality or
both. Efficiency could be allocative,
technical or economical.
5) To ensure steady growth and development,
resulting from an increase in output due to
improved tef~ology or enhanced . or
additional stock of capital and "land". This
of course, m~st be within tolerable limits CHAPTER TWO
and. should over time enhance
infrastructures and living standard DEMAND AND SUPPLY ANALYSIS
(economic development);
2.0 INTRODUCTION
Several fundamental economic problems of an economy
had been identified in chapter one. Some of these
problems are what, how, for whom and when to
produce. Economics, as a study of human behaviour,
aims at understanding how these fundamental
problems are solved. The one most important way of
solving these problems is through RESOURCE
ALLOCATION .
...
Resource can be privately allocated or collective
allocated (publicly by the government). When privately
made, resources can be allocated by the "INVISIBLE
HAND", whereby every person has the freedom of choice
of the commodity to be produced, moreso because the
production process and the factors of production are
owned by individuals. By this, producers produce
 26 Modern Microeconomics: A practical Arithmetical Approach
without restrictions and the only way to encourage or
discourage a producer is by the volume of his product
consumed. This way of private resource allocation is
known as PRIVATE MARKET MECHANISM.
On the other hand, the government can directly or
indirectly allocate resources. In the welfarist or socialist
economies, governments directly authorize the type of
production (and to some extent, consumption) to be
made. In other economies, particularly MIXED
ECONOMIES, government's allocation of resource is
indirectly done by means of economic policies. The
application of economic policies is only a way of
modifyingthe private market mechanism. For example,
the policy of the government can favour the production
of a particular commodity (say educational materials
which could be VAT-free) more than another commodity
(say home videos). In this case, some producers would
shift from producing home videos to the production of
educational materials. By this process, government has
influenced what to produce. In fact, because of the
complexity of interests in real life situations,
compromises are made between th~ market and the
government mechanism in resource allocation. The
level of prevalence of one mechanism over the other is
one determinant of the type of economy (capitalist,
socialist, or mixed) existing.
As far as international standards are required,
governments are expected to play very limited allocative
Demand and supply Analysis . 27
roles, especially in direct participation. It therefore
means that in this course, the PRIVATE MARKET
MECHANISM will be the focus. ·
rn the market mechanism, the actions or behaviours of
buyers and sellers determine the what, the when, the
how and even the efficiency level of production. Again,
this also depends on the type of markets as would be
seen later. Ordinarily, · the behaviour of buyers or
consumers is summed up as DEMAND and that of
producers or sellers as SUPPLY in a type of market
known as PERFECT MARKET or COMPETITIVE MARKET.
In this kind of market, producers produce their
commodities with the hope of making profits and
lherefore will sell their products at higher prices.
Depending on the producer's advantage . (i.e.
monopolistic power), a producer would prefer to supply
1. few quantity of the product so that as the request for
the product (quantity demanded) continues to exceed
I he quantity supplied, consumers. would necessarily
1lny highe r value just to consume the product. On the
nl her hand consumers would prefer lower price for the
product just to consume more q\.lantities of the product.
~ iotnetime s, because of this divergent interests in price,
111 · 1~otiations take place ~et.ween the consumer and the
p1 oducer or seller. This negotiation is' what is
lcdmically referred to as the forces of demand and
u Pl >ly. The magnitude of this negotiati.on and the
1u111 IJc r of parties involved is a principal determinant of
 ',
28 Modern Microeconomics: A practical Arithmetical Approach
th e type of private market in vogue, as well as the agreed
price and quantity. Where therefore a producer/ seller
p egs a higher price on a product than his counterparts,
consumers will shift to the lower priced producer/ seller.
This is how the forces of demand and supply determine
the price of products and the solutions to other
economic problems. Similarly, consumers will shift to a
h ighly effective product thereby increasing the quantity
sold by that producer/ seller. Technology makes these
two est>ential determinants of the magnitude of the
m a rket forces to be easily determined.
This leads to proffering of the solution of efficiency of
production later.
1n this chapter therefore attention shall be paid to
vario.us aspects of demand and supply analysis,
beginning with the distinction between demand and
quantity demanded as well as supply and quantity
supplied.
2.1 DEMAND ANALYSIS
To every aspect of life, there are two parts namely the
giving and taking, the making and using, the
production and the consumption, and the selling and
the buying. Economic analysis is no exception. In
econ omics, especially microeconomics producers and
consumers' behaviour results in the exchange of goods
and services. And the behaviour of producers is simply
Demand and supply Analysis 29
interchanged with the behaviour of sellers, which had
been described as supply, while that of consumers is
demand. These two patterns of behaviour have also
been called the forces of supply and demand
respectively.
But, sometimes people substitute demand for quantity
demanded . Although these two terms are similar, they
are n ot the same. Demand has been defined as the
behaviour of a consumer with regards to the quantity of
a product the consumer is willing and able to acquire at
a pa rticular price and within a given time period.
Demand arises out of the prioritization of needs. That is
when needs are arranged in the order of preference
(scale of preference), the need that is to be met almost
immediately because of its importance to the consumer
and given the amount of resources (money) available is
referred to as demand. But, quantity demanded refers
to the quantity of the commodity that the consumer
acquires at a particular price and within a particular
time. For example, if Mr. Soye has need for wives, motor
vehicles, houses, and educational certificates. Mr. Soye
can arrange these four (4) needs in a scale of preference
a s educational certificate first, houses second; motor
vehicle third and wives last. He will then pursue the
acquisition of the certificate with the resources
available. The pursuit of the acquisition of the certificate
becomes the demand. But, how many ·of these
certificates become the quantity demanded .
\
 Demand and supply Analysis 31
30 Modern Microeconomics: A practical Arithmetical Approach

persons, markets, governments etc.

Of course, not all the needs or demands will be Usage of Commodity: Demand analysis could be on
singlilarly demanded. The demand for each o.f the needs the basis of the uses or how the various commodities are
will be dependent on the type of satisfaction to be used. By this, demand could be joint, competitive,
derived from the consumption. This means that there composite or derived, effective demand, etc. Joint
·are different types of demand. demand is also known as complementary demand.
Joint demapd refers to the situation where two or more
2.1 .. 1 TYPESOFDEMAND
commodities are demanded together basically because
There are different types of demand, which can be they are consumed together. Examples include the
grouped into two main classes, namely: demand for garri and soup, motor vehicles and petrol,
and pens and ink. When the demand for commodities
(a) Number of consumers arejoint, changes in the quantity of commodities will be
(b) ' Usage of the commodity, as shown in figure in the same proportion with each other and in the same
1.2 below. direction. This is why the goods are said to be directly
and positively related to each other.
Number of Consumers: This refers · to classifying DE¥AND
demand into single consumer or totality of consumers of
a particular commodity. It could also mean the
r
Num~er of us!ge of
Consumers Consumers
classification
.
of demand into the collection of buyers
. I
available at a particular location or available at all I Competitive
locations. When a single consumer /buyer or the Market Demand Derived
Individual
collection of buyers at a particular location at a Demand Demand Demand
Composite
particular point in time is considered, it is referred to as Joint Demand
Demand
an individual demand. Individual demand could
therefore mean the demand for a commodity by a
person, an household, a firm, a government. The main Fig 2.1 classification ofDemand
determinant is singularity. On the other hand, when Competitive demand refers to the demand situation by
plurality is the basis of demand analysis, we refer to which two or more commodities are consumed as fairly
market demand. Market demand therefore refers to close substitutes. When commodities are substitutes,
· aggregation of the demands of households, firms,
•
 2 Modern Microeconomics: A practical Arithmetical Approach Demand and supply Analysis 33

Table 2.1 Individual Quantity Demanded for Derived demand exists for a commodity when the
Three Markets commodity is demanded because ·of another commodity
that can be obtained from the first commodity. That is,
Price Per Quantity Demanded the satisfaction derivable from another commodity that
Bottle (ff) Mile 1 Markel Mile 111 Market can be produced or obtained from the first. For example,
Greek Road the . demand for white sand . by NAFCON (a fertilizer
Market producing firm in Nigeria) is not because the sand will
60 20 30 25 be used for building or for reclamation, but the
50 40 50 25 production of fertilizer, as an input. In this case, the
40 70 55 45 demand for sand' is .derived from the demand for the
30 100 65 60 production of fertilizer. On the other hand, if the
20 • 120 90 90 demand for a commodity is purely from the ·natural
desire to consume, or the natural satisfaction from the
Any tabular presentation that shows the price per bottle
consumption of the commodity, it is said to be an
and each of the market is. an individual demand
AU.TONOMOUS DEMAND or DIRECT DEMAND. The
schedule. While the table showing the price and the sum
demand. for a commodity is said to be autonomous if
of the corresponding quantities is known as the market that demand is independent of the demand for any ot_h er
demand schedule. The quantities in the market demand commodity. Autonomous demand may be ca,µsed by
schedule are known as the total quantities demanded advertisement, ·incre;ase in population and rise in
as shown in table 2.2 below. income. For example, the demand for Jik Bleach could
be because of a TV advertisement. Where Jik Bleach is
Table 2.2 Composite Demand Schedule therefore demalf.ded irrespective of the demand for
washing power, the demand for J ik is autonomous. B9 t,
Price Per Bottle ( #) Quantity Demanded where the demand for Jik Bleach is because it will -be
60 75 used as sterilizer, then the demand. in this case is
Derived and the Jik Bleach itself becomes the PARENT
50 115
l'l~ODUCT. Derived demand is common with ~roducer
40 170 oods, that C?k~.H g~od~o '.9Ft!lt¢.ruW!P.iilities tlfflant for
30 225 prncluction, whickit·.W#.r~stimiRJy;,~mrPi§d> to ~) chapter
20 300 ··1111J ns factors of produqtjg~:}!') done - om~a (rf)
 ."i

34 Modern Microeco>romics: A practit:a/ Arithmetical Approach

Del11a11d a11d sUpp/y A11alysis 35"'"
Effective demand is a term used to describe the
behaviour of consumers. Demand is said to be effective (A) Pric~
when the consumer pays for a commodity. This is the
active aspect of demand because it is no longer the In the process of choice malting because of scarcity,
willingness and ability to acquire the commodity but the allocation of resources is usud1ly made. It has been said
demonstration of this willingness in real terms. Most that price is one sure way of allocating resources
times, because of the closeness in defining need and especially in the private market or capitalist economy.
demand, the terrri effective demand is used to describe In the market scenario, price performs the following ,,
the actual action of the consumer. functions:
2.1.2 DETERMINANTS OF DEMAND (a) Allocation of resources of the economic
Demand is a flow concept. It shows a multivariate
unit;
relationship. That is, it is determined by many factors
simultaneously By flow concept we mean that since (b) Provision of information (quality, direction
demand is the behaviour of buyers or consumers, and of consumption; etc.)
this behaviour cannot be determined but is purely (c) Provides incentives;
voluntary (Ahaiuzu, 2004), the decision aR per demahd (d) Provides focus of interaction between
or even quantity demanded is continuous and buyers and sellers.
dependent on so many factors. It follows that to
determine the quantity demanded of a commodity, Price of the commodity is the principal determinant of
there should be a definition of time range. This is demand for goods and services. Although most people,
opposed to stock concept. for instance, need to own at least a motor car, not every
person can own a motor car because of the prices of
There are basically eight (8) factors that determine
demand for goods and services, Which are motor cars. If the prices of motor car reduce to say
(A) Price Nl0,000, more people will acquire motor cars. · it is
(b) Income 1
therefore concluded in the study ofdemand that the law
(c) Taste, fashion; preferences of demand is that the higher the price the lower the
(d) Population quantity demanded, all other things being equal.
(e) Habit
(f) By this law, one can converU..-.ntly say that the qua~tity
Prices of other Commodities .. ' ~ ,..,..A ' ,;.;•

(g) Consumers expectation of goods demanded at a particular point in time depends

(h) Demo-snob effects on the price ofthe goods. Hertee, there is lnverge ·an
_,,
 36 Modern Microeconomics: A practical Arithmetical Approach Demand an~/ supply Analysis 37

relationship between quantity demanded and the pric" l'nble 2.4 Hypothetical Demand Schedule for
of a product under normal circumstances ._ The price of a IColiday
- commodity depends on the normal production cost
Price No. of Persons
incurred by the producer/ seller or the deliberate act of
(Quantity)
sellers to supply a few quantity of a highly demanded
commodity thereby pushing up the price. N200 6
N400 5
ILLUSTRATION 2.1
Nsoo · 3
Mr. Brown's fam'i ly is made up of 6 members and the
family undertakes weekend holidays at NICON NUGA N600 2
HOTEL Abuja. But due to rising costs, the number of
family ' members have been observed to be changing Table 2 .4 is called DEMAND SCHEDULE and shows the
within the last 4 months as in tables 2.3 a n d 2.4 below. numb er of Mr. Brown's family members that proceeded
on holiday at various prices. Deriving from the above,
Table 2.3 Mr. Brown's Family Monthly Holiday Price the demand schedule is just a table showing the
Table relationship between the quantity of products
d emanded and the corresponding prices of the
Month No. of Price products.
Holiday
'
Makers When this relationship is graphically presented, the
,. curve so plotted or made is known as DEMAND CURVE.
January 6 N200
Thus the demand curve is the graphical representation
February 5 N400 of the demand schedule~ The demand curve therefore
·~
March 3 . NSOO s hows the maximum quantities of product consumer(s)
April 2 N600 are willing to purchas:e at various prices at a point in
time . This definition covers all types of goods. It is
The above can be made in a more presentable table as worthwhile to say that there are five (5) types of goods .
ifollowB: namely; normal goods, inferior goods, ostentatious
Buh.· , •
goods , substitutes, and compliments. Complimentary
~1~evrd rm fli ~u ,, •' · - ' 1(J 'I rl! ·1; l ' l'WI <l ' ' .
goods are those that produce more consumer
38 Modem Microeco11omics: A practical Arithmetical Approach
Demand and supply Analysis 39

satisfaction when consumed together than when

Th~ downward slope of the demand curve is from left to
consumed separately. Substitutes are goods that are
right and has a negative gradient. This relationship and
alterna~ives to one another in consumption. Inferior
the downward slope from left to right is, however, not
good is one whose consumption (demand) decreases as
static. The law changes with some exceptions. In these
income increases or as price decreases.
cases, the demand curve could slope upwards from left
to right which means that as the price of a product
From our example, the curve slopes downwards
increases the quantity of the products demanded
confirming the law so stated, as shown in figure 2 . 2 .
1.........-• increases too.
Some exceptional cases are:
Price
(i) Inferior Goods: These type of goods are
600 also very similar to GIFFEN GOODS. These
goods include low quality goods and
500 essential goods. For these goods, as their
prices increase their consumption will
400 increase just to maintain the level of
satisfaction. By this, the consumption of
300
other alternative but highly quality goods
200 are given up. As demonstrated with bread
and meat by Sir Robert Giffen (1837 -
100 I . I x 1910), who used British low wage earners
0 I I I I I as case in point.
1 2 3 . 4 .5 6
Quantity (No. ofpersons) (ii) Ostentation Goods: Goods consumed just
to boost ego i.e. goods of high societal
Figure 2.2 Hypothetical Demand Curve for Holiday values e.g. jeweleries. This type of goods
Mak~rs are acquired in greater quantities at a
h igher price than at lower prices.
Sometimes they are referred to as high-
40 Modern Microeconomics: A practical Arithmetical Approach
class goods. For this type of goods the
higher the price the greater the quantity,
demanded. According to Vebler (1857 -
1929) if price is 1(1ne only measure of desire
for a product, then consumers would
demand for product at higher prices than
. oflower p:cices.-.r t '"' ·
(iii) Fear of Future Price Changes: Goods
whose prices are expected to fall, out of
pure competition or abnormal causes, will
have low quantity demanded by
consumers. In this case, the lower the price
the lower the quantity demanded or the
higher the price expectation the higher the
...
quantity demanded e.g. petroleum prices
and consumption in the Nigerian situation.
it
(b) Income
Under norm al situation, the quantity of goods
demanded will increase with an increase in the
purchasing power (income). This means that there is a
direct relationship between income level and quantity of
products demanded. This position may not apply to
infe~or goods' consumption, where the demand
normally will decrease with an increase in income. This
is because income is the most important determinant of
the quantity demanded. Income here means the
amount of money available to the consumer with which
demand can be effected. It is sometimes called
Demand and supp~v Analysis
Disposable Income. Where the disposable income (Yd) is
not . commensurate with the needs of-the consumer,
which usually is normal, a budget is made through
which the Yd is rationed to meet as many needs as
possible. If the amount budgeted for a comrpodity is
large, depending on the price of the commodity, more of
that commodity will be bought. it therefore follows that
the Income-Demand relationship is of a positive nature.
Mathematically, this relationship is stated thus:
Qo = f(y)
And
6.Qo > 0
6.Y
Where
Q0 =quantity demanded
Qx = CommodityX
Y =income
6. = change
Another thing about the income-demand relationship is
that it is not time-limited as the price-demand
relationship. That is, the relationship between income
and quantity demanded is important and holds both in
the short-run and in the long-run. The third issue about
the income-demand relationship is that the relationship
varies according to different types of consumer goods
and services. Just as in the case of price of a product,
commodities for the analysis of income-demanded

42 Modern Microeconomics: A practical Arithmetical Approach
relationship can be grouped into four (4) namely;
normal goods, essential goods, inferior goods and
It 1xury goods.
When the quantity demanded of a commodity increase
1s th.e income of the consumer increases, other things
being equal, that commodity is said to be a NORMAL
GOOD. That is, as the dosposable income apportioned to
the consumption of a particular good rises, causing the
quantity consumed of that good to rise, the good is
classified a s Normal. For normal goods , the demand
curve shifts to the right whenever income rises. This,
however, m ay not be the same for all time periods. For
instance, qua ntity demanded (Q0 ) rises at increasing
1utc initially and then at decreasing rate and later could
reach zero or even decline (that is negative increase) if
consumption shifts to another commodity. The demand
curve for normal goods is as shown in figure 2. 3a.
As far a s Income-Demand analysis is concerned, any
commodity that increases as income increases up to a
certain quantity after which the quantity demanded
n·mains constant is known as ESSENTIAL GOODS.
J~xomples include foodstuff, salt, soup~and cooking oils.
fhcy are a lso called basic needs. The demand curve for
<'Rsential goods is as shown in figure 2.3b below. In
figure 2.3b the quantity demanded increased until OQE
when the demand curve be~ame vertical and parallel to
the Y-axis.
Demand and supp~J' Analysis 43
As stated above, an INFERIOR GOOD is one for which the
quantity demanded decreases as income increaS<'H
· other things being equal. It is a commodity with n
negative income-demand relationship. In this case, th<'
entire demand curve shifts to the left as incom<'
increases . This means that as the income of th<'
consumer(s) increases people demand for less of this
group of goods because it will be worthless consuming
these goods given the change in income . Examples are
second-hand clothes, bus and rail transports in Nigeria.
The demand curve for this good is as shown in figure
2 .3c.
Luxury goods, also known as class-goods or prestige
goods, are goods which only give social satisfaction by
way of adding to the social status (prestige) of the
consumer. Sometimes, the demand for luxury goods do
not depend on the income capacity, but on the taste,
preference and perception of the consumers,.
Ordinarily, a rise in income should result in the increase
in the market demand for luxury goods, but not at all
times. The relationship between the demand for luxury
goods should therefore be positive, all other things
being constant. This is why the demand curve for luxury
goods seems to be rising from left to right as in figure
2.3d.
 44 Modern Microeconomics: A practical Arithmetical Approach Demand and supply Analysis 45
y (a) Y DE
N (b) . Nigeria, government has placed tax on cigarettes and
placed advertisements against smoking, yet the
quantity of cigarettes consumed either remain H
Q constant or had been on the increase. This is a matter of
QE
perception and habit. Another example is the price and
y y DL the demand for locally weaved clothes (simply called
/(d) Akwette Wrappers). Though these clothes appear to be
old fashioned and heavy in weight the preference for
these wrappers is simply unimaginable in the south
0 Q Q 0 Q 0
south, south-east zones of Nigeria. These examples
Figure 2.3 Incom,e-Demand curves for 4. Types of Goods show that tastes, fashion, customs, preferences, etc .
have high influence on the quantity demanded.
(C) Taste, Fashion and Preferences
Although it is difficult to measure, the quantity of goods (d) Population
demanded can be determined by ta~te /fashion because The quantity of products demanded increases with
the quantity of goods demanded increases with the rise increase in population in a given geographical location
in the awareness of any fashion or taste. Once the at a particular point in time. The what to produce could
taste/fashion drops the quantity demanded also be determined by the class of people existing in an area
decreases. This means that a positive relationship such that if in a state there are more children than
exists between taste/fashion and quantity demanded. adults, then more children clothes will be produced.
Population in this context refers to the volume of
Consumers' taste ~ and preferences are a function of so
1 1

potential consumers that can influence the quantity

many social, cultural and political parameters. Some of
demanded of a particular commodity
these factors are customs, tradition, religious beliefs,
the living standard, educational background, self- (e) Habit
principles, and other societal influences. Several Habit determines the quantity of goods demanded in th
researchers have studied the influence of certain sense that as people cultivate a particular consumptio11
governmental policies on the demand for certain pattern (habit) the quantity of products needed to
·ommodities (Friedman, 1972; Bennett, 1972). In •Satisfy that habit will be higher. · ·11 r
1 I ' J ! r 1! < 1 1 I il' , /· 1i i .' .\, · , : . ; '\ 11 · IV i J 1 '~ • H i •: l c;' 1 ) I l : 1
 46 Modern Microeconomics: A practical Arithmetical Approach
Demand and supply Analysis 47

(fl Prices of Other Commodities right as in figure 2.4a while that of complements is
The commodities that are closely related to any one negative (sloping downwards from left to right) as in
commodity are its complements and its substitute. The figure 2.4b. o..
L YI Py
compliment of any commodity is the commodity that is Ds
consumed jointly with the first commodity such as pen
a nd ink. Substitutes are commodities that can be
replacements for each other such as Cocoa Cola Coke
and Pepsi- Cola Coke The demand with the price of one ~

commodity changes the quantity and the price of c

another. Thus, for complementary goods, their O' . Qx
behaviours are the same i.e. as price of one rises the Figure 2. 4 Demand Curves for Substitutes cmd Complements
demand for the complement falls. But for substitutes as
(g) Consumers' Expectation
the price of one falls the demand for the substitute falls.
This means that the relation~hip between the price of a Sometimes, the quantity of a commodity demand at a
commodity and the quantity demanded of its particular time is influenced by the current and future
complement is negative, while that of substitutes is sizes and changes in the price of the commodity, price of
positive. Mathematically, therefore the relations will be other commodities, income, supply, climate, etc. For
written as: example, the international price of crude oil increased
For substitutes: Qx =./{Py) or Qy = ./{Px) consistently from year 2000. The price increase can not
be attributed to fall in the production but mainly
and,6.Qx > 0 6.Qx > because of the expectation that events in the Gulf, th
D.Qry 6.Qxx 0 Middle-East, and Nigeria would affect the future supply.
For cpmplements: Qx = J(Py} or Qy = .f{Px) Therefore out of anxiety, consumers decide to m a k
desperate orders to stock-pile, causing demand to
exceed supply and hence a demand· push increase in
And, !::::.Ox > 0 ~Qy > 0
/:'J.Qy ~Qx price. There are several other examples around us and it
is human nature that if the price of a commodity is to
It follows therefore that the demand curve for
.!, fall, little of that commodity would be bought in order t o
ubstitutes is positive and sloping upwards from left to
gain the benefit of the price fall. Therefore, th
48 Modern Microeconomics: A practical Arithmetical Approach
relationship between consumers' ~xpectation on
change in price and quantity demanded is positive in
nature. Similarly, there is a positive relationship
between expected changes in income and quantity
demanded, especially of storable commodities, all other
things being equal. This is because an announcement
that the salaries of public sector workers will increase,
will make workers to buy more goods (even on credit)
than they have been buying.
(h) Demo-Snob Effect
,\ ' principal determinant of the demand for a product.
The quantity demanded of a commodity is influenced by
the n ature of the commodity especially new brand
products, or old and very common products. New
brands of existing products or completely new products
attract more consumers particularly the rich, the
a ffluent and the prestige-conscious. This group of
consumers demands these products most times out of
curi~sity and at other times out of social value. This is
what economists call DEMONSTRATION EFFECT.
Demonstration (simply Demo). effects have . positive
relationship with quantity demanded. Examples
include the demand for Mobile handsets, C-class and
Beastclass Mercedes Benz Motor Cars, CRV Honda
Moto r ···'·~ars ;.H Telepho,ne ·Banking, Ownership of
Webs-ite.s, etc. On ~he "other hand, when commodities
becqne<; r.ampan t. , some i consumers _, would 1.ordinarily
avoid1_,sucl:( commoait ies-. This isuwhatawd oref&i to as
, , ml..11 .H l i' . fIi.1 >1 iq 11 Ii 1o Jibn~d ~dJ nio8
Demand and supply Analysis 49
SNOB EFFECTS and these effects have a negative
influence on the quantity demanded.
Variations in Demand Curve
There is the need to note the different forms of variations
that can occur to the demand curve. The demand curve
can experience a movement along the curve or there
could be another demand curve instead of an existing
curve . Recall that several factors determine the demand
for a product, and that the price of the product is the
Any change in the price of a product (holding other
factors constant) causes a movement in dem~nd curve.
This movement is known as CHANGE IN QUANTITY
DEMANDED. A SHIFT IN DEMAND occurs with changes in
the other determinants such as price of related
products, incomes, and tastes. The shift in demand
curve creates a new demand curve hence it is known as
CHANGE IN DEMAND. Shift in demand could be positive
or negative. A positive shift in demand curve will
produce another demand curve to the right while a
negative shift in demand curve will produce a new
demand curve to the left, see figure 2.5 and figure 2. 6
respectively.
 50 Modern Microeconomics: A practical Arithmetical Approach Demand and supply Analysis

p product By this as price changed from N 100 to H

Do
quantity demanded increased from 5 to IS units
NlO I '!Di From figure 2.6 the equilibrium point A chan

~ H801 1'~P2 (negative shift) with a reduction in the quantity f1

to 10 and a new demand curve is created (0 1 0 1,
N6ol I I ~ DoDo. A change from A to C is an increase in the qu••n•ut
demanded from 22 to 32 units and a new demand
Do
D2D2. This is a positive shift. This can occur if th
N40
of the commodity (say pump-price of petrol) is
.'--~_J,,~-j-~--l-~t-Q
0 5 . 15 25 35
constant at N60 but a man decides to buy 2 more m
cars because of an increase in his income or becau
Quantity
the newness of the motor cars. The increase in
Figure 2.5 Movement along De.mand Curve
number of cars increases the quantity of pet
Y1 demanded and therefore shifts the demand curve f1
100 point A to C and increases the quantity of petrol from
gallons to 32 gallons.
80
2.3 SUPPLYANALYSIS
60 -1- "
Like demand, supply is a flow concept. The supply of
product has a multivariate relationship whereby it l
40
determin~ by many factors ,simultaneously. Suppl¥ l
I 20 not a particul~r quantity, like demand, but a compJet
description of the quantit/ th~t sellers would like to sell
at each and every possible 'price and the every particular
10
0 time. Supply is not the same with production since th
Figure 2. 6 Shift in Demand curve quantity made available out of the total produced is
From figure 2.5 there is a movement from D1 to D2 along called the quantity supplied for exel:!ange.
the, DoDo demand curve with a drop in the price of the
 \,
5 Modern Microeconomics: A pract7'c al Arithmetical Approach
Quantity supplied therefore is the quantity of goods, out
of the quantity produced, that the producers or sellers
nre able and willing to offer for sale at each conceivable
price and under some other explicit terms. Like
demand, supply could be individual or market supply
hence individual . supply curve and market supply
curve. Whatever the type of supply, supply function is a
relationship bet~een different quantities supplied and
the determinants of the quantities.
And like demand . schedule a supply schedule is a
relation between •prices and quantities for a given
product, 1 i~ a given market, at a given time. Quantity
supplied . is therefore meant to depend on price and
other variables that can determine the quantity in the
midst of the, complexity of analysis of supply
2.3.1 TYPESOFSUPPLY
We have sa~d that supply is the behaviour of sellers with
respect to price and time. It has also been stated that the
price (whether; market price or individual price) paid for
acquiring a · co!Ilmodity is the . opportunity cost for
consuming the commodity. This means that consumers
or the demande~s \vill. compare the opportunity cost to
the benefitts) obtained from perceived consumption
before making demand. In the same vein, sellers
I
comp~re the monetary value (price) for exchanging their
commodities to the cost of production incurred and the
profit expected. The price becomes the opportunity cost
for disposing off of the commodities. We have said that
Demand and supplv Analysis 53
the higher the price the more the quantity supplied
because it creates avenue for more profits.
However, the supply function depends on the type of
supply. Whereas we had about five types of demand,
there are basically three (3) inter-related types of supply
namely joint supply, competitive supply and composite
supply. JOINT SUPPLY refers to the prpduction and/or
supply of two or more commodities together in a way
that a change in the supply condition (quantity and
price) of one affects the supply condition(s) of the other
commodities. In this case, if the supply of one
commodity (say Milo) increases, may be due to an
increase in demand this will result in an increase in the
jointly supplied commodity (say milk), all other things
I
held constant. Note that quantity supplied can be
increased if demand shifts to the right or if the supply
shifts also to the right as shown in figure 2. 7 below
(b)
01 (a) p $i S1
p
D:i
P1
P2
D1
D
Q 0
0
Figure 2. 7 Iri.c~ease in quantity Supplied
 4 Modern Microeconomics: A practical Arithmetical Approach Demand and supp~v Analysis 55

In figure 2.7(a), quantity supplied increased from Qi to Composite supply, also known as TOTAL SUPPLY or
02 because demand shifted from D0 D0 to D 1D1 resulting MARKET SUPPLY, is the aggregation of all individual
in price increase from P 1 to P2 , while the supply curve sellers, producers or market suppliers.
remained constant. But in figure 2.7(b) the demand
2.3.2 DETERMINANTS OF SUPPLY
·urve remains constant while supply shifted from S0 S0
As stated above, analysis of supply is more complex
t o S 1S 1 forcing price to fall from P 1 to P2 and quantity
than that of demand. This is why no simple statement
increasing from Q 1 to Q 2. If figure 2. 7(a) and 2. 7(b)
about the variables that affect supply can be made,
represent the market conditions for commodities A and
except that of price. However, studies have bee~ . ..
B, and the commodities are jointly supplied, then the conclusive as to some of the factors that determine
increase in demand in (a) from DoDo to D1D1 results in
supply of any product and these are shown
excess demand first. This excess is met by the market
mathematically as;
supplied quantity increasing to Q2 and at a new
equil.ibrium (CLEARING) price of P2. As the price Qs = j{P, Po, T, G, W, Cp)
increased more will be supplied of commodity B also. As =Quantity supplied
When~ Qs
the quantity supplied of B incr~ases the price of B will T = Technology
fall from P 1 to P2 as in figure 2.7(b). It follows therefore p =price of the product
that an increase in the demand for commodity A results G = Government policies
in an increase in the quantity supplied of the jointly Po = Price of other products
supplied commodity and hence a fall in the price of the w =Weather
jointly supplied commodity B. Cp = Cost of production
Supply is said to be COMPETITIVE if the increase in the Like demand, only the price of a product can cause a
production or supply of one commodity requires the movement along the supply curve while a change in any
reduction of the quantity of another commodity. For other :factor will cause a shift in supply curve.
instance, if more housing estates are to be constructed,
t hen there will be fewer,, recreational facilities or less (a) Price of the Product Itself
land for agriculture. In this case, the supply of houses .
. und agricultural output are competing. The price of a product is directly related to its supply
such that the higher the price of a product the greuk r
56 Modern Microeconomics: A practical Arithmetical Approach Demand and supp(y Analysis 57

the quantity supplied, and vis-a-vis. This means that p

there is a positive relationship between price and 500
quantity supplied i.e. the slope or the gradient is
450
positive. The reason for this direct positive relationship
is that at low prices, only the most efficient 400
producers/sellers will be able to make profits by
350-
producing/ selling the product. But, as prices rise,
producers who could not prevfously compete will find 300

that they can now produce/sell and make a profit, 250

hence they will be willing to supply. In general, higher I --Q
prices are needed to provide an incentive for firms, all J.::> I I I 500
100 200 300 400
other things being equal.
Figure 2.8 Supply Curve for Pectol
By this the supply schedule and supply curve can be as This upward slope as figure 2.8 shows that more
shown below. products are supplied at higher prices. But there are
exceptions to this rule just as in demand. For exampll
Table 2.3 Hypothetical Supply Schedule for Pectol the supply curves of some factors of production can
/ bend backward showing that a smaller quantity of that
Price per Product Quantity Supplies factor of production will be supplied at a higher price
e.g. highly professional services or consultants.
N250 100
N 300 200 (b) Technology
N 350 300 Technology here refers to all know-how about the
N 400 400 production methods and not only the state of available
machinery. For instance, in agriculture, the
development of disease -resistant seeds is a
technological advancement. In addition to such
/
devele>pment, improved weather forecasting, which
enabl1~s better timing and harvesting, will ensure more
outp'l:1t and hence supply. As the techno logy
58 Modern Microeconomics: A practical Arithmetical Approach
improves/advances there is the high tendency that it
will result in increase in the quantity produced and
supplied.
As it concerns variation of the supply curve,
technological advance will cause a shift in supply curve
to the right since producers will supply a larger quantity
than previously supplied ..
(c) Prices of Other Commodities
The changes in the prices of other commodities
determine the quantity of a particular product supplied.
Like with derhand, the supply of a product (A) will be
affected by the compliments of A (say B) or the
substitute products of A (say C). If the prices of
compliments rise producers of A will be encouraged to
produce and supply more of A
However, if the price of substitutes rise, producers will
be discouraged to produce more of A because demand
will shift from A to C. Therefore, a change in the prices of
otheI," commodities will cause a.shift in the supply curve.
(d) Input Costs
The quantity of a product ·supplied will depend on the
costs of the inputs.(or factors of production) such that if
the inputs cost more, producers will be discouraged to
produce/supply more of the product since their profits
will be affected, hence a fall in supply of the product.
Demand and supply Analysis 59 /
(c) Government Regulations
Government regulations refer to policies of government
issued from time to time such as taxation, regulations
on bank !endings, safety regulations, pollution control,
employment control, etc. If these policies are stringent,
producers affected by these policies will not supply
more of the product hence a fall in supply and a shift in
the supply curve inward to the left.
(fl Others
Other determinants of the supply of a product include
climate (such as in agriculture and aviation) and raw
m a terial availability (which will affect the supply of a
product through the production cost) .
2.4 DETERMINATION OF EQUILIBRIUM PRICE
A combination of the analysis of demand and the
analysis of supply discussed above leads one to the
determination of the market price and for equilibrium
prices for consumers and suppliers. Imagine a market
such as Trebor market in Port Harcourt where there are
m any buyers and sellers who want to buy and sell
quantities of Trebor. Each person in the market acts
independently. The market supply and the market
demand schedules are matched against each other
within the same time period. The equilibrium price in
the market within the time frame under consideration is
the price that equates the quantity ofTrebor demanded
 60 Modern Microeconomics: A practical Arithmetical Approach
and the quantity ofTrebor supplied. At this price buyers
are able and willing to buy exactly the quantity ofTrebor
supplied by sellers. There is no shortage and no
surplus.
The equilibrium price is determined at the point where
supply equals demand or where the supply curve
intersects the demand curve as figure 2. 9.
Do
.P1 I"
v
.....1-t(.)
D.. Po
P2
Quantity
Figure 2. 9 Equilibrium of Demand and Supply
From figure 2.9, A is the point where the demand curve
(DoDe>) intersects the supply curve (SoSo). This is the
point of equilibrium ..The equilibrium price and quantity
are OPc1 and OQo respectively. Anywhere outside the
point A, supply and demand are not equal thus
resulting in excess demand or excess supply. Excess
supply means. the excess of' quantity supplied over
quantity demanded at a particular price and time. It
,Demand and supply Analysis 61
occurs at price higher than the equilibrium price. On
the contrary, Excess Demand exists when the quantity
demanded is more than the quantity supplied at a
particular price and time. This occurs at a price lower
than the equilibrium price. Excess supply occurs where
the supply curve is higher than the demand curve and
this is represented in figure 2.9 as BC whereas Excess
Demand is represented by EM. This is because at a
higher price of OP 1, the quantity demanded is B or OQ1,
the quantity supplied is C or OQ2. Since OQ2 is greater
than OQ 1 we say there is excess supply ofQ1Q2, which is
OQ 2 - OQ 1. This will force down the price from Op 1 •
However, this price of OP 1can exist temporary since the
sellers want to sell more than the quantity buyers are
willing to buy. Similarly, a price lower than the
equilibrium can exist only briefly because the excess
demand EM or Q 1 Q3 will push the price up from OP2. As
long as the supply and demand curves are efficiently
determined, the equilibrium price and quantity will
remain the same. But where there is a shift in curve, a
new equilibrium price and quantity, will be created
2.5 SUMMARY
Having understood the elementary theory or analysis of
demand and supply, it will be of immen~e benefit to
mention the importance of this ~tudy. We have earlier
stated that demand and supply are flow concepts and
show multivariate relationships between many
influencing factors and the quantity demanded or
62 Modern Microeconomics: A practical Arithmetical Approach Demand and supp~y Analysis 63

supplied. The study of demand and supply analysis is 3) Estimates the effect of policies on the
important because it proffers answers to some purchase of goods and services by policy-
fundamental economic problems such as what, how, for makers (government) especially the use of
whom and when to produce. In summary, the study of taxation.
these analysis is important to a firm in the following
ways:
1) It enables firms to identify and measure the
forces that affect the consumption of a
product.
2) It enables the definition of the magnitude
and direction of relationship between these
factors (forces) and the resultant sale.
3) It enables planning activities for efficient
resource utilization to be done .
4) It is used in the determination of the
optimal level of production, preparation .o f
and initiation of prices, inventories and
. advertisement adjustments to production.

The purpose of the study of the demand and supply

analysis are:
1. Establishment of the relationship between
quantity demanded of a production and its
price.
2) Explanation for variations in demand and
the nature of demand curve.
)/
I/
It
 64 Modern Microeconomics: A practical Arithmetical Approach
CHAPTER THREE
ELASTICITY OF DEMAND AND SUPPLY
3.0 INTRODUCTION
In the last chapter, efforts were made to show the
relationship between the quantity demanded and the
various determinants of the quantity demanded. The
relationship between the quantity supplied and its
determinants were also discussed. The discussion also
cover the determination of equilibrium price,
equilibrium quantities, excess demand and excess
supply, and the importance ofthe demand and supply
analysis. One of the areas of applications of the analysis
is in planning, such as profit planning, production
planning, etc.
But, in planning and forecasting, there is the need to
know the reactions of both consumers and suppliers to
changes in the various determinants of demand and
supply, or the implication(s) of the actions of consumers
and suppliers on determinants. For instance, how
would spectators' react to an increase in the gate fees to
\
Elasticity ofDemand and Supp")! 65
watch Brazil-Nigeria football match in Port Harcourt?
Supposing such A-class matches have been played in
Port Harcourt, given the rate of attendance and a steady
gate fi:!e, how much will be charged should there be an
•
expected 50 percent increase in the attendance from
that of the last game? This kind ofreactiol1s on both the
quantity demanded or supplied and the factors
influencing the quantity, by consumers and suppliers
are among the several issues to be addressed in this
chapter. In this chapter therefore, we shall discuss the
magnitude of the changes in the quantity demanded or
supplied with respect to the factors influencing demand
or supply. We shall also examine the factors influencing
the magnitude of the changes and apply this idea to
some areas of our economic life. The chapter shall treat
these issues from two . independent standpoints viz
elasticity of demand and elasticity of supply.
3.1. ELASTICITY OF DEMAND
Generally, elasticity means the ability to extend, given
force. In · the application of force with the aim of
extending an object, say elastic rubber, the force must
be on either of the two ends of the object, or on one end
while the other end is fixed. In the process, the object
can be elongated or it could change position. In demand
and supply analysis, the extension (i.e. Elongation) and
contraction is referred to as MOVEMENT ALONG THE
CURVE, while a change of po·s i:tiion or .e xpansion of the
width of the obj.ect in whatever way is known as SHIFT IN
THE CURVE.
 Elasticity ofDemand and Supply 67
66 Modern Microeconomics: A practical Arithmetical Approach

Elasticity in economics is not different in definition from 3.2 PRICE ELASTICITY OF DEMAND
Price elasticity of demand is the ratio of the relative
its mathematical definition. Elasticity simply means the
change in the quantity demanded to the relative change
measurement of the level of responsiveness or the
measure ~f the -relative change between two variables. in the price of a given commodity. It is the measure of
That is, how large (elastic) one variable would change as the responsiveness of consumers to changes in the
a result of change in the other variable. The variable(s) price of a commodity over time. This measure in
that originate the change in the other variable(s) are quantitative terms is the COEFFICIENT OF PRICE
kno'".'n as INDEPENDENT VARIABLE(S), while the ELASTICITY ( 2:p)· This coefficient of elasticity or the
responding variables are known as DEPENDENT degree or magnitude of relativity is stated as the
VARIABLE(S). Elasticity therefore is the coefficient of percentage change in -quantity demanded divide by the
this relative change. In the case of demand, the quantity percentage change in price.
demanded is the dependent. Variable, while the factors %6Qo
That is, Ep =
influencing the quantity demanded at any particular %6P
period of time are the independent variables. And,
elasticity of demand therefore is the magnitude of the Where 6 = change
responsiveness of the quantity demanded (Q0 ) of a Q0 = Quantity Demanded
product: to changes in determinants of the Q0 . However, 'i! P = price fo the Commodity
not all the determinants of the Q0 can be easily
estimated and only the factors that can be quantified or Q2_:_Qi
And, %6Qo = ~Qo -=
estimated in finite terms shall be studied. For example, Qi
Qo
it will be difficult to estimate climate, weather, taste,
habit, fashion, preferences and culture in relation to
their impact on the quantity demanded of a product.
%6P
-6Pp = -
P2 - P1
P1
This is why in this chapter, attention shall be focused on
the fqllowing types of elasticity of demand: = Q2 - Qi P2 - Pt
· Ep = Qo / + ~PL Or Q1
... P1
(a) Price Elasticity of Demand /Qd /P
(b) Income Elasticity of Demand
(c) Cross Elasticity of Demand
(d) Expectation Elasticity of Demand
68 Modern Microeconomics: A practical Arithmetical Approach Elasticity o.fDemand and Supply 69

· ~Qo p Q2 - Qi P1 Illustration 3.1

= =
Qo x ~p . Q1 P2 - P1 Given that Qx = 700 - 2P

- P1 Calculate the price elasticity of demand if price is N25

~Qo x -2:.. Q2 - Qi
=
~p Q
= x --
P2 - Pi Qi
Solution 3.1
The knowledge of the coefficient of relative change is not The ratio of change in Qx and Px,
the end of this study. The knowledge is useful when ~Q dQx
appli.ed. But the application depends on the type of - =- = d(700-2p)
~p dPx
elasticity or the size, which also depends on' the kind of =-2
goods inyolved t~ ~ome extent.I.tis therefore important
to ascertain the types of elasticity. p = 25 Qx = 700 - 2(25)
If
Demand is technically said to be elastic if the quantity = 700-50
demanded responds strongly to . change in any =650
determinant of the quantity demanded, which in this
~Qx p
case is the price. The coefficient of price elasticity is Ep -- ·--
Apx Q
usually positive because it ranges from zero to infinity.
This does not mean that the law of demand is not =- 2 (2o/6so)
obeyed. Where a negative value is obtained, as is often
the result of analyses, the natural negative relationship
= -0.0769
between quantity demanded and . price, normally = 0.08
transforms such negative value unto positive. This This illustration used the mathematical approach. But,
means that there is usually an imaginary minus sign to this text book shall mostly use the arithmetical
every coefficient. This is why it is technically said to be approach. in ex~mp~es and illustrations except where it
negative. is unavoidable. -

Illustration 3.2
A young schoot-leaver wants to start a telephone call
business and found that the customers demand
 Elastici~y ~{Demand and Supply 71
70 Modern Microeconomics: A practical Arithmetical Approach

~Qx Q2 - Ql P2-P1
function in the locality is: i;p ,\ =:
- x -Px=
Qo = 5000-5P ~Px Qx QI P1

What is the price elasticity of demand if price changes = 4900 -4875 25

from N25 to N20 and from N35 to N50? 4875 x 20-25
Solution 3.2 25 25
(a) Let P 1 = N25, P2 = N20 = 4875 x T
Qi = 5000 - 5(25) = -0.0256
= 5000- 125
This means that the price elasticity of demand is
=4875
0 .0256, that is a 2.56% relative change in Qo results
from a 100% change in Px.
Q2 = 5000 - 5(20)
=4900 (b) Ql = 5000 - 5(35); Q2 = 5000- 5(50)
=4835 =4750
From the demand graph below it would be seen that the
change in price from N25 to N20 caused the quantity 4750-4835
Ep x 50 - 35
demanded to increase from 48 7 5 to 4900 and a 4835 35
movement along the demand curve from A to B. = -0.0176 (0.4286)
...
NSO = 0.0074
40
Illustration 3.3
t.l If 1000 plates of food were demanded when the price of
~
Cl.
301 .. ------------
-----~I--~ B
.
a plate of food was N 100 and the price elasticity of
demand is 17, what is the change in price if the change
20 ---------------~---, --T"'~D
I
I
I
I in quantity demanded is 340?
I I
10+.. I I
I I
I I

4800 4820 4840 4860 4880 4900

QUANTITY
 72 Modern Microeconomics: A practical Arithmetical Approach Elastici~)' a/Demand and Supply 73

Solution 3.3

Q 1 = 1000; P 1 = NlOO; Ep = 17 and dQ = 340

{ Demand is said to be PERFECTLY INELASTIC if
consumers are completely insensitive to changes in
price. In such cases, no matter the change in price, the
dQ p quantity demanded remains constant and therefore the
Ep = -X-
dP Q percentage change in quantity demanded is zero (0),
340 NlOO and hence the coefficient of elasticity equals zero (0).
17= - x -- The zero (0) coefficient results because the numerator in
dP 1000
17(1000) d P= 340 (NlOO) the formula is zero (0) while the denominator could
assume any value. In this type of situation, the demand
curve is completely vertical in shape and parallel to the
340(N100)
dP = price (or Y-axis) axis when graphically presented as in
17(1000)
figure 3. l(a).
=N2
At the opposite extreme is PERFECTLY ELASTIC
The change in price will therefore be N2 and the new
DEMAND. Demand is said to be perfectly elastic when
price will be N102 and in the arithmetic progression of
N2. consumers buy whatever quantity available at a
particular price. This means that price does not change
3.2.1 TYPES OF PRICE ELASTICITY OF DEMAND even if the quantity demanded changes. In this case, the
. ,... , .
numerator can assume any value but the denominator
The above illustrations have not identified the type of remains zero (0). The result is that the coefficient of
price· elasticity of demand. However, there are five · (5) elasticity is infinity (oo) and the demand curve is
types of price elasticity of demand namely:
completely horizontal and parallel to the quantity (X)
(i) Perfectly inelastic axis as shown in figure 3. 1 (b).
(ii) Perfectly elastic A FAIRLY INELASTIC DEMAND exists when a change in
(iii) Fairly inelastic the price of a product results in less than proportionate
(iv) Fairly elastic change in quantity demanded. In such a case, th 1
•

(v) Unitary elastic relative change in quantity demanded is smaller than

the relative change in the price, and consumers react
slowly to changes in price. This means that it will taken
 74 Modern Microeconomics: A practical Arithmetical Approach Elasticity o.f Demand and Supply 75

large change in price to influence a change in quantity p p

D (b)
demanded. Therefore, the Ep is· more than zero (0) but p4 ·--...,------- (a)
less than 1. That is:
B •---------- D n
0 < Ep < 1
I>i ·----------
See figure 3 . 1 (c) for graphical presentation.
Pi ·----------
On its part, a FAIRLY ELASTIC DEMAND is the type where D
consumers react rapidly to change in price. That is, a 0 0
demand situation in which a change in price results in
Qi
more tlian propurtionate change in quantity demanded, p D
(d)

pl~~
hence the n u merator in the elasticity formula is greater (c)
than the denominator. Therefore the elasticity
coefficient is more than 1. That is: Pi I
I
Pi~-----+-~o I I
I I I
I I
Ep > 1. Pi~---------1-..,-~ I
I
I
I
I I
I I I I
I I I I
I I I I
The demand curve for Ep > 1 is a gently sloped curve as I I I !
I !
shown in figure 3. l(d). 0 Qi Qi
0 Q1 Qi
p
Midway between these elastic and inelastic demand D (e)
elasticities is unitary elasticity. UNITARY ELASTIC
DEMAND exists when the relative change in quantity Pi .-
1
demanded as a result of a relative change in price is ·1
r.! ---------r- - - - -I
o..I L
equal to one (1). Consumers' reaction to changes in I I
I I
price synchronizes with the change in quantity. The I
I
I
I
I I
coefficien t of this elasticity of demand is one (1). I

0 Qi Qi
That is· Ep = 1
Figure 3. l Graphical presentation of Variou
Forms ofprice elasticity
 76 Modern Microeconomics: A practical Arithmetical Approach Elasticity of Demand and Supply 77

Apart from these forms of price elasticity of demand, the In figure 3.2a demand curve is elastic at h~gh prices
degree of responsiveness of consumers to change in and inelastic at low prices. Figure 3.2b is the opposite of
price can be at an infinitesimal point on the demand figure 3.2a. This means that the Ep could vary within
curve or within a range of time such that a segment of
some given ranges of time as well as from one price
the demand cuI"Ve is considered. Note that we have
range to another. Precision is not enough by, price range
stated that the demand for a product is a flow variable
in itself but precision requires .the elasticity to be
and therefore the demand curve may not necessarily be
.. linear. It also means that the measurement of the measured at a point on a derrind curve. Point elasticity
,' elasticity cou1d be within a time frame or a price range. is the ratio of an infinitesimally small relative change in
When elasticity is measured at the minutest point in quantity to an infinitesimally small change in price. It is
time, price or on the demand curve, the elasticity is also the proportionate change in the quantity
known as POINJ' ELASTICITY. But when a range is taken, demanded as a result of a small proportionate change in
it is known as ARC ELASTICITY. price. This is done by taking a tangent at the point on
the demand curve where the price and quantity form co-
3.2.2 POINT AND ARC ELASTICITY OF DEMAND
ordinates, and then taking the ratio of the distances
So far, the terms elastic and inelastic have beeri applied
from that point to the P and Q axis respectively as shown
to the whole demand for a commodity. This is correct
in figure 3.3.
enough for some purposes but not in all cases, because
the demand for a commodity can be elastic in on:e price
range ~nd inelastic in another. The degree of elasticity Po
as indic~ted by the Ep can also vary from one price range
to another as shown in figure 3.2a and 3.2b below.
p . p
Inelastic
(a)
(b) 101 '

D
Inelastic
\
0 0 0 J 0 Q
Figure 3 .2 Elasticities and prit;e.Ranges Figure 3.3 PointElast·i city ofDemand
i

~
78 Modern Microeconomics: A practical Arithmetical Approach Elasticity of Demand and Supply 79

In figure 3.3, the Demand curve DD is a nonlinear curve From triangle AQ 1 Qo

and therefore measuring the elasticity will mean taking AQ~ =AQi +Q1Q;
a segment from the curve which already appears to be = 10 2+12 2
an arc. But there might be the need to measure the price a AQ =/~10_0_+_1_4_4
0
elasticity at a particular point in time, at a particular = 15.62
price. or quantity. This might be difficult. To solve this
difficulty from the particular point (say A) a straight line From triangle AP0 P1
is drawn to joint both the price axis (at P0 ) and the Api = 11 P~ + P1A2
quantity axis (at Q0 ). The line P0 AQ0 will appear to be = 82 + 122
tangential to the curve DD at A, which will then enable APo = j~i-6+_1_4_4_
the measurernent of the Point Price Elasticity of = 14.42
Demand.
From figure 3.3, Point Elasticity= Elasticity of demand .·.Point Ep = 15.62
at a point say A 14.42
AQo = 1.08
= --
A Po The price elasticity at point A on the demand curve DD
Where AQ0 is longer than AP0 demand is elastic, if APo is is therefore fairy elastic.
longer than AQ0 demand is said to be inelastic, and The second method is the use of the various quantities,
where AQ0 = APO demand is unitary elastic. Where, especially where only the coordinate price at a point on
however, the length of AP0 and AQ0 are not known, the the curve is known and no demand function is given.
lengths could be obtained in either of the two (2) ways. Using the same information as above but assuming tha t
One way is to use Pathagoros Theorem. For instance, if OP0 is unknown, the point elasticity at A will b
OQ0 is24unitsandOP0 isN18.LetP 1 =HlOand Q1=12 calculated as:
units as given in figure 3 3 ·
Pointi~p = Q 1Q2
Then, P1P0 =H18 - HlO =HB OQ1
Q1Q2=24-12=12
= 12 = 1
P1A = 12 since P1A = OQ 1 12
AQ1 = 10 since OP1= Q1A Elasticity here would have been unitary.
 80 Modern Microeconomics: A practical Arithmetical Approach Elasticity a/Demand and Supply 81

Point elasticity is used when demand is known by Arc elasticity is the elasticity within a segment of
assumption or through statistical calculation based on demand curve and is taken as an average of the changes
many observations of prices and quantities. Because of in prices and quantities hence the formula:
some difficulties with point elasticity especially the
~Q ~p
scantiness of data, Arc Elasticity is used to express Arc Elasticity 1
precision (exactness). Y2(Q1 + Q2) /2 (P1 + P2)

~Q P1 + P2
Arc elasticity of demand is the measure of price -X ---
~p Qi+ Q2
elasticity where the changes in the price are reasonably
large. It is the average elasticity measurement of the
relationship between changes in price and quantity. It is Illustration 3.4
used when one ' knows only 2 points (say M and N in Using the data in illustration 3.2 above, what is the
figure 3.4 below) from a demand curve, and not the arc elasticity of demand if price rises from N35 to
intermediate points. It is said to be the true measure of NSO?
elasticity of demand at the ·mid-point of a chord
connecting 2 points (say Mand N) as in figure 3.4. Solution 3.4

p The demand curve, if plotted will be. linear (that is a

straight slanting line) and not a curve. The arc elasticity
D therefore will not be different from the solution 3.2(b).
However, the most popular method is the Averaging
P1 I \ Arc Elasticity
method as given by the Arc Elasticity formula above.

/ Although this averaging method is widely accepted, its

problem is that the ratio obtained ca;:t not be applied for
the entire range of price or quantity of the different
P21 1 ~--- points between the higher and lower princes and
0 quantities on the arc (or the segment of the demand
Q1 Q2 Q ". curve) they represent. With the averaging method:
-""
Figure 3.4 Arc Elasticity
 82 Modern Microeconomics: A practical Arithmetical Appl-oach Elasticity of Demand and Supply 83

tlQ x P2 + P1 The Number and Closeness of its Substitutes

Arc Ep --
!lP Q2 +Q2 This is by far one of the most outstanding determinants
Where P 1 = N35 and P2 = N50 of the elasticity of demand for a commodity. The
Q1 =4835 andQ2 =4750 responsiveness of consumers to changes in the price of
a product is highly dependent on the availability of
tlQ = 4 750 - 4835 = -85
close substitutes. Where there are very close
!lP =N50-N35 =N15
substitutes for a commodity and these substitutes are
readily available to consumers of the particular
-85 N35 +N50
Arc Ep = -x product, a little change in price will result in a more
15 4836+ 4750 than proportionate change in quantity. This means that
the greater the availability of substitutes and the larger
-85 85 the number of these substitutes, the greater the
- x--
15 9585 elasticity of demand (fairly elastic demand). For
0.05 instance, the entrance of Globacom, V-mobile, M-tel,
The demand, f-or the range of prices given, is fairly and Starcom into the mobile telephone industry in
inelastic. Nigeria has resulted in keen competition for sales.
Normally, sales have increased for Globacom more than
3.2.3 DETERMINANTS OF PRICE ELASTICITY MTN and this has resulted in the fall in the prices of
OF DEMAND MTN services. This is because as long as Glo's charges
The size of the p:ice elasticity of demand for any product are lower people will prefer it to other networks. This
is a function of certain variables or factors. Of course, it implies that the market for mobile telephone services in
has been shown-that the size, ratio, magnitude or level Nigeria is highly price sensitive.
of price elasticity ranges between zero (0) and infinity Nature of Commodity and Degree of Need
(oo), that is the price-quantity relationship could be
ela stic 6r inelastic. The factors that determi:ge the size of Commodities have been classified into normal,
elasticity are referred to as determinants a:nd include luxuries, necessaries, inferior, ostentatious, etc .
the following: Normal goods are goods demanded under normal
conditions, such goods would include clothings,
 84 Modern Microeconomics: A practical Arithmetical Approach
average accommodation, etc. These goods ordinarily
obey the law of demand. Luxuries are goods that provide
some pleasure and inert satisfaction, yet they could be
dispensed with and are mostly costly too. Examples of
luxury goods include the ownership of air-conditioned
motor vehicle, decoration items, handsets, and
television sets. Luxury goods are also known as comfort
goods. Luxury goods are also goods whose consumption
can be dispensed with or postponed when either the
prices are high or rising or when the income cannot
carry their ac.quisition. Necessaries are indispensable
and whose consumption can hardly be postponed. They
obey the law of demand to an extent and thereafter the
quantity demanded of such goods are constant.
Inferior goods, on the other hand, could be necessaries
luxuries or even ostentatious goods but which are less
in value and societal preference. Inferior goods are
goods bought in smaller quantities when their prices are
high relative to their original counterparts, and also
bought in ·S maller quantities when their prices are low
relative to their original or high quality counterparts.
They are so described because as their prices are
declining, more money (imaginarily) will be available to
consumers to demand for the better quality goods.
Where, however, the price of inferior good is high very
such that there is little price difference between the
price of inferior good and the price of the original,
consumers would shift from the consumption of the
l
Elasticity o,/Demand and Supply 85
inferior to the original commodity. GIFFEN goods are
examples of inferior goods though not all-inferior goods
are giffen goods. A giffen good is one that at lower prices
less is bought and at higher prices more is bought.
It follows therefore that the degree of responsiveness of
the quantity demanded to change in price depends on
the nature of the commodity and the level of need. This
is why ostentatious goods command more elastic
demand than necessaries and luxuries. The reason is
that an unwanted increase in the price of ostentatious
goods can make consumers avoid the goods The
implication is that relative in quantity change will be
greater than the relative change in price. Necessaries
have more inelastic demand than luxury goods, while
luxuries have less elastic demand than ostentatious
goods. However, it must ·be stated that the demand for
ostentatious and luxury goods are not elastic for no
reasons but just because they may have close
substitutes or they can be dispensed with. But for
necessaries like salt, they have no substitutes and
therefore their demand remains inelastic.
Time Factor
Price elasticity of demand is said to be more inelastic in
the short-run than in the long-run. This is because of
adjustment effects in the long run. These effects could
be cyclical (seasonality of demand), or psychological (in
the form of habit), institutional (information availability
86 Modern Microeconomics: A practical Arithmetical Approach
and applicability), durability and the nature of demand
Ooint or not). Normally, for seasonal goods, a change in
price within a particular season may take more than
that season for consumers to adjust the quantity
demanded. But with the passage of time consumers will
experience a more elastic demand. The same thing for
habit. Habits are easily formed with time. Time is the
only instrument of change such that demand based on
habit becomes more elastic in the long run. For
example, in a group of 10 person's, if 4 persons are
smokers, witp. time the number of smokers and the
quantity consumed will either increase or decrease.
Institutionally, not all consumers will have assess to
information about a change in price of a product at the
same tiine. This means that while some will demand at
higher price, for instance, others would have moved to
where the price has fallen. But with time, both the
sellers and buyers will adjust making the long run price
elasticity to be fairly elastic. On the nature of demand,
durable goods tend to be more inelastic. This is because
owners (consumers) of durable goods like TV sets would
not want to buy more or new sets except they are spoilt
or there is a the possibility of trading-in.
Quality of Commodity .
fhe quality of a commodity here means the usefulness
of the commodity to the consumer. In this regard,
commodities could be single-purpose, or multi-
purpose. A single-purpose or single-use commodity is
Elasticity o./Demand and Supply 87
also known as autonomous commodity. A multi-
purpose commodity has fairly elastic demand because
where the price increases the consumer will certainly
reduce the quantity demanded by foregoing some of the
less pressing uses. Therefore, the relative change in
quantity demanded will be higher than the relative
changes in price.
Importance of commodity
The reaction of consumers to changes in prices of
commodities could be influenced by the importance of
the particular commodity being demanded.
Importance, in this context, means the preference of the
consumption of the particular commodity with respect
to other commodities. This importance can objectively
be measured by the size or proportion of the consumers'
budget that is spent for the consumption of the
particular commodity. Where a greater proportion of the
budget (disposable income) per time is spent on a
product, the demand tends to be fairly elastic. This is
why the demand for essential goods is fairly inelastic
because almost the same amount of disposable income,
which is small compared to other commodities
acquired, is spent from time to time.
Consumer's Income Level
Income level of consumers also affects the relative
change in quantity demanded with respect to relative
 88 Modern Microeconomics: A practical Arithmetical Approach Elasticity of Demand and Supply 89

change in price. By this consideration consumers are 3.2.4 PRICE ELASTICITY AND SLOPE
generally categorized into two viz high-income and low- Just as change and relative change are related but not
income consumers, The reaction(s) of each of this group the same, price elasticity of demand and the slope of
also depends on the expensive nature of the commodity demand curve are closely related but not the same. In
in question. For less expensive commodities, usually fact, the slope is a sub-set of the elasticity. The slope of
high-income consumers are less sensitive and therefore any line or curve from B to A in figure 3.5 is defined as
the den;and is usually inelastic. It takes a big change in the change in Y-axis divided by change in X-axis for the
price of such commodities to effect a small change in coordinates of the two points.
quantity demanded. On the other hand, it takes a small tiY
change in price of less expensive commodities to record That is, Slope = tiX
a more than proportionate change in quantity
demanded. But when the reciprocal of this quotient is multiplied by
the ratio of Y and X, the product is known as the
Market supply elasticity.
p
Whatever the factors that influence the price elasticity D
of demand, the proportion of the market far a given
commodity has its independent influence. Where total N501------"'-
quantity demanded is more than total quantity
supplied, a small change in the price will result in more
than proportionate change in quantity demanded (i.e. N30
fairly elastic demand). For example, a slight decrease in
the price (tuition fee)' of education will make more
D
Nigerians to opt for higher education given the fact that
•
I

the quantity of tertiary fnstitutions are far less than the 0 5 15 Q

number of people intending to gain admission.
Figure 3.5 Illustration of slope and elasticity
90 Modern Microeconomics: A practical Arithmetical Approach
Elasticity of Demand and Supply . 91

From figure 3,5 above, the slope of the line DABD from B
=' -10
-X-
30
to A will be given as:
20 15
Slope = ~p = NSO- N30 =, 1 (i.e. unitary elasticity)
~Q 5- 15
Another relationship between slope and elasticity of
20 demand is that the slope of a straight-line demand curve
- = -2
-10 has been mathematically proven to be constant,
Note that the minus sign before 2 shows that the slope is whereas the price-quantity ratio (P / Q) changes
upward. The downward slope will not bear a negative depending on the point of the curve. It follows therefore
sign. This means that when the line slopes upward, the that the change in elasticity depends on the price-
slope will be positive. quantity ratio.

This kind of slope will be evidenced by supply curve.
But, a downward sloping line will result in negative
slope. This means any time P2 > P 1 slope will be positive
and when P2 < P 1 it will be negative. What is very
important is to be careful in noting the direction of the
change, But when the attention focuse.s on elasticity,
the first price and quantity are multiplied by the
reciprocal of the slope.
3.3 INCOME ELASTICITY OF DEMAND (Ey)
The relationship between changes in income and
changes in the quantity demanded is expressed through
the income elasticity of demand (Ey). Income elasticity of .
demand therefore means the ratio of percentage change
in the quantity demanded of a product to the percentage
change in the income of the consumer(s). This ratio,

ThatisEp = P/Q x f !iY

~Q .
unlike the price elasticity of demand, is positive in
nature. This is because of the positive relationship
between income and quantity demanded., already
explained in the previous chapter.
p~ x ~Q
= ·Q ~p
Mathematically, income elasticity of demand is defined
From the above illustration in figure 3. 5 as: %~QD
Ey
%~Y
~Q
Ep = x P/Q AQ \'
~p
-
AV
·-
Q
92 Modern Microeconomics: A practical Arithmetical Approach Elasticity a/Demand and Supply 93

A cursory look at the income elasticity formula abov1

shows that it is same as the formula for price elasticity <>I If' i"1i11on therefore, any commodity whose f:y is less
demand except that income (Y) replaced price (P) in tlw 111 11 '" 1·10 (0), that is negative, is not a normal
formula. il 1111111l 1ly. As far as income elasticity is concerned,
Ill !1 1 u111modities with negative income elasticities are
Although By is positive for all normal goods, the size of l!liPWlt ns JNFERIORCOMMODITIES.
the coefficient of elasticity depends on the type of
TYPES OF INCOME ELASTICITY OF DEMAND
commodity in question. Commodities have been
classified into normal, luxuries, necessaries, inferior !:I w1r· n re five (5) types of income elasticity of demand.
and ostentatious commodities earlier in 3.3.3 for the r111•::1· type s are defined on the basis of the coefficient of
sake of price elasticity. But for income elasticity, t IH• i11come elasticity (Ey). Although it has been said that
comm~dities 'c ould be luxuries, necessaries or
t:v i~ always positive for normal goods and negative for
ostentatious. The By, for ostentatious goods are higher
1i"if1 ·1ior goods, the coefficients as have been stated
than one (1), while that for luxury (comforts) is about 1,
d1ove differ. Note that a normal good, from the income
and the By for necessary is less than 1 but more than 1-l.1 s t icity perspective, is any commodity whose quantity
zero (0). Table 3.1 below summaries the nature of the Ey ck1nanded increases as income increases. It follows that
for these types of commodities and their effects. 111 inferior commodity is the commodity whose quantity
11<-manded decreases as income increases. This
Table 3.1 types of Commodities and Ey
I 1: 1ppens affect certain levels of income. This is because,
'!'able of Coefficient Effect 1>1 clinarily, quantity demanded (D) of every commodity
Commodity ofEy
111creases initially. But as income increases, more
Ey > 1 Change in income (Y)
Ostentatious results in more than 111cmey income become available for the procurement of
proportionate change the original (normal) commodity. This occurrence, of
in quantity (Q)
course is subject tb three major conditions:
Luxury Change in Y results in
(comfort) Ey ~ 1 almost proportionate (a) That the price . of the commodity remains
change in Q
constant
, . Chang~ in Y results in (b) That the taste and preferences remain
Necessaries
0 < Ey < 1 less than proportionate
change in Q constant
94 Modern Microeconomics: A practical Arithmetical Approach
(c) That money income is one of the scarce
resources for which there are competing
wants.
The coefficients of Ey vary between -oo to +oo, and the five
types of income elasticity of demand are:
(i) High Inco.m e Elasticity: This is when the
coefficient of elasticity is greater than one
(1). In this case, the relative change in
quantity demanded of a commodity is
greater than the relative change in income.
The implication is that as income changes
the quantity demanded changes but at a
greater rate than change in income. This
happens when ostentatious goods are
involved. Graphically, the income-demand
curve is a gentle upward sloping curve as
shown in figure 3.6(a).
·(ii) Low Income Elasticity: Here, the
coefficient of elasticity is more than zero (0)
but less than one (1). In this case, it takes a
bigger change in income to effect a small
change in quantity demanded. The
demand for necessaries (essential)
commodities like salt and soap are
examples of low income elasticities.
Graphically, the income-demand curve is a
steep upward sloping curve. The curve is
Elasticity of Demand and Supply 95
steeper than the unitary income elasticity
and the high-income elasticity curves. This
is shown in figure 3.6(b).
.(iii) Unitary Income Elasticity: Here, the
percentage change in income is
Proportionately equal to the percentage
change in the quantity demanded of the
commodity. This means that if there is a
5% change in income, quantity demanded
will also change by 5%. The effect is that
numerator and the denominator in the
income elast.i city formula are equal, with
the result that the quotient will be equal to
one (1). Graphically, the income-demand
curve is 45° from the origin in the first
quadrangle graph as shown in figure 3.6(c).
(iv) Zero Income Elasticity: Here the quantity
demanded of a commodity remains
constant irrespective of the changes in
income. That is, changes in income do not
affect the quantity demanded, meaning
that the quantity demanded is
autonomous to changes in income. In this
type , of situation, change in quantity
demand is zero (0) hence · the numerator
will be zero, while the denominator of the ey
formula changes . Graphically, the demand
curve is parallel to the Y (income) axis and
96 Modern Microeconomics: A practical Arithmetical Approach Elasticity of Demand and Supply 97

perpendicular with the quantity axis (see (b)

y y
figure 3.6d). (0< Ey > 1)
(a)
(v) Negative Income Elasticity: Demand is
said to be negatively elastic with respect to ( Ey > 1)
income if income increases but the
quantity demanded reduces . This means
that an inverse relationship exists between
the change in income and the quantity 0 Qo
demanded of a commodity. This occurs
0 Qo
when inferior goods like second-hand y (d)
(c) y D
clothes are considered. Naturally, when
the income of a consumer increases the ( Ey = 1)
consumer will find that the income ( Ey = 0)
differences can be equal to or more than
the differences in price, and therefore the
consumer will increase the consumption of D
the high quality commodities in preference 0 Qo
to that of the inferior commodities. 0 Qo
y (e)
Graphically, the demand curve moves from
point to origin like any other similar curve
but turns backward toward the vertical
axis. That is from the zero (0) point or ( Ey = 0)
south-west back to northwest instead of
north-east as with the preceding curves.
This is shown in figlire 3 .6 (e).
0 Qo

98 Modern Microeconomics: A practical Arithmetical Approach
3.3.2 DETERMINANTS OF INCOME ELASTICITY
Although the income elasticity of demand is positive
except the negative income elasticity, each of these
types of income elasticity depends on the following
factors:·
(a) The income patterns of consumers
(b) The consumption patterns
(c) Choices and preferences of consumers
(d) Demonstration effect
·(e) •The nature of the commodity
(f) The level of national income
(g) The time period
The income pattern of a consumer is a determinant of
the size of the coefficient of the income elasticity of
demand. If the income of the consumer is such that
changes can not be predicted, the income elasticity will
be unsteady. In such a case, the income elasticity of
demand tends towards zero elasticity in the very short
time or it may tilt towards unitary elasticity over a
relative.ly long time. This might be because with the up
and down movem·ent in income, consumers may want to
delay increase in quantity demand. But with an
unprecedented increase in income or the saving of the
smaller unpredicted income over a relatively long-run,
the consumer can effect a one time very significant
change in quantity demanded In the former case,
income changes but quantity demanded remains
·"'·
Elasticity of Demand and Supply 99
z
'Onstant, while in the later case the relative change in
1uantity demanded and the relative change in income
ould be equal.
Consumption pattern can also determine the income
elasticity of demand. Consumption pattern could be
defined as the seasonality of purchases or the size of
:·.
consumption expenditure in the income of the
consumer, etc. Seasonally, if a consumer effects
demand at definite points in time (say Christmas
season), then between such points in time, Ey will be
zero (0). But at the points in time, Ey could be greater
than one (1), even without the commodity being luxury
or ostentatious, as long as the change in the quantity
demanded is greaterthan the change in income. On the
other hand, if the consumption is such that · the
consumer spends more of this income on the
consumption of a particular commodity, it would
appear that the change in quantity demanded will be
greater than change in income and the size of Ey will be
greater than 1.
Tastes, choices and preferences of consumers are
another set of factors that influence the income
elasticity of demand. There are some consumers who
are addicted to low profile commodities, others to the
consumption of the latest brands of commodities (e.g.
telephone handsets, air-conditioners, motor vehicles,
wears, etc). These patterns of behaviour will result in
 l 00 Modern Microeconomics: A practical Arithmetical Approach
quantity demanded either increasing or remaining
constant irrespective of changes in income, and hence
the Ey changing accordingly.
The consumer's . susceptibility to demonstration or
bandwagon effect is another determinants of income
elasticity of demand. If the consumer is such principled
that other consumers can hardly influence, the
quantity demanded will remain relatively steady and
! include the consumption of telecommunication and
may not affect the Ey.
Another factor that can influence the Ey, is the nature of
the commodity. If the commodity is used for multi-
purpose, its demand will be high whether or not income
changes,· hence the Sy > 1. If the commodity is highly
inevitable (like basic food stuff and essential
comf:11odities), the quantity de.mantled could be .steady
even when income changes, resulting in Sy < 1. The size
of &y in this latter case will naturally decrease as more
incom e is earned. This is what is known as the ENGEL
LAW.
Income elasticity of demand is naturally affected by time
period. In the short-run, &y could move towards high
income or low income. But in the long run, By.tends to be
unitary. This is because both income and quantity have
adjusted sufficiently (or ideal pattern or size would
result;
Elasticity of Demand and Supply 101
Finally, the level of national income could also
determine Ey. Where the national income is low the
consumption of certain commodities would be
u nexpected as these commodities would appear either
expensive or luxurious. But in any economy with high
n ational income / the disposable income on the average
will also be high such that the expensive commodities
in the former economy can easily be afforded. Examples
computer products like mobile handsets and laptop
personal computers.
3.3.3 INCOME SENSITIVITY OF CONSUMPTION
EXPENDITURES
Income sensitivity of consumption expenditure (Sy)
deals with the changes in the monetary (N) expenditures
on a particular commodity as income changes. It is
different from income elasticity of demand because it
deals with the monetary expenditure changes instead of
the changes in the physical quantity of the commodity
demanded as income changes. The latter concept is
given a s income elasticity of demand. Income sensitivity
of consumption expenditure therefore i$ defined as the
coefficient or ratio of percentage change in monetary (N)
expenditure relative to a marginal (1 %) change in
disposable income (Yo) .
o/o~E
That is s =
Y %~Yo
 102 Modern Microeconomics: A practical Arithmetical Approach
Where Sy = Income Sensitivity of Consumption
Expenditure
.1.E = Change in E~enditure on the
\
Consumption in N '
.1.Yo = Change in Disposal Income
Sy varies between 0 and oo. When less than 0.5, it is
known as low Sy and when more than 1.5 it is known as
high Sy. Sy is a simple but not comfortable index unlike
Ey because it is difficult to separate change in income
(.1.Y) effect from the effect of change in price and tastes.
3.4 CROSS PRICE ELASTICITY OF DEMAND
So far, the discussions have been on the relationship
between price of a particular commodity and the
consumer's income, and the quantity demanded of a
commodity. We have earlier stated that elasticity
implies quantitative measurement of the quantity
demanded of a commodity and the determinants. There
are therefore occasions when the demand for a
particular commodity will influence either the price or
the demand for another commodity. The commodities in
question could definitely be demanded independently
and at other times jointly or alternatively. When what
happens to the price of a commodity (say A) affects the
qua~tity demanded of another commodity (say B), it
c?uld be said that there is a cross relationship.
...
Elasticity of Demand and Supply 103
Cross price elasticity of demand therefore is the
measurement of the responsiveness of the consumption
of a commodity (say A) to the change in the price of
another commodity (say B). That is, an increase in the
price of A could lead to either increase or decrease in the
quantity demanded of commodity B. Any two
commodities in this kind of relationship are known as
related commodities, else they are unrelated or
independent commodities. For instance, the demand
for fish and beef, if the price of fish increases, a
consumer may shift his demand from fish to beef. This
means that the quantity demanded of fish will fall (by
the law of demand), but the quantity of beef demanded
will rise. In this case, both fish .and beef are alternate
commodities (substitutes). lfthe increase in the price of
fish leads to a fall in the quantity of beef demanded, then
the commodities are said to be compliments. Where,
on the other hand, the increase in the price of fish has
no effect on the quantity of beef demanded, the two
commodities are independent or
un_r elated. This is
why the concept of cross price elasticity of demand is
very useful in studying inter-commodity relationship,
particular for competitors. It is used in studying the
effects of changes in prices and the possible reaction(s)
of competitors. Mathematically, cross price elasticity of
demand is defined as:
.1.Qs . .1.PA
f:sPA = Qs..,.. PA
 Elasticity of Demand and Supply 105
104 Modern Microeconomid: A practical Arithmetical Approach

unrelated or independent. It follows therefore that,

°ladQB
= -- apart from unrelated commodities, the higher the
%dPA
=dQs PA positive or negative EBPA the stronger the·relationship.
-
~PA x QB Illustration 3.5
Where EBPA = Cross price elasticity of A and B = the Given that the demand for Fanta is
elastiCity of•B·(EBPA) with respect to price QF = 4850 + 1.5 Pm
of A. Where Pm = Price of Mirinda
~Qa = Change in the quantity of commodity B And, PF=ff200, Pm =NlOO
demanded. . (a) Calculate QF
(b) Calculate cross price elasticity of demand for
~PA= Change in the price of commodity A Fanta
(c) Calculate the relative change in the demand
QB = Original quantity demanded of commodity
for Fanta as a result of a 10% change in the
·B before the change.
price of Mirinda.
PA = Original .price of commodity A before the
, change Solution 3~-5
(a) QF = 4850 + 1.5(ff100)
Substit:ute.s are commodities with positive EBPA. This is = 5.000
because the change in the price of A and the change in . ~QF..:.. ~PM
the quantity demanded ofB are in the same direction. (b) EBPA = - . -
QF PM
And the closer the substitutes the greater the coefficient
~QF PM
of EBPA. Consequently, complements are commodities =-X-
~pM QF
with negative BaPA based on the fact that the change in
the p·rice of commodity A and the change in the quantity
From the QF equation above, ~QF = 1.5
demanded of commodity B are in ·opposite direction. . ~PM ·
That is_the commodities have inverserelationship. And, \

when the EBPA is zero (0) , the commodities are said to be

 106 Modern Microeconomics: A practical Arithmetical Approach
Elasticity of Demand and Supply 107

100 ) elasticity of demand. For instance, if the price of

EaPA =1.5 ( 5000
mentholated spirit used for sterilization increases, the
quantity demanded of bleach will increase more than
=0.03
proportionately because it is a multi-purpose
fhe commodities (Fanta and Mirinda) are substitutes commodity. On the other hand, groundnuts can b
because the EF PM > 0 i.e. Positive. But they are not very eaten with bread, banana, cucumber etc. If the price of
close substitutes since the cross price elasticity is any of these compliments increases, there may be a
relatively insignificant (0.03). small change in the quantity of groundnuts demanded .
In this case, the cross price elasticity of demand for
%.1QF groundnuts with respect to one of the compliments (say
(c) _If EF PM = ' %.1QM bread) will be relatively small. One area where th"
knowledge of cross price elasticity of demand is useful is
And EFPM= 0.03 and %.1PM ·= 0.1 the definition and control of monopolized products. A
monopolized product is one with a low positive EaPM .
o/o,1QF
Then,EFPM = %.1PM This means that consumers are restricted to a singl<'
source of purchase and may not have alternatives in tht•
short-run. But in the long run, chances are thut.
0.03 =%.1QF
--
0.1 substitutes may emerge and therefore the EaPA will b<-
expected to be positively large, while the price elastici ty
:. o/o .1QF = 0.03 (0.1)
of demand (Ep) becomes far larger than one (1).
= 0.003 or =0.3%
3.4.1 CROSS PRICE ELASTICITY OF DEMAND
They are very weak substitutes with the cross price AND RANGE OF TIME/PRICE.
lasticity of 0.03.
We have defined range of time or prices as the ba:;,i:; ol
One very important determinants of cross price Arc Elasticity, therefore this subsection considers en>
elasticity of demand is the nature of commodity with price elasticity of demand and arc elasticity. That i:;, we
respect to its uses. This is· because the more the consider the magnitude of change that will occur in lhr
purposes a commodity serves the higher the cross price quantity demanded of a commodity (say B) wi1 hin 11

- ---·
 '\
I08 Modern Microeconomics: A practical Arithmetical Approach
given range of time or a given range of price of another
commodity (say A), particularly when the demand
relation is non.,.linear.
Where the demand relation is non-linear (i.e. arc); the
cross price elasticity of demand will be calculated like,
the case of price elasticity of demand, as below:
EsPA = .'.\Qs x . PA1 + PA2
.'.\PA Qs1 +Qs2
3.5 ELASTICITY OF PRICE EXPECTATION
One of the determinants of the quantity demanded of a
commodity is Price Expectation. By Price Expectation is
meant the anticipation of changes in the price of
commodities in the ·future. This has a major influence
on the quantity demanded because if prices are
expected to fall in the near future, consumers would
tend to endure the utility derivable from the immediate
consumption of that commodity. By this, quantity
demanded would remain constant or would change a
little. The implication would be that an expected fall in
price would result in less than proportionate change in
quantity demanded for normal goods. However, if prices
are expected to rise in the future, most consumers
would make brisky purchases, hence quantity
i!
demanded would increase presently. Price expectations
have extended relations with other- commodities just
like the explanation made under Cross-Price Elasticity
Elasticity ofDemand and Supply 109
of Demand. The substitutability or otherwise of a
commodity based on the expectation of changes in
prices also depends on or is limited by the consumer's
tastes, type of utility derived from the consumption,
type of commodity (durable, necessities, etc.) and the
income.
The influence of price expectation on quantity
demanded is difficult to analyze, particularly in general
merchandizing situations. The most practical situation
where price expectation influences quantity demanded
is in the Stock Market, where Jobbers, Brokers, and
Investors watch the movement in the prices of securities
In order to make decisions. However recent events have
shown that price expectation has had significant effects
on quantity demanded in Nigeria.
The influence of price expectation on quantity
demanded has been seen in the demand for petroleum
products where the slightest infonnation on price
increases have resulted in panic buying, stock-piling by
consumers, and hoarding to cause artificial scarcity by
sellers.
In 1939, J. R. Hicks devised the Elasticity of Price
Expectation and ·asserted that there are certain
determinants of price expectation, such as:
(a) Political news and changes;
(b) Current and recenteconomibevents,
 110 Modern Microeconomics: A practical Arithmetical Approach
Elasticity <?/Demand and Supply 111

(c) Prevailing climate of opinion by experts and reversal of the future prices is equal to the change in
observers;
current prices, Elasticity of Price Expectation would be
(d) Experiences of trends in past changes in UNITARY.
prices.
The above explanations can be summarized with
Out of the factors mentioned above, current and recent Table 3 .2
economic events and experience of past changes in Table 3.2 Coefficient of elasticity of price
prices bear heavy influence on price expectations. expec:tations, Interpretations and Implications
Elasticity of Price Expectations can therefore, be defined Coefficient Interpretation Implications
(Epx) n
as the ratio of the proportionate change in the expected
(
future prices tq the proportionate change in current High Elasticity Consumers expect, a
prices. This means that if prices have been observed to (Epx > I of price larger than
Expectation proportionate rise in
have changed by a certain rate or percent, a consumer (pX) future price than rise in
can change his expectation of future price by some other • current price.
rates. The ratio of these changes is what is referred to as
Unit Elasticity Consumers expect
Elasticity of Price Expectation. Given demand curves, a of PX same proportionate
rise in current prices will cause a shift in the demand Epx == 1 rise in future prices as
curve to the right. This will result in a MORE THAN 1 in current prices.
(UNIT) Elasticity, that is FAIRLY ELASTIC DEMAND. This Zero Elasticity Consumers expect
Epx == 0
of px current rise to have no
arises because consumers would want to buy more now
to avoid the higher prices expeded in the future. If there effect on future prices.
is a FAIRLY INELASTIC DEMAND (Low or Negative Low Elasticity Consumers expect a
Elasticity), it means that a rise in current prices would 0 > Epx = 1 of px less than proportionate
cause a decline in quantity demanded. In this case, the rise in future prices as
against rise in current
demand curve would shift to the left (or inwards), since prices.
consumers would wait for the price to decline in the
Negative Consumers expect
future. If on the other hand, a change in the current Epx < 0
Elasticity of px future prices will fall att
price would not result in the alteration of the . against current price
distribution of purchases through time, or where the increases.
 I 12 Modern Microeconomics: A practical Arithmetical Approach Elasticity a/Demand and Supply 113

Where whereas some determinants have positive coefficients

px = Price Expectations (like price elasticity of supply), others have negativ<·
Epx = Elasticity of Price Expectations coefficients. However, out of the various determinants ol
I}· = Future Prices quantity supplied, price of the commodity appears to b<·
Pc = Current Prices the most predominant. Therefore, discussion on th('
elasticity of supply will be centered on price elasticity of
jtJ,

Epx - ~I}" ~Pc
- pf Pc
3.6 ELASTICITYOFSUPPLY
Just as elasticity of demand, elasticity of supply is the
degree of responsiveness of quantity supplied of a given
commodity to changes in the determinants of supply.
This means that any change in the determinants of
supply will result in change in quantity supplied. But
the proportionate change or coefficient of change is
what is simply referred to as elasticity of supply.
Mathematically, elasticity of supply is defined as
E _ Percentage Change in Quantity Supplied
s- Percentage Change in any Determinant
The coefficient of elasticity, similar to the elasticity of
demand, rang~· between: ± oo. This means that the
coeffi.cient' can1 be infinitely: negative or infinitely
positive, . deRendin& on:. tlie: independent , variable
influencing th~ qµantity, · su1rnlied~ . ROr · instance;
supply.
By definition therefore, price elasticity of supply is the
ratio of proportionate change in the quantity of a
commodity supplied to the proportionate change in the
price of the commodity. The relationship between price
and quantity supplied is positive unlike that between
price and quantity demanded. This is because suppliers
will always prefer high prices for their goods and services
to lower prices, since higher prices mean higher profit(s).
Like elasticity of demand, there are five (5) forms of price
elasticity of supply, namely perfectly inelastic, perfect
elastic, fairly inelastic, fairly elastic and unit elastic
supply. Supply is said to be perfectly elastic when the
supply curve is horizontal and in fact parallel to the
quantity axis. In this case it is the same with any straight
line that can be drawn and can cut the price axis to
measure elasticity at the point of tangency. This can be
seen from figure 3.7a. When supply is perfectly elastic,
only quantity supplied changes while there is no change
in price (1'1P = 0).
On the other extreme is the perfectly inelastic supply.
Supply is said to be perfectly inelastic when the quantity
 114 Modern Microeconomics: A practical Arithmetical Approach Elasticity of Demand and Supply 115

Hllpplied remains constant even though price changes. Proof

Tl 1is can be seen in figure 3. 7b. In figure 3. 7b the supply . From figure 3.7c, Qs = OQ
<:urve is vertical or perpendicular to the quantity axis
~Ps = OP - OA = AP
but parallel to the price axis.
Ps = Qp
'l'hc a bove implies that unit elastic, fairly elastic, and
Qs = OQ
l"nirly inelastic supply lie between the two extremes. For
OQ OP
instance, with a given supply curve, a straight line could Es = -X -
be drawn to be tangent to the supply curve at any AP OQ
particula r point, especially when the supply is
curvilin ear. Where the straight line is drawn from or OP
AP
cuts the price axis and the straight line becomes
tangent to the supply curve, the supply is known as Where eventually OP < AP, supply become inelastic.
fairly e'lastic. In the case of fairly elastic supply, a Inelastic supply can be easily measured when either the
<'hange in the price of a commodity will result in more linear supply curve cuts the quantity axis:. qr the
than proportionate change in the quantity supplied. straight line drawn to be tangent with the supp·fy. curve
'I'his is illustrated in figure 3.7c. From figure 3.7c, at a point begins from or cuts the quantity axis. This is
<'lusticity of supply could be measured as seen in figure 3.7d. In inelastic supply case, the
coefficient of elasticity can be measured as:
Es = OP/AP Es AC/
= oc
Ordinarily, the supply curve could assume the nature of It is inelastic because AC < OC and therefore the
the straight line AB in figure 3.7c, that is if the supply quotient or ratio will result in a proper fraction with
curve SS is collapsed into AB. In either scenario, the £ = AC/ < l
l'lasticity of supply at point C could be measured as
s oc
ii lated above, which is just the same as:
For inelastic supply, a change in price will lead to less
than proportionate change in quantity supplied. This is
~Q Ps easily experienced with factors of production that are
- -x-
Es - ~Ps Qs special and specific in nature. The more specific th
 11 6 Modern Microeconomics: A practical Arithmetical Approach Elasticity of Demand and Supply 117

fl1ctor input the inelastic the supply while the less s s

:-;pccific the more elastic the supply.
Price
El.- Es = 0

Finally, unitary supply elasticity is the situation where

Es > 1
t'i 1her the linear supply curve or the curvilinear supply
curve is drawn from the point of origin. This means that
n t the point of tangency, the proportionate change in
price is equal to the proportionate change in quantity
:-;upplied . Unitary supply elasticity is geometrically 0 0
Quantity Quantity
:-;hown in figure 3. 7e.
Figur·e 3. 7 graphical Presentation of Various Forms
s
Price I (a) Es= oo js Price I
I

I (b) Es= 0
of Supply Elasticity
I
I One very important benefit of the knowledge of elasticity
I
Pl CJ.<= n---------1c
of supply is that it contributes to the determination of
I the effect of changes in the quantity demanded on price.
I
s. . . . . I
I
I
This is aimed at utilizing the advantages of invisible
I hand. By this therefore price adjusts to elasticity of
0 Qs Quantity 0 Qs
Quantity supply given changes in quantity demanded. For
instance, if supply is fairly inelastic an~) quantity
Price I // B demanded increases there will be more than
(c) Es > 1 /s Price
I

proportionate increase in price. This is because it will

B take a big change in price for suppfiers to increase
quantity supplied, with or without respect to tim e
adjustment. This s cenario is illustrated in figure 3.8
A below .
o~--.......J---
Qs
Quantity 0 A OQuantity •·.
 11 8 Modern Microeconomics: A practical Arithmetical Approach
Price
;,···1
P2
P1 D1
0 A 02
Quantity
Figure 3. 8 Illustration of Elasticity fo Supply and
Change in Demand
111figure3.8, the first equilibrium was at C, with P1 price
ilnd Q1 quantity. But quantity demanded increased
cu using the demand curve to shift from D 0 D 0 to D 1 DJ. A
11cw equilibrium price (P2 ) and quantity (Q 2 ) are
produced. The shift of equilibrium from point C to point
M results in change in quantity (~Q = Q 1 Q 2 ). If ~Q < ~P,
Hupply is fairly inelastic. It will take a bigger ~p to effect
the less than proportionate ~Q.
On the other hand, if the ·SS were to cut the price axis,
then ~Q > ~p and the shift from Do Do to D1 D1 will result
in only a less than proportionate change in price but
with a bigger change in quantity supplied.
119
CHAPTER FOUR
TFIEORY OF DEMAND BEHAVIOUR
4.0 INTRODUCTION
In chapters two and three, it was stated that demand
and supply theories are generalizations made by
classical economists about the psychological and
sociological outcome of consumers behaviours. This
was why it was stated that demand is the
indeterministic behaviour of consumer(s), influenced by
certain quantifiable and non-quantifiable factors, and
resulting in effective demand of certain quantities of a
given commodity. The theory of demand was therefore a
study of the relationship between the quantity
demanded of a commodity and the various
determinants of the quantity demanded. It will therefore
be proper to say that the quantity demanded is just the
outcome of the psychological decision made in the mind
of the consumer. And this decision cannot be overtly
revealed. This difficulty informed economists to
propound theories that can be used to study, analyze
 I;

120 Modern Microeconomics: A practical Arithmelica / Approach Theory ofDemand Behaviour 121

and ~xp lain the behaviour of the consumer. One of the 4.1 THECARDINALAPPROACH
theories is the theory of consum er deman d behaviour
This approach is also known as the utility on the basic
(simply put as theory of demand behaviou r). This
postulation of the utility (want-satisfying power in any
theory is an attempt to model the consumers' choice. It
commodity is countable or measurable. According to
explains how buyers reconcile what they would like to
this approach, utility can be measured in monetary
demand as described by their tastes and preferences
units, that is by the amount of money the consu mer is
and what they actually exhibit in the form of qu antity
willing to exchange (as sacrifice) for a unit of commodity.
demanded. The implication is that the theory of
Some of the cardinalists claim that since the taste and
consumer demand behaviour is an analysis that leads
preference of the consumer culminates into the
to the traditional theories of demand. Since tastes and
purchase of any commodity is psychological, the utility ..
preferences .are issues of the mind and can neither be
can be measured by subjective units known as unLS.. lt
interpreted nor measured, a study such as this on the
is based on this measurao ility of utilities under
behaviour of the consumer (which is actually the
certainty that the mathematical vocabulary cardinal is
outcome of the decision taken in the consumers black-
used to explain the theory of consumer behaviour.
box) will be limited to comparison between the
satisfaction derived or derivable from a set of In order to explain this theory the cardinalists made
commodities and either the price (s) of th e comm odities certain assumptions such as stated below.
or the consumers income. This satisfaction or the power
41.1 ASSUMPTIONSOFTHECARDINALAPPROACH
of satisfaction from th e possible con sumption of the set
of commodities is simply known as utility. And , a Like every other theory, the cardinal approach to the
consumer will behave independently by making choices explanation of the demand behaviour of consumers i~
among existing and competing need s in order to create hinged on certain assumptions for its understanding.
utility. The theory of consu m er behaviour is therefore These assumptions form the foundation for the validity
the study of h ow a con sum er makes utility from the of the theory and include the following:
commodities consumed. There are t wo main
Rationality: The consumer is assumed to be sane in
a pproaches (sometimes ca lled theories) to the theory of
choice-making such that he consistently wants the best
consumer demand behaviour namely the cardinal
or maximum satisfaction (UTILITY) out of' the Jittle
approach and the ordinal approach.
resources at .th is d isposa l. The consumer in his sane
 122 Modern Microeconomics: A practical Arithmetical Approach
state takes calculated costs that yield the highest utility
rriuch more than the costs incurred. This means that
inexpliCa~_le factors such as habit are not considered in
the choice of commodity demanded. Rationality also
implies that the consumer satisfies his needs in a way
that the commodity with the highest utility is demanded
(or acquired)
. .
first, while the commodity with the least
' .·
satisfaction is purchased last. This is way it is said that
'.'a.rational consumer is one t.? at calculates deliberately,
'c hooses consistently and maximizes utility.
- . '•
~ . .. . ,. .. ~-
.,
.
.. Measu.r ability: The cardinal approach assumes that
the satJsfaction power in any commodity is measurable
and countable, hence the name cardinal. Accordingly,
utility can be measured or counted in utils (quantifiable
. satisfaction) or in monetary terms . This is why the price
of a commodity is ·used to judge its usefulness. If a
~ ratip.naLconsµmer asks for a commodity, he haggles the
pric~, that is comparing the offer price to the benefits
.(utility) ··· deriv~ble from the commodity. Since if is
difficult to measure satisfaction in utils (units), price
f,ecci'mes the easiest means of measurement. However,
n~fall commodities can be measured in terms of money.
This is a major limitation to this approach. In spite of
this assumption, the cardinalists claim that a consumer
; ~akes an optimum d~mand when the satisfaction
gained by the consumption of the smallest one unit of a
commodity is equal to the price of the commodity. This
is what is simply referred to as the MARGINAL UTILITY
Theory ofDemand Behaviour 123
.l ~QUIL.IBRIUM PRINCIPLE. That is, equilibrium occurs
where the Marginal Utility (MU) of the commodity, say
1·ommodity Xis equal to the price (P) of the commodity.
Ma thematically stated as:
MUx =Px
It follows therefore that if the MUx > Px, the consumer is
said to be at an advantage (surplus), else deficit.
Consistent Transitivity: The cardinalists assume that
since the consumer is rational, and by excluding habit
a nd other inexplicable incalculable factors, the
consu mer will be consistent in his choice and
preferences. This means that if a consumer prefers
commodity A tn 13, and B to C then he must be
consistent and 1i 1nefore prefer A to C. This rules out
erratic and vacillating behaviour possible with
consumers.
Constant Value of Money: The cardinalists assume
that the purchasing power (or value) of money does not
change with increase or decrease in the quantity or size
of money income earned, unlike the utility that varies
with increase or decrease in quantity of commodity
demanded. This is what some refer to as the constant
marginal utility of money.
Limited Money Income: Given that the resources of an
individual consumer are time and money, and given
that the resources available to meet these needs are
scarcP the cardinalist assumes that money income is
 124 Modern Microeconomics: A practical Arithmetical Approach Theory a/Demand Behaviour 125

limited in terms of how much to be spent on Where there are more than one commodity, the
commodities to be consumed. This is why the consumer <'Onsumer attains equilibrium where there }s equality of 1

must make rational choices. l he ratios of the marginal utilities of the individuai
commodities to their prices.
Additivity of Utility: Since utility can be
measured/ counted, the cardinalists assume that it can . MUA MUs MUz
be added. The Sum of the utilities from each unit of I.e. PA = Pg = ... = Pz
commodity is known as TOTAL UTILITY {TU). This means
At the point of consumer equilibrium, given more than
that: one commodity, the price paid on one of the
TUx = Uxl + Ux2 + Ux3 .... + Uxn commodities yields the same increment in satisfaction
' a s the unit of money spent on each of the rest of the
Diminishing Marginal Utility: This approach assumes commodities in that equilibrium.
that the level of satisfaction gained from successive (or
additional) consumption of a given commodity Illustration 4.1
decreases as the quantity of that commodity consumed If Onyema is faced with the consumption of Malta
increases. This is however not instantaneous. The Guinness (G) and Maltina (MM), with the following
reduction in the utility commences at a certain quantity marginal utilities equations:
of consumption and continues until the point where MUG = 400 - BOG
further successive addition becomes zero. This is why Mumm = 200 - 20m
the marginal utility curve is d<twnward sloping, getting
If the consumer's maximum money income meant for
to where MU = 0 and · thereafter negative. This
the purchase of the two items is just N240 and the
assumption also forms a basis for deciding equilibrium prices of G and Mare N40 and N20 respectively. Find
of the consumer's demand. By .this assumption, the equilibrium point where money income will be
therefore, a consumer can continue to increase the completely exhausted.
purchase and consumption of commodity until its MU
just falls to the level of its price. Solution 4.1
MUµ = 400 - BOG
Combining assumptions (b) and (g), therefore, MU~m = 200 - 20mm
Where U =f (Px and qx). PG =N40.00
Pmm =N20.00
 T11 eory of' Demand Behaviour 127
126 . ·Modern Microeconomics: A practical Arithmetical Approach

ONYEMA'S MU and Utility Optimization Table /\t (ii ), 4G + 8mm = 4(N40) + 8(N20)

MUG/ MUMM/ = N160 +N160

Q MU0 MUMM
PG PMM
=N320
1 320 8 .00 180 9
t\t (ii) the consumer's money income of N240 is
2 240 6.00 160 8 com pletely exhausted. Therefore, the point of maximum: ,
3 160 4.00 140 7 equ ilibrium is at 3 Guinness Malta and 6 Maltina.
4 80 2.00 120 6 rhe a bove illustration explains th.e law ofEqui~Margin:aL :
• • . ~ - . - ~t. '. '

5 0 0 .00 100 5 Utility The law states that a Consumer that · consume~ ·
6 -80 -2.00 80 4 m ore than one commodity, will be at equilibrium if and
wh en the money income spent on each of he
7 -160 -4.00 60 3
commodities produces the same M.U.
8 -240 -6.00 40 2 i'
However, . in the case of single commodity the first
From the table above, it can be seen that equilibrium conditicyi holds , i.e. Mux = Px. In this case the- :·
MUG = MUMM) occurred at su mm,.ltion of the units of satisfaction (TOTAL UTILITY).·
( PG PMM •
beh,aves like the marginal utility even though the total
I .
utility (TU) cannot be zero or negative. The TUrises first
(i) 2G and 4mm,
a t an increasing rate, then at decreasing rate·•.s.atun~.~es '
(ii) 3G and 6mm, and
· (Iii) 4G and 8mm or stabilizes, and finally declines. The measurement: of
th e rate of change in the TU is known as the MARGINAL
At (i), 2G + 4mm = 2(N40) + 4(N20) UTILITY, such that MU = 0 when TU reaches its peak
=N80+N80 befo r e declining. At the point where MU = 0 the
=N160 consumer will not be capable of deriving any greater
s a tisfaction from additional or successive
At (ii), 3G + 6mm = 3(N40) + 6(N20) consumption. This maximum point of the TU is known
=N120+N120 a s SATURATION POINT as shown in figure 4.1 below. This
=N240 is why the marginal utility is defined as the ratio of
 TheOJ y of Demand Behaviour 129
128
Modern Microeconomics: A practical Arithmetical Approach

Fr om table 4.1 above, the marginal utilities could be

change in the total utility to change in total quantity of nl>lained and graphically shown as in table 4 .2 and
commodity consumed.
ligure 4.2 below.
Thatis, MU= A TU
. AQ Table 4.2 Total Utility and marginal Schedule

Quantity Total Utility Marginal Utility

Marginal utility is therefore the slope of the total utility.
1 4 4
Table 4.1 Total Utility Schedule 2 10 6
Quantity of.Bread 3 20 10
Total Utility
1 4 25 5
4
2 5 25 0
10
3 6 15 -10
. 20
4
2.5 Tu 12
5 &
25 Mu 10
6
15 \ 8
I

'\ 6
'-,
Total 3 4
Utility point 2
2
0
20
-2 I 1' 2 3 4 5\ 6 7
15 -4

1 -6

5
Tu -8

-lOr---------------------------
1 2 3 4
Quantity
5 6 7 8
Quantity of Bread Figure 4.2 Graphical Presentation ofMarginal Utility
Figure 4.1 Total Utility Graph
 130 Modern Microeconomics: A practical Arithmetical Approach Theory of Demand Behaviour 131

From the above, it could be seen that MU = 0 at Q = 5 MU curve will be declining), the sum of the MU at 1, 2,3,
when TU (25) is highest. Anywhere after this point, '1, and 5 units will be equal to the TU at the 5 units. This
there· will be loss of satisfaction (negative MU and ·an be shown in figure 4.3 below.
declining TU). It is the less than proportionate or even
negative utility from the successive addition of each Total I
I
Utility I I
quantity of the commodity that is referred to as I I
I I
Diminishing Marginal Utility. 1---..J
I I
I I
I I
4.2.2 RELATIONSHIP BETWEEN TOTAL UTILITY I I
I I
AND MARGINAL UTILITY I I

The total utility and the marginal utility are all from the : : Qty.
ICTTTTT1 I I I

same source and leads to one another. For instance, it is

the slope of the total utility or the rate of change in the
total utility per unit of change in the quantity of the Marginal
commodity consumed or demanded at a time that is Utility
known as marginal utility.

It has also been stated that both the TU and MU

increase initially as more commodities are consumed.
But while the TU increases at decreasing rate before Qty.
reaching its maximum (point of saturation), the MU
0 1
&u
declines. And when the TU declines the MU assumes Figure 4. 3 TU and MU
negative values as it continues to decline.
In figure 4.3 above, the upper part and the lower part
Another thing about TU and MU is that when show the Total Utility (TU) and Marginal Utility (TU) for 4
graphically shown.the, total area under the MU curve is units of a commodity, with 4 units as the highest
equal to the TU of the quantity considered. That is, if 5 quantity for the highest cumulative utility. At 4 units,
unit
I
of a commodity are consumed
.
with TU from
.
the 5 the TU is the highest (point of saturation) and the MU is
u~its increasing at decreasing rate (meaning that the
zero.
132 Modern Microeconomics: A practical Arithmetical Approach

The cumulative of the MU 1, 2, and 3 units is equal to Theory ofDemand Behaviour 133 .
the height of the TU at 3 in the upper part. That is the
shaded area in the lower part of the figure 4. 3 is equal to nnd how much he actual pays. That is the a.mount the
the height of the TU curve from the quantity-axis at 3 consumer values the commodity and the actual or final
units. Th relationship between TU arid the MU can be price the seller sells the commodity. In other words, it is
summarized in tabular form as shown in table 4.2 the net benefit a consumer derives from being able to
below. purchase a good. The simplest presentation of the idei;t
of consumer surplus using the cardinal approach was
Table 4.3 Relations between TU and MU
originally made by Alfred Marshall in 1920. In his
S/N. When TU is: Then MU is: presentation, Marshall considered the marginal utility
1 Increasing at Increasing of money income, optimum budget of a consumer, and
' the utility of expenditure of consumer. By assuming
increasing rate
that the marginal utility of money was constant at a
Increasing at
2 constant given quantity of utils, Marshall concluded that
constant rate
consumer surplus would be in utils and monetary
Increasing at decreasing
3. value. And that the consumer surplus in utils is the
decreasing
difference between Total Utility and the Utility of the
4 At maximum Zero
consumers expenditure for a given unit or quantity of
5 Decreasing Negative commodity consumed or purchased. Similarly, the
consumer surplus in monetary terms is the difference
The above relationship applies to any total and its
between the Total -Expenditure (TE) and the Price (P) of
marginals such as Total Product and Marginal Product.
the commodity.
4.2.3 CONSUMER SURPLUS
Illustration 4.2
Consumer surplus has earlier been defined as the Consider the following
condition where the MUx > Px. It is the difference
Prit::e (N) Quantity Bought MU (Utils)
between how much a consumer is prepared or willing to
2.50 1 50
pay for the purchase or consumption of a commodity
1.50 2 30
1.00 3 20
0.75 4 15
~.
 Theo1y of Demand Behaviour 135
134 Modern Microeconomics: A practical Arithmetical Approach

If the utility of money income is 20 utils (constant), what I .2 . 4 DERIVATION OF THE CONSUMER'S DEMAND
is the consumer surplus in utils and in monetary CURVE
terms? It has been stated in the previous chapters that the
tl em and curve is downward sloping because of the law
Solution 4.2 of demand. The law of demand itself is equally
. dependent on the law of diminishing marginal utility as
Price Qty MU TU TE Utility of Consumer
(N) Bought (UtilsJ N Expenditure Surplus well as the differences . in tastes and income of
consumers . By the law of diminishing marginal utility,
Utils. N
a s the TU increases due to the increase in consumption,
( 1) . ' (2) (3) (4) (5) (6) (7) (8)
and as TU increases at a decreasing rate, the MU
2.50 1 50 50 2.50 50 - -
decreases and gets to zero and even becomes negative.
1.50 2 30 80 3 .00 60 20 1.50
Since monetary values are taken as the easiest measure
1.00 3 20 100 3.00 60 40 2.00
of utility, the MU will be the price of each quantity
0.75 4 15 115 3.00 60 65 2.75 bought multiplied by the utility of the money. income.
Note: That is, MU= A.P
(a) TU = Cumulative of MU
(b) Total Expenditure (TE) =Price x Qty Where A =the utility of money income or expenditure.
(c) Utility of Expenditure = 20 utils x TE Assuming therefore that A is constant, the price of the
(d) Consumer Surplus in Utils =TU - Utility of commodity will become the measure of the utility. ~his
Expenditure means that the decrease in the MU as more
(e) Consumer Surplus in N = TE - Price commodities are consumed, will imply decreases in the
prices of this commodity. It also follows that the positive
The illustration 4.2 shows that where the utility of part of the MU curve will be the demand curve, as shown
money is not known, the consumer's surplus can be in figure 4. 4 below.
ascertained given that the prices that the consumer can
buy- at different quantities are known. The consumer
surplus then is the utility measured as an amount of
money.

136 Modern Microeconomics: A practical Arithmetical Approach
MU
MUi
MU2
MU3
D that utility can be objectively measured.
0 X2 XJ
X1
MUx 0 X1 X2
Qx
Figure.4.4 MU Curve and Demand Curve
From figure 4.4, it would be seen that the MU is a
downward sloping curve and substitution of the Mus
with prices for the positive segment of the MU curve is
the demand curve .
The movement along the demand curve precipitated. by
changes in the prices of the commodity results in the
changes in the quantity consumed because of the
magnitude of harm or benefit from the changes in the
price. If the price of the commodity rises, the consumer's
utility is harmed, hence a reduction in the quantity
purchased. The opposite happens when price goes
down. The harm is a loss in the consumer's surplus in
the form of reduction of the difference between the MUx
and the Px or even making the Px > MUx . On the other
hand the benefit is a gain in the consumer's surplus as
the gap between the Px and Mux is reduced or even
making MUx > Px.
Th eory a/Demand Behaviour
137
CRITICISM OF THE CARDINAL UTILITY
4 .2.5
APPROACH
The cardinal or utility approach to the study of the
demand behaviour of consumers has been criticized on
the following basis, among others:
It is criticized because of its assumption
l)
The quantity of a commodity a consumer
consumes or demands is an overt outcom
of so many psychological considerations.
Sometimes, the consumer has to demand a
commodity not because of perceived utility
and at other times the satisfaction may n ot
be explained. This is why this assumption
is criticized.
q)
,,,,, It is also criticized for using money as th"
only measurable measure of satisfaction .
in reality, there are some commodities tha t
are exchanged without the use of money.
r1) It also assumes that the utility of money
.:>
income is constant. This is grossly untrue
and not tenable since the value of m oney
changes from time to time, just as inconH
changes.
The approach assumes that a consumer':
4)
utility from the Consumption of ; 1
 138 Modern Microeconomics: A practical Arithmetical Approach
Theo1y of Demand Behaviour 139

particular commodity is independent of the

consumption of other goods. This
assumption is not accurate because the
consumption of related and non-related
goods affect the consumption of the
particular good.
4.3 ORDINAL UTILITY APPROACH
The criticisms associated with the classical and neo-
classical economists' cardinality of utility, by modern
economists like Hicks (1946) and Allen (1956) resulted
in the u se of another tool to analyze the consumer
demand behaviour. This tool is based on a box
containing indifference curves. The indifference curves
approach was the idea of an English economist called F.
Y. Edgeworth (1845-1926) in the late 19th century
(Watson, 1972) but was improved upon by other
conomists like Pareto, Hicks and Allen.
The ordinal utility analysis is similar to the cardinal
utility approach in the aspect of preference of on"
commodity to another. But while the ordinal approach
does not consider the preference and the magnitude of
preference (i.e. "by how much"), the cardinal emphases
preference and the size of preference (using
measurability). In the place of preference, the ordinal
utility approach emphasized ordering or ranking the
subjective (psychological) utilities of commodities. It is
its maximal use of the indifference curve that made it to
be christened the INDIFFERENCE CURVE ANALYSIS.
4.3.1 ORDINAL UTILITY APPROACH ASSUMPTIONS
In order to understand the analysis and for the
conclusion of the modern economists to hold, certain
basic assumptions were made. These assumptions
include:

Thes e economists emphasized that utility is

(a)
e this approach assumes that th
psychological and cannot be quantitatively measured
us claimed by the classical and neoclassical economists
like Alfred Marshall. To this modern economists, utility
can only be expressed in . terms of "less than", "more
than", "preferred to" and "indifferent". This means that
the satisfaction a consumer derives from the
consumption of a commodity can better be expressed
when compared to the consumption of other
commodities , such that the consumer either prefers one
to another or stays indifferent.
Rationality: Like any economic analysis ,
consumer(s) is rational by arriving at th
maximization of satisfaction (utility) given
income, market price, and a full knowledg"
under (certainty condition) of all relevan t
information concerning the commodity
and the market. By these qualities, t h e
consumer is assumed to be objective and
consistently objective too.

140 Modern Microeconomics: A practical Arithmetical Approach
(e)
(b) Ranking: The consumer . can express his
utility in the order of preferences according
to the level of satisfaction derived from each
of the commodities consumed. This is
what is known as "ordinality of utility".
(c) Size of Utility: Each quantity of
commodity has its associated utility. As
more units of the commodity is
(11
successively consumed , the utility derived
changes. The tota l utility derivable by a
consumer depe nds therefore on th e
quantity of commodities
consumed.
Hence, U = f (Qa , Qb,······ ······· ·· On)
(d) Transitivity: The approach assumes
consistent transitivity. That is, within a
reasonable period of time and all other
things being equal, if a consumer prefers
commodity X to commodity Y and
commodity Y to commodity Z, he will
therefore prefer commodity X to commodity
Z. It should not be inconsistent so that at
one time he prefers X to Y and at another
time Z to X or Z to Y. Here, transitivity
means preferring X to Y, Y to Z, while
consistency means the maintenance of this
p reference within a given reasonable time .
Theo1y of Demand Behaviour
141
Nonsatiety: It is assumed that the
consumers will always prefer to have large
quantities of a commodity or large
combination of commodities. This
assumption is also based on the
assumption that the consumer does not
get to the point of saturation and therefore
the commodity or combination of
commodities is never over·- supplied.
Diminishing Marginal Rate of
Substitution: The approach assumed that
utility can be expressed in the order of
preference (ran~ing) . These preferences are
represented by indifference curves, which
are curves assumed to be convex to the
origin. This is because the consumer has
trade-offs between commodities in order to
enhance utility and these variou s
commodities (combined or traded-off) are
shown as the Indifference Curves. Since
there will be giving up of one commodity
(Say A) for another (Say B), the curve will b e
downward sloping. The slope of th e
indifference curve is known as Marginal
Rate of substitution (MRS) of th "
commodities The curve slopes (slides)
downward because of the giving up of A for
more of B, and vice versa, as shown i 1'
figure 4. 5 below.
 142
Modern Microeconomics: A practical Arithmetical Approach
The01 y o/Demand Behaviour 143

4.3.3 INDIFFERENCE CURVE

3
QA The indifference curve is a geometrical or graphical
2 f I '\,,
presentation of an indifference schedule. The
~A
1 I I
I I
IL\B'\. ,
...
indifference schedule is the tabular presentation of a
I I list of combinations of commodities arranged in such a
I I IC
I I way that the consumer is indifferent to any of the
1 2 3 Q8
combinations because each of the combinations
Figure 4. 5 Indifference curve and Marginal ~ produces the same level of utility. This means that the
Substitution indifference curve shows the various combinations of
commodities that yield the same utility to a consumer.
In figure 4.5 the movement from point X on the
Graphically, therefore, the indifference curve is the.
indiffer~nce cµrve (IC) toµ and further to Y means that
locus of the coordinating points of the combinations of
QA will reduce from 3 to 2 to 1 units as Q 8 increases
commodities that yield the same level of satisfaction to
from 1to2 to 3 units. The slope of the IC is measured as
the ratio of the change in QA to change in Q . the consumer in such a way that the consumer does not
8 prefer any particular combination consumed; A
That is, slope ofIC =MRS
collection of indifferel'l.ce curves is known as
INDIFFERENCE CURVE MAP, as shown in figure 4.6
MRS= LiQA
. LiQs below.
A
4.3.2 BASIC TOOLS OF THE APPaOACH
The basic tools of this ordinal utility approach are:
(a) The indifference curves
(b) The marginal rate of substitution (i.e. the
slope ofIC) and
(c) The budget line . . IC3 IC4
IC1 IC2
These basic tools are used to explain the equilibrium of B
B
the consumer. By equilibrium we mean consumer's
choice of a commodity that produces the best utility. Figure 4. 6 Indifference Curve Map
144 Modern Microeconomics: A practical Arithmetical Approach
4.3 .3.1 CHARACTERISTICS OF
INDIFFERENCE CURVE
1) The indifference curve slopes downward
(that is, it is negatively sloped). The
negative sloping is the result of the
reduction in the quantity of a commodity
consumes in order to increase the
consumption of the (alternative)
commodity, blft yielding the same level of
satisfaction or utility. This is why the
indifference curve is known as ISOUTILITY
curve or EQUAL UTILITY curve.
2) The higher the indifference curve, that is
the farther the indifference Curve to the
right from the origin, the higher the
satisfaction. This means that consumers
will desire higher indifference curves and
that shift in indifference curves are
indications of higher preferences and
satisfaction.
3) The indifference curve is convex to the
origin. That is, it is relatively steep at the
top, curved towards (inwards) the origin
and relatively flat at the bottom. This is
because as the consumer gets more of
commodity Bas shown in figure 4.6 above,
he gets less of commodity A, that is trading
Theory of Demand Behaviour 145
THE
of A for B. This results in the slope falling.
It is possible for the indifference curve to
be linear (straight line) or even concave to
the origin though in rare occasion. When
the indifference Curve is linear, the slope
will be constant and the marginal rate of
substitution will be the same all through
the trading-off process. But, if the curve is
concave to the origin, there is an increasing
marginal rate of substitution (i.e. positive
slope). A linear indifference curve indicates
that the commodities are perfect
substitutes. Commodity with equal
complementary strength (i.e. one-to-one
relation) will produce a right-angled IC.
Another issue about this convexity of
indifference curves is that at the top, the
trade-off between commodity A and B is
such that the consumer has more of A and
will therefore require more of A to be trade-
off for less of commodity B. The reverse is
the case, at the bottom of the curve, see
figure 4 .7 below.
Indifference curves do not meet or intersect
each other. This is because, if they meet
the consumer will not be consistent in his
preference since two different sets or
combination of the commodities will
produce one utility. Where this happens,
146 Modern Microeconomics: A practical Arithmetical Approach Them y <lfDemand Behaviour 147

there will be no TRANSITIVITY. For A

instance, in figure 4.8, the intersection of (d)
indifference curve 1 (IC 1 ) and indifference Right-
curve 2 (IC 2) at point X means that a angled IC
combination of A 1 and B 1 will produce both
100 utils as well as 200 utils (assuming
ineasurability of utilities). This is hardly
possible. The intersection also implies that
the combination of A.J and B2 as well as A2 0 B 0 B
and B2 will result in either 100 u tils (IC 1 ) or
Figur·e 4. 7 Different Shapes of Indifference Curve
200 utils (IC2) . This too is not possible as
(IC)
shown in figure 4 . 8 since A.J + B2 will
result in IC2, while A2 + B2 will yield IC i .
A
AJ I '• \
A A A2

(a) A1
Convex
i-'
. ........, ,

I~
· - - - --_J.£1 (100 Utils)
IC
I
I
. --
---·
ICJ.2 (200 Utils)

~ B1
0 B 0 B
Figur·e 4. 8 Intersection of Two Indifference Curves

4.3.4 MARGINAL RATE OF SUBSTITUTION

As stated earlier, an indifference curve is formed when
the points showing the sets of combination of at least
 148 Modern Microeconomics: A practical Arithmetical Approach Theory of Demand Behaviour 149

two commodities that yield the same utility are joined in Solution 4.3
a graph. It shows the various trade-offs. The rate at
which one commodity is traded-off for another Marginal Rate of Substitution (MRS) is the slope of an
comparative or complement8;ty good is known as the indifference curve and is the ratio of change in plates of
slope of the indifference curve or Marginal Rate of pepper soup to change in the plates of rice.
Substitution (MRS). The MRS therefore is given as: .1Hy
i.e. MRS= /.1P
. r
M/.1B
Where .1P8 =change in plates of pepper soup
The MRS, as far as the isoutility approach is concerned,
decreases as one commodity is traded-off for another .1Pr =change in plates of rice
commodity. This is illustrated below.
Combinations Ps Pr .1ps .1pr MRS
Illu$tration 4.3
1 18 3 - ,.. 3
The fol~owing data shows the various combinations of
II 12 4 -6 1 -6
plates of pepper soup and rice that Oappa with his
III 7 7 -5 3 1.7
friend's took for a level of satisfaction.
IV 3 12 -4 5 -0.8
Combinations Plates of
Plate of Rice v 1 23 -2 11 -0.2
Pepper soup
1 18 3 Illustration 4.3 above shows that DIMINISHING
II 12 4 MARGINAL RATE OF SUBSTITUTION results as more of a
III 7 7 commodity is given up to gain more of another .
IV 3 commodity, if the consumer is expected to remain at the
12
v same level of utility ~ This is because the commodities
1 23
are perfect substitutes. Even if two commodities
perform the same work, consumers' have psychological
Calculate the m arginal ra tes of substitution
attachment to either of the. two commodities. This
. psychological attachment or preference is what is
 150 Modern Microeco11omics: A practical Arithmetical Approach The01y o/De111a11d Behaviour 151

known as SUBJECTIVE MARGINAL UTILITY (Sub-MU)., For instance, if the consumer has an income of NlOOO
The sub-MU of the quantity of a commodity decreases and wishes to consume a combination of plates of rice
fast with respect to another commodity whose total and salad and plates of pounded yam. If the price of
quantity consumed is on the decline. This is why as the plate of rice and salad (PRs) is N200, while the price of
quantity of one commodity (say plates of rice) increases pounded yam (Py) is N ~ 00, the consumer can purchase
and the quantity of another (Say plates of pepper soup) a maximum of 5 plates of rice and salad or l 0 plates of
decreases, the sub-MU of Ps increases and the sub-MU pounded yam. The line that links these maxima on the
of Pr declines. Consequently, the consumer (Dappa with horizontal and vertical axes of a graph is what is referred
friends) will be increasingly unwilling to trade-off more to as LINE OF CONSTRAINT or budget line as shown in
of Ps for Pr, and hence any more necessity to trade-off · figure 4. 9 below.
will result in more of PI( for any marginal loss of Ps in
QPRs
order tQ remain on the same level of satisfaction.
5
4.3.4 THE BUDGET LINE
The consumer's ability to purchase any quantity of a 4
~Budget Line
commodity or the ability to attain any indifference curve 3
depends on the consumer's money, the price(s) of the
2
commodity, and the relative importance of the
complement or substitute. This implies that the ' 1
consumer's ability to maximize ·his utility is limited by
these factors. These factors, especially the resource of
1 2 3 4 5 6 7 8 9 10
this consumer (money) is limited in supply. The
QRy
consumer cannot acquire the desired quantity of
commodities if the prices ate higher than expected. This Figur·e 4. 9 Budget Line
is why these factors are taken as BUDGET CONSTRAINTS
or BUDGET LINES or LINES OF LIMITATION. The budget line shows the possibility of spending tht•
budget on the two (2) commodities given the price of the
l'he budget line therefore shows the highest quantity of commodities. That is, all possible combination of two
t•nch c~mmodity that the consumer can purchase given commodities must be on the budget line or below 1lw
his income (budget) and the prices of the commodities.
 152 Modern Microeconomics: A practical Arithmetical Approach
Theory of Demand Behaviour 151

budget line. Any combination whose combined value

and Os= Y/Ps-PA/Ps (QA)
falls above the budget line can not be bought with the
income at the consumer's disposal. The area below and The QA and Os equations are also known as budg
including the budget line is known as FEASIBILITY equations . The plotting of the different values of QA ond
AREA, while the area above the budget is known as the the corresponding .PA, and Ps respectively, on a gra ph
NON-FEASIBILITY AREA. It follows that the budget line is produces budget lines that are downward sloping.
equal to the price of each commodity and the different
The above shows that the slope of such budget lines an·
quantities of each of the commodities that the consumer
the coefficients of Os and QA in the QA and Q8 respectiv
can consume to achieve a given level of satisfaction.
equations. These coefficients are Ps/pA for Q8 , and
This is why the budget line is defined as the graphical
PA/Ps for QA.
presenta•tion of t ¥ BUDGET EQUATION.
Mathematically, the budget constraint will be given as: On the other hand, the slope of the line of limitation is
the ratio of the change in the quantity of Y to change in
Y=PAQA +PaQa
the quantity of X. That is,
Where .Y = Budget or Income . Slope of Line of Limitation (P 1Qi) = !lYjt:;X = 0Pif OQ 1
PA = Price of Commodity A in figure 4. 10 below.
P8 = Price of Commodity B
QA = Quantity of A, the consumer can afford
Given price >-
Qa = Quantity of B, the consumer can afford .0 P1
;a
0
given price. 8
8
0
Since only the prices and the budget size are known, the u
quantity A or B that .the consumer can afford will be
obtain ed a s :
QA rn. y - PeQs and Oa y - PAOB
PA Pe 01
Commodity X
=Y/n
rA
- Fh/n
rA
(Qa.)
Figu1·e 4.1 0 Slope and Shifts in Budget Line
 154 Modern Microeconomics: A practical Arithmetical Approach Theo1y o_/Demand Behaviour 155

1-.4 EQUILIBRIUM OF THE CONSUMER

4.3.4.1 SHIFTS IN BUDGET LINE
As can be seen in figure 4.10, budget lines of an
individual can change position or direction. A budget
line can shift completely, producing another budget
line. An increase in the income of the consumer will shift
the budget line outwards to the right-hand side of an
existing budget-line, while a decrease will move the
budget line inwards to the left. From figure 4.10, a shift
I
Since income and price of commodities are restrictions
o 11 t he level of indifference curve attainable by the
('onsumer, he can maximize his utility by staying on the
highest indifference curve within or with the budget
line. The consumer can therefore maximize his utility
where the highest attainable indifference curve is at
tangent with the budget line. At that point, the slope of
the indifference curve (MRS) will be equal to the slope of

can be the change from Pi Qi to P3 Q3. the budget line. That is the point where
A change in the direction of the budget line, on the !Y.Yj Px
other hand, occurs as a result of change in price of !1X =-
Py
commodities involved. In this case, when there is a
Where /1 Y/ b.X = Slope of indifference curve
reduction in price of a commodity; the consumer will be
1
dispos~d to buy more of the commodity, all other things ~Py =Slope of the budget line, and
being equal. One of the things that will be assumed
equal or constant is the fact that the extra money MUx
income will not be spent elsewhere, or saved away, but
= Condition of equilibrium under the
MUv
Utility theory
will be used for the purchase of the commodity. Where
such happens, the budget line will change direction This can be seen from figure 4. 11 below
from .an existing direction, outwards to the right though
originating from the same point. Conversely, if it is an
increase in the price of the commodity the direction will
be inwards to the left, leaving the consumer with little
quantity of the commodity to afford. In figure 4.10 above
IC2
this can be seen when the budget line changed from IC
Pi Qi to Pi Q2. If it were from Pi Q2 to Pi Qi then it should 0 \.ll "l2
Qx
have been a reduction in price of Xi. Fig. 4.11 Equilibriumo/Con.sumer
 15'6 · Modern Microeconomics: A practical Arithmetical Approach Th eory of Demand Behaviour 157

In figure 4.11, there are two indifference curves (IC 1 and By transposition or simple selection of the like terms
IC2). IC1 falls within the feasible area which means that MUv /':,.X
the utility of the consumer is not maximized, moreso =
MUx /':,. y
when it is higher than the closest budget line (Y2Q2) and
it is not the highest possible indifference curve. I~ is I
of course, MUv
the highest indifference curve of the consumer given the MRS
MUx
highest budget iine (Y3Q3). Any budget line apart from Therefore, at equilibrium,
Y3Qs is lower than the capacity of the consumer. IC 3 and
MUv /':,.X Px
Y3Qs intersect or are at tangency at point M. At point M, MRS= - = -=-
MUx /':,. y Py
the slope of the indifference curve (IC3 ), given as /':,.Yl!!:.x :
is equal to the slope of the budget line given as OY3/0Q3. 4.1 Effects of Change in Price
We have stated that a change in the price of a
That is ' OY3 -
_ LlX
- commodity will rotate the budget line (BL) outwards or
OQ3 /':,. y inwards from the same point on the price (vertical) axis
This is the equilibrium point of the consumer where the depending on whether the change in price is a fall or rise
slope of the indifference curve and the slope of the in the price of the commodity respectively.
budget line are equal.
If the price of orie of the commodities is allowed to
Another way to look at the equilibrium of the consumer increase, while all others are held constant, the increase
is from the marginal utility angle. We have stated earlier will make the BL to rotate inward since the capacity
that the indifference curve is th.,e locus of points showing (power) of the consumer's budget relative to the
the various combinations of commodities consumed. commodity will reduce. At each BL there is bound to be a
We also said that the movement along the indifference point of consumer equilibrium. The. locus of the points
curve (IC) results in the loss of one of the commodities to of equilibrium is known as PRICE CONSUMPTION
gain more of the other commodity. ·It means therefore CURVE. This is shown
l
in figure 4.12 below.
thatthe
MU of the loss = MU of the gain

That is, MUy. /':,.Y = MUx · /':,.X

 158 Theory of Demand Behaviour 159
Modern Microeconomics: A practical Arithmetical Approach

calculating the equality between the slopes of the new

BL and the IC, instead equilibrium will be the point
B1 where the new budget line crosses the pri~e
consumption curve.

By extending the quantities from the upper section to

the lower section and joining the points where the
quantities cross their respective prices at d, e, and f, the
0 iAa ! A2 A1 consumer's · demand curve is derived as shown in the
iQudntity of A
'' . lower section of figure 4. 12.
D
'''
''' Another very useful point from the analysis of the effect
P3~---------··· 'f1~i
'
''
'
''
of changes in price is that the nature of the price
P2~-------·----f-----! e1~, consumption curve (PCC) can be used to determine the
:' r' '
I
type of price elasticity of demand for the commodity. For
P1~---·········t-····t····· i d1
QI i J i D
instance, when the PCC slopes gently upwards to the
Qs3 Qs2 "Qs1 right from the origin, or slopes gently downward to the
Qua~tity of A left from a higher IC and BL (especially when prices are
Fig. -4 .13 Effects of Changes in Price and Demand rising) demand is said to be FAIRLY ELASTIC. When.the
Curve Derivation PCC slopes downward to the right as price falls, demand
is said to be FAIRLY ELASTIC. When the PCC is
In figure 4.12 above, price of commodity A increased horizontal as price changes (whether price rises or falls)
from P 1 to P3 resulting in the creation of budget lines demand is UNIT ELASTIC. In this case, the distance
Bik and B1A3 from B1A1. On every BL there is a point of between the BLs are equal.
equilibrium shown in the upper section as d, e, and f.
And the line MN, whichjoins d, e, and f, is known as the 4.4.2 EFFECTS OF CHANGES IN INCOME
PRICE-CONSUMPTION CURVE. The curve shows the Just as in 4.4.1 above, if only the income (budget) of the
point of equilibrium of the consumer given either the BL consumer is allo~ed to vary, this will result in the
or the quantity. For instance, should price be between shifting of the BL inwards to the left or outwards to the
P2 and P3 (meaning a BL between B 1A2 and B 1A3), there right. The BL will shift (i.e. a completely new BL created
should be no need to obtain the equilibrium point by that will be parallel to an existing BL) to the right if
 160 Modern Microeconomics: A practical Arithmetical Approach
Theory of Demand Behaviour 161

income or the proportion of income budgeted for the

purchase of the commodity or commodities increases, Income
else it will shift to the left if the budget reduces. Again,
on each BLthere will be an equilibrium point. The line
joining these points of equilibrium is known as the
INCOME- CONSUMPTION CURVE (ICC) as shown in
IC3
figure 4.13. The ICC shows the quantity of a commodity
a consumer buys at different sizes of income. Therefore
norm.ally, when income increases, th,e consumer will 0
have more capacity to buy more of the commodity, Income
hence the shift of the ICC to the right. Again, the
directioh of the ICC can be used to identifynormal goods
and inferior goods. For ·instance, the ICC for normal
goods slopes upwards at increasing rate and later at
decreasing rate. This makes the ICC to be steep first and
later gentle
I
as it curves. to the northeast from its origin. 0 Qty. of B
The ICC for inferior goods curves first towards the
Figure 4.14 (a) ICC for Normal Goods (bJ For Inferior
northeast but later to the nortl;lwest from its origin. This
is shown in figure 4.14(a) and (ti). Goods

Income
4.4.3 Combined Effects of Price and Income Cbaiige
It is commonplace by now that a consumer is taken for
granted that an increase in income or a fall in price will
·Engel curve (ICC) make the consumer to buy more (i.e. move to a higher
..............,
'

level of satisfaction as shown by his point of equilibrium

a
to a higher IC). But, this movement to higher JC takes a
process. This process combines the effects of change§ iJl
0
price and the income of the consumer. In orQ.er to
Quantity of 8 understand this proce$s, we have taken jY$t Qft~ of
these changes and preGis~ly th~ ch~n~ in price.
Figure 4.13 Effect of Changes in income Supposing there is a . ris~ in. price, thi§ will m~ the
budget of the consumer smallt!f, that i& ii le&§ of
 Theory of Demand Behaviour 163
162 Modern Microeconomics: A practical Arithmetical Approach

purchasing power~ It is the loss of money income that is The graphical representation is shown in figure L.15
known as INCOME EFFECT. The income effect makes below
the consumer to reduce the quantity purchased. The Y2
Y2
income effect will not be able to explain "how much"
reduction in the quantity, so that the consumer will still
be on the same level of satisfaction (utility). The answer Substitution effect
Income effect
to this question is what is known as the SUBSTITUTION 8"'0
EFFEC't. This means that the income effect is the .E
change in the quantity demanded attributable to the
gain or loss in utility or the change in the quantity
SL1
demanded due soiely from a change in the real (money) I I '
B{.(3
income, every other thing remaining equal. In this case I I
Price 'f'D1 1 '
of rise in price, it means that the consumer is less able
I
PL~
to buy additional or the same units of the commodity.
~I: 1

...
P2 •• e I
I\ F
The substitution effect, on the other hand, is the change Do .iL.......
in the quantity demanded attributable solely to the I . 1'0 I
I 1 I
I I
change in the relative price of the commodity, after the
OQA1QA2 QA1
income effect has been netted-off, it therefore follows
Quantity of A
that the combination of the income effect and the
substitution effect explains why a change in price will Figure 4.15 Income Effect and Substitution
result in a change in quantity demanded. The combined Effect ofPrice Change
effects are known as the PRICE EFFECT. In this In figure 4.15, price of comm.odity A increased from P1 to
discussion, one basic assumption is that the budget for
P 2 • While at P1 , the real income of the consumer was Y1,
the consumption of the commodity must necessarily be
but the rise in price meant a decrease in real income
exhausted in demanding for or consuming the
commodity. This assumption .explains why the from Y1 to Y2 as shown in the upper panel. Also, at price
consumer will not cross-demand in the case of rise in Pl the budget line was BL 1 but the rise in the price
price or will not consume alternate commodities with a rotated the budget line to BL2 • Consequently, the
fall in the price of the commodity. consumer's equilib:ria were "a" on IC 1 and "b" on IC2,
hence the demand curve DoDo with equilibria of "f' and
 Theory of Demand Behaviour 165
164 Modern Microeconomics: A practical Arithmetical Approach

i 11 price) will fall vertically above the imaginary point of

"e". But the movement from "f' to "e" in the lower panel <'quilibrium and the new and old ICs will be parallel to
or from "a" to "b" in the upper panel is not automatic. euch other with the same slopes. In this only the
There was a loss of real income before the reduction in ., ubstitution effect would cause the change in the
the quantity. In order to identify these effects, an quantity demanded
imagin:;try budget line is created. This imaginary budget
When the income effect is negative, the size of the effect
line is the dashed budget line (BL3) which is tangential
would determine . whether the commodity is just an
with IC 1 at "c". The BL3 is parallel to BLi as a way to
inferior good or a Giffen good. For ordinary inferior good,
compensate assumingly for the loss in income. Point "C"
the negative income effect is smaller than the
lies in-between "a" and "b", such that the quantity
substitution effect such that the new point of
QA1 QA3 is divided into two (Le. QAi QA2 and QA2 QA3 ).
equilibrium resulting from a fall in price will fall between
The mo~ement from "a" to "c" is what Hick (1956) called
I
the first and the imaginary points to equilibrium. The
the income effect of price change, while the movement
price effect is still an · increase in the quantity
from "c" to "b" is the Substitution Effect. The effects of
demanded. But for inferior goods, the income effect will
these movement are seen in the rotation of the demand
be bigger than the substitution effect. In this cas~ the
curve from D0 D0 to D 1 D 1 at point "e" in the lower
n ew equilibrium point from the fall in price will lie to the
segment of the diagram.
left hand side of the first equilibrium point. For luxury
The above shows that the substitution effect is said to be or ostentatious goods, the new equilibrium point will lie
negative since an increase in price will lead to a decrease to the right of the first point with a rise in price.
in q1:1antity demanded. But the income effect could be
4.5 EFFICIENCY IN EXCHANGE
negative if price
. rises. or positive if price falls. When
One area where the ordinal utilities theory is applicable
there is a fall in price the income effect and the
is in exchange relationships between people. Vilfred?
substitution effect move in the same direction, but while
Pareto, in one of\ his extensive use of the indifference
substitution effect .is negative, income effect is positive.
curve analysis, postulated that the ordinal utility can be
.. When t.here is a rise in price, income effect becomes
used to determine equilibrium in exchan~e between
· negative while substitution effect remains negative.
parties even without involving money. Accordingly,
This means that the income effect can be zero,
exchange is efficient where people exchange products
som~times . When income effect is zero, then the new
optimally, that is at a point where no one party in an
point of equilibrium on.the higher IC (in the case of a fall
 166 Modern Microeconomics: A practical Arithmetical Approach
) Theo1y of Demand Behaviour 167

exchange is made better-off without making the other ~.6 CRITICISMS OF THE ORDINAL UTILITY
party worse-off. This occurs where the indifference APPROACH
curves of the two parties is tangent to each other. The There had been several criticisms against the ordinal
box containing the set of opposing indifference curves is utility approach, some of which are:
called EDGEWORTH BOX while the point of tangencies
1) The indifference curve is assumed to be
are called PARETO OPTIMUM POINTS and any line
smooth and continuous. This
joining the pareto optimum points is known as the
assumption is not always true and not
EXCHANGE CONTRACT CURVE. These are shown in
very realistic.
figure 4. 16 below.
~ B
2) The approach considers only the price
of the two commodities in question
while neglecting possible changes in the
prices of other commodities, which can
Paretor affect the consumption of the two
~ \ =r= i::;::::..optimum Point
goods.

3) Even in the analysis, the approach

concentrates more on the changes in
one of the pair of goods. This could be
highly misleading as the change in the
4.16 Edge worth Box withfi.ts Contents
commodity so considered could
Figure 4.16 shows the edgeworth box containing sets of
influence or be influenced by the
opposing indifference, curves for consumers A and B
circu mstances of the second
engaged iii an exchange of commodities Y and X. The
cpmmodity.
convex ICs belong to consumer A while the concave ICs
are for consumer B. Points m, n, and k are the points of 4) It is not realistic to assume that the
equilibrium while the curve ECC is the exchange consumer ·has a perfect knowledge of
contract curve. The ECC shows the points of efficiency his preferences and tastes, hence the
of exchange between the parties A and B.
168 Modern Microeconomics: A practical Arithmetical Approach
ranking or ordering of these preference
and tastes.
5) The approach is also criticized on the
comfortable use of just two- commodity ·
consumption scenario in analyzing the
consumer's behaviour. This means tha t
complicated mathematical equations
and computations will be used for th ree
or more commodity situations.
6) The approach is also criticized on de-
emphasis on money when in reality
most economic actions monetarily
determined.
169
CHAPTER FIVE
THEORY Of PRODUCTION
5.1 INTRODUCTION
Production has been defined as the transformation of
inputs into outputs . In the course of th is
transformation, certain task elements (called factors of
production) are processed. The method of processing
these factors of production is simply referred to as th e
technology. However, technology is very dynamic a nd
therefore has been changing, as long as scientifi c
discoveries are made. This technical aspect of
production is what makes some people think that ther"
are five (5) factors of production namely land, labour,
capital, entrepreneur and technology.
Whichever way it is considered production h as
symbiotic/ symmetrical relationship with consurnp1 io11
and the two are complementary and complete t he
economic cycle. This is way production involves the
activities that are engaged in the provision of goods 11 11 d
 0 Modern Microeconomics ~ A practical Arithmetical Approach
services. These activities have to · be efficient in the
utilization of the various factors of production.
There can therefore be no production without potential
d emand. And for the produced goods and services to be
ommensurate with the expectation of consumers,
production should both be efficient in producing more
outputs, and effective in producing output by
minimizing cost and maximization revenue.
In this chapter, we attempt to show how the producers
perform this t~ansformation of inputs into outputs in
such a· way that they are able to proffer solutions to
some of the expanded versions of the basic economic
questions of what to produce? how to produce and what
level of efficiency in production? The expanded
questions include:
(a) What do consumers want?
(b) What is the expected standard (quality) of
this identified commodity
.. (c) What are the resources for the production of
these commodities, and what are the
quantities of inputs
(d) At what level can production be optimal?
(e) Can the minimal (i.e. most effective and
efficient) cost be attained?, and
Theory of Production 171
(f) What is the role of technology in productio11
process or in manipulation of inputs fo1
outputs.
These and many more questions confront the producer,
and the questions simply point to the importance of this
study on the theory of production. We have summarized
these importance into three, namely:
(i) The theory of production is the basis for
analyzing ·the relations between cost and
volume of output.
(ii) The theory serves as the basis for th<.·
theory of demand of the firm's factors of
production.
(iii) It proffers answers to questions on scale of
operation as well as what to produce, how
to produce and the efficient allocation or
utilization of resources.
5.1 CONCEPTUAL DEFINITION OF BASIC TERMS
Inputs and Output
Inputs are the resources used up in the productio11
process. Inputs are all the things a firm buys for use i11
its production process (Baumol, 1985:267). This mean~
that inputs include the four factors for production and
more. In general, economists define inputs as land,
labour, capital, entrepreneurial skills, time, technolotzy ,
etc.
 II Modern Microeconomics: A practical Arithmetical Approach
< >11the other hand, output refers to the result from the
1>rod uction process in the form of goods or services
(tlimp1y called product or commodity). · Outputs are
11u•ns ured in units or in terms of time (e.g. man-hours).
When stated in definite physical units, they could be
1 derred to as PHYSICAL PRODUCT else just product.
hort-run and Long-run
These are two concepts used by economists to describe
t lie timing of production process. The distinctive
clt'finition of these concepts is not universal because a
' given scale of operation, is elastic.
"hort-n1n to a firm could be a long-run to another firm .
C:enerally, short-run refers to the time period when
<'t'rtainty and constancy of production conditions exist.
l 11 su·ch a period, the supplies of inputs are assumed to
I><· nxed or inelastic and output is relative to the known
quantity mix of inputs. Also it is a period when full
lrn owledge of issues relating to input and outputs
<:xists .
011 the other hand, long-run refers to a time period
when · all adjustments and variations of inputs have
f11kcn place, and therefore supply of these inputs
l>c•c•ome elastic. In this time period, changes in output
will be dependent on change~ in the employment of both
vurioble and fixed inputs. It could cover a time period
when technology is expected to change and hence
clwnge the production process and production mix.
Theory of Production 171
Fixed and Variable inputs
An input is fixed if its supply within a short run and for n
given output level is constant or inelastic. This mean .
that no matter the total demand for this input, tlw
quantity supplied remains constant. Variable inputs ,
on the other hand, is the input that changes with
changes in the level of operation. That is, as output or
level of production changes, the variable inputs change .
It is the input whose supply, in the short-run and for u
5.2 PRODUCTION FUNCTION
Production function is the name of quantitative relation
between the inputs and outputs. The input-output
relation can be graphically present and the curve shown
by graph is known as the production curve(s). Thi8
means that the production function can be in a tabular
form (Production Schedule) or in mathematical form
(Production Equation). Production function shows th<
minimum and maximum quantities of output to b<·
produced from given quantities of inputs in a given timr
period. Again, it is the description of the technologicnl
relationship between inputs and outputs in physicnl
terms, although the output need not necessarily I><'
physical. This is why some authorities and research<·•
refer to the outcome of the transformation proc e~rn o
physical product, hence Total Physical Product (Tl 1P)
Marginal Physical Product (MPP) and Average Physical
 174 Modern Microeconomics: A practical Arithmetical Approach Theo1y ofP roduction 175

Produc~ (APP). The other implication of this definition is the four factors of production, land is reason.a bly fixed
t hot every firm has a production function. The form of in supply by nature, and entrepreneur also is constant
the production function depends on the technological because the ideas of the founders of a firm do not vary as
Htate of the firm. When technology improves a new output varies .. It takes a long time for entrepreneur or
production function is created. land to vary. This is why it is said in economic parlance
that in the long-run all factors or inputs are variable ..
There are many inputs found or used in the production
The · Cobb-Douglas production function states that
process, and an analysis of 'the multiple flow of inputs-
labour contributes a greater proportion of the inputs
outputs relation could be complex, hence the limiting of
and it varies more than any other factor as production
the analysis to the Cobb-Douglas production function.
increases. This is why in the discussions following,
fhe Cobb- Douglas production function considers just
labour is mostly varied while capital is held constant.
two inputs (labour and capital) in the production
Mathematically, the general production function is
process. By this function the most efficient method or
point of production is sort. However, in reality, stated thus:
production function is more technical than theoretical. Q = f(L, K, E , l)
Note that a particular production method is said to be Or for the two inputs case:
more efficient than another if the former produces a Q = f(K, l)
commodity with smaller quantity of inputs than the Where, Q =output
tlternaiive method(s) in the production of the same L = Land, K = Capital, E = Entrepreneur,
quantity of output. Efficiency here means both l= Labour
technical and economic efficiencies. Technical
But the Cobb-Douglas function is stated as:
fficiency refers to the use of minimal quantities of
nputs but resulting in more than the proportionate or
111nxi.mum output. Economic efficiency refers to the
Y·1 =R.·x x
1-1l
82
2i
83
3i {,
/JUi

production of the maximum output with the least cost

WhereB2 the partial elasticity of output
combination of inputs, that is .least cost combination
(Y) with respect to labour input (X2)
µoint or m ethod .
B3 = partial elasticity ofY with
Another reason for the use of labour and capital as the
respect to capital (X3) input
inputs in a theoretical production process is that out of
 The01y of Production 177
17(> Modern Microeconomics: A practical Arithmetical Approach

(e) The factors of production are in the short-run

B2 + B3 = Scale of Returns inelastic in supply .
. 2.1 ASSUMPTIONS OF THE PRODUCTION
In the above forms of production function, there iH
. FUNCTION
uniformity with reference to the existence of returns to
Whether the production function subsists from the scale (~) and efficiency parameter ( J. ). Generally, th(•
'obb-Douglas' two factors such that Constant Elasticity of Substitution (CES) collapses into
Q = f(k,.e,~andf.)
two-factor production function. This is because land
and entrepreneur do not change in the short-run. That
Or the production function is originated from the is, land will remain constant, with periodic
Constant Elasticity of Substitution (CES) which improvements as a result of technology. Besides, tht'
'
1 ppears thus
classicalists assumed that land is natural and will not
Q = f(L, K, R, l, p, J. increase, instead it can decrease or it can lose it H
productivity. But in modern world, land can b<·
Where Q, L, .e and k are as defined above increased through reclamations. Similarly ,
R = Raw materials entrepreneur is assumed to be constant in the short
~ = Returns to scale run but vary in the long-run. Because the person, who
A = Efficiency parameter had the vision or ingenuity to commence an economic
activity like production, will not naturally want others to
There are certain basic assumptions on which the
join.
production function hangs. Some of these assumptions
Include: As for ~ (the returns to scale); it is a long-run m atkr
(a) There are only two factors of production in the since it depends on changes in the quantities of other
analysis of production. The two factors are inputs or changes in the size of operation (i.e. return8 t n
capital and labour; scale) . And the efficiency parameter (J.) refers to the ski 11,
(b) The factor inputs and outputs are divisible, ingenuity, commitment and competence of U11
measurable in quantitative terms; entrepreneur. This is simply referred to as t:l 11•
(c) The factors of production are substitutable on a entrepreneurial skill, organizational acumen, nr
limited basis; entrepreneurial-organization content of productio11 .
(d) There is a certain level of technology; This factor input makes a lot of difference bctwf•(·n
 178 Modern Microeconomics: A practical Arithmetical Approach
•qually endowed firms (in the sense of materials, plant
size, etc) with respect to outputs.
fhere are two approaches to the study of the theory of
production, namely the Utilities approach and the
lsoquant approach.
5.3 THE UTILITIES APPROACH
This approach explains the relation between inputs and
outputs in physical units but excluding monetary
values. This is why the production function is
considered to be concerned with technical efficiency.
This approach therefore is a study of the technological
link between the quantities of inputs and outputs. The
cost aspect is considered under cost analysis where
production decisions are made.
The approach assumes that even if two factors of
production are considered in the study of the relation
between inputs and outputs, both are not expected to
vary at the same time in the short-run. The approach
states that the quantity of output varies as the variable
input varies, even though the rate of variation swings
from increasing to decreasing. This means that if the
variable input increases, the total output produced will
increase initially but output will decrease with the
ontinued addition of the variable input after a certain
level of production.
Jn the same vein, as the output expands or increases the
ratio; relation, or PROPORTION existing between the
fixed and variable inputs is altered. Painting, printing,
Them:l' <f Production 179
snacks-making, etc. are examples of this condition. Thr
change in the proportional relation between fixed and
variable inputs is also referred to as the LAW OF
VARIABLE PROPORTION or LAW OF DIMINISHING
RETURNS. The law of variable proportion states that as
the total output increases as a result of continued
addition to the quantities of variable input(s), the rate of
increase in the total product (TP) or total output (TO)
becomes smaller and smaller after a particular point of
production. Note that the rate of change in TP with
respect to the variable factor (Vf) is defined as MARGINAL
PRODUCT (MP) or MARGINAL OUTPUT (MO). This is why
the marginal product curve rises initially and then falls,
(even as~;uming negative values). Another stance of th<·
law of diminishing marginal returns is that both tht•
AVERAGE PRODUCT (AP) and the MARGINAL PRODUCT
(MP), which are derived from the total product (01
production function), increase and then decrease. Nok
that Average Product is the ratio of the total product to
total variable input, while the marginal product is thr
ratio of change in total output to change in variablr
input. And, when even the AP ahd MP rise first and
decline later, the rising and the declining of the MP h
usually faster than that of the AP. The MP curve, whrn
graphically presented, is the slope of the TP n11d
therefore the MP curve can continue into the sccrn u I
quadrangle (i.e. negative values).The implication of Uu
nature of the MP (quantitatively and graphically) is tlwl
the MP of the variable input diminishes as more unitf\ ot
the factor are used in the production process.
 Theo1y of Production 18 1
180 Modern Microeconomics: A practical Arithmetical Approach

This a pproach therefore studies the production process

or fu n ction such that it is used by the traditional TP
theorists to identify the efficient part of production.
Accordingly, the efficient part is defined as the range of
output within which, the marginal product (MP)
declines though positive. At this range, total product TP
Stage
(TP) increases as more units of the variable factor are I
tdded. This implies that the production function can be Stage
split into four stages namely: Stage IV
(a) When the production function increases at / _,/~ III
/ /

incre?-sing rate, /
/

/
(b) When it increases at decreasing rate, /
/
(c) When it is constant, and
(d) When it is declining
0 + ~ ~
Vnits ~f Vf
The four stages are named introduction, growth,
stabilization and declining stages respectively in
product cycle and .could be demonstrated in table 5.1
Product
and figure 5.1 below, using the normal two-dimension
Vf Unit
graph and for a single commodity or output. The
variable factor could be either capital (K) or labour (£),
L
but for this illustration, labour (i.e. number of men) has
hceh u sed.
Table 5.1 Production Function (with one Variable

Unit• ofVf Total Marginal Average Stages

INo. Of Menl Product Product Product
I. 1 1 .00 1 . 00 N'
I
2. 4 3.00 2.00 Al g1
3. 8 4.00 2.67
II 0
4 . 11 0.vv ' '2 . f !:> MP
5. 12 1.00 2.40
III
Units of Vf
6. 12 0.00 2.00
7. 11 -1.00 1.57 IV Figure 5.1 Production Function
- 8. 10 -1. 00 1.25
 182 · Modern Microeco11omics: A pradical Arithmetical Approach
From table 5.1 above, it can be seen that there were
\dditions to the units of variable factor (Vf) in the form of
number of men. The increases to the labour resulted in
the total product (TP) increasing from 1 unit of output to
u maximum of 12 units before declining to 10 units. The
table shows that the highest unit of MP is 4, which
occurred at 3 units of Vf. Thereafter the MP declined
until at 6 units of Vf when the MP became zero (0) . The
point where MP= 0 is the same point where TP is highest
at 12 u n its . ThJs markes the boundary between stages
III and IV. In stage IV all fuhctions or curves decline . But
in stage III only TP was increasing while MP and AP
declined. The table also revealed that though MP
increased faster than AP, MP also declined faster. This
expliHns why the MP reached its maximum earlier than
AP a t 3 units of labour instead of AP'S highest (2. 7 5
units) at 4 units of Vf. The MP declined and became
equal to AP curve when AP curve is highest. This is the
boundary between stages II and III. In stage II, MP
begins to decline as against increases in TP and AP.
Stage II is the area between the highest MP and the point
where MP =AP.
A producer will produce efficiently when the MP and AP
are declining but with positive values. This is because at
such range of p roduction, TP rises even though less of
the Vf is employed and this means that the producer's
incremental cos ts a re not rising instead they are
Theo1y of' Production 183
declining. This also means that whereas revenue (which
depends on increasing total product) will be increasing,
incremental cost may not be rising proportionately,
hence profit maximization. Anywhere outside this stage
will result in irrational production decision because
either the fixed factor inputs (and of course their costs)
will be too abundant and overbearing that output (or
revenue) cannot cover. This is the case in stage I and II.
Or, any more addition to the Vf results in negative MP
and therefore TP cannot increase with the employment
of more of Vf as is the case with stage IV. If the producer
desires to increase TP in stage IV, then there must be a
change in the variable proportion, most likely an
increase in or variation of tne initial fixed factor. This is
why stage III is acclaimed to be the most efficient stage
or the stage where the LEAST COST COMBINATION OF
FACTORS occurs. Note that the combination of factors
that can result in the desired output level depends on
MP arid the respective prices of the factors or resources
used for production. It follows, that the maximization of
output or minimization of cost occurs where the ratio of
MPP per unit price of one input equals the MPP per unit
price of the other input.
That is MPK = MPz
PK Pl
 184 Modern Microeconomics: A practical Arithmetical Approach Theo1y a/Production 185

Drawing lines through these points to the horizonta l

MPK= ~l
Or, (labour) axis at A, B, C, A1 , B 1 , C 1 splits the areain the
MPz PK
two dimensional graph into the four parts or stages.
Curves such as shown in figure 5.1 are of general
That is why the traditional theorists' assert that the
n ature. In particular situations (or even in practice)
least cost combination requires input prices that must
there could be many of these curves and in different
be proportionate to the respective MPs.
though similar shapes . For instance, the stage of
Graphically, figure 5.1 demonstrates the four stages of increasing MP could be absent, long or brief. It is also
production with stage III being the most efficient stage. possible that when diminishing, the MP could be very
In figure 5.1, there are three (3) points of tangency in the sharp or very slow as witness in figure S. 1 between 2
upper graph, ' which form the boundaries between the a nd 3 men. These properties have been summarized in
stages . These point are E 1 F, and G, which by extension table S.2 below.
are the equivalents of H, I, and Jin the lower graph
Table 5.2 Summary Properties of TP, MP,and AP
At point Ethe slope of the TP is maximal as can be seen Curves
clearly from the lower panel where point His the highest S tages TP MP AP
Stages 1 up Increases first Increases Increases
point on the MP curve.
to point E at increasing
At point F, the TP curve reaches its steepest point. At rate
this point in the upper panel the slope of the TP is given Stages 11 from Rate of increase Reaches its Continues to
as FB /OB, which is also the AP since it is TP divided by point E to switches from maximum, . increase
point F increasing to and begins
the corresponding number of men (OB). At point F, AP
decreasing to diminish
per labour unit is at a maximum as shown in the lower Reaches its
Stages lll from Continues to in Continues to
p art of the figure. At point F, MP= AP and these curves point F and I crease at diminish, maximum
intersect each other at point I in the lower panel. to point G and diminishing rate reaches zero (==MP) and
J respectively the begins to
Finaily, at point G, the TP is highest thereafter the TP diminish
curve declines. At point G, the slope ofTP is zero (0), this Stages IV from Reaches Becomes Continues to
is why the MP curve slopes downward to zero (0) at point point G and J maximum negative diminish
J in the lower panel. and begins to
diminish
 186 Modern Microeconomics: A practical Arithmetical Approach
5.3.1 SCALE OF OPERATION AND RETURNS TO
SCALE
One other benefit of the Utilities Approach is the use of
the concept to define the scale of operation as distinct
from returns to scale. Scale of operation is defined as
the level of operation of a producer and is decided by the
size of the resources or plant employed by the firm. This
means that it depends on the ratio of the variable
proportion engaged in the production process. It is
therefore common rule that the more the factor inputs
the greater the scale of operation.
On the other hand, returns to scale is the ratio of change
in TP to change in variable factors employed to produce
the output. In other words, returns to scale is the
volume of output produced as more variable factors are
employed. There are three types ofreturns to scale (RTS)
namely increasing RTS, constant RTS, and decreasing
RTS .. If the change in TP is more than the proportionate
change in inputs, returns to scale is said to be
increasing. When the change iri TP is proportionate to
the change in inputs, there is CONSTANT RTS. A
DECREASING RTS occurs when the change in TP is less
G rn phically, the three types of RTS could be as shown in
than the change in inputs. These definitions mean that
fig 11 re 5.3 below.
RTS shows the output-input relationship and exists
when a firm uses more units of variable inputs.
The returns to scale depends on two major factors viz:
(a) Indivisibility of factor inputs such as 1and
and entrepreneur. In the case of
The01y of Production 187
entrepreneur, which most people agree is a
constant or fixed factor of production, his
decision and himself cannot be s p 1 i t o r
utilized fractionally. In · this regard,
therefore, an increasing or decreasing
returns to scale will depend on the variable
proportion operating in the production
process . If the entrepreneur is very effective
and efficient especially in co-ordinating
other factors with a concomitant increase
in output, then an increasing RTS will
occur else a decreasing RTS occurs.
(b) Degree of specialization as postulated by
Adam Smith. Where there is more
specialization which depends on the
availability of requisite quantity of
inputs (e.g. labour), output will increase or
decrease. A disgruntled and dissatisfied set
of workers with specialization will result in
decreasing RTS. This could be an abnormal
situation, however.

188 Modern Microeconomics: A practical Arithmetical Approach
· - - - - - - - - Increasing
~onstant RTS
Decreasing
Figure 5.2 Types of Returns to Scale
5.4 . ISOQUANT-ISOCOST APPROACH
So far in 5.3 discussion on the production theory has
been based not only on the traditional theory of utilities
but also on the employment of a single variable input. In
this section, the number ofvariable. inputs is increased
from one to two.
A production function with two variable inputs, as in the
case of Cobb-Douglas production function, can be
represented by a group of ISOQUANTS. Like the
indifference curve treated under the theory of
consumption, isoquants show the different
comt?inations of units of two variable inputs (labour and
capital) that can be used to produce a given quantity of
output.
Theory o,fProduction 189
lt is also known as PRODUCTION INDIFFERENCE CURVE
or ISOPRODUCT CURVE. The word "isoquant" means
equal quantities. The isoquant slopes downward from
left to right like the indifference curve. It is also convex
to the origin. These properties of the indifference curve
are as a result of the negative slope of the curve, making
an increase in the units of one of the variable inputs to
be compensated by a decrease in the units of the other
input. This is simply a "trade off', and the trade-off is
called MARGINAL RATE OF TECHNICAL SUBSTITUTION
(MRTS). This MRTS measures the slope of the curve,
such as shown in figure 5.3.
QK
K2 Is3 = 300 units of output
.,,
Is2 = 200 units of output
Ko- -+I- >t::,
Al \ 1 --..1s1 = 100 units of output
0 12 QI
l1
Figure S. 3 Isoquants and Stopes
From figure 5.3 above, the isoquant shows the scale of
operation. This is· why the isoquant is defined as the
production function, which indicates the level of
production or output given the possible combination of
 190 Modern Microeconomics: A practical Arithmetical Approach
various units of variable factor inputs. For instance, is1
shows that 100 units of output can be produced with
any of the possible combinations of capital (k) and
labour (1) at the points shown on the IS1 curve (say A and
B). The slope of the indifference curve is the MRTS
which is stated as:
MRTS = Lik
AI
Since the output at.each indifference curve is the same
at all possible combinations of the inputs, it follows that
an increase in the output resulting from the addition of
units of 'one of the variable inputs, equals the decrease
in the output as a result of reduction in the units of the
other variable input (following the Cobb-Douglas
production function). As stated earlier, the gain in
output for 'a n extra unit of an input is the extra product
of that input and is known as the MARGINAL PHYSICAL
PRODUCT (MPP). Therefore, the increase in output for
extra unit of an input (say labour) equals the product of
the MPP1 and the change in labour i. e ~
Gain in output = MPPt x L\ 1
and Loss in output = M'PPk x L\k
Since the output remains constant,
Gain in output= Loss in output
and MPPt x l = MPPt x L\k
L\k MPPz
Hence, --=
L\l MPPk
From the above equation, it can be seen that the slope of
Theo1y ofProduction 191
the isoquant is the ratio of the marginal physical
products of the two variable inputs.
Again, since the addition of more units of one input
means the subtraction of more units of the other input,
the MRTS would be DIMINISHING. This is the reason for
the CONVEXITY of isoquants. This convexity is
equivalent to diminishing returns,
Another characteristics of the isoquant is that the
farther the isoquant from the origin the higher the scale
of operation or the output, as shown in figure 5.3.
Also, no two isoquants meet at a point. This means that
isoquants for a firm are parallel to each other. If they
meet, it means that two different sets of combination of
the inputs can produce two different levels of output.
For instance, in figure 5.4, at point A, where IS1 and IS2
meet, the same 20k + SOL can produce 200 units of
output as well as 100 units of output. This is normally
not possible, otherwise the quality of the outputs would
differ.
Units!
of K
IC
2 ·
IC 1 .,
20
~--IC2 = 200 ul')its
IC 1 = 100 units
0
50 Units of L
Figur·e 5.4 Intersection ofIsoquant
 192 Modern Microeconomics: A practical Arithmetical Approach
The isoquants can be used to explain the scale of
production as well as returns to scale (proportions).
Where isoquant are equi-distantfrom each other on any
straight: line drawn from the origin, there would be
CONSTANT RETURNS TO SCALE, in figure 5. 5
Ki I b <
7
,(),
' =:>< >< 00
L The scale of operation for any firm depends on the units
Figure 5. 5 Scale and Proportion
The isoquants (50, 100, 150, 200) intersect the straight
line OM,10N, and OF at equal distances between them.
This means that if the units of K and l producing 50
units of output are doubled the output doubles to 100
units and if the inputs are increased by 50% the output
increases from 100 units to 150 units. The lines OM,
ON, OF are called RAYS. Rays are curves (or lines)
showing the ratio of two inputs (as in this case, the ratio
ofKto ~·
Where the successive isoquants are steadily closer to
each other, there would be DECREASING RETURNS TO
SCALE. On the other hand, if the successive isoquants
ihemy of Production 193
are steadily spaced further apart from each other, there
would be INCREASING RETURNS TO SCALE. In the
case of increasing returns to scale, a doubling of the
output would require a less than proportionate increase
in the units of the inputs, while the reverse is the case
for decreasing returns to scale.
The line K1 Z shows how more quantities of l will be
employed to increase output while holding the K
F constant. This is called PROPORTIONS, i.e. the holding
of one input constant while increasing (or decreasing)
z output with varying units of another input.
5.4.1 THE ISOCOST CURVE
of inputs available (together with their possible
combinations) and the prices of these inputs. The
isqquant had been used to discuss the possible
combination of the various units of inputs for different
levels of output. The isocost is the relatiori of the prices .
of the inputs. The isocost shows the maximum possible
combinations of the inputs with reference to the prices
of the inputs. Where two inputs are employed, the slope
of the isocost shows the ratio of their prices.
That is, slope of isocost curve = =~
fhe isocost is also a downward sloping curve, though
linear as shown in.figure 5.6.
194 Modern Microeconomics: A practical Arithmetical Approach
The01y of Production 195

K
K

L
Figure 5. 6 lsocost Curve MAP
0 L
From figure 5.6 it could be said that the farther the Figure 5. 7 Best Combination and Expansion Path
isocost from the origin the higher the Total Cost Outlay.
5.4.2 BEST COMBINATION OF INPUTS
At these points the slope ofisocost ~ i1 and

The best combination of inputs would be at the point

where the cost of production is lowest. This is where the
isocost line and the isoquant are tangential. At such
(MPPL \
lsoquant \ MPPK Jare equal. .,,
point(s) the firm would produce by choosing the units of
the inputs that corresponds to the least total cost MPPL PL MPPL MPPK
outlay. This is why this point of tangency i~ called the l'hatis MPPK and - - =--
PK PL PK
LEAST COST COMBINATION POINT (LCCP). This is shown
in figure 5. 7 as points B, C, and D. l'he locus of these points produces a curve known as
11:XPANSION PATH (i.e. AE).
A11y change in the prices of the inputs will shift the
ocost curve further to the right or left parallel to the
p• <·ceding isocost. For instance, a fall in the price of an

196 Modern Microeconomics: A practical Arithmetical Approach
input will seemingly make that input to be employed in
greater quantity or it would free the other input to be
employed in higher quantity This can be explained in
the form of SUBSTITUTION EFFECT AND OUTPUT
EFFECT. For example, ifthere is a fall in the price of one
input, the substitution effect will be the employment of
more of that input whether .the Total Output (TPP)
changes or not. The employment of more units of this
I
input is for substitution of the other inputs whose prices
have not changed. This obeys the law of demand. Again,
where the other input, which has not experienced a fall
in price, is superior, more units of this superior input
would be demanded or employed in production, with the
Fall in the price of the less superior input. An input is
more superior (or simply superior) if it is used more in
production or it accounts for a higher proportion of the
total cost outlay.
~ith :~!~e fall in pr~ce of one input, the quant~ty o~ that
mput::ii:J.emanded
,, mcreases, and as more imagmary
funds · are available, the quantity demanded will
increase further. Note that with the fall in price, another
isocost curve is created to the right of the one before, as
in figure 5.8.
Theo1:)' a/Production 197
Units
of K
Pk2
Substitution Effect
,/
Output Effect
152
Qu N Units of L
Figure 5.8 Substitution and Output Effects
From figure 5.9, the original isocost line was PK 1M while
the new isocost created out of the fall in price is PK 1 F and
the imaginary isocost is PK 2 N. The imaginary isocost is
drawn by fitting a parallel isocost, which has the same
slope as the second isocost.
The first isoquant is IS 1 and the second is IS 2 . The
.
imaginary isocost is tangential to the IS 1 at point C and
that corresponds to Q1.3, while the first least cost
combination point was at A and the second at B,
corresponding to Q 11 and Q12 respectively. A movement
from A to C or from Q11 to Q13 shows the SUBSTITUTION
EFFECT, while the movement frorrrQ1.3 to Q12 or point C
to B shows the OUTPUT EFFECT. The fall in price makes
the firm to change the combination of on IS 1 , which is an
-.,__
 198 Modern Microeconomics: A practical Arithmetical Approach 199

increase in quantity of l. But with an imaginary change

of increased output, mote units of Zwould be purchased,
hence the movement from QL3 to QL 2 or from C to B.

5.5 SUMMARY

So far, in this chapter, we have been able to explain how

producers behave in their bid to choose the various
units of factors of production in producing outputs. In
the course of the discussion, the importance of the
study were enumerated and explained to form the
backgrm.,;m d of the rest of the study. The meaning of
production and the production function were made and
it was revealed that production is necessary for
consumption and hence the creation of utilities. This
was where the discussion made to the production
process, that is, the making of choice of combination of
units of variable inputs based on the anticipated scale of
.operation, the anticipated returns to scale, the total cost
outlay and the availability of resources to embarked on
the production level desired.
In order td accomplish these things, the utilities or
traditional approach and the isoquant-isocost
approach were explained. The chapter ended with the
discussion on substitution and output effects of
changes in the price.~ of inputs.
' ilem used. Cost and price are therefore very similar but
CHAPTER SIX
COSTS ANALYSIS
6 .0 INTRODUCTION
In the last chapter, we stated that the production
function is the relation between the inputs and the
outputs. In that regard, it was stated that there are two
types of efficiencies common with production viz
technical efficiency and economic efficiency. It was also
stated that the discussion on the economic efficiency
a spect of production shall be deferred because it is the
basis of this chapter. In this chapter therefore, attention .
paid to the cost, types of costs in business, the cost
fu nctions, cost and revenue implication on business,
etc.
Generally, cost is sacrifice borne in acquiring or using
m item or the penalty for deriving satisfaction from any
ire quite different. While cost relates to production,
price relates to sales or demand. That is, to the producer

_./
200 Modern Microeconomics: A practical Arithmetical Approach
the sacrifice borne to acquire factor inputs is the co~t
while the price is the benefit or value for which the
producer/ seller is ready to give out or exchange the
product. Usually, the price is higher than the cost
because it includes the cost and other incidentals,
notional costs and profit or gain. An understanding of
these concepts is important for many reasons, one of
which is the wrong interchangeable use of cost and
price. Another reason is that economic entities need to
distinguish between the two so that proper recording,
classification and analysis will be done to ensure sound
business decision. It is therefore useful to mention some
of the types or classes of cost.
6.1 TYPES OF COST
By types of cost we mean the different meanings of cost
or the different classes of the cost of production. This
simply means that cost is a general term. There are so
many types of cost, some of which are as defined below
in their various related forms.
6.1.1 HISTORICAL AND CURRENT COSTS
These are basic accounting classifications. In
accounting parlance, most decisions are made from the
records of cost and revenue items that have taken place.
Such decisions are retrospective and are used as the
basis for assessment and prediction of accounting and
financial events and performances. When decisions are
based on the original or past values especially costs, the
Costs Ana(vsis 201
type C:if cost is known as historical cost. On the other
hand, cost could be based on the prevailing market
situation, hence current cost. Current cost therefore
refers to the going market value of items.in question. In
most cases current costs · are used when inflation is
considered so that economic decisions will be close to
reality.
6.1.2 FIXED AND VARIABLE COSTS
This classification of cost is also used in accounting but
in specialized aspect of accounting known as cost and
management accounting. Fixed and variable costs an'
very well pronounced in managerial economics and
other aspects of managerial decision-making Fixed
costs are costs that are constant within a given range of
activity or output. They are relatively constant and only
change with changes in the range of productiv<·
activities. However, the constancy of these costs is on
total basis, which means that on unit basis, fixed cost
vary. Examples of fixed :·cost ·include costs of fix<'cl .
assets, and deprecations. For instance if machinery
costs Nl00,000, this machinery could be used to
produce between 1 and 1,000 units of output. The ccmt
remains Nl00,000 no matter the level of output. But , ii
the actual cost of producing say 50 units is to be known ,
then the Nl00,000 will be apportioned to the 50 unit :,,
making the unit cost 'to be 2,000, as against NIOO pr· 1
unit if 1000 units were produced.
 0.l Modem Microeconomics: A practical Arithmetical Approach
On the other hand, variable costs are costs that change
with changes in the scale of operations or output.
Va riable costs are constant on unit basis but vary on
total basis. Variable costs include cost of raw materials,
·lectricity, wages and fuelling costs . For these costs ,
there are constant costs per unit but as the quantity of
input or as the level of production changes the costs
vary. This is why if a casual labourer is to be paid NSO
per hour, a nd he worked for 20 hours , the total wages
will be N l,000 as against workin g for 100 hours to earn
-N 5,000. Note that the variable cos t is constant at NSO
'
per unit but varying on total basis .
Again, between these two class of costs . Th ere a re s ome
cost items that are hybrid in n a tur e, that is having the
quali.ties of both the fixed and variable costs . This type
of cost is known as semi-variable cost, which can only
be apportioned when manageria l decisions involving
the .classification of all costs into fixed and variable are
made. Such costs include the salary of the operations
manager or the accountant.
6.1.3
ACTUAL COST. AND OPPORTUNITY
COST
Actual cost refers to the actual amount of money or
resou rce expended. They are the actual money or
reduction in value of assets recorded in the various
books for expenses incurred.
Costs Am1~vsi.\· 203
On the other hand, opportunity cost refers to the benefit
derivable from an alternative use of the same resource,
which have been foregone. This is why it is also called
Alternative Cost. It arises because, with the cost of
scarcity and the need to employ all resources into the
best uses, alternative uses for resources arise, and for
best economic decision, the benefits of thes e
alternatives a re weighed. The alternative with th e
highest benefit is accepted The benefit(s) of the
alternative(s) not accepted therefore become th e
opportunity cost of the one accepted .
6.1.4 PLANNED, OUT-OF-POCKET AND
NOTIONAL COSTS
Planned costs are costs that have been concluded to be
incurred before they are incurred . Planned cost could b<'
actually incurred or not. When not actually incurred by
the payment of resources instead by just a change in th <•
value of assets in the books of accounts (e .g.
depreciation of existing assets) . they are known as
Notional Costs. Notional costs are mpst times known os
.
provisions. Out-of-pocket costs are unplanned actuul
costs, incurred in the course of business operation.
Besides being provisional costs, notional costs HI'<·
imaginary costs, which are made to compensate certui11
sacrifices that may not be easily estimated or
quantified. Example of notional cost is the profit morgi 11
or difference between cost and price, which m ay b<· j1 rn t
discretionary.
 04 Modern Microeconomics: A practical Arithmetical Approach
6 . 1.5 DIRECT AND INDIRECT COSTS
Sometimes in business there is the need to distinctingly
identify costs with particular products for pricing, profit
ind control reason. Costs that are readily, tangibly and
separately traced to particular product, job, centre,
operation or process are known as direct costs. And,
costs that are not specific to any aspect of business
operation but incurred for the benefit of more than one
line of operation, process, centre, product, etc. are
known as indirect costs. Indirect costs are charged to
the various aspects of business by way of standard
accounting methods or apportioned on agreed ratios.
Because they cut across different areas of the business
or operation, indirect costs are also known as common
costs .
6.1.6 INCREMENTAL COSTS AND SUNK COSTS
Incremental costs and sunk costs are cost concepts
most useful in investment, financing and, economic
decision making. Incremental costs are costs incurred
as · a result of change in policies on the scale of
operation. For instance, if management adopts the
policy of changing from manual production to
mechanical production of.outputs, the difference in the
total costs between the two methods with regards to
cost-savings, cost outlay, etc. is known as incremental
costs.
205
Costs A11al)'sis
However, not all aspects of cost will be affected by th"
change. All such unaffected costs, which will still b e
incurred are known as sunk cost Surik costs do not also
change with changes in the scale of operation because
the amount of money spent on the former scale appears
to be lost and may not be recovered. For example, if
Ad'mass computers decides to expand operations such
that it moves from 3 Aba Road to 200 Aba Road within a
year but had spent for pertaining 3 Aba Road to its taste.
The cost already incurred becomes sunk cost while the
extra cost of adverts, building improvement cost, etc.,
become incremental costs .
6.1.7 BUSINESS COST AND FULL COST
•
Business cost refers to the total cost incurred in the
course of business operation and is made up of the
actual payments, reduction in the value of assets (e.g.
deprecation). It is usually broken down to capital and
revenue expenditures. In most cases business costs are
referred to as the combination' .of manufacturing,
trading and operating costs, and are most useful in the
determination of business profit/loss.
Full cost, on the other hand, refers to the
comprehensive cost of doing business. It is made up of
the business cost, notional costs, opportunity costs,
and the normal profit. It is worth noting that sometimes
notional profit will include the compensation for the
entrepreneur and a normal return on capital (often
referred to as the opportu n ity cost of capital).
 06 Modern Microeconomics: A practical Arithmetical Approach
.1.8 ACCOUNTING COSTS AND ECONOMIC
COST
Accounting costs are costs identified by the accountant
111d shown in the books of accounts . They are usually a
combination of out-of-pocket costs and some planned
ind notional costs. Most times accounting costs are
regarded as explicit costs but they are not completely
the same. When some other notional costs , such as the
opportu nity cost of the entrepreneur's engagement in
the business, normal profit and. the interest foregone for
,
the employment of capital in the business, are added to
tccounting costs the res'ult is economic costs. This
means that economic costs are inclusive of the
1ccountin g costs .
6.1.9 EXPLICIT AND IMPLICIT COST
l~xplicitcosts are costs actually incurred, whether paid
for or not, within a given time frame. Ordinarily, they
ould be referred to as accounting cost except that the
tccountant's view is shown in the revenue accounting
statement. The explicit costs include both the capital
ind revenue expenditures whether actual or postponed
(nrrears)
Implicit or imputed costs a·r e costs not expressly stated
in the records/books of a business but are assumed to
have been incurred in the ordinary course of business.
In fact it is the difference between economic costs and
1ccounting costs, mathematically stating.
Costs A 11a~vsi.1· 207
6.1.10 SHUT DOWN COST AND ABANDONMENT
COST
When operations dwindle, for whatever reason(s),
businesses could temporarily or permanently end.
Business could be suspended (temporary cessation) but
certain costs (whether fixed or semi-variable) could
continue to be incurred. Where the business operates in
such a way that revenue continues to cover variable
costs, the business operation may not be suspended
because suspension would result in no part of the costs
being covered. The cost that continues when operation
is temporarily ceased but which cost could have been
avoided if operations were allowed to continue is known
as shut down cost.
Where the cost of continued business far outweighs the
•
revenue such that a complete shut down will result in
cost-savings, the cost of such permanent cessation of
operation is known as abandonment cost .
Abandonment costs are common with construction
companies that abandon machinery and equipment a t
sites instead of moving them to base. The abandonment
cost in this case will be the outstanding value of th t•
machinery foregone.
6.1.1 l AVOIDABLE AND UNAVOIDABLE COSTS
Avoidable costs are costs · that could be saved with ou t
injuring the existence of business or the image of 1111
organization, should business be dull and opera t io11
 Costs A11a~vsis 209
08 Modern Microeconomics: A practical Arithmetical Approach

contract. In such downturn in operations, some costs Price

could be suspended, while others will continue to be &
incurred. Avoidable costs are those costs that can Cost SRAC1
conveniently be suspended, e.g. wages and motor SRAC2
vehicle running costs. Unavoidable costs on the other
hand are costs that even with the reduction in the level
RAC
of operation, the costs continues to be incurred, e.g.
maintenance of motor vehicles and building, and
security.
I
.1.12 SHQRT-RUN AND LONG-RUN COSTS
In economics, there are two principal time frames, Quantity
namely the short-nin and the long-run. Short-run is the
foreseeable time period within which some inputs vary
while others are fixed . Short-run cost are costs that vary Figure 6.1 Long-run and Short-run Average Curves
with the variation of outputs based on the combination
6.2 COST FUNCTION
of fixed and variable input One of the inputs that
remains constant is the plant, size that had been There are different cost functions when analyzing cost.
installed. Long-run, on the other hand, is the period Some of the most prominent cost functions are the total
within which all inputs vary and output can range from cost, total fixed cost, total variable cost, average fixed
cro to indefinitely large quantity depending on the cost, average variable cost) and marginal cost.
maximum capacity installed. This means that in the Total cost simply isthe sum of total fixed costs and total
long-run all costs are variable. Technically and average costs. It is the aggregate expenditure incurred
,ruphically, long-run costs are made up of several by the producer in the production of a given quantity of
hort-run costs. This is why the long-run average cost output. This means that it could cornprehen~ively be
curve is the locus of the lowest points on several short- the sum of implicit and explicit costs.
1 un cost curves as shown in figure 6.1 below.
 210 Modern Microeconomics: A practical Arithmetical Approach Costs Analysis 211

When the Total Fixed Cost (TFC) and the Total Variable short- run, the fixed cost curve is a straight line parallel
Cost (TVC) are divided by the quantity of output, the to the quantity axis. This is shown in figure 6.2 below.
result is the average fixed cost (AFC) or average variable The shape of the TC curve is the same as the shape of the
cost (AVC). By extension therefore, the sum of the AFC TVC curve, and can best be described as an inverse-S.
and AVC is known as the Average Total Cost (ATC) . This inverse-S results from the law of diminishing
technical returns which states that as more variable
Mathematically therefore: inputs are employed in the production process,
TC=TFC+TVC productivity increases first and later diminishes. This
. ATC=AFC+AVC leads to a rise in the average product (AP) initially and a
TC/ fall later. With the increase in productivity, AC (or even
ATC = /TQ AVC) falls initially before rising with the reduction in
AFC= TFXQ productivity. The point of change occurs after the
optimal combination of fixed and variable factors had
TVC been reached. The rise in the AVC when combined with
AVC= /r'Q
the AFC results or a rise in the increase in the AC or even
Marginal cost (MC) is cost with respect to change in total the TC.
quantity. This means marginal cost is the additional
cost incurred as a result of a one-unit change in output.
It is th e difference between two successive TCs. N (b)
(a) TVC
Mathematically, MC =TC1 -TCo
·-----C
TFC
= d~ I

dTQ
Graphically, the Total Cost (TC) function is an upward
0 Q
slopping curve, which is like the total product curve. It Q
increases at decreasing rate first and later increases at Figure 6 .2 (a) FC Curve, (b) TC= TVC + TFC,
increasing rate. It shifts with changes in fixed costs and TC Shifting by the Value ofTFC
since the fixed cost remains constant a t least in the
 212 Modern Microeconomics: A practical Arithmetical Approach Costs Analysis 213

Analytically, the above functions can be obtained from Solution 6.1

real values as shown in example 6.1 below:
Costs Schedule
Example6.1
Qty TC TFC TVC AFC AVC ATC MC
The following data were extracted from the cost 0 N200 IN2ool 0 N200 0 0 0
accountants' report produced after management 200
consulted the accountants to evaluate a new production 1 N640 N200 N440 N200 N440 N640 ~44o I
policy: - 2 N800 N200 N600 N lOO N300 I N400 N160

3 N900 N200 IN7ool N67 N233 N300 NlOO

(I) The total fixed cost of production per clay even
withbut production is N200. 4 N1040 N200 N840 NSO IN210 I [FiWJ N140
(ii) The daily marginal cost of production for 1 5 N1300 N200 Nl 100 N40 N220 N260 N260
unit of output is N440. 6 fil
6001 N200 N1400 N33
•
N233 N267 N300
(iv) The daily total cost of producing 6 units of Note: The values given in the question are in the boxes.
output is N 1,600. The above table can be graphically shown in figure 6.2
(v) The daily total variable cost for producing 3 and 6.3. In figure 6.2, the total values, i.e. Total Cost
units of output is N700. (TC), Total Variable Cost (TVC), and Total Fixed Cost
(vi) The daily total average cost of producing 4 (TFC) are shown, while in figure 6.3 the Marginal Cost
units of output is N260. (MC), Average Variable Cost (AVC), and Average Fixed
·(vii) The daily average variable cost of producing 2 Cost (AFC) are shown. From figure 6.2, it would be seen
units of output is N300 and for 5 units is that the TFC is a straight line parallel to the quantity
N220. axis, while the TC and TVC curve appear alike and the
difference is the value of TFC. And, from fiE:,'llre 6.3, it
Question: You are required to prepare a table showing could be seen that the AFC slopes downward
the TC, TFC, TVC, ATC, MC andAVC. continually though it cannot be zero. Again, the MC and
AVC curves take a cup or U-shape with the MC declining
faster and rising faster than the change in AVC Curve.
 2 14 Modern Microeconomics: A practical Arithmetical Approach Costs Analysis 215

Cost 6.3 RELATIONSHIP BETWEEN COST AND

(N) TC
PRODUCTION FUNCTIONS
1,600
1400 Cost functions and production functions are derivable
1200 from each other and are simply referred to as the duals
1000 of each other. <~ost functions are the monetary forms of
production functions. This is why the TVC or even the
800
TC curve and the TP curves look alike as shown in the (a)
600 part of figure 6.4.
400
200 ~~-+-~-+-~~~~~~~~TFC 6.3.1 Duality of Cost Functions and Production
l
0 1 2 f 3 4 5 6
Functions
Cost functions and production functions are the "duals"
OUTPUT
of each other i.e. one can be converted into the other just
Figure 6.3 TC, TVC, TFC curves as in figure 6.4
Cost
(N) •
480
440
400
360
320 ATC
280
240 .L..----"'----"'.AVC
200
160
120
80
40 ------AFC
0 ...L.~--1-~~~~-+-~-t-~-,~--;~~~--+
1 2 3 4 5 6
Figure 6.4 MC, AVC, and AFC curves
 Costs Analysis 217
216 Modern Microeconomics: A practical Arithmetical Approach

From figure 6.4, the TVC is shown in the uppermost part

and a close look shows that it is the TP curve. The slope
TVC
ofTVC is the MC, which is at point A. At point A, AB/OB
= AVC, hence MC = AVC. At this point, AVC is at its
J minimum.

The relation~ between the cost and production function

(curves) are that:
1) TP and TVC rise first but TP at an increasing
then at diminishing rate. while TVC at
0 diminishing then at increasing rate.
Output
2) AP rises to a diminishes, while minimum,
Cost Per MC then rises.
Unit
3) MP rises, then falls, intersects AP at 'its
maximum," and, continues to diminish
faster than AP while MC falls, then rises,
intersects AVC at its minimum and
continues ·to rise faster Than AVC.
0 maximum AVC falls then to a
Output

Product
Per Unit
of Input AP

0 Output

Figure 6.4 Cost and Production Functions

218
CHAPTER SEVEN
MARKET ANALYSIS
7.0 DEFINITION
Several persons have defined market differently
depending on the circumstance and the use of the term.
Market had long being defined as the place where
buying and selling take place (Hanson, 1978: 149).
Market brdinarily refers to the sale of commodities. This
definition is very common in Nigeria where slangs like
"you go buy market", and "no market" are very common.
These slangs simply mean the extent of sale or
purchase. There are still other definitions of market. It is
therefore the function of market to ensure or enable
exchange of goods and services to take place. The place
or the enablemeri.t of "exchanging goods and services
coul(i be on daily, weekly, monthly basis, etc. It could
also be specific or general in nature, hence building
materials market, financial markets, etc.
Market Analysis 219
The above definitions not withstanding, a market has
been comprehensively defined as the arrangeII1~nt,
medium or network by which exchange takes place no
matter the type of commodity, the quantum of
commodities, or the timing of the exchange involved. By
this definition, a market could refer to a particular
place, for instance Alaba International market, Garri
market in Port Harcourt and motor spare market '(lkoku
market) in Port Harcourt. Or it could be the non-loc~tion
specific impersonal network by which exchange takes
place like E-market and stock market. Another , way
markets have been defined has been the use of the term
interchangeably with competition and hence market are
taken as either pure/perfect or imperfect markets or
competition.
7.1 TYPES OF MARKET
There are different types of market but the simple wayto
identify these markets is to use some basis such as the
following:
(a) On the basis of the structure by which the
interrelationships within the producers
and between producers and consumers are
considered,
'
(b) On the basis of the quantity of commodities
involved in the exchange at a particular
time period, and
(c) On the type of commodity involved.
220 Modern Microecon9mics: A practical Arithmetical Approach
Market Analysis 221
Figure 7.1 shows some of these classifications.
homogeneous. When perfect market is interchanged
MARKET with perfect competition, it simply means that the
I characteristics of perfect market are the same with
_ --~-- I Typel of perfect competition. This is to a very great extent
I Quantum of Commodity
I I
correct. The exception is that in perfect competition

h . c:I
Structure · Commodity there will be a large number of producers producing the
same commodity, each producer produces just a small
I Intangiole
Imperfect Wholesale . ~
Tangible~ . fraction of the total market supplied quantity, and
Pure/ I Retail Mo ey Service therefore cannot influence the price of the commodity. A .
Perfect Factor market is said to be perfect if the following conditions
Monotiolyl I ·I
olistic Final capital exist:
Monop ..
Compet1t1on Products
(i) Large number of buyers and sellers;
Monopsony (ii) The commodity is homogeneous;
Oilgopolistic
Competition (iii) There is no preferential treatment of any
buyer by seller and vice versa,
Figure 7 .1 Types of Markets
(iv) There is free and unrestricted entry and exit
The classification of markets on structur~ basis simply by both consumers and producers;
means the consideration of the interdependence, that is (v) There is a close contact within and between
the close relationship, the · degree of reactions of buyers and sellers;
competitors depending on the number of firms in the (vi) There is perfect mobility and transferability
industry and the degree of product differentiation. of commodities from one person or point to
another;
Markets are either perfect or imperfect on the basis of (vii) There is perfect accessibility to information
their structures. A perfect market is one in which all by buyers and sellers;
consumers and suppliers, or buyers and sellers, take (viii) Only a single price obtains on market such
the price ruling on the market as fixed. It is the market that all buyers sellers are price takers.
where there is no special treatment for any one person
(buyer or seller), and the commodity to be exchanged is Any negation of the conditions in total or to any one,
makes a perfect market imperfect. An imperfect market
 222 Modern Microeconomics: A practical Arithmetical Approach
is therefore the absence of anyone condition of perfect
market. This is why every other market structure listed
under imperfect market is an abnormal market. For
instance, when there is no competitor in producing a
comihodity such that only one producer exists, . the
situation is said to be imperfect for many reasons
ranging from improper pricing to uncontrollable
quality. In reality, there is no condition ofperfect or pure
market or · competition, and there is hardly any
monopoJvr. This , is why it is commonly said that
monopolistic competition, oligopoly, duopoly and
monopsony are more real than perfect competition and
monopoly, and that the first set of markets/
competitions lie between the perfect market and
monopoly.
On the basis of quantum of commodity, markets are
classified into wholesale and retail markets.
Wholesalers and retailers are middlemen that channel
commodities from producers to consumers. Wholesale
markets ensure that commodities are channeled from
the manufacturers to retailers . One major form that
wholesalers take is DISTRIBUTORSHIP and on the stock
market they are known as JOBBERS, Merchant Bankers
(before universal banking era) in the banking system, or
even Discount Houses in the non-banking system.
Wholesalers are bulk buyers and in most cases
s pecialize in the type of commodities they deal in. They
break these bulks into smaller quantities to retailers.
Market Analysis 223
Wholesalers provide warehousing services by thei~ bulk
buying and smaller quantities' sale to retailers. By this,
retailers and manufacturers are relieved of the problem
of space and continuity in operation as the wholesalers
ensure availability of these commodities This also
means stability in prices and the net reduction of
transportation costs. Sometimes, manufacturers need
extra money to finance operations and this can easily be
sourced from the wholesalers through advance-
deposits. On the other hand, wholesalers provide not
only credit but also, in some cases, provide capital to
retailers.
Retailers, on the other hand, are links between
wholesalers (or even manufacturers) and the final
consumers. They are mostly non-specialists and
usually avoid bulk buying while selling in very small
units. This is why markets are generally classified into
wholesale and retail markets as one buys in large and
bulk quantities, while the other buys in smaller
quantities.
And on the basis of type of commodities, markets can be
classified into markets for tangible commodities and
those for intangible commodities. In comme:rcial
parlance, this classification is referred to as Trade and
Ancillary to Trade, with Trade referring to the market for
physical products. Markets for tangible commodities
could be divided into factor markets and markets for
 224 Modern Microeconomics: A practical Arithmetical Approach
final products. Factor markets are the markets for
factor inputs and intermediate goods. In this market
land, labourt'and capital are bought and sold, though
the market may not be location-specific nor easily
identifiable. Markets for final products are markets for
generally consumer products, that is products that will
not be further processed. The products could be durable
or non-durable. Sometimes, markets for final products
are referred to be the only markets that can be classified
into wholesale and retail markets. This is considered as
incomplete since the factor inputs can also be bought
and sold on both wholesale and retail basis. For
instance, in the banking sector; commercial banks are
originally known as retail bankers, while merchant
bankers and development bankers are referred to as
wholesale bankers. Of course, the banks are markets
for capital.
Finally, there are markets for intangible products
commonly referred to as service's and financial markets.
The markets for finance and financial services or
instruments are divided into money markets and
capital markets. While money markets are for the short-
term financial instruments of not usually more than one
year and are ordinarily grouped into near-money,
money substitutes and pure or real money (cash),
apital markets are markets for long term financial
instruments or services with tenures of one year and
1bovt·. The~c instruments include shares, debentures
Market Analysis 225
and other form of debt instruments. The third group of
production have been tagged the markets for service
such as transportation, communication, S<(CUrity and
health services.
7 .2 MARKET STRUCTURE AND BASIS
OF SUPPLY
Just as mentioned earlier, there ·are different forms of
market structures based on the interdependency and
interrelationship between producers/suppliers. But,
I
attention shall be paid to the following:
(i) Perfect competition
(ii) Monopoly
(iii) Monopolistic competition, and
(iv) Oligopoly
7 .2.1 PERFECT COMPETITION
In the discussion of this market structure and .indeed
the general market structure, certain issues must be
mentioned. One of such issues is the reminder that
market structure/ analysis is the combination of the
consumers and firms' demand curves/behaviour and
the producers' and sellers' (suppliers) supply curve and
cost behaviours. These two sides that complete an
exchange have been discussed in earlier chapters.
Again, it has been stated that .each market structure is
defined on the level of competitivenes-s, ·even though the
ordinary meaning of these terms may n0t •be the ·same
 226 , Modern Microeconomics: A practical Arithmetical Approach
with their practical meanings, especially in perfect
competition. The practical meaning of perfect
competition is RIVALRY, but in economic parlance,
perfect competition means the absence ofrivahy. In this
sense, therefore, there will not be any extra effort by
suppliers to impress and prevail on any of the
consumers (buyers) and vice versa in the perfect
market. In which case also suppliers sell-off any
quantity brought to the market atl eqJilibriufn price.
The Implication is that there is infinitely large number of
buyers yawning for supplies. And, for there not to be
rivalry, the actions of any one seller/supplier on -the
market is considered negligibly small that it cari not
affect the prevailing market conditions. Worse still, any
such independent action(s) of any one seller will result
in addition .to existing costs, hence the need for every
seller to avoid these AVOIDABLE COSTS. This
circumstance can better exist where there is very large
number of sellers/ suppliers, and the market does not
take cognizance of entry or exit of any seller or buyer.
Another issue worth mentioning is that both the social
benefit and social cost are equal or the same for both the
individual (firm and person) and the industry. That is,
the benefit of any commodity traded on the market that
accn;ies to those who consume the commodity (private
benefit) and that accruing to the general public or
society are known as social benefits. The same for social
costs which should be equal to private cost.
Market Analysis 227
Mathematically,
MU= MUs
and MC= MCs
Where MU = Marginal utility accruing to the
single buyer (person or firm).
MUs = Marginal utility accruing to the
industry or general public( society).
MC Marginal cost incurred by the single
producer (firm or person)
MCs = Marginal cost incurred by industry
or general public.
Remember that in the theory of consumption and the
theory of production in the earlier chapters, it was
stated that efficiency in consumption will be at the point
where the marginal utility (MU) equals the price, that is
marginal benefit equals marginal cost; and that efficient
production for the individual producer/ supplier is at
the point where the marginal revenue (benefit) equals
marginal cost. It has been stated also that the
combination of the demands of individuals is the
market demand or the demand of the society, same for
the suppliers. This means that the aggregate of the
marginal benefits or marginal costs is known as
marginal benefits of the society (MUs) and marginal
costs of the society (MCs). Since no one supplier or
consumer incurs extra costs or earns extra benefit in a
 Market Analysis 229
228 Modern Microeconomics: A practical Arithmetical Approach

(iii) The commodities traded on, the. market are

perfect market, economists consider this market
identical (homogeneous). No differentiation
stru~ture as the most efficient. This means generally
of commodities on this market.
that the economy will be efficient if and when the
marginal cost equals marginal benefit. Mathematically, (iv) There is no restriction on entry and exit from
this can be shown thus: the industry, moreso bec~mse of the large
(a) For the consumer, demand/purchases will number of suppliers and buyers.
expand until Px = MUx
(v) Because of the homogeneity of the
(b) For the individual producer/ supplier, Px = MCx
commodities, the commodities are · easily
(c) Therefore, Px = MCx = MUx
transferable from one person/firm or
Any market structure in which the MU * MC or the location . to another. This transferability
MU *
'MUs or MC *
MCs is considered imperfect. includes factors of production
(vi) There is no preferential treatment between ·
7.2.1.1 ASSUMPTIVE CONDITIONS FOR PERFECT
buyers and sellers.
COMPETITION
(vii) There is close contact between and within
There are some basic assumptive condition for this
buyers and suppliers. This is one of the basis
market structure to exist. A Look at these conditions or
of the COBWEB THEORY.
· characteristics shows that hardly this market structure
exist in any part of the world or in any sector of the (viii) There is perfect knowledge of the conditions
economy. These conditions include the following: on the market through perfed access to
information by every participant. This
(i) There is a large number of producers/ sellers
information on the prevailing conditions on
and consumers/buyers, such that each
the market is free, costless and available to
producer or consumer produces or
all participants at the same time.
consumes just a very small fraction of the
total commodity, therefore are not able to (ix) The basic objective of all participants is the
influence the price of the commodity. maximization of benefits in the form of
profits for firms or utility for persons.
(ii) Every producer/ supplier and consumer/
buyer is a price-taker
 230 Modern Microeconomics: A practical Arithmetical Approach Market Analysis 231

(x) There is no intervention of any kind in the
functioning of the market. This is why
perfect competition is sometimes taken for
Laissez Faire. Intervention, most times, is by
government in the form of taxation, tariffs,
subsidies, rationing of commodities, etc
{xi) Private benefits must be equal to social
. benefits and private costs equal to social
costs.
7.2.1.2 THE DEMAND AND SUPPLY CURVE
The demand curve and the supply curve of the market
or industry is the total sum of the demand and the
supply of the individual buyers and suppliers
respectively. Since it has been noted that the
participants are price-takers, there will be only one (1)
price ruling on the market. And, since every supplier
sells off whatever supply brought to the market, there
will be a perfectly elastic demand curve for both the firm
and the market. This demand condition implies that the
Average Price (AP) will be the same as the Marginal
Revenue of both the firm and the market. This is shown
in figure 7. 2 below.
On the other hand, the supply curve of the firm is
obtained by the process of adjustment of its output in a
way that maximizes its revenue. The adjustment must
be made so that the price should be more than the
average variable cost. This position might result in a
profit or loss. The price also must be equal to the
111nrginal cost. A loss will occur if the firm continues to
produce at points where the price is lower than the
1vcrage cost. The firm will rationally produce and
.~ up ply at points where marginal cost (MC) is equal to or
111ore than the average variable cost. This means that
11ny portion of the MC curve or quantities corresponding
to the points where MC is higher than the AVC will be
quantities to be supplied and the portion of the MC
higher than AVC therefore is the supply curve of the
firm. This is also shown in figure 7. 2 below.
Price
and
Cost
P3
AVC
P2
P1 I '>.. ~ ~ D = MR :::AR.
0 Qi Q2 Q3
Quantity
Figure 7 .2 Short Run Demand and Supply I Curve
In figure 7 .2 above, the most efficient point of
1
production is a t A and quantity Q1. The demand curve is
P1D , while the supply curve is the portion of MC curve
 232 Modern Microeconomics: A practical Arithmetical Approach
Market Analysis 233
above point A where MC= AVC that is the curve ABC on
the MC curve corresponding to Q1, Q2 and Q3. The Price
supply curve of th_e industry is .the combination of the and
ATC2
Cost ~
MC curves of firms, meaning that the industry supply
P4 L - - - - - - - - - - -
will be the total amount produced by the member-firms
of the industry at a single price that equates each firm's P3 ._, .03 = MRI = AR3
MCwithAVC ' ' :'

P2 I '< ') '==-1"< I D2 =· MR2 = AR2

7.2.1.3 . PROFJ.T/LOSS MAKING UNDER
PERFECT COMPETITION pl I ".A<:: I 7' I D1 = MR1 =AR1
Ordinarily, profits are made whenever Total Revenue
(TR) excee'ds Total Cost (TC). 0 Qi Qi QJ Q4

That is,
TR - TC = 7t
Sometimes, total revenue could be more than total cost
yet profit may not be made. It is because of this
possibility
. that the marginal cost and marginal revenue
'
approach is a better alternative. Even in this approach
profit is made as long as MR >.MC. But, at all points
where MR> MC profit will not be maximized. Profit is
maximized where MR = MC. This is why the firm will
expand output through the points where MR > MC to
where MR= MC. Any point after MR= MC, that is MR<
MC, the firm will make loss. This is demonstrated in
figure 7.3 below.
Figure 7.3 Profit/Loss Making under Perfect
Competition
In figure 7 .3 above, the most efficient point for the firm
will be point C where the MC= ATC and the point where
the firrri will maximize its profit is at B where the MC =
MR3 = AR3 = P3. For as long as the price is more than the
AVC, the firm will make gain, but such gain will not be
able to cover all fixed costs. This will be at anywhere
from point D. However, it will be advisable for the firm to
continue production so that it can cover some costs
instead of incurring abandonment cost without any
form of revenue.
Anywhere from Q3 the firm will not produce profitably
becaus~ the cost (MC) will be higher than the price
(revenue). And anywhere or output less than OQ3 the
firm will be producing sub-optimally since it has not
seized the chance of producing and selling products
whose MC is less than price.

234 Modern Microeconomics: A practical Arithmetical Approach
Wh ere, however, the ATC is higher than the price (say at
point A) then the firm can minimize its loss by producing
OQ4 where the MC= ATC2.
In figure 7.3, the firm's Total Revenue is the area
PJ8QJ0, while Total Cost is the area P2FQJO and the Net
profit (also called NET REVENUE) is given as:
Net n = PJBQJO - P2FQ3Q
= (P3 - P2)(Q3Q)
= ~in Price multiplied by quantity
PJBFP2
Also,»the Total fixed cost is TC - TVC, that is
P2FQ3Q - P1EQ3Q
P2FEPi.
And , the Gross Revenue or maximum profit will be given
as:
Total Revenue - Total Variable Cost
= PJBQJO - P1EQJO
= PJBEP1
With the loss situation, on the other hand, the firms
Total Cost (P4AQ40) is higher than its Total Revenµe
(PJBQJO), so its Gross loss will be the area P4AGPJ . The
firm can reduce this loss by producing OQJ where the
MC = p3 such that the Gross Revenue of PJBEP1, can
redu ce the loss.
Market Analysis 235
7.2.2 PURE MONOPOLY
There is no pure monopoly market structure anywhere
especially in accordance with Chamberlin's definition.
According to Chamberlin (1933) pure monopoly is the
market situation where one producer exercises total
control of the supply of all commodities and services.
Besides this extreme definition by Chamberlin, we have
earlier said that pure monopoly is an extreme market
structure. It is market that has a single
producer/ supplier serving the en tire market of large
number of buyers, with a single commodity that has no
close substitute. 1t is the market structure in which the
firm and the industry are the same. Given the large-
demand for this product with negative zero cross
elasticity, the monopolist manipulates price, hence the
producer/ suppler is a price-setter.
7.2 .2.1 ASSUMPTIVE CHARACTERISTICS
1) It has a single commodity produced/supplied
and bought;
2) The commodity has no close substitute;
3) There is a single producer/ supplier;
4) There are many buyers;
5) The monopolist is independent of his actions /
decisions;
6) There is entry restriction;
7) The market has a downward sloping demand curve,
which is higher than the marginal revenue curve.
236 Modern Microeconomics: A practical Arithmetical Approach Market Analysis 237

7.2.2.2 DEMAND CURVE, SUPPLY CURVE AN I> A look at table 7. 1 shows that apart from the first 1 unit
PROFIT! LOSS MAKING sold where P = AR = MR, MR assumed smaller values
for the rest and even assuming negative value after
The demand curve of the firm is the same with that ol
reaching zero. But total revenue continued to increast'
the industry/ market since the industry is a one-firrn
until it saturated at N240 before declining. Anothc1
industry. It follows that the downward sloping demand
point is that whereas MR can assume negative values,
curve of the industry is the same with the firm. It is
AR continues declining without reaching zero. Thes"
because of this that the monopolist can influence price
relationships are graphicahy shown in figure 7.4.
by increasing or decreasing quantity supplied to the
market. Price and
The demand curve of the monopolist is also the Average Cost
100
Revenue ·curve. This is because for every unit of the
90
product sold the total revenue (TR) is equal to the unit
80
price multiplied by the quantity sold. However, in the
70
monopolist situation, the marginal revenue (MR) falls ATC
lower than the average revenue.(AR = D). This is because 60
the cpange in TR as a result of additional unit of product 50
sold is usually smaller than the average revenue (AR). 40
This is illustrated in table 7.1 anp in figure 7.4 below. 30
20
Table 7 .1 Derivation of Marginal Revenue of the 20
Monopolist 10
0
1 9 10
Price Total Marginal -10 1
(P =AR) Revenue (P x Q) Revenue Quantity
Qty (Q) MR =ATR/.6.Q -20
(2) (3) (4) -30
1 N90 N90 N90
2 N80 N160 N70
-401 MR
-50
4 N60 N240 N40
-60
6 N40 N240 NO
9 NlO N90 N (50)
Figure 7.4 Monopoly Dd, 55 and Profit/Loss MaAi11r
 rn Modern Microeconomics: A practical Arithmetical Approach
Market Analysis 239
if

A ~muming that MC =MR at point A (i.e. 4 units and at

loss in quantity of the difference between the quanti ty
N'10) while MC= ATC at point B. Assuming that at point
corresponding to C1 and 4 units . This loss suffered by
A MC = AVC =MR, then all other part of MC curve above
society is also known as WELFARE LOSS. This is th<'
point A will produce the supply curve of the firm and
major point of criticism against monopoly as a n
Industry and p oint A becomes the equilibrium point or
inefficient and imperfect market condition, apart from
th e point of efficiency. At this point a normal profit
·other reasons like poor quality of commodity, irregular
would be made. But profit will be maximized at point E
pricing, and discrimination. However, the break even
where the TR = N60 x 4 units = N240 and TC = N50 x 4
point can be legislated for the firm to produce. At such
units (at poin t D) = N200. So, NET profit = N40 while
break-even point, the firm can still make a norma.I
Gross Profit = N240 - (N40 x 4 units) = N80 . The firm
profit, while meeting the society demands . That break-
/industry ca n irw ur loss if the ATC curve is higher than
even point is shown as point C in figure 7.4 where th"
the AR = · D curve just as been mentioned under the
ATC=AR=D .
competitive market structure.
7.2.2.3 CAUSES OF MONOPOLY
The efficien cy mentioned above (point A in figure 7.4)
1pplies only to the monopolist but does not apply to the Several reasons can give rise to monopoly. Some of the
Hociety. This is because the point of efficiency or reasons are as follows :
<'quilibrium for the monopolist is usually lower than the
(i) Natural Factors
point of efficiency for the society (which should have
h<'cn the point of equilibrium for the competitive Natural factors would include control over certain
1nnrket). Remember that equilibrium in the perfect fundamental aspects of the production, provision and
competition occurs where MC= MR = AR = D. In figure supply of the product. Such fundamental aspects could
.4 above, the point of society's equilibrium would be at be the source of raw materials, ownership of patent and
l'1. At C1, MC represents the marginal cost to both the production techniques. In this kind of situation, there
ociety and the monopolist (firm), and the MR = D will be restriction of entry by some other firms , hence
•<'presents the marginal benefit to society i.e. marginal monopoly.
utility to consumers. But the marginal benefit to the
monopolist is at point A. It follows therefore that the (ii) Cost Advantage
\
:-iociety will incur a loss of AEC1 due to monopoly and a 'Sometimes a firm will be so large in size with referenc<· t n

'·10 Modern Microeconomics: A practirnl Arithmetical Approach
ii s scale of operation that its long- run average cost of
:,~
1>met uction would coincide with the industry cost of
production. When this condition occurs it will be
difficult for other firms to enter the industry, survive
111d make profit, hence the elimination of competition.
I11 such cases, the AC continues to decline for the large
size firm. This is why this firm that eventual emerges to
.wrvice the industry is known as NATURAL MONOPOLY
11s different from natural factors or causes of monopoly.
A natural type of monopoly exists when the average total
cost (ATC) of a ·single firm falls within a given range of
output such that the firm produces the total market
quanty a t a lower ATC than by more than one firm . This
is the case with most nationalized firms like NEPA, NPA,
NIPOST, NITELandAT&T (in USA).
(iii) Legal Restrictions
Monopoly firms can be created by act of law by the
government. In such cases, the entry of other firms will
be prohibited . In Nigeria, between 1960 and 1977 some
111onopolies have been created for obvious reasons like
I lie reduction of foreign control and dominance of the
<TOnomic life of the nation. Such monopoly firms have
1•,rown to be dis-efficient .a nd have to be statutorily
dismembered into separate firms or allowed to compete
with new firms as could be seen with NEPA/PHCN and
other companies, the privatization of NPA, and the
Ii bcralization of telecommunications and the aviation
industries . This type of monopoly is known as
FRANCHISE MONOPOLY.
Market Analysis 241
(iv) Mergers and Acq.uisition
In this case monopoly results from collusive actions of
producers who may decide to merge their operations or
unify operations to their common or mutual benefits.
When this collusion is total and all-embracing,
monopoly results else a monopolistic competition or
even oligopoly will be created. In recent times mergers
and acquisitions (M & A) have been the easiest way of
creating monopoly or other imperfect market structures
world·-wide apart from international treaties and
accords that created outfits like OPEC. Monopoly
created by this means is known as COLLUSIVE
MONOPOLY.
(v) Unavoidable Condition
There could be a market situation by which there is only
one producer and one buyer of the product. These two
parties can easily agree (and sometimes might be
backed legally) to exclude others from the market. In
this case the single producer is the monopolist while the
single buyer is the monopsonist. This kind of monopoly
is known as BILATERAL MONOPOLY.
7.2.2.4 PRICE DISCRIMINATION UNDER
MONOPOLY
One major feature of imperfect market structure is
discrimination. Discrimination can take the form o f
different prices for same products, selling differc 11 t
qualities of the same product, selling the same product
 >4 Modern Microeconomics: A practical Arithmetical Approach Market Analysis 243

II same price but produced at different costs, etc. These In figure 7.5, the total average cost (AC) is assumed to be
forms of discriminations could be on the basis of age, at NP2 at point B which is higher than the average
location, income, language, relationship, length of revenue (AR) accruable to the producer at the given
business relationship, marital status, seasonally of quantity Q2 if the demand of the society will be met.
,,.1 le, quantity purchased, etc. Between points Band C, the producer makes a loss of
P2BCP1. If the producer is allowed to charge P3 to some
Of all forms of discrimination, price discrimination consumers, the producer can make ah extra profit of
1ppears to the most popular. Price discrimination is the P3AmP1 that can offset the loss so that the producer can
condition whereby the same product is sold to
still provide the product.
consumers at different prices, sometimes at prices (AR)
lower tha n theunitcostofprodu.ction (i.e. ATC). However, for price discrimination to exist, there must be
five (5) necessary conditions namely:
There is almost only one situation that can justify price
discrimination and that is when the AC is h igher than (i) The market must be divided into sub-
the AR= D curve such that there is no equilibrium point markets.
md hence the production/ sell of the commodity (most (ii) The different markets must be effectively
times very essential to the society) will be at a loss . In separable such that the buyers on one
this case, therefore, the monopolist can differentiate the market can not resell their purchases on
product slightly or outrightly charge different prices to another market.
'Over the natural loss inherent as shown in figure 7. 5. (iii) There must be different price elasticities of
Price and demand in the different markets.
Cost
(iv) There must be market imperfection of one
P3 form or the other.
I
I
I
(v) The demand must outweigh the profit
P2~-------1-----°"""'i' maximizing output.
P3 ~-------~-------Xe
m I
I . I
I I AC In the light of these pros, cons and conditions, the
I I
I I
I
I
I
I
monopolists' ability to maximize profit and the decision
I I
: I on the level of profit he makes are restricted or limited by
Qi Q2 Quantity the following realities:
Figure 7 .5 Monopolist Price Discrimination Justification
 >.M Modern Microeconomics: A practical Arithmetical Approach
Market Analysis 245

(a) Anticipation of potential rivalry

(b) Consumers resistance against exploitation
(c) Discovery of close substitutes, and
(d) Possibility of government intervention and
regulation.
..... 3 MONOPOLISTIC COMPETITION
lfrre, there are reasonably many producers/sellers of
differentiated commodities which are close substitutes
ind dis tinctly. different, with the following
l'hnracteristics (o:Hhe Monopolistic Competition):
results and the firm is encouraged to expand output.
With a loss situation (i.e. MR < MC) the firm will br'
better- off if output is reduced. These three conditions
are shown in figure 7. 6 and 7. 7. Particularly in figure
7. 7, the AC is higher than the AR, MR, and fo r
sometimes MC .
Monopolistic Competitor's Equil brium
Price
and Cost

(a) Product differ entiation

P2
(b) Fairly large but limited producers
pl
(c) Entry barriers exist
(d) The seller /producers are price Setters
(e) Perfect mobility of factors of production
(f) Complete access to market information 0 Qi Q2 Quantity

From the above, monopolistic competition can be said to Figure 7. 6 Short-run Loss
Costs
lw a ~ombination of some features of pure competition Revenue
111d that of pure monopoly. By this combination, Price MC
<'Onsumers have variety of commodities to select from ; P1 AC

there is aggressive marketing and advertisements to

l11rc buyers and domi:r:ate weaker firms; price is higher
I hnn pure competition and output is slightly less.
P2 ~---~ I
I
A monopolistic competitor is at equilibrium in the short- I
1un where AC = MC= MR, just as with pure competition I \I
IMR I
I
I
111d pure monopoly. Where, however MR > MC profit • Q1 Q2 Q3 Quantity [
In figure 7 ,fj.f/ttf~ lqZi§hwib'iH'thffl-t of the p roducer 1s r. I
 \
46 Modern Microeconomics: A practical Arithmetical Approach Market Analysis 247

I~, where MC = MR. By extension this point of oligopoly is that sometimes it tends to pu~e competition
(•q uilibrium, which is the necessary condition for profit or monopoly with the various actions a.l}d reactions. For
maximization, reveals a market demand ofOQ1, at point instance, where there is no product differentiation and
A on the demand curve. At this quantity the total no restriction on entry, 0ligopoly tends to pun ·
lVCrage cost (ATC) will be fully covered at point B. This competition. Also where there is product differentiation ,
means that a net or economic profit of P2ABP1 will be oligopoly tend to monopoly.
made . This quantity (OQ1) is lower than the point where
In the first situation, the demand curve is fairly elastic
ATC MC AR = D, meaning that there is a consumer
until it will be perfectly elastic. While in the second case,
liUrplus of Q1Q2. This surplus results in the payment of
the demand curve is fairly inelastic until it is perfectly
higher price of P2 instead of P3. This is why this market
' inelastic (hence kinked demand curve as in figure 7 .8).
structure is imperfect because the society is paying
higher than adequate price and receiving smaller
quantity than should be. Price.
0
.2 .4 OLIGOPOLY

The characteristics of this market structure include:

(a) Few sellers/producers (more than 2)
(b) Products are differentiated and standardized
D
(e.g. Labeling) O Quantity
(c) Firms are interdependent Figure 7. 8 Kinked Demand Curve (Oligopoly}
Oligopoly is therefore the market structure where there
ie:J a few producers/sellers and many buyers of a Another specialty about oligopoly is that firms do not
po.rtic11lar product. By this nature the actions of any one operate at full capacities of plant sizes installed hen c('
producer/ seller to undertake any peculiar action will be full economic potentiality of the firms ,are not explored .
weighed seriously against the reactions of other
producers/sellers. Such actions can be in the areas of
ldvertisement, product quality, price changes and
1uantity produced/supplied . One special feature of
 A8 Modern Microeconomics: A practical Arithmetical Approach
Index 249 ,

REFERENCES INDEX
A
lluumol, W. J. (1985) Economic'Theory and Operations
Abandonment Cost, 207
Analysis (4th Ed.) New Delhi: Prentice Hall oflndia.
Alternative, 2, 16, 144, 174, 204, 232
Cha m berlin, E. H. (1933) The Theory of Monopolistic
Average Pr(}duct, 179
Competition. Harvard: University Press.
Avoidable Costs, 207
Dean, J . (1951) Managerial Economics. New York:
Prentice-Hill. · B
Dwivedi, D. N. (1997) Microeconomic Theory. New Bilateral Monopoly, 241
Delhi: Vikas Publishing House. Break-Even Point, 239
I lanson, J . L. (1978) A Textbook of Economics. London: Budget Line, 151 152, 153, 154, 155, 156, 157, 158, ·
MacDon ald qnd Evans Ltd . 159,163, 164
Henderson, J. V. and Poole , W. (1991) Microeconomics .
Lexington: Heath & Co. c
Koutsoyiannis, A. (1981) Modern Microeconomics . New Capital, 14, 175
York: McGraw-Hill Book Company. •
Capitalism, 10, 11, 13
Lipsey, R. G. (1981) Introduction to Positive Economics, Ces,176, 177
London: Weidenfeid. Choice Making, 17,35
Stigler, G .J. (1949) "Monopolistic Competition in Cobweb Theory, 229
Retrospect," In Five Lectures -on Economic Problem, Collusive Monopoly, 241
Green: Longmans Publishing. Consistent Transitivity, 140
S tigler, G. J. (1956) "The Statistics of Monopoly and Consumers, 7, 9, 11, 27, 29, 34, 40, 41, 42, 43, 44, 47,
Merger", Journal of Political Economy pp. 33 - 40. 48,52,59,64,73,74,76, 83,84,85,86,87,88,
Wonnacott, P. and Wonnacott, R. (1979) Economics, 91, 98,99, 100, 108, 109, 111, 119, 120, 121,
New York: McGraw-Hill Book Company.
122, 123, 124, 125, 127, 132, 133, 134, 136,
I licks, J. R. (1946) . Value and Capital (2nd. Ed.). London: 137, 138, 139, 140, 141, 142, 143, 144, 145,
Oxford Un iversity Press. Pp. 50-74.
149, 150, 151, 152, 153, 154, 155, 156, 157,
All en, R. G. D. (1956). Mathematical Analysis for 158, 161, 162, 163, 166-, 167, 170,
Economists. London: Macmillan. Consumption,2, 3, 14, 17, 26, 28, 30, 33, 35, 38, 3 ,., ,
Watson, D. S. and Hoiman, M.A. (1978). Price theory 40, 42, 45, 52, 62, 84, 87, 96, 98, 99, 101,, 102, 103,
md Its Uses . Boston: Houghton Mifflin. 108, 109 , 120, 122 , 124 , 12 5 , 127 , 132, 135, 137, 14.,
/
 ,50 Modern Microeconomics: A practical Arithmetical Approach Index 251

Imbalance, 11 Laws, 2, 9, 12, 127,

12, 13,
160, 162, 167, 168, 169, Income, 34, 40, 41, 42, 43, Legal Restrictions, 240
Electricity, 202
188, 198, 227, 66, 87, 91, 93, 94,
Entrepreneur, 15, 175
'ontinuous, 167 Environmental Economics, 9 95, 96, 98 , 99, 100, M
Control, 12 Equipment, 14, 16, 207 101, 102, 123, 152, Machinery, 14, 57, 201207
Cost Advantage, 239 Exchanges, 6: Macroeconomics, 21, 28
160, 161, 162, 163,
Cost Function, 209 Existence, 11, 23, 177, 207 Marginal Output, 1 79
164, 165,
Costless, 229 Explicit Costs, 206, 209 Marginal Product, 179
Income Effect, 162
creation Of Utility, 9 Marginal Utility Angle, 156
Indifference Curve, 139,
F 141, 142, 143, 144, 145, Market, 11, 30, 32, 88, 218,
D Flow Concept, 34, 51 146, 147, 148, 149, 155, 219, 220, 221, 222,
Decision-Making, 13, 201,' Forecasts, 6 156,165, 166, 189, 190. 223, 224, 225, 226,
Definitions, 1, 2,4, 186, Franchise Monopoly, 240 Indifference Schedule, 143 228, 229, 230 . .
Degree Of Specialization, 187 Free-Market, 10 Indirect Costs, 204 Mathematical Analysis, 17
Fuelling Costs, 202 Inputs And Output, 171 Mathematical Economics, 9
Demand Analysis, 30 • Mathematical Form, 173
International Economics, 9
Demo-Snob Effects, 38 G Intervention, 230 Maximization Of
Dependent,9, 30, 34, 66, Geographic Area, 9 Isocost Curve, 193 Satisfaction, 139
83, 135, 172, Isoquant, 189, 191, 192, Maximum Quantities, 37,
Geometrical Analysis, 17
Descriptions, 6 194,197,198. 173
Desires, 15 Mergers And Acquisition, 241
Development Economics, 9 H Mixed Economy, 10, 13, 19,
Distribution, 2, 3, 9, 20, Habit, 34, 45 J Mixture, 13
23, 110, Habits, 9 Jobbers, 222 Monetary Economics, 9
Distributorship, 222 Homogeneous, 221, 229 Monopolistic Competition, 225
L Monopoly, 225, 235, 238,
Labour, 14, 175 239, 240, 241.
E I.
Land, 14, 175 Monopsonist, 235, 236,
Economic Analysis, 5, 238,
139, Ice., 160, 161, Law of Diminishing
Mrs, 141, 142, 148, 149,
i:conomic System, 9, 10, Imaginary Costs, 203 Returns, 179
 Index 253
2 Modern Microeconomics: A practical Arithmetical Approach
130, 137, 138, 140, 143, Traded-Off, 141, 148
144, 148, 150, 152, 161, Transactions, 3
155, 157, 178, 179, 180, 181, 183,
Multivariate, 34, 51, 61, 184, 187, 188, 189, 194, 199 Transformation, 14, 169,
Scale Of Preference, 15, 170,173
198, 199.
17,29 Transitivity, 146
N Production Equation, 173
Scarce Means, 3 Types Of Market, 219
Production Function, 173
Natural Monopoly, 240, Scarcity, 16, 17,35
Production Processes,
Nonsatiety, 141 Shut Down Cost, 207
Normative Economics, 6, 21,
11, 12, 15. u
Properties, 11, 12, 185; 188
Size Of Utility, 140
Number Of Consumers,30 Unavoidable Condition, 241
Public Sector Economics, 9 Social Science, 3, 4
Usage Of Commodity, 31
Pure Competition, 11, 40, Socialist, 10, 12, 13, 19,26
Utilization, 8, 62, 170, 171
0 ,, 244,247 Stability, 3, 223
Oligopoly, 225, 246, 24 7, Sub-Mu, 150
R Subsidies, 230 v
Opportunity Benefit, 17, Variable Factor, 179, 182,
Opportunity Cost, 17, 20, Ranking, 140 Substitution Effect,
183,190
52, 202, 205, 206, Rationality, 121, 139 162,196, 197.
Variables Inputs, 173, 179
Ordinality Of Utility, 140 Rationing Of T
Commodities, 230 VerbalAnalysis, 17
Out-Of-Pocket Costs, 203 Tabular Form, 132, 173
Raw Materials, 202, 239
Regional Economics, 9 Tangential, 78, 164, 194, w
p 197. Welfare Loss-, 239
· Regulations, 13, 59
Parent Product, 33 Resources, 1, 3,4, 9, 10, Tariffs, 230
PerfectCompetition,22 14, 15, 16, 18, 19, 20, Taxation, 59, 63, 230
Petroleum Economics,9 22, 23, 25, 26, 29, 35, Technology, 24, 57, 169,
Pla.nnedCosts,203 94; 121, 123, 170, 183, 171,172, 174,176
Policies, 7, 12, 21, 23, 26, 186, 198, 203. Total Fixed Cost, 208, 213
44, 55, 59, 63, 204 . Restriction Of Entry, 239 Total Output, 178
Population, 34, 45. Returns To Scale, · 176, Total Product, 179, 180,
Positive Economics,6,21, . 186, 192, 193, 198 182,183,210
Practical Science, 2 s Total Variable Cost, 209,
Predictions, 6 213,234
Satisfaction, 4, 8, 9, 11,
Production, 14, 19, 20, 22,
14, 18, 30, 33, 38, 39,
3, 169, 170, 171, 172,
84, 120, 121, 124, 127,
173, 174, J175, 176, 177,
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