CHAPTER 2 DEMAND AND SUPPLY

The corner-stone of economic analysis is the simple demand and supply model. Understanding what
demand is, what supply is, and the relationship between the two is essential for understanding
virtually all economics. Demand and supply are two ways of categorizing the influences on the price of
goods that we buy.

2.1 THEORY OF DEMAND

Demand is defined as the quantity of a good that consumers are able and willing to buy in a market
at a given price during a specified period of time (other things being equal).

When we describe demand, we must be specific about the units being measured and the time period
under consideration. So, we usually state a time dimension without which we could not make any
sense of some demand relationships, because the numbers would be different if we were talking
about the quantity demanded per month, or per year or say the quantity demanded per decade.

The theory of demand can be stated concisely as follows:

At higher prices, a lower quantity will be demanded than at lower prices, other things being
equal.

Or, stated differently:

At lower prices, a higher quantity will be demanded than at higher prices, other things being
equal.

↑P → ↓Qd

A fundamental characteristic of demand is this: Other things equal, as price falls, the quantity
demanded rises, and as price rises, the quantity demanded falls.

In short, there is a negative or inverse relationship between price and quantity demanded. Economists
call this inverse relationship the law of demand. The other-things-equal assumption is critical here.
Many factors other than the price of the product being considered affect the amount purchased.

Thus, the theory of demand states that the price and quantity demanded move in opposite directions.
Price goes up, quantity demanded goes down: price goes down, quantity demanded goes up.

Other Things being Equal (i.e. the ceteris paribus assumption)

By emphasizing the ceteris paribus assumption when we state the theory of demand, we are
assuming that ‘other things are held constant’. This is necessary because price is not the only thing
that affects purchases. There are many others: one for example is income. If, while the price of a
good is changing, income is also changing, then we would not know the change in the quantity
demanded was due to a change in the price or to a change in income. Therefore, we hold income
constant, as well as any other factor that might affect the quantity of the product demanded.
Since we are holding all other things equal, or constant, that obviously means that we are holding the
prices of all other goods constant when we state the theory of demand. Implicitly, therefore, we are
looking at the price change of the good under study relative to all other prices. An understanding of
relative prices is important in the study of economics.

Relative Prices

The relative price of any item is its price compared to the price of other goods, or relative to a
(weighted) average of all other prices in the economy. The prices that we pay in cedis for any good
or service at any point in time are called absolute, or nominal, prices. Consumer-buying decisions,
however, depend on relative, not absolute prices.

Making this distinction between absolute and relative price enables us to avoid a possible confusion
about the meaning of price (increases) during a period of generally rising prices. Someone not
familiar with this distinction may contend that the theory of demand clearly does not hold on say the
Tamale Abaabu market because perhaps the price of colour television sets went up last year by 10
per cent, but the quantity demanded did not go down at all. Assuming that other things in the
economy did not change, this indeed may have been a possible refutation of the theory of demand,
except for the fact that last year's inflation rate was probably as much as, or more than 10 per cent. It
is the price of colour television sets relative to all other prices that is important for determining the
relationship between price and quantity demanded.

For example, the quantity of Pepsodent purchased will depend not only on the price of Pepsodent but
also on the prices of such substitutes as Close up, Colgate, and Kel. The law of demand in this case
says that fewer Pepsodent will be purchased if the price of Pepsodent rises and if the prices of Close
up, Colgate, and Kel all remain constant. In short, if the relative price of Pepsodent rises, fewer
Pepsodent will be bought. However, if the price of Pepsodent and the prices of all other competing
toothpastes increase by some amount— say, GHc20—consumers might buy more, fewer, or the
same number of Pepsodent.

Three Reasons Why We Observe the Theory of Demand

There are three fundamental reasons that explain why the quantity demanded of a good is inversely
related to its price, other things being equal.

DIMINISHING MARGINAL UTILITY

In any specific time period, each buyer of a product will derive less satisfaction (or benefit, or utility)
from each successive unit of the product consumed. The second ball of kenkey will yield less
satisfaction to the consumer than the first, and the third still less than the second. That is,
consumption is subject to diminishing marginal utility. And because successive units of a particular
product yield less and less marginal utility, consumers will buy additional units only if the price of
those units is progressively reduced.

SUBSTITUTION EFFECT
Let us assume now that there are several goods, not exactly the same, or perhaps even very different
from one another, but all serving basically the same purpose. If the price of one particular good falls,
we most likely will substitute in favour of the lower-priced good and against the other similar goods
we might have been purchasing. Conversely, if the price of that good rises relative to the price of the
other similar goods, we will substitute in favour of them and not buy as much of the high-priced
good.
REAL INCOME EFFECT
If the price of something that you buy goes up while your money income and other prices stay the
same, then your ability to purchase goods in general goes down. That is to say, your effective
purchasing power is reduced even though your money income has stayed the same. It would be
impossible to purchase as much of the high-priced good (as you used to do at the lower price) and
still purchase the same quantity of all other goods and services that you were purchasing. You are
poorer, and hence it is likely that you will buy less of a number of things, including the good whose
price rose. The converse will also be true. When the price of one good that you are purchasing goes
down without any other prices changing and without your money income changing, you will feel
richer and undoubtedly will purchase a bit more of a number of goods, including the lower-priced
good.

In general, the real income effect is usually quite small. After all if the price of milk falls by say 50%
cet. par, and suppose I used to buy ten tins a month, even though I could now afford to buy twenty
tins of the milk for that month, the question however is: would I need as many as twenty tins of milk
for one month? Accordingly I may decide to increase my milk purchase from ten to say, twelve tins
and use my remaining increase in purchasing power to buy a few more handkerchief and/or soap
and/or toothpaste, etc.

As a consequence we expect the substitution effect to be usually more important in causing us to

purchase more of goods that have become cheaper and less of goods that have become more
expensive than the income effect.

The demand schedule and demand curve

The demand relationship can be expressed as a demand schedule or as a demand curve. A demand
schedule is a table relating prices to the quantity demanded at each price. It is a set of planned
purchasing rates that depends on the price of the product. It provides the coordinates of points
needed to plot the demand curve.

DEMAND FOR MAIZE

PRICE PER BOWL QUANTITY DEMANDED
GHc PER WEEK
5 10
4 20
3 35
2 55
1 80
Figure 1. Demand Curve

A demand curve is usually a downward-sloping curve showing the quantity of a well-defined

commodity demanded at various possible prices. By convention the price is measured on the vertical
axis, and the quantity demanded on the horizontal axis. Each combination of price and quantity
demanded listed in the demand schedule is represented by a point on the demand curve. These points
are connected to form the demand curve. The demand curve (except for Giffen goods) is downward
sloping, reflecting the fact that price and quantity demanded are inversely related.

At times it is useful to distinguish between individual demand, which is the demand of an

individual consumer, and market demand, which is the sum of all the individual demands of
consumers in the market. The market demand traces the relationship between the price of a good and
the quantity that all consumers in the market are prepared to buy. In most markets there are many
consumers, sometimes millions.
FIGURE 2. Market demand for corn, three buyers.

The market demand curve D is the horizontal summation of the individual demand curves (D1, D2,
and D3) of all the consumers in the market. At the price of $3, for example, the three individual
curves yield a total quantity demanded of 100 bushels ( =35 + 39 + 26)

Be careful to distinguish between say, the demand for Star Beer and the quantity demanded. When
we talk about the demand for Star Beer, we do not mean a specific quantity but rather the
relationship between various possible prices and the quantity demanded at each price. The entire
curve is referred to as the demand for Star Beer. Individual points along the demand curve show the
quantity demanded at each price - the amount consumers are willing and able to purchase if the good
is offered for sale at that price. For example, at a price of 7GHp per bottle, 200,000 crates are
demanded. When the price of Star Beer changes, this change is expressed by a movement along the
curve.

Movements along the demand curve are called changes in quantity demanded, not changes in
demand.

Changes in Demand
A change in one or more of the determinants of demand will change the demand data (the demand
schedule) in the table accompanying Figure 3 and therefore the location of the demand curve there.
A change in the demand schedule or, graphically, a shift in the demand curve is called a change in
demand.
If consumers desire to buy more corn at each possible price than is reflected in column 2 in the table
in Figure 3., that increase in demand is shown as a shift of the demand curve to the right, say, from
D1 to D2. Conversely, a decrease in demand occurs when consumers buy less corn at each possible
price than is indicated in column 2. The leftward shift of the demand curve from D1 to D3 in Figure
3.
shows that situation. Now let’s see how changes in each determinant affect demand.

FIGURE 3. Changes in the demand for corn.

A change in one or more of the determinants of demand causes a change in demand. An increase in
demand is shown as a shift of the demand curve to the right, as from D1 to D2. A decrease in
demand is shown as a shift of the demand curve to the left, as from D1 to D3. These changes in
demand are to be distinguished from a change in quantity demanded, which is caused by a change in
the price of the product, as shown by a movement from, say, point a to point b on fixed demand
curve D1.

DETERMINANTS OF DEMAND

Demand schedules and demand curves enable us to see how the inverse relationship between the
price and the quantity demanded looks. Thus a typical demand curve is drawn with all other non-
price factors that determine demand held constant. There are many such determinants. The major
non-price determinants of demand are:

i. Consumer income: we refer here to the size of household income - i.e. how much
money consumers have to spend. In some cases, the cost and availability of credit,
e.g. with spending on credit cards,
ii. The prices of related goods: we refer here to two issues - first of all the price and
availability of substitute goods - i.e. goods which might be bought instead and
secondly, the price and availability of complements - i.e. goods which are usually
bought in conjunction with the good,
iii. Consumer tastes and preferences: we refer here to tastes, fashions and attitudes
towards a good,
iv. Changes in expectations of future relative prices: we refer here to consumer
expectations about future market conditions (e.g. expected price rises or supply
shortages),
v. The number of consumers in the market: we refer here to the population or the
market size. Related to this is the distribution of income among the population - i.e.
how wealth is spread among the population. For example - Is there a large number of
very poor people living at a subsistence level. Is there a large affluent middle class
etc?

Other non-price determinants of demand are, for example, the season of the year for some goods,
culture and religion and the cost of financing the purchase of some very expensive consumer items,
e.g. interest rates.

Let us examine in much more detail how these non-price determinants of demand can cause a shift in
the demand curve which we refer to as change in demand:

i. Changes in Income

Demand reflects both consumer willingness and consumer ability to purchase the good at each
possible price. The ability to purchase goods is based on income; the greater the income, the greater
this purchasing ability. A demand curve assumes some given consumer income. An increase in that
income will normally increase demand - that is, at each price level the quantity demanded will
increase. If consumer income increases, the demand curve say, for milk will shift to the right. This
increase in demand indicates a greater willingness and ability to purchase milk at each price level.

More generally, an increase in demand - that is, a shift to the right in the demand curve -means that
consumers are willing to pay more for each unit than before.

The demand for normal goods increases as consumer income increases. For most goods, an increased
income will lead to an increase in demand. Goods for which demand increases when income
increases are called normal goods. Thus since the demand for milk in Ghana increases when
consumer income increases, milk is considered to be a normal good. Most goods are ‘normal’ in this
sense.

One category of goods is referred to as inferior goods because the demand for these goods actually
declines as income increases. Thus demand for black-and-white television sets has actually fallen as
more people have felt able to buy colour television sets. Other examples of inferior goods may
include gari and tro-tro rides in Ghana. As consumer income increases, they tend to switch from
consuming these inferior goods to consuming normal goods (attending quality restaurants,
automobile or plane rides).

It should be noted that the terms ‘normal’ and ‘inferior’ are merely part of the economist's
terminology; no value-judgements are associated with them.

ii. Changes in the Prices of Related Goods

There are alternative ways of trying to satisfy any particular want. For example, thirst can be
quenched not only by a glass of milk but also by a soft drink, fruit juice, or even a glass of water.
These goods are, to a certain extent, substitutes in satisfying the particular want, thirst. The choice
will depend in part on the prices of the available alternatives. However, most pairs of goods selected
at random will be unrelated. For example, the demand for milk has no relation to the price of
exercise books.

Demand schedules are always drawn with the prices of all other commodities held constant. When
we draw demand curve for Milo, we assume that the price of Bournvita is held constant. When we
draw demand curve for stereo speakers, we assume that the price of stereo amplifiers is held
constant. When we refer to related goods we are talking about those goods whose demand is
interdependent. In other words, if a change in the price of one good shifts the demand for another
good, we say those two goods are related.

There are two kinds of related good; substitutes and complements. We can define and distinguish
between substitutes and complements in terms of how the change in price of one commodity affects
the demand for its related commodity. As substitutes, an increase in the price of peak milk leads to
an increase in the demand for ideal milk. Thus for substitutes, a price change in the substitute will
cause a change in the same direction in the demand for the good under study.

With complementary goods, the situation is reversed. Consider stereo speakers and stereo amplifiers.
If the price per constant-quality unit of stereo amplifiers decreases from, say, ¢500 to ¢300, that will
encourage more people to purchase component stereo systems, and they will now buy more speakers,
at any given price than before. The demand curve for speakers will shift outwards to the right. The
reverse situation is also true: an increase in the price of amplifiers will lead to a decrease in the
demand for speakers. Thus, for complements, a price change in a product will cause a change in the
opposite direction in the demand for its complement.

iii. Changes in Tastes

A change in consumer tastes in favour of a good can shift its demand curve outwards to the right.
When 'Guarantee' shoes became fashionable some time ago in Ghana, the demand curve for them
shifted to the right; when the fashion died out the demand curve shifted inwards to the left. Fashion
and taste changes can be related to the time of the year: for example, Christmas time generates high
demand for new clothes and chicken consumption!

Tastes are nothing more than your likes and dislikes in consumption. Some people crave certain
foods that would gag others. What determines tastes? Who knows? Economists certainly do not, nor
do they spend much time worrying about it. Economists do recognize, however, that tastes are very
important in shaping demand, and a change in tastes can change demand.

Since it is so difficult to observe a change in tastes, we should be reluctant to attribute a change in

demand to a change in tastes. In our analysis of consumer demand, we will assume that tastes are
given and are relatively stable over time. Only after investigating all other possible factors will we
attribute a change in demand to a change in tastes. Otherwise, there is a temptation to explain any
shift in demand by saying that- consumers' tastes changed. For example, "Why did the demand for
milk change?" "Obviously, it is because the taste for milk changed." There is no way to test such an
assertion, so economists try to use this explanation sparingly and only after other possible changes
have been ruled out.

This cautionary note is not meant to downplay the role of tastes in determining demand; it is simply a
warning not to attribute the source of a change in demand to a change in tastes before carefully
considering the other possibilities. At times it may be possible to trace changing tastes to specific
events. For example, if health officials warn that milk consumption is linked to heart disease, the
demand for milk is likely to fall. Similarly, if the common perception that only wimps drink milk
develops, this perception could reduce the demand for milk.

iv. Changes in Price Expectations

Another factor that can shift the demand curve is a change in consumer expectations about the future
price of a good. If consumers expect the price of housing to go up next year, they will probably
increase their demand for housing this year. On the other hand, expectations of a lower price in the
future will encourage consumers to postpone purchases. Changes in expectations will have less effect
if the good in question is perishable. If you expect the price of bread to go up next month, you will
not buy 50 loaves today. Even in this case, though, expectations will still matter to some degree: if
you expect the price of bread to go up tomorrow, you are more likely to buy two loaves today rather
than your usual one loaf.

Thus expectations about future relative prices play an important role m determining the position of a
demand curve because many goods are storable.

It is important to note that we are talking about changes in expectation of future relative prices than
absolute prices. Consider, for example what would happen to the demand curve for computers if it
were known that their price would rise by 30 per cent next year. If it were anticipated that the prices
of all other goods would also rise by 30 per cent, then the price of computers relative to an average
of all other prices would not be any different next year from what it is this year. Thus, the demand
curve for computers this year would not increase just because of the anticipated 30 per cent price rise
in absolute price.

v. Changes in the Number of Consumers (or population)

Often an increase in the population in an economy (holding per capita income constant) shifts the
market demand outwards for most products. This is because an increase in population leads to an
increase in the number of buyers in the market. Conversely, a reduction in the population will shift
most demand curves inwards because of the reduction in the number of buyers in the market.

Market demand is the sum of the individual demands of all consumers in the market. If the number
of consumers in the market changes, this change will shift the demand curve. For example, if the
population grows, the demand for food will increase. Even if the total population remains the same,
demand could change as a result of a change in the composition of the population. For example, if
the number of retired couples increases, the demand for recreational vehicles will probably increase.
If the baby population declines, the demand for baby food will decrease.

Distinguishing between 'Changes in Demand' and 'Changes in Quantity demanded'

Changes in demand refer to shifts in the entire demand curve so that the quantity demanded at each
and every price changes. The term demand refers to the entire demand schedule or curve. Demand,
therefore, refers to a schedule of planned rates of purchase. Demand - the demand schedule or curve
- is drawn with non-price determinants (discussed above) held constant. If any of the non-price
determinants changes, the demand curve will shift to the right or left.

On the other hand, a change in the quantity demanded can only come about because of a change in
price. A change in the quantity demanded occurs when there is a movement to a different point (co-
ordinate) along a given demand curve. A change in price causes a movement along a given demand
curve.

In economic analysis therefore we must be careful to note the following distinction:

A change in demand shifts the demand curve and is caused by changes in the non-price
determinants of demand

A change in quantity demanded involves a movement along a given demand curve and is caused by a
change in price.

Elasticity of Demand

Elasticity of Demand determines the extent to which changes in price affect changes in quantity
demanded. The variation in demand in response to a variation in price is called price elasticity of
demand. It may also be defined as the ratio of the percentage change in quantity demanded to the
percentage change in price of particular commodity.

Figure 4. Elasticity of Demand

A simple way to see the degree of responsiveness is simply to look at the slope. A flatter demand
curve represents a greater degree of responsiveness (for a supply or demand curve), as shown in the
above graphs: the flatter demand curve produces a larger change in quantity for the same change in
price.
Using just the slope is the quick-and-easy way to think about elasticity. The extremes are easy to
remember: A perfectly elastic demand curve is horizontal, because an infinitely small change in price
corresponds to an infinitely large change in quantity; the graph looks like the letter E for elastic. A
perfectly inelastic demand curve is vertical, because quantity will never change regardless of the
change in price; the graph looks like the letter I (for inelastic).

The formula for the coefficient of price elasticity of demand for a good is:

Ed = |%∆Qd/%∆P|

Ed = |(∆Qd/Qd)/(∆P/P)| = (Q1 – Q2) / (Q1 + Q2)     

(P1 – P2) / (P1 + P2)

(1)

where P is the price of the good demanded, ΔP is how much it changed, Q

is the quantity of the good demanded, and ΔQ is how much it changed. In other words, we can say
that the price elasticity of demand is the percentage change in demand for a commodity due to a
given percentage change in the price. If the quantity demanded falls 20 tons from an initial 200 tons
after the price rises GHc 5 from an initial price of GHc 100, then the quantity demanded has fallen
10% and the price has risen 5%, so the elasticity is (−10%)/(+5%) = −2.

The price elasticity of demand is ordinarily negative because quantity demanded falls when price
rises, as described by the "law of demand". Two rare classes of goods which have elasticity greater
than 0 (consumers buy more if the price is higher) are Veblen and Giffen goods. Since the price
elasticity of demand is negative for the vast majority of goods and services, economists often leave
off the word "negative" or the minus sign and refer to the price elasticity of demand as a positive
value (i.e., in absolute value terms). They will say "Motorbikes have an elasticity of two" meaning
the elasticity is −2. This is a common source of confusion for students.

Depending on its elasticity, a good is said to have elastic demand (> 1), inelastic demand (< 1), or
unitary elastic demand (= 1). If demand is elastic, the quantity demanded is very sensitive to price,
e.g. when a 1% rise in price generates a 10% decrease in quantity. If demand is inelastic, the good's
demand is relatively insensitive to price, with quantity changing less than price. If demand is unitary
elastic, the quantity falls by exactly the percentage that the price rises. Two important special cases
are perfectly elastic demand (= ∞), where even a small rise in price reduces the quantity demanded to
zero; and perfectly inelastic demand (= 0), where a rise in price leaves the quantity unchanged.

Elastic Demand
Elasticity of demand is illustrated in Figure 5. Note that a change in price results in a large change in
quantity demanded. An example of products with an elastic demand is consumer durables. These are
items that are purchased infrequently, like a washing machine or an automobile, and can be
postponed if price rises. For example, automobile rebates have been very successful in increasing
automobile sales by reducing price.
Close substitutes for a product affect the elasticity of demand. If another product can easily be
substituted for your product, consumers will quickly switch to the other product if the price of your
product rises or the price of the other product declines. For example, beef, pork and poultry are all
meat products. The declining price of poultry in recent years has caused the consumption of poultry
to increase, at the expense of beef and pork. So, products with close substitutes tend to have elastic
demand.

Figure 5. Elastic Demand

An example of computing elasticity of demand using the formula is shown in Example 1. When the
price decreases from $10 per unit to $8 per unit, the quantity sold increases from 30 units to 50 units.
The elasticity coefficient is 2.25.

Inelastic Demand
Inelastic demand is shown in Figure 6. Note that a change in price results in only a small change in
quantity demanded. In other words, the quantity demanded is not very responsive to changes in price.
Examples of this are necessities like food and fuel. Consumers will not reduce their food purchases if
food prices rise, although there may be shifts in the types of food they purchase. Also, consumers
will not greatly change their driving behavior if gasoline prices rise.
Figure 6. Inelastic demand
An example of computing inelasticity of demand using the formula above is shown in Example 2.
When the price decreases from $12 to $6 (50%), the quantity of demand increases from 40 to only 50
(25%). The elasticity coefficient is .33.

This does not mean that the demand for an individual producer is inelastic. For example, a rise in the
price of gasoline at all stations may not reduce gasoline sales significantly. However, a rise of an
individual station’s price will significantly affect that station’s sales.

Unitary Elasticity
If the elasticity coefficient is equal to one, demand is unitarily elastic as shown in Figure 7. For
example, a 10% quantity change divided by a 10% price change is one. This means that a 1% change
in quantity occurs for every 1% change in price.

Figure 7. Unitary elastic demand

 KEY POINTS 2.1

 A demand curve is a downward-sloping curve showing the quantity of a well-

defined commodity demanded at various possible prices.

 The demand for an inferior good decreases as income rises.

 The demand for a normal good increase as income rises.

 Two goods are substitutes if an increase in the price of one leads to an increase in
demand for the other.

 Two goods are complements if an increase in the price of one leads to a decrease
in demand for the other.

 A change in price, other things constant, results in a change in the quantity

demanded, as reflected by a movement along the demand curve. A change in one
of the non-price determinants of demand, however, will result in a change in
demand as reflected by a shift in the demand curve.

 There are five major determinants of demand: (1) consumer income, (2) the prices
of related goods, (3) consumer expectations, (4) the number of consumers, and (5)
consumer tastes. A change in any of these determinants could cause the demand
curve to shift.

The distinction between a change in demand and a change in the quantity demanded is
confusing at first, so be careful.

2.2 THEORY OF SUPPLY

Supply is defined as the quantity of a good that producers are willing and able to sell in a market at a
given price during a specified period of time, ceteris paribus (other things being equal).

Thus just as demand is the relation between price and quantity demanded, supply is the relation
between price and quantity supplied. In particular, supply indicates how much of the good producers are
both willing and able to offer for sale at each possible price, other things constant.

The Law of Supply states that “when the price of a good rises, and everything else remains the same,
the quantity of the good supplied will also rise.” In short,

↑P → ↑Qs

Just like demand, there is also a relationship between price and quantity supplied which involves the
following:

At higher prices, a larger quantity will generally be supplied than at lower prices, all other
things held constant.

Or, stated otherwise,

At lower prices, a smaller quantity will generally be supplied than at higher prices, all other things
held constant.

In other words, there is generally a direct relationship between quantity supplied and price. This is the
opposite of the relationship we saw for demand. There, price and quantity demanded were inversely
related. Here they are directly related. For supply, as the price rises, the quantity supplied rises; as the
price falls, the quantity supplied also falls. Producers are normally willing to produce and sell more of
their product at a higher price than at a lower price, other things being constant.

Why a Direct, or Positive, Relationship?

Producers offer more goods for sale when prices are higher for two reasons. The first has to do with a
willingness to offer more for sale at a higher price man at a lower price (i.e. incentives for increasing
production). A second reason why the supply curve tends to be upward sloping is the producers'
increased ability to supply the good at the higher prices (i.e. the theory of increasing costs).

(a) INCENTIVES FOR INCREASING PRODUCTION

First there is the willingness to offer more for sale at a higher price than at a lower price. Higher
prices for a good means that producers are rewarded more for production, and they naturally are
more willing to produce when they are paid more to do so. The prices of other goods are assumed to
remain constant when the price of maize increases. An increase in the price of maize provides
farmers with an incentive to shift some resources out of the production of other goods, such as
cassava, where the price is now relatively lower, to maize, where the price is now relatively higher.
You can think of prices as signals to existing and potential suppliers about the relative reward for
producing the good. A higher maize price serves as a beacon that attracts resources from less-valued
uses to the higher-valued use. Farmers will find it more rewarding monetarily than it was before to
spend more of their time and resources producing maize than they used to. They may, for example,
switch more of their production from cassava production to maize production because the market
price of maize has risen. The maize farmer may even find it now profitable to add the use of more
labour and sophisticated tools to the production of maize because of its higher market price. Thus, as
the price of a good increases, other things constant, a producer is more willing to supply the good.

(b) THE THEORY OF INCREASING COSTS

A second reason why the supply curve tends to be upward sloping is the producers' increased ability
to supply the good at the higher prices. Here is why the ability to supply increases. Recall the law of
increasing opportunity cost, which states that as more of a particular good is produced, the greater its
opportunity cost will be. Based on this law, as the quantity of a particular good increases in supply,
so does its cost of production. Because producers face a higher cost of production for greater levels
of production, they need to receive a higher price for their product before they are able to increase
the quantity supplied.

Now apply this analysis to a maize-farmer wishing to increase quantity of maize supplied. That
farmer will eventually find that each additional output of maize production will involve higher and
higher costs. Hence, the only way that the maize-farmer would be induced to produce more and more
maize would be because of the lure of a higher market price that maize could fetch. For example,
only if a higher market price of maize could be fetched would a farmer be willing to pay overtime
rates for workers and to pay the extra costs involved in tilling stony, less desirable land. Higher
maize prices make the farmer more able to draw resources away from these alternative uses. In a
sense, then it is because of the law of increasing costs that price has to go up in order to create a
situation in which the quantity supplied will also go up.

As with demand, we distinguish between individual supply and market supply. Although we will
continue to focus on market supply, keep in mind that market supply is the sum of the amount
supplied at each price by the individual suppliers.

The supply schedule and supply curve

A supply schedule is a table relating prices to the quantity supplied at each price. It is a set of
planned production rates that depends on the price of the product. It provides the co-ordinates of
points needed to plot the supply curve.

A supply curve shows the quantity of a well-defined good supplied at various prices
As with demand, it is convenient to represent individual supply graphically. In Figure 8, curve S is
the supply curve that corresponds with the price–quantity supplied data in the accompanying table.
The upward slope of the curve reflects the law of supply—producers offer more of a good, service,
or resource for sale as its price rises.

FIGURE 8. An individual producer’s supply of corn.

Because price and quantity supplied are directly related, the supply curve for an individual producer
graphs as an upsloping curve. Other things equal, producers will offer more of a product for sale as
its price rises and less of the product for sale as its price falls.

Market Supply
Market supply is derived from individual supply in exactly the same way that market demand is
derived from individual demand. We sum the quantities supplied by each producer at each price.
That is, we obtain the market supply curve by “horizontally adding” the supply curves of the
individual producers.

The determinants of supply

The supply curve isolates the relationship between price and quantity supplied, other things constant.
Thus, the supply curve is drawn under the assumption that no changes occur in other factors that can
change supply. Such factors include:

 the state of technology

 the price of resources (inputs) used to produce the product
 the prices of related goods
 taxes and subsidies
 price expectations of producers
 the number of producers.
 supply conditions - e.g. weather conditions in the case of agricultural goods; quota
restrictions when a government imposes production limits.

These are the non-price determinants of supply. If any of them changes, there will be a shift in the
supply curve. Let us examine them in detail:

i. Changes in Technology

The supply curve is constructed under the assumption that the technology available to producers does
not change. The state of technology represents the economy's stock of knowledge about how
resources can be combined most efficiently. If some new method is devised to produce the good
more efficiently, production costs will go down and suppliers will be more willing and more able to
supply the good.

For example, suppose a new cow-milking machine called ‘The Invisible Hand’ has a very soothing
effect on cows; cows find the new machine so relaxingly delightful that they produce more milk.
Such a technological advance will be reflected by a shift to the right in the market supply curve for
milk. A larger quantity will be forthcoming at each and every price because the cost of production
will have fallen.

Notice that just as a change in demand could be interpreted in two different ways, so can a change in
supply. First, an increase in supply means farmers supply more milk at each possible price. Second,
an increase in supply means that farmers supply the same quantity at a lower price.

ii. Changes in the price of resources (inputs) used to produce the product

A second change that could shift the supply curve is a change in the price of one or more of the
resources used in the production of the good. A decrease in the price of a resource will lower the cost
of producing the good and will shift the supply curve to the right, reflecting the greater ability to
supply the good at each price. For example, if the price of cow feed falls, the supply of cow-milk will
shift to the right.
On the other hand, an increase in the cost of a resource will shift the supply curve to the left,
indicating that suppliers are offering less of the good at every price. For, example, higher electricity
rates increase the cost of heating the storage place and operating the milking machines. These higher
production costs would be reflected in a shift to the left in the supply curve.

Again, the reduction in supply can be interpreted in two ways: when supply is reduced, farmers
supply less milk at each price or supply the same quantity of milk but at a higher price.

iii. Changes in the prices of related goods

In our discussion of demand we identified two types of related goods: substitutes and complements.
There is a parallel case on the supply side. Some goods are in competitive supply and some are in
joint supply.

Goods in competitive supply means that one good can be quite easily produced using the same
factors of production as an alternative to another good. The price relationship between two such
goods will therefore have a major influence on the amounts producers are willing to supply. The
relative profitability of the two goods will determine their supply situation. An expansion in supply
of one good leads to a contraction in the supply of the other.

In general terms we may consider the situation when there are changes in the prices of alternative
goods. Nearly all resources have alternative uses. The farmer's field, tractor, bam, and time could be
used to produce a variety of goods. Alternative goods are goods that use some of the same resources
as used to produce the good under consideration. For example, it is obvious that the production of
maize uses some of the same resources as the production of cassava. An increase in the price of
maize raises the opportunity cost of producing cassava. As the production of maize is now relatively
more rewarding, resources will shift from cassava production into maize production. With fewer
resources supplied to the production of cassava, the supply of cassava will decrease, or shift to the
left.

In the case of goods in related supply or joint products an expansion of one good gives rise to a
parallel expansion in the supply of by-products of the related good. For instance the more people
produce palm oil, the more we end up having large supplies of palm kennels for the production of
palm kennel oil as well.
iv. Changes taxes and subsidies

Certain taxes, such as sales taxes, are effectively an addition to production costs and therefore reduce
the supply. A subsidy will do the opposite: every producer would get a 'gift' from the government of,
say, a few cedis for each unit produced.

v. Changes in price expectations of producers

A change in the expectation of a future relative price of a product can affect a producer's willingness
to supply, just as price expectations affect a consumer's current willingness to purchase. Farmers
may withhold from market part of their current maize crop if they anticipate a higher maize price in
the future.

vi. Changes in the number of producers.

Since the market supply is the sum of the amount supplied by each producer, market supply depends
on the number of producers in the market. If the number of producers increases, supply will shift to
the right; if the number decreases, supply will shift to the left.

vii. Changes in the supply conditions

The supply of agricultural goods like maize, yam, cocoa, etc., undoubtedly depends heavily on the
general weather conditions of the year. In the case of goods that are either imported or rely on
imported inputs changes in government policy that may liberalize or impose, say quota restrictions,
can also really affect the quantum of supply of the good on the domestic market.

Shifts in the Supply Curve

FIGURE 9. Changes in the supply of corn.

A change in one or more of the determinants of supply causes a change in supply. An increase in
supply is shown as a rightward shift of the supply curve, as
from S1 to S2. A decrease in supply is depicted as a leftward shift of the curve, as from S1 to S3. In
contrast, a change in the quantity supplied is caused by a change in the product’s price and is shown
by a movement from one point to another, as from b to a on fixed supply curve S1.

A change in the price of the good itself will cause a movement along the supply curve. Thus if the
price of a good changes, its supply curve will not. change and therefore will not shift. It is only when
there is a change in the non-price determinants of supply that the entire curve will shift. Thus a shift
in the supply curve can be caused by any, or combination of, the following:

 Changes in the state of technology

 Changes in the price of resources (inputs) used to produce the product
 Changes in the prices of related goods
 Changes in the taxes and subsidies
  Changes in the price expectations of producers
 Changes in the number of producers.
 Changes in the supply conditions

Price elasticity of supply

The concept of price elasticity also applies to supply. If the quantity supplied by producers is
relatively responsive to price changes, supply is elastic. If it is relatively insensitive to price changes,
supply is inelastic.
We measure the degree of price elasticity or inelasticity of supply with the coefficient Es, defined
almost like Ed except that we substitute “percentage change in quantity supplied” for “percentage
change in quantity demanded”:
Price elasticity of supply = % Change in quantity supplied
% Change in price

The price elasticity of supply has a range of values:

PES > 1: Supply is elastic.

PES < 1: Supply is inelastic.
PES = 0: The supply curve is vertical; there is no response of demand to prices. Supply is “perfectly
inelastic.”
PES = ∞ (i.e., infinity): The supply curve is horizontal; there is extreme change in demand in
response to very small change in prices. Supply is “perfectly elastic.”

KEY POINTS 3.2

 Supply is a schedule indicating the quantity of a well-defined good that producers

are willing and able to sell at various prices during a given time period, other
things constant.
 Producers offer more goods for sale when prices are higher for two reasons. The
first has to do with a willingness to offer more for sale at a higher price than at a
lower price (i.e. incentives for increasing production). A second reason is the
producers' increased ability to supply the good at the higher prices ( resulting
from the theory of increasing costs)
 Some goods are in competitive supply and some are in joint supply.
 A change in price, other things constant, results in a change in the quantity
supplied, as reflected by a movement along the supply curve. A change in any of
the non-price determinants of supply, however, will result in a change in supply
as reflected by a shift in the supply curve
 The major determinants of supply are:
 the state of technology,
 the prices of relevant resources,
 the prices of related goods,
 taxes and subsidies,
  producer expectations, and
 the number of producers in the market
 supply conditions.
 A change in any of these determinants could cause the supply curve to shift.

You should notice that supply and demand have some similar determinants. Both depend
on the prices of related goods, price expectations, and the number of participants in the
market.

2.3 MARKET EQUILIBRIUM

Putting demand and supply together, we can find an equilibrium where the supply and demand curve
cross. The equilibrium consists of an equilibrium price P* and an equilibrium quantity Q*. The
equilibrium must satisfy the market-clearing condition, which is Qd = Qs.

P
S

P*
PL
D
Qs Q* Qd Q
Figure 10. Market Equilibrium

Mathematical example: Suppose P = 20 - .1Qd and P = 5 + .05Qs. In equilibrium, Qd = Qs, so

we have a system of equations. Solve for Q like so:
20 - .1Q = 5 + .05Q
15 = .15Q Q* = 100.
Then plug Q* into either equation: P = 20 - .1(100) = 10. So the market
equilibrium is P* = 10, Q* = 100.

The equilibrium price is also called the market-clearing price. In a stable and free market, the forces
of demand and supply will interact so that an equilibrium price and quantity will be reached. This is
where the quantity demanded equals the quantity that firms want to supply, and so all production
output is purchased by customers at the market price, and there are no market pressures for a change
in price or quantity.

Thus market equilibrium occurs at a price where the quantity demanded by consumers is equal to the
quantity supplied by producers. This is shown at point e. At prices above the equilibrium price, the
quantity supplied exceeds the quantity demanded; here a surplus exists, and there is downward
pressure on the price. ;At prices below equilibrium, quantity demanded exceeds quantity supplied;
the resulting shortage puts upward pressure on the price.

EQUILIBRIUM IN THE MARKET FOR A HYPOTHETICAL PRODUCT

Figure 11. Market Equilibrium

To examine how the price and quantity will gravitate toward their equilibrium values, suppose the
initial price is 100, say cedis, exceeding the equilibrium value. According to the market supply curve
in the figure, producers supply 24 units at that price. At a price of 100 cedis consumers demand only
14 units of the 24 units supplied, leaving 10 units unsold. The amount by which quantity supplied
exceeds quantity demanded is called an excess quantity supplied, or a surplus. Notice that the surplus
is measured at a particular price - in this case, 100 cedis.

Unless the price falls, the surplus will continue. Thus, a surplus will create downward pressure on the
price level to clear the market. As the price falls, producers reduce their quantity supplied, and
consumers increase their quantity demanded. As long as quantity supplied exceeds quantity
demanded, there will be a tendency for the price to fall until the quantity just equals the quantity
demanded. This equilibrium will occur when the price equals 75 cedis.

What if the price is initially 50 cedis, a price below equilibrium. The quantity supplied would be 16
units. Consumers, however, would like to buy 26 units at that price, so they quickly empty the store
shelves. The result is an excess quantity demanded, or a shortage, of 10 units. This shortage creates
upward pressure on the price. As the price rises, producers increase their quantity supplied, but
consumers reduce their quantity demanded. The price will increase until the shortage is eliminated.
Again, the market will be hi equilibrium only when the quantity demanded equals the quantity
supplied. Thus, excess supply creates downward pressure on the price level, and excess demand,
upward pressure on the price level.

Impact of Demand Shifts on Equilibrium Price and Quantity

In general, if the demand for a product increase, given an upward-sloping supply curve, the
equilibrium price and quantity will also increase. If the demand curve shifts and the supply curve
remains unchanged, the resulting change in price will move producers to a different point on their
supply curve. Thus, equilibrium price and quantity will move up or down the supply curve as the
demand curve shifts to the right or to the left.

For instance any of the following changes could shift the demand curve of ideal milk to the right: (1)
an increase in consumer income (as long as milk is a normal good); (2) an increase in the price of a
substitute, such as peak milk, or a decrease in the price of a complement, such as milo, (3) a change
in consumer expectations that encourages them to buy more milk now, (4) an increase in the
population; or (5) a change in consumer tastes based, for example, on a growing awareness that the
calcium in milk builds stronger bones.

After the increase in demand, quantity demanded would exceed quantity supplied. The resulting
shortage puts upward pressure on the price. As the price increases, the quantity supplied increases,
but the quantity demanded decreases until once again the two are in equilibrium. Thus, an increase in
demand increases both equilibrium price and equilibrium quantity.

In contrast, a change in one of the determinants of demand that shifts the demand curve to the left
will result in a lower equilibrium price and lower equilibrium quantity. As long as the supply curve is
upward sloping, any increase or decrease in demand will change equilibrium price and quantity in
the same direction as the change in demand.

Impact of Supply Shifts on Equilibrium Price and Quantity

The impact of a change in supply on equilibrium price and quantity is not as easily remembered as a
change in demand, but it is still quite simple. For a given downward-sloping demand curve, any
increase in the supply of the good will lead to a lower equilibrium price and a greater equilibrium
quantity. For review, consider the kinds of changes that could shift the supply curve to the right: (1)
improved technology in milk production, such as a more efficient milking machine; (2) a reduction
in the price of a resource, such as electricity; (3) a reduction in the price of an alternative good; (4) a
change in price expectations that encourages suppliers to produce more milk now; etc.

On the other hand, a change in any of these factors that results in a reduction in supply will shift the
supply curve to the left, causing equilibrium quantity to fall but equilibrium price to rise.

Thus, a shift in the supply curve, with the demand curve held constant, will cause equilibrium
quantity to change in the same direction as the change in supply but will cause equilibrium price to
change in the opposite direction. An easy way to remember is to picture the supply curve moving
along a given downward-sloping demand curve. As the supply curve shifts to the left, price increases
but quantity decreases; as the supply curve shifts to the right, price decreases but quantity increases.

SHIFTS IN DEMAND AND IN SUPPLY

In panel (a), the supply curve is stable at SS. The demand curve shifts out from DD to D'D'. The
equilibrium price and quantities rise from PeQe to P'eQ'e respectively. In panel (b), again, the supply
curve remains stable at SS. The demand curve, however, shifts inwards to the left showing a decrease in
demand from DD to D"D". Both equilibrium price and equilibrium quantity fall. In panel (c), the
demand curve now remains stable at DD. A supply increase is shown by a movement outwards to the right
of the supply curve from SS to S'S'. The equilibrium price falls from Pe to P'e. The equilibrium quantity
increases, however, from Qe to Q'e. In panel (d), the demand curve is stable at DD. Supply decreases, as
shown by a leftward shift of the supply curve from SS to S"S". The market-clearing price increases from Pe
to P"e. The equilibrium quantity falls from Qe to Q"e.

Figure 12. Shifts in demand and in supply

If supply and demand move in opposite directions, we cannot say without reference to particular
shifts what will happen to equilibrium quantity, but we can say what will happen to equilibrium
price: equilibrium price will increase if demand increases and will decrease if demand decreases. For
example, if demand increases and supply decreases, the equilibrium price will increase.

KEY POINTS 3.3

 The transaction costs of an exchange are the costs of the time and information
required to carry it out.
 A surplus is an excess of quantity supplied over quantity demanded at a given price.
 A shortage is an excess of quantity demanded over quantity supplied at a given price.
  Equilibrium: The market condition which, once achieved, tends to persist: no forces
are present that would cause price or quantity to change. This occurs when the
quantity of a commodity demanded equals the quantity supplied to the market.
 Stable equilibrium: The type of equilibrium where any deviation from equilibrium
brings into operation market forces which push us back toward equilibrium.
 Unstable equilibrium: The type of equilibrium where any deviation from the
equilibrium position brings into operation forces which push us further away from
equilibrium.

Review Questions

1. In drawing an individual's demand curve for a commodity, all but which one of the following are
kept constant?
(a) The individual's money income,
(b) the prices of other commodities,
(c) the price of the commodity under consideration
(d) the tastes of the individual.

Ans. (c)

2. A fall in the price of a commodity, holding everything else constant, results in and is referred to as
(a) an increase in demand,
(b) a decrease in demand,
(c) an increase in the quantity demanded
(d) a decrease in the quantity demanded.

Ans. (c)

3. When an individual's income rises (while everything else remains the same), his or her demand for a
normal good
(a) rises, (b) falls, (c) remains the same (d) any of the above.

Ans. (a)

4. When an individual's income falls (while everything else remains the same), his or her demand for an
inferior good
(a) increases, (b) decreases, (c) remains unchanged
(d) we cannot say without additional information.

Ans. (a)

5. When the price of a substitute of commodity X falls, the demand for X

(a) rises, (b) falls, (c) remains unchanged (d) any of the above.

Ans. (b)

6. In drawing a farmer's supply curve for a commodity, all but which one of the following are kept
constant?
(a) Technology,
 (b) the prices of inputs,
(c) features of nature such as climate and weather conditions
(d) the price of the commodity under consideration.

Ans. (d)

7. If the supply curve of a commodity is positively sloped, a rise in the price of the commodity,
ceteris paribus, results in and is referred to as:
(a) an increase in supply,
(b) an increase in the quantity supplied,
(c) a decrease in supply
(d) a decrease in the quantity supplied.

Ans. (b)

8. If, from a position of stable equilibrium, the market supply of a commodity decreases while the
market demand, remains unchanged,
(a) the equilibrium price falls,
(b) the equilibrium quantity rises,
(c) both the equilibrium price and the equilibrium quantity decrease
(d) the equilibrium price rises but the equilibrium quantity falls.

Ans. (d) - A decrease in the market supply of a commodity refers to an upward shift in the market supply
curve. With an unchanged market demand curve for the commodity, the new equilibrium point will be
higher and to the left of the previous equilibrium point. This involves a higher equilibrium price but a
lower equilibrium quantity than before.
 SOME SOLVED PROBLEMS

DEMAND

1 Problem

From the demand function Qdx =12 - 2 Px (Px is given in dollars), derive
(a) the individual's demand schedule and
(b) the individual's demand curve,
(c) What is the maximum quantity this Individual will ever demand of commodity X per time period?

Solution

(a)

(b) It should be noted that in economics, contrary to usual mathematical usage, price (the independent
or explanatory variable) is plotted on the vertical axis while the quantity demanded per unit of time
(the dependent or "explained" variable) is plotted on the horizontal axis.

(c) The maximum quantity of this commodity that the individual will ever demand per unit of tune is 12
 units. This occurs at a zero price. This is called the saturation point for the individual. Additional
units of X result in a storage and disposal problem for the individual. Thus the "relevant" points on
a demand curve are all in the first quadrant.

2 Problem
From the Individual's Demand Schedule for commodity X below:
(a) draw the individual's demand curve,
(b) In what way is this demand curve different from the one in the previous question?

Individual's Demand Schedule

Solution
(a)

(b) In this problem, the individual's demand is given by a curve, while in the previous question it was
given by a straight line. In the real world, a, demand curve can be a straight line, a smooth curve or
any other irregular (but usually negatively sloped) curve. It is for the sake of simplicity that we usually
deal with straight-line demand curves.

3 Problem:
What happens if the government:
(a) grants a per-unit cash subsidy to all producers of a commodity or
 (b) collects instead a per-unit sales tax from all the producers of the commodity?
(c) How is the imposition of a price floor or price ceiling different from the granting of a per-unit cash
subsidy or the collecting of a per-unit sales tax from all the producers of a commodity?

Solution:
(a) If the government grants a per-unit cash subsidy to all the producers of a commodity, the supply curve
of each producer will shift downward by a vertical distance equal to the amount of the cash subsidy
per unit. This is like a reduction in-the costs of production; it has the same effect on the producers'
supply curves and the market supply curve as an improvement in technology.

(b) The exact opposite to the result in part (a) occurs if instead the government collects a per-unit sales
tax from each of the individual producers of commodity X.

(c) The imposition of a price floor or a price ceiling represents an interference with the operation of
the market mechanism and as a result, the equilibrium point of the commodity may not be
reached. On the other hand, when the government grants a per-unit cash subsidy or collects a per-unit
sales tax from all producers of the commodity, the equilibrium point will change but it will still be
determined by the intersection of the market demand curve and the market supply curve of the
commodity. The government is then said to be working through the market rather than interfering with
its operation.

4 Problem:
Explain the concept of consumer surplus.

Solution:
The concept of consumer surplus is illustrated in figure below, which shows the market demand
curve of all the consumers in the market.

The equilibrium price of 10 cedis is the price which every consumer in the market pays for the good in
question. It is also the price which the marginal consumer is only just prepared to pay in order to obtain
the good. If the price rose above 10 cedis, the marginal consumer would either drop out of the market
or reduce his demand. However, some consumers, who value the good more highly, would be prepared to
pay 15 cedis for it. They gain a consumer surplus (or surplus utility) equal to the difference between what
they would be prepared to pay and what they actually need to pay. The total consumer surplus, the
utility which consumers enjoy but do not pay for, is shown by the shaded area of the graph.

5 Problem:

If the demand and supply curve for computers is:

D = 100 - 6P, S = 28 + 3P

Where P is the price of computers, what is the quantity of computers bought and sold at equilibrium?

Solution: We know that the equilibrium quantity will be where supply meets or equals demand. So
first we'll set supply equal to demand:

100 - 6P = 28 + 3P

If we re-arrange this we get:

72 = 9P

Which simplifies to P = 8.

Now we know the equilibrium price, we can solve for the equilibrium quantity by simply substituting
P = 8 into the supply or the demand equation. For instance, substitute it into the supply equation to
get:

S = 28 + 3*8 = 28 + 24 = 52.

Thus, the equilibrium price is 8, and the equilibrium quantity is 52.

6 Problem:

The quantity demanded of Good Z depends upon the price of Z (Pz), monthly income (Y), and the
price of a related Good W (Pw). Demand for Good Z (Qz) is given by equation 1 below:

Qz = 150 - 8Pz + 2Y - 15Pw

Find the demand equation for Good Z in terms of the price for Z (Pz), when Y is $50 and Pw = $6.

Solution: This is a simple substitution question. Substitute those two values into our demand
equation:

Qz = 150 - 8Pz + 2Y - 15Pw

Qz = 150 - 8Pz + 2*50 - 15*6

Qz = 150 - 8Pz + 100 - 90

Simplifying gives us:

Qz = 160 - 8Pz

This is the final answer.

7 Problem:

Beef supplies are sharply reduced because of drought in the beef-raising states, and consumers turn
to pork as a substitute for beef. How would you illustrate this change in the beef market in supply-
and-demand terms?

Answer: The supply curve for beef should shift leftward (or upward), to reflect the drought. This
causes the price of beef to rise, and the quantity consumed to decrease.

We would not move the demand curve here. The decrease in quantity demanded is due to the price of
beef rising, creating the shift of the supply curve.

8 Problem:

Given the following data:

WIDGETS P = 80 - Q (Demand)
P = 20 + 2Q (Supply)

Given the above demand and supply equations for widgets, find the equilibrium price and quantity.

Answer: To find the equilibrium quantity, simply set both of these equations equal to each other.

80 - Q = 20 + 2Q

60 = 3Q

Q = 20

Thus our equilibrium quantity is 20. To find the equilibrium price, simply substitute Q = 20 into one
of the equations. We will substitute it into the demand equation:

P = 80 - Q

P = 80 - 20

P = 60
Thus, our equilibrium quantity is 20 and our equilibrium price is 60.

9 Problem: Suppose that Carlos and Deborah are the only consumers of scented candles in a
particular market. The following table shows their annual demand schedules:

Find the market demand schedule.

Answer:

10 Problem: Consider the market for cereal in Tamale, where there are over a thousand stores that
sell cereal at any given moment. Suppose the Surgeon General issues a public statement saying that
consuming cereal is bad for your health.
Holding all else constant, this will lead to a:
a) Change in Demand
b) Change in Supply
c) Change in Demand and Change in Supply
 d) No change in Demand and Supply
Answer 10: Change in Demand.
This public statement will lead to a leftward shift in the demand curve. This is because when
consumers find out that eating cereal is bad for their health, they will decrease their consumption of
cereal.
The supply curve does not shift because none of the factors affecting supply have changed.

11 Problem: Consider the market for hamburgers in Accra, where there are over a thousand burger
joints at any given moment. Suppose an innovation in meat processing technology makes it possible
to produce more hamburgers at a lower cost than ever before.
Holding all else constant, this will lead to a:
a) Change in Demand
b) Change in Supply
c) Change in Demand and Change in Supply
 d) No change in Demand and Supply
Answer 11: Change in Supply.
The innovation in meat processing technology lowers the cost of producing hamburgers. Therefore,
for any given price, producers are willing and able to supply more hamburgers. This leads to a
rightward shift in the supply curve.
The demand curve does not shift because none of the factors affecting demand have changed.

12 Problem:
With respect to each of the following changes, identify whether the demand curve will shift leftward
or rightward.
a) An increase in income (the good under consideration is an inferior good)
b) A rise in the price of a complementary good
c) A fall in the price of a substitute good
 d) A rise in the number of buyers
Answer 12:
a) Demand Curve will shift leftward
b) Demand Curve will shift leftward
c) Demand Curve will shift leftward
d) Demand Curve will shift rightward

13 Problem:
Indicate how each of the following will affect the current supply (Increase supply or Decrease
Supply) for personal computers.
a) A rise in wage rates
b) An increase in the number of sellers of computers
c) A tax placed on the production of computers
d) A subsidy placed on the production of computers
Answer 13: 
a) Decrease Supply
b) Increase Supply
c) Decrease Supply
d) Increase Supply

14 Problem:

Assume that an apartment rents for $650 per month and at that price 10,000 units are rented as
shown in the figure. When the price increases to $700 per month, 13,000 units are supplied into the
market. By what percentage does apartment supply increase? What is the price sensitivity?

Solution: Price Elasticity of Supply. The price elasticity of supply is calculated as the percentage
change in quantity divided by the percentage change in price.

Using the Midpoint Method,

% Change in quantity13,000−10,000 / (13,000+10,000)/2 ×100 = 3,000 /11,500×100 = 26.1%
Change in price $700−$650 / ($700+$650) /2 ×100 = 50 / 675×100 = 7.4
Price Elasticity of Demand 26.1% / 7.4% = 3.53

15 Problem:
Yesterday, the price of envelopes was $3 a box, and Julie was willing to buy 10 boxes. Today, the
price has gone up to $3.75 a box, and Julie is now willing to buy 8 boxes. Is Julie's demand for
envelopes elastic or inelastic? What is Julie's elasticity of demand?
Solution: To find Julie's elasticity of demand, we need to divide the percent change in quantity by
the percent change in price.

% Change in Quantity = (8 - 10)/(10) = -0.20 = -20%

% Change in Price = (3.75 - 3.00)/(3.00) = 0.25 = 25%
Elasticity = |(-20%)/(25%)| = |-0.8| = 0.8
Her elasticity of demand is the absolute value of -0.8, or 0.8. Julie's elasticity of demand is inelastic,
since it is less than 1.
16 Problem: If Neil's elasticity of demand for hot dogs is constantly 0.9, and he buys 4 hot dogs
when the price is $1.50 per hot dog, how many will he buy when the price is $1.00 per hot dog?
Solution: This time, we are using elasticity to find quantity, instead of the other way around. We will
use the same formula, plug in what we know, and solve from there.

Elasticity =
And, in the case of John, %Change in Quantity = (X – 4)/4
Therefore :
Elasticity = 0.9 = |((X – 4)/4)/(% Change in Price)|
% Change in Price = (1.00 - 1.50)/(1.50) = -33%
0.9 = |(X – 4)/4)/(-33%)|
|((X - 4)/4)| = 0.3
0.3 = (X - 4)/4
X = 5.2

Since Neil probably can't buy fractions of hot dogs, it looks like he will buy 5 hot dogs when the
price drops to $1.00 per hot dog.
17 Problem: Which of the following goods are likely to have elastic demand, and which are likely to
have inelastic demand?

Home heating oil

Pepsi
Chocolate
Water
Heart medication
Oriental rugs
Solution
Elastic demand: Pepsi, chocolate, and Oriental rugs
Inelastic demand: Home heating oil, water, and heart medication