Introduction To Microeconomics Booklet 2

UNIVERSITY OF LUSAKA
SCHOOL OF BUSINESS, ECONOMICS AND

MANAGEMENT STUDIES
DEPARTMENT OF ECONOMICS
ECF 100 – INTRODUCTION TO MICROECONOMICS

COURSE MODULE
PREPARED BY
ELIAS MUWAU (BA, MA)

Copyrights @2021
NOTE:
THIS MATERIAL IS STILL IN THE WRITE-UP PHASE.
KEEP CHECKING YOUR STUDENT PORTAL FOR
NEW ADDITIONS TO THIS MATERIAL
A
PREPARED BY: ELIAS MUWAU - ZAMBIA
CONTENTS
COURSE OUTLINE .............................................................................................................................. i
UNIT ONE: INTRODUCTION............................................................................................................. 1
Unit Aim .............................................................................................................................................. 1
Study Outcomes .................................................................................................................................. 1
Study Material for the unit ................................................................................................................. 1
1.1. Definition of Economics ....................................................................................................... 1
1.2. Basic concepts...................................................................................................................... 2
1.2.1. Scarcity and Choice ..................................................................................................... 2
1.2.2. Factors of Production................................................................................................... 3
1.2.3. Rationality ...................................................................................................................... 5
1.2.4. Marginal Analysis: Marginal benefit and marginal cost .......................................... 6
1.2.5. Opportunity Cost........................................................................................................... 6
1.3. Principles of Economics ...................................................................................................... 7
1.3.1. How People Make Decisions ...................................................................................... 8
1.3.2. How People Interact..................................................................................................... 8
1.3.3. How the Economy as a Whole Works ....................................................................... 8
1.4. Microeconomics Vs. Macroeconomics.............................................................................. 9
1.5. Positive Vs. Normative Economics .................................................................................... 9
1.5.1. Positive Economics ...................................................................................................... 9
1.5.2. Normative Economics ................................................................................................ 10
1.6. The Methods of Economics .............................................................................................. 10
1.6.1. The Role of Assumptions .......................................................................................... 11
1.7. Theories and Models ......................................................................................................... 11
1.7.1. Economic Theory........................................................................................................ 11
1.7.2. Models .......................................................................................................................... 11
1.7.3. Variables ...................................................................................................................... 11
1.7.4. Pitfalls to avoid in formulating economic theory .................................................... 12
1.8. Why Economists Disagree ................................................................................................ 12
1.9. Why Study Economics....................................................................................................... 12
Unit One Review Questions ............................................................................................................. 13
UNIT TWO: MATH REVIEW ............................................................................................................ 14
Unit Aim ............................................................................................................................................ 14
i
Study Outcomes ................................................................................................................................ 14
Study Material for the unit ............................................................................................................... 14
2.1. Algebra and Arithmetic ...................................................................................................... 14
2.1.1. Arithmetic ..................................................................................................................... 14
2.1.2. Algebra ......................................................................................................................... 17
2.2. Tables and Graphs............................................................................................................. 19
2.3. Straight-line graphs ............................................................................................................ 20
2.3.1. Inverse Relationships ................................................................................................ 20
2.3.2. Direct Relationships ................................................................................................... 21
2.3.3. Intercepts ..................................................................................................................... 21
2.3.4. Slope ............................................................................................................................ 23
2.3.5. Straight Lines with Different Slopes and Vertical Intercepts ................................ 24
2.4. Curved lines ........................................................................................................................ 26
2.4.1. Slope of a curved line ................................................................................................ 26
2.5. Linear equations ................................................................................................................. 27
2.6. Lines and curves shift ........................................................................................................ 28
2.7. Shifts vs. movements along a line ................................................................................... 29
2.8. The use of graphs in economics ...................................................................................... 29
Unit Two Review Questions ............................................................................................................. 30
UNIT THREE: FUNDAMENTAL QUESTIONS AND ECONOMIC SYSTEMS ......................... 31
Unit Aim ............................................................................................................................................ 31
Study Outcomes ................................................................................................................................ 31
3.1. The Basic Economic Problem .......................................................................................... 31
3.2. The Fundamental Questions ............................................................................................ 32
3.2.1. What to produce ......................................................................................................... 33
3.2.2. How to Produce .......................................................................................................... 33
3.2.3. For Whom to Produce................................................................................................ 34
3.3. The Economic System....................................................................................................... 34
3.3.1. The Market Economy................................................................................................. 34
3.3.2. The Command Economy .......................................................................................... 35
3.3.3. The Mixed Economy .................................................................................................. 35
UNIT FOUR: OPPORTUNITY COST AND TRADE-OFF ............................................................ 36
Unit Aim ............................................................................................................................................ 36
ii
Study Outcomes ................................................................................................................................ 36
4.1. Opportunity cost ................................................................................................................. 36
4.1.1. Production Possibility Frontier .................................................................................. 36
4.1.2. Increasing opportunity cost ....................................................................................... 37
4.1.3. Constant Opportunity Cost........................................................................................ 43
4.2. Economic Growth ............................................................................................................... 46
4.2.1. Balanced Growth ........................................................................................................ 47
4.2.2. Biased Growth ............................................................................................................ 48
4.3. Weaknesses of the PPF .................................................................................................... 49
UNIT FIVE: DEMAND AND SUPPLY ............................................................................................. 50
Unit Aim ............................................................................................................................................ 50
Study Outcomes ................................................................................................................................ 50
5.1. Demand ............................................................................................................................... 50
5.1.1. Law of Demand........................................................................................................... 51
5.1.2. Determinants of demand and quantity demanded ................................................ 55
5.1.3. Revisiting the Demand Function .............................................................................. 66
5.1.4. Market Demand .......................................................................................................... 67
5.2. Supply .................................................................................................................................. 69
5.2.1. Law of supply .............................................................................................................. 70
5.2.2. Determinants of supply and quantity supplied ....................................................... 74
5.2.3. Revisiting the Supply Function ................................................................................. 84
5.2.4. Market Supply ............................................................................................................. 85
5.3. Equilibrium and the price system in the Market ............................................................. 88
5.3.1. Equilibrium ................................................................................................................... 88
5.3.2. Excess Demand.......................................................................................................... 92
5.3.3. Excess Supply ............................................................................................................ 93
5.3.4. Effects of Changes in demand on the Market ........................................................ 97
5.3.5. Effects of Changes in Supply on the Market .......................................................... 99
5.3.6. Simultaneous Changes in Demand and Supply on the Market ........................ 100
5.4. Welfare Economics .......................................................................................................... 104
UNIT SIX: ELASTICITY................................................................................................................... 106
Unit Aim .......................................................................................................................................... 106
iii
Study Outcomes .............................................................................................................................. 106
Study Material for the unit ............................................................................................................. 106
UNIT SEVEN: CONSUMER CHOICE THEORY ......................................................................... 107
Unit Aim .......................................................................................................................................... 107
Study Outcomes .............................................................................................................................. 107
UNIT EIGHT: THEORY OF THE FIRM ........................................................................................ 108
Unit Aim .......................................................................................................................................... 108
Study Outcomes .............................................................................................................................. 108
UNIT NINE: COST OF PRODUCTION ......................................................................................... 109
Unit Aim .......................................................................................................................................... 109
Study Outcomes .............................................................................................................................. 109
UNIT TEN: MARKET STRUCTURE.............................................................................................. 110
Unit Aim .......................................................................................................................................... 110
Study Outcomes .............................................................................................................................. 110
iv
COURSE OUTLINE
Introduction/Background/Description to the course
 This course ECF100 (Introduction to Microeconomics) is an introductory

course to the field of economics and business courses that provides a general
understanding of basic microeconomic concepts and methods. It is designed
to help students understand basic economics and the study of individual
consumers, groups of consumers, firms and individual government actions.
The course will focus on how individuals make decisions that affect their
income and wealth, how firms make decisions that affect profits and
production, and how government regulation affects individuals and firms. It is
a pre-requisite to most of the school of business programs
Rationale
 In introducing students to the study of economics, particularly

microeconomics, this course will form a solid foundation for students in
understanding the basics of the economics approach to the study of human
behaviour. The course applies microeconomic concepts and theories in a
range of contexts and to appreciate their value and limitations in explaining
real world phenomena. After completing this course, students should be able
to apply the economic concepts to their daily decision making. They should be
able to demonstrate (using models) how the economy works. Students should
also be able to analyze difference market structures and identify gaps in
market operation. Lastly, students should be able to forecast possible effects
of government intervention on the market
Course Aim
The aim of this course is to:
 Provide an understanding of the macroeconomic theories and how these

theories can be used in policy issues and program intervention.
 Identify the tools of microeconomic analysis and formulate possible solutions

to contemporary economic and social issues such as agricultural production,
i
world food problems, poverty and the distribution of income, the energy crisis
and environmental pollution.
Course objectives
The objectives of this course are to:
 Introduce students to the various principles of microeconomics and indicate

how these principles might be applied in various situations.
 Examine how decisions are made by individual economic units such as
households and firms and how they interact to determine the quantities and
prices of goods and factors of production and the allocation of resources.
 Develop a strong practical link between the economic theory and present day
economic realities.
 Provide a foundation for the study of other courses which require the
knowledge of microeconomics.
Learning outcomes
By the end of this course, students are expected to:
 Demonstrate an understanding of the principles nature and methodology of

microeconomics.
 Show knowledge of the concepts of supply and demand in product and input
markets.
 Demonstrate an understanding of the connection between microeconomic
theory and a wide range of daily events.
 Apply the concepts, methods and principles of economics to other courses.
Course content
1. Introduction
 Definition of economics
 Basic concepts: scarcity, choice, rationality, opportunity costs, marginal
concepts
 Distinction between micro- and macroeconomics
 Positive and normative economics.
 The methods of economics
2. Math Review
 Algebra and Arithmetic
ii
 Tables and graphs
 Straight-line graphs
 Curved lines
 Linear equations
 Lines and curves shift
 Shifts vs. movements along a line
 The use of graphs in economics.
3. Fundamental Questions and Economic Systems

 Deciding what to produce, how to produce it, and for whom to produce.
 The market economy; the planned economy and mixed economy
4. Opportunity Cost, Trade-offs

 Production Possibilities Curves (PPC/PPF)
 Efficient, Inefficient, and Beyond Possibilities.
 Marginal Rate of Transformation (MRT) and
Constant and Increasing Opportunity Costs
5. Demand and Supply

 Law of demand; demand schedule and demand curve; determinants of
demand and quantity demanded; shift in demand curve versus
movement along the demand curve; normal and inferior good;
substitutes and compliments
 Law of supply; supply schedule and supply curve; determinants of
supply and quantity supplied; shift in supply curve versus movement
along the supply curve
 Equilibrium and the price system: Excess demand; excess supply;
effects of changes in demand; effects of changes in supply; effects of
simultaneous changes in demand and supply
 Consumer and producer surpluses
 Government intervention in the market: Price floors and ceilings;
taxes and subsidies; deadweight loss
 Demand and supply in the factor markets
6. Elasticity
 Price elasticity of demand/Supply: Point and arc elasticity of
demand/supply; determinants of price elasticity of demand/supply;
income and cross elasticities
 Relationship between price elasticity of demand and
revenues/expenditures
7. Consumer Choice Theory
 The concept of utility (cardinal and ordinal utility): total utility; average
utility, marginal utility, the law of diminishing marginal utility
iii
 Indifference curve approach; budget line/constraint; income and
substitution effects
 Derivation of the demand curve
8. Theory of the Firm
 Objectives of the firm.

 Production function: total product; average product; marginal
product;
 production in the short run; diminishing returns Graphical illustration
 Production in the long run: returns to scale
9. Costs of Production
 Total, average and marginal costs, economic versus accounting profits,
sunk costs
 Short run and long-run costs: long run average costs and economies of
scale; diseconomies of scale; sources of economies of scale
 Supply curve of a firm, market supply curve.
 Revenues and costs, pricing and profits
10. Market Structures

 Perfect competition
 Monopoly
 Monopolistic competition
 Oligopoly
Methods of Instruction/Mode of Delivery
 Five contact hours consisting of four hours of lectures and one hour for
tutorials per week.
Assessment
 To evaluate your progress in this course, you will be subjected to assignments

in the form of quizzes, group presentation, individual assignments, and the
Mid-semester examination.
Grading
 The grading system for this course is as follows
Assignment : 10%
Mid-semester Examinations/ Test : 20%
iv
Final Examinations : 70%
Total Marks : 100%
Grading Scheme:
Marks Grades Points Classification
86% - 100% A+ 5 Distinction
76% - 85% A 4 Distinction
66% - 75% B+ 3 Meritorious
61% - 65% B 2 Satisfactory
56% - 60% C+ 1 Clear Pass
50% - 55% C 0 Pass
0% - 49% D 0 Fail
Required/Prescribed readings
 McConnell C R, Brue S L, Barbiero T P, Microeconomics, Ninth edition,

McGraw-Hill, 2003
 Mankiw N. Gregory.,Principles of Microeconomics, Fourth edition
Recommended readings
 Frank, R.H., Microeconomics and Behavior, 5th edition, McGraw-Hill, 2003.
 Hardwick, P. B. Khan and J. Langmead. Introduction to Modern Economics.

London: Longman, 2006.
 David a. Besanko & Ronald R. Braeutiga; Microeconomics, John Wiley &

Sons, Inc.
 Dominick Salvatore Schaums Outline of Microeconomics, 4th edition

Schaums Outline Series 2006
v
UNIT ONE: INTRODUCTION
Unit Aim
The aim of this unit is to introduce students to the commonly used concepts and
methodology in economics
Study Outcomes
At the end of this unit, students are expected to:
 Define economics and other basic economic concepts

 Demonstrate understanding of the basic economic problem
 Demonstrate understanding of the branches of economics
 Demonstrate understanding of the methodology of economics
Study Material for the unit
Mankiw chapter 1&2 and McConnell chapter 1&2
1.1. Definition of Economics
Economics is a subject that has gained recognition in almost all fields of sciences,
arts and humanities. It is not just about prices, income and money but generally
shows how society deals with the problem of scarcity. The analysis of economics
helps us decide when to leave things to the market and when to override the market.
This necessitates making choices.
Definition: Economics is the study of how society manages its scarce resources. In
other words, it is the study of choice under conditions of scarcity.
In most societies, resources are allocated not by a single central planner but through
combined actions of millions of households and firms. People who study economics
are called economists. Economists therefore study how people make decisions
such as how much they work, what they buy, how much they save, and how they
invest their savings. They also study how people interact with one another.
Economists also analyse forces and trends that affect the economy as a whole,
1
including the growth in average income, the fraction of the population that cannot
find work, and the rate at which prices are rising. In general, Economists study
choices, consequences of those choices, and the indirect effects of individual
choices on our society.
1.2. Basic concepts

1.2.1. Scarcity and Choice
We live in a World where we cannot get everything we want. Some things are always
lacking (due to unlimited wants). This is because the resources needed to produce
all that we want are limited (Scarce). Scarcity limits our options and necessitates that
we make choices. We have to decide on what we will have and what we will forgo
(Trade-off). Choice involves choosing between two or more alternatives.
Definition: Scarcity is the limited nature of society’s resources. It is actually a

situation in which the amount of something available is insufficient to satisfy the
desire for it.
At any point in life, we there is always something that we desire to have but due to
scarcity we end up not having it. If we managed to have it, there will arise something
different that we will desire to have but the scarcity of resources will make it hard for
us to acquire it.
As a quote by Ralph Waldo Emerson say, “Want is a growing giant whom the coat of
Have was never large enough to cover.”
An economy or society is made up of different households that are endowed with

different resources in different amounts. Households then have to make decisions
regarding the management of such resources. Similarly, society also faces many
decisions in terms of allocation of resources. For example, a society or an economy
must decide what jobs will be done and who will do them. It needs some people to
grow food, other people to make clothing, and still others to design computer
software. Once society has allocated people (as well as land, buildings and
machines) to various jobs, it must also allocate the output of goods and services that
they produce. For example, it must decide what type of food will be eaten by certain
class of society and what type of transport different kinds of people will use.
2
Society faces scarcity in many things. For example, scarce time relating to limited
number of hours in each day to satisfy our desires. Scarce spending power cause
people not to afford buying more of the things they want. Society faces a scarcity of
resources such as Labour, Capital (Human capital, Capital stock), Land/natural
resources, and Entrepreneurship.
The problems studied in economics emanates from the scarcity of resources and the
choices it forces us to make. For example, households have limited income to
allocate among goods and services, firms‟ production is limited by the costs of
production, and government agencies face limited budgets. As such, economists
study the decisions made by households, firms, and governments to explain how our
economic system operates. They forecast the future of our economy and suggest
ways to make that future even better.
1.2.2. Factors of Production
Definition: Factors of production - An economic concept that refers to the inputs

needed to produce goods and services (Corporate Finance Institute, n.d.)
1.2.2.1. Land
Land is a broad term that includes all the natural resources that can be found on
land, such as oil, gold, wood, water, and vegetation. Natural resources can be
divided into renewable and non-renewable resources.
 Renewable resources are resources that can be replenished, such as water,

vegetation, wind energy, and solar energy.
 Non-renewable resources consist of resources that can be depleted in supply,
such as oil, coal, and natural gas.
All resources, whether it is renewable or non-renewable, can be used as inputs in
production in order to produce a good or service. The income that comes from using
land and its natural resources is referred to as rent.
Besides using its natural resources, land can also be utilized for various purposes,
such as agriculture, residential housing, or commercial buildings. However, land
differs from the other factors of production because some natural resources are
limited in quantity, so its supply cannot be increased with demand.
3
1.2.2.2. Labour
Labour as a factor of production refers to the effort that individuals exert when they
produce a good or service. For example, an artist produces a painting or an author
writing a book. Labour itself includes all types of labour performed for an economic
reward, such as mental and physical exertion. The value of labour also depends on
human capital, which is determined by the individual‟s skills, training, education, and
productivity.
Productivity is measured by the amount of output someone can produce in each

hour of work. The income that comes from labour is referred to as wages. Note that
work performed by an individual purely for his/her personal interest is not considered
to be labour in an economic context.
The following are several characteristics of labour in terms of being a factor of

production:
 First, labour is considered to be heterogeneous, which refers to the idea of

how the efficiency and quality of work are different for each person. It differs
because it depends on an individual‟s unique skills, knowledge, motivation,
work environment, and work satisfaction.
 Additionally, labour is also perishable in nature, which means that labour
cannot be stored or saved up. If an employee does not work a shift today, the
time that is lost today cannot be recovered by working another day.
 Also, another characteristic of labour is that it is strongly associated with
human efforts. It means that there are factors that play an important role in
labour, such as the flexibility of work schedules, fair treatment of employees,
and safe working conditions.
1.2.2.3. Capital
Capital, or capital goods, as a factor of production, refers to the money that is used
to purchase items that are used to produce goods and services. For example, a
company that purchases a factory to produce goods or a truck that is purchased to
do construction are considered to be capital goods.
Other examples of capital goods include computers, machines, properties,

equipment, and commercial buildings. They are all considered to be capital goods
4
because they are used in a production process and contribute to the productivity of
work. The income that comes from capital is referred to as interest.
Below are several defining characteristics of capital as a factor of production:
 Capital is different from the first two factors because it is created by humans.
For example, capital goods like machines and equipment are created by
individuals, unlike land and natural resources.
 Additionally, capital is also a factor that can last a long time, but it depreciates
in value over time. For example, a building is a capital good that can endure
for a long period of time, but its value will diminish as the building gets older.
 Capital is also considered to be mobile because it can be transported to
different places, such as computers and other equipment.
1.2.2.4. Entrepreneurship
Entrepreneurship as a factor of production is a combination of the other three
factors. Entrepreneurs use land, labour, and capital in order to produce a good or
service for consumers.
Entrepreneurship is involved with establishing innovative ideas and putting that into
action by planning and organizing production. Entrepreneurs are important because
they are the ones taking the risk of the business and identifying potential
opportunities. The income that entrepreneurs earn is called profit.
1.2.3. Rationality
Rationality is a fundamental assumption in standard economics. The assumption of

rationality implies that people take full account of all information available to make
their decisions. This means that individuals will make different choices under
different circumstances. As such, individuals pursue actions that will allow them to
achieve their greatest satisfaction (self-interest). Rational self-interest is not the
same as selfishness. People make personal sacrifices to help family members or
friends, and they contribute to charities because they derive pleasure from doing so.
Self-interest behaviour is simply behaviour that enables a person to achieve
personal satisfaction, however that may be derived.
5
1.2.4. Marginal Analysis: Marginal benefit and marginal cost
Definition: Marginal analysis is the comparison of marginal benefits and marginal

costs, usually for decision making.
The term marginal simply means “extra” or “additional” or “change in”. Marginal
changes then describe small incremental adjustments to an existing plan of action.
Since the term “margin” means “edge,” marginal changes are adjustments around
the edges of what you are doing. Economists conduct marginal analysis to arrive at
the best decision. For example, marginal opportunity cost of a good is the additional
value of the best alternative that must be sacrificed to obtain the additional unit of
that good. The marginal opportunity cost of giving up 4 units of good X to obtain
additional 2 units of good Y is 2.
1.2.5. Opportunity Cost
Definition: Opportunity cost is the value of the best alternative forgone.
It is the amount of other products that must be forgone or sacrificed to produce a unit
of a product. The opportunity cost of an item is what you give up to get that item.
When making any decision, decision makers are aware of the opportunity costs that
accompany each possible action.
It should be noted that the cost of any activity is made up of two components (The
explicit cost and the opportunity cost). A rational individual must consider both
explicit and opportunity costs in making decisions.
Example 1-1
Suppose you want to spend a day watching a movie with your friends at the cinema
and the cost of doing so is ZMW30 (all inclusive). Suppose that you really like going
to the cinema with your friends and that you will be willing to pay ZMW60 to do so.
Suppose that the best alternative of going to the movie is to work at the campus
shop at Unilus to earn ZMW70 per day. Suppose you like working at the campus
shop but only if they pay you at least ZMW30.
i. What is the value of working at the campus shop for you?

ii. What is the cost of going for the movie?
6
iii. As a rational consumer, would you consider going for the movie of working at
the campus shop?
Solution 1-1
The ZMW60 you are willing to pay for the movie represents the maximum amount
you are willing to pay for that activity and it represents its benefit in monetary terms.
The ZMW30 daily rate at which you are willing to work at the shop is the minimum
payment that will make you work at the shop. Thus it is the benefit in monetary terms
of working at the shop
i. ZMW40 (which is ZMW70-ZMW30).

ii. The cost of going for the movie is not only the explicit cost of ZMW30; it also
reflects the implicit cost given by the best alternative you are sacrificing. In this
case, the value of the best alternative is ZMW40. This represents the
opportunity cost of „going for a movie with your friends‟. If we take into account
this opportunity cost, then the cost of „going for a movie with your friends‟ is
ZMW70 (which is ZMW30+ZMW40).
iii. Given that the benefit of „going for a movie with your friends‟ is ZMW60 and it is
lower than the cost (explicit cost plus the opportunity cost), as a rational
individual you should choose not to do it; instead you should work at the
campus shop.
1.3. Principles of Economics

You need to understand that there is no mystery to what an “economy” is. An
economy is just a group of people interacting with one another as they go about their
lives. The behaviour of an economy reflects the behaviour of individuals who make
up the economy.
There are Ten (10) principles of economics. The first four principles show how an
individual behaves. However, the individual decisions affect other people in society
as well. Principles 5-7 show how individuals interact. Principles 8-10 show the
Economy as a Whole and the Standard of Living.
7
1.3.1. How People Make Decisions
1. People Face Tradeoffs: Scarcity in relation to wants means you face tradeoffs;
therefore you have to make choices.
2. Opportunity Costs: The cost of the choice you make is what you give up for it,
or the opportunity cost.
3. Rational people think at the Margin: we choose a “little” more or a “little” less
of something.
4. The Influence of Incentives: The choices you make are influenced by
incentives.
1.3.2. How People Interact
5. Specialization and Trade: Specialization and trade will improve the well-being
of all participants.
6. The Effectiveness of Markets: Markets usually do a good job of coordinating
trade among individuals, groups, and nations. According to Adam Smith,
households and firms interacting in the market act as if they are guided by an
“invisible hand” that leads them to desirable outcomes
7. The Role of Governments: Governments can occasionally improve the
coordinating function of markets. Why government intervention?
1.3.3. How the Economy as a Whole Works
8. Production and the Standard of Living: The standard of living of the average
person in a particular country is dependent on its production of goods and
services. A rise in the standard of living requires a rise in the output of goods and
services.
9. Money and Inflation: If the monetary authorities of a country annually print
money in excess of the growth of output of goods and services it will eventually
lead to inflation.
10. Inflation-Unemployment Tradeoff: In the short run, society faces a short-run
tradeoff between inflation and its level of unemployment.
8
1.4. Microeconomics Vs. Macroeconomics
The word “micro” comes from the Greek word mikros, meaning “small”.
Microeconomics studies the behaviour of individual households, firms, and
governments
 The choices they make

 And their interaction in specific markets
Microeconomics focuses on individual parts of an economy. It is the branch of
economics that examines the behaviour of individual decision-making units.
The word “Macro” comes from the Greek word makros, meaning “large”.
Macroeconomics on the other hand studies the behaviour of the overall economy. It
focuses on the big picture and ignores fine details. It is the branch of economics that
examines the behaviour of economic aggregates such as income, output, and
employment on a national scale.
1.5. Positive Vs. Normative Economics

1.5.1. Positive Economics
Positive economics shows how the economy works. Positive economics statements
can be true or false. It can be tested by looking at the facts. It studies economic
9
behaviour without making judgments. It describes what exists and how it works. It
studies objective or scientific explanations of how the economy works.
Positive economics deals with what the economy is actually like. It is concerned with
“What is” and not “what ought to be”.
Examples of positive economics
 The unemployment rate in Zambia is higher than in Canada.

 Other things equal, if tuition fee is substantially increased, then college or
university enrolment will fall
Positive economics works with the propositions of the form, „if this is changed, then
that will happen‟. For example; if the government imposes a tax on a good, then the
price of that good will rise. In short, positive economics deals with fact based
statements.
1.5.2. Normative Economics
Normative economics offers to recommendations based on personal value

judgments. Value judgments identify problems, and prescribe solutions. It is the side
of economics that cannot be proved or disproved by the facts alone. It is also called
policy economics. Normative economics analyses outcomes of economic behaviour,
evaluate them as good or bad, and may prescribe courses of action. It is subjective.
Examples of normative economics statements
 Zambian should undertake policies to reduce their unemployment rate.

 College and University tuition fee should be lowered so that more students can
obtain an education
1.6. The Methods of Economics

Like any other field of study, economics has its own language and methodology. The
Scientific Method in economics takes the three roots method: Observation, Theory,
and more observation. The methods of economics devise theories, collect data and
then analyse the data in an attempt to verify or refute those theories.
10
1.6.1. The Role of Assumptions
Assumptions make the world easier to understand and/or make us focus our
thinking. In economics, we look at two types of assumptions.
 Simplifying assumptions
Essential features can stand out more clearly
 Critical assumptions
This affects the conclusions of a model in important ways. If critical assumptions
are wrong, the model will be wrong.
1.7. Theories and Models

Theories involve models, and models involve variables.
1.7.1. Economic Theory
Definition: An economic theory is a general statement of cause and effect, action

and reaction.
Economic theories involve building models of behaviour.
1.7.2. Models
Definition: A model is a formal statement of a theory.
Models are descriptions of the relationship between two or more variables. Models
are simplifications, not complications, of reality. For example, Ockham‟s razor is the
principle that irrelevant detail should be cut away. Economic models are built with
words, diagrams, and mathematical statements.
Economic models are abstract representation of reality. They should be as simple as

possible to accomplish its purpose
1.7.3. Variables
Definition: A variable is a measure that can change from observation to

observation.
11
In the process of abstraction, economists use the ceteris paribus device in order to
focus the abstraction and prediction. Using the ceteris paribus, or all else equal,
assumption, economists study the relationship between two variables while the
values of other variables remain constant.
1.7.4. Pitfalls to avoid in formulating economic theory
 The post hoc, or ergo propter hoc fallacy refers to a common error made in
thinking about causation: If event A happened before event B, it is not
necessarily true that A caused B.
 The fallacy of composition is the erroneous belief that what is true for a part is
also true for the whole.
1.8. Why Economists Disagree

 The difference of opinion may be positive in nature
This is a situation where facts are being disputed
 The disagreement can be normative
This is a situation where facts are not being disputed
 When economists have different values, they may arrive to different conclusions
 Disagreement - over goals and values
1.9. Why Study Economics

 To understand the world better
Global events and personal phenomena
 To achieve social change
This requires one to understand the origins of social problems and design more
effective solutions
 Voting decisions also require a basic understanding of economics.
 To help prepare for other careers
A wide range of careers deal with economic issues on many levels
 To become an economist
Develop a body of knowledge that could lead you to become an economist in the
future.
12
Unit One Review Questions
13
UNIT TWO: MATH REVIEW
Unit Aim
The aim of this unit is to provide students with a review to the basic O-level and/or A-
level mathematics, and to demonstrate how to the basic maths can be applied in the
study of economics.
Study Outcomes
 Demonstrate understanding of the basic math

 Demonstrate understanding of the key components of an equation
 Apply the basic math to the economic modelling and analytics
2.1. Algebra and Arithmetic

2.1.1. Arithmetic
2.1.1.1. Integers
The set of integers, I, is composed of all the counting numbers (i.e., 1,2, 3, . . .),
zero, and the negative of each counting number (i.e.,…,-3,-2,-1). Therefore, some
integers are positive, some are negative, and the integer 0 is neither positive nor
negative. Integers that are multiples of 2 are called even integers, namely {. . . , - 6,
-4, -2, 0, 2, 4, 6 . . .}. All other integers are called odd integers; therefore, {. . . , -5, -3,
-1, 1, 3, 5 . . .} represents the set of all odd integers.
Integers in a sequence, such as 57, 58, 59 or -3, -2, -1 are called consecutive
integers.
Basic rules on integer Operation
14
 Multiplication by zero always result in zero
E.g.
 Division by zero is infinity
E.g.
At some point, we will just call this undefined and just put a dash (-).
 Multiplication (or) division of two integers with different signs results in a solution
with a negative sign.
E.g. ( ) and
 Multiplication (or) division of two integers with the same sign results in a solution
with a positive sign
E.g. and
( )
( ) ( ) and ( )
2.1.1.2. Fractions
A fraction is a number of the form , where a and b are integers and .
From the definition, „a’ is called the numerator of the fraction while „b‟ is called the
denominator of the fraction. For example, the number is a fraction that has -7 as
its numerator and 5 as its denominator. If we multiply the numerator and the
denominator of the fraction by the same integer, the resulting fraction will be
equivalent to .
2.1.1.3. Decimals
In our number system, all numbers can be expressed in decimal form. To do this, a
decimal point is used. The place value for each digit will then depend on the position
of the digit relative to the decimal point in a number. For example, in the number
82.537,
 “8” is the tens digit because its place value is 10.

 “2” is the units digit because its place value is 1.
 “5” is the tenths because its place value is .
15
 “3” is the hundredths because its place value is .
 “7” is the thousandths because its place value is .
2.1.1.4. Exponents and Square Roots
Exponents provide a shortcut notation for repeated multiplication of a number by

itself. For example, means which equals 81. In short, we simply
write . The number 4 in the exponent is called the exponent or power. When
the power is 2, we call the process „squaring‟. Thus, is read as „3 squared‟.
A square root of a positive integer N is a number which, when squared, equals N.

For example, √ and
Some basic rules of exponents and roots
If , then
 (√ )(√ ) √
√
 √
√
 ( ) ( )
 ( )( ) ( )
2.1.1.5. Ordering and the Real Number Line
The set of all real numbers, which includes all integers and all numbers with values
between them such as 1.25, 2/3, √ , etc., has a natural ordering which can be
represented by the real number line.
Note that for any two numbers on the real number line, the number to the left is less
than the number to the right. For example, √ .
16
2.1.1.6. Percent
The term percent means “per humndred” or divide by one hundred. Thus, 28%
means 28 out of one hundred or or 0.28.To find out what 28% of a number N is,
you multiply N by either 0.28 or by .
2.1.1.7. Ratio
The ratio of the number 9 to the number 21 can be expressed in three different
forms:
 9 to 21

 9:21
Since a ratio is an implied division, it can be reduced to its lowest term. Therefore,
the three ways above can be reduced to:
 3 to 7

 3:7
The ratio of the number of months in a year (12) to the number of minutes (60) in an
hour, in its lowest term, can be written as 1 to 5 or ⁄ or 1:5.
2.1.2. Algebra
Basic algebra is essentially advanced arithmetic; therefore much of the terminology

and many of the rules are common to both areas. The major difference is that in
algebra variables are introduced, which allows us to solve problems with equations
and inequalities. Equations have an equal sign. Inequalities have an inequality sign.
2.1.2.1. Turning Words into Algebraic Expressions
This part of algebra involves turning statements or word expressions into algebraic
expressions. Algebraic expressions are a combination of numbers and letters. For
17
Example, 2X is an algebraic expression where 2 is called the coefficient of X, X is
called the variable and 2X is the term.
 If the square of the number X is multiplied by the number 3, and the 10 is

added to that product, the result can be presented as .
 If John‟s present salary S is increased by 14 percent, then his present salary
is 1.14S.
2.1.2.2. Operation with Algebraic Expressions
Every algebraic expression can be written as a single term or a series of terms

separated by the plus or minus sign.
Examples
 The algebraic expression has two terms.

 The algebraic expression 1.14S has one term.
Note that the same rules that govern operations with numbers apply to operations
with algebraic expression. One additional rule, which helps in simplifying algebraic
expressions, is that terms with the same variable parts can be combined. For
example,
( ) ( )
Definition: An Equation is a statement that equates two algebraic expressions.
For example,
 is a linear equation in one variable

 is a linear equation in two variables
 is a quadratic equation in one variable
2.1.2.3. Solving Linear Equations
To solve a linear equation means to find the value(s) of the variable(s) that make the
statement true.
18
Example 1-2
Solve the following equation for the value of X.
3X + 2 = 10
Solution 1-2
Other algebraic expressions include the simultaneous equations, cubic equations,

etc. Please review your O-Level or A-Level mathematics for these expressions.
2.2. Tables and Graphs
Economists use numbers to express many of the concepts in the field. These
concepts or variables are related to one another. For instance, when the price of
tomatoes reduces, people buy more tomatoes.
One way of expressing the relationships among variables is by using Tables or

graphs. In graphing, we will only involve two variables to keep the analysis simple.
Using tables we will be able to involve more than one variable.
Definition: A graph is a two-dimensional representation of a set of numbers or data.
In other words, it is a visual representation of the relationship between two variables.

Consider two variables (X and Y) which are linearly related. If the X variable is
presented on the horizontal axis and the Y variable on the vertical axis, then the
horizontal axis can be called the X-axis and the vertical axis can be called the Y-axis.
The two lines meet at the join called the origin, labelled „O‟, hence the name for
the graph as the XOY plain. It should be noted here
19
Definition: A table is a tabular representation of the relationship between or among
variables.
Note that you can present the same data using the graph or the table. Consider the
data in the table below showing the relationship between X and Y.
a b c d e f
X 1 2 3 4 5 6
Y 12 10 8 6 4 2
The data in the table above can be presented on the XOY plain.
2.3. Straight-line graphs

2.3.1. Inverse Relationships
Using the data in the table above, we can plot an XOY plain as shown below.
14 Y
12
a
10
b
8
c
6
d
4
e
2
0
fX
1 2 3 4 5 6
The graph shows that there is an inverse relationship between X and Y. Inverse
relationship is also called the negative relationship. An inverse relationship exists
when the two variables change in opposite directions. That is, when X decrease, Y
increases and when X increase, Y decreases. Note that the graph with an inverse
relationship has a negative slope. Slope is found using the formula
20
2.3.2. Direct Relationships
We can also show a graph with a direct relationship based on some data.
Y
14
12
f
10
e
8
d
6
c
4
b
2
0
a
1 2 3 4 5 6 X
The graph shows that there is a direct relationship between X and Y. Direct
relationship is also called the positive relationship. By a direct relationship we mean
that two variables, in this case, X and Y, change in the same direction. An increase
in X is associated with an increase in Y and a decrease in X accompanies a
decrease in Y. The graph with a direct relationship has a positive slope.
2.3.3. Intercepts
The intercepts of a function or graph are coordinates at which the function meets the
X or Y axis. The point at which the line intersects the Y-axis is called the Y-intercept.
The Y-intercept is also known as the vertical intercept. The Y-intercept, is the value
of Y when X = 0. The point at which the line intersects the X-axis is called the X-
intercept. The X-intercept is also called the horizontal intercept. The X-intercept, is
the value of X when Y = 0.
21
Point „a‟ is the Y-intercept or the vertical intercept. It is the value of Y when X is zero.
Its coordinate is (0,a). Point „c‟ is the X-intercept or the horizontal intercept. It is the
value of X when Y is zero. Its coordinate is (c,0). Recall that this graph shows the
inverse or negative relationship between X and Y and thus has a negative slope.
Example 2-2
Consider an equation below and find the vertical and horizontal intercepts.
a.
b.
Solution 2-2
a.
Vertical intercept
This is the Y-intercept. It is found by assuming that X = 0.
( )
The coordinate for the vertical intercept is (0,8).
Horizontal intercept
This is the X-intercept. It is found by assuming that Y = 0.
The coordinate for the horizontal intercept is (4,0).
b.
Vertical intercept
This is the Y-intercept. It is found by assuming that X = 0.
22
( )
The coordinate for the vertical intercept is (0,2).
Horizontal intercept
This is the X-intercept. It is found by assuming that Y = 0.
The coordinate for the horizontal intercept is ( ).
2.3.4. Slope
The slope of the line is the measure of the rate of change in one variable with
respect to another variable. Consider the figure below.
The slope (b) of the line is computed as follows:
Note: Slope can also be computed for the downward sloping graph.
23
Recall that an upward-sloping line describes a positive relationship between X and Y
and thus a positive slope. A downward-sloping line describes a negative relationship
between X and Y and thus a negative slope.
The following chats show the different slopes for the lines described.
2.3.5. Straight Lines with Different Slopes and Vertical Intercepts
We are able to analyse the effect of a change in the slope or intercept on the line.
The
24
25
2.4. Curved lines
There are many graphs of different functions showing the curved lines. A good
example is the graph for the quadratic function, logarithmic function or the cubic
function. Below are some examples of curved graphs with the nature of the slopes.
2.4.1. Slope of a curved line
The slope of a curved line at a given point is found by drawing a tangent to the curve
at that point and then finding the slope of that tangent. In finding the slope of the
tangent, we use the same formula used under slope of a straight line.
The slope of a nonlinear curve changes from point to point on the curve. The slope
at any point (say, B) can be determined by drawing a straight line that is tangent to
that point (line bb) and calculating the slope of that line.
Note: A line is tangent at a point if it touches, but does not intersect, the curve at that
point. At point B from the Figure below, the = (−5)/15
26
Now suppose that we want to determine the relationship between advertising and
sales and that we are using advertising to know how the sales will change. Such a
relationship can be observed under a non-linear function. Expenditure on advertising
is likely to influence the sales of the business or organisation.
2.5. Linear equations
If we know the vertical intercept and slope, we can describe a line succinctly in
equation form. In its general form, the equation of a straight line is
 Y = dependent variable
 a = vertical intercept
 b = slope of line
 X = independent variable
27
Examples of linear equations
From the equation
 Y = dependent variable
 3 = vertical intercept
 6 = slope of line
 X = independent variable
From the equation Q
 Q = dependent variable
 5 = vertical intercept
 -2 = slope of line
 P = independent variable
2.6. Lines and curves shift
Shifts in the curves or lines come about as a result in the changes in the intercept of
a given function.
Suppose that there is a change in the intercept or other factors in the model, initially
held constant. The curve will shift up or down depending on the change.
28
2.7. Shifts vs. movements along a line
Suppose Y is the dependent variable, which is measured on one of the axis. If the
independent variable measured on the other axis changes, we move along the line.
But if any other independent variable in the model (other than the variable
considered in drawing the graph) changes, the entire line shifts. For example, from
the demand function
 Changes in P will cause a movement along the demand curve,

 Changes in Y will cause a shift in the demand curve
2.8. The use of graphs in economics
Economics uses graphs to simplify reality. There are different models presented
using graph. Graphs used include the production possibility frontier (PPF), the
demand curve, the Supply curve, cost curves, income curves, revenue curves, etc.
29
This line slopes upward, indicating that there seems to be a positive relationship
between income and spending. Points A and B, above the 45° line, show that
consumption can be greater than income.
Unit Two Review Questions
30
UNIT THREE: FUNDAMENTAL QUESTIONS AND ECONOMIC
SYSTEMS
Unit Aim
The aim of this unit is to introduce students to the basic economic questions and how
these questions are answered in different economic systems.
Study Outcomes
 Demonstrate understanding of the basic economic problem in economics

 Demonstrate understanding of the three fundamental questions used to solve
the basic problem
 Demonstrate understanding of the economic systems and how each system
answers the three fundamental questions
3.1. The Basic Economic Problem
Two fundamental facts together constitute the economic problem and provide a
foundation for economics:
i. Society‟s wants are virtually unlimited and insatiable

ii. The resources for producing the goods and services to satisfy society‟s wants
are limited or scarce.
Thus, the basic economic problem is that of scarcity. Scarcity comes about due to
the gap between limited resources and theoretically unlimited wants. This situation
requires people to make decisions about how to allocate resources efficiently, in
order to satisfy basic needs and as many additional wants as possible. In other
words, scarcity necessitates choices between or among competing ends. The
fundamental questions are raised to try and address the economic problem. As such,
31
every society needs to consider what to produce, how to produce and for whom to
produce the commodities for. In making the choices, economic agents have to incur
costs (opportunity cost). The Figure below summarises the basic economic problem.
3.2. The Fundamental Questions
There are basically three fundamental questions that society or economic agents use
in solving societal problems. These are: What to produce? How to Produce? For
whom to produce?
The three questions are part of the economic problem that society must solve. In
answering these questions, resources get allocated efficiently. In other words, these
32
questions form a puzzle which each society should solve to ensure that the
economic problem is addressed.
3.2.1. What to produce
This is the first problem facing any given society. It is a problem of allocation of
resources. Society must consider asking this question to ensure that what is
produced satisfies the wants of the people in that society. The problem of what
goods are to be produced and in what quantities arises directly from the scarcity of
resources. In the absence of scarcity, this question would not be necessary as
society will have everything at its disposal.
Note that when society decides what goods to produce, some of the wants for goods
which have not been considered will not be satisfied. Thus, the question of „what to
produce‟ implies which wants should be satisfied and which ones should be left
unsatisfied. If society decides to produce more of one good, it must withdraw some
resources from the production of the other good. For example, to produce more guns
in times of war, the production of some civilian goods would have to reduce. The
problem of what to produce exist in every economic system, be it market, command
or mixed. In all these economic systems, the question of what to produce implies that
we should produce something for which the benefits of producing it are larger than
the costs of producing it.
3.2.2. How to Produce
The problem of how to produce relates to which combination of resources is to be

used for the production of goods, and which technology is to be used for the
production of those goods. In short, it looks at the combination of resources and the
technology. Scarcity of resources requires that goods are produced in the most
efficient way. The choice between different production methods depends on the
available resource supplies and the prices of the factors of production.
Producers use the least cost methods of production whilst retaining the quality of
goods and services being offered. For example, producers may decide whether to
use more labour in production or more capital. A farmer may decide to use a tractor
33
or cattle in farming. In short, the how to produce question implies that we should
produce goods in the least costly way.
3.2.3. For Whom to Produce
This problem relates to the distribution of the produced resources in the society.
Society must decide who should get how much from the total output of the produced
goods and services. This problem is concerned with social justice or equity.
The society is made up of different types of people and the question of „for whom to
produce‟ must be looked at with the population composition in mind. As such, we
should produce for the individuals who value those goods the most.
3.3. The Economic System
Definition: .An economic system is simply a particular set of institutional

arrangements and a coordinating mechanism for solving the economizing problem.
The type of goods and services produced, how they are produced and distributed
depends on the type of economic system adopted by a particular country. It consists
of a matrix of social institutions (law, political institutions, religion, etc), agents
(individuals or actors), organizations (corporations, unions, charitable organizations,
non-profit firms, etc) and society. In this module, we consider three basic types of
economic system: the market economy, the command economy and the mixed
economy.
3.3.1. The Market Economy
Definition: The market economy is an economic system in which property resources

are privately owned and markets and prices are used to direct and coordinate
economic activities.
The market economy is commonly referred to as capitalism. In this economic

system, each individual seeks to maximize his/her satisfaction through his/her
decisions regarding consumption. Each business under this system seeks to
maximize profit through its own decisions regarding production. The government has
little or no role to play in deciding what, how and for whom to produce.
34
In pure capitalism (laissez-faire capitalism) government‟s role is limited to protecting
private property and establishing an environment appropriate to the operation of the
market system. Laissez-faire here is used to mean „keep government from interfering
with the economy‟. Thus, in the market system, decisions are determined by market
forces. The forces of demand and supply determine the market operation. That is,
the buying decisions of consumers and selling decisions of suppliers determines the
operation of the market. Examples of countries under market economy include USA.
3.3.2. The Command Economy
Definition: The command economy is an economic system in which most property

resources are owned by the government and economic decisions are made by a
central government body.
The command economy is commonly referred to as Socialism or Communism. A

government central planning board determines nearly all the major decisions
concerning the use of resources, the composition and distribution of output, and the
organization of production. In the command system, government owns most of the
business firms. A pure command economy would rely exclusively on a central plan to
allocate the government-owned property resources. Modern day command
economies allow for a very minimal role of the private sector and contribution of the
private sector in deciding what, how and for whom. Examples of countries under
command economy includes Cuba and India
3.3.3. The Mixed Economy
Definition: The mixed economy is an economic system in which the government

and the private sector jointly solve economic problems.
The government influences decisions through taxation, subsidies and provision of

free services such as defence and the police. Government also regulates the extent
to which individuals may pursue their self-interest. In between self-interest decision
making and central control of resources lies the mixed economy. Examples of
countries under mixed economy includes Zambia
35
UNIT FOUR: OPPORTUNITY COST AND TRADE-OFF
Unit Aim
The aim of this unit is to explore the different types of production possibility frontiers
and examine the opportunity costs involved in when making choices.
Study Outcomes
 Demonstrate knowledge of the different types of the production possibility

frontiers
 Use the PPF to show the basic economic problem
 Be able to measure and illustrate the opportunity cost of an action
4.1. Opportunity cost
Definition: Opportunity cost is the value of the best alternative forgone.
It is the amount of other products that must be forgone or sacrificed to produce a unit
of a product. In other words, the opportunity cost of an item is what you give up to
get that item. Opportunity cost can be showed on the production possibility frontier.
4.1.1. Production Possibility Frontier
Definition: The Production Possibility Frontier (PPF) is a locus of points showing the
different combinations of goods and services that can be produced in a full-
employment, full-production economy where the available supplies of resources and
technology are fixed.
Assumptions
36
From the definition of the PPF, we can draw four assumptions underlying the
construction of the PPF.
 Two goods
 Fixed Resources
 Fixed Technology
 Full employment and productive efficiency
Given our assumptions, we see that society must choose among alternatives. The
implication of fixed resources is the limited outputs of the two goods. The implication
of Full employment of these resources is that to increase the production of one good
we must shift resources away from the production of the other good – trade-off. This
necessitates choice. The PPF does not only represent the opportunity cost but it also
measures the opportunity cost. It demonstrates that:
 there is a limit to what you can achieve, given the existing institutions,
resources, and technology
 every choice made has an opportunity cost - you can get more of something
only by giving up something else
The slope of the PPF is called the Marginal Rate of Transformation (MRT). The
marginal rate of transformation, measures the rate at which one good must be
forgone in order to produce an additional unit of the other good. Recall from unit two
how we compute the slope of a straight line and that of a curved line. When
discussing the production possibility frontier, we distinguish between PPF showing
increasing opportunity costs and the one that shows constant opportunity costs.
4.1.2. Increasing opportunity cost
The economic rationale for increasing opportunity cost is that resources lack perfect
flexibility because
 Most resources are not completely adaptable to alternative uses.

 Many resources are better at producing one good than at producing others
 To get more X, resources whose productivity of Y is great in relation to their
productivity of X will be needed
37
 It will take more and more of such resources, and hence greater sacrifices of
Y, to achieve each increase of 1 unit in the production of X.
Increasing opportunity cost is displayed using an outward bowed, downwards

slopping PPF. Since resources are scarce but wants are unlimited, it means that we
need to give up resources in the production of one good for us to increase the
production of the other goods. However, the giving up of resources to produce an
additional unit of another good increases the more we keep producing extra units.
4.1.2.1. Law of increasing opportunity cost
It states that, as the production of a good increases, the opportunity cost of

producing an additional unit rises. This implies that the marginal opportunity cost
keeps on rising.
Consider the figure below where we are producing two goods, X and Y.
The above PPF has three key regions.
 Points that lie inside the PPF are attainable but they are inefficient. This is
because there are a lot of resources but due to underutilization, production is
not done to full capacity.
 Points on the PPF are attainable and efficient. This is because all available
resources are being put to full use. Production on the PPF means there is full
38
employment and the only way one can produce more of one good is by
reducing the production of the other good.
 Points outside the PPF such as W, are unattainable and thus inefficient. This
is because the available resources are not sufficient to meet the production of
goods on those points
It should be noted that points inside the PPF and on the PPF are both feasible and
that points on the PPF such as A, B, C, D, and E are productively efficient. It should
also be noted that a PPF that is concave to the origin reflects increasing opportunity
cost and that the downward slopping feature reflects trade-off.
4.1.2.2. Calculating increasing opportunity cost
When calculating opportunity cost, students must be very careful in understanding

the requirement. In this module, we distinguish between total opportunity cost, and
marginal opportunity cost. Regardless of the measure you are using, it should be
noted that opportunity cost of an item is measured in terms of the forgone item. If
you are giving up 2 units of X to produce 7 units of Y, then the opportunity cost of
producing 7 units of Y is 2X. Notice how the forgone commodity „X‟ is being used the
units for measuring opportunity cost.
For example, When we move from A to B, just 1 unit of Y is sacrificed for 1 more unit
of X; but in going from B to C we sacrifice 2 additional units of Y for 1 more unit of X.
Moving from C to D, 3 additional units of Y are sacrificed for 1 additional unit of X.
Moving from D to E, 4 additional units of Y are sacrificed for 1 additional unit of X
4.1.2.2.1. Total Opportunity cost
Total opportunity cost measures the total amount of an item or a good that must be
given up to produce a certain amount of the other good. For example, suppose you
are considering producing 30 loaves of bread and that for this to be possible, you
need to give up the production of 15 cakes. Then the opportunity cost of producing
30 loaves of bread is 15 cakes.
39
4.1.2.2.2. Marginal opportunity cost
Marginal opportunity cost measures the additional units of one good that must be
given up in order to produce one additional unit of another good. In our bread-cake
production decision, the marginal opportunity cost of bread will be the number of
cakes that must be sacrificed or given up in order to produce just one loaf of bread.
In calculating the marginal opportunity cost, we use the following formula.
In short,
Or simply,
Example 1-4
Suppose you are considering producing 30 loaves of bread or of 15 cakes with your
resources.
i. What is the marginal opportunity cost of cakes?

ii. What is the marginal opportunity cost of bread?
Solution 1-4
i. marginal opportunity cost of cakes
40
Recall that production starts from zero. If the firm produces nothing, then production
volumes will be zero. But since in our example, the firm produces 30 loaves of bread,
the change in the volumes of bread is 30 – 0. In the same way, if the firm decides to
produce 15 cakes, the change will be 15 – 0.
You must be very careful here when capturing the change. If the firm is increasing
production of bread from 0 to 30 and reducing production of cakes from 15 to zero,
then change in bread will be 30 – 0, while the change in cakes will be 0 – 15.
Therefore,
Therefore, to produce 1 additional cake, the firm will have to give up

production of 2 loaves of bread.
ii. marginal opportunity cost of bread
Therefore, to produce 1 additional loaf of bread, the firm will have to give up
production of half a cake.
Example 2-4
Consider a table below that shows the PPS for Lukanga Republic.
41
Options Guns Butter (Kg)
A 0 20
B 2 18
C 5 14
D 9 6
E 10 0
i. Draw the PPF for Lukanga clearly showing the points A-E.
ii. Find the opportunity cost of producing 5 guns.
iii. Find the opportunity cost of producing 9 guns.
iv. Find the marginal opportunity cost of producing the 9th gun.
Solution 2-4
i. PPF for Lukanga

The opportunity cost of producing 5 guns is 6Kg of Butter.
This is because for Lukanga to produce 5 guns, the nation has to sacrifice the
production of 6 Kg of butter.
Hint: Start from 20Kg and 0 guns (point A) of butter and check how many Kgs
of butter you will give up to produce 5 guns (5 guns coincides with point C).
iii. Find the opportunity cost of producing 9 guns.
42
The Opportunity cost of 9 guns is 14Kg of Butter
This is because for Lukanga to produce 9 guns, the nation has to sacrifice the
production of 14 Kg of butter.
of butter you will give up to produce 9 guns (9 guns coincides with point D).
Therefore, to produce the 9th gun, the firm will have to give up production of
2Kg of Butter.
Note: here, we are starting from point C and not point A.
4.1.3. Constant Opportunity Cost
The straight lined production possibility frontier that is downward slopping reflects
constant opportunity cost. The slope of the frontier is the same throughout the
frontier.
43
As we move from point A to B, the opportunity cost is the same as that of moving
from point B to C. Point E is attainable but inefficient. Point F is unattainable and
thus inefficient given the available resources and technology.
Note: That the calculations for both marginal and total opportunity cost takes the
same procedure as discussed under increasing opportunity cost.
Here, the law of increasing opportunity cost does not hold because the marginal
opportunity cost of an item is constant. The above PPF has three key regions.
 Points that lie inside the PPF are attainable but they are inefficient. This is
because there are a lot of resources but due to underutilization, production is
not done to full capacity.
 Points on the PPF are attainable and efficient. This is because all available
resources are being put to full use. Production on the PPF means there is full
employment and the only way one can produce more of one good is by
reducing the production of the other good.
 Points outside the PPF, such as point F, are unattainable and thus inefficient.
This is because the available resources are not sufficient to meet the
production of goods on those points
It should be noted that points inside the PPF and on the PPF are both feasible and
that points on the PPF such as A, B, C, and D, are productively efficient. It should
also be noted that a PPF that is linear with respect to the origin reflects constant
opportunity cost and that the downward slopping feature reflects trade-off.
Example 3-4
Consider a table below that shows the PPS for Great Republic.
44
Options Guns Butter (Kg)
A 0 12
B 2 9
C 4 6
D 6 3
E 8 0
i. Draw the PPF for Great Republic clearly showing the points A-E.
iii. Find the marginal opportunity cost of producing the 4th gun.
Solution 3-4
i. PPF for Great Republic
ii. Opportunity cost of 4 guns

The opportunity cost of producing 4 guns is 6Kg of Butter.
This is because for Great Republic to produce 4 guns, the nation has to
sacrifice the production of 6 Kg of butter.
of butter you will give up to produce 4 guns (4 guns coincides with point C).
iii. Find the marginal opportunity cost of producing the 4th gun.
45
Therefore, to produce the 4th gun, the nation will have to give up
production of 1.5Kg of Butter.
Note: here, we are starting from point B and not point A.
Therefore, to produce the 6th gun, the nation will have to give up
production of 1.5Kg of Butter.
Note: here, we are starting from point C and not point B or A.
Notice that the Marginal opportunity cost has remained 1.5Kg of Butter for both the
4th and the 6th Gun to reflect constant opportunity cost.
4.2. Economic Growth
When there is economic growth, the PPF changes position by either shifting
outwards or tilting outwards. Society can produce more output if:
46
 Technology is improved
 More resources are discovered
 Economic institutions get better at fulfilling our wants
 Or economic growth in general
All these will change the position of the production possibility frontier. Consider a
PPF below for the production of coconuts and fish. Assume that before growth took
place, the nation is at point A on a lower frontier. After growth took place, the PPF
shits outwards and the nation can now increase the production of both coconuts and
fish. Meaning that the point that was initially unattainable could be attainable if we
allow any of the above four factors to hold. Economic growth has the potential of
allowing nations produce that they could previously not able to.
From the above Figure, Production is initially at point A (20 fish and 25 coconuts).
After economic growth takes place, it can move to point E (25 fish and 30 coconuts).
Recall that more output is represented by an outward shift in the production
possibility curve. This means that if technology deteriorated, resources reduced,
economic institution got bad at fulfilling our wants, or in general economic growth
became negative, the PPF would instead shift inwards.
4.2.1. Balanced Growth
Balanced growth or neutral growth exists when the PPF shifts evenly outwards.
Assume two commodities, butter and guns. If technology required in the production
of butter and that needed in the production of guns improves by the same proportion,
47
the PPF will shift outwards evenly. Alternatively, if the resources needed to produce
butter increase by the same proportion as that for the production of guns, the PPF
will shift outwards evenly from frontier AB to frontier CD. This is the case of a
balanced growth and is presented graphically below.
4.2.2. Biased Growth
Biased growth exists when the PPF shifts unevenly outwards or just tilts along the
other axis. Assume two commodities, butter and guns. If technology required in the
production of butter grows proportionately more than the technology required in the
production of guns, the PPF will shift outwards unevenly. The shift will be more along
the butter axis. If on the other hand, technology only improves in the production of
butter, then the PPF will tilt outwards along the butter axis. The same will be the
effect if resources only increase in the butter production. The PPF will tilt outwards
from frontier AB to frontier AC. This is the case of a biased growth and is presented
graphically below.
48
4.3. Weaknesses of the PPF
Production efficiency requires that we produce on the PPF. This ensures that all the
resources have been utilised efficiently. However, the production possibilities
curve/frontier only focuses on productive efficiency and ignores distribution. In our
society, more is generally preferred to less and many policies have relatively small
distributional effects. The PPF does not say anything about the distribution of the
gains or costs from production.
The PPF shows us the economically efficient possibilities, but does not help us
choose among them. Because of many competing end, to choose one item, we must
weigh costs and benefits. You should take an action (move along the PPF) if and
only if the extra benefits of the action are at least as great as the extra costs
associated with that action.
49
UNIT FIVE: DEMAND AND SUPPLY
Unit Aim
The aim of this unit is to introduce students to a simple model of supply and demand
for a single good in an isolated market.
Study Outcomes
 Demonstrate understanding of the factors that affect demand and quantity

demanded
 Demonstrate understanding of the factors that affect supply and quantity
supplied
 Determine the market equilibrium
 Demonstrate understanding of the methods used by the government to intervene
in the market
Mankiw chapter 4 and McConnell chapter 3
5.1. Demand
Definition: Demand is the amounts of a product that consumers are willing and able
to purchase at each of a series of possible prices during a specified period of time.
This implies that demand shows the quantities of a product that will be purchased at
various possible prices, other things equal. Two things stand out from the definition
of demand:
 Willingness
 Ability
A consumer must be willing to spend on a particular good. In addition, he/she must

have the ability to pay for that good. Given these two features, demand for a
particular good can easily be defined.
50
5.1.1. Law of Demand
The law of demand states that; other things equal, an increase in a product’s price
will reduce the quantity of it demanded; and conversely for a decrease in price.
Hence, there is a negative or inverse relationship between the own price of a

commodity and quantity of it demanded. We are using the „other things equal‟
(ceteris paribus) assumption because own price is not the only factor that affect the
demand for a product. For example, coca cola is not only affected by the price of
coca cola but even price of related goods, and other factors to be considered later.
The ceteris paribus assumption then allows us to only focus on the effect between
own price and the quantity demanded of a product. With this assumption then, an
increase in the price of coca cola will lead to a decrease in the quantity demanded of
coca cola. Conversely, a decrease in the price of coca cola will lead to an increase in
the quantity demanded of coca cola.
The law of demand can be stated in four distinct ways:
 Using the demand schedule

 Using the demand curve
 Using the demand function
 And using words
5.1.1.1. Demand Schedule
Definition: A demand schedule is a table showing the total quantity of a good (or
service) that buyers wish to buy at each price.
Consider the demand for Ice cream. A demand schedule can be constructed to show
how quantity demanded of ice cream will change as price changes.
Price (ZMW) Quantity demanded

of ice cream
0 8,000
2 6,000
4 4,000
6 2,000
8 0
51
The demand schedule shows that as the price of ice cream increases from ZMW0,
quantity demanded of ice cream reduces from 8,000 units. For example, when the
price of ice cream is ZMW0, consumers will be willing and able to buy 8,000 units of
ice cream. However, when the price of ice cream increases from ZMW0 to ZMW2,
the quantity demanded of ice cream reduces from 8,000 to 6,000 units. When the
price is ZMW4, quantity demanded of ice cream reduces further to 4,000. This
observation is in line with the law of demand. Recall what the law of demand states:
other things equal, an increase in a product’s price will reduce the quantity of it
demanded; and conversely for a decrease in price.
5.1.1.2. Demand Curve
Definition: A demand curve is a graph showing the total quantity of a good (or
Consider the demand for Ice cream. A demand curve can be constructed to show
how quantity demanded of ice cream will change as price changes.
The demand curve, just like the demand schedule, shows that as the price of ice
cream increases from ZMW0, quantity demanded of ice cream reduces from 8,000
units. For example, when the price of ice cream is ZMW0, consumers will be willing
and able to buy 8,000 units of ice cream. However, when the price of ice cream
increases from ZMW0 to ZMW2, the quantity demanded of ice cream reduces from
8,000 to 6,000 units. When the price is ZMW4, quantity demanded of ice cream
reduces further to 4,000. This observation is in line with the law of demand. Recall
52
what the law of demand states: other things equal, an increase in a product’s price
5.1.1.3. Demand Function
Definition: A demand function is an equation showing the total quantity of a good (or
The general demand function for a single commodity and the one that takes into
consideration the ceteris paribus assumption takes the form:
Where Q is the quantity demanded of ice cream and P is the unit price of ice cream.
„a‟ and „b‟ are constants. Since P has a negative coefficient, there is an inverse
relationship between own price of a commodity and the quantity of that commodity
demanded.
Consider the demand for Ice cream that we looked at. A demand function can be
constructed to show how quantity demanded of ice cream will change as price
changes. The demand function for ice cream will take the form:
The demand function, just like the demand schedule and the demand curve, shows
that as the price of ice cream increases from ZMW0, quantity demanded of ice
cream reduces from 8,000 units. For example, when the price of ice cream is ZMW0,
consumers will be willing and able to buy 8,000 units of ice cream. However, when
the price of ice cream increases from ZMW0 to ZMW2, the quantity demanded of ice
cream reduces from 8,000 to 6,000 units. When the price is ZMW4, quantity
demanded of ice cream reduces further to 4,000. This observation is in line with the
law of demand. Recall what the law of demand states: other things equal, an
increase in a product’s price will reduce the quantity of it demanded; and conversely
for a decrease in price.
53
5.1.1.3.1. Direct demand function vs. inverse demand function
Not that the demand function can be presented as either a direct function or an
inverse function. A direct demand function is a function where quantity demanded is
expressed as a function of price. In general form, a direct demand function will take
the form:
„a‟ and „b‟ are constants.
We can obtain an inverse demand function from the direct demand function by
simply making price the subject of the formula. That is, an inverse demand function
is a function where price is expressed as a function of quantity demanded. From, the
above function, an inverse demand function will take the form:
„a‟ and „b‟ are constants.
Using our ice cream example, the direct demand function for ice cream will take the
form:
An inverse demand function on the other hand will take the form:
As you substitute the values of P or Q as indicated in the demand schedule for ice
cream, you will see that the law of demand holds and the figures will match
regardless of whether you are using the direct or the inverse demand function.
In terms of plotting the demand function, when we put price on the vertical axis and
quantity demanded on the horizontal axis, then we are plotting the inverse demand
function. This is because, from what we covered in unit two, if we plot the XOY plain,
54
the variable that goes on the vertical axis (Y) is the dependent variable and the
variable that goes on the horizontal axis (X) is the independent variable. This means
that if we put price on the vertical axis, we are making price the dependent variable
and by putting quantity demanded on the horizontal axis, we are making quantity
demanded the independent variable. However, we expect the effect to be the
opposite according to the law of demand. To allow the law of demand hold, we
simply call such a demand function as an inverse demand function.
5.1.1.4. Written/Verbal Words
Words, written or verbally, can be used to present the law of demand. Thus, one can
simply write down or verbally state that: other things equal, an increase in a
product’s price will reduce the quantity of it demanded; and conversely for a
decrease in price.
Just like the demand schedule, demand function and the demand curve, one can
use observations on the market and indicate that as the price of ice cream increases
from ZMW0, quantity demanded of ice cream reduces from 8,000 units. For
example, when the price of ice cream is ZMW0, consumers would be willing and
able to buy 8,000 units of ice cream. However, when the price of ice cream
increases from ZMW0 to ZMW2, the quantity demanded of ice cream reduces from
8,000 to 6,000 units. When the price is ZMW4, quantity demanded of ice cream
reduces further to 4,000. This observation is in line with the law of demand. Recall
what the law of demand states: other things equal, an increase in a product’s price
5.1.2. Determinants of demand and quantity demanded
We have demonstrated that the amount of a commodity demanded is not only

affected by its own price. Other factor that affect the demand include
 Income
 Price of related goods
 Tastes
 Expectations
 Number of buyers
55
5.1.2.1. Own Price
Own price affects the quantity demanded directly. This implies that, when price of a
commodity changes, the quantity demanded of that commodity changes as well.
Note that own price of a commodity will not change the entire demand for a product
but rather change the quantity demanded of that product. Graphically, changes in the
own price of a commodity is represented by a movement along the demand curve,
from one point to the other, and not the shift in the demand curve.
Consider a single commodity (Ice cream). Changes in the price of ice cream will
affect the quantity demanded of ice cream.
Suppose that the price of ice cream increases from 4 to 6, ceteris paribus, then the
quantity demanded of it will reduce from 4,000 to 2,000 because ice cream has now
become more expensive. This is basically a movement along the demand curve from
one point to the other.
5.1.2.2. Income
The effect of income on the demand of a product differs depending on the nature of
the product. Here, we distinguish between normal goods and inferior goods.
5.1.2.2.1. Normal Goods
For normal goods, a rise in income, ceteris paribus, leads to an increase in demand
and a decrease in income, ceteris paribus, leads to a decrease in demand. The
56
effect of the change in income on the demand for a product is that, demand tends to
change.
Increase in Income
An increase in income leads to an increase in demand and is reflected by a shift in

the demand curve to the right. This is because you are now able to get more units of
the commodity you like, ceteris paribus.
With the initial demand curve , an increase in income shifts the demand curve to
the right to . Demand increases.
Decrease in Income
For normal goods, a decrease in income, ceteris paribus, leads to a decrease in

demand. This is reflected in a shift in the demand curve to the left. This is because
your purchasing power reduces and you are now not able to get more units of the
commodity you like, ceteris paribus.
57
With the initial demand curve , a decrease in income shifts the demand curve to
the left to . Demand reduces.
5.1.2.2.2. Inferior Goods
For inferior goods, an increase in income, ceteris paribus, leads to a decrease in

demand for that good. This is because you would want to consume better goods
given now that you have more income.
For example, if you consider a meat pie to be an inferior good and Pizza to be a
normal good, then an increase in income would lead to a decrease in your demand
for meat pies. In this case, it means you can now buy more of Pizza since your
abilities to purchase it have increase.
Increase in Income
For inferior goods, an increase in income leads to a decrease in demand and is

reflected by a shift in the demand curve to the left. This is because you are now able
to get more units of the other commodity you prefer, ceteris paribus.
With the initial demand curve , an increase in income shifts the demand curve to
the left to . Demand reduces.
Decrease in Income
For inferior goods, a decrease in income, ceteris paribus, leads to an increase in

demand. This is reflected in a shift in the demand curve to the right. This is because
your purchasing power reduces and you are now not able to get more units of the
58
commodity you prefer, ceteris paribus. This will lead you purchase more of the
inferior commodity.
With the initial demand curve , a decrease in income shifts the demand curve to
the right to . Demand increases.
5.1.2.3. Price of Related Goods
When looking at the effect of the price of related goods on demand, a distinction is
made between substitute goods and complement goods
5.1.2.3.1. Substitute Goods
Two goods are said to be substitutes if an increase in the price of one good leads to
an increase in the demand for the other good.
Increase in Price of one Substitute Good
Consider Coca-cola and Pepsi to be substitute goods. If the price of Coca-cola goes
up, consumers will find Coca-cola to be expensive and as such they will switch to a
relatively cheaper good which gives them similar satisfaction as that from Coca-cola
(Switch to Pepsi in this case). The more the price of Coca-cola increases, the more
consumers will be substituting Pepsi for Coca-cola. This is because with an increase
in the price of Coca-cola, the quantity demanded for Coca-cola will fall. This means
that consumers will have to look for alternative commodity to try and replace the lost
consumer units of Coca-cola. Pepsi will then be substituted for Coca-cola.
59
The demand curve for Coca-cola will not be affected because the increases in Coca-
cola price will only cause a movement along the demand curve for Coca-cola. On the
other hand, the demand curve for Pepsi will shift to the right because consumer are
now demanding more of it due to the increase in the price of a substitute good,
ceteris paribus.
Decrease in Price of one Substitute Good
Consider Coca-cola and Pepsi to be substitute goods. If the price of Coca-cola

reduces, consumers will find Coca-cola to be cheap and as such they will buy more
of it. Some Pepsi lovers will also want buy Coca-cola. The more the price of Coca-
cola reduces, the more consumers will be substituting Coca-cola for Pepsi. This is
because with a reduction in the price of Coca-cola, the quantity demanded for Coca-
cola will increase. This means that consumers will have to buy more of it and reduce
the demand for Pepsi.
60
The demand curve for Coca-cola will not be affected because the decreases in
Coca-cola price will only cause a movement along the demand curve for Coca-cola.
On the other hand, the demand curve for Pepsi will shift to the left because
consumer are now demanding less of it due to the decrease in the price of a
substitute good, ceteris paribus.
5.1.2.3.2. Complement Goods
Two goods are said to be complements if an increase in the price of one good leads
to a decrease in the demand for the other good. These are goods that work together
or go hand in hand. Examples include DVD and a DVD player, Gasoline and a car,
etc. The figure below show an example of complement goods, DVD player (A) and
DVD (B)
Increase in Price of one Complement Good
Consider a DVD player and a DVD to be complement goods. If the price of DVD
players goes up from to , consumers will find DVD players to be expensive and
as such the quantity demanded of DVD players will reduce from to ,. This
change has a ramification on the demand for the DVDs. The demand for DVDs will
reduce because they will be less significant if only a few DVD players are being
purchased. The more the price of DVD players increases, the more consumers will
be demanding less of DVDs. This is because with an increase in the price of DVD
players, the quantity demanded for DVD players will fall. Thus, DVD players and
61
DVDs complement each other and there is an inverse relationship between the price
of one good and the demand for the other complement good.
The demand curve for DVD players will not be affected because the increases in
DVD players‟ price will only cause a movement along the demand curve for DVD
players upwards. On the other hand, the demand curve for DVDs will shift to the left
because consumers are now demanding less of DVDs due to the increase in the
price of a complement good, ceteris paribus.
Decrease in Price of one Complement Good
players goes down from to , consumers will find DVD players to be cheap and
as such the quantity demanded of DVD players will increase from to ,. This
change has a ramification on the demand for the DVDs. The demand for DVDs will
increase because they will be more important since a lot of DVD players are being
purchased. The more the price of DVD players decreases, the more consumers will
be demanding more of DVDs. This is because with a reduction in the price of DVD
players, the quantity demanded for DVD players will increase. Thus, DVD players
and DVDs complement each other and there is an inverse relationship between the
price of one good and the demand for the other complement good.
62
The demand curve for DVD players will not be affected because the reduction in
DVD players‟ price will only cause a movement along the demand curve for DVD
players downwards. On the other hand, the demand curve for DVDs will shift to the
right because consumers are now demanding more of DVDs due to the decrease in
the price of a complement good, ceteris paribus.
5.1.2.4. Taste
A favourable change in consumer tastes (preferences) for a product (a change that

makes the product more desirable) means that more of it will be demanded at each
price. This means that demand for that particular product will increase. This will
cause the demand curve for that product to shift to the right.
An unfavourable change in consumer taste on the other hand will reduce demand.
This is because with reduced consumer taste for a particular product, less of that
63
product will be demanded. New products may affect consumer tastes; for example,
the introduction of compact discs greatly decreased the demand for cassette tapes.
Introduction of android phones reduced the demand for Nokia 3310. A reduction in
consumer taste will reduce demand and the demand curve will shift to the left.
5.1.2.5. Expectations
Your expectations about the future may affect your demand for a good or service
today. For example, if you expect to earn a higher income next month, you may be
more willing to spend some of your current savings to buy items today. Hence the
demand for drinks will increase today. If you expect the price of your preferred shirts
to fall tomorrow, you may be less willing to buy the shirts at today‟s price. This is
because you will be willing to wait until tomorrow when the price for the shirt
reduces. As such, demand for the shirts reduces today and the demand curve for the
shirts shifts to the left today as shown below.
64
If you expect the price of your preferred shirts to increase tomorrow, you may be
more willing to buy the shirts at today‟s price. As such, demand for the shirts
increases today and the demand curve for the shirts shifts to the right today.
5.1.2.6. Number of Buyers
The population of buyers for a particular product is very important in any market. An
increase in the number of buyers in a market for a particular product increases the
demand for that product. For example, the increase in the number of adults in a
population increases the demand for housing. The increase in the number of new
births increases the demand for diapers, baby lotion, and under-five clinical services.
The demand curve for each of these products will then shift to the right as shown
below.
A decrease in the number of buyers in a market for a particular product reduces the
demand for that product. For example, the decrease in the number of new births
65
reduces the demand for diapers, baby lotion. The demand curve for each of these
products will then shift to the left as shown below.
5.1.3. Revisiting the Demand Function
The above analysis of the determinants of demand brings a new picture of the
demand function. This means that If we want to focus on commodity X, the demand
function for that commodity will then take the following form;
( )
Where;
 is the demand for commodity X

 is the own price (price for commodity X)
 is the cross price (Price of a related product, i.e. commodity Y)
 is the income of the consumer
 is the taste of the consumer
 is the number of buyers in the market
 is the consumer expectation
To simplify analysis, remember we use the ceteris paribus assumption. In later

sections of this unit and the next unit you will see many applications of this type of
the demand function. We can specify the demand function by picking some of the
determinants.
66
5.1.4. Market Demand
We have looked at the demand for a product by a single consumer. The market
however is made up of several consumers. The market demand therefore for a
product will be the sum of the individual consumers‟ demand for that product.
5.1.4.1. Market Demand Curve
The market demand curve is obtained from the horizontal summations of the
individual consumer‟s demand curves. Let us assume a market for bananas made
up of two consumers, Maraji and Ab-Raham. Suppose that at a price of ZMW3,
Maraji buys 4 bananas while Ab-Raham buys 6 bananas, then the quantity
demanded in the market for bananas at a price of ZMW3 will be 4 + 6 = 10 bananas.
If the price of a banana increases to ZMW4, Maraji reduces his quantity demanded
of bananas to 3 bananas. Ab-Raham also reduces his quantity demanded of
bananas to 4 bananas. This entails that the quantity demanded of bananas in the
market, at a price of ZMW4, will be 3 + 4 = 7 bananas. Joining the points for
individual consumers and for the market independently, gives rise to the respective
demand curves. The figure below summarises the horizontal summation of the
individual consumer‟s demand curves to form the market demand curve for bananas.
5.1.4.2. Market Demand Function
Just like the market demand curve, the market demand function is also a summation
of the individual consumers‟ demand functions. Each consumer has a unique
demand function, depending of the factors affecting demand that we discussed
67
earlier on. This part is very tricky and as such you need to pay particular attention to
the type of the demand function for each individual consumer. Note that if you are
presented with an inverse demand function, needed is to transform the function into
a direct demand function. This will require you to make quantity subject of the
formula. Once all the demand functions are such that quantity is the function of price,
you can proceed to deriving the market demand function by adding the individual
demand functions.
For example, suppose that we have two consumers (Maraji and Ab-Raham), each
with a unique demand function as being the demand for Maraji and being the
demand for Ab-Raham. The market demand will be obtained as
Example
A market consists of three consumers (Maraji, Ab-Raham, and Joel) whose demand
functions are:
……….Maraji
……..Ab-Raham
…………Joel
Where P is the price and Q is the quantity of a given commodity. Generate the
market demand function for the commodity
Solution
To answer this question, you first need to convert the indirect demand functions into
direct demand functions.
68
Market Demand
To generate the market demand function, we sum up the individual direct demand
functions.
( ) ( ) ( )
Therefore, the market demand function is
NOTE: If the individual consumers‟ demand functions are presented in direct form,
there is no need to transform the functions. You just need to proceed and sum up the
demands for the consumers. If however the demand functions for the consumers are
a mixture of the direct and indirect demand functions then you need to convert the
functions which are in indirect form to the direct form and then proceed adding up the
direct functions to generate the market demand function.
5.2. Supply
Definition: Supply is the amounts of a product that producers are willing and able to
make available on the market at each of a series of possible prices during a
specified period of time.
This implies that supply shows the quantities of a product that will be supplied at
various possible prices, other things equal. Two things stand out from the definition
of supply:
 Willingness
 Ability
A producer must be willing to release a particular good on the market. In addition,

he/she must have the ability to do so. Given these two features, supply for a
particular good can easily be defined.
69
5.2.1. Law of supply
The law of demand states that; other things equal, an increase in a product’s price
will increase the quantity of it supplied; and conversely for a decrease in price.
Hence, there is a positive or direct relationship between the own price of a

commodity and quantity of it supplied. We are using the „other things equal‟ (ceteris
paribus) assumption because own price is not the only factor that affect the supply of
a product. For example, coca cola is not only affected by the price of coca cola but
even price of related goods, and other factors to be considered later. The ceteris
paribus assumption then allows us to only focus on the effect between own price and
the quantity supplied of a product. With this assumption then, an increase in the
price of coca cola will lead to an increase in the quantity supplied of coca cola.
Conversely, a decrease in the price of coca cola will lead to a decrease in the
quantity supplied of coca cola.
The law of supply can be stated in four distinct ways:
 Using the supply schedule

 Using the supply curve
 Using the supply function
 And using words
5.2.1.1. Supply Schedule
Definition: A supply schedule is a table showing the total quantity of a good (or
service) that sellers wish to make supply at each price.
Consider the supply of Ice cream. A supply schedule can be constructed to show
how quantity supplied of ice cream will change as price changes.
Price (ZMW) Quantity demanded

of ice cream
2 0
4 2,000
6 4,000
8 6,000
70
The supply schedule shows that as the price of ice cream increases from ZMW2,
quantity supplied of ice cream also increases from 0 units. For example, when the
price of ice cream is ZMW2, suppliers will be willing and able to supply 0 units of ice
cream. However, when the price of ice cream increases from ZMW2 to ZMW4, the
quantity supplied of ice cream increases from 0 to 2,000 units. When the price is
ZMW6, quantity supplied of ice cream increases further to 4,000. This observation is
in line with the law of supply. Recall what the law of supply states: other things equal,
an increase in a product’s price will increase the quantity of it supplied; and
conversely for a decrease in price. Thus, there is a positive relationship between
own price of a commodity and the quantity of it supplied.
5.2.1.2. Supply Curve
Definition: A supply curve is a graph showing the total quantity of a good (or
service) that sellers wish to supply at each price.
Consider the supply of Ice cream. A supply curve can be constructed to show how
quantity supplied of ice cream will change as price changes.
The supply curve, just like the supply schedule, shows that as the price of ice cream
increases from ZMW2, quantity supplied of ice cream increases from 0 units. For
example, when the price of ice cream is ZMW2, producers will be willing and able to
supply 0 units of ice cream. However, when the price of ice cream increases from
ZMW2 to ZMW4, the quantity supplied of ice cream increases from 0 to 2,000 units.
When the price increases to ZMW6, quantity supplied of ice cream increases further
71
to 4,000. This observation is in line with the law of supply. Recall what the law of
supply states: other things equal, an increase in a product’s price will increase the
quantity of it supplied; and conversely for a decrease in price.
5.2.1.3. Supply Function
Definition: A supply function is an equation showing the total quantity of a good (or
service) that producers wish to supply at each price.
The general supply function for a single commodity and the one that takes into
consideration the ceteris paribus assumption takes the form:
Where Q is the quantity supplied of ice cream and P is the unit price of ice cream. „c‟
and „d‟ are constants. Since P has a positive coefficient, there is a direct relationship
between own price of a commodity and the quantity of that commodity supplied.
Consider the supply for Ice cream that we looked at. A supply function can be
constructed to show how quantity supplied of ice cream will change as price
changes. The supply function for ice cream will take the form:
Where Q is the quantity supplied of ice cream and P is the unit price of ice cream.
The supply function, just like the supply schedule and the supply curve, shows that
as the price of ice cream increases from ZMW2, quantity supplied of ice cream
increases from 0 units. For example, when the price of ice cream is ZMW0,
producers will be willing and able to supply 0 units of ice cream. However, when the
price of ice cream increases from ZMW2 to ZMW4, the quantity supplied of ice
cream increases from 0 to 2,000 units. When the price increases to ZMW6, quantity
supplied of ice cream increases further to 4,000. This observation is in line with the
law of supplied. Recall what the law of supply states: other things equal, an increase
in a product’s price will increase the quantity of it supplied; and conversely for a
decrease in price.
72
5.2.1.3.1. Direct supply function vs. inverse supply function
Not that the supply function can be presented as either a direct function or an
inverse function. A direct supply function is a function where quantity supplied is
expressed as a function of price. In general form, a direct supply function will take
the form:
Where Q is the quantity supplied and P is the unit price. „c‟ and „d‟ are constants.
We can obtain an inverse supply function from the direct supply function by simply
making price the subject of the formula. That is, an inverse supply function is a
function where price is expressed as a function of quantity supplied. From, the above
function, an inverse supply function will take the form:
Where Q is the quantity supplied and P is the unit price. „c‟ and „d‟ are constants.
Using our ice cream example, the direct supply function for ice cream will take the
form:
An inverse supply function on the other hand will take the form:
As you substitute the values of P or Q as indicated in the supply schedule for ice
cream, you will see that the law of supply holds and the figures will match regardless
of whether you are using the direct or the inverse supply function.
In terms of plotting the supply function, when we put price on the vertical axis and
quantity supplied on the horizontal axis, then we are plotting the inverse supply
function. This is because, from what we covered in unit two, if we plot the XOY plain,
the variable that goes on the vertical axis (Y) is the dependent variable and the
variable that goes on the horizontal axis (X) is the independent variable. This means
73
that if we put price on the vertical axis, we are making price the dependent variable
and by putting quantity supplied on the horizontal axis, we are making quantity
supplied the independent variable. However, we expect the effect to be the opposite
according to the law of supply. To allow the law of supply hold, we simply call such a
supply function as an inverse supply function.
5.2.1.4. Written/Verbal Words
Words, written or verbally, can be used to present the law of supply. Thus, one can
simply write down or verbally state that: other things equal, an increase in a
product’s price will increase the quantity of it supplied; and conversely for a decrease
in price.
Just like the supply schedule, supply function and the supply curve, one can use
observations on the market and indicate that as the price of ice cream increases
from ZMW2, quantity supplied of ice cream increases from 0 units. For example,
when the price of ice cream is ZMW0, producers will be willing and able to supply 0
units of ice cream. However, when the price of ice cream increases from ZMW2 to
ZMW4, the quantity supplied of ice cream increases from 0 to 2,000 units. When the
price increases to ZMW6, quantity supplied of ice cream increases further to 4,000.
This observation is in line with the law of supplied. Recall what the law of supply
states: other things equal, an increase in a product’s price will increase the quantity
of it supplied; and conversely for a decrease in price.
5.2.2. Determinants of supply and quantity supplied
We have demonstrated that the amount of a commodity supplied is not only affected
by its own price. Other factor that affect the supply include
 Input price
 Technology
 Price of related goods
 Expectations
 Number of sellers
 Taxes
 Subsidies
74
5.2.2.1. Own Price
Own price affects the quantity supplied directly. This implies that, when price of a
commodity changes, the quantity supplied of that commodity changes as well. Note
that own price of a commodity will not change the entire supply for a product but
rather change the quantity supplied of that product. Graphically, changes in the own
price of a commodity is represented by a movement along the supply curve, from
one point to the other, and not the shift in the supply curve.
Consider a single commodity (Ice cream). Changes in the price of ice cream will
affect the quantity supplied of ice cream.
Suppose that the price of ice cream increases from 4 to 6, ceteris paribus, then the
quantity supplied of it will increase from 2,000 to 4,000 because ice cream has now
become more attractive to the producer. This is basically a movement along the
supply curve from one point to the other.
5.2.2.2. Input Price
To produce a good/service, Producers use various inputs such as machines, labour,

etc. When the price of one or more of these inputs rises, production of that
good/service becomes less profitable, and thus the supply of that commodity
reduces. This causes the supply curve to shift to the left. If input prices continue to
rise, you might shut down your firm and supply nothing at all. Thus, the supply of a
good is negatively related to the price of the inputs used to make the good. NOTE
75
that a reduction in the supply is represented by a shift in the supply curve to the left
as shown below.
If on the other hand the price of one or more of the inputs reduces, production of that
good/service becomes more profitable, and thus the supply of that commodity
increases. This causes the supply curve to shift to the right. If input prices continue
to fall, you might make more abnormal profits for your firm and continue to supply
more of that commodity. Thus, the supply of a good is negatively related to the price
of the inputs used to make the good. NOTE that an increase in the supply is
represented by a shift in the supply curve to the right as shown below.
5.2.2.3. Technology
The technology for turning the inputs into a good/service is yet another determinant
of supply. The invention of the mechanized ice-cream machine, for example,
reduced the amount of labour necessary to make ice cream. This means that the
firm will employ less labour units in the production of ice cream. Hiring less labour
76
units implies reduction in costs. By reducing firms‟ costs, the advance in technology
raised the supply of ice cream. The supply curve therefore shifts to the right as
shown below.
The deterioration of technology on the other hand reduces the supply of a particular
commodity. If for example, the mechanized ice-cream machine deteriorates, there
will be need for more manual works. This will reduce the supply of ice cream. The
supply curve therefore shifts to the left as shown below.
5.2.2.4. Price of related goods
When looking at the effect of the price of related goods on supply, a distinction is
made between substitute goods and complement goods.
5.2.2.4.1. Substitute Goods
Two goods are said to be substitutes if an increase in the price of one good leads to
a decrease in the supply of the other good.
77
Increase in Price of one Substitute Good
Consider Coca-cola and Pepsi to be substitute goods. If the price of Coca-cola goes
up, producers will find Coca-cola to be more attractive for profit making and as such
they will draw some resources away from the production of Pepsi and devote then to
Coca-cola production. The more the price of Coca-cola increases, the more
producers will be substituting Coca-cola for Pepsi. This is because with an increase
in the price of Coca-cola, the quantity supplied for Coca-cola will increase.
Therefore, the supply for Pepsi will reduce while the quantity supplied for Coca-cola
will increase.
The supply curve for Coca-cola will not be affected because the increases in Coca-
cola price from to will cause a movement along the supply curve for Coca-cola.
On the other hand, the supply curve for Pepsi will shift to the left because producer
can now supply less of it due to the increase in the price of a substitute good, ceteris
paribus.
Decrease in Price of one Substitute Good
Consider Coca-cola and Pepsi to be substitute goods. If the price of Coca-cola

reduces, producers will find Coca-cola to be less attractive for profit making and as
such they will draw some resources away from the production of Coca-cola and
devote then to Pepsi production. The more the price of Coca-cola reduces, the more
producers will be substituting Pepsi for Coca-cola. This is because with a decrease
in the price of Coca-cola, the quantity supplied for Coca-cola will reduce. Therefore,
78
the supply for Pepsi will increase while the quantity supplied for Coca-cola will
reduce.
The supply curve for Coca-cola will not be affected because the decrease in Coca-
cola price from to will cause a movement along the supply curve for Coca-cola.
On the other hand, the supply curve for Pepsi will shift to the right because producer
can now supply more of it due to the decrease in the price of a substitute good,
ceteris paribus.
5.2.2.4.2. Complement Goods
Two goods are said to be complements if an increase in the price of one good leads
to an increase in the supply of the other good. These are goods that work together or
go hand in hand. Examples include DVD and a DVD player, Gasoline and a car, etc.
The figure below shows an example of complement goods, DVD player (A) and DVD
(B).
79
Increase in Price of one Complement Good
players goes up from to , producers will find DVD players to be more attractive
for profit making and as such the quantity supplied of DVD players will increase from
to ,. This change has a ramification on the supply of the DVDs. The supply for
DVDs will also increase because they will be more important if only more DVD
players are being supplied. The more the price of DVD players increases, the more
producers will be supplying more of DVDs. This is because with an increase in the
price of DVD players, the quantity supplied of DVD players will also increase. Thus,
DVD players and DVDs complement each other and there is a direct relationship
between the price of one good and the supply of the other complement good.
The supply curve for DVD players will not be affected because the increases in DVD
players‟ price will only cause a movement along the supply curve for DVD players
upwards. On the other hand, the supply curve for DVDs will shift to the right because
producers are now supplying more of DVDs due to the increase in the price of a
complement good, ceteris paribus.
Decrease in Price of one Complement Good
players reduces from to , producers will find DVD players to be less attractive
for profit making and as such the quantity supplied of DVD players will reduce from
80
to ,. This change has a ramification on the supply of the DVDs. The supply for
DVDs will also reduce because they will be less important if only a few DVD players
are being supplied. This is because with a decrease in the price of DVD players, the
quantity supplied of DVD players will also reduce. Thus, DVD players and DVDs
complement each other and there is a direct relationship between the price of one
good and the supply of the other complement good.
The supply curve for DVD players will not be affected because the reduction in DVD
players‟ price will only cause a movement along the supply curve for DVD players
downwards. On the other hand, the supply curve for DVDs will shift to the left
because producers are now supplying fewer units of DVDs due to the decrease in
the price of a complement good, ceteris paribus.
5.2.2.5. Expectations
Your expectations about the future may affect your supply for a good or service
today. For example, if you expect the price of your diesel to increase tomorrow, you
may be less willing to supply diesel at today‟s price. This is because you will be
willing to wait until tomorrow when the price for diesel increases. As such, supply for
diesel reduces today and the supply curve for diesel shifts to the left today as shown
below.
81
If you expect the price of diesel to fall tomorrow, you may be more willing to supply
diesel at today‟s price. As such, supply for diesel increases today and the supply
curve for diesel shifts to the right today.
5.2.2.6. Number of Sellers
The population of sellers for a particular product is very important in any market. An
increase in the number of sellers in a market for a particular product increases the
supply for that product. For example, the increase in the number of newly built house
owners increases the supply for housing. The increase in the number of new births
increases the number of diapers manufacturers, baby lotion manufacturer, and
under-five clinical services providers, and thus the supply for these products and
services. The supply curve for each of these products will then shift to the right as
shown below.
82
Note that the reduction in the number of sellers for a particular product reduces the
supply for that product, ceteris paribus, and the supply curve shifts to the left as
shown below.
5.2.2.7. Taxes and Subsidies
Taxes and subsidies have the same effect as that of input prices. A tax is a
compulsory contribution to state revenue, levied by the government on workers'
income and business profits, or added to the cost of some goods, services, and
transactions. In our case, we are looking at it from the point of view of adding to the
cost of production. When a tax is levied on a particular commodity, the cost of
producing that commodity increases. As such, the supply for the commodity will
reduce and the supply curve will shift to the left as shown below.
83
It should be noted however, that the incidence of the tax will depend on other factors
such as the elasticity of demand and the elasticity of supply. The later factor will help
us understand who bears the burden of a tax.
A subsidy on the other hand is a sum of money granted by the state or a public body
to help an industry or business keep the price of a commodity or service low. This
tends to motivate producer to produce more. A subsidy can also aim at directly
lowering the cost of production. A subsidy increases the supply of a commodity and
the supply curve shifts to the right as shown below.
5.2.3. Revisiting the Supply Function
The above analysis of the determinants of supply brings a new picture of the supply
function. This means that If we want to focus on commodity X, the supply function for
that commodity will then take the following form;
( )
84
Where;
 is the supply for commodity X

 is the own price (price for commodity X)
 is the cross price (Price of a related product, i.e. commodity Y)
 is the input price (cost of production)
 is the technology
 is the number of sellers in the market
 is the consumer expectation
 is the tax
 is the subsidy
To simplify analysis, remember we use the ceteris paribus assumption. In later

sections of this unit and the next unit you will see many applications of this type of
the supply function. We can specify the supply function by picking some of the
determinants.
5.2.4. Market Supply
We have looked at the supply for a product by a single producer. The market
however is made up of several producers. The market supply therefore for a product
will be the sum of the individual producers‟ supply for that product.
5.2.4.1. Market Supply Curve
The market supply curve is obtained from the horizontal summations of the individual
producer‟s supply curves. Let us assume a market for bananas made up of three
producers; Firm A, Firm B and Firm C. Suppose that at a price of $1.75, Firm A
supplies 5,000 bananas, Firm B supplies 10,000 bananas and Firm C supplies
10,000 bananas, then the quantity supplied on the market for bananas at a price of
$1.75 will be 5,000 + 10,000 + 10,000 = 25,000 bananas.
If the price of a banana increases to $3, Firm A increases the quantity supplied to
10,000 bananas, Firm B increases to 30,000 bananas and Firm C increases to
85
25,000 bananas. This entails that the quantity supplied of bananas in the market, at
a price of $3, will be 10,000 + 30,000 + 25,000 = 65,000 bananas. Joining the points
for individual producers and for the market independently gives rise to the respective
supply curves. The figure below summarises the horizontal summation of the
individual producer‟s supply curves to form the market supply curve for bananas.
5.2.4.2. Market Supply Function
Just like the market supply curve, the market supply function is also a summation of
the individual producers‟ supply functions. Each producer has a unique supply
function, depending of the factors affecting supply that we discussed earlier on. This
part is very tricky and as such you need to pay particular attention to the type of the
supply function for each individual producer. Note that if you are presented with an
inverse supply function, needed is to transform the function into a direct supply
function. This will require you to make quantity subject of the formula. Once all the
supply functions are such that quantity is the function of price, you can proceed to
deriving the market supply function by adding the individual Producers‟ supply
functions.
For example, suppose that we have three consumers (Firm A, Firm B, and Firm C),
each with a unique supply function as being the supply for Firm A, being the
supply for Firm B and being the supply for Firm C. The market supply will be
obtained as
Example
86
A market consists of three Producers (Firm A, Firm B and Firm C) whose demand
functions are:
……….Firm A
………....Firm B
…………...Firm C
Where P is the price and Q is the quantity of a given commodity. Generate the
market supply function for the commodity.
Solution
To answer this question, you first need to convert the indirect demand functions into
direct demand functions.
Market Supply
To generate the market supply function, we sum up the individual direct supply
functions.
( ) ( ) ( )
Therefore, the market supply function is
87
NOTE: If the individual producers‟ supply functions are presented in direct form,
there is no need to transform the functions. You just need to proceed and sum up the
supplies for the consumers. If however the supply functions for the consumers are a
mixture of the direct and indirect supply functions then you need to convert the
functions which are in indirect form to the direct form and then proceed adding up the
direct functions to generate the market supply function.
5.3. Equilibrium and the price system in the Market
Definition: A market is any institution or mechanism that brings together buyers and
sellers of particular goods, services, or resources for the purpose of exchange.
Note: A market is not necessarily a place where buyers and sellers meet to trade.
Any arrangement, be it online, specific location or any institutional arrangement
established for the purpose of exchange between buyers and sellers.
5.3.1. Equilibrium
In a market, equilibrium occurs at the point where demand equals supply. This is a
point where the demand curve intersects the supply curve. Thus, we bring together
supply and demand to see how the buying decisions of households and the selling
decisions of businesses interact to determine the price of a product and the quantity
actually bought and sold in the market.
In the figure below, with a downward slopping demand curve and an upward
slopping supply curve, the point where the two curves cross each other becomes the
equilibrium point (Point E). The corresponding price ( ) is called the equilibrium
price and the corresponding quantity ( ) is called the equilibrium quantity.
88
When the market in in equilibrium, quantity demanded by buyers in the market
exactly equals quantity supplied in the same market. That is, in equilibrium;
The above equation tells us that given the demand and the supply functions,
equilibrium can be attained by equating the two equations. After solving the equation
for P or for Q, depending on whether you used the direct functions or inverse
functions, respectively, you can substitute the observed value back into the demand
or supply function to obtain the remaining value. For instance, if you solved for P,
you can substitute the observed value of P into either the demand or supply function
to obtain the value of Q. If in the first calculation you used the indirect functions and
obtained the value of Q, you can substitute the value of Q into either the demand or
supply function for the value of P.
The resulting value of Q is called the equilibrium quantity (or market equilibrium
quantity) while the corresponding value of P is called the equilibrium price (or market
equilibrium price).
Example 5.3.1 (1)
The demand and supply functions of a good are given by
Where P, and denote the price, quantity demanded and quantity supplied
respectively.
i. Determine the equilibrium price and quantity.

ii. Sketch the graph showing the above equilibrium point.
Solution
i. To answer the above question, one needs to use the equilibrium condition of
equating demand and supply.
89
Therefore, the equilibrium quantity is 10 and the equilibrium price it 30.
NOTE: If the currency for the price is known then the price should be presented with
the corresponding currency symbol. If the unit measure for quantity is known the
quantity should be presented with the corresponding units of measure.
ii. To sketch the demand, supply and the market equilibrium, we need to use the
knowledge from Unit 2 of this module. Since both our demand and supply
functions are linear, we can sketch the functions by first finding the vertical and
horizontal intercepts for each function (i.e. demand and supply functions). Since
both our demand and supply curves are plotted as an inverse function where price
is placed on the vertical axis (Y – axis) and quantity on the horizontal axis (X –
axis), vertical intercept is the value of P when Q = 0 and the horizontal intercept is
the value of Q when P = 0. So we need to find the (Q, P) coordinates.
Let‟s start with the demand function then supply function.
⁄ ………Demand function
90
…….. Supply function
Now that we have the intercepts for each function, we can sketch our graph. Note
that you do not need a graph paper to do this. It‟s not the matter of accurate
drawing but model presentation. So place the vertical and horizontal intercepts for
the demand function on the QoP (XoY) plain and join the two points with a straight
line. Label it with the demand function. Do the same for the supply curve.
We note that negative quantity is an economic nonsense. We can then sketch the
diagram by focusing on the positive side of the figure. Hence;
91
Note that both diagrams are okay. If you draw any of these then there is no need
to redraw the other.
5.3.2. Excess Demand
Excess demand occurs when the commodity price is below the equilibrium price. At
any price below the equilibrium price, there will be a shortage of commodities. This is
because producers will be demotivated to supply more at a lower price (Recall the
law of supply). Consumers on the other hand, will see the low price as an incentive
to increase their purchases (Recall the law of demand). As such the quantity
demanded will exceed the quantity supplied at any given price below the market
equilibrium price.
To show how the shortage can be presented and how we can get back to
equilibrium, consider the figure below.
92
The figure above shows that the market is in equilibrium at a price of . If anything
happened on the market that pushed the price below equilibrium to a price level such
as , then there will be excess demand on the market equal to the distance bd. At
the price , producers are only supplying quantity but the consumers are
demanding quantity. So the distance between and or bd measures the
shortage on the market. Because of this shortage, consumers will bid up the prices
as they will be willing to pay more to get the commodity. The price will keep rising,
back to equilibrium. Because the market discussed so far is governed by demand
and supply, no other price other than the equilibrium price will prevail in the market.
This means that the shortages on this market are temporal.
5.3.3. Excess Supply
Excess demand occurs when the commodity price is above the equilibrium price. At
any price above the equilibrium price, there will be a surplus of commodities. This is
because producers will be motivated to supply more at a higher price (Recall the law
of supply). Consumers on the other hand, will see the higher price as a disincentive
and they will reduce their purchases (Recall the law of demand). As such the
quantity supplied will exceed the quantity demanded at any given price above the
market equilibrium price.
To show how the surplus can be presented and how we can get back to equilibrium,
consider the figure below.
The figure above shows that the market is in equilibrium at a price of . If anything
happened on the market that pushed the price above equilibrium to a price level
such as , then there will be excess supply on the market equal to the distance bd.
93
At the price , producers are supplying quantity but the consumers are only
demanding quantity. So the distance between and or bd measures the
surplus on the market. Because of this surplus, producers will bid down the prices as
they will be willing to accept less than to release the commodity. The price will
keep falling, back to equilibrium. Because the market discussed so far is governed
by demand and supply, no other price other than the equilibrium price will prevail in
the market. This means that the surpluses on this market are temporal.
Example 5.3.1 (2)
The demand and supply functions of a good are given by
Where P, and denote the price, quantity demanded and quantity supplied
respectively.
i. Determine the equilibrium price and quantity.

ii. Sketch the graph showing the above equilibrium point.
iii. Suppose that the price on the market is now 25. Determine the shortage or the
surplus on this market.
iv. Suppose that the price on the market is now 40. Determine the shortage or the
surplus on this market.
Solution
i. See solution to Example 5.3.1 (1) part I (P = 30 and Q = 10)

ii. See solution to Example 5.3.1 (1) part i
iii. Since the equilibrium price was found to be 30, then the price of 25 will lie
below the equilibrium price. This means that there will be a shortage or excess
demand on the market. To find the shortage volume, follow the following steps.
Step 1
Substitute the new price of 25 into the demand function to obtain the
corresponding quantity demanded at a price of 25.
94
⁄
⁄ ( )
Step 2
Substitute the new price of 25 into the supply function to obtain the
corresponding quantity supplied at a price of 25.
( )
This means that at a price of 25, supplied will not make available any unit on
the market.
Step 3
Get the difference between the quantity demanded and quantity supply. If the
answer is negative, disregard the negative sign or take the absolute value.
This means that at a price of 25, demand will exceed supply by 12.5 units on
this market. See the figure below for the illustration.
95
NOTE: it doesn‟t matter whether in step one you start with quantity supplied or
demand or whether in step 3 you subtract quantity demanded from quantity
supplied or vice versa, the answer will always be the same in absolute terms.
iv. Since the equilibrium price was found to be 30, then the price of 40 will lie
above the equilibrium price. This means that there will be a surplus or excess
supply on the market. To find the surplus volume, follow the following steps.
Step 1
Substitute the new price of 40 into the demand function to obtain the
corresponding quantity demanded at a price of 40.
⁄ ( )
Step 2
Substitute the new price of 40 into the supply function to obtain the
corresponding quantity supplied at a price of 40.
( )
96
Step 3
Get the difference between the quantity demanded and quantity supply. If the
answer is negative, disregard the negative sign or take the absolute value.
| |
This means that at a price of 40, supply will exceed demand by 25 units on this
market. See the figure below for the illustration.
NOTE: it doesn‟t matter whether in step one you start with quantity supplied or
demand or whether in step 3 you subtract quantity demanded from quantity
supplied or vice versa, the answer will always be the same in absolute terms.
5.3.4. Effects of Changes in demand on the Market
Changes in demand, keeping the supply unchanged, changes the equilibrium point
and thus changes the equilibrium price and quantity. Changes in demand occur
when any of the factors that affect demand changes. Recall the determinants of
demand. Recall also that an increase in demand is depicted by a shift in the demand
curve to the right and a decrease in demand is depicted by a shift in the demand
curve to the left. Further, recall that changes in own price do not shift the demand
curve but rather cause a movement along the demand curve.
97
5.3.4.1. Increase in Demand
Suppose that there in an increase in demand, ceteris paribus. For example, if

income of consumers increases, the demand for a normal good increases. The
demand curve will then shift to the right from D to D‟. Keeping supply constant, the
equilibrium point changes from point E to E‟.
As a result of the increase in demand, the equilibrium price increases from to

and equilibrium quantity increases from to . Therefore, we notice the following
Demand Supply Equilibrium Equilibrium Equilibrium

Price Quantity Point
Increase constant Increase Increase Move up
5.3.4.2. Decrease in Demand
Suppose that there in a decrease in demand, ceteris paribus. For example, if the
number of buyers reduces in the market, the demand for a particular product will
reduce. The demand curve will then shift to the left from D to D‟. Keeping supply
constant, the equilibrium point changes from point E to E‟.
98
As a result of the decrease in demand, the equilibrium price reduces from to
and equilibrium quantity reduces from to . Therefore, we notice the following

Decrease constant Decrease Decrease Move down
5.3.5. Effects of Changes in Supply on the Market
Changes in supply, keeping the demand unchanged, changes the equilibrium point
and thus changes the equilibrium price and quantity. Changes in supply occur when
any of the factors that affect supply changes. Recall the determinants of supply.
Recall also that an increase in supply is depicted by a shift in the supply curve to the
right and a decrease in supply is depicted by a shift in the supply curve to the left.
Further, recall that changes in own price do not shift the supply curve but rather
cause a movement along the supply curve.
5.3.5.1. Increase in Supply
Suppose that there in an increase in supply, ceteris paribus. For example, if there is
technological advancement in the production of a certain commodity, the supply for
that commodity increases. The supply curve will then shift to the right from S to S‟.
Keeping demand constant, the equilibrium point changes from point E to E‟.
As a result of the increase in demand, the equilibrium price reduces from to

and equilibrium quantity increases from to . Therefore, we notice the following
99
Constant Increase Decrease Increase Move down
5.3.5.2. Decrease in Supply
Suppose that there in a decrease in supply, ceteris paribus. For example, if the
number of sellers reduces in the market, the supply for a particular product will
reduce. The supply curve will then shift to the left from S to S‟. Keeping demand
constant, the equilibrium point changes from point E to E‟.
As a result of the decrease in supply, the equilibrium price increases from to

and equilibrium quantity reduces from to . Therefore, we notice the following

Constant Decrease Increase Decrease Move up
5.3.6. Simultaneous Changes in Demand and Supply on the Market
5.3.6.1. Demand and Supply move in one Direction
Suppose that there is an increase in both demand and supply. The demand curve
will shift to the right from D to D‟. The supply curve will also shift to the right-
downwards from S to S‟. As a result, quantity will also increase. However, price will
be ambiguous because it can increase, decrease or remain constant depending on
the magnitude of the increase in demand and in supply. If supply increases more
100
than demand, then price will reduce. This means that the equilibrium point will also
move down as shown below.
If demand increases more than supply, then prices will increase. This means that the
equilibrium point will also move up as shown below.
If however demand and supply increases by the same magnitude, then price will not
change. This means that the equilibrium point will remain at the same level of price
but move to the right.
Therefore, an increase in both demand and supply will increase the quantity but the
effect on price and the equilibrium point will be ambiguous. Therefore, we notice the
following

Increase Increase Ambiguous Increase Ambiguous
101
NOTE: A decrease in both demand and supply will shift the demand curve to the left
and the supply curve to the left. The obvious result will be a decrease in quantity on
the market. However, changes in price and equilibrium point will be ambiguous. The
later will depend on the magnitude of reduction in demand and in supply. If supply
decreases more than demand, then price will increase. This means that the
equilibrium point will also move up. If demand decreases more than supply, then
prices will decrease. This means that the equilibrium point will also move down. If
however demand and supply decreases by the same magnitude, then price will not
change. This means that the equilibrium point will remain at the same level of price
but move to the left.
Therefore, a decrease in both demand and supply will reduce the quantity but the
effect on price and the equilibrium point will be ambiguous. Therefore, we notice the
following

Decrease Decrease Ambiguous Decrease Ambiguous
5.3.6.2. Demand and Supply move in Opposite Directions
Suppose that there is a decrease in demand but an increase in supply. The demand
curve will shift to the left from D to D‟. The supply curve will however shift to the right
from S to S‟. As a result, price will reduce and the equilibrium point will move down.
However, quantity will be ambiguous because it can increase, decrease or remain
constant depending on the magnitude of the decrease in demand and increase in
supply. If supply increases more than the decrease in demand, then quantity will
increase.
102
If demand decreases more than the increase in supply, then quantity will reduce.
If however, the decrease in demand is proportional to the increase in supply, then

quantity will remain constant. Therefore, we notice the following

Decrease Increase Decrease Ambiguous Move down
Suppose that there is an increase in demand but a decrease in supply. The demand
curve will shift to the right. The supply curve will however shift to the left. As a result,
price will increase and the equilibrium point will move up. However, quantity will be
ambiguous because it can increase, decrease or remain constant depending on the
magnitude of the increase in demand and decrease in supply. If supply decreases
more than the increase in demand, then quantity will reduce. If demand increases
more than the decrease in supply, then quantity will increase. If however, the
increase in demand is proportional to the decrease in supply, then quantity will
remain constant. Therefore, we notice the following

Increase Decrease Increase Ambiguous Move up
103
5.4. Welfare Economics
Market equilibrium reflects the way markets allocate scarce resources (issue of
invisible hand). Whether the market allocation is desirable or not can be addressed
by welfare economics.
Definition: Welfare economics is the study of how the allocation of resources affects
economic well-being.
Buyers and sellers receive benefits from taking part in the market. The equilibrium in
a market maximizes the total welfare of buyers and sellers. This means that
equilibrium in the market results in maximum benefits, and therefore maximum total
welfare for both the consumers and the producers of the product. Therefore we need
to understand the welfare of both consumers and producers and how their welfare
gets affected by changes in market activities. We begin by looking at consumer
surplus, producer surplus and total surplus. Consumer surplus measures economic
welfare from the buyer‟s side. Producer surplus measures economic welfare from the
seller‟s side.
5.4.1. Consumer Surplus
Definition: Consumer surplus is the difference between what the consumers are
willing to pay for commodities and what they actually pay.
Willingness to pay is the maximum amount that a buyer would pay for a good. It
measures how much the buyer values the good or service. The market demand
curve depicts the various quantities that buyers would be willing and able to
purchase at different prices. Therefore, the area below the demand curve and above
the price actually paid by consumers measures the consumer surplus in the market.
Consumer surplus tells us about the welfare of consumers in the market. An
increase in consumer surplus is an indication of improved welfare of consumers
while the decrease indicates reduced welfare.
To get to the consumer surplus, for example, we can some someone this question,
„How much are you willing to pay for a pair of jeans? As an individual consumer, you
have no say in determining the market price. Hence, you take the market price as
104
given in the market. If the market price is at or below what you are willing to pay for a
good, then you go ahead and buy it. If the market price is below what you are willing
to pay for a pair of (your favourite) jeans, your purchase will result in consumer
surplus: the difference between the price that you were willing to pay and the price
you actually paid. For an individual in a market,
Total consumer surplus is the sum of all consumer surpluses gained by all buyers of
a good in the market.
105
UNIT SIX: ELASTICITY
Unit Aim
Study Outcomes

demanded
supplied
in the market
106
UNIT SEVEN: CONSUMER CHOICE THEORY
Unit Aim
Study Outcomes

demanded
supplied
in the market
107
UNIT EIGHT: THEORY OF THE FIRM
Unit Aim
Study Outcomes

demanded
supplied
in the market
108
UNIT NINE: COST OF PRODUCTION
Unit Aim
Study Outcomes

demanded
supplied
in the market
109
UNIT TEN: MARKET STRUCTURE
Unit Aim
Study Outcomes

demanded
supplied
in the market
110

Introduction To Microeconomics Booklet 2

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Introduction To Microeconomics Booklet 2

Uploaded by

Copyright:

Available Formats

UNIVERSITY OF LUSAKA

SCHOOL OF BUSINESS, ECONOMICS AND

ECF 100 – INTRODUCTION TO MICROECONOMICS

ELIAS MUWAU (BA, MA)

Introduction/Background/Description to the course

 This course ECF100 (Introduction to Microeconomics) is an introductory

 In introducing students to the study of economics, particularly

The aim of this course is to:

 Provide an understanding of the macroeconomic theories and how these

 Identify the tools of microeconomic analysis and formulate possible solutions

The objectives of this course are to:

 Introduce students to the various principles of microeconomics and indicate

By the end of this course, students are expected to:

 Demonstrate an understanding of the principles nature and methodology of

3. Fundamental Questions and Economic Systems

4. Opportunity Cost, Trade-offs

5. Demand and Supply

7. Consumer Choice Theory

8. Theory of the Firm

 Objectives of the firm.

10. Market Structures

Methods of Instruction/Mode of Delivery

 To evaluate your progress in this course, you will be subjected to assignments

 The grading system for this course is as follows

Mid-semester Examinations/ Test : 20%

Total Marks : 100%

Marks Grades Points Classification

86% - 100% A+ 5 Distinction

76% - 85% A 4 Distinction

66% - 75% B+ 3 Meritorious

61% - 65% B 2 Satisfactory

56% - 60% C+ 1 Clear Pass

50% - 55% C 0 Pass

 McConnell C R, Brue S L, Barbiero T P, Microeconomics, Ninth edition,

 Mankiw N. Gregory.,Principles of Microeconomics, Fourth edition

 Frank, R.H., Microeconomics and Behavior, 5th edition, McGraw-Hill, 2003.

 Hardwick, P. B. Khan and J. Langmead. Introduction to Modern Economics.

 David a. Besanko & Ronald R. Braeutiga; Microeconomics, John Wiley &

 Dominick Salvatore Schaums Outline of Microeconomics, 4th edition

At the end of this unit, students are expected to:

 Define economics and other basic economic concepts

Study Material for the unit

Mankiw chapter 1&2 and McConnell chapter 1&2

1.1. Definition of Economics

1.2. Basic concepts

Definition: Scarcity is the limited nature of society’s resources. It is actually a

An economy or society is made up of different households that are endowed with

1.2.2. Factors of Production

Definition: Factors of production - An economic concept that refers to the inputs

 Renewable resources are resources that can be replenished, such as water,

Productivity is measured by the amount of output someone can produce in each

The following are several characteristics of labour in terms of being a factor of

 First, labour is considered to be heterogeneous, which refers to the idea of

Other examples of capital goods include computers, machines, properties,

Below are several defining characteristics of capital as a factor of production:

Rationality is a fundamental assumption in standard economics. The assumption of

Definition: Marginal analysis is the comparison of marginal benefits and marginal

1.2.5. Opportunity Cost

Definition: Opportunity cost is the value of the best alternative forgone.

i. What is the value of working at the campus shop for you?

i. ZMW40 (which is ZMW70-ZMW30).

1.3. Principles of Economics

1.3.2. How People Interact