Introduction to Economics (PDF)

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Introduction to Economics,By: Mohammed Ibrahim (MSc.)
(Introduction to EconomicsLecturer Note), for Natural students

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Chapter Two
Theory of Demand and Supply
2.1Theory of demand
Demand is one of the forces determining prices. The theory of demand is related to the economic
activities of consumers-consumption. Hence, the purpose of the theory of demand is to determine
the various factors that affect demand.In our day-to-day life we use the word demand‘in a loose
sense to mean a desire of a person to purchase a commodity or service. But in economics it has a
specific meaning, which is different from what we use it in our day to day activities. Demand
implies more than a mere desire to purchase a commodity. It states that the consumer must be
willing and able to purchase the commodity, which he/she desires. His/her desire should be
backed by his/her purchasing power. A poor person is willing to buy a car; it has no significance,
since he/she has no ability to pay for it. On the other hand, if his/her desire to buy the car is
backed by the purchasing power then this constitutes demand. Demand, thus, means the desire of
the consumer for a commodity backed by purchasing power. These two factors are essential. If a
consumer is willing to buy but is not able to pay, his/her desire will not become demand.
Similarly, if the consumer has the ability to pay but is not willing to pay, his/her desire will not
be called demand.
More specifically,demandrefers to various quantities of a commodity or service that a
consumer would purchase at a given time in a market at various prices, given other things
unchanged (ceteris paribus). The quantity demanded of a particular commodity depends on the
price of that commodity.Law of demand:This is the principle of demand, which states that ,
price of a commodity and its quantity demanded are inversely related i.e., as price of a
commodity increases (decreases) quantity demanded for that commodity decreases (increases),
ceteris paribus.
2.1.1Demand schedule (table), demand curve and demand function
The relationship that exists between price and the amount of a commodity purchased can be
represented by a table (schedule) or a curve or an equation.Demand schedulecan be
constructed for any commodity if the list of prices and quantities purchased at those prices are
known. An individual demand schedule is a list of the various quantities of a commodity, which
an individual consumer purchases at various levels of prices in the market. A demand schedule
states the relationship between price and quantity demanded in a table form.
Demand curveis a graphical representation of the relationship between different quantities of a
commodity demanded by an individual at different prices per time period.
Introduction to Economics,By: Mohammed Ibrahim (MSc.)
(Introduction to EconomicsLecturer Note), for Natural students

~ 2 ~
In the above diagram prices of oranges are given on =OY‘axis and quantity demanded on =OX‘
axis. For example, when the price per kilogram is birr 1 the quantity demanded is 13 kilograms.
From the above figure you may notice that as the price declines quantity demanded increases and
vice-versa.Demand functionis a mathematical relationship between price and quantity
demanded, all other things remaining the same. A typical demand function is given by:
Market Demand: The market demand schedule, curve or function is derived by horizontally
adding the quantity demanded for the product by all buyers at each price.
Introduction to Economics,By: Mohammed Ibrahim (MSc.)
(Introduction to EconomicsLecturer Note), for Natural students

~ 3 ~

2.1.2Determinants of demand
The demand for a product is influenced by many factors. Some of these factors are:
I. Price of the product
II. Taste or preference of consumers
III. Income of the consumers
IV. Price of related goods
V. Consumers expectation of income and price
VI. Number of buyers in the market
When we state the law of demand, we kept all the factors to remain constant except the price of
the good. A change in any of the above listed factors except the price of the good will change the
demand, while a change in the price, other factors remain constant will bring change in quantity
demanded. A change in demand will shift the demand curve from its original location. For this
Introduction to Economics,By: Mohammed Ibrahim (MSc.)
(Introduction to EconomicsLecturer Note), for Natural students

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reason those factors listed above other than price are called demand shifters. A change in own
price is only a movement along the same demand curve.Changes in demand:a change in any
determinant of demand—except for the good‘s price causes the demand curve to shift. We call
this a change in demand. If buyers choose to purchase more at any price, the demand curve shifts
rightward—an increase in demand. If buyers choose to purchase less at any price, the demand
curve shifts leftward—a decrease in demand.
Now let us examine how each factor affect demand.
I.Taste or preference
When the taste of a consumer changes in favour of a good, her/his demand will increase and the
opposite is true.
II.Income of the consumer
Goods are classified into two categories depending on how a change in income affects their
demand. These are normal goods and inferior goods.Normal Goodsare goods whose demand
increases as income increase, whileinferior goodsare those whose demand is inversely related
with income. In general, inferior goods are poor quality goods with relatively lower price and
buyers of such goods are expected to shift to better quality goods as their income increases.
However, the classification of goods into normal and inferior is subjective and it is usually
dependent on the socio-economic development of the nation.
III.Price of related goods
Two goods are said to be related if a change in the price of one good affects the demand for
another good. There are two types of related goods. These are substitute and complimentary
goods.Substitute goodsare goods which satisfy the same desire of the consumer. For example,
tea and coffee or Pepsi and Coca-Cola are substitute goods. If two goods are substitutes, then
price of one and the demand for the other are directly related.Complimentary goods,on the
other hand, are those goods which are jointly consumed. For example, car and fuel or tea and
sugar are considered as compliments. If two goods are complements, then price of one and the
demand for the other are inversely related.
IV.Consumer expectation of income and price
Higher price expectation will increase demand while a lower future price expectation will
decrease the demand for the good.
V.Number of buyer in the market
Since market demand is the horizontal sum of individual demand, an increase in the number of
buyers will increase demand while a decrease in the number of buyers will decrease demand.
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