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DEMAND ANALYSIS
Many economists have considered demand and supply as the core of economics. This is
because basis of economics is built around it. As Thomas Carlyle - was quoted to have
said teach a parrot to say demand and supply and you have made an economist of
him.
NEED
Need in economics refers to an urgent requirement or something essential or necessity
which someone is lacking and which in normal sense is supposed to possess. For
instance, a sick parson needs medical attention.
WANT
This refers to a mere desire to have something. Thus the wish of a consumer to have a
commodity which in actual sense may not be backed by the ability and willingness to
purchase. For example, Mr. Fauzan may desire to have Sala dress for the celebration of
Idil fitr. However, the money to pay for this dress is not there. So we say this is a mere
desire.Mr. Fauzan can live without this dress and this therefore distinguishes a want from a
need. It means that a need is a necessity which a consumer cannot live without while in
the case of the want a customer can live without it.
DEMAND
Demand refers to the quantities of goods and services that consumers are willing and
are able to buy at various prices over a given period of time.
DEMAND SCHEDULE: It is a table showing} the relationship between quantities
demanded of a commodity at various prices at a particular time. This can be shown
below. We have the individual and market demand schedule.
PRICES OF PINEAPPLE QUANTITY DEMANDED
10 100
20 80
30 60
40 50
50 30
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MARKET DEMAND SCHEDULE: This is referred to as the total demand schedule.
Thus, the summation of alldemand schedules of all consumers of a commodity. The
table below shows the total quantities of a commodity which ail consumers of that
commodity are willing to buy at various prices, at a particular period of time. This is
shown on the table below.
Price Individual consumer
(A)
Individual
consumer(B)
Market demand
10 100 300 400
8 200 450 650
6 300 550 850
4 400 650 1050
2 500 750 1250
The summation of consumer A and B demands gives the market demand.
INDIVIDUAL DEMAND SCHEDULE: It is a table showing the various quantities
demanded by a particular or individual consumer at various prices at a particular period.
INDIVIDUAL DEMAND: This is defined as the quantity of a commodity the
individual consumer is willing and able to buy during a given period of time.
MARKET DEMAND: This is the sum total of the various quantities of a commodity
demanded by all consumers in the market at various prices and at a particular time
period.
TYPES OF GOODS
1. Normal goods: These are goods whose demand increases as the consumer's incomelevel increases.
2. Inferior goods:These are goods and services whose demand decrease as the level ofincome of consumer increases.
3. Giffen goods: These are goods whose demand decrease as the prices falls and asprices increase more is demanded.
4. Necessity or goods subjects to satiety: These are goods whose demand remains theh i f h i
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THE FUNDAMENTAL LAW OF DEMAND
The law statesthat, all things being equalthelower the price, the higher the quantity
demanded and the higher the price, the lower: the quantity demanded of a commodity
or a service.
Factorsthat affect or determine the demand of any given commodity or service in
an economy
1. Price of the commodity: The demand for a particular commodity in most casesdepends on the price of the commodity itself. If the price of the commodity falls it
means that demand is going to be high. This is attributed to the feet that asthe price
is falling many consumers can now afford to buy more of the commodity and the
existing consumers can also buy more hence demand would be increased. When
there is a fall in price consumers substitute cheaper goods for expensive ones as a
result more of the good whose price has fallen is demanded. Any time there is a fall
inprice the real income of the consumer increase as such more normal goods are
demanded and vice versa. And increase in price will also result in decrease in
demand, since that commodity becomes expensive in the eyes of the consumer.
2. Price of other commodities in addition: The price of other commodities alsodetermines the demand for a particular commodity, especially when the
commodities are substitutes or complements. Complementary goods are the goods
that are jointly demanded to achieve a particular level of satisfaction. With such
commodities a change in price of one affects the demand of the other as in the case
of car and fuel. If price of one falls demand will increase and this may cause an
increase in demand for the other and vice versa.
In the case of substitutes it can be considered as where two or more commodities
serve the same purpose. Change in the price of one will affect* the demand of the
other. An increase in the price in of a commodity will lead to an increase in the
demand for its substitute and vice versa. A good example is Milo and Bourn vita. If
the price of Milo falls whilst that of Bournvita whose price remains the same,
consumers will look at Bourn vita whose price remains as being expensive hence
they will tend to demand more of Milo.
3. Taste and preference: Consumers taste and preference also determines how muchof a commodity or service that should be demanded. If consumers taste increase for
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4.Expectation of future changes in prices:In most case, if consumers expect price toincrease, demand will be high, since consumers will like to buy more before the
increment in price takes place. On the other hand, if they expect price to fall, they will
demand less of the commodity. Here consumers being rational will wait for the fall in
price before they can increase their demand.
5.Population size: The population of a country also determines the demand for acommodity. If the population is high demand is more likely to be high but where the
population is small demand is likely to be low. E.g. Ghana and Nigeria.
6.Income of the consumer:The income level of the consumer also affects demand.But this however depends on whether the commodity is an inferior or normal good. If
the commodity is a normal good more will be demanded if income increases and a fall
in income also leads to a fall in demand. Meanwhile if it is an inferior, as income
increases less is demanded and a fall in income brings less to demand and a fall in
income brings about an increase in demand. Good subject to satiation: the quantity
demanded remains unchanged once the consumers income increases.
7.Income distribution: if the distribution of income favours the few rich in the societydemand will be low than where the income is fairly distributed. Where income is fairly
distributed everyone has a fair share of the national cake, therefore the purchasing
power will be high, hence increase in demand.
8.Advertisement:Increase in advertisement may also bring about an increase demandfor a particular commodity. And low advertisement may bring about low demand for a
particular commodity. Since advertisement will always inform consumers of the
existence of a particular and also go on to persuade these consumers to prefer such
commodities to others.
STUDY QUESTION
Discuss the effects of the following on the demand for commodity Y.
1. An increase in the income of the consumer.2. A fall in price of its substitute.3. An increase in price of its compliments.4. An increase in supply of its substitute.
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THE DEFERENCE BETWEEN CHANGE IN QUANTITY DEMAND AND
CHANGE IN DEMAND
CHANGE IN QUANTITY DEMAND
This is the situation where more or less of a commodity is bought at different prices. It
is also known as movement along the same demand curve. The major underlying factor
is a change in the price of the commodity itselfwhileall other factors remain the same.
This can be illustrated on the diagram below. (Price induced) This is also known as a
movement along the same demand curve.
As shown in the diagram above, as the price of the commodity increase from P0 to P2 it
resulted in a movement on the same demand curve from A to B, qty demanded of the
commodity reduces from Q0 to Q2. While a fall in price from P0 to P1 resulted in a
movement on the demand curve from A to C, quantity demanded of the commodity
increases from Q0 to Q1.
The above situation can be dichotomize into increase in quantity demanded and
decrease in quantity demanded.
INCREASE IN QUANTITY DEMANDED
This is the situation where more of the commodity is bought as the prices falls. This is
shown on the diagram below.
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The fall in price from P0 to P3 has resulted in an increase in quantity demanded from Q0
to Q1 resulting in a movement on the same demand curve from A to C.
DECREASE IN QUANTITY DEMANDED
This is also the situation where less of the commodity is bought as the price increases.
This can be shown on the diagram below.
The increase in price from P0 to P2 has resulted in a decrease in quantity demanded
from Q0 to Q2,resulting in a movement on the same demand curve from A to B.
CHANGE IN DEMAND
This involves a boldly shift of the demand curve either to the left or to the right. Simply
put it is situation where more, or less of a commodity is demanded at the same price. It
implies a fundamental change in the entire demand situation of the consumer for that
particular commodity. This diagram below illustrates the situation.
With the price of the commodity remaining at same at P0it is possible for the demand
to increase from Q0 to Q2 or decrease from Q0 to Q1 Resulting in a bodily shift of the
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INCREASE IN DEMAND
This is the situation where more of the commodity is demanded at the same price.This
involves a bodily shift of the demand curve to the right.
From the diagram, at t the same price of Po, quantity demanded increases from Q0 to
Q2. There are several factors that have caused this, apart from the price of the
commodity. These include:
1. An increase in the price of a substitute or a fall in the price of its jointly demandedgoods.
2. An increase in the income of the consumer will increase their demand for inferiorgoods.
3. An increase in taste for the commodity or where a commodity becomes fashionable.4. Consumer's expectation that the price of a commodity is to rise in the near future.5. An increase in population.6. An increase in advertisement.
A DECREASE IN DEMAND
This is the situation where less is demanded at the same price. Thus it involves
bodily shift of the demand curve to the left. This is also known as autonomous change
in demand.
The boldly shift has resulted in a decrease in demand from Q0 to Q2 Such a situation
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1. Decrease in the price of a substitute or an increase in the price of a jointly demandcommodity.
2. A decrease in consumers taste for the commodity or where the commodity fallsout fashion.
3. Consumers' expectation that price of the commodity is going to fall in the nearfuture.
4. A decrease in population and hence a decrease in the number of consumers forthe commodity.
5. A decrease in consumer's income decreases demands for inferior goods.6. Decrease in advertisement.
FACTORS THAT MAY CAUSE CHANGE I N DEMAND
i. Change in the price of other goods which are related ( i.e substitutes or
compliments)
ii. Change in taste and fashions
iii. Changes in income
iv. Change in population ie changes in the number of buyers.
v. Change in weather conditionsvi. Consumers expectation.
vii. Advertisement i.e information in commodities
viii. Availability of credit,
ix. Taxation on commodities.
TYPES OF DEMAND
There are basically four types of demand, these include the following;
(1) Composite demand:this occurs when a single product is wanted for a numberof different uses. Simply put when a commodity serves several different uses. A
good example is. Timber which is demanded for making chairs, tables, windows.
Bread Hour which can be used for bread, cake, pie, rough bands etc. When a
commodity has composite demand, an increase in demand for any one of its
uses will raise the commodity's price and this will reflect in the price of timber
and affect the price of other commodities made from timber.
(2) Derived demand: Some goods are needed not for the satisfaction that the)yield but for the reason that they help in the production of another commodity.
For example, the demand for cement, block is derived from the demand for
H I t th d d f F O B (f t f d ti ) i d i d
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(3) Competitive demand: This is where two or more goods serves the same purpose,and for that matter compete for the same income of the consumer. In other words
we say that the commodities give the consumer the same satisfaction. Examples
of such commodities include beef and mutton, Milo and Bourn vita, Margarine
and Butter etc. Some of these commodities are close substitutes others are not.
Whether the commodities are close substitute or not will depend much on the
consumer's taste for the commodity. Since the consumer may decide to buy one
relative to other, if the price of Bourn vita increases, while that of Milo remains
the same, consumers may shift their demand from Bourn vita to Milo as shown
in the diagrams below.
A. Bournvita B. Milo
From the diagrams, an increase in price of Bourn vita from PO to PI has resulted in
a fall in quantity demanded of Bourn vita from Q0 to Q1 with the price of Milo
remaining the same there is increase in demand from Q0to Q1.
On the other hand when the price of Bourn vita falls while that of Milo remains the
same consumers are likely to shift their demand from Milo to Bourn vita as show in
the diagram below.
Price
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The fall in price of Bournvita causes an increase in demand of Bourn vita while the
price of Milo remaining the same has resulted in a decrease in demand of Milo for
Q1to Q2.
(4) Joint or complementary demand: Where two or more commodities are jointly
demanded then they are complementary to each other or consumed together to give
certain level of satisfaction. Very common examples are chair and table, TV and
player, car and fuel and many others. For instance when the price of car falls more
is demanded and bought and since petrol is needed to move cars more petrol would
also be demanded.
So here there is an inverse relationship between the price and demanded for
complementary demand goods. This is shown on the diagrams below.
From the diagram, a fail in the price of Cars from P0 to P1 has resulted in an
i i h i d d d f i f Q Q i h h i
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more of fuel is going to be demanded. On the other hand there could be an increac ear
as shown in the diagram below.
EXCEPTIONAL/ABNORMAL DEMAND CURVES
Exceptional/abnormal demand is any demand situation which does not obey the
fundamental of demand.
It is not always that consumers will behave according to the general rule of den
exceptional demand curves are curves that do not behave like the normal demand
curves and this curve normally illustrates these abnormal situations.
(1)POSITIVE SLOPED DEMAND CURVEHere the consumer buys more of the commodity when the price of the commodity use
of it is demanded when the price falls.
The demand for ostentatious and Giffen goods ire very good examples. This is shown
diagram below.
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(3)The demand for an inferior good; these are goods which are demanded by the poor,for instance Gari may be considered inferior to rice among many people. Here,
when the income of the consumer increases he demands less of such commodities.
(4)Habit, where a consumer has developed a very strong habit to consume a particularcommodity his demand for it will be perfectly inelastic within a certain price range.
That is, for instance, if the price of commodity increases his demand for it remains
unchanged.
(5)Perfect market, in a perfect market where there are many buyers and sellers sellinghomogenous goods, the demand for the product of a seller is price perfectly elastic,
if a seller sells at a price slightly higher than the market price, there will be no
demand for the product or commodity at all.
(6)Ignorance about the existence of substitute. If consumers are not aware of theexistence of a substitute good somewhere there will tend to demand more of a
particular commodity even when the price is high.
THE REASONS WHY THE DEMAND CURVE IS NEGATIVELY SLOPED
(1) The first reason is the fundamental law of demand, as the price of the commodity
falls it appears cheap in the eyes of consumers and those who could not buy it at all
can now afford it. This implies that the number of consumers for a commodity
increase when the price of the commodity falls and vice versa.
(2) The second reason is Marginal Utility Theory, which is used to explain the natureof the curve. Utility is the Satisfaction derived from consuming a particular
commodity, which is measured in psychological sense using a unit call Utils.
Marginal Utility is the extra satisfaction derived from consuming n additional
unit of a commodity. It means that when the marginal utility is high, the consumer
will demand more of the commodity, and if the income of the consumer increases
and as a result of this, they can now buy more quantities of the commodity with
their given level of income and the reserve is the case.
(3) The third is the substitution effect occurring,if the price of commodity changes,normally consumers being rational, often tries to compare the prices of goods that
they have been
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(2) PERFECTLY INELASTIC DEMAND
Here the consumer demands the same amount of the commodity irrespective of the
price level. This goes with the demand for very basic essential commodities within a
certain price range as shown on this demand curve. Again habit forming commodities
also show this behavior. Example is alcohol.
(3)PERFECTLY ELASTIC
This is the 'situation where at a fixed price consumers may increase or decrease quantity
demanded of the commodity. Here as soon as there is an increase in price consumers
will entirely refuse to buy the commodity. This is shown on the diagram below.
This situation happens where government fixes prices of goods or under perfect
market situations where price is fixed and there is prefect flow of information.
REASONS FOR OCCURRENCE OF EXCEPTIONAL DEMAND
(1) Where the quality of a good is judged by its price. Here more of the commodity
is
bought at a higher price and less is bought at a lower price. Examples are
ostentatious
goods.
(2) Expectation of future change in price; here consumers ma) expect a fall in the
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buying with the price of others. La a situation where substitutes of the goods exist, when
the price of the commodity fails it may be relatively cheaper than the substitute whose
prices have remained the same. As a result consumers will shift their demand to the
commodity whose price has fallen and the reverse is the case.
ELASTICITY OF DEMAND
When price falls, quantity demanded generally increase. It is useful to know the degree
of increase. Again when price rises, quantity demanded generally decreases. To
measure the extent to which changes in prices affects the quantity demanded of the
commodity we use elasticity of demand.
Elasticity of demand therefore, is defined as the degree of responsiveness of quantity
demanded of a commodity to a change in price of the commodity in question, price of
other commodity and consumers income.
TYPES OF ELASTICITY
(1)Price elasticity of demand (own elasticity of demand)(2)Cross elasticity of demand(3)Income elasticity of demand
PRICE ELASTICITY OF DEMANDThis is the degree of responsiveness of quantity demanded to a change in price of the
commodity itself.
MEASUREMENT OF PRICE ELASTICITY
(1) PED = Proportionate change in quantity demanded
Proportionate change in price of the commodity itself
(2) PED = Relative change in quantity demanded
Relative change in price of the commodity itself
(3) PED = Percentage change in quantity demanded
Percentage change in price of the commodity itself
PED = Q P
Q P
= Q x P
AP Q
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Note: Always deduct the new price and new quantity from original price and original
quantity respectively.
Where:
Q = Change in quantity (Q2Q1)
P = Change in price (P2-P1)
P = Initial price
Q = Initial quantity
NB: For example the table below relates the quantity demanded of a KAAKO at
various prices. Use it to determine the price elasticity of demand.
Price of KAAKO Quantity Demanded of Kaako
Period 1 100 110
Period 2 99 100
Q = 1 0 0 - 100=10
P = 99-100 = -1
P = 100
Q = 100
PED = 10 x 100
-1 100
= -10
= 10
Note: with price elasticity of demand we ignore the negative sign and take the
absolute figure.
The formula we have used above is the point elasticity.
The second formula is Arc, which is given as:
PED = Q x (P1+ P2)
P (Q1+P2)
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Let us consider this example; again to determine the price elasticity of demand by using
the second formulae.
Periods Price Quantity demanded of KAAKO
Period 1 100 100
Period 2 80 150
PED = 50 x (100 + 80)
-20 x (100+150)
= -1.8 = 1.8
From the above example, the negative sign show the demand curve slopes negatively,
which I implies that there is an inverse relationship between price and quantity
demanded. But in elasticity we don't consider the negative signs hence the co - efficient
of elasticity is 10 and 18.
NB The co-efficient (answer) from any of the above examples would give an
indication of the elasticity of demand facing the commodity.
INTERPRETATION OF PRICE ELASTICITY OF DEMAND
(1)Where the co - efficient is less than 1; i.e. ED 1 = price elastic(3)Where ED = I price unitary elastic(4)Where ED = 0 price perfectly inelastic demand(5)Where ED = price perfectly elastic demand
ILLUSTRATIONS
(a) Inelastic demand: This is where a large proportionate change in price of a
commodity leads to a small proportionate change in quantity demanded. This is shown
on the diagram below.
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From the diagram, due to a decrease in price of fee commodity from 20 to 5, quantity
demanded of the commodity increase from 2 to 3. Calculate the price elasticity of
demand.
E = Q x P = Q = 32 = 1
P Q P = 520 = -15
P1 = 20
Q1 = 2
PED = 1 x 20 = -0.6 = 0.6
-15 x 2
(b)Elastic demand: This is where a small proportionate change in price of the commoc
leads to more than a proportionate change in quantity demanded. This can be shown
the diagram below. Price
Q = 2 0 - 5 = 15
P = 2 -3 = 1
P1 = 3
Q1= 5
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(c)Unitary elastic demand;this is where a proportionate change in the price of the
commodity leads to almost the same proportionate change in quantity demanded of
the commodity.
P = 1
Q = -1
P1 = 100
Q1 = 99
PED =
PED = 1.0
PED = 1, meaning that the quantity demanded has Unitary price Elastic.
(d)Perfectly inelastic:This is the situation where a change in price has no effect
on quantity demanded. This can be shown below.
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Q = 0
P = 5
P1 = 10
Q1 = 6
PED =
= 0
(e)Perfectly elastic demand: this is the Situation where consumers are highly sensitive
to a slightest increase in price. A smallest increase in price of the commodity will
cause the consumers to entirely refuse buying the commodity. But at the ruling price
the consumers are willing to buy any quantity of the commodity. This is shown on the
diagram below.
Q = 105 = 5
P = 0
P1 = 8
Q1 = 5
PED =
= 0
DETERMINANTS OF PRICE ELASTICITY OF DEMAND
(1)Availability of substitutes: Where a commodity has a substitute the demand for itwill be elastic. The closer the relationship between the substitute goods, the more
elastic their demand would be. For instance if commodity A and B are closely related
as substitutes , a very small increase in the price of say commodity A will result in
consumers shifting to the other closely related commodity B and vice versa. A
commodity however, may have inelastic demand where it has not close substitute.
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(2) Necessity: This is yet another strong factor and therefore even where a commodityhas no substitute, its demand could be elastic if it is nut a necessity. A commodity
which is very essential may have inelastic demand because even where the price of
the commodity increases consumers would still look for money to buy them, except
may be, where the consumer is very poor, that he will go without such an essential
commodity. In this case the entire demand will fall by a smaller proportion. On die
other hand if the commodity is a luxury the demand for it will be elastic. Any small
increase in the price may cause many consumers to refrain from buying such a
commodity but a small fall in price will induce several consumers to buy such a
commodity.
(3) Habit/taste: If a consumer has developed a very Strong taste or habit for a particularcommodity it makes them to have inelastic demand for such commodity. It simply
means that if a consumer develops a strong habit for a commodity it is difficult to
change his demand irrespective of what happens to price. Example is cigarettes and
necessities. (Unless the consumer is poor and may decide to do without thecommodity.
(4) The time period: It is an accepted fact that, it takes consumers time to adjust theirtaste or spending habits or patterns when price changes. This makes demand to be
inelastic in the short run because the consumer finds it very difficult to adjust their
purchase or taste for any new commodity when price of the commodity changes so in
the short run, consumers do not reduce their purchase by a greater margin since they
are not prepared to take other substitutes when the price changes. On the other hand,
demand is elastic in the long run.
(5) The number of uses of thecommodity:If commodity has so many uses; it tends tohave elastic demand. The reason is that, any increase in the price of the commodity
will lead to a small fall in each of the numerous uses resulting in a greater fall in
quantity demanded of commodity since die change in demand may come from only
source.
(6) Occasion: It is known that certain specific items or commodities are demandedduring certain occasions, demand for such commodities tends to be inelastic. For
instance the demand for Christmas cards, seasons, this is because they are needed
during the reason, so if even the price increases people would still buy them.
(7) The consumer's income: The income of the consumer will determine hisresponsiveness to price changes. The larger the income of a consumer, the more
inelastic his demand for commodities. A consumer with a high income will complain
less about any price increase. A small increase in price of a commodity will mean
little to him. He will still buy the commodity, since he can afford. On the other hand,
the demand for a commodity with low income tends to be elastic. He will react
sharply to price changes. A little increase in price will discourage him from
purchasing it and his
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demand for it will decrease appreciably but if the price falls he is likely to increase the
quantity demanded.
(8) Durability of the commodity: Goods that last for a longer time and such
commodities, for example television sets, video decks, are goods that the consumers
required only one at any given period of time with all things being equal. In this wise if
there happen to be change in price, it is prospective consumers that come and not Old
Ones, so few people would buy such commodities if the price changes, so demand tend
to be inelastic.
THE IMPORTANCE OF PRICE ELASTICITY OF DEMAND
(1)Importance to the businessmanThe concept of price elasticity helps the businessman to price their commodities.
The concept enables the businessman or producers to know how to raise their
revenue, since it is the aim of every producer to increase his total revenue and
hence maximize profit. We know that is given as PROFIT is given as TR
= P X Q T Y
A seller who wants to increase the revenue will have to consider the price elasticity
of demand for his commodity. If the commodity has elastic demand, then a small
reduction in price will induce a greater increase in quantity demanded. That will
bring about an increase in Total revenue. Example if the price of a commodity is
150 and the quantity demanded is 300 units, hence TR - 45,000 i.e. (P x Qty) - 150
x 300 if pace fells to 140 and quantity demanded increased 500. The total revenue
after the fall in price will now be 140x500 = 70,000.
On the other hand, if the commodity has inelastic demand, then an increase in price
will not result in a big change in quantity demanded and the seller will increase histotal revenue by doing so. It therefore means that the seller is likely to loss than
gain when he reduces price, in other words, the seller will gain if he charges higher
prices for his commodity, since increase in price will result in a small change in
quantity demanded. For example if the price of the commodity is 40 and the
quantity demanded is 200 units the TR x 40 x 200 = 8,000. But if price should
increase to 060 and the quantity demand fails to amounts, then the new Total
Revenue = 60 x 160 = 9,600. This has shown on increase in the total for 8000 to
9600.
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(2)DevaluationThis is deliberate reduction of the value of a country's currency in terms of other
currencies. The main aim of such a policy is to solve balance of payments
problem and increase production. Devaluation in most cases lead to a reduction in
imports and increase in export s but the effectiveness of this policy depends on
the price elasticity of demand for imports and exports because for devaluation to
be effective demand for exports must be elastic and demand for imports must be
inelastic.
(3)It determines incidence of taxationPrice elasticity of demand also helps to determine how the burden of an indirect
tax is shared between the consumer and producer. If demand is fairly elastic, the
producer bears the greater part of the tax but if demand is fairly inelastic, the
consumer will bear a greater part of the indirect tax.
But in case, where demand is unitary elastic both
the producer and consumer bear the tax, on one hand if demand is perfectly
inelastic consumers would bear the whole tax burden.
(4)It Determines the terms of TradeThe terms of trade are the rate at which a country exchanges her goods and
services for other goods from other countries. This is mostly determined by the
magnitude of elasticity of demand for export and imports.
In most case, if demand for imports is inelastic and
that of export is elastic there will be unfavorable terms of trade. But where
demand exports is inelastic and that of imports is elastic there will be favourable
terms of trade.
(5)Indirect Taxation Policy of the Government
Price elasticity of demand also helps to ensure effective implementation of the
government tax policy means to raise revenue or control consumption. To obtain
or raise revenue the government must impose tax on commodities with inelastic
demand. This is because if tax rate is raised and as a result price increases
quantity demanded will fall by less than proportionate increase in price of the
quantity. On the other hand, if indirect tax is meant to control consumption there
is the need to impose tax on goods having elastic demand. This is because with
the imposition of the indirect tax, price increases and as a result quantity
demanded will fall by more than proportionate increase in price.
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INCOME ELASTICITY OF DEMAND
It is the degree of responsiveness of quantity demanded to change in die consumer's
income.
MEASUREMENT OF INCOME ELASTICITY
It is measured by the following: -
YED =Proportionate change in quantity demanded
Proportionate change in income
YED =Percentage change in Quantity Demanded
Percentage change in income
Where; Q = change in quantity demanded
Y = change in income of the consumer
Y = is the initial income Q = is the initial quantity
Q = is the initial quantity
YED =
X
ILLUSTRATION
When a consumer income was GHl00 quantity demanded was 20 units. As his
income increase to 150, quantity demanded also increased to 25 umts. Calculate the
income elasticity of demand.
Quantity Y (income GH)
20 100
25 150
Q = 25-20 = 5
Y = 150- 100 = 50
Given the formula;
YED =
X
=
X
ARC = YED
X
=
X
INTERPRETATION OF CO-EFFICIENT OF INCOME ELASTICITY OF
DEMAND
A good is said to be inferior, superior or necessity depending upon its numericalvalue in income elasticity of demand.
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If the income elasticity is positive, then the commodity is a normal or superior
commodity. If the elasticity is negative then it means the good is inferior, also if the
elasticity is less than one or equal to zero, the commodity is a necessity oh the other
hand if income elasticity is greater than one or elastic the commodity is considered
luxurious.IMPORTANCE OF INCOME ELASTICITY
1. BusinessmanIf income elasticity is positive and large in the case of normal goods, in that case
the trader will offer more goods for sale when income rises.
2. Income elasticity may be negative as in the case of inferior goods.In that case it is advisable for the traders to reduce the quantity of inferior goods
they offer for sales when income rises.
3. GovernmentThe knowledge of income elasticity of demand helps the government to
determine which item/ products need to be emphasized during a development
process.
4. If the government effort results in the increase in income levels then thegovernment must encourage the production of goods with higher income
elasticity.
5. A guide to the government with respect to which commodity to tax more.
CROSS ELASTICITY OF DEMAND
It is the degree of responsiveness of quantity demanded of a commodity (X) to a
change in price of another commodity (Y) this is measured by: -
CED = Proportionate change in quantity demand o f commodity (X)
Proportionate change in priceo f commodity (Y)
CED=
X
Where; = change in quantity demanded commodity (X)
= change in price of commodity (Y)
ILLUSTRATION (1)
A decrease in price of Milo from 01500 to 01200 a tin cause quantity demanded of
Bourvita to decrease from 50to 40 tin a day. Find the cross price elasticity of demandbetween the two commodities.
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CPED=
X
= 1
Midpoint or ARC = CPED=
X
From the above it means that the two commodities are unitary, cross price elastic.
The co -efficient (answer) obtained from any of the above mathematical methods
would give an indication of the type of relationship existing between the two
commodities (X) and (Y). It would at the same time indicate the degree of
relationship existing between the two commodities.
ILLUSTRATION
The price of a commodity Y increase from GH30 to GH341 per unit and all the
quantity of another commodity X bought increased from 120 to 150 units.
a. What type of demand relationship does commodity X and Y have?
b. Is demand for commodity x elastic or inelastic?
INTERPRETATION OF CROSS PRICE ELASTICITY OF DEMAND
i. Where the co - efficient is positive, k indicates that the commodities underconsideration are related as substitutes.
ii. Where the co - efficient is negative it indicates that the goods existcomplements.
iii.The co - efficient is equal to zero it means that there exists no relationship atall, between the goods under consideration.
iv.Where the co- efficient is a small figure, it is an indication that very littlerelationship exist between the good under consideration.
v. Where the co -efficient is a large it is an indication that there exists a closerelationship between the goods.
vi.Again where the co - efficient is unitary, it means that the goods are perfectsubstitutes, they are perfectly the same and very substitutable.
In the same vein, we can classify cross elasticity into
a. Cross elastic
b. Cross inelastic
c. Cross unitary elastic
d. Cross perfectly elastice. Cross perfectly inelastic
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SUPPLY ANALYSIS
Supply is the quantities of goods and services that sellers are willing and able to offer
for sales at various prices over a given period of time in a given market.
DIFFERENCE BETWEEN SUPPLY AND TOTAL OUTPUT
Total output is the total amount of goods which producers are able to bring out as
output after successfully combining factors of production in an economic activity
while supply is that part of total output that producers are willing to offer for sale
whether there is market forthe goods or not.
RELATIONSHIP BETWEEN PRICE AND QUANTITY SUPPLIED OF A COMMODITY
There is an appositive relationship between price and quantity supplied. This implies
that all other things being equal, the higher the price of the commodity, the higher the
quantity supplied. There are three different ways through which this relationship can
be presented. A tabular form which is called the supply schedule; a graphical form
that is also called the supply curve; a mathematical form and this is also known, as the
supply equation.
SUPPLY SCHEDULE
This is a tabular presentation which shows the relationship between quantities
supplied of a commodity at various prices over a given period of time.
Price of yam GH GH 10 GH 20
Quantity supplied 10 tubes 15 tubes 46 rubes
SUPPLY CURVE
This s a graphical presentation which shows the relationship between quantities
supplied of a commodity at various prices over a given a period of time. The supply
curve has a positive slope, indicating that more of a commodity is supplied at higher
prices, while less is supplied at lower prices. This can be illustrated blow on thediagram.
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From the diagram it can be clearly seen that when price was 10, quantity supplied
was 25 units. As price falls to 5, quantity supplied falls to 10 units. However, when
price increased to 20 quantity supplied increase to 46 units. This shows that, there is
a positive relationship between price and quantity supplied of a commodity.
SUPPLY EQUATION
This also a mathematical presentation of the relationship between price and quantity
supplied of a commodity. This is normally put in an equation form, where quantity
supplied is the dependant variable and the various prices of the commodity is the
independent variable. E g
Qs = 40 + 4 Px
Where Qs = quantity supplied of the commodity
Px = is the price of the commodity
ILLUSTRATION
Given supply function as Qs = 40 + 4Px, find the quantity supplied of the commodity.When price is:
i. Px = 04ii. Px = 08
iii.Px-020SOLUTION
GIVEN Qx = 40 + 4Px
ii) If price = 4
Qx = 40 + 4(4)
40 + 16
Qx = 56 units
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