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- 2. 1.1 Meaning ofEconomics Definition of Economics •Economics is the study of how the society choose to use scarce economic resources, to produce goods and services, and to distribute them for consumption among the members of the society •Economics is preoccupied by the following basic problems: What to produce, how to produce and for whom to produce
- 3. 1.1 Meaning ofEconomics What to produce? •This question refers to what types of goods and services and the quantity of each that the economy should produces. •The problem arise because resources are scarce •No economy can produce as much of every good or service as desired by all members of society •So every society must choose which goods and service to produce and how much
- 4. 1.1 Meaning ofEconomics How to reach the solution to what to produce • In a free enterprise economy, the problem is solved by the price mechanism • Producers will choose to produce those goods and services for which consumers are willing to pay a price sufficient to cover the full cost of producing them • In a mixed enterprise economy, the government influence the decision of what to produce through taxes, subsidies and direct control
- 5. 1.1 Meaning ofEconomics How to produce? • This is the decision that refers to the choice of combination of factors of production • Normally a combination is chosen that uses the least resource to produce a particular good/service • Least cost • In a free enterprise economy “how to produce” is solved by price mechanism, a method that involves the least cost of production is chosen • In a mixed enterprise economy government modifies this decision
- 6. 1.1 Meaning ofEconomics For Whom to produce? • This is the decision as to how the total output is to be divided among different consumers • Again we are faced with this problem because of scarcity • No society can satisfy all the wants of all its people • In a free enterprise economy, the economy will produce the commodities that satisfies the wants of those with money to pay for them • Usually governments modify the working of the price mechanism in the name of equity and fairness
- 7. 1.2 Microeconomics • Microeconomicsis the branch of economics which studies the economic behaviour of individual decision making units such as consumers, resource owners and business firms • The flow of goods and services from business firms to households and the composition of such a flow • How prices of goods and services are determined • The flow of economic resources from resource owners to business firms and the use of the resources • How the prices of the resources are determined
- 8. 1.2 Microeconomics The flowof goods and services
- 9. 1.2 Macroeconomics •Macroeconomics isthe branch of economics which studies the aggregate levels of output, national income, employment and prices for the economy viewed as a whole •It is preoccupied with the problems of how to ration the commodity over time, and how to provide for the maintenance and growth of the system
- 10. 1.3 Positive Economicsand Normative Economics •A distinction is made between positive and normative economics •Positive Economics deals with what is. • Positive economics is objective and fact based •Positive economic statements can be proved •e.g. Raising the rate of taxation shrinks economic activities •Government financed education increases public expenditure
- 11. 1.3 Normative Economics •Normative Economics, on the other hand deals with or studies what ought to be • Normative economics is subjective and value – based • Normative economics is opinion based: normally with such statement as should, ought to be, etc. • Economists need not agree on normative statement because they are opinion based • e.g. “government should provide healthcare for all the people” is a normative economic statement
- 12. 1.3 Positive andNormative Economics • All of what we learn in the class, all that you will read in books of economics constitute positive economics, defining and explaining the subject matter, they are empirical in nature • All what the minister of finance, minister of planning, minister of agriculture, minister of industry and trade are doing, to address specific problems constitute normative economics • They deal with how to solve economic problems facing the society • They involve ethical position or value judgement
- 13. 1.4 Scarcity •Economics isthe study of scarcity •People’s material wants are unlimited •Output to satisfy those wants is limited • Quantity and quality of available resources • The available technology to produce the output at least cost •The productive resources that are scarce are known as economic goods, or factors of production
- 14. 1.4 Scarcity Economic resources •Limited in supply (scarce) • Command a price • At price zero demand is greater than supply • Examples: Land, Labour, capital Non Economic resources • Unlimited in supply (non scarce) • Available for free • At price zero supply is greater than demand • Examples: air, lake water for people of locality 14
- 15. 1.4 Scarcity • Economicresources are the services of the various types of labour, capital, equipment, land (natural resources) and entrepreneurship • Land means the economy’s natural resources such as land, forests, mineral, even water bodies • Labour means the mental and physical skills of individuals in a society • Capital means goods – such as tools machines and factories used in production • All these resources are scarce
- 16. 1.4 Choice andOpportunity Cost • Due to scarcity of such resources choices have to be made • What to produce • How to produce and • For whom to produce • When we choose to produce something we also choose to forego to produce something else • This is known as opportunity cost • Opportunity cost is what is given up to produce or obtain a particular good or service • It is the value of the next best alternative
- 17. 1.4 Choice andOpportunity Cost Production Possibility frontier Is a curve that shows different combinations of goods/services that a society can produce when resources are used to the maximum and the best technology is employed • Assumptions 1. Society uses all resources to produce two goods 2. All the available resources and best available technology are used 3. Society must choose the combination of the number of the goods and services to be produced 4. Whenever the production of one good is increased, there must be a reduction of another good
- 18. • The tablerepresents alternative combinations of guns and butter output for an economy • In the decision of what to produce we can choose any bundle A, B,.. or E • In bundle C choice is made to produce 5000 guns and 14 mill butter units Table 1. Production Possibility Schedule 1.5 PPF 18
- 19. 1.5 PPF • Table1 is plotted in figure 1 • The figure is the production possibility frontier PP • Point C in the PPF plots the combination of 5000 guns and 14 million units of butter • To move from C to D increase 4000 guns and decrease 8 million units of butter Fig. 1. Production Possibility frontier 19
- 20. 1.5 PPF • ThePPF can shift outward over time • When more resources are available • Or when technology improves • In this PPF it is a shift from PP to P’P’ • If the society chose C, with the shift of PPF 4000 additional guns can be produced with the same butter production 20
- 21. 1.5 PPF • Pointson the PPF are considered to be efficient because all available resources are used • Points within the frontier are inefficient because some resources are unemployed • Points outside the frontier are unattainable as the frontier defines the maximum amount that can be produced at given time 21
- 22. 1.6 Methodology ofEconomics • Economics is a social science that studies individuals and organisations engaged in the production, distribution and consumption of goods and services • The aim is to predict economic occurrences and to develop policies to correct such problems as inflation, unemployment, or lack of growth • Economics has developed principles, theories and models to isolate the most important determinants of economic events
- 23. 1.6.1 Model Building Inconstruction of a model •Assumptions are made • To eliminate unnecessary detail • To reduce the complexity of economic behaviour •Economic behaviour in a model is presented as a relationship between dependent and independent variables •DV – behaviour being explained
- 24. 1.6.1 Model Building •TheDV is presented as being influenced by one independent variable • The influence of other independent variables is held constant (ceteris paribus) •An economic model will specify whether the dependent and independent variables are positively or negatively related •e.g. We assume that the amount a consumer spends (C) is positively dependent on her disposable income (Yd)
- 25. 1.6.1 Model Building IndividualDisposable income Y Consumption A 20,000 20,000 B 21,000 20,750 C 22,000 21,500 D 24,000 23,000 E 27,000 25,200 0 5000 10000 15000 20000 25000 30000 0 5000 10000 15000 20000 25000 30000 CONSUMPTION DISPOSABLE INCOME C=f(Y) Table 2 presents data on consumer spending for five individuals with different levels of income. It is plotted in the adjacent graph 25
- 26. 1.6.1 Model Building 0 5000 10000 15000 20000 25000 30000 05000 10000 15000 20000 25000 30000 CONSUMPTION DISPOSABLE INCOME C=f(Y) • The dependent variable (consumption) is plotted in the vertical axis • The independent variable (disposable income is plotted on the horizontal axis • This graphical representation of data makes the positive relationship visual 26
- 27. 2 Consumer Behaviour 2.1Introduction to Consumer Behaviour •Consumer behavior studies how the consumer reaches important decisions regarding his consumption and hence demand for goods and services •The basic issue is what drives the consumer to want to consume a particular good or service •It has to do with utility, and how with the limited funds the consumer has, utility is maximized
- 28. 2.2 Utility •An individualdemands a particular commodity because of the satisfaction or UTILITY received from consuming it •UTILITY is the property of commodity that satisfies a want or a need of a consumer •Utility can be approached by a cardinal or ordinal utility •We will distinguish between the two approaches and study each approach separately
- 29. 2.3 Cardinal vsOrdinal Utility Cardinal Utility Meaning • Is the utility wherein the satisfaction derived by the consumers from the consumption of good or service can be measured quantitatively. • It is assumed that utility can be measured just as we measure length, height, weight etc. Ordinal Utility Meaning • Is the utility wherein the satisfaction derived from the consumption of a good or service cannot be expressed numerically. • Since they cannot be measured numerically they can be ranked in terms of more than or less than 29
- 30. 2.3 Cardinal vsOrdinal Utility Cardinal Utility Approach • Quantitative Measurement • Utils Analysis • Marginal utility analysis Ordinal Utility Approach • Qualitative Measurement • Ranking Analysis • Indifference curve analysis 30
- 31. 2.3 Cardinal Utility •Total Utility is the overall satisfaction that an individual receives from consuming a specified quantity of a commodity per unit time • Marginal utility is the change in the total utility per unit change in the quantity of a commodity consumed per unit of time • It is the extra satisfaction a consumer gets from consuming an additional unit of the product • When you are very thirsty, the first glass of water provides a lot of satisfaction to you, the second increases the total satisfaction • Additional glasses add total satisfaction but up to a point
- 32. 2.3 Cardinal Utility •Although total utility increases, the extra utility (marginal utility) received from consuming each additional unit of the commodity usually decreases • At some level of consumption total utility received by the individual from consuming the commodity will reach a maximum and marginal utility will be zero • This is the saturation point • Additional units of the commodity cause total utility to fall and marginal utility to be negative
- 33. 1 2 3 QxTUx MUx 0 0 .. 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2 2.3 Cardinal Utility • In the table, a hypothetical total utility (TU) schedule for consuming alternative quantities of commodity X per unit time is given • Utility here is measured by utils (a fictitious unit) • Column 1 shows quantity, column 2 total utility and column 3 marginal utility • Note that up to the consumption of the 5th unit total utility increases 33
- 34. 1 2 3 QxTUx MUx 0 0 .. 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2 2.3 Cardinal Utility • Upon the consumption of the 6th unit, the marginal utility is 0. • This is the saturation point • On the consumption of the 7th unit of the product the total utility decreases and the marginal utility is negative • Note that the Marginal utility constantly decreases, and at on the 6th unit ceases to increase, and on the 7th unit becomes negative • This is what is known as the principle of diminishing marginal utility 34
- 35. 2.4 Diminishing MarginalUtility • Plotting the total and marginal utility curves we get the TU and MU curve • Note that each value of MU are recorded midway between the two levels of consumption • Saturation point is reached when consumption is increased from 5 to 6 units • Falling MU curve illustrates the principle of diminishing marginal utility 35
- 36. 2.4 Consumer Equilibrium •The objective of a rational consumer is to maximize the TU derived from spending personal income • The objective is reached and the consumer is said to be in equilibrium when • The consumer is able to spend personal income in such a way that the utility of the last shilling spent on various commodities is the same. This can be expressed • 𝑀𝑈𝑥 𝑃𝑥 = 𝑀𝑈𝑦 𝑃𝑦 = … Subject to a constraint that • 𝑃𝑥𝑄𝑥 + 𝑃𝑦𝑄𝑦 + … = 𝑀 (The individual’s income
- 37. 2.4 Indifference Curves •An ordinal approach to consumer behavior uses the concept of indifference curve, which shows consumer’s tastes and equilibrium • An indifference curve is a curve which shows the various combinations of commodity X and Y which yield equal utility or satisfaction to the consumer • A higher indifference curve shows a greater amount of satisfaction and lower one less satisfaction • It is an ordinal rather than cardinal approach to utility
- 38. 2.4 Indifference Curves Indifference curveI Indifference Curve II Indifference Curve III 𝑄𝑥 𝑄𝑦 𝑄𝑥 𝑄𝑦 𝑄𝑥 𝑄𝑦 1 10 3 10 5 12 2 5 4 7 6 9 3 3 5 5 7 7 4 2.3 6 4.2 8 6.2 5 1.7 7 3.5 9 5.5 6 1.2 8 3.2 10 5.2 7 0.8 9 3 11 5 8 0.5 10 2.9 12 4.0 9 0.3 10 0.2 This table gives points on three different indifference curves for a consumer When we plot the points on the same set of axes and join them by smooth curve we get 3 indifference curves 38
- 39. 2.4 Indifference Curves •When the points are plotted and joined by smooth curves we have the three indifference curves 39
- 40. 2.4 Indifference Curves •All points in the same indifference curve yield the same satisfaction to the consumer • Point C (10Y and 1X) and point D (5Y and 2X) are of the same utility to the consumer • Points on indifference curve II give greater satisfaction than points on IC I, and less satisfaction than points on indifference curve III • Absolute amount of satisfaction is not indicated • What is done is ordering consumer preference 40
- 41. 2.4 Indifference Curve •Indifferencecurves are a graphic picture of a consumer tastes and preferences •The consumer is indifferent among all the different combinations of X and Y on the same indifference curve •But the consumer prefers points on a higher indifference curve to points on a lower one •In our example we chose to present 3 indifference curves, but the field of indifference curves is dense
- 42. 2.4 Indifference Curves Characteristicsof Indifference Curves 1. Indifference curves are negatively sloped 2. Indifference curves are convex to the origin 3. Indifference curves do not cross 4. Indifference curves need not be and are usually not parallel to one another
- 43. 2.4 Indifference Curves Indifferencecurves are negatively sloped •We are dealing with economic (scarce) goods •If consuming more of X the individual must consume less of Y to remain on the same level of satisfaction •Therefore an indifference curve must be negatively sloped
- 44. 2.4 Indifference curves IndifferenceCurves are convex to the origin •This is because they exhibit diminishing marginal rate of substitution •We will see the concept of marginal rate of substitution later
- 45. • 2.4 Indifferencecurves • IC do not intersect • Suppose we assume the contrary as shown in the figure • G and H are points on IC I, they yield equal satisfaction • G and J are on IC II, yield equal satisfaction • It follows that H and J are points of equal satisfaction, and by definition lie in the same IC • Thus it is impossible for ICs to intersect 45
- 46. 2.4 Marginal Rateof Substitution •Marginal rate of substitution of X for Y (MRSxy) refers to the amount of Y that a consumer is willing to give up in order to gain one additional unit of X (and still remain on the same indifference curve) •𝑀𝑅𝑆𝑥𝑦 = − ∆𝑄𝑦 ∆𝑄𝑥 •As the individual moves down an indifference curve, the MRSxy diminishes
- 47. 2.4 Marginal Rateof Substitution MRSxy •In the figure, on IC I, moving from point C to D the individual gives up 5 units of Y in exchange for one additional unit of X. •Thus MRSxy= 5. •Similarly from D to F the MRSxy= 2 47
- 48. 2.4 Marginal Rateof Substitution • On moving down the indifference curve, the individual is willing to give up less and less of Y in order to gain each additional unit of X • The MRSxy diminishes • This is so because now the individual has less and less of Y, and Y becomes more valuable to him/her • So the individual is willing to give up less and less of Y to get each additional unit of X 48
- 49. 2.4 Marginal Rateof Substitution
- 50. 2.4 Marginal Rateof Substitution •The MRSxy between two points on the same indifferent curve is the absolute (positive value) of the slope of the chord between the two points •The distance between two points on an indifference curve decreases as we move to the right and approaches zero in the limit •This is known as the Marginal Rate of Substitution
- 51. 2.5 Budget ConstraintLine •The budget constraint line shows all the different combinations of the two commodities that the consumer can purchase given his or her money income and the price of the two commodities •Suppose 𝑃𝑥 = 𝑃𝑦 = $ 1 •Suppose the consumer’s money income is $10 per time period •Suppose all income of the person is spent on two products X and Y
- 52. 2.5 Budget ConstraintLine • The budget line of the consumer is given by the line KL • If the consumer spends all of her income on commodity Y, she could purchase 10 units of Y • This defines point K • If she spent all her income on commodity X she could purchase 10 units of X • This defines point L • By joining point K to point L by a straight line we get the budget line 52
- 53. 2.5 Budget ConstraintLine • The Budget line KL shows all the different combinations of X and Y that this individual can purchase given her money income and prices of X and Y 53
- 54. 2.5 Consumer Equilibrium •Aconsumer is in equilibrium when, given personal income and price constraints, the consumer maximizes the total utility or satisfaction from his or her expenditure •In other words, a consumer is in equilibrium when, given his or her budget line, the person reaches the highest possible indifference curve
- 55. 2.5 Consumer Equilibrium •By bringing together on the same set of axes the consumer’s indifference curves and the budget constraint line, we can determine consumer equilibrium • It is given by point E in this figure 55
- 56. 2.5 Consumer Equilibrium •The consumer would like to reach indifference curve III (the highest) • But he or she cannot because of the limited income and price constraints • The individual could consume at point N or R on indifference curve I • But he/she would not maximize total satisfaction from expenditure 56
- 57. 2.5 Consumer Equilibrium •Indifference curve II is the highest indifference curve this individual can reach with this budget constraint line • To reach equilibrium the consumer should spent $5 to purchase 5 unis of Y and the remaining to purchase 5 units of X • Note that equilibrium occurs when the budget line is tangent to an indifferent curve • At point E the slope of the budget line is equal to the slope of the indifference curve II 57
- 58. 2.5 Consumer Equilibrium 𝑄𝑦0= 𝑀 𝑃𝑦 when 𝑄𝑥 = 0 𝑄𝑥0 = 𝑀 𝑃𝑥 when 𝑄𝑦 = 0 The slope is MRS ∆𝑌 ∆𝑋 = − 𝑄𝑦0 𝑄𝑥0 = − 𝑀 𝑃𝑦 𝑀 𝑃𝑥 = − 𝑀 𝑃𝑦 . 𝑃𝑥 𝑀 = − 𝑃𝑥 𝑃𝑦 58
- 59. 3. Foundation ofMicroeconomics 3.1 Demand 3.1.1 Demand vs Effective Demand •Demand is the quantity of goods/services the consumers are willing and able to purchase at given price in a given period of time ceteris paribus •Effective demand refers to the amount of goods or services that consumers are actually buying
- 60. 3.1.1 Effective Demand Need,Want and Demand •Demand for a particular commodity arises because of its ability to satisfy a need or a want •Demand, in economic sense, arise when there is • A need for the commodity and, • The consumers have the money to pay for it • So demand refers to effective demand rather than a simple need
- 61. 3.1.2 Law ofDemand • In the graph we see that the lower the price of X, the greater the quantity of X demanded by the individual • With some exceptions, demand curve always slopes downwards • This is known as the law of demand 61
- 62. 3.1.2 Explanation ofthe Law Income Effect: • Is the increase in the quantity purchased of a commodity with a given money income when the price falls Substitution Effect • Is the increase in the quantity purchased of a commodity when its price falls as a result of switching from another similar product 62
- 63. 3.1.2 Explanation ofthe Law Income effect • When price of a commodity falls, the real income of the consumer increases • Therefore, his purchasing power increases: he is required to pay less for the same quantity • The increase in real income encourages the consumer to demand more of goods and services • The increase in demand on account of increase in real income is known as the income effect • For the case of inferior goods the income effect is negative
- 64. 3.1.2 Explanation ofthe Law Substitution effect • When price of a commodity falls, price of all other related goods remaining constant (particularly substitutes), the substitute goods become more expensive • In other words, the commodity whose price has fallen becomes relatively cheaper • The rational consumers, wanting to maximize their utility will substitute cheaper goods for expensive ones • The increase in demand on account of this factor is known as substitution effect
- 65. 3.1.3 Determinants ofDemand •When we were defining demand we used the term ceteris paribus •What are these other things that remain constant, and what happens if they do not. •These other things are known as Determinants of demand •They include, money income, price of other goods, changes in tastes and preferences and changes in consumer expectations
- 66. 3.1.3 Determinants ofDemand 1. Price of related goods • The demand for a commodity is affected by the changes in the price of its related goods. • Related goods may be substitutes or complements Substitutes • Two commodities are deemed to be substitutes for each other if change in the price of one affects the demand for another in the same direction • If the price of x increases, the demand for y increases
- 67. 3.1.3 Determinants ofDemand Complements: •A commodity is deemed to be a complement for another when the two products go together so that their demand changes together simultaneously •e.g. Petrol is a complement to a car, butter is a complement to bread, sugar is a complement to tea or coffer, cartridge is a complement to a printer etc. •The increase in price of one causes a decrease in the demand for the other
- 68. 3.1.3 Determinants ofDemand 2. Consumer’s Income • Income determines the purchasing power of the consumer. So it is a basic determinant of demand • People with higher disposable income spend larger amount on goods and services than those with lower income • The effect of income on the quantity of goods demanded depends on whether the goods are essentials, inferior goods, normal goods or luxury goods
- 69. 3.1.3 Determinants ofDemand a. Essential Consumer Goods • These are goods and services that are consumed by all persons of a society • They are called basic needs • Examples: food grains, water, electricity, fuel for cooking, salt, clothing, housing etc. • Quantity demanded of this category of goods increases with an increase in consumer’s income, but up to a certain limit • After that it tends to stabilize
- 70. 3.1.3 Determinants ofDemand b. Inferior Goods • These are goods and services that are only used when substitutes of better quality cannot be afforded • Examples: kerosene lamp is inferior to electric light, kaniki is inferior to kitenge, travelling by town bus is inferior to travelling by taxi or own car etc. • Quantity demanded of this category of goods increases with an increase in consumer’s income up to a certain point beyond which it decreases
- 71. 3.1.3 Determinants ofDemand c. Normal Goods •These are goods and services whose demand increase as the consumer’s income rises •Examples: clothing, furniture, cars •Quantity demanded of this category of goods increases with an increase in consumer’s income
- 72. 3.1.3 Determinants ofDemand d. Prestige or luxury goods •These are goods which are consumed by the rich section of the society e.g. gold and diamond jewelry, luxury cars, expensive cosmetics, expensive clothing, etc. •Demand for these goods manifests itself when the income rises beyond a certain level •For the rich people, the higher the income the higher the demand for such products •Also the higher the price the higher the demand for the products
- 73. 3.1.3 Determinants ofDemand 3. Consumer’s Tastes and Preferences • Taste and preference depend on changing of lifestyle, social customs, religious values attached to a commodity, fashion, age and sex of the consumer • Change in any of these factors changes consumers’ tastes and preferences • Consumers may reduce or give up the consumption of some goods and add new ones to their consumption pattern • Advertisement normally influence the change in tastes
- 74. 3.1.3 Determinants ofDemand 4. Consumers’ Expectations • This is a factor that affects short run demand • If consumers expect a rise in the price of a storable commodity, they would buy more of it at its current price to prepare for the price rise • On the contrary, if consumers expect a fall in the price of a certain good, they postpone their purchase of such goods to take advantage of future lower prices • This factor applies mainly to non-essential goods
- 75. 3.1.3 Determinants ofDemand 5. Population of the Country •The total domestic demand for a product of mass consumption depends on the size of the population •Given the price, per capita income, tastes and preferences etc. the larger the population the larger the demand for a product •With an increase in size of population, demand for a product increases ceteris paribus
- 76. 3.1.3 Demand Schedule •DemandSchedule is a chart that shows the quantity demanded of a commodity at different prices: An example is given below
- 77. 3.1.3 Demand Curve Thegraphic representation of the demand function is known as the demand curve
- 78. 3.1.3 Exception toLaw of Demand The law of demand does not apply to the following cases 1. Expectation regarding future prices: When consumers expect a continuous increase in the price of a durable commodity, they buy more of it despite increase in its price to avoid the pain of much higher price in the future 2. Luxury goods The law does not apply to commodities that are used as status symbol of enhancing social prestige or to display wealth and riches, e.g. expensive suits for MPs, gold and diamond jewelry etc • The rich buy these because the prices are high
- 79. 3.1.3 Exception toLaw of Demand 3. Inferior goods (Giffen goods) A giffen good may be any inferior good much cheaper than its superior substitutes, consumed by the poor households as an essential commodity • If price of such goods increases (price of its substitute remaining constant), its demand increases instead of decreasing because of income effect • When the price of an inferior good rises, poor people cut the consumption of superior substitutes to buy more of the inferior good to meet basic needs
- 80. 3.1.4 Change inDemand •When any of the ceteris paribus condition changes, the entire demand curve shifts. •This is referred to as change in demand •Note that this is different from change in quantity demanded, which is the movement along the same demand curve
- 81. 3.1.4 Change inDemand
- 82. 3.1.4 Change inDemand Change in Quantity Demanded • Movement along the same demand curve • Caused by change in price Change in Demand • Shift in demand curve • Caused by change in factors other than price 82
- 83. 3.1.4 Change vsshift in Demand
- 84. 3.1.5 Demand Function •The quantity of a commodity that an individual is willing and able to purchase over a specific period of time is a function of the price of the commodity, the person’s money income, the prices of other commodities and individual tastes • By varying the price of the commodity under consideration while keeping constant the individual’s money income and tastes and the price of other commodities (ceteris paribus) we get the demand function
- 85. 3.1.5 Demand Function •Wecan present the demand function as 𝑄𝑑𝑥 = 𝑓 𝑃𝑥 𝑐𝑒𝑡. 𝑝𝑎𝑟. •Remember we said 𝑄𝑑𝑥 = 𝑓 𝑃𝑥, 𝑀, 𝑃𝑜, 𝑇 By keeping constant the individual’s money income, the prices of other commodities and the individual tastes we can write: 𝑄𝑑𝑥 = 𝑓 𝑃𝑥, 𝑀, 𝑃𝑜, 𝑇 The bar on top of M Po, and T means they are kept constant
- 86. 3.1.2 Market Demand Market(Aggregate Demand) • The market or aggregate demand for a commodity gives the alternative amounts of the commodity demanded per time period, at various alternative prices, by all the individuals in the market • The market demand depends on all the factors that determine the individual’s demand and the number of buyers in the market • It is obtained by the horizontal summation of all the individual demand curves for the commodity
- 87. 3.1.2 Market DemandCurve
- 88. 3.1.2 Market DemandCurve • In this case the individual demand functions were identical represented by this demand function 𝑑1 = 𝑑2 = 8 − 𝑃𝑥 • The market demand is given by 𝐷𝑥 = 𝑑1 + 𝑑2 = 16 − 2𝑃𝑥 • The market demand for a good is influenced by the way income is shared among household • The economy with many rich people, will have high market demand for luxury goods • The economy with many poor people will have high market demand for inferior goods