Ministry of Science and

Higher Education,
ETHIOPIA

HARMONIZED FRESH-MAN MODULE FOR UNDERGRADUATE STUDENTS

INTRODUCTION TO ECONOMICS
UNIT Two-PART One
Tutorial content

Chapter Two
Theories of Demand and Supply
 2.1. Theory of Demand
 2.1.1. Demand schedule, curve, and equation
 2.1.2. Determinants of demand
2.1 Theory of demand

 Demand is one of the forces determining prices.

 Here, the meaning 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.

Demand → Desire + Purchasing power

 demand refers 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).
 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.
2.1.1 Demand schedule (table), demand curve and
demand function
Combinations A B C D E
Demand
Schedule Price per KG 5 4 3 2 1

Qd/week 5 7 9 11 13
 Q=a+bP
 Q=a+bP
Price

6 DEMAND CURVE  A to B
(5,5) b=Y2 –Y1 / x2 –X1 b=-2 and a=15
5
(7,4) b=Q2 –Q1 / P2 –P1 Q=15-2P
4
= 7-5 / 4-5 Demand
(9,3)
= -2
3
Demand Function
(11,2) At point A (Q=5 and P= 5)
2
Curve Q=a+bP
1 (13,1) 5= a+ (-2 x 5)
0 5= a-10
0 2 4 6 8 10 12 Qd 14 a= 5+10= 15
Individual and Market Demand
Price Individual Demand Market
Consumer 1 Consumer 2 Consumer 3 Demand

8 0 0 0 0
5 3 5 1 9
3 5 7 2 14
0 7 9 4 20

CONSUMER-1 CONSUMER-2 CONSUMER-3 Market Demand

90, 8 9 9 9
8 8 0, 8 8 0, 8 8 0, 8
7 7 7 7
6 3, 5 6 6 6
5 5 5, 5 5 1, 5 5 9, 5
4 4
4 5, 3 4
3 2, 3
3 3 7, 3 2
3 14, 3
2 2 2
1
1 7, 0 1 0 4, 0 1
0 Qd 0 9, 0
Qd 10
-1 0 2 4 6 0 20, 0
0 5 10 0 5 0 5 10 15 20 Qd25
Are the following statements ‘True’
or ‘False’?
Ifprice of Banana increases, then the demand for banana
will decrease.
False
Ifprice of Banana increases, then the quantity demanded
for banana will decrease.

True
• Change in quantity
P demanded
A→B and A→C
6 C (4,6) • Movements along the curve
• Caused by only price change
of the given good
4 A (4,4)

2 B (6,2)

dd1

2 4 6 Qd
Change in demand (SHIFT of DEMAND
CURVE): because of changes in other factors
P of demand other than price
Decrease in
6 demand: A→ E
(Inward Shift)
4 Increase in demand:
A→ D (Outward Shift)
2
dd2

dd3 dd1

2 4 6 Qd
Can price affect Demand?
Other Determinants of demand
 The demand for a product is influenced by
many factors.
1. Taste or preference of consumers
2. Income of the consumers
3. Consumers expectation of future price
4. Price of related goods
5. Number of buyers in the market
1. 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.
2. Income of the consumer
 Normal Goods are goods whose demand increases as income
increase,
 Inferior goods are those whose demand is inversely related with
income.
3. Consumer expectation of price
 Higher price expectation will increase demand while a lower
future price expectation will decrease the demand for the
good.
4. 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.
Substitute goods are goods which satisfy the same desire of the consumer.
 If two goods are substitute, then price of one and the demand for the other are
directly related.
Complimentary goods: are those goods which are jointly consumed.
 If two goods are complements, then price of one and the demand for the other
are inversely related.
5. 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.
Ministry of Science and
Higher Education,
ETHIOPIA

HARMONIZED FRESH-MAN MODULE FOR UNDERGRADUATE STUDENTS

INTRODUCTION TO ECONOMICS
UNIT Two-PART Two
Tutorial content

Chapter Two-Part Two

Theories of Demand and Supply
2.2.2. Elasticity of Demand
 Price elasticity of demand
 Income elasticity of demand
 Cross-price elasticity of demand
2.2.2. Elasticity of Demand
 Elasticity is a measure of responsiveness of a dependent
variable to changes in an independent variable.
 Elasticity of demand refers to the degree of
responsiveness of quantity demanded of a good to a
change in its price, or change in income, or change in
prices of related goods.
 Commonly, there are three kinds of demand elasticity:
1. Price elasticity
2. Income elasticity
3. Cross elasticity.
1.Price Elasticity of Demand

 Price elasticity of demand means degree of

responsiveness of demand to change in
price.
 Price elasticity of demand is a measure of
how much the quantity demanded of a
good responds to a change in the price of
that good.
 Price elasticity demand can be measured in
two ways.
1. Point elasticity
2. Arc elasticity
a. Point Price Elasticity of Demand
 This is calculated to find elasticity at a given point. The price elasticity of
demand can be determined by the following formula.

Epd =
% = and % =

Epd = = = X
 In this method, we take a straight-line demand curve joining the two
axes, and measure the elasticity between two points Qo and Q1 which
are assumed to be intimately close to each other.
BUT it is Cont…
P
applicable
only when we R
 N is Po and M is Qo
have
information N Q0
about even the ∆𝑃
slight changes
in the price N1 Q1
∆𝑄
and the
quantity
O M M1 T Q
demanded of
the  It should be remembered that the point elasticity of
commodity. demand on a straight line is different at every point.
b. Arc price elasticity of demand
 In arc price elasticity of demand, the midpoints of the
old and the new values of both price and quantity
demanded are used.
 It measures a portion or a segment of the demand curve
between the two points.

Epd = /
Interpretations of Ed
➢ Elasticity of demand is usually a negative number because of the
law of demand.. So we take absolute values for interpretations.
❖ |Edp| < 1 : Inelastic
❖ |Edp| > 1 : Elastic
❖ |Edp| = 1 : Unitary Elastic
❖ |Edp| = ∞ : Perfectly Elastic
❖ |Edp| = 0 : Perfectly Inelastic
 Note that: Elasticity of demand is unit free because it is a ratio of
percentage change.
Numerical Example
 Suppose that the price of a commodity is Br. 5 (Po) and the quantity demanded at
that price is 100 units (Qo) of a commodity.
 Now assume that the price of the commodity falls to Br. 4 (P1) and the quantity
demanded rises to 110 units (Q1).
 Find the value of the point and arc elasticities of demand and interpret the results.
Other Determinants of price Elasticity of
Demand
 The availability of substitutes:
 Time: In the long- run, price elasticity of demand tends to be
elastic. Because:
➢ More substitute goods could be produced.
➢ People tend to adjust their consumption pattern.
 The proportion of income consumers spend for a product:-the
smaller the proportion of income spent for a good, the less
price elastic will be.
 The importance of the commodity in the consumers’ budget :
Luxury goods tend to be more elastic; example: gold.
Necessity goods tend to be less elastic example: Salt.
2. Income Elasticity of Demand
 It is a measure of responsiveness of demand to change
in income.
Point income elasticity of demand

EId = X
i) EId > 1, the good is luxury good.
ii) EId < 1,(positive), the good is necessity good,
iii) EId < 0, (negative), the good is inferior good.
3. Cross price Elasticity of Demand
❑ Measures how much the demand for a product is
affected by a change in price of another good.

xy = X

xy for substitute goods is positive.

xy for complementary goods is negative.

xy for unrelated goods is zero.

Numerical Example
 Calculatethe cross –price elasticity of demand between the
two goods. What can you say about the two goods?
Price of Y Quantity demanded of X
10 1500
15 1000
Cross Price Elasticity:
𝑄𝑥1 𝑄𝑥0
𝜀 xy = − X 𝑃𝑄𝑦0
𝑃𝑦1 𝑃𝑦0 𝑥0
−

1000−1500
= 10
X 1500
15−10
~-0.67
Therefore, the two goods are complements .