ECONOMICS ASSIGNMENT

ASSIGNMENT #2

Prepared by:

Section: 9

Submission date:
November 8/2023
Question and Answer Format

12−Q 1 12−Q 2 12−Q 3

1. Let demand function for three individual consumers is P = , ,
2 3 4
a) Derive demand schedule of individual at different prices (P) based on perfectly
competitive market structure.

We can construct a demand schedule by using Q1=12−2 P for consumer 1, Q2=12−3 P for
consumer 2 and Q3=12−4 P . We can choose different prices for the product and make a table as
follows:

Price Consumer 1 Consumer 2 Consumer 3

1 10 9 8
2 8 6 4
3 6 3 0
4 4 0 -4

b) Calculate market demand at different prices (P). Show the market demand using
graph.

To calculate the market demand, we only need to add the Quantity demanded for each price of
all the consumers. The resulting table will look like the following:

Price Consumer 1 Consumer 2 Consumer 3 Market

Demand
1 10 9 8 27
2 8 6 4 18
3 6 3 0 9
4 4 0 -4 0

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2. In a given hypothetical market, there are three individual suppliers with the following
supply functions: Q1=8 P−15, Q2=6 P−15 and Q3=4 P−15 .

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d) Define elasticity of demand. From question #2c above, calculate point price elasticity
of market demand when price increases from $2 to $3.

Elasticity of demand is a measure of how much the quantity demanded of a good or

service responds to a change in price. It is calculated as the percentage change in quantity
demanded divided by the percentage change in price. If the quantity demanded changes
significantly in response to a change in price, the demand is considered to be elastic. If the
quantity demanded changes by small amount in response to a change in price, the demand
is considered to be inelastic.

To calculate the point price elasticity of market demand when price increases from $2 to
percentage change∈quantity demanded
$3 we can use the formula: Ed =
p
percentage change ∈ price
=
Q1−Q 0
×100
Q0 ∆ Q P0
¿ = ×
P1−P 0 ∆ P Q0
×100
P0
∆ Q P0 9−(−9) 2
Now, by substitution we will get: ×
∆ P Q0
= × =−4
3−2 −9

e) Comment on the relationship between price and quantity demanded and supplied.

The price and quantity demanded and supplied are related through two very important
laws in economics, the law of demand and the law of supply.

The law of demand states that, all things being equal, as the price of a good increases, the
quantity demanded of the good decreases. Conversely, as the price of a good decreases,
the quantity demanded for those good increases as well. This relationship is typically
represented by a downward-sloping demand curve.

On the other hand, the law of supply states that, all else being equal, as the price of a good
or service increases, the quantity supplied of that good or service also increases.
Conversely, as the price of a good or service decreases, the quantity supplied of that good
or service also decreases. This relationship is typically represented by an upward-sloping
supply curve

These two laws work together to determine the equilibrium price and quantity in a market.
When the demand and supply curves intersect, they indicate the price and quantity at

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 which the market is in equilibrium which means that the quantity demanded equals the
quantity supplied.

3. In the model of demand as well as supply, which variable(s) is/ are controlled to derive
the law of demand and supply? Explain

To derive the law of demand, Economists manipulate the price of a specific product while
holding all other variables constant. They hold factors such as preferences, consumer income,
price of related goods and systematically vary the price of the product in question.

Because all other factors that could affect the quantity of a product are controlled Economists
now observe and measure how the quantity demanded by consumers changes as the price of the
product decreases or increases. The law of demand states that, all else being equal, when the
price of a product decreases, the quantity demanded increases and vice versa.

Similarly, to derive the law of supply, economists control the price of a given product while
keeping all other factors constant, such as production cost, technology, price of related goods and
all other determinants of supply.

Economists then vary the price of the product and observe how producers respond in terms of the
quantity they are willing to supply to the market. The law of supply says that if all factors are
held equal, when the price of a product increases, the quantity supplied increases, and when the
price decreases, the quantity supplied decreases.

4. What are the determinants of price elasticity of demand? Explain.

Price elasticity of demand is a measure of the sensitivity of a quantity demanded of a good to

changes in it’s price. It is very useful because it helps us understand how consumers respond to
price changes. The price elasticity can be influenced by the following factors:

The availability of Substitutes: If substitutes of a product are available consumers can easily
switch to alternative products if the price of the main product increases. This leads to the demand

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being more elastic than if no substitutes were available. So if there are no substitutes available
the consumer would have no choice and the demand would be less elastic.
Time: Demand elasticity might change across different time intervals. Demand tends to be more
inelastic in the near term because consumers might not have the time to change their spending
habits or look for alternatives. Over time though, as customers have more time to research
alternatives and make adjustments, demand becomes more elastic.
The proportion of income consumers spend for a product: Goods that make up a significant
portion of a consumer's income tend to have more elastic demand because price changes have a
larger impact on their budget. Conversely, goods that represent a small portion of income have
less elastic demand.
The importance of the commodity in the consumers’ budget: goods that are a basic
component of day-to-day life or which are necessary tend to be less elastic. On the contrary,
goods that are regarded as luxury tend to be more elastic.

5. What is income elasticity of demand? Compare it with price and cross-price elasticity of
demand.

Income elasticity of demand is a term that quantifies how the quantity of a commodity or service
that consumers seek varies in response to changes in their income. It provides insights into how
consumer demand for a particular product is affected by shifts in income levels.

Income elasticity of demand:

 Is calculated as the percentage change in the quantity demanded of a good divided by the
percentage change in consumer income.
 Can be classified into three categories:
 Luxury goods: When the income elasticity of demand is greater than 0. it indicates
that as consumer income increases, the demand for the good also increases.
 Inferior goods: When the income elasticity of demand is negative. it implies that as
consumer income rises, the demand for the good decreases.
 Necessities: When the income elasticity of demand is between 0 and 1. it suggests
that changes in income have little impact on the demand for the product.

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Price Elasticity of Demand:
 Measures how sensitive the quantity demanded of a good is to changes in price.
 It is calculated as the percentage change in quantity demanded divided by the percentage
change in price.
 Elasticity of demand is usually a negative number because of the law of demand. If the
price elasticity of demand is positive the product is inferior.
 Based on the calculated value it can be elastic, inelastic, unitary elastic…etc
Cross-price Elasticity of Demand:
 Measures how the quantity demanded of one good changes in response to changes in the
price of another related good (either a substitute or complement).
 Is calculated as the percentage change in the quantity demanded of one good divided by
the percentage change in the price of another related good.
 Can be categorized as:
 Positive: Indicates that the goods are substitutes.
 Negative: Indicates that the goods are complements.
 Zero: Suggests that the goods are unrelated.
Overall Income elasticity of demand measures the responsiveness of quantity demanded to
changes in income, Price elasticity of demand measures the responsiveness of quantity
demanded to changes in price, and Cross-price elasticity of demand measures the responsiveness
of quantity demanded for one good to changes in the price of another related good. These
concepts are very helpful for economists to understand consumer behavior and make informed
decisions regarding pricing, marketing, and resource allocation.

6. The following table illustrates quantity of three different goods or services demanded at
different levels of consumers’ income.

a) Calculate income elasticity of demand for each good when the consumers’ income
increases from Birr 20,000.00 to Birr 40,000.00.

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The Equation needed to work out this problem can be found by using:
Q1−Q 0
×100
Q0 ∆ Q I0
= ×
I 1−I 0 ∆ I Q0
× 100
I0
Now, we need to calculate the elasticity of demand for each good using the above equation.
∆ Q I0 8−18 20 , 000 −10
Tomato: × =¿ × ¿
∆ I Q0 20 , 000 18 18

∆ Q I0 24−8 20,000
Olive Edible Oil: × = × =2
∆ I Q0 20 , 000 8
∆ Q I0 8−6 20,000 1
Avocado: × = × =
∆ I Q0 20 , 000 6 3

b) From question 6a above determine the type of each good.

Tomato: Because the income elasticity of demand for tomato was found to be a negative number.
This indicates that this good is an Inferior good.
Olive Edible Oil: The income elasticity of demand for Olive Oil was 2, which is greater than 1.
So, this good was a luxury good.
Avocado: The income elasticity of demand for Avocado was calculated to be a number between
0 and 1 (one third). So it is categorized as a necessity.