Economic Model

 Circular flow diagram: fig 2.1

Market for goods

And services

Firms Households

Market for Factors

Of production
Production possibility frontier
 Graph showing the various combinations
output that economy can possibly produce
given the available factor of production
and technology
 Fig 2.2
Law of Demand
 The quantity of a good demanded per period of
time will fall as price rises and will rise as price falls,
other things being equal.
Price A’s Demand B’s Demand Total Market
Demand
20 28 16 700
40 15 11 500
60 5 9 350
80 1 7 200
100 0 6 100
 Quantity Demanded:
 The amount of a good that a consumer is willing
and able to buy at a given price over a given
period of time.

 Demand Curve
A graph showing the relationship between the
price of a good and the quantity of a good
demanded over a given period of time.
Demand

 Reasons for the law:

 Income Effect
 More proportion of spending more effect
 Substitution Effect
 Number and closeness of substitutes as coffee, tea
Income Effect

 The effect of a change in price on quantity

demanded arising from the consumer
becoming better or worse off as a result of
the price change.
Substitution Effect

 The effect of a change in price on quantity

demanded arising from the consumer
switching to or from alternative (substitute)
products.
Other determinants of demand
 Taste
 Number and price of substitute goods
 The number and price of complementary
goods
 Income
 Population
 Distribution of income.
Movements and Shifts in Demand Curve

 Change in demand
 Change in quantity demanded
Demand Equation
 Simple demand functions
 Qd = a- bp
 Qd = 10,000 – 200P

 Complex Demand Functions

 Qd = a- bp + cY + dPs - ePc
Law of Supply

 When the price of good rises, the quantity

supplied will also rise.
 Reasons:
 Switching

 New producers
 More cost so more price required
Price of A’s Supply Total Market
Potatoes Supply

20 50 100

40 70 200
60 100 350

80 120 530

100 130 700

Other Determinants of Supply
 Cost of production
 Change in input price
 Change in technology
 Government policies
 Profitability of alternative products.
 Profitability of goods in joint supply
 Nature, shocks, other events
 Aim of producers
 Expectation of future price.
 Number of suppliers.
Movements And Shifts In Supply Curve

 Change in quantity supplied.

 Change in supply.
Supply Equations

 Qs = c + dP
 Qs = 500 + 1000P
Equilibrium Price and Output

Price of Total Market Total Market

Potatos Demand Supply
20 700 100
40 500 200
60 350 350
80 200 530
100 100 700
 Effects of shift in Demand curve
 Movement on supply curve
 Effects of shift in Supply curve
 Movement on supply curve

 Shift in one curve leads to movement on

other
 Price elasticity of demand:
 “Theresponsiveness of quantity demanded to a
change in price”
 Measurement
 “Percentage (or proportionate) change in quantity
demanded divided by the percentage (or
proportionate) change in price”
 %∆QD / %∆P.
 40% rise in the price of oil caused quantity
demanded to fall by 10%
 -10% / 40% = -0.25
 5% fall in the price of potato caused quantity
demanded to rise by 15%
 -15% / - 5% = -3
Value of Elasticity
 Elastic > 1
 Where quantity demanded change by a larger
%age than price
 Inelastic < 1
 Where quantity demanded change by a smaller
%age than price
 Unit Elastic = 1
 Where quantity demanded change by a same
%age than price
Special Cases
 Totally Inelastic Demand
 Infinitely Elastic Demand
Measurement of Elasticity
Determinants of price Elasticity
 The number and closeness of substitute
goods
 The proportion of income spent on good.
 The time period.
Price Elasticity
and Revenue
Cross-Price Elasticity of Demand

 The responsiveness of demand for one

good to a change in the price of another.

 The percentage (or proportionate) change

in demand for good a divided by the
percentage (or proportionate) change in
price of good b: %∆QDa + %∆Pb.