INTRODUCTION TO AGRICULTURAL

ECONOMICS
AEDM 111
Lecture 3: DEMAND, SUPPLY AND
PRICES
 UNIT OUTCOMES
 Understand the determinants of demand and supply
 Explain movement along and shift of demand and
supply curves
 Understand the concept of market equilibrium
 Distinguish between consumer surplus and
producer surplus
 Calculate price elasticity of demand and supply
 Calculate the income elasticity of demand
 Calculate the cross elasticity of demand

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 The Theory of Demand
The market is a central factor in economic analysis
Demand flows from decisions about which wants to satisfy,
given the available means.
 When we talk about demand we are referring to the quantities
of a good or service that the potential buyers are willing and
able to buy.
 Wants are the unlimited desires or wishes that people have for
goods and services.

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 Demand is only effective if the consumer is able and willing to
pay for the good or service concerned.
 You should also not confuse demand with needs or claims.
 Demand is a flow concept which is measured over a period.
 We should always specify the period concerned (eg day, week,
month or year). F
 Demand refers to the quantities of a good or service that
prospective buyers are willing and able to purchase during a
certain period.
Individual Demand is influenced by
 The price of the product
 The price of related products – complements or
substitutes
 Income of the consumers
 The taste/preference of the consumers
 Household’s size

 Any other factors?

Symbolically we can say that:
The Law of Demand
The quantity demanded of a good or service is the amount that
consumers plan to buy during a given time period at a particular
price
The Law of Demand
The law of demand states:
 Other things remaining the same (ceteris paribus), the higher
the price of a good, the smaller is the quantity demanded;
and the lower the price of a good, the greater is the quantity
demanded
Demand Schedule and Demand Curve
 A demand schedule is a table which lists the
quantities demanded at different prices when all other
influences on planned purchases are held constant.
 The information in the demand schedule can also be illustrated graph ically by
drawing a demand curve.
Market Demand
 The individual demand curve is one of the most important
building blocks of microeconomic theory.
 But firms are interested in the total (or market) demand for the
goods and services that they supply, rather than in the demand
of a particular individual or household.
 In a market system the plans of all the consumers and
producers of a good or service have to be taken into account.
 To move from individual demand to market demand is quite
straightforward.
 Market demand is simply the sum of all the individual
demands in the particular market.
Market Demand Curve
 The market demand curve has the same characteristics as the
individual demand curve.
 Now we are dealing with all the prospective buyers of
tomatoes in a particular market, not just one.
 The total income of all the prospective buyers, the tastes of all
of them and the total number of people served by the market
therefore have to be taken into account.
 We also explicitly provide for other factors which may
influence the demand for tomatoes.
 These include things like expected future prices and the quality
of the tomatoes.
Movements along the demand curve and shifts of
the curve

If the price of the product changes, we obtain

the change
in the quantity demanded by comparing the
relevant points on
the fixed, given or unchanged demand curve,
that is, by moving
along the curve. This is how we determine a
change in the
quantity demanded.
 What are the factors that can cause a change in demand, that is, a
shift of the demand curve?
 A change in any of the determinants of demand other than the
price of the product will shift the demand curve.
 Change in the prices of related products
 Substitutes – Fish and Chicken, Bread and Cake, Tea and Coffee etc
 A substitute is a good that can be used in place of another good to
satisfy a certain want
 An increase in the price of fish will lead to increase in that for
chicken due to SUBSTITUTION
 Complements – Tea and Sugar, Coffee and Milk, Fish and Chips
etc. Complements are goods that tend to be used jointly to satisfy a
want.
 When 2 products are complements, increase in the price of reduces
demand for the other.
 Change in consumer’s income: Income Effect
 An increase in income will normally lead to an increase in demand.
 The demand curve will thus shift to the right when income increases and to the
left when income decreases. When this happens, the good is called a
normal good.
 If demand decreases as income increases -inferior goods.
 We also have Giffen Goods – demand increases as price
increases due to lack of substitutes- it defies the law of
demand.
 Change in consumer’s taste and preferences – Taste
changes with adverts, fashion, discovery
 Change in population – War, Earthquake, Banditry etc
 Change in expected future price.
 Income redistribution.
SUPPLY
 Supply can be defined as the quantities of a good or
service that producers plan to sell at each possible
price during a certain period.
 Like demand, supply is a flow concept which is
measured over a period of time (hour, day, week,
month, etc).
 It can also be expressed in words, schedules
(numbers), curves (graphs) or equations (symbols).
Individual Supply
Refers to the quantities of a good or service that prospective sellers plan to sell at
various prices.
These will be influenced by:
The price of the product
The price of factor of production and other inputs.
Expected future price
The state of technology
 Supply
Law of Supply
 Keeping other factors constant, an increase in price result to an increase in quantity
supply. Direct relationship

 Because business seek to increase revenue, when they expect to receive higher price,
they will produce more.
• A supply schedule lists the quantities supplied at each price when all the other
influences on producers’ planned sales remain the same
A Change in Supply
1. Prices of Factors of Production
2. Prices of Related Goods Produced
3. Expected Future Prices
4. The Number of Suppliers
5. Technology

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Supply Schedule
Supply Curve
Market Supply
 To move from individual supply to market supply, the individual supplies are added
together horizontally.
 In principle the market supply curve is the same as the individual supply curve. The
only real difference is that the
 market supply pertains to all the prospective sellers of the product in a particular
market.
 Other factors that influence supply:
 Government policy
 Natural disaster
 Joint products and by-products. Some products are produced jointly (eg sugar and
molasses, wheat and bran, lead and zinc, beef and leather) with the result that a
change in the supply of the major product results in a similar change in the supply of
the by-product
 Productivity
Movement Along and Shift of Supply Curve
 Market Equilibrium
• The equilibrium price is the price at which the quantity demanded equals the quantity
supplied

Price as a Regulator
• If the price is too high, the
quantity supplied exceeds the
quantity demanded
Price Adjustments

• A Shortage Forces the

Price Up

• A Surplus Forces the Price

Down

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 Predicting Changes in Price and Quantity
An Increase in Demand
• Demand creates a shortage
at the original price and to
eliminate the shortage, the
price must rise

A Decrease in Demand
• The decrease in demand
shifts the demand curve
leftward

• When demand increases,

the price rises and the
quantity increases
• When demand decreases,
the price falls and the
quantity decreases

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 Predicting Changes in Price and Quantity
 An Increase in Supply
• When supply increases, the supply curve shifts rightward

 A Decrease in Supply
• The decrease in supply shifts the supply curve leftward

• When supply increases, the

price falls and the
quantity increases
• When supply decreases, the
price rises and the
quantity decreases

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All the Possible Changes in Demand and Supply

28 Economics 2ed: Global and Southern African Perspectives

© 2013
All the Possible Changes in Demand and Supply

29 Economics 2ed: Global and Southern African Perspectives

© 2013
All the Possible Changes in Demand and Supply

30 Economics 2ed: Global and Southern African Perspectives

© 2013
Consumers’ Surplus
 A downward-sloping demand curve and a uniform market price imply that
consumers actually receive more than their money’s worth.
 The reason is that the market price is usually lower than the highest prices
consumers are willing to pay for all but the last (or marginal) unit of the product
concerned.
Producers’ Surplus
 The Concept of Elasticity
 … is a measure of how much buyers and sellers
respond to changes in market conditions
 … allows us to analyze supply and demand with
greater precision.
Elasticity
4 basic types used:
 Price elasticity of demand
 Price elasticity of supply
 Income elasticity of demand
 Cross elasticity
Elasticity – the concept
 If price rises by 10% - what happens to demand?
 We know demand will fall
 By more than 10%?
 By less than 10%?
 Elasticity measures the extent to which demand will
change as price changes.
 Same applies to Supply!!!!
 Price
Price Elasticity
elasticity of demand is the of Demand
percentage change in
quantity demanded given a percent change in the price.

 It is a measure of how much the quantity demanded of a

good responds to a change in the price of that good.
 Price Elasticity of Demand
Calculating Price Elasticity of Demand

Price Elasticity = Percentage Change in Qd

Of Demand Percentage Change in Price

To calculate the price elasticity of

demand, we express the change in price
as a percentage of the average price
and the change in the quantity
demanded as a percentage of the
average quantity

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 Ranges of Elasticity
Inelastic Demand
 Percentage change in price is greater than
percentage change in quantity demand.
 Price elasticity of demand is less than one.
Elastic Demand
 Percentage change in quantity demand is greater
than percentage change in price.
 Price elasticity of demand is greater than one.
Unitary elasticity = 1
 Determinants of
Price Elasticity of Demand

 Necessities versus Luxuries

 Availability of Close Substitutes
 Definition of the Market
 Time Horizon
 Elasticity and Total Revenue
 Total revenue is the amount paid by buyers and received
by sellers of a good.
 Computed as the price of the good times the quantity sold.

TR = P x Q
The Total Revenue Test for Elasticity

Increase in Decrease in
Total Revenue Total Revenue

Increase in INELASTIC ELAELASTIC

Price DEMAND DEMAND
STIC
Decrease in ELASTIC DEMAND
INELASTIC
Price DEMAND DEMAND
 Income Elasticity of Demand
 Income elasticity of demand measures how much the
quantity demanded of a good responds to a change in
consumers’ income.
 It is computed as the percentage change in the quantity
demanded divided by the percentage change in income.
 Computing Income Elasticity

Percentage Change
Income Elasticity = in Quantity Demanded
of Demand Percentage Change
in Income
 Income Elasticity
- Types of Goods -
 Normal Goods
 Income Elasticity is positive.
 Inferior Goods
 Income Elasticity is negative.
 Higher income raises the quantity demanded for
normal goods but lowers the quantity demanded for
inferior goods.
 Example Income Elasticity
Percentage Change
Income Elasticity in Quantity Demanded
of Demand =
Percentage Change
in Income
Suppose that when people's income increases by 20%, they buy 10% less of fast food

In this situation, what type of good would fast food be?

Cross Elasticity of Demand

 Cross Elasticity:
 The responsiveness of demand for one good to
changes in the price of a related good – either
a substitute or a complement

% Δ Qd of good t
__________________
Xed =
% Δ Price of good y
 Goods which are complements:
 Cross Elasticity will have negative sign (inverse relationship
between the two)
 Goods which are substitutes:
 Cross Elasticity will have a positive sign (positive relationship
between the two)
Thank you for listening, ANY QUESTIONS?