CHAPTER TWO

THE FUNDEMENTAL ECONOMIC

CONCEPT
 2.1. DEMAND AND SUPPLY

2.1. The concept of demand

• Under the concept of demand, the issue of buyers (consumers)
is discussed.
• How buyers are deciding quantity of purchase and what
factors affect the buyer’s quantity of purchase are explained
2.1.1.Meaning and other related concepts of demand
• In common language we treat ‘demand’ as
synonymous with terms like desire/wish/need for an
object.
• In economics, demand has a specific meaning
distinct from its ordinary usage.
 Having desire does not necessarily mean that the
individual or the household may actually posses the
item.
• In economics, demand refers to effective demand
which implies three things:
 Desire for a commodity
 Sufficient money to purchase the commodity(ability
to pay)
 Willingness to spend money to acquire that
commodity
• Regarding the definition of demand different scholars
defined the term demand by using their own
statement.
• According to Prof. Hidbon, “Demand means the
various quantities of goods that would be purchased
per time period at different prices in a given market.
• In the opinion of Stonier and Hague, “Demand in
economics means demand backed up by enough
money to pay for the goods demanded”.
• In other words, demand means the desire backed by
the willingness to buy a commodity and purchasing
power to pay.
• General Definition: Demand indicates the different
quantities of a product that buyers are willing and able
to buy at various prices in a given period of time, other
things remain unchanged.
• Demand= Willing plus ability to purchase/consume a
given commodity
• It shows the relationship between prices and the different
quantities of a product to be purchased/consumed.
• In economics the term demand is different from the
terms need and want.
• In general for demand to exist, information on four things are
necessary
i. Quantity demanded iii. Period of demand
ii Price iv. Place of demand
• For instance, the statement that demands for potatoes in city X at
Rs. 8 per kilogram is 10,000 kilograms again has no meaning,
unless we state the period for which the quantity is being
demanded.
• A complete statement would therefore be as follows: 'The weekly
demand for potatoes in city X at Rs. 8 per kilogram is 10,000
kilograms'.
 Why demand Analysis?

The main objectives of demand analysis are;

1. To determine the factors affecting the demand.
2. To measure the elasticity of demand.
3. To forecast the demand. .
4.To allocate the resourses efficiently
Producing/supplying how much is demanded by
efficiently utilizing inputs or scarce resourses)
 Law of Demand

• Law of demand shows the relation between price and quantity

demanded of a commodity in the market.
• In the words of Marshall “the amount demanded increases
with a fall in price and diminishes with a rise in price”.
• According to Samuelson, “Law of Demand states that people
will buy more at lower price and buy less at higher prices”.
• In other words while other things remaining the same, an
increase in the price of a commodity will decreases the
quantity demanded of that commodity and decrease in the
price will increase the demand of that commodity.
• So the relationship described by the law of demand is
an inverse or negative relationship because the variables
(price and demand) move in opposite direction.
• The concept of law of demand may be explained with
the help of a demand schedule, graph and function.
i. Individual demand Schedule
• An individual demand schedule is a tabular
representation of the relationship b/n quantities
of a commodity purchased by an individual
consumer at different prices.
• The following table shows the demand schedule of an
individual consumer for apple.
Combination Price of Apple Quantity demanded
for apple

A 10 1

B 8 2

C 6 3

D 4 4

E 2 5
• Demand function: is a mathematical
relationship between price and quantity
demand.
Qd  f ( p )
• Example: Let the demand function be linearly
explained as Qd=a-bP .Since b shows slope it
can be explained as Q
b 
P
iii.Demand curve: is a graphic representation of a demand
schedule.
• In economics, the vertical axis represents price and the
horizontal axis represents the quantity, in this case the quantity
demanded.
Market demand :Schedule ,graph and functional expression

• Market demand refers to the total demand for a

commodity by all the consumers.
• It is the aggregate quantity demanded for a
commodity by all the consumers in a market.
• If the existing consumers are identical(those who
demand equal amount of the commodity at a given
price) market demand equals the multiplication of
respective quantity by number of consumers in the
market.
• It can be expressed in the following schedule.
Price per dozen(in Demand by consumers Market demand
birr)
A B C D

10 1 2 0 0 3

8 2 3 1 0 6

6 3 4 2 1 10

4 4 5 3 2 14

2 5 6 4 3 18
• Derivation of market demand curve is a simple process.
By adding up the quantity demanded by all the four
consumers at various prices we get the market demand
curve.
Numerical Example:
• Suppose the individual demand function of a product
is given by P= 10-1/2Q, and there are about 100
identical buyers in the market. Then the market
demand function is given by:
P= 10-1/2Q
½Q =10-P
Q= 20 -2P
Qm = ( 20 – 2P)100 = 2000-200P is the market
demand function
• Determinants of demand
The demand for a product is determined or
influenced by:
i. Price of the product.
ii. Taste or preference of consumers.
iii. Income of the consumer.
iv. Price of related goods and services.
v. Consumer’s expectation of income and price.
vi. Number of buyers in the market
• The first determinant, price of the product, is known
as own-price determinant of demand. It result in
change in quantity demand along the original
demand curve.
• The remaining determinants are known as demand
shifters since the entire demand curve shifts inward
or outward if one or more determinants changes.
2.1.2. Theory of supply and other related concepts
• Definition: Supply Indicates the various quantities of
a product that sellers ( producers) are willing and
able to provide at various prices in a given period of
time, other things remain unchanged.
• The relationship between prices of a product and
the different quantities sold(supplied) can be
presented in the form of a table, graph, or equation
using Supply schedule , curve and function
A. Supply schedule: is a tabular representation
of relationship between prices of a product
and the different quantities supplied.
Combinations A B C D E

Price ( birr per kg) 30 25 20 15 10

Quantity supplied 100 90 80 70 60

in kg/week
b.Supply function: is a mathematical
relationship between price and quantity
supplied.
Qs=f(p)
Example:Let the x supply function be Qs = a+
bp b  QPs

Thus, from the above table by taking movement from

90  100
point A to B point b 2
25  30
• Since Qs =a+2P , to find a, substitute the value
of price and quantity supplied at either point
A or B.
100= a+2(30)
a=40
• Therefore, QS=40+2P is the supply function
c. Supply curve: is a graphic representation of a
supply schedule.
• In economics, the vertical axis represents price
and the horizontal axis represents the quantity, in
this case the quantity supplied.
• The supply curve is upward slopping or positively
sloped because many sellers are willing to sell at a
higher price or fewer seller are willing to sell at a
lower price.
ii. The Law of supply: states that, ceteris paribus, as
price of a product increases, quantity supplied of the
product increases, and as price decreases, quantity
supplied decreases.
iii. Market supply: is derived by horizontally adding the
quantity supplied of the product by all sellers at each
price.
• Example: Consider that there are only three sellers
supplying good X in the market.
2.2.2. Determinants of Supply
• The supply of a particular product is determined by:
• price of the product
• The first determinant, price of the product, is known as own-
price determinant of supply. It result in change in quantity
supplied along the original supply curve.
• However, the following factors shift the supply curve (in other
words, change supply) either to the right (increase) or to the
left (decrease):
• price of inputs ( cost of inputs)
• Technology
• prices of related goods
• sellers’ expectation of price of the product.
• Taxes & subsidies
• Number of sellers in the market
• weather, etc.
2.3. Market Equilibrium
• Having seen the demand and supply side of the
market, now let’s bring demand and supply together
so as to see how the market price of a product is
determined.
• Market equilibrium occurs when market demand
equals market supply.
A numerical example: Given market demand : Qd= 100-2P, and Market
supply: P = 1/2 Qs+ 10
• Calculate the market equilibrium price and quantity?
• Determine, whether surplus or shortage occurs if P= 25?
Solution:
• At equilibrium, Qd=Qs
• 100 – 2P = 2P – 20
• 4P=120
P  30, Q  40
and
b) Qd(at P=25) = 100-2(25)=50
Qs(at P= 25 ) = 2(25) -20 =30
• Therefore, a shortage of: 50 -30 = 20 has been occurred.
•Implication: While calculating demand and supply
i. If there is surplus since it brings loss to the
business by reducing market price the company
has to reduce production
ii. If there is shortage since it brings loss to the
business by increasing market price(customers
shift for substitutes) the company has to increase
production