VM 465 Veterinary Economics

Theory of Demand and Supply

Prepared by Ms. Janeth George

Department of Veterinary Medicine and Public Health
Sokoine University of Agriculture
Morogoro Tanzania
Can money buy Happiness?
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Theory of Consumer Behaviour

• It explains how consumers allocate their income among
different goods and services to maximize their well-being.

• The theory recognises that consumer behaviour will depend to

some degree on individual preferences which may be linked to
the age, sex, education, religion, social class, location and other
characteristics of the consumer.

• The consumer gains satisfaction, welfare or utility from the

consumption of goods. In deciding how much of each good to
purchase, the consumer will try to obtain the greatest possible
satisfaction
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Theory of Consumer Behaviour…

• Consumer behavior is best understood in three distinct steps:

1.Consumer preferences

2.Budget constraints

3.Consumer choices
Demand

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Demand concept
Definition of Demand
Demand is the desire to own anything, the ability to pay for it, and

the willingness to pay during a specific period

The power to purchase a good along with willingness to purchase

it
The quantity of a good that potential purchasers would buy or
attempt to buy, at a certain price
It is not just the wishing, or desire of consumers to buy a particular

product, but they must also be able to purchase the goods by

paying for it.
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Demand is the representation of the various

amounts of a product that consumers are
willing and able to purchase at each of a
series of possible prices during a specific
period of time”
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Demand Schedule and Demand

Demand Schedule: A list showing the quantity of a good that
consumers would choose to purchase at different prices, with
all other variables held constant

Price 500 300 200 100 50

Quantity 10 25 35 40 70

Demand Curve: Graphically shows the relationship between the

price of a good and the quantity demanded , holding constant all
other variables that influence demand
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Demand curve

P
Do
P1

P2
Do

Q1 Q2 Qy

The formula for the demand curve relating the good’s price and
quantity demanded holding all other factors constant is :
Qy= f (P1, | P2,…,Pn, M,TP)
 Law of Demand
The law of demand states that “Other factors being constant,
price and quantity of demand of any good and Service are
inversely related to each other. When the price of the product
Increases, the demand for the same Product will fall”

 Negative relationship between price and quantity demanded

 Assumptions and Limitations of the Law of
Demand
Assumptions Limitations
 Income is constant
 No change in tastes, fashion and  Very high-priced goods
habits  Very low-priced goods
 Price of related goods remains  Ignorance of the consumer
unchanged  Necessities
 No future expectations
 No change in weather and
population
 Determinants of Demand
 Price of the good

 Price of related goods [substitutes and complements]

 The size of household income

 Taste and fashion

 Expectation of future price change

 The distribution of income among households

 Number of Buyers
Reasons for Downward Sloping of
the Demand Curve

 Customer effect

 Income effect

 Substitution effect

 Law of diminishing the marginal utility

 Change in Quantity Demanded vs.
Change in Demand
Change in Quantity demanded Change in demand

Occurs due to change in price Occurs due to changes in

determinants other than
price

Results in movement Results in shifting of the

from one point to another demand curve either to
on a fixed demand curve the right or to the left

Also called extension and Also called rise and fall of

contraction of demand demand
 P D1
Do
D2
The demand curve shifts to the right
D1
Do

D2
Demand curve shifts to left

Qy

In the real world, a higher price could cause a movement along the
demand curve, but in the long-term, it could cause a shift as
consumers respond to the persistently higher prices or find
alternatives
 Engel curve
The Engel curves informs us on the relationship between the
quantity of a good purchased and the consumers income all other
factors held constant

M
Income Normal good

Inferior good
Qy

The Engel curve is the graphical representation of the following

demand function.
Qy= f (M|P1, P2,…,Pn, TP)
 Economics of market demand
In applied economics for analytical purposes the focus is on
market demand i.e. the aggregate demand of a number of
individuals in a specified market.

The market demand curve may be constructed by horizontal

summation of individuals demand curves in the market.

The position of the market demand curve will depend on the

factors influencing individual demand curve and certain factors
that operate at the population level.

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 Market Demand Function
The market demand function for a good Y1 may be specified as:
Qy1=f (P1, P2, ...,Pn, M, POP, ID|TP) i=1,2,...,n

Where
• Qyi denotes the demand for the i-th product,
• M is defined as per caput income,
• POP is the market population and
• ID is an index of income distribution.
• P1, ...,Pn denote the per unit prices of all market goods.

 If there is a change in population it is likely to affect per caput

income, income distribution and even tastes and preferences (as the
population structure-age, sex-will also change).
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 Market Demand Function…
Responses to changes in income will depend largely on the
current distribution of income.

Those with lower incomes for example are likely to use

additional income on foodstuffs

while

Those who are well to do are likely to spend additional income

on something else than foodstuffs as they may already be
buying all that they need.
Demand and Quality of Livestock Products
Consumers have preferences and tastes for :
Wholesome products-the wholesomeness of products is inspected by
EXAMINING the;
• Aesthetics (visual and smell)
• Hygiene (visual and public health techniques)

Products with no or little risk of transmitting disease Zoonoses

Products which have no intrinsic disease causing factors such as fatty

acids in milk (Butter), uric acid in red meat may cause gout.

Products which do not have potentially harmful residues.

 Demand and Quality of Livestock
Products
 In the above context since the risk associated with any of
the above factors may increase or become known then
the quality of the product should not be taken as fixed.

 Departures from the preferred quality-real or perceived-

will induce a shift in the demand curve.

 The increase in risk or perceived risk will cause a shift in

the demand curve to the left where as a reduction in risk
(improvement in quality) will result in a rightward shift.
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 Research information
• Preferences may also change with availability of research
information.

• For example there is apparently a switchover from red meat to

white meat for health reasons.

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Consumer confidence ~Quality control
• Testing for residues, meat inspection

• Consumer Confidence: Monitoring, inspection and certification

as means of quality assurance and maintaining consumer

confidence. A good example is the activities associated with
meat inspection (Ante- mortem and Post-mortem).
• Certify products free of disease or very low risk

• Consumer confidence real or perceived CAN only be allayed

with real data.

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Consumer confidence ~Quality control
• Successful disease control or new technologies
that reduce disease risk are likely to shift the demand curve to
the right.

• Export demand
• As the wholesomeness of the product increases or a reduction
in the risk of zoonoses occurs and is documented, new export
markets may become available and existing ones may be
expanded. The key is effective and action oriented
surveillance and monitoring systems.
Supply

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 Supply concept
Definition of Supply

• Quantity of output brought for sale in the market at a certain

price

• The amount of a good producers would want to produce and

sell at a specific price
“The amounts of a product that producers
are willing and able to make available for
sale at each of a series of prices during a
specific period”
 Supply Schedule and Supply Curve

Supply Schedule: A list showing the amount of a product that

producers would produce and sell at a series of varying prices,
during a certain time, with all the other factors held constant

Supply Curve: The graphical representation of the relation

between the quantity supplied of a good that producers are
willing and able to sell and the price of the good
 The Law of Supply

“The supply of goods increases as its price rises and

all the other factors remain unchanged. Suppliers
tend to provide more goods when the price is high
and fewer goods when the price is low”

Positive or direct relationship between the quantity supplied and

the price
 Supply curve

P
P2 S
P1

Qy
Q1 Q2
 Assumptions of the Law

 Constant cost of production

 Constant price of capital goods
 Constant technology

Exceptions of the law of supply

 Perishable goods
 Stock clearance sale
 Price expectation of seller
 Auction Sale
 Determinants of Supply

 Price of the good

 Resource Prices
 Technology
 Taxes and subsidies
 Price of Other Goods
 Expectations
 Number of Sellers
Change in Quantity supplied vs. Change
in supply
Change in Quantity Change in supply
supplied

Occurs due to change in Occurs due to change in

the market price determinants of supply
other than price
Represented by Is represented by a shift
movement from one point in the supply curve either
to another on the same to the right or to the left
supply curve
Also called extension and Also called rise and fall in
contraction of supply supply
 Shift in Supply/Change in Supply
Shift in Supply
P
S0

S1
A change in a shift factor
causes a shift in supply

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Equilibrium

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 Equilibrium
When a market is in equilibrium
 Both price of good and quantity bought and sold have settled into
a state of rest
 The equilibrium price and equilibrium quantity are values for
price and quantity in the market but, once achieved, will remain
Constant. Unless and until supply curve or demand curve shifts
 The equilibrium price and equilibrium quantity can be
found on the vertical and horizontal axes, respectively
 At point where supply and demand curves cross
P
D0 S0

Equilibrium price and quantity

Pe

D0

Qe Q
 P
D0 Excess supply S0

Equilibrium price and quantity

Pe

Excess Demand
D0

Qe Q

Excess Supply or Surplus: The excess of quantity supplied over quantity

demanded at a given price

Excess Demand or Shortage: The excess of quantity demanded over quantity

Supplied at a given price
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Elasticity
 Elasticity
Elasticity ~ means sensitivity to change’. In economics ~ it is the
degree of responsiveness of output or demand to a price change.

If the focus is on the change in quantity as a result of a change

in income, then we refer to the elasticity as income elasticity

We talk about price elasticity of when the interest is on the

relationship between price change and resultant quantity
change.
In demand, Price elasticities are of two types:
Own price: Own Price elasticity of demand and
Change in the price of another product-: Cross Price
Elasticity of demand.
 Why are elasticities
important?

Elasticities are useful for

Policy analysis
- can test for what happens if you increase
subsidies etc.
Forecasting
– Given increases in prices what is the expected
impact on consumption
 Price elasticity of Demand
 A measure of the extent to which the quantity demanded of a
good changes when the price of the good changes.

 To determine the price elasticity of demand, we compare the

percentage change in the quantity demanded with the
percentage change in price

ii=(Q/Q) divided by (P/P). For the purposes of calculations

Q and P are taken to be the mean values of the quantity and
prices before and after the change.
 Degree of elasticity
Some products are more responsive to price change than
others. Compare maize flour and beef. This is known as
the degree of elasticity.

The demand for a product is considered highly elastic if a

change in price results in an extremely large change (more
than proportionate) in quantity demanded.
 Elastic demand: Is when percentage change in the quantity
demanded exceeds the percentage change in price

 Unit elastic demand: If the percentage change in the quantity

demanded equals the percentage change in price

 Inelastic demand: If the percentage change in the quantity

demanded is less than the percentage change in price

 Perfectly elastic demand: When the quantity demanded changes by

a very large percentage in response to an almost zero percentage
change in price

 Perfectly inelastic demand: When the quantity demanded remains

constant as the price changes
 Exercise on Demand Elasticity

In the last week livestock market, the

price of bull was 600,000TZS and
Marwa was willing to pay buy 10 bulls.
This week, the price has gone up to
800,000 TZS and Marwa is now willing
to buy 8 bulls. What is the elasticity of
demand? Is it elastic or inelastic?
 Price elasticity of Supply

A convenient measure of producers response to

change in price is termed: ELASTICITY OF SUPPLY
or OWN PRICE ELASTICITY of supply Eis
Eiis = Proportionate  in Qi
Proportionate  in own price Pi
 Price elasticity of Supply
Managers are interested in two types of supply
elasticity measures:

Own-price elasticity of supply - measures the

responsiveness of quantity supplied of a good to a
change in the price of that good.

Cross-price elasticity of supply - measures the

responsiveness of quantity supplied of a good to a
change in the price of a related good.
 Price elasticity of Supply
Price Elasticity of Supply is defined as the percentage change
in the quantity supplied relative to the percentage change in
price.
It is a measure of responsiveness of quantity supplied to
changes in price.
 Calculating Own Price Elasticity of Supply from a Supply
Function:

Using calculus:
Qs=quantity supplied.
 Price elasticity of Supply
Classifications:
Inelastic supply (Es < 1): a change in price brings
about a smaller change in quantity (we are less
responsive to price)

Unitary Elastic supply (Es = 1): a change in price

brings about an equivalent change in quantity.

Elastic supply (Es >1): a change in price brings about a

relatively larger change in quantity.
 Cross-price Elasticity of Supply

Measures the effect of a change in the price of good X on the

quantity supplied of Y.

Using Calculus from a Supply function:

Qsy Px
Esyx  
Px Qsy

Read this as the cross-price of elasticity of supply for product

Y with respect to price of product X.
 Interpretation & Classification of
Cross-price elasticity of Supply
Interpretation:
ES =1.5 implies that as price of X changes by 1%, the
YX
quantity supplied of Y changes by 1.5%.
Classification:
Complements in production (ES >0): implies that as
YX
the price of X increases, the quantity of Y supplied by
the firm will increase.

Substitutes in production (ES <0): implies that as the

YX
price of X increases, the quantity of Y supplied by the
firm will decrease.
From the data shown in the table about supply of beef, calculate the
price elasticity of supply from: point J to point K, point L to point M,
and point N to point P. Classify the elasticity at each point as elastic,
inelastic, or unit elastic

Point Price (TZS) Quantity Supplied

J 18,000 50
K 20,000 70
L 23,000 80
M 25,000 88
N 28,000 95
P 30,000 100
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