1. Olufemi Obembe (PhD) DEPARTMENT OF ECONOMICS, OBAFEMI AWOLOWO UNIVERSITY, ILE-IFE, NIGERIA.

2. Theory of Demand TOPIC 2

3. Outline Concept of Demand Law of Demand Reasons for the downward sloping demand curve Exceptions to the law of demand Determinants of demand Demand function Change in demand and quantity demanded

4. Concept of demand Demand refers to the quantity of a commodity that a consumer is willing and able to buy at a given price over a period of time. ◦It is a desire backed by willingness and ability to pay. ◦Reference is made to price and period

5. Law of Demand The relationship between price and demand is expressed by the law of demand. ◦The law of demand states that quantity of a product demanded per unit of time increases when its price falls, and decreases when its price increases, other factors remaining constant ◦It can be represented by a schedule or graph

6. Law of demand—schedule and graph

7. Reasons for Downward Sloping DD curve Substitution effect ◦consuming a cheaper product in place of a costlier product Income effect ◦Increase in purchasing power Diminishing marginal utility—increase in stock of money reduces MU of money. ◦Balancing MU of money with MU of commodity Increase in number of consumers ◦Reduction in price draws more consumers

8. Exceptions to the Law of Demand The Bandwagon Effect—goods in vogue ◦The dd curve becomes flatter or more elastic The Snob Effect—ignoring a product due to popular demand ◦The demand curve becomes steeper or less elastic Veblem goods— consumers associate prestige to consumption--At a higher price demand rises Giffen goods—inferior and superior goods ◦As prices of inferior goods falls, demand falls (Maize and Wheat example)

9. Market Demand Market dd schedule Market dd curve

10. Determinants of Demand Price of the commodity Price of other commodities Income of the consumers Tastes and preference Consumers’ expectation Credit Population Income distribution

11. Determinants—Price of the commodity The higher the price, the lower the quantity demanded ◦An increase in price of a commodity leaving its substitute the same will lead to an increase in dd of substitute

12. Price of other commodities

13. Subst/complementary— cont. Demand for a good varies directly with its substitutes Demand for a good varies inversely with its complements

14. Income of the Consumer There are 3 cases: ◦Normal goods—an increase in income leads to an increase in demand ◦2 possible exceptions ◦Change in income might leave demand unchanged--Salt ◦Variations in income beyond a point might lead to a fall in demand—inferior goods

15. Income of the consumer Explanation of: ◦ Normal goods—income elasticity is +ve ◦Inferior goods—income elasticity is -ve ◦luxury goods—elasticity is greater than 1 ◦Necessities—elasticity is greater than zero but less than 1.

16. Others Tastes & preferences—favourable taste will shift demand outwards Expectations—expectation of future rise in price will shift demand outwards and vice versa Credit—it affects durable goods—cheaper credits (banks, relatives etc) will shift demand outwards

17. Others continued Population of a country—the larger the population (domestic) the higher the demand Distribution of income ◦Even distribution—increase in demand for normal goods ◦Skewed distribution to lower group—increase in demand for essential goods ◦Skewed distribution for higher group—luxurious goods and low consumption

18. Demand Function Mathematical expression of determinants of demand

19. We usually focus on the relationship between demand and price The specific demand function is given as:

20. Movement along the line vs. shift in demand Movement along the line—Expansion or Contraction in Demand

21. Shifts in Demand Changes in demand brought about by other factors apart from price

22. Theory of Supply--Outline Definition Supply function Relationship between supply and price Shifts in supply Factors determining supply Market equilibrium Comparative statics Application of price system

23. Definition Supply Curve Quantity supplied of a commodity refers to the quantity of a commodity that producers are willing and able to make available in the market at a given price over a period of time It shows the relationship between price and supplied

24. Supply Function

25. Shifts in Supply—changes brought by other factors apart from price

26. Some causes in Shift in supply INCREASE IN SUPPLY Reduction in input costs Progress in technology that boosts productivity DECREASE IN SUPPLY Increase in input costs Imposition of exercise duty or slaes tax

27. Factors determining Supply Price of the commodity— change along the line Technology Price of inputs Prices of related products— Sorghum and cassava Number of producers— profit inducement Expectations—mobility of factors to areas of profitability in future Taxes and subsidies— taxes will cause a left shift while subsidies will cause rightward shift

28. Equilibrium A state where all traders are able to buy or sell as much as they want. No participant wants to change its behaviour as they want Quantity bought and sold is equilibrium quantity The price in which they are bought and sold is called equilibrium price

29. Mathematical Derivation of Equilibrium

30. Example

31. Comparati ve Statics Comparing two equilibrium states, i.e. before and after a change occurs Determining how endogenous variable (Price of the commodity) will change wrt to change in one of the exogenous variables (Y)

32. Example Equilibrium price and quantity : Y = 100, m = 60, n = 2, k = 0.1, a = 10, and b = 0.5. Find: The equilibrium price and quantity Use comparative statics to estimate the effect on the equilibrium price P* of a N1 change in income and; Confirm the comparative statics results by re-estimating the equilibrium price

33. Diagrammatic Representations increase/decrease in demand on equilibrium Increase/decrease in supply on equilibrium Simultaneous change in both demand and supply on equilibrium Effect of increase in both demand and supply

34. Impact of Increase/Decrease on Equilibrium An increase in demand with constant supply will cause a rightward shift A decrease in demand will cause a leftward shift

35. Increase or decrease in supply on equilibrium An increase in supply will cause a rightward shift A fall in supply will cause a leftward shift

36. Simultaneous Change The effect depends on the size of change in both demand and supply ◦A substantial increase in demand with a little decrease in supply ◦A substantial reduction in supply with a smaller increase in demand

37. ◦A substantial increase in demand with little decrease in supply Price and Quantity Increases, but the price rises much more than equilibrium quantity

38. ◦A substantial reduction in supply with a smaller increase in demand Price rises, but quantity supplied and demand falls. In both cases, the effect of increase in demand and decrease in supply is to raise price, but the effect on equilibrium quantity is ambiguous.

39. Maximum and Minimum Price Law Maximum Price law Minimum Price Law

40. Effect of Maximum Price Legislation Maximum Price Law Setting maximum price above the equilibrium price will have no effect. Setting maximum price below the equilibrium price will create excess demand. Goods will be allocated through: Long queues Seller preferences Issuing coupons Black markets

41. Minimum Price Law Setting a minimum price of goods by law—wages, resale price maintenance If minimum price is set below the equilibrium price, it has no effect If the minimum price is set above the equilibrium price, there will be excess supply