INTRODUCTION

Definition of economics
There are many definitions of economics with no single of them being generally accepted to all economists.
Robbins.
He defined economics as a science, which studies human behaviors as the relationship between ends and scarce
means, which have alternative uses. Hence Robbins definition looks at scarcity as the major aspect of economics.

Adam Smith
He defined economics as a study of natural resources or wealth as an end in itself. He was not interested in the value
of non-materials such as services.

Alfred Marshal
He defined economics as a study of man land in ordinary business life. He considered economics as a social science
and study of material welfare.
Harrison
Defines economics as a study of how society chooses to use the resources that have alternative uses to produce
commodities of various kinds and to distribute among different groups.

Thus economics can generally be defined as a social science that deals with the methods which people use
to allocate scarce resources in the production of goods and services to satisfy human wants.

Wants
These are human desires that can be satisfied by material and non-material goods. They can also be called needs,
ends, and desires
Characteristics of human wants

They are insatiable i.e. all of them cannot be satisfied at once.

They are unlimited i.e. endless

They are dynamic i.e. ever changing.

They are complementary i.e. satisfaction of one need may lead to the satisfaction of another.

Wealth
This refers to material goods that can be owned and sold. Wealth has the following characteristics:

It is scarce

It has value

It has to be exchanged at a price.

It is transferable from one person to another i.e. it changes hands

It gives satisfaction

There are three categories of wealth i.e. personal wealth, company wealth and social wealth.
Personal wealth: This includes items, which are owned and enjoyed by an individual e.g. TV, Radio, and clothes
e.t.c.
Company or Business Wealth: This includes assets that are used in the running of a business e.g. company
vehicles, Buildings, industries e.t.c.
Social wealth: This is the wealth which is collectively or public owned e.g. roads, Hospitals, school, bridges e.t.c.
THE BASIC PRINCIPLES OF ECONOMICS (FUNDAMENTAL PRINCIPLES OF ECONOMICS)

The basic principles of economies explain the fundamental economic problems of man. These problems are scarcity,
choice and opportunity cost.

(a )

SCARCITY

This refers to the fact that resources are not enough to are not enough to satisfy all human wants i.e. they are limited
in supply. Because of this problem individuals have to decide what to produce or buy.

(b )

CHOICE

This refers to taking the right decisions between alternative needs. Because resources are scarce or limited supply,
man has to make a choice in making choice he normally follows the scale of preference.
The scale preference refers to a least of alternative needs when arranged in order of their importance i.e. starting
with the most pressing / important needs and then the least important needs.

(c )

OPPORTUNITY COST.

This refers to the alternative fore gone when choice has been made between alternative needs i.e. when making
choice the goods or needs which are left out are referred to opportunity cost.

THE PRODUCTION POSSIBILITY FRONTIER (PPF CURVE, Opportunity cost curve)

The production possibility frontier curve is a locus of points showing all commodity combinations that can be
produced when all the available resources are fully utilized/ employed.
It is based on the following assumptions

Resources are fully employed

The quantity of the available resources is fixed

The technology is fixed/ constant

Only two commodities are produced using the available resources e.g. beans and peas

Assuming a country specializes in the production of only two commodities. I.e. beans and peas and uses all the
available resources to produce these two goods, then the production possibility frontier will be as follows.

o According to the diagram resources are divided differently between peas

and beans
Points along the PPF curve e.g. a and b show the maximum possible combined out put of beans
and peas which the economy can produce.

o Points inside the PPF curve e.g. g shows that resources are not
fully/under/inefficiently utilized
Points outside the PPF curve shows that such combinations as at point k can not be attained at
the current level of resources.

IMPORTANCE OF THE PPF CURVE:

(i).

It shows the problems of scarcity i.e. we cant produce more beans and at same produce more peas.
This is because resources are fixed.

(ii).

The PPF curve also explains the concept of choice i.e. choice must be made between alternative
needs. We must choose to produce more beans than peas and vice-versa.

(iii).

It also explains opportunity cost. Opportunity cost is shown by the slope of the ppf curve e.g. moving
from B to C means that in order to produce more three units of peas. We must give up three units of
beans.

(iv).

The PPF shows the efficient in production effort when production is done along the ppf curve, it means
that resources are fully utilized. Any combination below the ppf implies that there is efficient and under
utilization of resources.

(v).

The PPF curve shows the economic growth. The shift of the ppf curve out wards to the right shows the
economic growth. It implies more goods and services being produced and consumed. This can be
possible through

Improvement in technology,

Research and innovations.

increase in the ability of workers to produce more output

Economic growth can be illustrated as below:-

ECONOMIC QUESTIONS
Scarcity of resources gives rise to economic question answering these questions help an economist in taking
economic decisions. These questions are: 1.

What to produce?

E.g. decisions on whether to produce capital or consumer goods; the producer has to make a choice of what exactly
to produce. The decision will be determined by the availability of resources.
2.

How to produce?

This question is related the type of technology to be used and also the special needs of the consumer e.g. fashions.
The technology to be used should normally suit the fashion and tastes of consumers.
3.

How much to produce?

This is influenced by market the availability of resources and the type of technology to be used i.e. labour intensive
and capital-intensive technology.
4.

Where to produce?

The question is normally answered in relation to the market, location of resources. Power and communication system
e.t.c. e.g. furniture industries are allocated near markets because it is easy to transport timber to make furniture than
transporting furniture itself. All food industries are normally located near gardens due to perish ability.
5.

When to produce?

The choice here is related to time e.g. production is normally carried out when market is available e.g. characteristics
cards are normally bought in December while umbrellas are normally produced and bought in rainy seasons.

6.

For whom to produce?

This is usually determined by availability of market and this can be local or foreign. It will however be influenced by
other conditions i.e. economic and non-economic conditions.
THE SCOPE OF ECONOMICS
Economics has two branches i.e. micro and macroeconomics.
a)

Micro Economics

This is the branch of economics, which studies individual actions, or elements of the economy. E.g. individual
demand, individual supply, personal income household consumptions
b)

Macro Economics

This is the branch of economies that deals with aggregate behaviours or elements of the economy as whole and not
in individual or specific terms. It considers problems such as economic growth, unemployment, inflation e.t.c. In other
hands macroeconomics assess the performance of the economy in general.
Economics can again be broken down in two branches. I.e. positive and normative economics
a)

Positive Economics

This is the branch of economics which deals with the statements that explain how things are and how actually the
economy operates. Disagreements with such statements are usually settled by reference to real facts in life e.g. what
policy measures can solve unemployment, how demand reacts to supply e.t.c.
b)

Normative Economics

This is the branch of economics that describes the world, as it ought to be e.g. fully employment, sufficient supply
balancing balance of payment. Disagreements of over these situations cannot be solved by facts. Norm active
economics deals with imagined situations just as we would want them to be.

TYPES OF GOODS
A commodity, good and service
A commodity:

Is a product of factors of production, which can be used to satisfy human wants. A commodity can be a good or a
service.
Goods
These are tangible commodities, which can be used to satisfy human wants
Services
These are intangible commodities which can be used to satisfy human wants e.g. teaching, banking, insurance,
transport.
Free goods and economic goods
A free good is that one whose supply is abundant and therefore exists as a free gift of nature. It consumption by one
person does not stop others from consuming at the same time. It is supplied at zero prices e.g. air, rain water,
sunshine e.t.c.
Economic goods are characterized by;

They are scarce or limited in supply.

Their consumption by one person will stop some other person from consuming them at the same
time.

They are normally supplied at a price e.g. shirts, shoes, cars, caps, pens e.t.c.

Consumer goods and capital goods

Consumer goods are those goods produced for immediate use. They are final products to the consumer or the user.
Capital goods are those goods which are man made but not consumed directly but are set side to furthering
production e.g. tractors, Lorries e.t.c.
Intermediate goods and final goods
Intermediate goods are those goods which appear to be in a finished form but can further be used in production of
goods and services e.g. wheat flour, newsprint paper e.t.c.
On the other hand final goods are those goods which constitute the final products of a commodity e.g. Bread, pen,
pencil e.t.c
Private goods and public goods

A Private good is that one which is owned and can be exchanged by an individual i.e. its that commodity over which
individual has exclusive right and entitlement to eat e.g. a shirt, a pen, under wears e.t.c.
Public goods are those owned and consumed publicly i.e. an individual consumption doesnt exclude the
consumption of others e.g. a road, a bridge, Hospitals, schools e.t.c.
ECONOMIC AGENTS
These are decision-making elements or groups in the economy. They also provide market business units i.e. by
buying the products. These are mainly categorized in two forms.
a)

House holds: This refers to individuals or groups of individuals that own factor resources in the economy.

They also provide market to business units by buying products.

b)

Firms: A firm is a business unit that enjoys factors of production and transforms them into goods and

services. They turn resources into final products.

ECONOMIC SYSTEMS
An economy
This refers to the material and non-material resources of a country and how they are governed
On the other hand
An economic system refers to the ownership management distributions and allocation of resources in a country.
There are three major economic systems and these include:

Free enterprise economy

Centrally planned economy

Mixed economy

FREE ENTERPRISE ECONOMY/MARKET/ LAISEZ FAIRE ECONOMY

This refers to where the ownership management distribution and allocation of resources is by private individuals in
the economy. I.e. the economic decision s concerning what, how, for whom, how much to produce are taken by
private individuals on the economy.
Characteristics of a market economy

Prices are determined by forces of demand and supply

Limited intervention of the government

The driving of the economic activities is profit Maximisation.

There is freedom of choice and enterprise. I.e. an entrepreneur is free to choose any economic activity.

Many buyers and sellers in the market

Advantages of a free market enterprise economy

(i). Efficiency in production. Producers tend to use highly productive methods of production so as to
produce high out put and incur low average costs.
(ii). There is consumer sovereignty. I.e. consumers determine what, how, when and how much to be
produced.
(iii). There is free setting of prices in the economy and this enhances automatic distribution of
resources.
(iv). Encourages innovations and inventions due to competition and this is likely to lead to production of
better quality products.
Disadvantages of a free market enterprise economy
(i). Goods of the poor may not be produced i.e. because of profit motive resources may be geared
towards the production of goods for the rich.
(ii). Public goods can not be produced this is because they are very expensive and yet it is difficult to
charge them from the users e.g. roads, streets lines, Railway lines, defense and police.
(iii). There is fluctuation in prices. Since prices are fixed by the forces of demand and supply. As a result
consumers may be exploited with high prices due to the absence of government protection.
(iv). Monopoly power may develop when new firms go out of business i.e. through competition.
(v). Harmful products may be produced and this may affect the health of citizens e.g. cigarettes and
marijuana.
COMMAND/CENTRALLYPLANNED/PURE SOCIALISM ECONOMY

It is sometimes called a planned or centrally planned economy. This is an economic system where resources are
owned and controlled by the state (government).

The central authority carries out economic decisions.

When this economic arrangement takes a political dimension we call it socialism or communism.
Examples of such economies include Cuba, North Korea China and former Soviet Union.
Advantages of a Command Economy
(i). There is no price fluctuation since the government sets prices.
(ii). Public goods can be made available by the government e.g. roads, Hospitals schools e.t.c.
(iii). There is no consumer exploitation because the government will protect consumers.
(iv). Monopoly power cannot arise in a planned economy.
(v). Harmful products are controlled by the government e.g. cigarettes, marijuana and cocaine e.t.c
(vi). Essential products or goods of the poor can be produced though they are not highly profitable e.g.
basins, plastic cups, plates e.t.c.
Disadvantages of a Command Economy
(i). There is no consumer sovereignty i.e. consumers cannot consumers goods of their choice.
(ii). A command economy is associated with corruption and embezzlement.
(iii). Misallocation of resources i.e. some goods will be produced irrespective of whether they are
demanded or not.
(iv). There are no incentives to work hard this is because will not work for sell benefit but for the
common good.
(v). There is a problem of excesses and shortages i.e. there is no direct relationship between supply
and demand.
MIXED ECONOMY

This is a compromise between a market and command economy.

Features of a mixed economy

Decision making on economic issues is shared out between individuals

Both the state and the individuals jointly own resources.

Market forces operate along side prices determined by the government.

Advantages of a mixed economy

Note:
In reality all economies in the world are mixed economize because state influence is ever present along side private
ventures.

PRICE THEORY
A price is a relative value of good and services in terms of money at a particular time.
Concept of a market
A Market is a situation of interaction between buyers and sellers with a view of exchanging goods and services. The
interaction may be physical or non-physical.
Essentials of a market

The commodity for sale.

Two parties are involved i.e. buyers and sellers.

There must be a ruling price in the market i.e. the monetary rate at which goods and services are
exchanged.

Location i.e. physical and non-physical

Types of markets

Competitive markets, with perfect competition.

Imperfect market, where there is limited competition.

Commodity markets, where goods and services are traded.

Factor markets, where factors of production are traded.

Free markets where government (central authorities) exerts no control

Controlled markets; where government or central authorities exert a degree of control e.g. by fixing
prices and setting quotas etc.

Spot markets; commodity or a currency is traded for immediate delivery and future markets is where
a commodity is traded for future delivery.

PRICE DETERMINATION IN THE MARKET

Prices in the market are determined in various ways.

Haggling/bargaining

Refers to the price negotiation process between one buyer and one seller where the seller keeps on reducing the
price and buyer keeps on increasing the amounts he is willing to pay until they both agree on the same price.Its
however, a tiresome and time-consuming method.
Fixing treaties
The buyer and seller come together to fix the price of a product or service which (price) is later revised by amending
the treaty e.g. coffee prices are fixed by international coffee agreement.
Sales auction
Here theres one seller and many buyers who compete for the commodity by offering high prices and the highest
(buyer who offers the highest price) takes the commodity.
Price controls: prices are fixed by the government
Forces of demand and supply
This is where price determination depends on the forces of demand and supply on the market.
DEMAND AND SUPPLY THEORIES
DEMAND THEORY
Demand refers to desire for a product or service backed by the willingness to have the desired commodity.
Effective demand refers to the actual buying of the commodity.
Quantity demanded
This refers to the amount of a commodity that buyers are willing and able to purchase per period of time.

Quantity actually demanded i.e. quantity available in the market is referred to as effective demand.
FACTORS THAT DETERMINED QUANTITY DEMANDED OF A COMMODITY
Assuming other factors constant (ceteris paribus), the following factors determined quantity demanded.
1.

Price of the commodity

When price of a commodity falls, consumers buy more of it and when the prices increase consumers leave it and buy
substitutes which are cheaper.
2.

Prices of other products

Increase or decrease in prices of other products e.g. substitutes, complements etc affect quantity demanded.
Substitutes: This is where two products or services satisfy the same demand e.g. petrol and diesel, meat and fish
etc. Increase in the price of substitutes result into increase of quantity of a commodity demanded while fall in prices of
substitutes reduces quantity demanded of the commodity.
Complements: Here, commodities are jointly demanded e.g. cell phones and airtime, cars and petrol, food and
drinks etc. Increase in prices of complements decrease quantity demanded of the product and fall in price of
complements increase products quantity demanded.
3.

Changes in the Income of the consumer

Rise in incomes is expected to cause increase in quantity demanded although only in case of normal goods.
For inferior goods, as consumers income increases, quantity demanded falls since the consumer considers the
product too cheap for him and shifts to more expensive products presumed to be of a high quality.
For necessities, even if income increases, quantity demanded cannot increase after a certain level e.g. slat,
foodstuff etc.
4.

Tastes and Preferences

These depend on habit, age, sex, education, religion, time etc. When they are favourable to the product, quantity
demanded falls when such conditions are unfavorable e.g. quantity demanded of raincoats and sweaters is high
during the wet seasons compared to dry seasons.
5.

Government policy

Taxes reduce disposal income of consumers; therefore increase in taxation reduces quantity demanded whereas
reduction in taxation increases quantity demanded. However Subsidization where governments avails commodities to
consumers at lower pries than the market price quantity demanded increases.
6.

Past levels of demand

Consumers tend to maintain the same level of demand therefore the higher the past levels of demand the greater the
quantity demanded in the present period and vise versa. Past income levels higher incomes in the past imply there
would be savings to be spent in the present period.

7.

Price expectations

When prices are expected to increase, quantity demanded will be high because consumers prefer to buy and keep
stocks for the future fearing that prices will keep increasing. However, when prices are expected to fall, quantity
demanded would be low because consumers postpone buying the commodity expecting that prices will keep falling.
However, if incomes were low in the previous period, quantity demanded would be low because little or no savings
will be available to be spent in the present period

8.

Seasonal factor

If it is a season for a commodity its demand will be high e.g. during the rainy season, the demand for rain coats is
high and vice versa.
9.

Population size

Increase in population increases quantity demanded while quantity demanded reduces with decrease in population.
10. Income distributions
Fair distribution of income increases quantity demanded unlike unfair income distribution where money or income is
held in hands of a few people.
DEMAND SCHEDULE
Its a numerical representation showing quantity demanded at various price levels.
Illustration
Price (shillings) per unit Kg

Quantity demanded per period of time

(kilograms)

1500

20

1000

40

60

A demand schedule showing quantity demanded by one household at various prices referred to as an individual
household demand schedule.
On the other hand, a market demand schedule shows total households for a commodity by all households in the
market of a commodity.
THE DEMAND CURVE

Its a graphical representation demand schedule.

Its referred to as a locus of points showing quantity of a product or service demanded at various price levels over a
period of time.
Its drawn on the assumption that the higher the price, the lower the quantity demanded, other factors remaining
constant (ceteris paribus)
Ceteris Paribus
This is a Latin word meaning Holding other factors constant.
Illustration

The demand curve illustrates an increase in prices from OP1 to OP2 decreases quantity demanded from OQ1 to
OQ2.
The demand curve can be drawn for an individual demand or market demand.
A market demand curve is the horizontal summation of all individual household demand curves.

THE SLOPE OF THE DEMAND CURVE

The demand curve slopes from left to right i.e. it has a negative slope this is in an agreement with the law of demand
which states that The higher the price the lower the quantity demanded the lower the price the higher the quantity
demanded.
The slope of the demand curve therefore can be explained by the following reasons:
1.

Income effect / real income effect

A decrease in price of a commodity increases the real income of the individual. Real income is the amount of goods
and services that an individual can buy using his / her money income or nominal income.
Real income increases with price reduction and decreases in price increase e.g. if the income of a consumer is
1000Shs and price of a commodity is 100Shs he can therefore buy ten pens and his nominal income is 1000Shs.
However if the price increases to 200Shs he can only buy 5 pens therefore more is bought at lower prices and less at
higher prices. This justifies the negative slope of the demand curve.
2.

Substitution effect

This refers to a situation where consumers will substitute goods whose prices have fallen or remained stable for
those goods whose prices have increased. An increase in the price of a substitute means that people will buy less of
it and buy more of its substitute. However a fall of price in this commodity will imply that people will shift from the
substitute and demand more of this commodity and hence the negative slope.

3.

The presence of low income earners

Low income earners consume more at owner prices and less at higher prices. This is because they have limited
income in relationship to goods. This is not true with rich people. Rich people can even demand at higher prices.
4.

The many uses of a commodity

Some commodity serves the different purposes e.g. electricity. An increase in price of such commodity will imply that
many uses of this commodity are reduced or done away with (at down).
The commodity will only be used for the most essential services / uses hence less of it being demanded. However a
fall in price of such commodity will imply that a commodity will be used for many uses hence more of it being demand
e.g. if the price of electricity goes up, consumers may only use it for lighting but if the price goes down they will use it
for many purposes e.g. ironing, cooking, e.t.c. this justifies the slope of the demand curve.
5.

Price effect

Quantity demanded will always increase due to the fall in price and vice verse. This is because consumers are
always assumed to be rational i.e. having a fair judgment. They will try to maximize quantity and minimize price
hence the negative slope of the demand curve.
6.

Due to the law of diminishing marginal utility

This law states that As more and more units of a commodity are successively consumed, total utility increase but
extra satisfaction / marginal utility decreases therefore one will be willing to pay at higher price when marginal utility
is very high and then willing to pay a lower price when marginal utility is low. Thus the negative slope of the demand
curve

THE DEMAND FUNCTION

This is a technical algebraic relationship between quantity demanded and the price of the commodity.

EXCEPTIONS OF THE LAW OF DEMAND

An exemption demand curve is that one, which disobeys the law of demand i.e. of sloping from, left to right. Therefore
it takes a different shape in contrast to the typical normal demand curve. Exceptional demand curves are sometimes
called abnormal demand curves or regressive demand curves / perverse demand curve. Some are vertical other
have positive slope and some have a backward bending slope. This phenomenon / scenario can be explained by
different factors and they include the following:-

1.

Giffen goods / giffen paradox

This is the special type of inferior good whose demand increases whenever there is an increase in price. This is
because people cut down of the expenditure of other goods and concentrate on buying this good. Giffen goods are
majority consumed by the poor. E.g. basic food stuffs like Posho and beans. It is assumed that whenever prices
increase of such commodity then its substitutes are manageable e.g. matooke and rice.

A giffen paradox means the unusual situation where quantity demanded increases with increasing prices. This
abnormal situation presents a paradox.
Note;
Inferior goods are those goods whose consumption increases when peoples income fall. They are basically goods of
the people. All giffen goods are inferior goods this is because prices are subject to income i.e. when prices increase
real incomes fall and vice-verse.
2.

Luxurious goods / superior / goods of ostentation

This is sometimes called conspicuous consumption. There are goods that attract consumers who are well of these
people believe that the higher the price the better the quality of the commodity. In most cases they buy these gods to
show people that they are rich or to impress the public. E.g. luxury cars, golden watches and necklaces

3.

Goods of necessity:

These are goods which are demanded as a matter of necessity i.e. goods which man can not do without. These
goods continue to be demanded even at higher prices. A price reduction does not guarantee more being bought

4.

Depression effect

This is a period when there is low economic activity i.e. low output, low prices, low incomes, low investments low
aggregate demand. In other words the economy is stagnant. During this period quantity demanded remains low even
at low prices.
5.

Ignorance effect

This is a situation where some commodities may be mistaken for others of higher quantity. This may either be due to
packing or labeling. Advertisement may also affect demand of the commodity e.g. quantity may increase when prices
are increasing due to lack of facts and knowledge about market conditions. This can cause abnormal demand curve.
6.

Speculation / future price expectation

When individual anticipate that prices may rise in future, they will always tend to buy more even when prices are
rising this is because they have a fear of worse prices in future. I.e. prices rising further.
7.

War situations

During periods of war people tend to buy more even at higher prices. This is because they will always think that
scarcity of commodities will worsen because of the breakdown in production processes associated with war.
8.

Demonstration effect

This is the situation where an individual may demand for the commodity either by copying or limiting others such that
an increase in price of that commodity will not affect quantity demanded of that commodity. This is because people
are buying because they want to be identified with a certain category of people. This is sometimes called snob appeal
/ veblem effect or Bandwagon effect.
Question 1.
a)

Explain why people tend to demand more of a commodity when its price falls.
(10 marks)

b)

What are the exceptions to this phenomenon?

(10 marks)

Question 2.
a)

Account for the slope of the demand curve.

b)

Under what conditions may a law of demand fail to apply?

(10 marks)
(10 marks)

CONTRACTION AND EXPANSION IN DEMAND (CHANGE IN QUANTITY DEMANDED)

This refers to increase or decrease in the amount one is willing to buy due to changes in the price I that particular
commodity as other factors are held constant.
It is illustrated by a movement downwards or upwards along the same demand curve.

A movement downwards indicates increase in quantity demanded due to a fall in the price of a commodity.
This is also referred to as expansion in demand. A movement upwards indicates increase fall in quantity demanded
due to a rise in the price of the commodity.
This is also referred to as contraction in demand.

EXTENSION IN DEMAND/CHANGE IN DEMAND (INCREASE OR DECREASE IN DEMAND)

This refers to changes in the demand of a commodity due to changes in other determinants of demand other than
price of the commodity.
It is illustrated by a rightward or leftward shift in the demand curve.
A rightward shift indicates increase in demand where as a leftward shift indicates a decrease in demand.

A rightward shift can be caused by a

Rise in income,

A rise in the price of a substitute,

A fall in price of a complement,

A change in tastes and preferences in favour of a commodity,

An increase in population,

A redistribution of income towards groups who like the commodity

Expectations that the future relative price of a commodity will rise

INTER-RELATED DEMAND OF COMMODITIES

It is normally observed that demand for a particular commodity affect the demand for other commodities. This may be
explained under the following expressions.
Joint demand / complementary demand
This is where commodities are demanded or consumed together / jointly or simultaneously e.g. petrol and car, sugar
and milk e.t.c.
With joint demand if quantity demanded for one goes up quantity demanded of others also goes up.
Competitive demand
This is a demand of a commodity where two commodities can serve the same purpose i.e. one can work in the place
of another. An increase in demand for a commodity leads to a decrease in quantity demanded of another. This
applies to substitute goods e.g. Butter and cheese.

Composite demand
This is the demand for a commodity that serves several uses e.g. electricity. Electricity can be demanded for uses
such as cooking, ironing, and lighting. Even if the demand for one use falls, such a commodity can still be demanded
for other uses.
Derived demand
This is the demand for a commodity as a result of demand for another commodity e.g. by-products. The demand for
factors of production tends to be derived demand. I.e. they are mainly demanded because of the goods and services
they can produce. The demand for beans and maize will lead to an increase in demand for land and labour so as to
produce these goods
THE SUPPLY THEORY
Supply refers to the quantity of goods and services producers are willing to offer for sell at a given price and a given
time.
The supply schedule
This refers to the table showing the relationship between price and the amount of goods and services producers are
willing to sell. It can also be said to be a numerical relationship between price and quantity supplied of a given
commodity.
A Hypothetical supply schedule

Price

Quantity demanded

130

12

140

16

145

18

150

20

160

25

At low prices less is supplied and at high prices more is offered for sale in the market. Therefore form the supply
schedule, the formation can put on the graph to form a supply curve.
The supply curve

From the graph above the following information can be given.

-

The supply curve slopes upwards from left to right.

There is a direct relationship between quantity supplied and price.

The two observations above do lead to the law of supply and it states that the higher the price the higher the quantity
supplied and the lower the price the lower the quantity supplied; ceteris paribus.
FACTORS AFFECTING QUANTITY SUPPLIED

1.

The price of the commodity

Government policy

Gestation period

Demand for other commodities.

Number of producers.

The level of technology.

The cost of production.

Working conditions.

Aims or goals of a firm.

The Price Of The Commodity

From the law of supply it can be observed that prices influences quantity supplied. More of goods and services are
supplied at high prices and low quantity is supplied at low prices. Supplies are also assumed to rational and therefore
they aim at maximizing their gains from the output.
2.

Price Of Other Related Commodities

The best aim of a produce it is profit Maximization. Implying that producers are always looking for profitable areas
e.g. if the price of pork increases to comp are to that of beef, producers will out down on the production of beef / cattle
and they driver to the rearing of pigs for pork.
3.

The Cost Of Production

If the cost of the factors of are high then less will be produced than supplied e.g. if the cost of land is high is high
supply for agricultural products will be low and vice-verse.
4.

The Method Of Production Level Of Technology

Advanced and efficient methods of production leads to more being produced and supplied while a poor method of
production leads to less pro-activity and less supply e.g. a farmer using a tractor to produce and supply more
compared to the one using a hoe.
5.

Availability Of Raw Materials

If factors pf production or raw materials are available in abundancy, production and supply of a commodity will be
high and vice-verse. E.g. a man with 10 hectares of land will produce more compared to a man with a half hectare of
land.
6.

Working Conditions

Labour is an influential factor of production, therefore the working conditions and the level of training for labour will
influence the amount of supply e.g. if working conditions are good supply will high e.g. medical care, food, leisure
time. e.t.c.
7.

Aims Or Goals Of A Firm

Usually firms pursue goals such as profit maximization, market sharing, sales maximization e.t.c. if a firm is profit
oriented; there will a possibility of limited supply. However if a firm aims at the sales maximization there will size in the
increased supply in the market.
8.

The Number Of Firms

If there are many producers of a certain commodity, supply will tend to rise in the market compared to where there is
few or only once supplier.
9.

Natural Factors

This applies mainly to agriculture products such that during periods of good season e.g. enough rainfall, absence of
floods, pests and diseases supply will high however during periods of disaster less will be produced.

10.

Gestation Period / Time Lag

If a commodity takes along to be produced then its supply tends to be low or fixed in the short run e.g. the supply of
coffee can not be raised with in a short period. however if it takes a short period to produce a commodity then its
supply will be high even in the short run e.g. bread.
11.

Government Policy

This may be in forms of taxes and subsidies. If the government imposes a tax on a producer, the effect will be
released in the amount supplied of that commodity i.e. less will be supplied however if a commodity is subsided the
result will be high supply.
CHANGE IN QUANTITY SUPPLIED
This refers to changes in quantity supplied of a commodity resulting from change in price. It is shown as a movement
along the same supply curve and it is caused by changes in price while other factors affecting supply remain
constant.

The movement along the supply curve upwards implies an increase in quantity supplied as a result of an increase in
price i.e. from p1 to p2. However a movement along the supply curve downwards implies a fall in quantity supplied
due to change in price from p2 to p1.
CHANGE IN SUPPLY / SHIFT IN SUPPLY

This refers to change in quantity supplied resulting from changes in other factors affecting supply other than price.

The change in supply is sometimes referred to as shift of the supply curve either to the right or to the left.

Quantity supplied can increase or decrease between Q2 and Q3 at a constant price P1

THE SUPPLY FUNCTION
This is a technical or algebraic relationship between quantity supplies and changes in the price of the commodity.

REGRESSIVE SUPPLY CURVES

These are curves that disobey the law of supply. These curves take different directions and therefore are called
abnormal supply curves.

1.

The fixed supply curve

This is where a supply curve takes a vertical direction implying that the supply of a good is fixed to respective of the
price if that commodity and example is land.

2.

Regressive supply curve of labour

This is where the supply curve disobeys the law of supply and is back ward bending e.g. the supply curve of labour.

The higher the wages paid to labour the lower the labour supplies. This is due to some reasons.

(i). Leisure preference. This is the preference of leisure to work between some people. When wages
rise beyond a certain points workers tend to reduce on the number of hours to work so that they
can enjoy more leisure.

(ii). Age: Age tends to reduce an individuals ability do work. Therefore even if is paid a lot of money
he/she will work less due to age.
(iii). Target workers: Some people work for certain targets. E.g. to buy bicycle, to build the house e.t.c.
once they have achieved these targets they tend to work less or even they can stop working.
(iv). Fatigue: i.e. humans are not like machines. the more they work the more tired they become and
therefore they will less even if they are paid a lot money Wages
3.

Supply at a fixed price / perfectly Elastic supply

This mainly happens

international a commodity agreements e.g. international coffee agreement (I C A),

International tea agreement (I T A) in this case prices are usually fixed at a price determined by the producing and
consuming countries.
No individual country can price without permission of other countries.

In the figure above the price given by international commodity agreement is fixed at price but supply is perfectly
elastic i.e. quantity supplied can change but price does not change.

DIFFERENT FORMS OF PRICE

(a )

Market price

This is the prevailing price of a commodity with in the market and it may or may not be the equilibrium price. It is
sometimes described as day to day price or the ruling price. From the market price, the forces of demand and supply
tend to react to one another to form the equilibrium in price.
(b )

Equilibrium price

This is the price determined by the intersection of demand and supply forces i.e. what is demanded equals what is
supplied at this price. It is a price attained when demand and supply curves meet.

(c )

Normal price

This is the price which is attained after along period of time ruling in the market. It is the equilibrium price but when it
has taken along period of time ruling with in the market.
(d )

Reserve price / reservation price.

This is a price at which a seller is wiling to sell off her / his product but below which he / she cant sell her / his
product. It is a minimum price at which a seller can sell off his / her product.
It is determined by the following factors:(i). The cost of production i.e. if the cost of production is expected to rise, reserve price would be high
and vice-verse.
(ii). Future demand for that commodity i.e. if demand is expected to rise the reserve price will be high
and the reverse is true.
(iii). Durability of the commodity the reserve price for durable goods tends to be high while the reserve
price for perishable goods tends to be low.
(iv). Cash flow requirements be agency at which cash is required. If there is a great need for money the
reserve price will be low.

CONSUMER AND PRODUCERS SURPLUS

The consumers surplus
This is the difference between the price a consumer is willing to pay and the actual price he pays for the commodity.
e.g. if a consumer goes to the market to buy 1 kg of meat at Shs 2000 but he finds the same kg at Shs 1500 he then
enjoys the surplus of Shs 500
Alternatively consumers surplus to extra utility enjoyed by a consumer without paying for it.
Graphically consumers surplus is represented by the area above the market price and below the demand curve.
Mathematically consumers surplus is represented by the difference between total utility and marginal utility i.e. TU
MU = consumers surplus.
Question
Study the table below and answer the questions that follow:-

Price (Shs)

Quantity demanded

300

250

200

150

100

50

Using Shs 150 as the fixed market price

i)

calculate the consumers surplus

ii)

Illustrate the level of consumers surplus on the graph

The producers surplus

This refers to the difference between the price a producer is willing to charge and what he actually charges.

Price

Quantity supplied

300

350

400

450

500

550

650

MU TU
MU = 550 x 6 = 3,300Shs
TU = 300 + 350 + 400 + 450 + 500 + 550 + = 2250
Producers surplus = 3300 2200 = 750Shs

Graphically producers surplus is represented by the above the supply curve and below the market price. Graphically
it is shown as below: -

supply

MARKET EQUILIBRIUM
When supply and demand are equal (i.e. when the supply curve and demand curve intersect) the economy is said to
be at equilibrium.
At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the
same as the amount of goods being demanded.

DETERMINATION OF EQUILIBRIUM PRICE AND QUANTITY USING THE DEMAND AND SUPPLY FUNCTIONS

Given the following functions:

Qd = 36 4P
Qs = -12 + 12P,
Calculate the equilibrium price and quantity.
SOLUTION

DEVIATIONS FROM EQUILIBRIUM

Maximum Price Legislation: This is where the government sets the maximum price of a commodity such that it
becomes illegal for one to buy or sell above that price. It is usually imposed in periods of scarcity of commodities.

Effects of Maximum Price Legislation

If the government sets the maximum price at OP2;
(i).
(ii).

There would be excess demand.

Artificial shortage of the commodity where sellers board commodities to create shortage and sell at
very high prices

(iii).

Black-market would prevail i.e. a market in which commodities are sold illegally are prices that
violate the restriction. Sellers would break the law and sell at very low prices behind the counters.

(iv).

Bribery, corruption and selling of scarce commodities to only friends

MINIMUM PRICE LEGISLATION (PRICE FLOOR)

This is where the government fixes minimum prices of commodities such that it becomes for one to sell or buy below
that price.

COMPUTING CONSUMER SURPLUS, PRODUCERS SURPLUS SHORTAGE AND EXCESS SUPPLY USING
THE DEMAND AND SUPPLY FUNCTIONS

THE CONCEPT OF ELASTICITY

Elasticity refers to the degree of responsiveness of one valuable to another valuable in an economy. It can also be
defined as the responsiveness of consumers and producers to changes in the prevailing conditions in the market.
The concept of elasticity is divided into two special areas i.e. elasticity of demand and elasticity of supply.
ELASTICITY OF DEMAND
This is the degree of responsiveness of quantity demanded due to changes in any of the factors affecting demand. It
can also be defined as the percentage change in quantity demanded due to a percentage change in any of the
factors affecting demand. Under elasticity of demand there are several sub-divisions and these include:

Price elasticity of demand

Income elasticity of demand

Cross elasticity of demand

PRICE ELASTICITY OF DEMAND

This refers to a percentage change in quantity demanded resulting from a percentage change in price of that very
commodity. Alternatively it can be said to be the degree of responsiveness of quantity demanded of a commodity due
to changes in price of that particular commodity.

Note:
Price elasticity of demand is always positive because it expresses a ratio / relationship between price and quantity
demanded therefore when we get a negative answer we multiply it with a negative sign to get a positive answer.

Interpretation of elasticity of demand

PED variation

Interpretation

Explanation

If equal to zero

Demand is perfectly inelastic

Quantity demanded does not

change even if price changes
by any proportion.

If equal to one

Demand is unitary elastic

A percentage change in price

leads to an equal percentage
change in quantity
demanded

If infinite

Demand is perfectly elastic

At a constant t price quantity

demanded can change by
any percentage.

If greater than zero but less than

Demand is inelastic

one

A greater proportionate
change in price leads to a
smaller proportionate change
in quantity demanded.

If greater than one but not

infinite

Demand is elastic

Quantity demanded changes

by a bigger proportion due to
a smaller proportionate
change in the price.

ILLUSTRATIONS

This means that a fall in price reduces total revenue where as an increase in price increases total revenue.

This implies that selling more or less of the commodity will not change total revenue.

This means that customers will buy nothing until price 0P0 is reached and then they will buy all they can at that price.

This means that a fall in price reduces total revenue where as an increase in price increases total revenue.

This means that reducing the price of a commodity will increase the total revenue and vice-versa.
Example one
The quantity demanded of a certain commodity X is 200 units when the price is Shs 500; however when the price
increases to Shs. 1000 quantity demanded goes down to 100 units. Calculate the price elasticity of demand.

Example two
Below is demand schedule for fish

Calculate price elasticity of demand in the following price levels.

When Price increases from Shs 1000 to Shs 1500
When Price decreases from Shs 6000 to Shs 5000
In which price level should the government levy high taxes and why?

Question (iii)
The government should levy high tax rates in the first price level i.e. 1000 to 1500 where the elasticity of demand is
price inelastic. Here, its possible for the producer to shift a bigger tax burden to the consumer in form of raised prices
without significantly affecting the quantity demanded. Thus, the government will raise more tax revenue.
MEASUREMENT OF PRICE ELASTICITY OF DEMAND
There are two methods of measuring price elasticity of demand namely:

Point of elasticity of demand

Arc elasticity of demand

Point elasticity of demand

This refers to elasticity of demand at a given point on the demand curve. It is the most common method used when
calculating price elasticity of demand. It is given as a point on the demand curve. Point elasticity of demand can be
therefore be measured as

Graphically below it is expressed at point a or b

Arc Elasticity of Demand

This refers to elasticity between two points i.e. it is sometimes called average elasticity of demand. Graphically above
it is expressed between points a and b.
Arc Elasticity of demand =

Basing on the above diagram, calculate the arc elasticity of demand from point a, to b

FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

Elasticity of demand for any commodity is affected by a number of factors and these include:1.

The nature of the commodity: The elasticity of demand for any commodity depends upon
whether the commodity is necessity or luxury. The demand for a necessity such as salt is
general inelastic. This is because the demand for such goods does not change very much with
a rise or a fall in prices. However, luxurious goods have elastic demand this is because a small
change in their prices will lead to a relatively bigger change in their quantity demanded.

2.

Availability of substitutes: Commodities which have variety of cross substitutes tend to have
elastic demand e.g. toothpaste and different brands of bread. However, commodities which
have few or no cross substitute tend to inelastic demand.

3.

Variety of uses: commodities that have more than one use tend to have inelastic demand this
is because even if they are not demanded for one use they will be demand for E.g. electricity.
However commodities with limited or one use tend to have elastic demand this is because once
that use is suspended or controlled then less of them will be demanded.

4.

Habit forming nature of the commodity: Commodities which tend to form habits among
people have inelastic demand e.g. cigarettes and alcohol. This is because the moment some
one has started consuming them he/she can hardly to stop demand for commodities which are
not habit forming tend to be elastic.

5.

Goods that are jointly demanded and consumed together such as cars and petrol tend to
have inelastic demand: This is because once one commodity is demanded its complementary
good must be demanded.

6.

Differed consumption: Commodities whose consumption can be postponed normally have

elastic demand i.e. because people can do with out them at a given point. However those
goods whose consumption can not be postponed tend to have inelastic demand.

7.

Income group or peoples income: People who belong to a higher income group normally
have demand for their commodities as being inelastic however individuals in lower income
groups have demand for their commodities being elastic.

8.

The proportional of income spent on the commodity: If consumers spend small proportional
of their income on a commodity it means the demand for such commodity will be inelastic
because their amount does not matter to the consumers so much e.g. needles matchboxes.
However commodities which necessity a larger proportion will always have their demand being
elastic e.g. mobile phones, cars.

9.

Price levels: when the price level is high for a given commodity demand for such commodity is
elastic compared when the price level is low i.e. this makes demand to be inelastic.

10.

Time factor / time lag: The shorter the time the consumer takes to buy a commodity the more
in elastic the demand for such commodity will be. However if it takes along time the consumer
to buy the commodity then demand for such commodity will be inelastic e.g. demand for a
television set.

IMPORTANCE OF PRICE ELASTICITY OF DEMAND

The concept of price elasticity of demand is of a great importance in understanding economic problems and policies
e.g. in the day to day operation of economic activities. This is in regard to the consumer to the producer and to the
government.

(A )

To the consumer:

It helps the consumer to determine his expenditure on goods and services consumed i.e. as prices change he
changes his consumption behaviour or pattern e.g. if demand for the commodity is in elastic it helps him in budgeting
i.e. his expenditure decreases as the prices increase where as if demand is elastic his expenditure will always
increase as prices decreases due to the cheapness of the commodity.
(B )

To the Producer
Determination of price by a monopolist: A producer who is a monopolist has to put into

consideration the elasticity of demand. When the demand for his product is elastic, he will get
more profits by fixing a low price. However, in case demand is in elastic he will get more profits
by fixing the price.
Price discrimination: He can use the concept of price elasticity of demand when pricing his

commodity to different users / markets. In market where demand is elastic he will lower the
price however in the market where demand is inelastic he changes high prices. This
combination will bring him a lot of money.
Determining the price of utility: when services tendered by public utilities e.g. UMEME Ltd

and NWSC have inelastic demand then the higher rate of individual/domestic consumption
However, when demand is elastic for these utilities the lower rate will be charged e.g. commercial demand for
electricity and water.
(C )

Government

Nationalization: This is where the government takes over full control and ownership of production
ventures which were originary privately owned and controlled. The government will most nationalize
production ventures whose products are price inelastic in order to limit the exploitation of consumers by
producers.

Raising revenue / taxation: The government will always charge heavy taxes on goods whose demand
is price inelastic. This is because an increase in taxes rises the price of the commodity and therefore
the government will get more revenue if elastic of the commodity is inelastic. Consumers will continue to
consume that commodity even at a higher price and therefore paying the tax.

Protection of home infant industries: The government will always protect home infant industries from
competition of foreign firms through restriction of imports by imposing heavy taxes. This will be
successful only if the demand for such products / imports is elastic. This makes imports expensive and
home products cheaper. On the other hand protectionism will not succeed if the price elasticity of
demand or imports is inelastic.

Devaluation: this is a legal reduction in the value of a countrys currency in terms of other currencies.
Devaluation is intended to increase exports by making them cheaper. And reducing imports by making
them expensive hence improving balance of payment position, devaluation will be successful if price
elasticity of demand for imports is price elastic.

INCOME ELASTICITY OF DEMAND

This refers to the percentage in quantity demanded as a result of a percentage change in consumers income.
Alternatively it can be defined of responsiveness of quantity demanded due to changes in consumers income.
Therefore income elasticity of demand can be derived as follows:-

OR

Question
The quantity demanded of a certain is 250 units when the level of income Shs 5000. However, when income goes up
to Shs7500 quantity demanded goes down to 200 units.
Calculate the income elasticity of demand:
ANSWER:

The concept of income elasticity of demand has great importance in distinguishing the nature of goods.
When income elasticity of demand is negative the commodity in question in an inferior good. This implies that an
increase in ones income brings about a fall in quantity demanded of that commodity.
When income elasticity of demand is positive it means that the commodity in question is a normal good. This implies
that an increase in peoples income brings about an increase in quantity demanded of that commodity.
When income elasticity of demand is zero it means that the commodity in question in necessity

Question
Study the table below showing income and quantity demanded of a commodity x and answer the questions that
follow:Income (Ug Shs)

Quantity demanded of x (kg)

10,000

50

30,000

20

i)

Calculate the income elasticity of demand for commodity x.

ii)

What type of commodity is x.

CROSS ELASTICITY OF DEMAND

Cross elasticity of demand this refers to the percentage change in quantity demanded of a commodity say X due to
the percentage change in price or related commodity say Y. Alternatively it can be defined as the degree of
responsiveness of quantity of a commodity due to changes in price of related commodity. It can be derived as
follows:-

Interpretation pf cross elasticity of demand

The co-efficient of value got from cross elasticity of demand can help to describe the relationship between the
commodities and this can be as follows:-

Question:
Given that quantity demanded for commodity Y increased from 200 units to 300 units due to a fall of price of Y from
Shs 800 to Shs 600 per unit.
Calculate the cross elasticity of demand.
Given the possible examples of commodity x and y.
SOLUTION:

Question for revision:

The price of commodity p increased from 1000Shs by 28% and quantity diamonded of commodity q reduced from 40
units by 25%.

Calculate the relevant elasticity.

ELASTICITY OF SUPPLY
It is the degree of responsiveness of quantity supplied due to changes in factors affecting supply. It can also be
defined as a percentage change in quantity supplied resulting from percentage change in factors affecting supply.
It should be noted that it is difficult to measure the changes in some of the factors determining supply and as search
price is commonly used to measure elasticity of supply.
PRICE ELASTICITY OF SUPPLY
This refers to the percentage change in quantity supplied due to a percentage change in price of a commodity.
The Price Elasticity of Supply measures the rate of response of quantity demand due to a price change
PES = (% Change in Quantity Supplied)/ (% Change in Price)
Calculating the Price Elasticity of Supply
Given the following data,

Calculate the price elasticity of supply when the price changes from Shs 900 to
Shs 1000

How Do We Interpret the Price Elasticity of Supply?

The price elasticity of supply is used to see how sensitive the supply of a good is to a price change.
The higher the price elasticity, the more sensitive producers and sellers are to price changes.
Very high price elasticity suggests that when the price of a good goes up, sellers will supply a great deal less of the
good and when the price of that good goes down, sellers will supply a great deal more. Very low price elasticity
implies just the opposite, that changes in price have little influence on supply.
If PES > 1 then Supply is Price Elastic (Supply is sensitive to price changes)
If PES = 1 then Supply is Unit Elastic
If PES < 1 then Supply is Price Inelastic (Supply is not sensitive to price changes)
If PES = 0 then supply is perfectly inelastic
If PES = infinity, then supply is perfectly elastic
ILLUSTRATING PRICE ELASTICITY OF SUPPLY

FACTORS THAT AFFECT PRICE ELASTICITY OF SUPPLY

1.

Gestation period / Time lag: When the gestation period is short the supply of a commodity will
be elastic because in case of an increase in prices, quantity supplied will take a short period of
time. In case of a long gestation period the reverse is true.

2.

Business Expectations: If people expected future prices to fall the supply of a commodity will
be inelastic. However if prices are expected to rise future prices will be elastic.

3.

Nature of the commodity perishable goods have inelastic supply because they cant be stored
for long e.g. tomatoes, fruits e.t.c. however durable goods such as coffee, cotton have elastic
supply. This is because they can be stored once prices are low.

4.

Costs of production: When the costs of a commodity are high, its production will be low
leading to inelastic supply. However, when production costs are low the production of a
commodity will increase in case of price increases hence elastic supply.

5.

Availability of raw materials (F.O.P): When resources for the production of a commodity are
easily available, production can easily increase in case of prices increases hence supply being
elastic and the reverse is true when factors of production are available.

6.

The number of firms engaged in the production of a commodity. In case there are many
firms supplying that commodity, production of such commodity will be high and hence supply
being elastic and the reserve is true.

7.

The mode of production or the level of technology: If production is carried out inefficiently
with a better technology more out put will be produced and supplied hence supply being elastic.
However, if the production process is poor or inefficient there will be a tendency to produce low
output even if prices are high hence supply being inelastic.

8.

Natural factors; during periods of good weather conditions, supply will increase when prices
are high making supply elastic however during periods of natural hazards e.g. during drought
little will be produced hence making supply inelastic.

9.

Government Policy Government policy can influence supply to be elastic or inelastic e.g.
high taxes increase the cost of production hence produce output and this makes supply to be
inelastic. However, subsidies towards to the production of a commodity led to increase output
making supply elastic.

10.

Market structure: In case of a monopoly, market structure output tends to be low due to
restricted supply with a view of getting high prices this makes supply to be inelastic however,
under competitive market

APPLICATION OF PRICE ELASTICITY OF SUPPLY

1.

When supply is perfectly inelastic, a shift in the demand curve has no effect on the equilibrium
quantity supplied onto the market. Examples include the supply of tickets for sports or musical
venues, and the short run supply of agricultural products (where the yield is fixed at harvest
time) the elasticity of supply = zero when the supply curve is vertical.

2.

When supply is perfectly elastic a firm can supply any amount at the same price. This occurs
when the firm can supply at a constant cost per unit and has no capacity limits to its production.
A change in demand alters the equilibrium quantity but not the market clearing price.

3.

When supply is relatively inelastic a change in demand affects the price more than the quantity
supplied. The reverse is the case when supply is relatively elastic. A change in demand can be
met without a change in market price.