Principals of Economics for Law class 1 By Edward Gatwaza 12/03/2018 Lesson three

DEMAND, SUPPLY AND THE PRICE MECHANISM 3.1. MARKET Market is a place where buyers and sellers meet. Some examples of markets, Nyarugeng market in Kigali. There is a famous Nyagasambu market. Market A market is the number of people. When a person says I have got a market for my photocopying business on campus, he may be referring to the fact that since there is many people willing and able to photocopy then he will get profit. But the amount of money they have and are willing to use in the market is also important

Markets and competition A market is a group of buyers and sellers of a particular good or service. The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets. 4

Markets and competition Buyers determine demand. Sellers determine supply 4

3.2. DEMAND 3.2.1. Meaning Desire refers to people’s willingness to own a good. Demand is the amount of good that consumers are willing and able to buy at a given price. 3.2.2. Law of demand The law of demand states that as price rises quantity that is demanded falls and as prices fall more goods are demanded. The result is a downward sloping curve from the left to the right. A demand curve is has a negative slope

Demand schedule ntity demanded The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. 17

3.2.3.Demand schedule Price in RWF Quantity of goods demanded 3000 10 2500 20 2000 30 1500 40 1000 50 500 60

Demand Curve The demand curve is a graph of the relationship between the price of a good and the quantity demanded.

Demand Schedule and Demand Curve Price of good Frw 3.00 2.50 1. A decrease in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of good 2. ... increases quantity demanded.

More generally the demand curve is depicted as a smooth curve

3.2.3. Determination of demand The amount of good demanded depends on: The price of the good; The income of consumers; The demand for alternative goods which could be used (substitutes); The demand for goods used at the same time (complements); Whether people like the good (consumer taste).

3.2.4. Shift in the demand curve A change in price never shifts the demand curve for that good. In the figure below an increase in price results in a movement up the demand curve. Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of the product. The fall in the quantity demanded from 8 to 4 is sometimes called a contraction in demand.

Changes in Quantity Demanded Price of good A tax that raises the price of a good results in a movement along the demand curve. B Frw2.00 A 1.00 D 4 8 Quantity of a good

Shift in the demand curve

Changes in Quantity Demanded A demand curve shifts only if there is a change in income, in taste or in the demand for substitutes or complements. In the diagram below a decrease in demand has shifted the demand curve to the left. The new demand curve shifts upwards or downwards

Shifts in the Demand Curve Price of good Increase in demand Decrease in demand Demand curve, D 2 Demand curve, D 1 Demand curve, D 3 Quantity of good Copyright©2003 Southwestern/Thomson Learning

3.2.5. Types of demand Composite demand The demand of good incorporates the total demand for all users. A demand curve for sugar includes demand for sugar to us in tea and coffee, to use in factories producing alcohol and medicine. Demand is composite because many commodities have many uses. Joint demand There are many types of commodities whose demands are tied together. Tyres of cars are demanded together. Shoes and body stockings have joint demand and so is bread and margarine.

Types of demand Derived demand Demand is derived if it would not arise had not the other commodities existed. It is not the same as joint because derived demand is a consequence of the demand of another commodity. The demand for teachers may be a consequence of building more schools or a new policy in the Country. Demand for economists may be derived from the Vision 2020 policy.

3.3. SUPPLY 3.3.1. Meaning Supply is the quantity sellers are willing to offer in the market at a given price. 3.3.2. Law of supply As prices rise quantity supplied also rises and as prices in the market fall the quantity sellers are ready to offer decreases. A table showing the relationship is a supply schedule and the curve sloes upwards from the left to the right. The slope of a supply curve is positive. The supply curve labeled SS in the figure below shows the amount of a good one or more producers are prepared to sell at different prices.

Supply schedule Supply Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied.

Supply Schedule 29

Supply Curve Price of goods Frw 3.00 2.50 1. An increase in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of goods 2. ... increases quantity of goods supplied.

3.3.3. Determinants of supply Supply depends on: The price of the good; The cost of making the good; The supply of alternative goods the producer could make with the same resources (competitive supply); The supply of goods actually produced at the same time (joint supply); Unexpected events that affect supply

Shifts in the Supply Curve Input prices Technology Expectations Number of sellers

Shifts in the Supply Curve Change in Quantity Supplied Movement along the supply curve. Caused by a change in anything that alters the quantity supplied at each price. 30

Change in Quantity Supplied Price of good S C 3.00 A rise in the price of ice cream cones results in a movement along the supply curve. A 1.00 Quantity of goods 1 5 30

Shifts in the Supply Curve Change in Supply A shift in the supply curve, either to the left or right. Caused by a change in a determinant other than price. 30

Shifts in the Supply Curve Price of good Supply curve, S 3 curve, Supply S 1 Supply curve, S 2 Decrease in supply Increase in supply Quantity of goods

3.3.5. Types of supply Composite supply Joint supply

SUPPLY AND DEMAND TOGETHER Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. 36

Supply and Demand Together Equilibrium Price The price that balances quantity supplied and quantity demanded. On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity The quantity supplied and the quantity demanded at the equilibrium price. On a graph it is the quantity at which the supply and demand curves intersect. 36

Supply and Demand together Demand Schedule Supply Schedule At $2.00, the quantity demanded is equal to the quantity supplied! 36

The Equilibrium of Supply and Demand Price of Ice-Cream Cone Supply Demand Equilibrium Equilibrium price $2.00 Equilibrium quantity 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of Ice-Cream Cones

Markets Not in Equilibrium (a) Excess Supply Price of Ice-Cream Supply Cone Surplus Demand $2.50 10 4 2.00 7 Quantity of Quantity demanded Quantity supplied Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Equilibrium Surplus When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

Equilibrium Shortage When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

Markets Not in Equilibrium (b) Excess Demand Price of Ice-Cream Supply Cone Demand $2.00 7 1.50 10 4 Shortage Quantity of Quantity supplied Quantity demanded Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Equilibrium Law of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

Three Steps to Analyzing Changes in Equilibrium Decide whether the event shifts the supply or demand curve (or both). Decide whether the curve(s) shift(s) to the left or to the right. Use the supply-and-demand diagram to see how the shift affects equilibrium price and quantity. 45

How an Increase in Demand Affects Equilibrium Price of Ice-Cream 1. Hot weather increases the demand for ice cream . . . Cone D D Supply New equilibrium $2.50 10 2. . . . resulting in a higher price . . . 2.00 7 Initial equilibrium Quantity of 3. . . . and a higher quantity sold. Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Three Steps to Analyzing Changes in Equilibrium Shifts in Curves versus Movements along Curves A shift in the supply curve is called a change in supply. A movement along a fixed supply curve is called a change in quantity supplied. A shift in the demand curve is called a change in demand. A movement along a fixed demand curve is called a change in quantity demanded.

How a Decrease in Supply Affects Equilibrium Price of 1. An increase in the price of sugar reduces the supply of ice cream. . . Ice-Cream Cone S2 S1 Demand New equilibrium $2.50 4 2. . . . resulting in a higher price of ice cream . . . Initial equilibrium 2.00 7 Quantity of 3. . . . and a lower quantity sold. Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

3.4.2. Law of demand and supply This can be stated as follows. If demand is held constant a forward shift of the supply curve will lower the equilibrium price. Likewise if supply is held as a constant a forward shift of the demand curve will result in a rise in equilibrium price. The reverse should be true. A backward shift of the supply curve when demand is held as a constant raise equilibrium price and a backward shift in the demand curve with supply held as constant should lower equilibrium price.

ELASTICITY . . . … allows us to analyze supply and demand with greater precision. … is a measure of how much buyers and sellers respond to changes in market conditions

The elasticity of demand Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.

Price Elasticity of Demand Price elasticity of demand equation: PED= Percentage change in quantity demanded/Percentage change in price Or PED=∆Q /Q÷∆P/P or Where P= the original price Q= the original quantity ∆Q= “the change in quantity demanded” And ∆P= "the change in Price

The Price Elasticity of Demand and Its Determinants Availability of Close Substitutes Necessities versus Luxuries Definition of the Market Time Horizon

The Price Elasticity of Demand and Its Determinants Demand tends to be more elastic : the larger the number of close substitutes. if the good is a luxury. the more narrowly defined the market. the longer the time period.

Computing the Price Elasticity of Demand The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

Computing the Price Elasticity of Demand Example: If the price of an ice cream cones increases from Frw2.00 to Frw2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:

3.5.2. Features of price elasticity of demand Elastic goods Inelastic goods PED value Greater than 1 Less than 1 A rise in price means A larger fall in demand A smaller fall in demand Slope of demand curve Flat Steep Number of substitutes Many Few Type of good Luxury Necessary Price of good Expensive Cheap Example Maestro car Petrol

Income Elasticity of Demand Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

Computing Income Elasticity

Income Elasticity Types of Goods Normal Goods Inferior Goods Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

THE ELASTICITY OF SUPPLY Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price. PES = % change in quantity supplied/% change in price Or PES = Or PES = P/Q x ∆Q/∆P

The Price Elasticity of Supply (a) Perfectly Inelastic Supply: Elasticity Equals 0 Price Supply $5 1. An increase in price . . . 4 100 Quantity 2. . . . leaves the quantity supplied unchanged.

The Price Elasticity of Supply (b) Inelastic Supply: Elasticity Is Less Than 1 Price Supply 110 $5 1. A 22% increase in price . . . 100 4 Quantity 2. . . . leads to a 10% increase in quantity supplied.

The Price Elasticity of Supply (c) Unit Elastic Supply: Elasticity Equals 1 Price Supply 125 $5 1. A 22% increase in price . . . 100 4 Quantity 2. . . . leads to a 22% increase in quantity supplied. Copyright©2003 Southwestern/Thomson Learning

The Price Elasticity of Supply (d) Elastic Supply: Elasticity Is Greater Than 1 Price Supply $5 200 1. A 22% increase in price . . . 4 100 Quantity 2. . . . leads to a 67% increase in quantity supplied. Copyright©2003 Southwestern/Thomson Learning

The Price Elasticity of Supply (e) Perfectly Elastic Supply: Elasticity Equals Infinity Price 1. At any price above $4, quantity supplied is infinite. $4 Supply 2. At exactly $4, producers will supply any quantity. 3. At a price below $4, quantity supplied is zero. Quantity Copyright©2003 Southwestern/Thomson Learning

Determinants of Elasticity of Supply Ability of sellers to change the amount of the good they produce. Beach-front land is inelastic. Books, cars, or manufactured goods are elastic. Time period. Supply is more elastic in the long run.

Computing the Price Elasticity of Supply The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.

3.5.4.Features of elasticity of supply Elastic goods Inelastic goods PED value Greater than 1 Less than 1 A rise in price means A larger rise in supply A smaller rise in supply Slope of supply curve Flat Steep The good is produced Rapidly Slowly The time period is Months Days The firm has Large stocks Limited stocks Example Screws Beef

Cross Elasticity of Demand Cross elasticity of demand (XED) measures the responsiveness of demand for one good (z) to a given change in the price of a second good (w): XED = Percentage in quantity demanded of good z/Percentage change in the price of good w If XED is positive then the two goods are substitutes. If XED is negative then the two goods are complements.