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Unit 2 - Syllabus
Analyses the rational behavior of household and firms in the market

1 Classifies market according to the economic analysis

Market
Classification of markets
o Goods and service market
o Factor market
2 Investigating the factors determining the market demand
Demand
Definition
o Individual demand
o Market demand
The theory of demand
o Individual demand
o Market demand

Demand function
o Individual demand function
o Market demand function
3 Analyses the relationship between the prices and the quantity demanded
The law of demand
Methods of presenting the law of demand
o Demand schedule
o Demand curve
o Demand equation
Reasons for the slope of demand
o Income effect
o Substitution effect
o Diminishing marginal utility
Exceptions to the law of demand
o Geffen goods
o Demonstrative goods
o Speculation

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4 Distinguishes between changes in quantity demanded and change in demand

Change in QD
o Increase in QD
o Decrease in QD
Change in demand
o Increase in demand
o Decrease in demand
5 Calculates elasticity to identify the types of PED
Concept of elasticity
Definition
o Point elasticity of demand
o Formula and calculation
o Arch elasticity of demand
Formulas and calculation
Elasticity categories according the coefficient of elasticity
o Price in elastic
o Inelastic
o Unitary elastic
o Elastic
o Perfectly elastic
o PED and slopes of the demand curve
o PED and demand equation
6 Examines the rational decision making in market based on PED
Determinants of PED
Price elasticity and consumer out lay
Practical relevance of PED
7 Examines rational decision making in market based on YED

YED
Definition
Formula and calculation
Classification of goods according to the elasticity coefficient
Substitute goods
Complementary goods
Practical importance of cross price elasticity of demand

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8 Examines rational decision making in market based on YED

YED
Definition
Formula and calculation
Calculation of goods according to the elasticity coefficient]
o Normal goods
o Inferior goods
o Practical importance of YED

9 Analysis the factors determining market supply

Supply
Definition
Firms supply
o Essential goods
o Luxury goods
Market supply
Theory of supply
Supply function
10 Examines the relationship between price and quantity supplied
The law of supply
Ways of presenting law of supply
o Supply curve
o Supply schedule
o Supply equation
Reasons for the law of supply
Increasing opportunity cost
11 Distinguishes between changes in quantity supply and changes in supply
Changes in QS
o Increase in QS
o Decrease in QS
o Changes in supply
Increase in supply and reasons
Decrease in supply and reasons

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12 Investigate rational decision making process in a market according to PES

Price elasticity of supply
Definition
Formula and calculation
Categories of price elasticity of supply according to elasticity coefficient
o Perfect inelastic
o Inelastic
o Unitary elastic
o Elastic
o Perfect elastic
Price elasticity of supply and slope of the supply curve
Price elasticity of supply and supply equation
Determinants of price elasticity of supply
Usefulness of price elasticity of supply and its practical applications
13 investigates the determination of price in a market
Market equilibrium
Definition
Methods of determination market equilibrium
o Demand and supply schedules
o Graphical methods
o Equations
Concepts associated with market equilibrium
14 investigates the changes equilibrium according demand and supply changes
Excess demand
Excess supply
Excess demand price
Excess supply price
Consumer surplus
Producer surplus
Change in equilibrium
Demand changing in fixed supply
Supply changing in fixed demand
Change in both demand and supply
15 investigates the impact of producer taxes on market operations
Taxes on goods and services
Specific tax/unit tax
Ad valorem tax
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Methods of presenting impact of taxes

Demand and supply schedule
Graphical method
Equations
Effects of taxes on
Equilibrium
Total outlay
Total revenue

16 investigates the distribution tax incidence according demand and supply elasticity
Consumer surplus
Producer surplus
Government revenue
Social welfare
Tax incidence of taxation on
Consumers
Producers
Tax incidence according to demand and supply elasticity
17 investigates the effects of subsidies on market operations
Producer subsidies
Unit subsidy
Ad valorem subsidy
Methods of presenting impact of subsidies
Demand and supply schedule
Graphical method
Equations
Impact of producers subsidies on
Equilibrium
Total outlay
Total revenue
Consumers surplus
18 investigates the effect of price controls on market operations
Producer surplus
Government expenditure
Social welfare
Distribution benefits of subsidies on
Consumers
Producers
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Distribution benefits of subsidies according elasticity of demand and supply

Price controls
Price ceiling/maximum price
o Graphical presentation
o Impact
Arrangements to make meaningful of price ceilings
o Rationing
o Importation
o Encourage production
Floor price / minimum price
o graphical presentation
o impact

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Rational behavior of house hold and Firms in the market

A firm exists when a person or a group of people decides to produce a product or products
By transforming inputsthat is, resources in the broadest senseinto outputs, the products
that are sold in the market
Entrepreneur A person who organizes, manages, and assumes the risks of a firm taking a new
idea or a new product and business. Turning it into a successful
The consuming units in an economy are households. Household decisions are presumably based
on individual tastes and preferences.
The household buys what it wants and can afford
Input Markets and Output Markets:
The Circular Flow
Households and firms interact in two basic kinds of markets:
Product (or output) markets
Input (or factor) markets.
o Goods and services that are intended for use by households are exchanged in
product or output markets. In output markets, firms supply and households
demand. To produce goods and services, firms must buy resources in input or
factor markets.
o Firms buy inputs from households, which supply these inputs. When a firm
decides how much to produce (supply) in output markets, it must
simultaneously decide how much of each input it needs to produce the
desired level of output.
o To produce automobiles, Ford Motor Company must use many inputs,
including tires, steel, complicated machinery, and many different kinds of
labor.
The Circular Flow of Economic Activity
Here goods and services flow clockwise: Labor services supplied by households flow to firms,
and goods and services produced by firms flow to households. Payment (usually money) flows in
the opposite (counterclockwise) direction:
Payment for goods and services flows from households to firms, and payment for labor services
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flows from firms to households

The circular flow of economic activity
through a simple market economy
Note that the flow reflects the direction in
which goods and services flow through input
and output Markets. For example, goods and
services flow from firms to households
through output Markets. Labor services flow
from households to firms through input
markets. Payment (most often in money
form) for goods and services flows in the
opposite direction.
Types of Market
Labor market: The input/factor market in
which households supply work for wages to
firms that demand labor.
Capital market: The input/factor market in which households supply their savings, for interest
or for claims to future profits, to firms that demand funds to buy capital goods.
Land markets: The input/factor markets in which households supply land or other real property
in exchange for rent.
Factors of production: The inputs into the production process. Land, labor, and capital are the
three key factors of production.
Quantity Demand
The quantity demanded is the number of units of a good that consumers are willing and can
afford to buy over a specified period of time.
A household's decision about what quantity of a particular output, or product, to demand
depends on a number of factors, including:
The price of the product in question.
The income available to the household.
The household's amount of accumulated wealth.
The prices of other products available to the household.
The household's tastes and preferences.
The household's expectations about future income, wealth, and prices.
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Individual & Market Demand

Individual demand: It refers to demand from the individuals /family/house- hold. It is a single
consuming entitys demand.
Market demand: It refers to the total demand of all buyers, taken together. It is the aggregate
of the quantities of a product demanded by all the individuals buyers at a given price over a
given period of time-it is the sum total of individual demand function
Market demand is more important from the business point of view, sales depends on market
demand ,so does planning future marketing strategy Prices are determined on the basis of
demand for the product etc.
INDIVIDUAL DEMAND
Price of the products
Income
Tastes, Habits, Preferences
Relative price of other goods-substitutes and complementary goods
Consumers Expectations
Advertisement Effect
MARKET DEMAND
Price of the product
Distribution of wealth and income in the community
Communitys common habit sand scale of preferences
General standard of living and spending habits of the people
Growth of the population
Age structure/sex ratio of the population
Future Expectations
Level of taxation and tax structure
A demand schedule is a table showing how the quantity demanded of some product
during a specified period of time changes as the price of that product changes, holding all
other determinants of quantity demanded constant.
A demand curve is a graphical depiction of a demand schedule. It shows how the
quantity demanded of some product will change as the price of that product changes
during a specified period of time, holding all other determinants of quantity demanded
constant.
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Demand function
At any point of time, the quantity of a given product
(good/service) that will be purchased by the consumers
depends on a number of key variables/determinants.
The most important variables are listed below:
The own price of the product (P)
The price of the substitute and complementary
goods(Ps or Pc)
The level of disposable income(Yd) with the
buyers(ie; income left after direct taxes)
Change in the buyers taste and preferences(T)
The advertisement effect measured through the level of advertising expenditure(A)
Changes in the population number or number of buyers(N)
o Individual demand function

o Market demand function

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Properties of Demand curve

1. They have a negative slope. An increase in price is likely to lead to a decrease in quantity
demanded, and a decrease in price is likely to lead to an increase in quantity demanded.
2. They intersect the quantity (X-) axis, a result of time limitations and diminishing marginal
Utility.
3. They intersect the price (Y-) axis, a result of limited income and wealth.
Demand Equation
A linear demand function may be stated as
D = a bP
Where, D amount demanded
a - is a constant parameter which signifies initial price irrespective of price
b- Denotes functional relationship b/w (P) &(D)
Questions on Demand Equation - Refer your workbook

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The law of demand

The law of demand expresses the nature of functional relationship b/w two variables of the
demand relation viz; the price and the quantity demanded. It simply states that demand varies
inversely to change in price.
Statement of law of demand
Ceteris paribus, the higher the price of a commodity the smaller is the quantity demanded and
lower the price, larger the quantity demanded
Other things remaining unchanged, demand varies inversely with price
so, D= f (P)
Assumptions of law of demand
The law of demand is based on certain assumptions
No change in consumers income
No change in consumers preferences
No change in fashion
No change in the price of related goods
No expectation of future price changes or shortages
No change in government policy etc.

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Reasons for downward sloping demand curve

1. Income effect
Changes in price can affect buyers' purchasing decisions; this effect is called the income
effect. Increases in price, while they don't affect the amount of your paycheck, make you
feel poorer than you were before, and so you buy less. Decreases in price make you feel
richer, and so you may feel like buying more
2. Substitution Effect
Tendency to change your purchase based on changes in relative price is called the
Substitution effect

3. 'Law of Diminishing Marginal Utility'

A law of economics stating that as a person increases consumption of a product - while
keeping consumption of other products constant - there is a decline in the marginal utility
that person derives from consuming each additional unit of that product.
Exceptions to the law of demand
The upward sloping curve is contrary to the law of demand, where there is a direct relationship
b/w price and demand
These exceptional cases can be listed as
Giffen goods : In the case of certain inferior goods called Giffen goods(named after Sir
Robert Giffen), in spite of price rise, demand will also rise. It was seen in Ireland in 19 th.
Century people were so poor that they spent a major part of income on potatoes and a
small part on meat, as price of potatoes, rose the demand also rose since they could not
substitute it for meat which was very expensive. Giffens paradox is seen the case of
inferior goods like potatoes, cheap bread etc.

Speculation : when people speculate about prices on the commodity in the future they
may not act according to the laws of demand. Speculating the prices of the commodity
will further increase they will demand more of the commodity for hoarding etc. In the
stock market, people tend to buy more shares when prices are rising in the hope of bull
runs in anticipation of future profits.

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Article of snob appeal : Certain commodities are demanded because they happen to be
expensive or prestige goods or snob value having a status symbol. So increase in price will
lead to increase in demand for such goods. E.g. Diamonds, exclusive cars etc.

Consumer psychological Bias: when a customer is wrongly biased against quality of a

commodity a fall in price may not lead to an increase in demand example clearance of
stock, discounted sale, etc.

Types of demand
The demand behavior of the consumer differs with different types of demand in the study of
managerial economics it is important to distinguish these types of demand
Demand for consumers goods and producers goods
Goods /services that are demanded by the consumer for direct satisfaction of their
wants ie; for consumption purpose- food, clothes, services of doctors ,maids, teachers
Goods that demanded by producers in the process of production are called
production goods eg; tools and equipment, machinery, raw material, factory
building, offices
Demand for consumer goods is direct /autonomous ,whereas demand for producer
goods is derived ie; based on demand for output
Dean (1976) explained this distinctive demand behavior for producer goods in the
economy.
o Buyers of producers goods are professionals /experts, so they are less likely to
be influenced by sales promotion.
o Producer buyers are more sensitive to factor price differences and substitutes.
The motive of the producers are purely economic and capital goods are bought
on account of profit prospective. The demand of producers goods is derived
from consumption demand, so there are frequent fluctuations in demand
levels.
Demand for perishable and durable goods:
Perishable goods have no durability, they cannot be stored for a long period of time
eg. Fish, egg, vegetables etc.
Durable good have a long shelf life and can be stored example furniture, car etc.
Perishable goods give a one shot service whereas durable goods can be used for
several years
Demand for perishable goods depends on convenience, style & income of the
consumer. This demand is always immediate.
Demand for durable goods depends on product design, current trends, income levels,
price etc. this demand is postponable.
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Autonomous and derived demand:

Spontaneous demand for goods is based on a urge to satisfy some want directly, such
a demand is called Autonomous demand. Demand for consumer goods is
autonomous. It is a direct demand, it is a final demand.
When the demand of the product depends on the demand of some other product, it
is called derived demand. When the demand of the product is tied to the purchase of
some parent product its demand is called derived(Dean 1976). Eg. Demand for doors
derived from demand from houses. demand for bulbs derive from demand for lamps.
Demand for dependent product is caused by complementary consumption. Example
demand for sugar emerges from demand for tea.
Demand for all capital goods are derived. Nowadays it is rare to see demand for goods
to be wholly dependent of all other demands. Most demands are derived demands.
Example demand for car by an individual is derived from demand of transportation
service.
This distinction between two types of demand is a matter of degree.
Industry demand and firm / company demand :
A firm is a business unit, whereas industry is a group of closely competitive firms.
A firms/companys demand relates to the market demand for the firms output. An
industrys refers to the to the total demand for a commodity produced by a particular
industry eg; Car industry, Sugar industry etc.
The basic relationship of a firms demand and industry/market depends on the market
structure whether perfect competition, monopoly or monopolistic competition. The
elasticity of the demand curve will vary accordingly.
Movements Along and Shifts in Demand Curves
A movement along the demand curve occurs when quantity demanded changes because of a
change in the price of the commodity alone, while other factors in conditions of demand
(income, tastes, population, price of complements and substitutes, etc) remain constant.

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A shift in the demand curve or a change in demand occurs when quantity demanded changes
only because there are changes in conditions of demand, while the price of the commodity
remains constant. The demand curve can shift either to the right or to the left, depending upon
the changes in the conditions of demand. The shift in the demand curve is shown as follows:

Factors Influencing Demand (determinants)

There are indeed several factors which affect the quantity demanded for a certain product.
1. Change in the price of the commodity itself:
Changes in the price of the commodity will lead to changes in quantity demanded. For
instance, a rise in the price of good X will lead to a fall in quantity demanded for good X.
This is because good X is now more expensive and consumers buy less.
2. Change in real income:
A change in real income means that there is a change in the quantity of goods and
services money income can buy. For most goods, an increased in real income will lead to
an increase in demand.
3. Tastes and fashion:
Demand depends on the individuals taste which is controlled and influenced by
advertising and sales promotion. A change in consumer tastes in favour of a good can
increase the demand for that commodity. This may be attributed to a successful
advertising campaign. Similarly, if a commodity is in fashion, demand will rise.
4. Changes in the prices of complements and substitutes:
Demand for a commodity depends much on the price of its complementary goods. If the
price of a complementary good falls, demand for the product will rise.
For example, if the price of car falls, demand for petrol will increase. This is because more
people will buy cars, and hence, more petrol. Thus, there exists an inverse relationship
between demand for a commodity and the price of its complements.
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Demand for a commodity is also influenced by changes in the price of its substitutes. If
the price of substitutes increases, demand for a commodity will also increase.
For example, if the price of tea increases, demand for coffee will also increase. This
is because people will buy less tea, and therefore, they will shift to coffee. Thus,
there exists a direct relationship between demand for a commodity and the price
of its substitutes.
5. Changes in population:
When the size of the total population changes, demand for goods and services would
generally change. An increase in total population would generally lead to an increase in
demand. However, the pattern of demand depends on the composition of the population
in terms of age and sex. An increase in old age people would mean a greater demand for
walking sticks, spectacles. An increase in young people would mean greater demand for
CD players. On the other hand, more females in the population indicate that demand for
goods and services consumed by women will rise.
6. Expectation of future changes in price:
Expectations by consumers of future changes in prices would affect demand. For example,
if consumers expect future increases in the price of a commodity, then they will buy more
of it now in order to avoid paying a higher price for it later.
7. Changes in distribution of income:
Demand is also affected by changes in the distribution of income within a society.
Incomes could be redistributed to achieve greater equality of income by taxing the rich
and subsidizing the poor. This would leave the poor with more money, thus, increasing
their demand for goods and services.
8. Government policy income tax:
If government imposes high income tax rate or lowers transfer payments, this would
lead to a fall in disposable incomes, thus reducing demand for the commodities.
9. Saving and Rate of interest:
An individuals desire to save would influence his demand for commodities. An increase
in savings would lead to a fall in demand since the individual forgoes present
consumption in order to save. But what encourages people to save is the rate of interest.
Hence, an increase in rate of interest will cause demand to fall.

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Elasticity
Elasticity A general concept used to quantify the response in one variable when another
variable changes.
Type of Elasticity
Price elasticity
o Price elasticity of demand
o Price elasticity of Supply
o
Income Elasticity
Cross elasticity

Price elasticity of demand

We define price elasticity of demand simply as the ratio of the percentage of change in
Quantity demanded to the percentage change in price.
Percentage changes should always carry the sign (plus or minus) of the change. Positive
Changes, or increases, take a (+). Negative changes, or decreases, take a ().
The law of demand implies that price elasticity of demand is nearly always a negative
number. Price increases (+) will lead to decreases in quantity demanded (), and vice
versa.
Measuring Price elasticity of Demand

Price elasticity of supply

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change in quantity supplied * initial price

Change in price.
Initial quantity supplied

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Types of Elasticity
Demand for most goods is elastic, inelastic or unitary depending on whether its coefficient is
greater than, less than or equal to one. Demand is said to be elastic when a percentage change
in price brings about a more than proportionate change in quantity demanded.

Perfectly inelastic demand

Demand in which quantity demanded does not respond at all to a change in price.

Inelastic demand
Demand is said to be inelastic when a percentage change in price brings about a less than
proportionate change in quantity demanded.

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Unitary elastic
Demand is said to be unitary when a percentage change in price brings about an equal
proportionate change in quantity demanded. The coefficient of elasticity is equal to 1 (PED = 1).

Elastic demand
Inelastic demand occurs when the percentage change in quantity demanded is less than the
percentage change in price, and the coefficient of the elasticity is less than 1 (PED < 1).

Perfectly elastic demand

Demand in which quantity drops to zero at the slightest increase in price.

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Relationship between price and total revenue depending upon price elasticity of demand
Total Revenue (TR) / Total Expenditure (TE) = Price (P) * Quantity (Q)
Whether total expenditure or total revenue rises, falls or remains constant with a change in
price depends on the price elasticity of demand of the commodity.
1. Price Elastic:
When demand is elastic, an increase in price causes TR to fall and a decrease in price
causes TR to rise. Thus, there exists an inverse relationship between price and total
revenue or total expenditure when demand is elastic.
2. Price Inelastic:
When demand is inelastic, an increase in price causes TR to rise and a decrease in price
causes TR to fall. Thus, there exists an direct relationship between price and total
revenue or total expenditure when demand is inelastic.
3. Demand is unitary:
When demand is unitary, TR / TE remains the same with a change in price. A rise or fall in
price causes TR / TE to remain unchanged.
Factors influencing price elasticity of demand:
There are various factors which influence the price elasticity of demand.
1. Nature of commodity:
(a)Necessities: The demand for necessities is inelastic because when their prices rise, the
consumers demand will fall very slightly.
(b)Luxuries: Demand for luxuries is elastic. If their prices fall, demand will increase by a
much greater percentage, but if their prices rise, consumers will reduce their demand
considerably.
2. Availability of substitutes:
The more close and numerous availability of substitutes a commodity has, the more will
be its price elasticity of demand, that is, demand is price elastic. This is because if the
price of a commodity rises, consumers would then shift to other substitutes. Thus, the
demand for the commodity will fall by a greater proportion. But fewer substitutes a
commodity has, the lower is the price elasticity of demand (inelastic). However, demand
for a group of commodity as a whole has an inelastic demand.
3. Proportion of income spent on a commodity:
Commodities on which a very low proportion of income is spent, the demand for the
product is inelastic. For example, an increase in the price of match box from 50 cents to
60 cents (20%) will not reduce quantity demanded to a larger extent. On the other hand,
commodities on which a large proportion of income is spent, the demand is elastic.
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4. Number of uses of a product:

A product, which has several uses, has an elastic demand. For example, people use
electricity for many purposes. A slight fall in the price of electricity will cause quantity
demanded to increase by a larger extent. Consumers will be in a position to afford its use
even for less important purposes. On the other hand, a product, which has a single use,
has an inelastic demand, for example, toothpaste.
5. Habit:
There are certain goods which people consume because they have developed a habit, for
example, cigarettes for a chain-smoker. Once consumers develop a habit for a particular
commodity, they will continue to demand even if the price increases. Thus, the demand
for these commodities is inelastic since quantity demanded will change very slightly to a
change in price.
6. Time period:
Demand tends to be more elastic in the long run than in the short run. This is because it
takes time for consumers to develop satisfactory substitutes. For example, if the price of
petrol rises, consumers will find it very difficult to switch from petrol to diesel
immediately. Thus, in the short run, demand for petrol will fall by a smaller percentage.
7. Price of commodity itself:
Demand is generally more elastic at higher level of prices than at lower levels. This is
because at a lower price level, consumers can be expected to be already buying as much
of the commodity as he desires. Thus, a further decline in price is unlikely to induce him
to raise his demand for that commodity.
Evaluation of PED
However, the firm cannot only rely on the concept of price elasticity of demand to increase
revenue. The data of price elasticity of demand do not reveal absolute truths. They are based on
survey carried out on small sample of consumers. Hence, they cannot be completely accurate.
Moreover, the concept of price elasticity of demand is calculated on the basis of all other factors
affecting demand remain constant. But, in practice, demand keeps changing due to changes in
other factors too.
Besides, the concept of price elasticity of demand is useful for the producer in order to increase
revenue. But in fact, the producer aims to maximise profits. Hence, the firm needs to know
more about its costs. If the firm faces an inelastic demand curve, pushing up prices will reduce
output, and therefore, costs will fall at the same time. With revenue rising, and costs falling,
profits must go up. But the firm has a more difficult decision if facing an elastic demand curve. If
price is lowered, this will also increase output, and therefore, costs.

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Income Elasticity of Demand:

Income elasticity of demand measures the degree of responsiveness of quantity demanded to a
change in income of consumers. Income elasticity of demand is calculated as follows:
Income elasticity of demand = percentage change in quantity demanded
Percentage change in income.
OR

Income elasticity of demand =

Type of Goods with Income Elasticity

The coefficient of income elasticity of demand can be positive or negative depending
upon the nature of the commodity.
In other words, demand might increase or decrease in response to a rise in income,
depending upon whether the product is a normal good or an inferior good.
Normal Goods
The demand for normal goods increases as income increases, and therefore, the value of
the income elasticity of demand is positive. It indicates the direct relationship between
income and demand for normal goods.
However, it is important to distinguish between 2 types of normal goods namely luxuries
and necessities. Though positive, the value of income elasticity of demand differs
accordingly.
For a luxury, the value of income elasticity of demand is greater than 1, implying that the
percentage increase in quantity demanded is larger than the percentage increase income.
The commoditys demand is income elastic. On the other hand, for a necessity, the value
of income elasticity of demand is less than 1, implying that the percentage increase in
quantity demanded is smaller than the percentage increase income. The commoditys
demand is income inelastic.
Inferior Goods
However, with inferior goods, as income rises demand falls and the coefficient of income
elasticity of demand is therefore negative. It indicates the inverse relationship between
income and demand for inferior goods.
An exceptional case is that demand will remain constant as income rises. In this case
there is said to be zero income elasticity of demand.

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Usefulness of knowledge of income elasticity of demand

A knowledge of income elasticity of demand is useful to a manufacturer as it helps him to
plan his sales and allocate resources more efficiently in order to maximise profits should
there be any change in consumers income. Indeed, the producer must take into account
the economic situation of the country.
To plan the demand , If the country experiences economic growth, national income will
rise, and this rise in income will be shared among most households. As the latter finds
their income increasing, they increase their demand for many commodities.
o However, even products with positive income elasticities, there is a great
variability of response. For instance, with commodities for which income elasticity
of demand is inelastic, although demand may rise with income, it might not rise
faster. The booming industries tend to be those making products which are highly
income elastic.
o On the other hand, a downturn in national income may well mean a rapid decline
in the demand for positive income elasticities. Hence, only in such an economic
situation should inferior goods be promoted.
Cross elasticity of Demand:
Cross elasticity of demand measures the degree of responsiveness of quantity demanded of one
commodity to a change in the price of another commodity. If two goods X and Y are taken, cross
elasticity of demand of X in relation to the price of Y is calculated as follows:
CEDXY = percentage change in quantity demanded of X
Percentage change in price of Y
XED based on Goods
The coefficient of cross elasticity of demand can be positive or negative depending upon the
nature of interrelationship between the two commodities.
o If the tow goods are substitutes, then the value of cross elasticity of demand is
positive as changes in price of the commodity will lead to changes in quantity
demanded of another commodity in the same direction.
o If, the two goods are complements, then the value of cross elasticity of demand is
negative, indicating the inverse relationship between quantity demanded of one
commodity and the price of its complementary goods.
o The value of cross elasticity of demand may vary from - to + . But if the two
goods are non-related, the cross elasticity of demand is zero.

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Usefulness of knowledge of cross elasticity of demand:

The concept of cross elasticity of demand becomes more relevant in determining price
structure in an oligopolistic market situation where few firms compete with each other.
These firms are interdependent in decision making, and as a result, ignoring cross
elasticity might prove to be disastrous.

The concept of cross elasticity of demand allows the producer to identify whether his
product is a complement or a substitute which is produced by other firms. Hence, he is
able to assess the impact of sales and make better business decisions regarding price and
output polices when prices for substitutes or complements change.
o If the cross elasticity of demand is positive, it means that a cut in price by a rival
business will significantly reduce the firms sales.
o On the other hand, if the value of cross elasticity of demand is negative, the
producer must be cautious when supplying the commodities. If the price of its
complements rises, it is not advisable for the producer to increase production.

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THEORY OF SUPPLY
Quantity supplied: The amount of a particular product that a firm would be willing and able to
offer for sale at a particular price during a given time period.
Supply schedule: A table showing how much of a product firms will sell at alternative prices.

A supply curve is a graphical depiction of a supply schedule. It shows how the quantity supplied
of some product will change as the price of that product changes during a specified period of
time, holding all other determinants of quantity supplied constant.

law of supply: The positive relationship between price and quantity of a good supplied An
increase in market price will lead to an increase in quantity supplied, and a decrease in market
price will lead to a decrease in quantity supplied.
Explaining the Law of Supply : There are three main reasons why supply curves for most
products are drawn as sloping upwards from left to right giving a positive relationship between
the market price and quantity supplied:
1. The profit motive: When the market price rises (for example after an increase in
consumer demand), it becomes more profitable for businesses to increase their output.
Higher prices send signals to firms that they can increase their profits by satisfying
demand in the market.
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2. Production and costs: When output expands, a firms production costs rise, therefore a
higher price is needed to justify the extra output and cover these extra costs of
production.
3. New entrants coming into the market: Higher prices may create an incentive for other
businesses to enter the market leading to an increase in supply.

Supply Function

Supply Equation

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Factors Influencing Market Supply Curve

1. The price of the good itself:
Changes in the price of the commodity will lead to changes in quantity supplied of that
commodity. For instance, a rise in the price of good X will lead to a rise in quantity
supplied of good X. This is because good X is now more profitable and producers supply
more of it.
2. Weather / climatic conditions:
The supply of agricultural products is affected by changes in weather conditions. A
favorable climatic condition may bring bumper (abundant) harvest so that producers
supply more of the agricultural products. On the other hand, an unfavorable season
which results in a poor harvest may cause quantity supplied to fall
3. Technical progress:
Technical progress means improvements in the performance of machines, labour,
production methods, management control and quality. This allows more to be produced
and supplied.
4. Changes in the prices / costs of factors of production:
Movement in wages, prices of raw materials, fuel and power, rents, interest rates and
other factor prices affects the cost of production. For instance, increase in wages paid to
workers increases the cost of production and reduces the profits of firms. Hence, firms
will supply less goods.
5. Government policy Indirect taxation and Subsidies:
Governments can also influence supply. If the government wants firms to produce more,
it may give them a subsidy which will lower their costs, boost their profits and increase
supply. However, if government imposes indirect taxes on goods and services to the
producers, supply will fall because of the increase in costs of production.
Note: Indirect taxes increase cost of production and cause supply to fall (shift to the left),
whereas subsidies reduce cost of production and cause supply to rise (shift to the right).
Movement along the Supply Curve and a Shift In The Supply Curve
A movement along the supply curve occurs when quantity supplied changes because of a
change in the price of the commodity alone, while other factors affecting supply remain
constant. In fact, when a supply curve is drawn, only the price of the product is allowed to vary,
while the conditions of supply do not change. The movement along the supply curve is shown as
follows:

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A shift in the supply curve or a change in supply occurs when quantity supplied changes only
because there are changes in conditions of supply such as weather conditions, prices of factor
inputs, etc, while the price of the commodity remains constant. The supply curve can shift either
to the right or to the left, depending upon the changes in the conditions of demand. The shift in
the demand curve is shown as follows:

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Elasticity of Supply
The law of supply, which expresses a direct relationship between quantity supplied and price,
shows only the direction of supply.
Measuring Elasticity of Supply
Price elasticity of supply measures the degree of responsiveness of quantity supplied to a
change in the price of the commodity. Price elasticity of supply is calculated as follows:
Price elasticity of supply =

OR

Price elasticity of supply =

percentage change in quantity supplied

Percentage change in price.
change in quantity supplied *
initial price
Change in price.
Initial quantity

supplied
Price elasticity of supplied is always positive, indicating the direct relationship between
quantity supplied and price.
Supply for most goods is either elastic, inelastic or unitary depending on whether its
coefficient is greater than, less than or equal to one.
Types of Elasticity
Perfectly inelastic supply
Perfectly inelastic supply curve value of price elasticity of supply is zero.

Inelastic supply
Any straight line supply curve that meets the vertical axis (Price axis) will be elastic and its value
is greater than 1.

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Unitary Elastic Supply

Any straight line supply curves passing through the origin whatever the slopes have unitary price
elasticity of supply and its value is equal to 1.

Elastic supply
2. A straight line supply curve that meets the horizontal axis (Quantity axis) will be inelastic and
its value is less than 1.

Perfectly elastic supply

Perfectly elastic supply curve - The coefficient of elasticity is equal to infinity. Nothing is supplied
at any price below 0P, while an infinite quantity is supplied at price 0P.

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Factors Influencing Price Elasticity of supply:

1. Time periods:
The elasticity of supply tends to be greater in the long run than in the short run because it
is easier to increase the amount produced when the firm has more time in which to do it.
It may be difficult to change quantities supplied in response to a price increase in the
short run.
E.g. This is obvious if one considers agricultural products. Suppose that the price of
an agricultural product rises unexpectedly.
2. Availability of resources:
If a firm wishes to expand production, it will need more resources. If the economy is
already using most of its scarce resources, then firms will find it difficult to employ more,
and therefore, output will not rise.
3. Availability of stocks:
When suppliers are holding large stocks, supply will be elastic. This is because any
increase in demand can be easily met by running down the stocks. However, once the
stocks are depleted, it may be very difficult to increase output, and therefore, supply will
be inelastic.
4. Producing at full or below capacity:
In some industries the expansion of capacity takes a long time. Once such industries
operate at full capacity, supply will be inelastic. However, if industries operate below full
capacity, supply will be elastic.
5. Risk taking:
The more willing entrepreneurs are to take risks the greater will be the elasticity of
supply. This will be partly influenced by the system of incentives in the economy. If the
rates of taxes are very high, this may reduce the elasticity of supply.

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Market equilibrium
A situation in which the supply of an item is exactly equal to its demand. Since there is neither
surplus nor shortage in the market, price tends to remain stable in this situation.
Market clearing
Equilibrium price is also called market clearing price because at this price the exact quantity that
producers take to market will be bought by consumers, and there will be nothing left over. This
is efficient because there is neither an excess of supply and wasted output, nor a shortage the
market clears efficiently. This is a central feature of the price mechanism, and one of its
significant benefits
How is equilibrium established?
Graphically, we say that demand contracts inwards along the curve and supply extends
outwards along the curve. Both of these changes are called movements along the demand or
supply curve in response to a price change.

Excess demand

Excess supply

Excess demand price

Excess supply price

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Consumer and producer surplus

Consumer surplus
Consumer surplus is derived whenever the price a consumer actually pays is less than they are
prepared to pay. A demand curve indicates what price consumers are prepared to pay for a
hypothetical quantity of a good, based on their expectation of private benefit.
For example, at price P, the total private benefit in terms of utility derived by consumers from
consuming quantity, Q is shown as the area ABQC in the diagram.

The amount consumers actually spend is determined by the market price they pay, P, and
the quantity they buy, Q - namely, P x Q, or area PBQC. This means that there is a net
gain to the consumer, because area ABQC is greater that area PBQC. This net gain is
called consumer surplus, which is the total benefit, area ABQC, less the amount spent,
area PBQC. Hence ABQC - PBQC = area ABP
Producer surplus
Producer surplus is the additional private benefit to producers, in terms of profit, gained when
the price they receive in the market is more than the minimum they would be prepared to
supply for. In other words they received a reward that more than covers their costs of
production.
The producer surplus derived by all firms in the market is the area from the supply curve to the
price line, EPB.

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Economic welfare
Economic welfare is the total benefit available to society from an economic transaction or
situation.
Economic welfare is also called community surplus. Welfare is represented by the area ABE in
the diagram below, which is made up of the area for consumer surplus, ABP plus the area for
producer surplus, PBE.

In market analysis economic welfare at equilibrium can be calculated by adding consumer and
producer surplus. Welfare analysis considers whether economic decisions by individuals,
organisations, and the government increase or decrease economic welfare.

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Changes in equilibrium
Graphically, changes in the underlying factors that affect demand and supply will cause shifts in
the position of the demand or supply curve at every price.
Whenever this happens, the original equilibrium price will no longer equate demand with
supply, and price will adjust to bring about a return to equilibrium.
There are four basic causes of a price change:
An increase in demand shifts the demand curve to the right, and raises price and output.
Demand shifts to the right

Demand shifts to the left

A decrease in demand shifts the demand curve to the left and reduces price and output.

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Supply shifts to the right

An increase in supply shifts the supply curve to the right, which reduces price and increases
output.

Supply shifts to the left

A decrease in supply shifts the supply curve to the left, which raises price but reduces output.

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The entry and exit of firms

In a competitive market, firms may enter or leave with little difficulty. Firms may be attracted
into a market for a number of reasons, but particularly because of the expectation of profit. This
causes the market supply curve to shift to the right. Rising prices may provide a sufficient
incentive and provide a signal to potential entrants to enter the market.
There is a chain reaction, starting with an increase in demand, from D to D1. This raises price to
P1, which provides the incentive for existing firms to supply more, from Q to Q1. The higher
price also provides the incentive for new firms to enter, and as they do the supply curve shifts
from S to S1. A market where prices are rising provides the best opportunity for the
entrepreneur. Conversely, lower prices encourage firms to leave the market.

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Impact of producer taxes on market operations

Taxes on goods and services
A value-added tax levied on most goods and services sold for domestic consumption. The tax is
levied in order to provide revenue for the federal government. The Goods and Services Tax is
paid by consumers, but it is levied and remitted to the government by businesses.
Specific tax/unit tax &
A per unit tax, or specific tax, is a tax that is defined as a fixed amount for each unit of a
good or service sold, such as cents per kilogram. It is thus proportional to the particular
quantity of a product sold, regardless of its price. Excise taxes, for instance, fall into this tax
category.
Ad valorem tax
By contrast, an ad valorem tax is a charge based on a fixed percentage of the product value.
Per unit taxes have administrative advantages when it is easy to measure quantities of the
product or service being sold
Impact of taxes
Graphical method Unit Tax

Graphical method Ad valorem tax

Equations

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Impact of taxes Equation Method

Unit Tax

Ad valorem tax - Removed From Syllabus

Distribution tax incidence according demand and supply elasticity

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Effects of subsidies on market operations

Producer subsidies

A subsidy is a payment by the government to suppliers that reduce their costs of production and
encourages them to increase output
The subsidy causes the firm's supply curve to shift to the right
The amount spent on the subsidy is equal to the subsidy per unit multiplied by total
output
A direct subsidy to the consumer has the effect of boosting demand in a market
Different Types of Producer Subsidy

A guaranteed payment on the factor cost of a product e.g. a guaranteed minimum

price offered to farmers such as under the old-style Common Agricultural Policy (CAP).
An input subsidy which subsidises the cost of inputs used in production e.g. an
employment subsidy for taking on more workers.
Government grants to cover losses made by a business e.g. a grant given to cover
losses in the railway industry or a loss-making airline.
Bail-outs e.g. for financial organisations in the wake of the credit crunch
Financial assistance (loans and grants) for businesses setting up in areas of high
unemployment e.g. as part of a regional policy designed to boost employment.

Economic and Social Justifications for Subsidies

Why might the government be justified in providing financial assistance to producers in certain
markets and industries? How valid are the arguments for government subsidies?
1. To keep prices down and control inflation in the last couple of years several countries
have been offering fuel subsidies to consumers and businesses in the wake of the steep
increase in world crude oil prices.
2. To encourage consumption of merit goods and services which are said to generate
positive externalities (increased social benefits). Examples might include subsidies for
investment in environmental goods and services.
3. Reduce the cost of capital investment projects which might help to stimulate economic
growth by increasing long-run aggregate supply.
4. Subsidies to slow-down the process of long term decline in an industry e.g. fishing or
mining
5. Subsidies to boost demand for industries during a recession e.g. the car scrappage
scheme

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Economic Arguments against Subsidies

The economic and social case for a subsidy should be judged carefully on the grounds of
efficiency and fairness
Might the money used up in subsidy payments be better spent elsewhere?
Government subsidies inevitably carry an opportunity cost and in the long run there
might be better ways of providing financial support to producers and workers in specific
industries.

Free market economists argue that subsidies distort the working of the free market mechanism
and can lead to government failure where intervention leads to a worse distribution of
resources.

Distortion of the Market: Subsidies distort market prices for example, export subsidies
distort the trade in goods and services and can curtail the ability of ELDCs to compete in
the markets of rich nations.
Arbitrary Assistance: Decisions about who receives a subsidy can be arbitrary
Financial Cost: Subsidies can become expensive note the opportunity cost!
Who pays and who benefits? The final cost of a subsidy usually falls on consumers (or
tax-payers) who themselves may have derived no benefit from the subsidy.
Encouraging inefficiency: Subsidy can artificially protect inefficient firms who need to
restructure i.e. it delays much needed reforms.
Risk of Fraud: Ever-present risk of fraud when allocating subsidy payments.
There are alternatives: It may be possible to achieve the objectives of subsidies by
alternative means which have less distorting effects.

Impact of Subsidy

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Impact of Subsidy Equation Method

Unit Tax

Ad valorem tax - Removed From Syllabus

Distribution tax incidence according demand and supply elasticity

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10

MARKET STABILIZATION
Price stabilization schemes

Many primary markets are subject to extreme fluctuations in price. There are several methods
of intervention available to governments and agencies
Buffer stocks
Buffer stocks are stocks of produce which have not yet been taken to market. They can help
stabilise prices by taking surplus output and putting it into a store, or, with a bad harvest, stock
is released from storage.

A target price can be achieved through intervention buying and selling.

Evaluation of buffer stocks
While buffer stocks can help stabilise price, there are several disadvantages, including:
1. Additional costs to society, such as building costs, extra storage, insurance and
costs of managing the scheme.
2. Furthermore, some commodities cannot easily be stored because they are
perishable.
3. The system relies on starting with a good harvest, indeed, without stocks in the
system it is not possible to react to a poor harvest.
4. Buffer stocks do not prevent the initial problem from arising.
5. Critics argue that they distort the operation of free markets and prevent the price
mechanism working effectively.
CEILINGS AND FLOORS
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The buffer stock managers are likely to establish a price ceiling, above which intervention selling
will occur, and a price floor, below which intervention buying will take place.

Guaranteed prices
Guaranteeing a price to producers (at P1 in the diagram below), irrespective of the output they
produce, is another way of stabilising prices and incomes.
A government or agency can establish a target price, and then guarantee to pay farmers and
growers this price, whatever output is produced. If the market price rises above this guarantee,
the market price will prevail. But if the market price falls below the guarantee, then the
guaranteed price will prevail.

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However, they can also be criticised because:

1. They encourage over-production creating a surplus of Q2 to Q1.This problem is
particularly associated with the EUs Common Agricultural Policy (CAP).
2. They can promote inefficiency. For example, farmers may question whether it is
worth bothering to be efficient if they are guaranteed a buyer.
3. There are also extra costs of storage or disposal.
Maximum control prices
The government or an industry regulator can set a maximum price in an attempt to prevent the
market price from rising above a certain level. One aim of this might be to prevent the
monopolistic exploitation of consumers
To be effective a maximum price has to be set below the free market price.
One example might be when shortage of foodstuffs threatens large rises in the free
market price.
Other examples include rent controls on properties for example the system of rent
controls still in place in Manhattan in the United States.
A maximum price seeks to control the price but also involves a normative judgement on
behalf of the government about what that price should be. An example of a maximum
price is shown in the next diagram.
The normal equilibrium price is shown at Pe but the government imposes a maximum price of
Pmax. This price ceiling creates excess demand equal to quantity Q2-Q2 because the price has
been held below the equilibrium.

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Maximum prices and consumer and producer welfare

How does the introduction of a price ceiling affect consumer and producer surplus? This is
shown in the next diagram. At the original equilibrium price consumer surplus = triangle ABPe
and producer surplus equals the triangle PeBC.
Because of the maximum price ceiling, the quantity supplied contracts to output Q2. Consumers
gain from the price being set artificially lower than the equilibrium, but there is a loss of
consumer welfare because of the reduction in the quantity traded. At P max the new level of
consumer surplus = the trapezium ADEPmax. Producer surplus is reduced to a lower level Pmax
EC. There has been a net reduction in economic welfare shown by the triangle DBE.

Black Markets

A black market (or shadow market) is an illegal market in which the market price is higher than
a legally imposed price ceiling. Black markets develop where there is excess demand for a
commodity. Some consumers are prepared to pay higher prices in black markets in order to get
the goods or services they want.

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Minimum control prices

A minimum price is a price floor below which the market price cannot fall. To be effective the
minimum price has to be set above the equilibrium price
The best example of a minimum price is a minimum wage in the labour market

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11

Price Mechanism
Price Mechanism is a system where, the private sector allocates scarce resources or solves basic
economic problems of an economy based on the market prices of goods and services which is
decided through the intention of free market forces of demand and supply.
Function of Prices in the Market
The price mechanism describes the means by which millions of decisions taken by consumers
and businesses interact to determine the allocation of scarce resources between competing
uses
The price mechanism plays three important functions in a market:
1. Signaling function

Prices perform a signalling function they adjust to demonstrate where resources are
required, and where they are not
Prices rise and fall to reflect scarcities and surpluses
If prices are rising because of high demand from consumers, this is a signal to suppliers to
expand production to meet the higher demand
If there is excess supply in the market the price mechanism will help to eliminate a
surplus of a good by allowing the market price to fall.

In the example on the right, an increase in market supply causes a fall in the relative prices of
digital cameras and prompts an expansion along the market demand curve
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2. Incentive function

Through their choices consumers send information to producers about the changing
nature of needs and wants
Higher prices act as an incentive to raise output because the supplier stands to make a
better profit.
When demand is weaker in a recession then supply contracts as producers cut back on
output.

3. Rationing function

Prices serve to ration scarce resources when demand in a market outstrips supply.
When there is a shortage, the price is bid up leaving only those with the willingness
and ability to pay to purchase the product. Be it the demand for tickets among England
supporters for an Ashes cricket series or the demand for a rare antique, the market price
acts a rationing device to equate demand with supply.
The popularity of auctions as a means of allocating resources is worth considering as a
means of allocating resources and clearing a market.

Maximizing Behavior

To say that individuals maximize is to say that they pick some objective and then seek to
maximize its value.
Economists pay special attention to two groups of maximizers: consumers and firms. We
assume that consumers seek to maximize utility and that firms seek to maximize
economic profit. The difference between total revenue and total cost, which is the
difference between total revenue and total cost.

Judging the Market

Economists are interested in knowing how to judge whether market are the best way of
allocating resources. There are two main ways in which they do this,
o Whether markets are efficient in resources allocation
o Whether equity is there in the economy

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12
Practice Questions
1) Calculate the producer surplus for the supply curves of S1 and S2 in following diagram.

2) Answer the questions using the diagram given below.

a.
b.
c.
d.
e.

Identify the equilibrium price and quantity before and after government taxation.
What is the total amount of tax borne by the consumer?
What is the total tax income after the implementation of taxation?
Calculate the producer surplus before and after the implementation taxation?
Calculate the consumer surplus before and after the implementation taxation?

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3) Consider the following data regarding a product in a perfect competitive market,

a.
b.
c.
d.

Qd= 20-2P
Qs=2P
Draw the demand and supply curve according to the given data.
Assume government decides to provide 20% subsidy to the producers of this
product, draw the new supply curve.
Calculate the producer surplus and consumer surplus before and after the
provision of subsidy.
Identify the cost of government subsidy? Calculate the consumers subsidy benefit
and producers subsidy benefit?

4) Data of a product are given below,

Price
20
100
a.
b.
c.
d.
e.
f.
g.

Demand
500
100

Supply
100
500

Draw the demand and supply curve and identify the equilibrium price and quantity.
Assume there is 50% VAT on this product. Show that in your graph.
What is the new equilibrium price and quantity?
Calculate the government tax income?
Calculate the tax burden of both the producer and the consumer?
Calculate the producer surplus and consumer surplus before and after tax.
Calculate the economic loss?

5) Consider the following data regarding a product in a perfect competitive market,

Price
2
4
6
8
10

Demand
500
400
300
200
100

Supply
-100
0
100
200
300

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. At the equilibrium point, calculate the price elasticity of demand and price
elasticity of supply?
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c. Identify the price for excess demand at100 units.

d. Identify the price for excess supply at 300 units.
e. If government introduces a maximum control price of Rs.6, what would be the
total demand, local supply, excess demand, black market price and excess income
for the producers?
f. Calculate the consumer surplus and producer surplus at the maximum control
price.
g. What government can do to protect the control price?
6) Data of a product are given below,
Price
Demand
Supply

2
100
0

4
80
20

6
60
40

8
40
60

10
20
80

12
0
100

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. Calculate the consumer surplus and producer surplus at the equilibrium point.
c. Assume that the government introduces a minimum control price of Rs.8; identify
the
d. Total supply, local demand, excess supply and the price requested by the
consumers.
e. In order to protect the control price what actions can be taken by the government?
f. Calculate the consumer surplus and producer surplus at the minimum control
price.
7) Data of a product are given below,
Price
1
5

Demand
250
50

Supply
50
250

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. Calculate the consumer surplus and producer surplus at the equilibrium point.
c. Assume government plans to provide 50% subsidy per unit, draw the new supply
curve.
d. Calculate the changes in consumer surplus and producer surplus after the
provision on subsidy.
e. Calculate the benefit from subsidy for the consumer and producer.
f. Identify the total government expenditure for subsidy.
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8) Data of a product are given below,

Price
4
20

Demand
200
40

Supply
40
200

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. Assume the government introduces a unit tax of Rs.4 per unit; show that in your
graph.
c. Calculate the consumer surplus and producer surplus before and after tax.
d. Calculate the economic loss.

9) Data of a product are given below,

Price
4
6
8
10
12
14

Demand
200
150
100
50
0
-50

Supply
-50
0
50
100
150
200

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. Calculate the consumer surplus and producer surplus at the equilibrium point.
c. Assume the government introduces a unit subsidy of Rs.2 per unit; show that in
your graph.
d. Identify the total government expenditure for subsidy.
e. Calculate the benefit from subsidy for the consumer and producer.

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10) Consider the following data regarding a product in a perfect competitive market,

Price
20
120

Demand
6000
1000

Supply
0
7000

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. Identify the following using your graph.
Excess demand at Rs.50
Excess supply at Rs.100
Excess demand price at 2000 units
Excess supply price at 5000 units
Price elasticity of demand at equilibrium
Price elasticity of supply at equilibrium
c. Identify the demand and supply equation.
d. Identify the excess demand and excess supply equation.
11) Consider the following data regarding a product in a perfect competitive market,
Price
5
10

Excess demand
200
-200

a. Draw the excess demand curve and identify the equilibrium.

b. Calculate the equilibrium price by identifying the excess demand equation.

12) Assume that a price elasticity of demand of a product is -0.4 and price elasticity of supply
is 1.5. this price 1000 units are demanded and 400 units are supplied.
a. Calculate the quantity demanded and the quantity supplied at Rs.24.
b. Draw the demand and supply curves and identify the equilibrium point.

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13) Following graph shows the change in a market after government imposing indirect tax.

Calculate the following,

a) Equilibrium price and quantity before tax?
b) quilibrium price and quantity after tax?
c) Per unit tax borne by the producer?
d) Per unit tax borne by the consumer?
e) Total tax burden for consumers?
f) Total tax burden for producers?
g) Government tax income?
h) Consumer surplus before taxation?
14) Consider the following data for a product in competitive market,
Price
16
64

Demand
5000
2000

Supply
1000
4000

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. Assume that this product can be imported from a neighboring country at Rs. 32, draw the
supply curve.
c. If the government introduces 25% tax on import, show that in your graph.
d. Calculate the tax income for the government?

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15) Data of a product are given below,

Price
1
4

Demand
160
80

Supply
0
120

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. Assume that the government introduces a minimum control price of Rs.4; show that in
your graph.
c. How much should the government purchase in order to maintain the control price?
Calculate the purchasing expense?
d. Calculate government expense for the provision of subsidy?

16) Data of a product are given below,

Price
4
16

Demand
40
10

Supply
0
30

a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. If government introduces a maximum control price of Rs.8, what would be the total
demand, local supply, excess demand, black market price and excess income for the
producers?
c. Identify the quantity to be imported?
d. Calculate government expense for the provision of subsidy?
17) Consider the following data regarding a product in a perfect competitive market,
Price
Excess supply
10
-30
30
30
Draw the excess supply curve and identify the equilibrium price.
18) Data of a product are given below,
Price
8
40

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0
80
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a. Draw the demand and supply curve and identify the equilibrium price and quantity.
b. Calculate the price elasticity of demand and price elasticity of supply at equilibrium.
c. Calculate the Consumer surplus and producer surplus at equilibrium.

19) Demand and supply equations of a product is given below,

Qd=60-4p Qs= 20-6p
a. Identify the equilibrium price and quantity.
b. If the government imposes an indirect tax of Rs.2, identify the new equilibrium
price and quantity.
c. Calculate the tax burden of the consumer and the producer.
d. Calculate the government tax income.
20) Demand and supply equations of a product is given below,
Qd = 400-10P
Qs = -100+15P
a. Identify the equilibrium price and quantity.
b. Assume that the government imposes a maximum control price of Rs.15,
a. late the excess demand.
b. What is the black market price
c. Calculate the local supply?
d. Calculate the amount to be imported?

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