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UNIVERSITY OF MAIDUGURI
Maiduguri, Nigeria
CENTRE FOR DISTANCE
LEARNING
MANAGEMENT
SCIENCES
ECON 200:
UNITS: 3
ECON
200:
UNIT: 3
MICROECONOMICS I
MICROECONOMICS
I
ii
CDL, University of Maiduguri, Maiduguri
ECON 200:
UNITS: 3
Published
MICROECONOMICS I
2008©
All rights reserved. No part of this work may be reproduced
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University
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This text forms part of the learning package for the academic
programme of the Centre for Distance Learning, University of
Maiduguri.
Further enquiries should be directed to the:
Coordinator
Centre for Distance Learning
University of Maiduguri
P. M. B. 1069
Maiduguri, Nigeria.
This text is being published by the authority of the Senate,
University of Maiduguri, Maiduguri – Nigeria.
ISBN:
978-8133-
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CDL, University of Maiduguri, Maiduguri
ECON 200:
UNITS: 3
MICROECONOMICS I
P R E FA C E
This study unit has been prepared for learners so that they
can do most of the study on their own. The structure of the
study unit is different from that of conventional textbook.
The course writers have made efforts to make the study
material rich enough but learners need to do some extra
reading for further enrichment of the knowledge required.
The learners are expected to make best use of library
facilities and where feasible, use the Internet. References are
provided
to
guide
the
selection
of
reading
materials
required.
The University expresses its profound gratitude to our course
writers and editors for making this possible. Their efforts
iv
CDL, University of Maiduguri, Maiduguri
ECON 200:
UNITS: 3
MICROECONOMICS I
will no doubt help in improving access to University
education.
Professor J. D. Amin
Vice-Chancellor
v
CDL, University of Maiduguri, Maiduguri
ECON 200:
UNITS: 3
MICROECONOMICS I
HOW TO STUDY THE UNIT
You are welcome to this study Unit. The unit is
arranged to simplify your study. In each topic of the unit,
we have introduction, objectives, in-text, summary and selfassessment exercise.
The study unit should be 6-8 hours to complete. Tutors
will be available at designated contact centers for tutorial.
The center expects you to plan your work well. Should you
wish to read further you could supplement the study with
more information from the list of references and suggested
readings available in the study unit.
PRACTICE EXERCISES/TESTS
1. Self-Assessment Exercises (SAES)
This is provided at the end of each topic. The exercise
can help you to assess whether or not you have actually
studied and understood the topic. Solutions to the exercises
are provided at the end of the study unit for you to assess
yourself.
vi
CDL, University of Maiduguri, Maiduguri
ECON 200:
UNITS: 3
MICROECONOMICS I
2. Tutor-Marked Assignment (TMA)
This is provided at the end of the study Unit. It is a
form of examination type questions for you to answer and
send to the center. You are expected to work on your own in
responding to the assignments. The TMA forms part of your
continuous assessment (C.A.) scores, which will be marked
and returned to you. In addition, you will also write an end
of Semester Examination, which will be added to your TMA
scores.
Finally, the center wishes you success as you go through
the different units of your study.
vii
CDL, University of Maiduguri, Maiduguri
ECON 200:
UNITS: 3
MICROECONOMICS I
INTRODUCTION TO THE COURSE
In every given economy, the decision of individual (s)
and households i.e. undertake certain choices of goods
and service, to consume, to save, and undertake
businesses are influenced my tractors only known to the
individual producer and consumers.
However, the
availability and ease in the flow of these resources from
production firms to consumers and flow a resources from
consumers to firms and the determination of their prices
may be the physical factors.
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MICROECONOMICS I
200:
MICROECONOMICS I
UNIT: 3
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PAGES
PREFACE
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HOW TO STUDY THE UNIT
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INTRODUCTION TO THE COURSE
1
TOPIC:
1:
MEANING
AND
SCOPE
OF
MICROECONOMICS- 3
2:
PROBLEMS
OF
SCARCE
RESOURCES
AND
ALLOCATION OF RESOURCES IN
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MICROECONOMICS I
FACTOR AND PRODUCT MARKETS9
3:
CONCEPT OF EQUILIBRIUM, DYNAMIC
EQUILIBRIUM, PARTIAL EQUILIBRIUM
AND GENERAL EQUILIBRIUM -
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4:
THEORY
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OF
CONSUMER
BEHAVIOUR
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COMBINED THEORY
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6:
THE
SUPPLY
THEORY
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OF
DEMAND
AND
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SOLUTIONS TO EXERCISES
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TOPIC 1:
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1.0
TOPIC:
MARGINAL FUNCTIONS
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1.1
INTRODUCTION
1.2
OBJECTIVES
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1.3.3 LIMITATIONS OF MICROECONOMICS -
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1.3.4 SCOPE OF MICROECONOMICS -
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1.3
IN – TEXT
1.3.1
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MEANING OF MICROECONOMICS-
1.3.2 USES OF MICROECONOMICS
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SUMMARY -
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SELF ASSESSMENT EXERCISES -
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REFERENCE
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SUGGESTED READINGS -
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1.7
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1.0 TOPIC:
MICROECONOMICS I
MEANING
AND
SCOPE
OF
MICRO
ECONOMICS
1.1 INTODUCTION
In every given economy, the decision of individual (s) and
households i.e. undertake certain choices of goods and
service, to consume, to save, and undertake businesses
are influenced my tractors only known to the individual
producer and consumers. However, the availability and
ease in the flow of these resources from production firms
to consumers and flow a resources from consumers to
firms and the determination of their prices may be the
physical factors.
1.2
OBJECTIVES
At the end of the topic, students should be able to:
i. Explain the meaning of microeconomics.
ii. State the goals of microeconomics.
iii. Explain why microeconomics is often referred to
as price theory in text.
1.3
IN-TEXT
1.3.1
MEANING OF MICROECONOMICS
The economic word microeconomics is derived from a
Greek word “Mikros” meaning “small”. Derive from this,
microeconomics is the study that concentrates in the
economic behaviour of “small” economic units. If focuses in
consumers, workers, savers, business managers, firms
individual industries and markets etc. it is concerned with
individual producers and consumers, the flow of production
from firms to consumers the flow of resources from consumers
to firms, and how prices of these resources and goods are
determined.
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MICROECONOMICS I
Microeconomics is often referred to as a price theory.
The reason is that microeconomics focuses on how relative
prices of small units of economic elements are determined and
the various equilibria reached.
The essential goals of microeconomics include the
improvement in the material welfare of people through the
efficient use of the existing resource in the economy.
The field of study in microeconomics has been:
1. Price determination.
2. Production relation called production function.
3. Distribution of goods and services in the
economy.
4. Efficiency in the use of factor inputs in the
production processes.
5. Other areas are the theory of consumer
behaviour as utility analysis, indifference
curve analysis and theory of consumer
surplus.
These are discussed extensively in the theory of price
determination in microeconomics.
Finally, microeconomics is particularly concerned with the
behaviour of individual agents.
Such agents may be
individuals, families, capitalists firms cooperative enterprises
or Government departments but all face with choices of
amount the use of the scarce resources available in the
economy.
1.3.2
USES OF MICROECONOMICS
The uses of microeconomics includes:
1. It enable one to explain the behaviour of a free market
economy in terms of the behaviour of consumers in
their decision on purchases of different goods and
their amount.
2. It helps in explaining behaviour of different goods to
produce and the amount of different factors to be
employed in the production of these goods and
services.
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MICROECONOMICS I
3. It helps in explaining the behaviour of workers in
deciding how much services to offer at different wages.
4. Microeconomics assists in determing how equilibrium
is reached in various products and factor markets.
5. It provides framework for studying different kinds of
market structures such as perfect competition
monopoly oligopoly etc.
6. It provides framework for the study of welfare
economics hence it defines and analyse the rule of
economic efficiency i.e. efficiency in the use and
allocation of resources.
7. It is also concerned with the study or public finance as
it explains the incidence and burden of different taxes
which are helping in formulation of tax policies.
8. It contributes numerically in the area of managerial
economics towards the improvement of decisionmaking in business through demand analysis cost
analysis evolving methods to calculate prices and
profits.
9. It analysis business problems word in finding
solutions calling for optimums choices where the
problems have to be solved in definite bounds.
1.3.3
LIMITATIONS OF MICROECONOMICS
One limitation of microeconomics is that if fails to explain
the operation of the entire economic system. This is within the
fallacy of composition that what is true of the whole economy
or society. Example: a wage out in an increased in demand
for labour in that industry leading to more employment.
However, it such policy is adopted in all industries it leads to a
fall in the aggregate demand of the economy, hence there will
be no inducement to invest and economic activity will suffer.
Another limitation of microeconomics is the assumption
of full employment under which all its analysis are carried out.
This assumption is always Wrong hence condition of less than
full employment prevail in all economics of the world.
Also, the assumption of Laissez-fair (non-intervention of
government in economic affairs) which microeconomics was
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MICROECONOMICS I
built upon is no longer practiced since the end of the Great
Depression of 1930s.
This makes the study unrealistic.
Microeconomic analysis concentrates its analysis on a single
issue, involving (Ceteris-paribus) i.e. all things being equal but
the picture of the event will be different if other things are
allowed to operate i.e. mutatis mutandis.
However, as
economic activities are dynamic, this destroys the analysis of
microeconomics.
1.3.4
SCOPE OF MICROECONOMICS
The scope of microeconomics can best be discussed when
we analyze the methods utilized in its analysis.
One method of analysis often adopted in microeconomic
is the partial equilibrium analysis in the analysis of the
determination of equilibrium portion for a small part of the
economy.
It takes a single market and examine, the
determination its equilibrium position.
Microeconomics analysis is done based on static
analysis. The static analysis is the calculation of equilibrium
value of some economic variable that results from a stated set
of condition.
Lastly, microeconomics adopt positive analysis approach
as a method of analysis. The positive analysis that economics
which is concerned with propositions about what is, rather
than what might to be. It develops in hypothesis that are
often rebutted by objective factual evidence. E.g. if the rate of
interest rises the demand for money will fall:
that if
investment increase national income will rise. The price of
gold falls in the market, demand for and will rise etc.
1.4
SUMMARY
Microeconomics is a term derived from a Greek
word “Mikros” is meaning small which is the study of
economic behaviour of small economic units.
It is
concerned with individual economic units. The goals of
microeconomics
are production, distribution, price
determination, efficiency in resource use, utility,
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MICROECONOMICS I
indifference
curve,
consumer
surplus,
markets
operations, choice of goods and services and allocation of
resources.
The use of microeconomics include are explanation
of the behaviour of free markets interm of behaviour of
consumers in decision of purchases of different goods
and behaviour of producers in the decision of producing
amount of different goods and resources use.
The limitation of microeconomics includes its
inability to explain the operation of the whole economy
the assumption of full employment assumption of ceteris
paribus, assumption of Laissez faire that are not
obtainable in reality.
The scope of microeconomics is in its analysis is
used in partial equilibrium analysis static analysis and
the adoption of positive analysis which are mighty
restrictive, and dynamic with the dynamic events of most
economics of the world.
1.5
SELF ASSESSMENT EXERCISE
1.
2.
3.
1.6
a.
What is microeconomics?
b.
Explain the use of microeconomics.
State the goals of microeconomics.
Explain the following:
a.
Partial equilibrium analysis.
b.
Static analysis
c.
Positive analysis
d.
Ceteris paribus.
REFERENCE:
Elikwu
A.B.
(2005)
Introductory
Approach
to
Microeconomics Emmanuel Concept Nag Ltd
Jhingan M.L. (1997) Microeconomic Theory Vrind &
Publication (P) Ltd. 5th Revised and Enlarged
Edition
CDL, University of Maiduguri, Maiduguri - Nigeria
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ECON 200:
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1.7
MICROECONOMICS I
SUGGESTED READING
Shehu
U.A.R
(2004)
Introduction
to
Modern
Microeconomics Bench Mark Publishers Ltd. Abuja,
Nigeria
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TOPIC 2:
TA B LE
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C O N T E N TS
PAGES
2.0
TOPIC:
PROBLEMS OF SCARCE RESOURCES AND
ALLOCATION OF RESOURCES IN FACTOR
AND PRODUCT MARKETS
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2.1
INTRODUCTION
2.2
OBJECTIVES
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2.3.1 THE CONCEPT OF RESOURCES -
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2.3.2 SCARCITY AND CHOICE -
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2.3
IN – TEXT
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2.3.3 THE PRODUCTION POSSIBILITY FRONTIER
AND OPPORTUNITY COST
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2.3.4 ASSUMPTION UNDERLYING PRODUCTION
POSSIBILITIES CURVE
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2.3.5 ILLUSTRATION OF PRODUCTION POSSIBILITIES
CURVE
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2.3.6 RESOURCE ALLOCATION USING THE MARGINAL
PRODUCT OF FACTORS -
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2.4
SUMMARY -
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2.5
SELF ASSESSMENT EXERCISES -
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2.6
REFERENCE
MICROECONOMICS I
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2.0
MICROECONOMICS I
TOPIC: PROBLEM OF SCARCE RESOURCES
AND
ALLOCATION
OF
RESOURCES
IN
FACTOR
AND PRODUCT MARKETS
2.1
INTRODUCTION
In every economy, the problem faced economic
agents are, what to produce, how to produce and to
whom to produce. The problem of what to produce
entails the nature and volumes of the goods needed in
the society, how to produce is the techniques and
resource allocation given their prices for efficient
production, and for whom to produce i.e. those with
effective demand for the products. All these problems are
resolved through the price system of the economy.
2.2
OBJECTIVES
At the end of the topic students should be able to:
i. Define what a resource is.
ii. Explain the word scarcity in economics.
iii. Explain production possibility curve.
iv. Discuss resource allocation using the marginal
products of the factors and marginal utility
approach.
v. Explain resource allocation using the managerial
product of the factor resources.
2.3 IN TEXT
2.3.1
THE CONCEPT OF RESOURCES
A resource is something that is useful and valuable in
the condition in which we find it. In its raw or unmodified
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MICROECONOMICS I
state, it may be an input into the process of producing
something of values or it may enter consumption processes
directly and thus be valued as an amenity.
2.3.2
SCARCITY AND CHOICE
The word “scarcity” refers to a state of affairs in which
given the “wants” of the society at any particular moment the
means available to satisfy them are not sufficient.
The
problem of scarce resource arises as a result of limited
productive resources in relation to the amount of goods and
services to be produced. Therefore, a society must use its
scarce resources as efficiently as possible to produce the goods
and services most needed in the societies. As a result of the
scarcity of resources, goods and services, command price.
Therefore, goods and services that are brought and sold at a
price are called economic goods it is the scarcity of resources
that forced individuals and societies to make choices.
A decision to produce one things implies a decision to
produce less of some other things. Hence all societies are
faced with the problem of deciding what i.e. sacrifice to get the
things that want. In general, economics is fundamentally
concerned with choice or decision in the use of resources.
Problems of choice arise when there are alternative ways of
achieving a given objective.
Since all desires can not be totally satisfied and choices
have to be made as to which of them are going to be satisfied,
it follows then that economics is about scarcity and about
choices. The fact that the problem of a choice arise when
there are alternative way of achieving a given objective, it
means when choice is made, alternatives are given up. The
necessity of choice therefore result unto the concept of
opportunity cost.
The concept of opportunity cost describes the sacrifice
made in making a choice. The opportunity cost or real cost of
anything is the most desirable alternative commodity project
or service forgone.
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2.3.3
MICROECONOMICS I
THE
PRODUCTION
POSSIBILITY
FRONTIER AND OPPORTUNITY COST
The production possibility for frontier sometimes called
production possibility curve or transformation curve, shows
how a society using all its resources can produce different
combination of goods or services. It is an economic model that
helps us to see what a society has to sacrifice in order to
produce more goods of a certain type.
It showed that, there is a limit to the amount of goods
and services that a country can produce with its existing
resources.
A production possibility further or curve joins together
the different combination of goods and services which a
country can produce using all available resources and the
must efficient techniques of production. It illustrates the
problem of choice between how much of each good to produce
and the opportunity cost of re-allocation of resources.
2.3.4
ASSUMPTIONS
UNDERLYING
PRODUCTION POSSIBILITIES CURVE
The first assumption is that, there are and only two
goods in the economy e.g. food and cloth.
Secondly, all factors of production are fully employed. It
means that who ever wants job, has one, land and capital are
full employed; all factories are producing at a full capacity.
Finally, all factors of production are homogenous or
exactly alike, i.e. labour capital and land is perfectly
substitutable for another unit of the same factor.
2.3.5
ILLUSTRATION
OF
A
PRODUCTION
POSSIBILITIES CURVE
Clot
h
10
8
A
B
C
CDL, University of Maiduguri,
Maiduguri - Nigeria
D
6
4
E
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The above diagram shows the production possibility
curve. The shape of the curve shows that, as we increase our
production one commodity, it will be harder and harder to get
further units of the other commodity. In other words, as we
increased food production we shall have to given up more and
more units of cloths to increase our food production in one
unit.
From the diagram as we move from A to point E, we
increasing cost in food production as some by downward
arrow of increasing length along the vertical cloth axis.
A point inside the production possibilities curve such as
U implies that the economy is not utilizing all of its available
resources or not using it best technology available. It i.e. there
are unemployed or under employed resources.
By fully
employing all of its resources the society can move from point
U to a point on the production possibility curve and produce
either the same units of food but more cloth (point C), the
same cloth and more food (point D) or more food and (a point
between C and D in the curve). A point outside (such as F).
Cannot be reached with the resources and technology
available.
The scope of the production possibilities curves is
sometimes called the marginal rate of transformation. It
measures the opportunity cost or the rate at which one
commodity is transformed into a unit of other commodity in
my re-allocation of resources.
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2.3.6
MICROECONOMICS I
RESOURCE
ALLOCATION
USING
THE
MARGIMAL PRODUCT OF FACTORS
Given the prices of the factors (resources) in the factor
market, the producer or society allocation these resource
based
on the contribution of each factor on the total output
produced. In a production process, where only one factor is
used, the producer employs the use of the factor until the
marginal product equals the price of the factor in the
production process.
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e.g.
MICROECONOMICS I
Qx
MPx
=
=
MPx
f (x)
-
Px
=
=
Px
MPx
=
Px
=0
This means that the change in the total of x as a result of
the employment of factor input x must equal the prices of the
factor x. If two factors are employed in the production process
the allocation will be made in such a way that the ratio of the
marginal products of the factors must equal to the ratio of
prices of the factor resources employed or the rate of technical
substitution between the two factors must equal the ratio of
their prices given the budget of the society e.g.
X
=
f (L.K)
Y
=
output, L = Labout, K = Capital
C – WL – rk = O
+ ^ (-w) = 0
= + ^ (-r) = 0
= C – wL – rk = 0
= ^ or ^ =
= MPL
= ^ or ^ =
= MPL
r
=MPL = w
=
or
This is an efficient allocation of factor resources based in
their contribution to the total output with respect to their
prices, given the limited financial resources of the society.
2.4 SUMMARY
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MICROECONOMICS I
A resource is anything useful and valuable. It may be
input into the processes of production of something
valuable or enter consumption directly. It must be
scarce to command value. The scarcity means, given the
wants of the society the means available to satisfy them
are not sufficient. Scarce resource arises because the
amount of goods and services needed to be produced are
limited. As a result of the scarce resource, societies are
forced to make choice in their production decision i.e.
how much to sacrifice in order to produce additional
amount of the goods needed. It means, when a choice is
made, alternatives are given up. A society’s decision to
make a choice of introducing a particular amount of good
is done at the expense of the other goods. A resource is
allocated in the production of a particular goods when
certain amount of the other commodity is given up. With
regards to resource allocation using marginal product of
the resources resources are allocated when the marginal
products of these factors are equal to the ratio of the
prices of these factors or the marginal rate of technical
substitution must equal the ratio of the prices of the
factors.
2.5 SELF ASSESSMENT EXERCISE
1. What do you understand by the word scarcity in
economics?
2. What is resource?
3. What is production possibility curve and what does
it illustrate?
4. State the assumption underlying production
possibility curve.
2.6 REFERENCES:
Shehu
U.A.R
(2004)
Introduction
to
Modern
Microeconomics Bench Mark Publishers Ltd.
Law First Edition
CDL, University of Maiduguri, Maiduguri - Nigeria
19
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UNITS: 3
MICROECONOMICS I
Alex B.E. (2005) Introduction Approach to Microeconomics
Emmanuel Concept Nigeria
2.7 SUGGESTED READING:
Jhingan M.L. (1997) Microeconomic Theory
Production (P) Ltd. 5th Revised Enlarged Edition
CDL, University of Maiduguri, Maiduguri - Nigeria
Vrinda
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UNITS: 3
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TOPIC 3:
TA B LE
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C O N T E N TS
PAGES
3.0
TOPIC:
CONCEPT OF EQUILLIBRIUM -
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3.1
INTRODUCTION
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3.2
OBJECTIVES
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3.3.1 CONCEPT OF EQUILLIBRIUM -
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3.3.2 DYNAMIC EQUILLIBRIUM
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3.3
IN – TEXT
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3.3.3 PARTIAL EQUILLIBRIUM
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3.3.4 GENERAL EQUILLIBRIUM
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3.4
SUMMARY -
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3.5
SELF ASSESSMENT EXERCISES -
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23
3.6
REFERENCE
-
-
-
-
-
-
-
-
-
SUGGESTED READINGS -
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-
-
-
-
23
23
3.7
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MICROECONOMICS I
3.0 TOPIC: CONCEPT
OF
EQUILIBRIUN:
DYNAMIC
EQUILIBRIUM
AND
GENERAL
EQUILIBRIUM
3.1 INTRODUCTION
In
all
economies,
whether
developed,
underdeveloped or developing the policy thrust of these
economies is to find stability balance and development in
all its economic sectors and the citizens of these
economies. The concept of equilibrium which is all
almost finding stability balance and development is the
concern of this topic.
3.2 OBJECTIVE
At the end of this topic, students should be able to:
i. Define what are equilibrium is.
ii. Demonstrate how equilibrium are reached in an
economy; and
iii. Distinguish
between
partial
and
general
equilibrium.
3.3
3.3.1
IN-TEXT
CONCEPT OF EQUILIBRIUM
The word equilibrium was derived from a Latin word
“equilibrium” which equal balance. In physics, it means a
state even balance in which opposing forces a tendencies
neutralize each other. An equilibrium therefore, is a situation
where there is no net tendency to move. In economics,
equilibrium, implies a position characterized absence of
change i.e. absence in change of movement. In others it is a
market situation where all decisions by the participants are in
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MICROECONOMICS I
unicity with each other.
diagram below:
This can be demonstrated in the
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MICROECONOMICS I
s
Price
d1
1
P
s1
s
Fig. 1
d
d
0
Quantity
Q
In this market in fig. 1, the market price P must be such
that it equates the demand and supply of the product. When
demand and supply are equal at a particular price, it is a state
of equilibrium. The price which the product is bought and
sold is the equilibrium price and the quantity bought and sold
is the equilibrium quantity.
3.3.2
DYNAMIC EQUILIBRIUM
In dynamic equilibrium, prices, quantities income, taste
and technology are constantly changing. Thus, over a period
of time a state disequilibrium rather than equilibrium is to be
found. There is disagreement in the decision of the market
participants and this tends to alter the existing equilibrium
situation and there is disequilibrium.
Those market
participants in a state of disequilibrium wanting to reach
equilibrium position throw others into disequilibrium. Thus, a
chain reaction set in which ultimately brings the participants
in economy and a new equilibrium is established.
The
diagram below explains the situation.
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MICROECONOMICS I
Pric
e
P1 P3
P2
P
Quality
0
q
q1 q2 q3
q1
Suppose some consumers developed the taste of fish
instead of the usual meat consumption and the demand for
fish increases. It will upset the previous equilibrium position
sellers will raise the price for fish and therefore change the
behaviour of buyers. The market will be thrown into a state of
disequilibrium and will remain until the supply of fish
increases to the current level of demand where new
equilibrium will be brought in by the contending forces. This
state of disequilibrium the equilibrium is base explained by a
cobweb theorem therein with the increase in demand from D
to D1, price shoots up to gb (=OP1), this price induces the
suppliers to increase their supply by q q1, but this is more
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than the equilibrium quantity 0q3 which is needed in the
market, therefore, it will lower the price to q1d equal the price
(=OP2). This further alters the production and supply of the
suppliers thereby reducing the supply to 0q2.
But this
quantity is less than the equilibrium level 0q3; therefore price
rises to OP4 which in turn stimulates the supply to 0q3. Thus,
equilibrium will be established at point g when S and D1
curves intersect and 0P3 – 0q3 is the price – quantity
combination.
This is dynamic equilibrium with tagged
adjustments.
3.3.3
PARTIAL EQUILIBRIUM
Partial or particular equilibrium analysis is known as
microeconomics. It is the study of the equilibrium position of
individuals, a firm, an industry or group of industries viewed
in isolation. It is a market process for the determination of
product prices and factor prices with one or two variable
discussed with other things remaining constants or equal
(Ceteris Paribus).
Example, a consumer is in equilibrium, when he spends
all his income on the purchases of different goods and services
in such a way that he gets the maximum satisfaction.
The condition is that the marginal utility of each goods is
equal to its price (P)
i.e. MUA =
Mub
=
- - - =Mun
PA
Pb
Pn
And that the consumer must spend in entire income (Y) =
PA QA + Pb Qb + -------- t Pugn.
It is assumed that his tastes, preference money income
and prices of other goods he wants to buy are given and
constant.
A firm is in equilibrium when it has no tendency to
change its output i.e. its marginal cost equals its marginal
revenue in the short run, in the diagram, when MC = MR =
LAC
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3.3.4
MICROECONOMICS I
GENERAL EQUILIBRIUM
General equilibrium analysis is a study of a number of
economic variable, their interrelations and interdependence,
for understanding the working of the economic system as a
whole.
General equilibrium exists when all prices are in
equilibrium. Each consumer spends his income in a manner
that yield him maximum satisfaction all firms in each industry
are in equilibrium at all prices and outputs and the supply
and demand for production resources are equal equilibrium
prices.
The assumptions underlying the general equilibrium
include.
1. There is perfect competition within the commodity and
factor markets.
2. Tastes and habits of customers are given and constants.
3. Incomes of consumers are given and constant.
4. Factors of productions are perfectly mobile between
different occupation and places.
5. There are constant return to scale.
6. All firms operate under identical cost condition.
7. All units of a productive service are homogenous.
8. There are no changes in the technique of production.
9. There is full employment of labour and other resources.
Given these assumption, the economy is in a state of
general equilibrium when the demand for every commodity
and service is equal to the supply for it. i.e. perfect harmony
of decisions made by all the market participant similarly the
decision of owners for selling each factor service must be in
perfect harmony with the decisions of their employers.
Thus, the economy is in general equilibrium when
commodity prices make each demand equal to its supply and
factor prices make the demand for each factor equal its supply
so that all product markets and factor markets are
simultaneously in equilibrium. The general equilibrium is
characterized by two conditions.
1. All consumers maximize their satisfactions and all
producers maximize their profits.
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2.
MICROECONOMICS I
All markets are cleared which means that the total
amount demanded equal the total amount supplied at a
positive price in both the product and factor markets.
FLOW OF PRODUCTIVE RESOURCES
Factor market
Demand
Supply
Producers
Consumer
Demand
Supply
Product
market
The consumer purchase all goods and services provided
by producers and make payments to the producers. The
producers, in turn make purchases and payments to
consumers for the services interest for productive resources
applied. Therefore payments go round in a circular manners
from producer to consumers and from consumers to
producers. Thus, the economy is in a general equilibrium
when a set of income flow from producers to consumers is
equal to the magnitude of the money expenditure from
consumer to producers.
3.4 SUMMARY
The word equilibrium was derived from a Latin word
which means equal balance. The equilibrium can be a
point of no tendency to move or change. Equilibrium can
be dynamic i.e. always changing as a result of
disturbance in the initial equilibrium partial equilibrium
which is an analysis of an equilibrium of a particular
individual firm an industry or group of industries in
isolation; or a general equilibrium which is a study of
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interrelations and interdependence of variable for better
understanding of the entire economy.
The general
equilibrium occurs when the decisions of consumers and
producers are in perfect harmony and the market is
cleared.
3.5 SELF-ASSESSMENT EXERCISE
1. Define
the
word
equilibrium
in
economics.
2. Define dynamic equilibrium and show how
equilibrium is achieved.
3. With the use of diagram, explain how general
equilibrium is allowed in an economy.
3.6 REFERENCES:
Jhingan
M.L. (1999) Microeconomic Theory Vrinda
Publication (P) Ltd Revised and Enlarged Edition
Alee B.E. (2005) Introductory Approach to Microeconomics.
Emmanuel Concept Nigeria Ltd
3.7 SUGGESTED READING:
Jhingan M.L. (1997) Microeconomic Theory
Production (P) Ltd. 5th Revised Enlarged Edition
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Vrinda
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TOPIC 4:
TA B LE
O F
C O N T E N TS
PAGES
4.0
TOPIC:
-
THEORY OF CONSUMER BEHAVIOUR
-
-
24
4.1
INTRODUCTION
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25
4.2
OBJECTIVES
-
-
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25
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4.3.3 THE CARDINALIST APPROACH -
-
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26
4.3.4 ORDINAL UTILITY APPROACH -
-
-
27
25
4.3
IN – TEXT
-
-
4.3.1 CONSUMER BEHAVIOUR THEORY
25
4.3.2 CARDINAL UTILITY APPROACH
25
4.3.5 MEANING OF AN INDIFFERANCE CURVE
-
28
4.3.6 ASSUMPTION OF THE INDIFFERENCE
CURVE ANALYSIS -
-
-
-
-
30
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-
4.3.8 MARGINAL RATE OF SUBSTITUTION -
-
31
4.3.9 BUDGET LINE OR CONSTRAINTS
-
-
-
-
-
-
33
-
-
-
34
4.3.7 PROPERTIES OF INDIFERRENCE CURVE
31
32
4.3.10 CONSUMER EQUILLIBRIUM
4.4
SUMMARY -
-
-
-
-
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4.5
SELF ASSESSMENT EXERCISES -
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-
-
-
36
4.6
REFERENCE
-
-
-
-
-
-
-
-
SUGGESTED READINGS -
-
-
-
-
-
36
36
4.7
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4.0
MICROECONOMICS I
TOPIC:
THEORY
OF
CONSUMER
BEHAVIOUR
4.1
INTRODUCTION
The theory of consumer behaviour is another
avenue of decision making by a consumer who is faced
with limited resources and has to choose between the
different types of goods and services with a view of
maximizing satisfaction.
4.2 OBJECTIVES
At the end of the topic, students could be able to:
i. Identify the assumption of both cardinal and
ordinal utility maximizing ,,,,
ii. Explain who consumers can maximize their
utility (satisfaction) using both cardinal and
ordinal school of through.
iii. Explain the difference between cardinal and
ordinal utility there is.
4.3 INTEXT
4.3.1
CONSUMER BEHAVIOUR THEORY
The theory of the consumer behaviour is concerned with
the decision making behaviour of the consumers. It deals with
how consumers express their preference interm of how people
might prefer one good to the other when faced with a budget
constrain (limited income), so that he/she can make
combination of goods that gives him the maximum satisfaction
given his preference and income.
The consumer behaviour analysis has two major
approaches.
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4.3.2
MICROECONOMICS I
CARDINAL UTILITY APPROACH
1. Cardinal utility approach by the new classical economists
which was popularized by Alfred Marshall.
This
approach argues that utility is a measure of satisfaction
that consumer receives from consuming a commodity or
the satisfying of commodity can measured.
2. The ordinal utility approach which is also known as
indifference curve analysis by J.R. Hicks and Allen. This
analysis believed that utility cannot be measured but
that consumers can rank the goods in order of utility.
The consumer is able to arrange various combinations of
goods and services in a scale of preference. This means
that the consumer can indicate.
a. Whether he prefers one commodity bundle to
another.
b. Whether he is indifferent between two commodity
bundles.
The consumer can rank alternative
commodity bundles in order of his preference for
them.
4.3.3
THE CARDINALIST APPROACH
The central concepts in this approach are the marginal
utility and the hypothesis of diminishing marginal utility. The
marginal utility is the extra utility or additional satisfaction
derived by an individual from consuming one additional unit
of a good. i.e. increase in the stock of the good by additional
unit.
In other words, MU = TU2 – Tu1
The law of diminishing marginal utility states that, the
marginal utility derived from consumption of a good
diminishing when the quantity of the good consumed per unit
of time increases. I.e. as the quantity of a good consumed by
an individual increases, the marginal utility of the good will
eventually decrease.
The diminishing marginal utility provides answers for
condition of an individual to minimize satisfaction from
purchases of a range of goods and services.
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Example assuming that a consumer who has to choose
between two (2) goods x and y with prices Px and Py. If the
consumer is rational and wishes to maximize his total utility
subject to the size of his income, he will maximize his total
utility subject to size of his income, he will maximize his total
unity by allocating his income in such a way that the unity
derived from each Naira worth of x is equal to the utility
derived from one extra Naira worth of Y. i.e. when marginal
utility per Naira of y when this equality is reached, it will not
be possible for the consumer to switch his expenditure from
one good to the other.
i.e. MUx
=
MUY
or
MUx = Px/Py
Px
Py
MUY
Where MUX and Muy are marginal utilities of x and
y and Px and Py are prices of x and y respectively. For more
than two goods equilibrium is attained as:
MU1 =
MU2 =
MU3 =
----- =
P Mun
P1
P2
P3
Pn
This is an expression of the law of equal-marginal utility
also known as the law of maximum satisfaction law of
substitution; Gossen’s second law, the law of proportionality
utility maximization is when the consumer allocates income so
that the marginal utility divided by the goods price is equal for
every good purchased.
MUx
=
MUY
Px
Py
e.g. If MUx = 20
Px = 4 and Py = 5
= MUx
=
Px
MUx
Px
Muy = 25
20
4
=5
=
MUY
Py
MUY = 25 = 5
Py
5
= 5 utib per
Naira
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4.3.4
MICROECONOMICS I
ORADINAL UTILITY APPROACH
The ordinal utility approach was based in the fact that
utility cannot be measured because:
1.
It is a subjective concept therefore its
quantitative measurement is not possible.
2.
The utility from a unit of good is different for
different persons and different at different times.
Therefore it is difficult to make accurate
measurement.
3.
Utility analysis is restricted i.e. the consumption
of one commodity at a time. It cannot be for
consumption for several goods.
Utility of a good is not a function of that good alone not
dependent on all goods and services that the consumer
purchases.
The fact that utility cannot be measured given the
reasons above, consumers can only rank the goods in their
order of utility called the ordinal measure of utility what if
means is that the consumer can arrange various
combinations of goods and services in a scale of
preferences. Given to bundles of goods, the consumer can
rank the two bundle in order of is preference for them or he
is indifferent between the two alternative commodity
bundles. The ordinal approach is based on a procedure of
ranking the total satisfaction obtained from different
combination of goods and serves whether they give a
consumer higher or lower levels of satisfaction. The ordinal
utility concept is based on an analytical technique called an
indifference curve.
4.3.5
MEANING OF AN INDIFFERENCE CURVE
An indifference curve is a locus of point each
representing combination of two goods which yields the same
level of satisfaction to the consumer so that the consumer is
indifferent between any two combinations of goods when it
comes to choice.
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The concept of indifference curves is one way by which
the consumers preference can be described.
If an indifference schedules is presented as follows:
Combination
Rice(Kilos)
Beans(Kilos) Satisfaction
A
25
5
5
B
15
7
5
C
10
12
5
D
6
20
5
E
4
30
5
This combination of two goods yields to the consumer the
same total satisfactions for these goods rice and beans.
However, for another pattern of combinations.
The
indifference schedule is a combination.
The indifference
schedule is a combination between which a consumer is
indifferent if combinations a b c d e we plotted and jointed to
form a smooth curve, the resulting curves is known as
indifference curve.
Beans
a
30
b
25
20
c
15
d
10
e
5
0
5
10
15
20
25
IC
30
Rice
These five combination (abcde) of rice and beans represents for
the consumer the same level of satisfaction.
On the indifference curve (IC),one can locate many other
points showing many different combinations of rice and beans
which yield the same satisfaction. Therefore, the consumer is
indifferent between the combinations. Thus, it is possible to
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(kilos)
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draw a number of indifference curves without intersecting or
touching the other.
The set of indifference curves, IC1, IC2, 1C3, 1C4, drawn
in this manner make the indifference map. An indifference
map may contain any number of indifference curves, ranked
in the order of consumers, preferences. These indifferences
curves shows that higher indifference curves in the scale of
preferences carry a higher number. Higher indifference curves
show higher levels of satisfaction and lower indifference curves
indicates lower levels of satisfactory.
4.3.6
ASSUMPTION
OF
THE
INDIFERENCE
CURVE ANALYSIS
The indifference curve analysis is based in the following
assumptions:
1.
The consumer is rational and aims at maximizing
his satisfaction.
2.
The consumer possesses complete information
about the prices of the goods in the market.
3.
The prices of the two goods are given and
constant.
4.
The consumers tastes, habits and income
remained constant throughout the analysis.
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5.
6.
7.
8.
9.
4.3.7
MICROECONOMICS I
He prefers more of x to less of y which is a
negatively,
inclined
downward
sloping
indifference curve i.e. convex indifference curve.
There are two goods x and y.
The consumer arranges the two goods in a scale
of preference.
He has both preference and
indifference for the goods. He is expected to rank
them in order of preference or remained
indifferent between them.
Both preferences and indifference are transitive
i.e. if A is preferable to B, and B to C, then A is
preferable to C. Also if he is indifferent between
A and B and B and C, then he is indifferent
between A and C.
An assumption of non-satiation which implies
that the consumer prefers more than less of the
commodity.
PROPERTIES
OF
INDIFFERENCE
CURVES
1.
2.
i.e.
The scope of an indifference curve is negative
down ward scoping from right.
Indifference curves can neither touch nor
intersect each other so that one indifference curve
passes through only one point in the indifference
map.
Bean
s
C
A
IC2
B
0
IC1
Rice
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3.
4.3.8
MICROECONOMICS I
This shows two level of satisfaction which is
unacceptable. An indifference curve can never cut
each other.
The indifference curves is always convex which
means as the consumer substitutes x for y the
marginal rate of substitution diminishes i.e. as x
increases, y diminishes.
MARGINAL RATE OF SUBSTITUTION
The marginal rate of substitution measures the number
of unit or litres of good A that must be given up to gain one
unit of a litre of good B so as to maintain a constant level of
satisfaction. It is given by the scope of an indifference curve at
a point:
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C
DC
MRSLC = AC
DL
DL
0
L
The marginal rate of substitution of L for C at point x is
given by the scope of the tangent at point x and is measured
by the ratio AC/AL.
Therefore the marginal rate of constitute:
MRSXY for good x and y
is MRSXY = Loss of y = AY
Receipt of x AX
4.3.9
BUDGET LINE OR CONSTRAINT
The budget there is the limited amount of money that is
available to the consumer to spend on goods per unit or time.
It show the different combination of goods the consumer can
purchase given the income he has and the market prices of
the two goods.
The budget must be exhausted on the
purchase of the two goods. Thus the budget is expressed as I
= Px qx + Py qy or Y = XPx + Ypy. The budget is expressed as
Y = 1 1- Px x where I is the vertical
Py
Py
intercept indicating the amount of y purchased if x is not
purchased at all. The scope of the budget line is given as:
- px/py. This implies that the scope of the budget is the
negative of the price ratio. The budget schedule for two goods
rice and beans are presented below:
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Combination
Beans
Rice
A
0
4
B
2
3
C
4
2
D
6
1
E
8
0
when the schedule is presented in a curve or the
budget line, it reveals as below:
Rice
4
a
b
3
c
2
d
1
e
0
2
4
6
8
Bean
s
The scope of the budget line can now be expressed as:
Oq =
Pr
< 0
Oe
Pb
Which means the scope of the budget line is negative.
4.3.10
CONSUMER EQUILIBRIUM
For the consumer to be at an equilibrium, he makes in
purchases for the sale aim of obtaining the greatest
satisfaction as rational consumer from in available money
incure i.e. he aims at maximize in utility within the limited
income he has given the market prices of the two goods as a
rational consumer. This can be illustrated using the diagram
below:
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Beans
A
B
C
G
Q
F
I3
I2
I1
e
0
T
Rice
On the diagram ordinarily, C is preferred to A because it is an
higher indifference curve 13 not the budget constraint makes it
impossible. The equilibrium is that the combination of beans
and rice that maximizes satisfaction must be on the highest
indifference curve that toughes the budget line. In this case,
point A is the point of the tangency between the indifference
curve 12 and the budget line are. At point A, the point of
maximization, the marginal rate of substitution between the
two goods equal the prices ratio. i.e. MRS = Pr/Pb. At this
point A it is called a point of equilibrium. At this point the
scope of the indifference curve 12 is equal to the scope of the
budget line. In algebraic expression, it can be stated as:
MUR
=
Mub
PR
Pb
4.4 SUMMARY
The theory of consumer behaviour examine how
consumer express his preference given that level of limited
resources. It is analysed using two approaches.
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1.
Cardinal utility: This approach states that utility
can be measured by the utility received from
consumption of goods.
2.
An ordinal utility approach which states that
utility cannot be measured but the consumer can
only rank the goods in order of their utility based
on a scale of preference.
The cardinal utility approach central concept in the
marginal utility and the diminishing marginal utility.
Therefore, a consumer can attain a level of equilibrium when
the ratio of the marginal utility over the price we equal for all
goods consumed. i.e.
MUX = Muy = --------- = Mun
Px
Py
Pn
The ordinal utility which is sometimes called the
indifference curve express the combination of two goods which
yields the consumer the same level of satisfaction. Therefore
given the consumers preferences and his budget constraints
(Y= XPx + YPy) which the consumer is expected to exhausted
all the income attain a level of equilibrium when the consumer
has attained the highest indifference curve tangential to the
budget line
Bean
s
E
Q
13
12
I1
0
T
Rice
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Algebraically, equilibrium is attained when the ratio of
the marginal utility over the price of the good are equal for all
goods:
MUR = Mub
PR
Pb
4.5 SELF-ASSESSMENT EXERCISE
1. Briefly explain the major difference between the
cardinalist approach and ordinalist approach to the
analysis of consumer behaviour.
2. Define budget line. Given two goods x and y price of
x is Px and price of Y is Py, given the consumer
income as I, present the budget equation.
3. Given the goods x and y, and prices of x and y are Px
and Py i.e. Px = N25 and Py = N50, and consumer
income is I = N200 present the budget equation and
show the budget line diagram.
4.6 REFERENCES
Alex, B.E (2005) Introductory Approach to Microeconomics
Emmanuel Concept, Nigeria Ltd
Shehu,
U.A.R
(2004)
Introduction
to
Modern
Microeconomics Benchmark Publishers Ltd Kano
Nigeria
Jhingan, M.L. (1999) Microeconomic Theory Vrinda
Publication (P) Ltd. Revised and Enlarged Edition
4.7 SUGGESTED READING
Alex, B.E (2005) Introductory Approach to Microeconomics
Emmanuel Concept, Nigeria Ltd
Shehu,
U.A.R
(2004)
Introduction
to
Modern
Microeconomics Benchmark Publishers Ltd Kano
Nigeria
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Jhingan, M.L. (1999) Microeconomic Theory Vrinda
Publication (P) Ltd. Revised and Enlarged
Edition
TOPIC 5:
TA B LE
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C O N T E N TS
PAGES
5.0
TOPIC:
COBWEB THEORY -
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5.1
INTRODUCTION
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5.2
OBJECTIVES
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5.3.1 DEFINITION OF COBWEB THEOREM -
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5.3.2 PERPETUAL OSCILLATION
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5.3
IN – TEXT
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5.3.3 DECLINING OSCILLATION OR CONVERGENCE
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5.3.4 EXPLOSIVE OSCILLATION
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5.4
SUMMARY -
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5.5
SELF ASSESSMENT EXERCISES -
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5.6
REFERENCE
MICROECONOMICS I
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SUGGESTED READINGS -
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42
5.7
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5.0 TOPIC: COBWEB THEORY
5.1 INTRODUCTION
The cobweb theory is a name given to cyclical fluctuation
in the prices and quantities of various agricultural
commodities where the quantity demanded of the
product at a given time depends on the price at that time
while the supply at a given time depends on its price at a
previous time when the production plans were initially
formulated.
5.2 OBJECTIVE
At the end of the topic, students should be able to:
i.
Define what a cobweb theory is.
ii.
Demonstrate with the use of diagrams the
different types of oscillations.
5.3 IN TEXT
5.3.1
DEFINITION OF COBWEB THEOREM
The cobweb theory is used to explain the dynamics of
demand, supply and price over long periods of time. When
prices of goods move up and down in cycles, quantities
produced also move up and down in a counter cyclical
manner.
The cobweb theory can apply to prices and outputs of
goods whose production is discontinuous such as annual
crops, commodity that take two a more years to produce such
as animals and fruit trees.
The essential features of the theory is that output in
period (year 2) is a response to price in year 1; output in year
(3) is a response to price in year (2) and output in year (4) to
the price in year (3) output then is lagged one (1) year behind
price.
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5.3.2
MICROECONOMICS I
PERPETUAL OSCILLATION
(AMPLITUDE CONSTANT)
This perpetual cobweb which is sometimes called
continuous cobweb shows that D,=f(p) which is the demand
curve for the product in period t. While the supply S. = f (Pt-1)
the supply curve of the product in period t.
The cobweb theory (perpetual oscillation) can be
illustrated as follows.
-S=f(Pt-1)
Price P1
P2
D = f (D.)
quantity
0
S1
q2
Assuring the price in period 1 is OP1, in response to this
price, farmers produce an output of 022 in period 2 but the
demand for the product 022 can only be sold at a low price
OP2. Thus, the price in period 2 becomes OP2. In response to
the low price farmers supply in period 0q1. This small
quantity in period 3, will fetch higher price OP1, hence the
price in period 3 is the same as the price in year 1. Thus, the
price and quantity perpetually oscillate round and rounds
perpetual oscillation taken place when the scope of the
demand curve and that of the supply curve are equal or the
elasticity of demand and that of supply are in unity or equal.
5.3.3
DECLINING
OSCILLATION
OR
CONVERGENCE OSCILLATION
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In the case of convergence cobweb theory, the scope of
the demand curve is less steeper than that of the supply curve
or the elasticity of demand is less than the elasticity of supply.
This is illustrated in below:
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P
P1
P3
P4
P
P5
S= f (py-1)
D= f (p)
Q
0
q4
q2
q3
The price in period 1 is OP1 and produce output of 0q2
in period 2, however, this output in period is can be sold at
price OP2 now due to low price, suppliers produce less output
which result in a low supply of 023 in period 3. However, this
low output will fetch a high price of OP3 in period 3 which will
lead to expansion of output of 024 in period 4. This fetches
price of OP4 and so on. This occurs when the scope of the
supply curve is greater than the scope of the demand curve.
5.3.4
EXPLOSIVE
OSCILLATION
OR
DIVERGENCE COBWEB
In the explosive oscillation the scope of the demand curve
is greater than the scope of the supply curve. If the elasticity
of demand is greater than the elasticity of supply co-efficient.
P
P2
P1
Q3
0
Q
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In this cobweb, the line of cobweb keeps moving further and
furthers away from the of equilibrium, thus, the oscillation are
explosive and equilibrium is unstable.
When the price in period one (1) is OP1, the producers in
response produced output 0q2, in period 2 but this output in
period2 can be sold at a price of OP2 which is a low price. At
this low price, the producers will cut down the supply to 0q3
in period 3. As result of the low output in period3, the output
fetches higher price of OP3 in period 3, this makes producers
to expand their supplies to 0q4 in period 4 this will fetch price
of OP4 in period 4. This will continue on and on. Thus, the
path is one of explosive oscillation. The equilibrium is always
unstable.
5.4 SUMMARY
The concept of cobweb theory is a dynamic equilibrium
analysis and is used to explain dynamics of demand,
supply and price fluctuation over a low period of time.
The price of goods move up and down in cycles and
quantities produced also move up and down but in
counter cyclical manner. This cyclical movement of price
and quantities give rise to three types of cobweb theory
called perpetual, convergence and divergence cobweb
theorem. The perpetual cobweb occur when the scope of
the demand and supply curves are equal; leading to
perpetual cycle of price and quantity. In the convergence
cobweb, it occurs when the scope of the supply curve
while for the divergence, it occurs when the scope of the
demand curve is greater than that of supply curves.
5.5 SELF-ASSESSMENT EXERCISES
1.
Define what is cobweb theorem.
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2.
3.
MICROECONOMICS I
With the aid of a diagram, explain the nature of
cobweb model when the scopes of the demand curve
and the supply curve are equal.
What can you say about the scopes of the supply
curve and the demand curve in respect of the
cobweb situation that has to do with:
a.
Divergence is increasing.
b.
Convergence or declining.
c.
Perpetual or constant.
5.6 REFERENCES:
Alex, B.E. (2005) Introductory Approach to Microeconomics
Emmanuel Concept Nigeria Ltd
Jhingan, M.L. (1999) Microeconomic Theory Vrinda
Publications (P) Ltd 5th Revised and Enlarged
Editions
5.7 SUGGESTED READING
Alex, B.E. (2005) Introductory Approach to Microeconomics
Emmanuel Concept Nigeria Ltd
Jhingan, M.L. (1999) Microeconomic Theory Vrinda
Publications (P) Ltd 5th Revised and Enlarged
Editions
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TOPIC 6:
TA B LE
O F
C O N T E N TS
PAGES
6.0
TOPIC:
-
THE THEORY OF DEMAND AND SUPPLY
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6.1
INTRODUCTION
6.2
OBJECTIVES
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6.3
IN – TEXT
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6.3.1 THE THEORY OF DEMAND AND SUPPLY
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6.3.2 CLASSIFICATION OF DEMAND -
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6.3.3 THE DEMAND FUNCTION
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6.3.4 EXCEPTION TO THE LAW OF DEMAND
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6.3.5 TYPES OF DEMAND
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6.3.6 EALASTICITY OF DEMAND
49
6.3.7 CALCULATING PRICE ELASTICITY
51
6.3.8 THE CONCEPT OF SUPPLY
51
6.3.9 TYPES OF SUPPLY -
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6.3.10 THE SUPPLY FUNCTION -
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6.3.11 MARKET EQUILLIBRIUM
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6.4
SUMMARY -
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6.5
SELF ASSESSMENT EXERCISES -
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6.6
REFERENCE
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56
6.7
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6.0 TOPIC: THE THEORY OF DEMAND AND
SUPPLY
6.1 INTRODUCTION
People in every nation engages in demand for goods
and services for their satisfactions these goods and
services demanded are generally supplied by producer for
sale in the markets. The actions of the consumer and
suppliers are dictated by their desire to satisfy
themselves in the form of utility maximization and profit
maximization. The actions of these different actors in the
market are regulated by the market through the price of
goods and services, and prices of factor resource used in
the production of these goods and services.
6.2 OBJECTIVES
At the end of the topic, students would be able to:
i. Explain the classification of demand
ii. Discuss what a demand function is
iii. Differentiate between individual producer supply
and aggregate supply.
iv. Explain the types of supply.
v. Demonstrate how in market equilibrium can be
attuned demand and supply.
6.3
IN TEXT
6.3.1
THE THEORY OF DEMAND AND SUPPLY
The concept of demand and desire through seemed
synonymous are difference in economics, demand refers to
effective demand which comprise of three things. The first is
the desire for the commodity second, sufficient money to
purchase the good and the third, the willingness to spend
money to acquire the good. This entails that demand refers to
demand at a price and demand per unit of time.
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6.3.2
MICROECONOMICS I
CLASSIFICATIONS OF DEMAND
Individual and market demand for a commodity.
An individual demand for a commodity refers to the
quantity of a commodity demanded at various price during a
specific time period; other things remained constant. The
market demand is the summation of the individual consumer
for a homogeneous commodity. It is summation of different
quantities of a commodity demanded by individual at various
prices.
Demand for firms product and industry’s
products
The quantity of a firms produce that can be sold off at a
given price over time periods is the demand for the firm’s
product, while, the aggregate of demand for the product of
all firms of an industry is known as the demand for
industry’s product.
Autonomous and Derived demand. An autonomous
demand for a product is the biological or physical demand as a
result of needs or human beings. It is not related to price or
income. The demand for food, cloth etc. derived demand on
the other hand is the demand for some other commodity the
demand for land, fertilized and other agricultural tools is as a
result of demand for food.
Demand for Durable and Non-Durable Goods
The demand for durable commodity is a demand for
commodity whose total utility (or use) is not exhaustible by a
single use. While the demand for non-durable is the demand
for a commodity whose total is exhausted in a single use.
Short-Term and Long-Term Demand
Short-term demand refers to a demand for such goods
that are demanded over a short period. Such as variety of
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consumer goods of sensual use; inferior substitutes in terms
of superior goods etc. the long term demand refers to the
demand which exists over a long period eg demand for
consumers, and producers, goods, durable and non-durable
goods.
6.3.3
THE DEMAND FUNCTION
In a given market, the demand function for a commodity
is the relationship between the various amount of the
commodity that might be bought and the determinant of those
amounts. The quantity demanded Qd by a household depend
(is a function of) four major factors which are:
a. The price of the commodity P.
b. The price of other commodity Pj.
c. The income of the household (Y).
d. The taste of the household T.
This expression can be written as Qd=F (P,Pj,Y,T).
however, from the above expression, if Pj,Y and T are held
constant, and price of the commodity is allow to vary then the
expression can be written as Qd=F(p). now best on the law of
demand the demand curve will slope downwards from the left
to the right this show that as the price of a good falls, people
will increase their purchase of the good and the amount
demanded will rise.
The demand curve based on the law of demand is shown
below.
D
Price
a
D
b
quantity demand
0
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This means that as one moves thing the demand curve
DD, from A to B, there is an increase in the quantity
demanded as the price of the good falls.
However, change in demand resulting from change in
factors other than the price of the good in question are
represented by sniff in the demand curve, indicating that at
even price, consumers demand all other quantity than before.
This signifies increase in demand while a sniff in demand
curve indicating that at every price consumer demand a
smaller a utility than before, fatuities a decrease in demand.
This is illustrated below:
D1
D
Price
D
2
Increase in
demand
D1
D
D
2
0
6.3.4
quantit
y
Decrease in
demand
EXCEPTION TO THE LAW OF DEMAND
The law of demand does not apply in some cases, in
such cases, an increase in price lead to increase in quantity
demanded and a decrease in price lead a decrease in quantity
demanded.
The factors that lend to these exceptions include:
1. Expectation regarding future rise or fall in price when
prices of goods are increasing and consumers expect a
further increase in the price, then tend to buy more of
the good despite increase in the price, in the event of
falling price if consumer expect further fall in price, in
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2.
3.
4.
5.
6.
MICROECONOMICS I
future, they tend to postpone their purchase and wait for
the price to further fall.
Verblen Goods: when avoids purchased indicates a rise
in status, e.g gold, precious stoner etc; the higher the
price of these goods the greater will be the status. Thus,
people are motivate when price riser, these goods are
called (status maximization) and are referred to as
Verblen goods.
Giften Goods: these are inferior goods whose demand
increase as price rises, and demand decreases as price
falls. These goods are referred to as a Giffer goods
derived from Giffen paradox. E.g a rise in the price of
bread caused more of it to be purchased. The Giffen
goods are associated with goods of necessities.
price as an indicator of quantity there are instance that
increases in their thinking believed that price is an
indicator of quantity which either rightly or wrongly, in
the case the higher the price, the better the quantity and
greater the demand. And demand tends to fall as price
falls because consumers will be suspicious that the
quality has deteriorated.
Ignorance effect: consumer may buy more goods at
higher price under the influence of “ignorance effect”
especially when the goods in mistaken for some other
goods due to price, deceptive, packaging labels etc.
Change fashion: this is a behaviour which is opposite
the law of demand. Now due changes in the fashion, the
demand for certain goods are reduced even if there is a
cut in the price, and the demand for a new fashion
increases even when there is rise in price.
6.3.5
TYPES OF DEMAND
1. Joint or complementary demand: Tow or more goods are
said to be complementary in demand when an increase in
the price of one is generally associated with a decrease in
demand for the other e.g bread and butter, motor cars and
petrol. The demand for complementary goods move in the
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D
Price of bread
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some direction and the associated curve has a negative
slops e.g.
D
2. Composite Demand.
The composite is a demand for a product which arises from
the several use of the product. E.g leather is demanded for
making shoes and brief case etc.
3. Competitive Demand: tow or more goods are said to be in
competitive demand when an increase (decrease) in the
demand for the other e.g Tea and coffee as a substitutes
goods. If the price of tea increases the price of coffee
remained constant, people are likely to increase their
demand for coffee and reduce the demand for tea. Then the
demand curve slope upward from left to right as shown in
the figure below.
6.3.6
ELASTICITY OF DEMAND
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The elasticity of demand is a measure of the degree of
responsiveness to changes in quantity demanded as a result of
slight change in price. The elasticity of demand =
= percentage change in demand for X
Percentage change in price of X
OR
ep
%∆x
%∆Px
OR
ep = 4x =
X
∆P/P
∆x . ∆x = ∆x x Px
X
∆Px
∆Px
X
The value of the elasticity co-efficient is used to explain the
following:
ep > 1
=
Price elasticity in elastic
ep < 1
=
inelastic
ep 1
=
unitary
ep
= ∞ perfectly elastic
ep
= 0 perfectly elastic.
These five categories of price elasticity of demand can be
illustrated as follows:
Price
D
P1
elastic
demand
P2
Price
P1
P2
unit elastic
demand
P2
q1
q
2
D
D
P
D
0
D
Pric
e P1
quantit
y
0
Perfectly elastic
quantity
q1
q2
Price
inelastic
demand
P
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D
quantit
D
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6.3.7
MICROECONOMICS I
CALCULATING PRICE ELASTICITY
OF DEMAND
a. The point method
eqx px= proportionate change in Qx
Proportionate change in Px
OR
Eqxpc
dqx/gx
dpx/px
=
dqx X px/qx
dpx
If demand is:
Qx = 8-0.5Px and Px = N10,
At Px = N10
= 8 – 0.5Px
qx = 8-0.5 [10] = qx = 3
from
Qx = 8 – 0.5Px
= dQx
= - 0.5
dPx
eqxpx= dqx . px
= - 0.5x10
= - 1.67
The Arc method:
e a = qA – qB PA – PB
qA+qB
PA+PB
2
2
i.e. 500-300
500+300
4-5
4+5
= 200 x-1
800 9
= 9e = -2.25
6.3.8
THE CONCEPT OF SUPPLY:
The concept of supply refers to ineffective supply of
commodity which is the quality of that commodity which
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producers are able and willing to offer for sale at each
alternative price drop since specified period of time.
The law of supply states that the producers will offer
more of their product for sale as price rises and will offer less
as price falls.
An individual supply is an individual producers supply of
a good which is an alternative quantities per time period the
would be willing to put on the market at all relevant prices.
e.g. Price [N]
quantity supply [Bags]
5
75
4
70
3
60
2
40
1
10
This is a supply schedule depicting the amount
quantities put in the market at different prices.
This can be represented in a diagram.
S
Price
5
4
3
2
1
0
10
40
60 70
75
quantity
This shown the supply are derived from the supply
schedule. The supply curve slopes upwards from left to right
reflecting the fact that the quantity supplied of a product
varies directly with price. This is the law of supply.
A market (aggregate) supply is the total alternative
quantities per time period that all producers of the particulars
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good would be willing to put on the market at all relevant
prices. The aggregate is formation of the supply curve of
individual sellers. The aggregate supply curve in supply a
graphical representation of aggregate supply schedule.
S
Price
5
4
3
2
1
0
6.3.9
S
20
40
60 80
10
0
quantity
TYPES OF SUPPLY
1. Joint supply. This is the type of supply that use to do
with two or more production which are necessarily
produced by a given a process. E.g meat and skin corn
and cornstalks
2. Competitive supply: A supply is said to be competitive
when the use of the supplied product means that they
will not be available for use in another process.
3. Composite supply: this is the supply of two or more
products to satisfy particular demand e.g. tea, sugar and
milk.
6.3.10
THE SUPPLY FUNCTION
The supply function for good is the relation between the
various amounts of goods that can be produced and the
determinants of the amounts.
The quality supplied of a good depends upon (is a
function) of four (4) factors
(a)
price of the commodity (p)
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(b)
(c)
(d)
price of other commodity (pj)
cost of the various inputs (pc)
technology of production (T)
Qs= f (p pj pc T)
However, if expression of pi pc T are held construct, then
Qs= f(p). The effect of change in price while other factors
remained constant is shown below:
e.g.
Price
S
5
4
3
2
S
1
0
20
40
60 80
10
0
quantity
If other factors are changes such as price of other goods,
less of production of Technology then the position of the entire
supply curve shift, such a shift is known as a change in
supply.
Price
Decrease in
S1
e.g.
supply
SO
S1
S2
SO
S2
0
In crease in
supply
quantity
The shift firm SSo to SS2 in the increase in supply and a shift
from SSo to SS1 is the decrease in supply.
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6.3.11
MICROECONOMICS I
MARKET EQUILIBRIUM
Equilibrium in is a state of rest in which an economic
agent is able to fulfill its market plans. Market equilibrium can
be determined in combining market supply and market
demand.
The market equilibrium is the price at which quantity by
consumers is equal to suppliers is willing to supply.
A diagram of market demand and market supply of a
good is shown below:
S
Price
5
4
3
2
D
0
4
6
8
Q
Given the price at N4, suppliers would like to supply 8Kg
but household are willing to purchase 4Kg. planned supply is
greater than planned demand resulting to excess supply. The
supplier being a mach eel fulfill in market plans reduce the
price so that he can sell the excess. The price will fall until
amount the household wish to equals exactly the quantity the
supplier are prepared to supply.
6.4 SUMMARY
The concepts of demand in economics refers to effective
demand, which are classified into individual and market,
demand for firms product and industry, autonomous and
derived demand, demand for durables and non-durables and
short term and long term demand.
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The demand function of a goods is expressed as Qd= f
(P,Pj, Y, T) however the factors such as Pj,Y, T are held
constant, thus demand is a function of P [price]. This gives
the law of demand which states that quantity demanded of
goods increases as price decreases. However, there are other
factors apart from price which makes the demand curve to
shift in an increasing and decreasing positions such factors
are price of related goods, income, tastes etc. There are
factors which make the law of demand to be an exception.
These factors are expectation, verblen goods, Giften goods
price as an indicator of quality, ignorance and change in
fractions. The types of demand include joint demand
composite demand and competitive demand. However, in
order to increase the changes in quantity demanded of good as
a result of change in price, the concept of elasticity of demand
is used. This increase the degree of responsiveness of demand
to suit changes in price measured as % ∆Q/% ∆P OR
∆x
x Px/Qx .
∆Px
This results to elasticity coefficient of elastic, inelastic
unity perfectly inelastic and perfectly elastic.
The concept of supply which is an effective supply is the
amount of supply producers are willing at an alternative prices
to supply to the market. The concept of supply are classified
into individual supply and market supply. However, the
supply curve scopes upward from the left to the right reflecting
that the quantity supplied varies directly with price. The types
of supply are joint supply, competitive supply and composite
supply. The supply revealed that supply is a function of price,
price of related goods, cost, and technology. However, if price
of related good cost and technology are held constant, supply
becomes a function of price. This gives an upward supply
curve. But if these factors other than the price are
incorporated in the analysis it results into a shift in the supply
curve either upward or outward.
The analysis of the demand and supply assists in making
market e.g buyer and seller come to and agreement of price
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the consumer are willing to purchase the good and suppliers
are willing to supplier the quantity at that price
6.5 SELF ASSESSMENT EXERCISES
1.
2.
3.
4.
5.
a. What do you understand by the theory of
demand?
b. Explain the concept demand as used in
economics.
a. Explain the following: a. Substitutes,
b. Compliments, c. Verblen goods d. Giffen goods.
What do you understand by the theory of supply?
Distinguish between:
a. Individual producers’ supply and market supply a
good.
b. Joint supply and composite supply.
c. What is competitive supply?
Suppose that the demand law is given as Q= 8-0.5P,
calculate the elasticity of demand at price Px = N10.
6.6 REFERENCES:
Alex, B.E. (2005) Introductory Approach to Microeconomics
Emmanuel Concept Nigeria Ltd
Jhingan, M.L. (1999) Microeconomic Theory Vrinda
Publications (P) Ltd 5th Revised and Enlarged
Editions
Shehu U.A.R (2004) Introduction to modern Microeconomic
Benchmark Publish Ltd Kano Nigeria 1st Edition
6.7 SUGGESTED READING
Alex, B.E. (2005) Introductory Approach to Microeconomics
Emmanuel Concept Nigeria Ltd
Jhingan, M.L. (1999) Microeconomic Theory Vrinda
Publications (P) Ltd 5th Revised and Enlarged
Editions
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Shehu U.A.R (2004) Introduction to modern Microeconomic
Benchmark Publish Ltd Kano Nigeria 1st Edition
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SOLUTIONS TO THE EXERCISES
TOPIC 1:
1. a. The term microeconomics is derived from a Greek word
“Mikro” which means “small” gives the meaning of
microeconomics as the study of economic behaviour of
small economic units e.g. consumers, workers, savers,
business managers, firms individual industries and
markets. It deals with flow of production from firms to
consumers and the flow of resource from consumers i.e.
firms and price determination.
b. The uses of microeconomics are:
i. It helps in explaining the behaviour of free
markets especially behaviour of consumers and
producers in their decision.
ii. It assists in explaining how equilibrium is
achieved in various products and factor
markets.
iii. It helps in deforming and analyzing the rule of
economic efficiency i.e. efficiency in the use
and allocation of resources.
iv. It is needful in the study of public finance,
hence if explains the incidence and burden of
taxes which assist in formulation of tax
polices.
1.
It assists in improving decision making of
managers in business through demand analysis cost
analysis calculation of price and profits. It is helpful in
managerial economies.
2.
The goals of microeconomics is the
improvement of material welfare through the more
efficient use of existing resources.
3.
i.
Partial equilibrium is the analysis of
the determination of equilibrium position for a small
part of the economy.
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iii.
iv.
v.
MICROECONOMICS I
Static analysis: Is the calculation of equilibrium
values of some economic variable that results from
stated set of conditions.
Positive analysis: An analysis of that part of
economics concerned with propositions almost what
is rather than what might to be.
Ceteris paribus: This is an assumption which
states that all things remaining equal indicates that,
in an analysis of an economic single issue, there is
need to hold other influences construct better
analysis of the situation.
TOPIC 2:
1.
2.
3.
4.
The word scarcity refers to a state of affair
in which the wants of a society of any particular
moment, the means available to satisfy them are not
sufficient.
A resource refers to something that in useful and
valuable in the state in which it is found. It is
scarce and command value. It is raw or unmodified
state it can be inputs into the process of production
or it may enter consumption directly and valued as
an amenity.
A production possibility curve is an economic model
that helps to explain a society was to sacrifice in
order to produce more goods of a certain type. It
joins together the different combination of goods
and services which a country can produce given
available resources and efficient techniques of
production. It illustrates the concept of opportunity
cost, i.e. how a country can increase a production of
a commodity at the expense of the other. In other
words how a society can increase production of
goods by giving up more and more units of the other
good.
The
assumption underlying the production
possibility curve are:
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a. There are only two goods in the economy e.g.
capital goods and consumer goods or food and
cloth etc.
b. It is assumed that all factors are fully
employed i.e. land, labour and capital are fully
employed.
c. All the factors of production are homogenous
and can perfectly be substituted for another.
d. Lastly, technology is assumed to be fixed or
constant (no change in technology).
TOPIC 3
1. The word equilibrium which is derived from Latin word
equilibrium means and state of even balance is a
position of from which there is no net tendency to
move or change. Equilibrium denotes in economics
absence of change in movement. It is a market
situation where all decisions by the participants are in
unicity with each other.
2. Dynamic equilibrium is a situation where prices
quantities, income, tastes, technology etc are
constantly changing. Thus, a state of disequilibrium
rather than that of equilibrium is found. This arises
as a result of disagreements in the decision being
made by some of the markets participants.
The
diagram below shows how equilibrium is established
In this situation.
Pric
e
P1
P3
P2
P1
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q q
q q1
0
6 2
3
Quality
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The initial equilibrium of the market is OP for price
and 0q quantity, if there is a change in demand, the price
shoot up to OP1 and producers increase quantity to 0q1
but this is more than the quantity demanded therefore
price falls to 0P2 and producers adjust their production of
0q2 which is also less than the quantity demanded, and
price rises the 0P3, the producers also adjust their
production at the current price. And equilibrium is
established at price 0P3 and quantity supplied 0q3 i.e.
quantity demanded and supplied is 0q3 at price 0P3.
3.
General equilibrium is the study of economic variable,
their interrelations and interdependence for the purpose
of understanding the working of the whole economy.
General equilibrium exists when all prices are in
equilibrium, each consumer spends his entire income
and get maximum satisfactions, all firms in the industry
are in equilibrium at all prices and outputs; and the
supply and demand for productive resources are equal at
equilibrium prices.
This can be demonstrated with the use of diagram.
Flow of productive resources
Factor market
Demand
Producers
Supply
Consumer
Demand
Supply
Product
market
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Consumers purchase all goods and services provided in
producers and make payments, to the producers.
The
producers, in turn make payments to consumers for the
services rendered to the producers. Thus, the economy is in
general equilibrium when a set of prices is allowed at which
the magnitude of income flow from producers to consumer is
equal to the magnitude of the money expenditure from
consumers to producers.
TOPIC 4:
1.
2.
3.
The major difference between the cardinalist and
the ordinalist school of approach are: in the case of
cardinalist it argues that utility is measure of
satisfaction a consumer receives from consuming a
commodity and can be measured, while cardinalist
approach argues that utility cannot be measured but
a manner can rank the goods in ordinal of utility and
express in preference.
A budget line is the united amount of money
available for the consumer to spend on goods and
services per unit of time. It sums the different
consumption of two goods that the consumer can
afford to buy given his income And the market price
of the two goods.
Given the goods x and y, and their prices Px and
Py while the income of the consumer I, the
equilibrium is:
I = XPx+YPy equilibrium is attained when
Bean
s
the indifference curve 12 is ………… to the
budget line I at point E.
Q
E
13
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4. Given two goods x and y and their prices as Px = N25,
Py = N50. With total income of the consumer as I =
N200.00. The budget quantum is:
I = 200, Px = 25
Y = N50
N200 = N25x + N50y.
Y = 1 200 = 25 X
60
50
On the diagram, it is presented as:
Y
1/Px
200=25x +50y
1/Py
0
x
TOPIC 5:
1. A cobweb theory is a theory of cyclical fluctuation in
prices and quantities of various agricultural commodities
fluctuations which arises because for certain agricultural
products.
a. The quantity demanded of the commodity at any
given time depends on its price at that time.
b. The quantity supplied at my given time depends on
its price at a previous time when the production
plans were initially formulated.
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2. The scopes of the demand curve and the supply
curve the equal; the result is perpetual cobweb.
This diagram shows the perpetual cobweb model.
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S=f (P1)
P1
P2
D=f (P1)
q1
q2
At the price OP1 in period 1 output supplied is 0q2
in periods, but the demand for the output 0q2 can why
be sold at OP2 price, which is how; this low price made
supplier to reduce the supply 0q1 in period 3, but this
0q1 quantity can fetch higher price of 0P1 etc.
3. a. When the cobweb model has an increasing oscillation
or divergence cobweb is greater than the scope of the
supply curve.
i.e. oscillation are explosive, and
equilibrium instable.
b. When the cobweb model has decreasing oscillation, or
convergence cobweb theorem, the scopes of the supply
curves is greater or steeper than the scopes of the
demand curve. In this situation, the response of the
producers enables equilibrium to be eventually reached.
c. And when the oscillation is perpetual the scopes of the
demand curve and that of supply curve are equal.
TOPIC 6:
1. the concept of demand in economic means that demand
refers to effective demand which entails to three things.
Desire, sufficient money to purchase and willingness to
spend money to acquire that commodity. Demand refers
also to demand at price and demand per unit of time.
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2. a. substitute; two good are equal to be substitute when
and increase in the demand for one lead to the
decrease in the demand for the other.
b compliment: two good or more are said to be
compliment in demand when and increase in the price
of one is generally associated with decrease in demand
for the other.
c.verblen good: these are good for which their price
indicate status. It is a symbol of status for a enhancing
social prestige or displaying wealth and riches. E.g gold
precious stone etc.
d.
Giften good: these are inferior good which demand
increase when price increase and demand decrease
when price fall e.g goods of necessity (food shelter
clothes)
3. Supply: Theory of supply is and effective supply which
refers to the amount by a commodity which actually fined
it way to the market place, and which is available for sale
at a price during some specified period of time.
4. The individual producer supply is the alternative quantity
per time period he would be willing to put on the market
at all relevant prices while market supply is the aggregate
supply of good by all producer to the market at all
relevant prices. Joint supply is the type of supply that
has to with two or more product which are necessarily
produced by a given process, while composite supply is
the supply two or more product to satisfies a particular
demand e.g tea, sugar and milk. Competitive refers to the
supply of factors of production having competing
demand, hence the used of one from production means
that they will not be available for use in another
production process.
5. Given the law of demand as:
Qdx = 8-0.5 px and Px =N10
Qx = 8-0.5 Px 8-0.5 (10) =Qx =3
= -0.5
Px
Qx /Px = Qx X Px = -0.5 x 10/3 = -1.67
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The absolute value is 1.67 the elasticity of demand is thus
1.67 greater than hence, the demand is elastic.
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TUTORS MARKED ASSIGNMENT
1.
Given the table below
Unit of food
0
1
2
3
4
Unit of cloth
10 9
8
4
0
Plot the graph of the above table in the form of a smooth
curve. What does the curve represent? What does the
point outside and inside the curve signify respectively?
What the points on the curve represent? What is the
shape of the curve drawn called and what does it
measured?
2. Reconcile the fact the rule for consumer equilibrium
under the marginal utility approach can equally can be
obtained using the indifference curve approach.
3. Given the demand curve and supply curve as follow
Qd =12- 0.5p
Qs = 4+ 1.5p
i. Calculate the price equilibrium.
ii. Compute the quantity equilibrium demanded and
supplied.
iii. With the aid of diagram explain each of the following
cobweb phenomenon:
a. Perpetual oscillation.
b. Damped oscillation.
c. Explosive oscillation.
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