MICRO-ECONMICS

Microeconomics and macro- economics are the main pillars of modern economic theory.
Another name for micro economics is price theory. The corresponding name for macro-
economics is income theory. Micro-economics owes its origin to the economists such as
Adam Smith, Alfred Marshall, E.H Chamberline and J.R Hicks etc. Micro means a small part
thus micro-economics is the study of the economic actions of individuals and small groups of
individuals. These small groups of people may be households, firms and industries consisting
of several firms. Micro-economics explains how and why these units make decisions. Micro-
economics deals primarily with the determination of relative prices and the allocation of
resources among completing hence under fall employment condition. In addition, micro-
economics studies, the economic decision making of firms and industries in a market setting.

The importance of Microeconomics

1. To understand the working of the economy. Micro-economics is useful for

understanding the operations of an economy. It tells us whether the particular
economic unit functions optimally or not.
2. Price determination and allocation of resources. Microeconomics is useful in the
determination of price of price and allocation of resources among competing elements.
Demand and supply are frequently used in economic analysis. The model states that
price is determined by demand and supply forces. Both demand and supply determine
the point of equilibrium. At the equilibrium price the quantity demanded equals the
quantity supplied.
3. Optimum utilization of factors of production. Microeconomics helps the consumer to
achieve maximum user satisfaction; likewise it helps the producers to reap maxim
profits. In order to achieve the maximum satisfaction a rational consumer follows the
principles of substitution i.e. he substitutes the commodity for another until the ratio of
marginal utilities equals the ratio of prices of various commodities.
Mathematically a consumer maximizes utility at the point where,

MUa MUb MUn

= =
Pa PB Pn

Where MU=marginal utility

P=price
4. Predictions. Economic laws are based on predictions which show that if something
happens a series of results follow. For example the law of demand states that if prices
fall demand increases.
5. Helpful for managers. Microeconomics principles help business executives make
managerial decisions by applying the tools of economic theory. The firm can estimate
the demand and the cost of its products.
Macroeconomics

Macroeconomics is concerned with the economy as a whole. It is defined as the study of key
economic magnitudes such as prices, income and unemployment measured over the entire
economy thus macroeconomics is concerned with the determination so broad aggregates in
the economy such as national products employment the price level and balance of payment.
According to R. Lipsey the problems of macroeconomics include the following

1. Problem relating to fluctuations to the level of unemployment or labor

2. Problems relating to the fluctuations in the average level of prices
3. Problems relating to the rate of growth of production capacity etc.

Not; economics can be described as a social science that gives a classified boy of knowledge
concerning human relationships centered man’s effort to earn a living. The term economics is
derived from the Greek words

Oikos (a house) and Nemein (to manage)

Which implies that economics means managing a household with limited funds? Adams say
in his book and enquiry into nature and causes of the well combinations published in 1776
laid a strong foundation for its growth of economics. In addition to the above definition of
economics we can include the following definitions of economics.

i. The wealth definition. The early economists including Adam Smith defined economics
as the study of wealth. The term wealth was taken to mean riches or the abundance of
money or scarce goods having an exchange value.
ii. The welfare definition. Adam Smith’s wealth definition received great criticism because
of its attachment to wealth. Alfred Marshall was the first neo-classical economist to
rescue economics from ridicule, condemnation and misunderstanding. According to
Marshall his definition for economics shifted the emphasis from wealth to human
welfare. According to him wealth is simply a means to an end in all activities and the
end her being human welfare. According to Marshall Economics is on the one ride a
study of wealth and of more importance side the study of man which implies that to
Marshall primary importance is given to man and secondary importance is given to
wealth.
iii. The scarcity of definition. Economics is defined as a science that studies human
behavior as a relationship between ends and scarce means which have alternative
uses. Economics is study of the allocation of resources among competing ends. Ends
imply various needs and wants. Resources include: land, labor, capital. Ends refer to
human wants which are infinite but the resources available to satisfy them are limited.
If resources were available in abundance, then there would never arise economic
problems. Economic resources are not only scarce they are also versatile i.e., they can
 be used for different uses. If resources would not be having alternative uses then the
question of choice would not arise. Indeed the concept of choice is central to the study
of economics.

The modern definition.

J.M Keynas (John Mayanard) is credited for revolutionizing the study of economics.

Keynas defined microeconomics as the study of the administration of scarce resources and
the determinance of income and unemployment.

Economics is also classified as the study of the factors affecting the size, distribution and
availability of a country’s income. Further it is defined as the study of how people and society
end up choosing with or without the use of money ,employ scarce productive resources that
could have been used for alternative uses to produce various commodities and distribute
them for consumption now or in the future among various persons or groups in the society.
Economics analyses the course and the benefits of various patterns of resource use.

Important assumptions in microeconomics

1) Ceteris paribus assumption

2) Optimization assumption
3) Normative positive distinction

1. Ceteris paribus assumption.

Ceteris paribus refers to the holding constant of some factors. For example quantity of goods
x demanded depends on factors as tasks, price of another commodity (z), price of the
commodity x and income.

If say a graph of price of x is plotted against its quantity.

Px Qx=∫ (T1, P2, PX, Y)

Qx
This means that the price of good x varies with its quantity ceteris paribus (other factors held
constant)

2) Optimization assumption
Many economic models start from the assumption that the economic aspects being studied
are rationally pursuing the same goals.

Rational choices are choices that involve weighing up the benefit of any activity against its
opportunity cost thus as concerns optimization we assume that the goal of the consumer will
be maximizing utility will be minimum costs and the government planners will be attempting
to maximize public welfare.

3) Normative –positive distinction

Example

Harriet: minimum wage laws cause unemployment

This means that unemployment is caused by minimum wage laws and since this is a fact it is
positive economic statement.

Sophie: the government should raise the minimum wage. This is a normative statement since
it is an opinion to solve a problem.

Positive economics is concerned with “what is”. Positive economic statements can be defined
as a science that is a body of knowledge concerning what is.

Positive analysis describes relationships or cause and effect.

Positive economic statements are statements about what is, was or will be and their
statements about matters or facts. Sometimes we may want to go beyond explanation and
prediction to ask questions about what is best. This involves normative analysis.

Normative statements are prescriptive; they make a claim about how the world ought to be...

Normative economic statements depend on value judgments and involve issues of personal
opinion and therefore are subjective in nature.

Normative economics is a body of knowledge relating to what ought to be and is concerned

with ideas as distinguished from the actual.

A key difference between positive and normative statements is how we judge the validity.

We can confirm or deny positive statements by examining evidence. For example an

economist might evaluate Harriet statements by analyzing data on changes in
unemployment over time. By contest evaluating normative statements involves values as
well as facts.

Sophie’s statement cannot be judged using data alone. Deciding what is good or bad policy is
not a matter of science it involves our views on ethics, religion and political philosophy.
Example

1. Tariffs reduce economic welfare. -positive

2. The government should redistribute income. -normative
3. Governments should hire the jobless.-normative
4. Rent controls reduce the quality of housing.-positive
5. Lowering the price of coffee causes people to buy less of it.-positive

(This statement is a false statement but it is a positive economic since it can be put into test
(experiment)

Consumer behavior and individual demand.

Consumer behavior on individual demand. The amount of product better consumer wishes to
purchase is called the quantity demanded.

Quantity demanded years of law for example we are concerned note with a single isolated
but with a continuous flow of purchases.

Our main concern in economics is with effective demand for example the amount of
commodity that consumers are willing and able to purchase at various prices.

I desire to purchase will not be by itself act as a signal to producers unless it is packed up by
a means purchase.

The determinance of quantity demanded

Qd x = f(px,py,y,s)

Where

Qdx = quantity demanded of good X

Px= Price of good x

y=income.

S=other factors.

Y =f(x)

A basic economic hypothesis is that the lower the price of a product the larger the quantity
that will be demanded Ceteris paribus.

The quantity demanded in the market depends on the price of product being sold, prices of
all of other products, the income individuals buying that market, tastes and preferences etc.
To obtain the demand curve we hold constant all the factors that influence demand other
than the price of the product. A demand schedule is a table showing the different quantities
of a good that a person is willing and able to buy at various prices over a given period of
time.

Example.

Price Quantity demanded

1 700

2 600

3 500

4 400

5 300

A demand curve shifts to a new position your response to a change in any of the variables
that were held constant when the original curve was drawn.

P D1
D

D2

D1
D
D2

A rise in the price of a product substitute will shift the demand curve for the product to the
right. More will be purchased at each price.

Substitutes two goods such that if the price of one increases more of the other good will be
demanded. A fall in the price of one product that is complementary to the second product will
shift the second product demand curve to the right.
 Compliments too good night if the price of one rising demand for the other will fall.

Arise in the consumer incomes shifts the demand curve for normal products to the right
indicating that more will be demanded at each and every possible price.

For a few products called inferior goods arrive in income leads to a reduction in their
purchases. Therefore, a rise in incomes will shift the demand curve for inferior goods to the
left indicating less will be demanded at each price.

An example of inferior goods is secondhand clothes. Note: An increase in demand means that
the whole demand curve has shifted to the right.

A decrease in demand means that the whole demand curve has shifted to the left.

Anyone point on the demand curve represents a specific amount being bought at a specific
price.

It represents a particular quantity demanded.

Movement along the demand curve is referred to as a change in quantity demanded.

Therefore, a movement down at demand curve is called an increase in the quantity
demanded and movement up at the demand curve is called a decrease in the quantity
demanded.

Qdx=f(Px,Py,Y,T S)
P1

P2

Q1 Q2 Q
Increase/decrease in demand
 D1
P

Increase
D

D2

Decrease
D1
D
D2

An example

1. Describe and illustrate what will happen to the demand for commodity x under the
following circumstances

1. A rise in Py where x and y are substitutes in consumption.

2. A fall in Py where x and y are compliments in consumption.

3. A fall in income where x is a normal good.

4. A change of tastes in favor of x.

5. A change in. The distribution of a given level of income to sections of the population
with a higher propensity to purchase x.
The normal demand curve of good x against its price.

Px

D
0
Qx

Substitute goods

D1
Px

D1
D

0 Qx

Since good x and a good y are substitutes a rise in the price of x leads to an increase in
demand for the good x hence its demand curve shifts to the right. The demand curve shifts
from DD to D1D1
Complement Goods

D1

Px
D

D2
D
0
Qx

Complement others goods which are used together e.g., a pen and ink. Decrease in price of
compliment good y leads to a decrease in the price of good x and increasing its demand. The
demand curve shifts to the right.

A fall in income

D1

D1 D
0
Qx

Change of Taste in favor of X

 D1

Px

D
D1
0
Qx

Change in Distribution

D1
Px

D D1

Qx

Distribution of income them remove the patch is good x since they have a demand to the
good. This leads to a shifting of the demand curve to the right

SUPPLY
The general relationship between supply and price is that when the price of good raises the
quantity supplied will also rise.

There are various reasons for this including.

1. As firms supply more they are more likely to find that beyond a certain level of output
costs more and more rapidly. If higher output involves higher costs of production then
producers will need to get a higher price if they are to be persuaded to produce extra output.

2. The higher the price of a good profitable it becomes to produce.

3. Given time if the price of a good remains high new producers will be encouraged to set
up production so that the total market supply rises. A supply schedule is a table showing the
different quantities of good producers are willing and able to supply at various prices over a
given period of time for example.

Price Quantity supplied.

1 100

2 300

3 400

4 700

5 900

The determinacies of supply

Lake demand or supply is not simply determined by price the other determinants of supply
include

1. The cost of production. The higher the cost of production the less the profit will be made at
any price. The main reasons for a change in costs are.

1. Change in input prices. The cost of production will rise in the raw material prices, rent,
interest rates and any other input prices rise.

2. Change in technology. Technological advancements can fundamentally alter the cost of

production. Technology increases efficiency and therefore impact directly on the cost of
production.

3. Government policy. Costs will be lowered by government subsidies and raised by

different taxes.
2. The profitability of alternative products. That is substitutes in supply. If a product which is
a substitute in supply becomes more profitable to supply than before, producers are likely to
switch from the first good to this alternative. Therefore supply of the first good falls. Other
Goods are likely to become more profitable if.

1. Their prices rise.

2. Their cost of production falls.

3. The profitability of goods in joint supply. Sometimes when a good is produced another
good is also produced at the same time. This is said to be goods in joint supply. For example
the refining of crude oil to produce petrol also implies that other fuels will be produced as
well such as diesel and paraffin. If more petrol is produced due to arise in demand then the
supply of these other fuels will also rise.

4. Nature and other unpredictable events. In this category we will include the weather,
diseases affecting farm input, wars affecting the supply of imported raw materials industrial
dispute earthquakes, floods etc.

5. Expectations about a future price changes. If price is expected to rise the producers may
temporarily reduce the amount of the produce they release to the market, they are likely to
build up their stocks and only release them into the market when the price rises.

1. Availability of factors of productivity

this can be looked at as the ease with which factors of production could be shifted from
one use to another.It can also be looked at as the number of available resources. When
factors of production are available, supply will highly be elastic and vice versa.

Suppliers will be able to meet demand in good times.

2. Excess capacity of unsold stock (Buffer-stock)

if there exist a lot of stock, incase prices increase, supplier would be able to respond very
fast by increasing supply. In such a case supply is said to be highly elastic.

3. Time factor
This refers to the time it takes to produce and supply a product in the market. In the short
run, supply of most items that take a long time to produce is inelastic. But, in the long run
supply is inelastic.

4. Nature of a commodity
durable/ stockable commodities as clothes etc. have greater elasticity of supply than
perishable goods as milk. This is so because, incase the price of perishable items is low,
producers will still be forced to supply the items. Because it cannot be stored for future
sale when the prices would increase.
 Usefulness of the concept of elasticity

1. Useful in taxation.
If it is the aim of the government to raise revenue it has to put into consideration
elasticities of the commodities to be taxed, especially price elasticity of demand.

In order to raise revenue the government has to impose heavy taxes on goods which have
inelastic demand. E.g. cigarettes and beer. This is because after taxes are imposed on
such goods consumers will continue to demand the goods in large quantities as before
and therefore the government is able to collect more revenue.

On top of this, the burden of taxes on goods which have inelastic demand falls more on
consumers because sellers are able to pass a greater part of the tax to the consumers
through high prices.

This leaves the production of such goods more or less un affected thus making it possible
for the government to raise enough revenue.

This is shown in the diagram below.

 Price
D0
S1
S0

C
p1
B E
p0
S1
v1 A
S0
D0

Quantity
0 Q1 Q0

The original equilibrium price before the imposition of tax was p0 and the new equilibrium

price after tax p1 .

is

Distance AC on the diagram represents the tax imposed on the good.

AB of the tax is met by the consumers.

It can be seen from the diagram that the quantity in the market fell by a small proportion
Q1Q0

It can thus be said that when a commodity has inelastic demand it pays the government to tax
that commodity heavily because the greatest part of the tax is met by consumers, thus leaving
the production of that good more or less unaffected, hence enabling the government to collect
more revenue from that good.
2) Elasticity is important in international trade
Before a country devalues her currency so as to encourage export
and discourage imports, it has to put into consideration the elasticity
of demand and supply for her export and imports.

For devaluation to succeed, exports must be highly elastic so that

after devaluation, greater quantities can be sold in the foreign market.
Similarly, the export must have elastic supply in order to meet
increased demand in foreign markets.

On the import side, imports must have elastic demand so that after
devaluation greater quantities of imports can be abandoned.

We can therefore say that before any country devalues her currency,
it is important to consider elasticity of demand and supply for export
and imports.

3) Elasticity also tells us the degree to which goods are related.

High cross elasticity between two commodities shows that the two
commodities are very related. This is a useful concept especially for
formulating pricing strategies. Such elasticity is especially important
in studying how unfair competition of dumped goods affects
performance of domestic industries. This would thus enable the
government know how much import duty to impose on such goods
as to protect local industries from collapsing.

4) Useful in pricing decision by the business.

5) Useful in price discrimination by a monopolist.

Example

Illustrate and describe what will happen to the supply curve of butter
under the following circumstances.

1. New technology that allows more efficient churning of butter.

2. An increase in the profitability of milk.

3. But the producers expect the prizes to rise in the near future.
SB
SB1
PB
I.

P1

SB

SB
1

SB
QS1 QS2
 SB1
PB

SB

SB1

QB

II.
SB2
PB SB

SB2

SB

QB

The determination of equilibrium price and quantity

PRICE Quantity Quantity Excess demand
demanded supplied

0.2 110 5 10.5

0.4 90 46 44

0.6 77.5 77.5 0

0.8 67.5 100 -32.5

1.0 62.5 115 -52.5

1.2 60 122.5 -65.5

From the graphs previously there is one point at which supply and
demand curves intersect. This point is called the market equilibrium. The
price at this intersection at this intersection is called equilibrium price and
the quantity is called the equilibrium quantity.

From the graph the equilibrium price is 3 and the equilibrium quantity is
500.

Equilibrium occurs where quantity demanded equals quantity supplied so

that there is neither no the excess demand nor excess supply. For lower
prices there is exes demand and for higher prices there is excess supply
which is shown on the table as negative excess demand.

When quantity demanded equals quantity supplied we say that the

market is in equilibrium that is a state of balance.

At the equilibrium price is the quantity of the good that buyers are willing
and able to buy is equal to the quantity that producers are willing and
able to sell.

The equilibrium price is sometimes called the market clearing price

because at this price everyone in the market has been satisfied. Buyers
have bought all the wanted to buy and sellers have sold all they wanted to
sell.

The assumptions concerning a competitive market can be summarized as

follows.

1. All demand curves have negative slopes throughout the entire range.

2. All supply curves of positive slopes throughout the entire range.

 3. Prices change if and only if there is excess demand rising. If excess
demand is positive and falling excess demand is negative, the implication
of these are:

1. Where is no more than one price at which quantity demanded

equals quantity supplied what is equilibrium is unique.

2. Only at the equilibrium price will the market price be constant.

3. If either of the demand or supply curve shifts the equilibrium price

and quantity will change.

Graphically. P=3 Q=3

1. Qd=800-100p

Qs=-100+200p

2. P=8-0.01 Q

P=0.15+0.005Q

From the equation 1.

QD=Qs

800-100p=-100+200p

800+100=200p+100

900 300
= p
300 300

P=3

Qd =800-100p

Qd=800-100(3)

Qd=800-300=500

P=3

Qd = 500

Or
From equation 2.

P=8-0.01q

P=0.5+0.005q

But p=p

8-0.01q = 0.5 +0.005q

8-0.5 = 0.005q + 0.01q

7.5 0.015
= q
0.015 0.015

Q = 500.

P= 8 -0.01 q

P= 8-0.01(500)

P= 8-5

P=3

P= 3. Q= 500.

3. P= 10-9

q
P=1 +
2

4. Qd= 72 -0.5p

Qs= 62 + 0.12p

Solve for the equilibrium price and quantity.

Solution
3. P=10-q

q
P= 1+
2

P=p

q
10-q =1+
2

q
2 (10-q) = (1+ ) 2
2

20 -2q = q + 2q

18×3=3q×3

Q=6

P = 10-q

P = 10-6 = 4.

P = 4. Q= 6.

4. Qd= 72 -0.5p

Qs = 62+ 0.2p

Qd = Qs.

72- 0.5 p= 62 +0.2 p

72-62 = 0.2 p + 0.5 p

Qd=72-7.145
Qd=64.855
P=14.29
Qa= 65

Suppose that the price of tickets to see a local food bank to play at home
is determined by market forces. Currently the demand and supply
schedules are as follows.

Price Quantity demanded Quantity supplied

10 50000 30000
20 40000 30000
30 30000 30000
40 20000 30000
50 10000 30000

1. Draw the demand and supply curve. What is unusual about this
demand curve? Why might it be true ?
2. What is the equilibrium price and quantity of the tickets?
3. Your team plans to increase total capacity by 5000 seats next season.
What admission price will it charge?

Solution.
1. The supply is fixed.
1. Equilibrium price is 30.
2. Equilibrium quantity of tickets is 30 000

C) Graphical solution.

Qd=a +bp
Clo, 50,000
Ceo, 20,000
50000−20000
b=
10−40

30,000÷ -30

b = - 1,000
Qd= a - 1,000p

50,000= a -1000(10)
50,000 - - 10,000 = a
60,000. = a

Qd = 60,000- 1000p
Qs = c + dp

30000−30000
d=
10−40
d =0

Qs = c
30k = c
Qs = qd

60000-1000p=30000
60000-30000= 1000p
P=30

Q=60000-1000p
Q =60000 -30000
Q =30000

Qd= 60000-1000p
Qs= 35000

60k-1000p = 35000
60k -35k = 1000p
25000÷ 1000=1000p÷ 1000

P = 25

Q= 35000

Question.
Can good news to farmers be bad news to farmers? What happens to
wheat farmers when scientists discover a new wheat hybrid that is more
productive than the existing varieties?
 P

P2

P1

Q2 Q1 Q

Elasticity.

Elasticity is a word meaning responsiveness. Price elastic of demand is

derived as the percentage change in quantity demanded of good x divided
by the percentage change in the price of x that is.

PEd =% change in qty demanded of x /% change in price of x

Here we consider movements along a demand curve in response to a

change in the price of a commodity
Strictly speaking the sign for PEd is negative because of the increase
relationship between quantity demanded and price under the law of
demand.
However it is to write the sign when expressing the numerical value price
elasticity of demand
Table.
Numerical value of Terminology Description
PED
0 Perfectly inelastic Whatever the
demand percentage change in
price no change in
quantity demanded
>0<1 Relatively inelastic A given percentage
demand change in price leads
to a smaller
percentage change in
quantity demanded
1 Unit elastic demand A given percentage
change in price leads
to exactly same
percentage change in
quantity demanded
>1<infinite ∞ Relatively elastic A given percentage
demand change in price leads
to a larger percentage
change in quantity
demanded
∞ Perfectly elastic An infinitely small
demand percentage change in
price leads to an
infinitely large
percentage in quantity
demanded

The determinants of price elasticity of demand.

* Availability of substitute goods. Goods with close substitute goods tend
to have more elastic demand because it is easier for consumers to switch
from that good to others eg butter and margarine are easily substitutes.
So that small increase of price of butter assuming the price of margarine
remains the same causes quantity of butter sold to fall by large amounts.
Thus the more numerous and closer the substitutes available the more
elastic itΓÇÖs demand.
* Necessities vs. luxuries. Necessities tend to have less inelastic demand
than luxuries e.g. people use electricity and gas if itΓÇÖs price increase.
People wonΓÇÖt demand less of them. By contrast when the price of a
luxury car e.g. Mercedes Benz increases the quantity of those vehicles
demanded falls substantially. This is because most people will find a
luxury car to be a luxury good.
* Proportion of income spent on the commodity. The greater the
proportion of income spent on the commodity the more elastic the
demand will be.
* Time horizon. Goods tend to have maximum elasticity of demand over
longer time horizons e.g. when the price of petrol increase the quantity
demanded falls only slightly in the first few months. Over time however
people buy more fuel efficient cars. Switch to public means of transport
and move closer to where they work. Within several years the quantity
demanded for petrol falls substantially thus the longer the period of time
the more elastic the demand.
1. Point elasticity. A measure of elasticity at a specific point on the
demand curve e.g. Point A or B.

P÷ Q .do÷ dp. Measure of slope.

2. Arc elasticity. A measure of elasticity between two points on the
demand curve e.g. Point A and B. Formula
Q/P
Measure of slope.

P1+p2 / q1 + q2

Suppose.
y=ax^n
dy/dx = n ( ax ) ^n-1
y = 4x^3
dy/dx = 12x ^ 2

y = 3x -4x^2

If y = a
dy/dx =0

dy/dx =3-8x

Q = 800-100p
dq/ dp = -100

Example.

A medium size publishing company produces journals for electrical

industry. ItΓÇÖs market demand schedule is described by the data given
below.

Price of journal Quantity demanded per month

11 0
10 100
9 200
8 300
7 400
6 500
5 600
4 700
3 800
2 900
1 1000
0 1100

Question.
1. Draw a demand curve for the data given in the table.
2. Calculate the point price elasticity of demand first when price the
journal is 5£ and the second the price has been raised to 6£
3. Calculate the arc price elasticity of demand when the prices rise from
£5 to £6 and explain the relationship between the result and those
obtained in 2 above.
Solution.
Qd = a + b p
( 200, 9)
(600,5)

Qd = a + bp
b = qd/ qp
b = 200-600/9-5
b= -400/4

b= -100

Qd = a-100p
Qd=200 and p = 9

200= a - (100)9
200= a- 900
200+900= a
1100=a
Qd = 1100 -100p
Qd/qp =-100
P/q multiply do/dp = point elasticity.
5/600 multiply -100

- 5/6 = 0.833
- -0.8
When price is £ 6 quantity is 500
P / q multiply do/qp

6/500 multiply -100

- 6/5
-1.2.

3. P1 +p2/ q1 +q2 . Dq /dp

5+6 / 600+500 . -100
11/1100. -100
= -1.

Elasticity.
Types.
1. Income elasticity.
2. Price elasticity of demand.
3. Cross price elasticity.
4. Price elasticity of supply.

Income elasticity.
IED = % change in quantity demanded of good x/ % change in income.

Where IED is income elasticity of demand. Here we consider shifts in

demand curve for the commodity. For a normal good the sign will be
positive. I.e. rise in income increases demand.
For an inferior good the sign will be negative i.e. rise in income decreases
demand.

Cross elasticity of demand.

CED = % change in quantity demanded of good x/ % change in price of
good y.
In this case the change in the price of some other commodity y will cause
a shift in the demand curve of good x. The cross elasticity of demand will
indicate the direction of the shift.
The direction of the shift will depend upon the relationship in consumption
between the goods x and y.
Where x and y are substitutes in consumption a fall in the price of y will
result in the decrease in demand for x. Leftward shift in the demand curve
for x. Here the sign for CED will be positive. Where x and y complements
consumption a fall in the price of y will result in increase in the demand
for x i.e. a rightward shift in the demand curve for x. Here the sign for CED
is negative.
Price elasticity of supply.
PES = % change in the quantity supplied of good z/ % change in the price
of good z.
In economics the price elasticity of supply is defined as a numerical
measure of the responsiveness of the quantity supplied of good z to the
change in the price of good z. This elasticity is usually positive because as
higher price gives producers an incentive to increase output.
Nb. For most products long run supply is more price elastic than short run
supply.
Thai is because firms face capacity constraints in the short run and need
time to expand capacity by building new production facilities and hiring
workers this firms will be able to expand output much more when they
have the time to expand their facilities and higher a larger permanent
work force.
In summary when there is a relatively inelastic supply for a good the
coefficient is low.
When supply is highly elastic the coefficient is high.
Application of elasticity to the:
1. Government
2. Industries etc.

UTILITY

The refers to the satisfaction Gaga consumers derive from the

consumption of goods.
On the consumption that utility can be measured. I.e. it is cardinal we can
be able to calculate for marginal utility.
Total utility represent the overall satisfaction to the consumer from
consuming a given ama pint of a goods. Whereas the marginal utility is
the change in satisfaction resulting from consuming an extra unit of the
good.

Drinks Total Marginal

consume utility. utility
d
0 0 0
1 27 27
2 39 12
3 47 8
4 52 5
6 57 2
7 58 1
8 58 0
9 56 -2
Total utility

TU

Drinks

Marginal utility

Mu drinks consumed
Question. At what level of drinks is the total utility at a maximum
=8

Note. From the graph total utility rises up to 8 drinks but falls the after.
Marginal utility falls after the first drink consumed. (The principle of
diminishing marginal utility.) Being zero where total utility is maximum
and zero thereafter.
The theory of utility that attaches significance in the magnitude of utility
known as cardinal utility theory.
The numbers 1,2,3,4 and so on are cardinal numbers. The cardinal utility
theory states that it is measurable just as height, temperature and length.
The unit of measurement for utility is known as the util. The according to
the concept of cardinal utility can be measured and compared in terms of
the number of units for example. The apple possesses 10 utile and an
orange possess 5 utile. Thus the utility of one apple is twice the utility of
an orange.

The assumptions of the cardinal utility theory.

1. Rationality. The consumer is assumed to be rational and he aims at the

maximization of utility subject to the constraint imposed by his income
and the prices of the commodities.
2. Cardinal utility. The utility of each commodity is measurable. Utility
here is a cardinal concept and the most convenient measure is money. I.e.
the utility is measured by the monetary utile that the consumer is
prepared to pay for another unit of the commodity.
3. Constant marginal utility of money for money to function as a standard
unit of measurement itΓÇÖs marginal utility must remain constant as
income increases or decreases.
4. There is diminishing marginal utility in the consumption of commodities
ie each extra unit of a commodity increases total utility by progressively a
smaller amount.
For example suppose individual x is Hungry and eats oranges one by one.
The first orange gives him great satisfaction the second one yields less
satisfaction compared to the first one. Implying that the Incremental
utility will go on decreasing until it drops to zero and takes small
satisfaction may become negative implying disutility has crept in.
5. Total utility u over bundle of commodities depends on the quantities
consumed of the individual commodities x un the bundle consisting of n
commodities.

U = f ( x1,x2,….xn)

The cardinal utility theory.

Critics of the cardinalist approach noted the following.

1. It is unrealistic to assume that the marginal utility is more constant as
incomes increases and decrease. Rye monetary units cannot be used as a
a standard measuring utility.
2. Other than money no other measurement ha sheen credibly proposed.
As a consequence of such criticism economists have sought a more
realistic assumption as the basis for consumer behavior. The cardinalist
approach has replaced the assumption that the consumer utility be
measurable with assumption that consumer preferences can be ranked in
order of importance. The numbers 1,,2,3,2 are cardinal numbers and
according to the approach each consumer must be able but carious
bundles of commodities in terms of satisfaction they yield. In other words
the consumer must be able to determine the order of preference between
the various bundles of commodities.
The assumptions of the ordinalist approach.

1. Rationality. The consumer is assumed to be rational. IΓÇÖm addition it

is assumed that he has full knowledge of all relevant information.
2. Utility is ordinal. It is assumed that the consumer can rank his
preferences according to the satisfaction each basket he need not to know
precisely the amount of satisfaction if it is enough that he expresses his
preventive for the various bundles of commodities.
3. Consistency and transitivity of choice. ItΓÇÖs is assumed that the
consumer is consisted in his choice. If In one period he chooses bundle A
over B he will not choose B over A in another period. If both bundles are
available to him. Similarly it is assumed that the consumer choices are
characterized by transitivity ie. If bundle A is preferred to B and B is
preferred to C then bundle A is preferred to C.

THE FIRM AND ITS TECHNOLOGY

INTRODUCTION.

A firm most fundamentally is an economic unit that produces a good for

sale.
In any economy there are different types of firms. Including sole
proprietorship partnership, corporations etc. economists generally assume
that the goal of firms is to maximize profits.
Observers in the modern corporations argue that profits are not the sole
objective that drives the actions of firms. Indeed firms are also interested
in achieving better social conditions in their communities increasing or at
least maintaining their market share. Some firms also pay importance on
the environment. Other goals of the firm may include:-
Sales revenue maximization etc. economists are interested in the theory
of the profit maximizing form because it provides the rules of behavior.
For the firms that want to maximize profits.
The theory can also be useful even when firms do not want to maximize
profits as it can help the firm access the costs of perusing other
objectives.

Some definitions.

Inputs. An input is defined as anything that a firm uses in the production

process.
For example. Computer manufacturers need skilled silicon chips, plastics
and light weight metal. The inn service of designers managers etc.
we assume that the inputs can be divided into categories
.
Fixed inputs and variable inputs.
An input is considers Fixed if quantity cannot be changed during the
period of the time under consider. An input is considered variable quantity
can be changed during the same period of time.
Whether the input is related variable or fixed depends on the length of
time being considered. The longer the period the more inputs that can be
classified as variable. The short run is defined to be the period of high at-
least some of the firms inputs are fixed because plant and equipment are
among difficultly inputs to change quickly the short run is generally
understood to mean the length of time which plant and equipment cannot
practically or economically adjusted. The long run refers to a period of
time in which all inputs are variable. Firms change just about anything in
their environment.

The production function.

The production function any good or service is the relationship between
the quantities various inputs employed in a given period of time and the
maximum quantity of the commodity that can be produced over that
same period of time.
Production functions can be described in the tube. They can be displayed
on the graph and they can be summarized by an equation. In every case
is the presentation shows the maximum output that can produced from
any specified combination of inputs.
In addition production functions summarize the characteristics of existing
technology at any given point in time. A simple case of a production
function is one in which there is one forced input and one variable input.
Suppose that the fixed output is the service of 10 acres of land and the
variable input is labor and the output is maize.

Amount of labor Output of maize Apl Mpl

0 0 - -
1 60 60 60
2 135 67.5 75
3 210 70 75
4 280 70 70
5 340 68 60
6 380 63.33 40
7 380 54.29 0
8 370 46.25 -10

Note.
The average product of an input is total output divided by its amount of
the inputs used to produce this amount of output.
The marginal product of an input is the addition to total output that can be
attributed to the addition of the last unit.
 Apl = TP/L or Q /L

Where TP = total product.

Q = total output.
Mpl = Tp / L and dTP/ dL

output Total product

Units of labour

Output

APL

MPL

Units of labor