ECONOMICS

UNIT
1
NATURE AND SCOPE OF ECONOMICS

1.1 DEFINITION OF ECONOMICS

Economics has been defined in different ways by different economists in different
times and places. In his book “The Wealth of Nations” in 1776, Adam Smith, who
is regarded as the Father of Economics defined economics as “the study or
enquiry into the nature and causes of the wealth of nations”. That is to say,
economics studies why some countries are so rich and others are so poor.

Alfred Marshall, a Great Victorian Economist, also defined Economics as “the

study of man in the ordinary business of life”. Alfred Marshall’s definition is
also concerned with how man earns and enjoys a living. That is, the definition
emphasizes on man as a buyer or seller, producer or consumer; investor or
borrower; employer and worker.

Another equally important definition, which is also accepted, is the one given by
Professor Paul Samuelson, America’s first Nobel Prize winner in economics,
in his book ‘Economics’. He states that “Economics is the study of how people
and society end up choosing, with or without the use of money, to employ
scarce productive resources that could have alternative uses to produce
various commodities and distribute them for consumption, now or in the
future among various persons and groups in the society”.

However, the most generally and widely quoted definition is the one given by
Professor Lionel Robbins in his book ‘An Essay on the Nature and Significance
of Economic Science’ in 1932 which states that: economics is a science, which
studies human behaviour as a relationship between ends and scarce means
which have alternative uses”.

Looking at the above definitions closely, we can conclude that ‘economics is a

social science which studies how the scarce resources in the world are
managed or used to produce goods and services for the wellbeing of
individuals and society as a whole’.

It is important to note that terms such as ends, means, scarcity and choice are
stressed in the various definitions.

Ends: Ends (Needs and Wants) as used by Robbins refer to the numerous
economic goods and services; and certain material things that give us satisfaction.

Page 1
 ECONOMICS

In other words, Ends can defined as the aims, targets, goals or objectives in which
individuals, firms, organisations or the state seek to achieve. Examples of Ends
may include food, shelter, clothing, better education, medical care, holidays,
entertainment, etc. No one is ever satisfied with what he or she has. Thus, ends
are said to be unlimited and therefore insatiable.

Means: Means in economics refers to the resources we use to obtain or achieve

our ends. It consists of Land, Labour, Capital and Entrepreneurship.

 Land: It refers to all natural resources. In fact, it does not only refer to land
surface area but also, comprises mineral deposits, the forest, rivers, etc.

 Labour: Labour is defined as human effort (whether exerted mentally or

physically) in production, which is termed as labour.

 Capital: All sorts of man–made resources meant for further production.

Examples are tools, machines, factory buildings, bridges, etc.

 Entrepreneurship: The entrepreneur is the one who bears the risk of

organising the other factors of production to produce goods and services.
The entrepreneur takes risks by introducing both new products and new
methods of improving the quality of old products.

It must be noted that our means or resources of the society are limited
and hence scarce.

1.2 RELATIVE SCARCITY

Scarcity refers to the limitedness of resources in relation to man’s demand for

them. Scarcity implies that the existing supplies of resources are woefully
inadequate compared with man’s needs and wants. This is due to the fact that
resources to obtain these needs are limited or scarce in supply. For instance,
there’s a limit to the available forest land from where wood is obtained, there’s also
a limit to the amount of mineral deposits beneath the soil. Physical cash also has
a limit. This means that our resources (land, labour, capital and entrepreneurship)
cannot produce all our wants but rather can produce only a fraction of goods and
services we desire. They are therefore scarce. This gives rise to the basic
economic problem – scarcity and hence choice has to be made.

Page 2
 ECONOMICS

Choice: Choice is the act of selecting from several alternatives. Because our
needs or wants are unlimited but our resources to satisfy these needs are scarce
or limited in supply, there’s the need to choose between what to satisfy and what
not to satisfy. It must be emphasized that, since resources are scarce in relation
to their supply, it is necessary to make choice as to which ends to be satisfied and
which not to be satisfied. For example a country cannot produce everything her
citizens would like to consume. There must exist some mechanism to decide on
what will be done and what will be left undone; which goods will be produced and
whose wants will be satisfied and whose wants will be left unsatisfied. The
individuals and firms also face this basic economic problem. To help in making
choice, a scale of preference is prepared.

Scale of Preference: A scale of preference is the list of wants arranged in order

of priority. In other words, it is a list of individual’s unsatisfied wants arranged in
order of satisfaction. It must be emphasized that a Scale of Preference is normally
arranged in a descending order. This means that items that lies on top of the list is
expected to yield more satisfaction and it must be satisfied first before the other
ones. This suggests that we must forgo some of our wants and this leads us to the
problem of opportunity cost.

Opportunity Cost: Opportunity cost is the next most desired alternative forgone.
In other words, they are ends that are not satisfied or the wants sacrificed. For
example, if a student wants a pair of shoes and a textbook but his or her means
(resources or money) cannot buy all the two commodities but he or she chooses
to buy the textbook, then the pair of shoes he or she has forgone is the opportunity
cost.

1.3 ECONOMICS AS A SCIENCE

Economics is a science because economists use scientific methods of analysis
and investigation in basically the same way as scientists do. The scientific
approach involves Making Observations, Formulation of Hypothesis, Collection of
Data, Organisation of Data, Generalisation (Making a theory) on the basis of data
collected, Testing of the theory and Making Predictions based on theory.

 Making Observations: a fact or phenomenon is observed over a

reasonable period of time. For instance, we may observe how an individual
consumer normally behaves when the price of a commodity changes.

 Formulation of Hypothesis: Hypothesis is a statement about presumed

relationship between two or more variable. As we observe the phenomenon

Page 3
 ECONOMICS

for some time, an idea which may be true or false will be formed in the
mind.

 Collection of data: Information is gathered on the observed fact. This

should be directed to the problem in order to achieve the objectives of the
research.
 Organisation of Data: The data collected is organised in a form of a table
in order determine its general pattern.

 Making a Generalisation / Theory: A generalisation or theory is made on

the basis of the hypothesis. For example, the researcher can state that “all
other things being equal (Ceteris Paribus), the lower the price of a
commodity the greater the quantity demanded of the commodity and
vice versa.

 Testing of Theories: The validity of the theory is then tested with new data
to see if it is always true or otherwise. If a theory is tested and the result is
always true, it becomes a Law.

 Making Predictions: predictions are therefore made on the basis of the

theory. Predictions in economies are however less reliable than in physical
science because.
a. Human Behaviour is subject to change with time.
b. During research the Economists may not have full control over the
variables they studied because man cannot be put under controlled
laboratory.

Thus, it must be emphasized that economics studies behaviour but does not
study nature. It is therefore a social science but not a natural science.

1.4 POSITIVE ECONOMICS AND NORMATIVE ECONOMICS

POSITIVE ECONOMICS: Positive economics deals with the scientific or

theoretical explanations of economic policies. It involves statements like: “what
is”, “what was” or “what will be”. Positive economics statements relate to
“if……then” propositions (causes and effects relationships devoid of personal
opinions or value judgements). They are facts which can be tested and proved or
disproved. For example, our use of fossil fuel (coal and petroleum) is causing
global warming. A rise in money supply will lead to inflation. Also, the statement;

Page 4
 ECONOMICS

‘Doctors earn more salary than teachers’ is a positive statement. This is

because it can be verified and be proven to be right or wrong.

NORMATIVE ECONOMICS: Normative economics on the other hand, refers to

that aspect of economic analysis that is based on value judgement about
economic policies. It involves expressions like “what should be” or “ought to
be” the case. It states whether the outcome of a policy is good or bad and
recommends or prescribes policies based on personal opinions and ideologies
which cannot be tested scientifically. For example, the statement “Party A is better
than party B” is a normative statement because it depends on one’s political
ideologies and how he or she sees a party. Also, the statement; ‘Doctors should
earn more salary than teachers’ is a normative statement. This is because it
depends one’s personal perceptions about the two professions. Other examples
of normative economic statements are as follows: The Bank of Ghana should
reduce interest rates, Government ought not to increased road tolls, etc.

1.5 BRANCHES OF ECONOMICS

Economics is divided into two main branches. These are:

a). Microeconomics: This is a branch of economics which deals with the

economic behaviour of individual decision-making units such as consumers,
resource owners, business firms as well as individual markets in a free-enterprise
economy. For instance, we may study why an individual household prefers one
commodity to another.

b). Macroeconomics: Macroeconomics is concerned with the economy as a

whole. It deals with determination of economic aggregates such as national income
/ output, total employment level, and prices for the economy viewed as a whole.

In short, microeconomic issues affect only a segment of the economy but

macroeconomic issues affect the entire economy or everyone in the
economy.

1.6 THE PRODUCTION POSSIBILITY FRONTIER (PPF)

The PPF, also known as Production Possibility Curve or Boundary (Transformation
Curve), shows the maximum combinations of two goods that an economy can
produce when its resources are fully utilized. The PPF can be used to illustrate the
problem of scarcity, choice and opportunity cost. Let us assume an economy
produces Food and Clothing with all her resources; the economy can produce

Page 5
 ECONOMICS

several combinations (for simplicity, we use six combinations) as illustrated in the

hypothetical table below:

Alternative Production Possibilities

Possibilities Food (X) ‘000 of tonnes Clothing (Y) in ‘ 000 of bales
A 0 30
B 2 28
C 4 24
D 6 18
E 8 10
F 10 0

Extreme possibilities are: either to produce only Food and no Clothing (Possibility
A) or produce only Clothing and no Food (Possibility F). Plotting the points A, B,
C, D, E and F in the X – Y plane gives the PPF as shown the diagram below:

Y
A
30 B
28

24 C

D
18

10 E

0
2 4 6 8 10 X

Page 6
 ECONOMICS

KEY POINTS

 Trade-offs (choices) are represented graphically by a production possibility curve

showing the maximum output combinations obtainable over a one-year period from
a given set of resources.

 Points outside the production possibilities curve are unattainable meaning that
they are impossible to achieve during the present time period; points inside
represent an inefficient use or under-utilization of available resources; points
on the PPF represent an efficient or full-utilization of resources.

 Society’s production possibilities curve is bowed outwards reflecting the law of

increasing relative cost - many resources are better suited for certain productive
tasks than for others.

1.7 EFFECTS OF ECONOMIC GROWTH ON THE PPB

A country’s PPB shift outward if the economy’s capacity to produce goods is
increasing through time. This indicates that there is economic growth and as such,
higher level of output can be produced. Economic growth may occur when:

(i) Resources previously unemployed are now fully employed.

(ii) Resources previously used inefficiently are now used efficiently.

Economic growth may occur as a result of increased investment, new discoveries,

expansion of natural resources and technological advancements. We can illustrate
the effects in the diagram below:

Quantity of Food

PPB after economic growth

C
A
D

PPB before economic growth

B
0 M
0 Quantity of Clothing

Page 7
 ECONOMICS

Economic growth shifts the PPB outward, allowing more of the goods – cocoa and
maize to be produced. The arrows show this. Before growth in productive capacity,
points C, A, B and M were on the boundary and point D was an unattainable
combination. However, after growth, point D becomes attainable.

1.8 ECONOMIC SYSTEMS

Economic system refers to the institutional framework through which the relatively
scarce resources of an economy are managed. Therefore, economic systems deal
with all matters concerning who owns or controls the resource in the society.

1.8.1 TYPES OF ECONOMIC SYSTEMS

Basically, three (3) types of economic systems can be distinguished. Namely:
Capitalist Market / Free Enterprise Economy (Laissez faire economy), Centrally
Planned / Controlled /Socialist Economy and Mixed Economy.

1.8.2 FREE MARKET / CAPITALIST/ FREE ENTERPRISE ECONOMY / LAISSEZ

FAIRE ECONOMY

This refers to an economy or economic system that is based on private ownership

of economic resources. In this system private individuals have the right to own,
control and even dispose off a country’s resources such as plots of land, farms
factories, buildings, shops, machinery, oil deposits, to mention but a few.
Government owns and controls comparatively smaller proportion of the resources.
Prices of goods and services are determined by the forces of demand and supply.
Decisions about what kind of goods to produce, where to produce, and what
method of production should be should be used and how distribution must be done
are mostly influenced by private individuals’ decision and choices. In this system
consumers decide what ought to be produced and also influence what quantities
private entrepreneur should attempt to satisfy the demands. Examples of countries
that practice this system are Britain, Germany, USA, etc.

Page 8
 ECONOMICS

1.8.3 MERITS OF FREE MARKET ECONOMIC SYSTEM / PRICE MECHANISM

1. The profit motive of the individual entrepreneur motivates him to work hard,
invest more and become more innovative and creative. This is results in
higher productivity and hence economic growth.

2. Higher level of (both technical and economic) efficiency. The private

entrepreneur uses resources rationally to avoid waste and thus, maximizes
profit. Competition between firms keeps prices down and therefore firms come
out the best production techniques to minimize losses and wastages.

3. Consumer sovereignty is guaranteed. Consumers dictate to producers what

they have to produce. In a situation where consumers cherish the commodity,
they demand more. This gives producers the urge to produce more. The
reverse is true.

4. Consumers enjoy Freedom of Choice in market economies. Consumers get

the opportunity of consuming different varieties of goods produced by the large
number of producers unlike command economies where producers can buy a
product from just one state owned firm.

5. No administrative cost is required. Free market or capitalist economies

function automatically. The economy on its own responds to changes in the
demand and supply. There is no need to employ government officials (Central
Planning Committee) to decide on resource allocation. The system itself (the
market forces of demand and supply) is capable of achieving this.

1.8.4 DEMERITS OF FREE ENTERPRISE ECONOMY

1. Unequal / unfair distribution of income: since rich individuals normally

invest in areas where they can make much profit, certain essential services
like education may not be provided at all in rural areas. This may worsen
the plight of rural people whilst those who are privileged to own a greater
percentage of the nation’s resources will continue to be rich.

2. Externalities (positive or negative spill-over effects): externalities such

as pollution may occur because producers in trying to maximize profit only
consider their own private cost and not the social cost of their activities.

Page 9
 ECONOMICS

3. Public Goods: Public goods may not be produced. A public good is a good
that has non-rivalry consumption and non-excludability. Examples are
traffic lights, street lights, roads, bridges, fence wall, etc. These goods may
never be produced in a free market economy because people will feel
cheated to provide them with their hard earned resources for people to use
them for free.

4. Production of demerit (harmful) goods: due to the fact that the capitalist
(entrepreneur) always aims at maximizing profit, all kinds of goods and
services will be produced. Producers may not consider whether the
commodity is good for people’s health or not; so far as they are prepared to
buy, they will sell it to them.

1.8.5 CENTRALLY PLANNED / CONTROLLED / COMMAND / SOCIALIST

ECONOMY
This is normally referred to as Socialist System. Virtually all the economic
resources are owned, controlled and disposed of by the state. The government
employs almost all those who take charge of the various means of production. It is
the government that takes decisions about the kind of goods and services that
should be produced. Decisions on methods of production and distribution are all in
the hands of the government. That is to say the decisions on what, how, where
and for whom to produce are taken by a central planning body. The central
planning body issues commands or directives to all the households, producing
firms and other organizations in the society. Thus the state owns the land,
factories, schools, hospitals and roads, to mention but a few.

Countries like the former Soviet Union (USSR), China, Cuba and Ghana during
the 1st Republic are examples of countries that practiced the socialist system.

1.8.6 MERITS OF SOCIALISM

1. Economies of scale can be acquired by the firms in charge of production in
the countries where this is practiced. Wasteful competition will be limited
and natural monopolies placed under state control.

2. Basic needs of most of the population can be met rather than production
being geared to the demands of the few rich.

Page 10
 ECONOMICS

1.8.7 DEMERITS OF SOCIALISM

1. Lack of personal freedom: People do not get the chance to choose their
career but have to accept the job which the government allocates to them.
Also the consumers do not have the opportunity to decide what should be
produced to satisfy their wants.

2. A waste of production inputs (factors of production). The many officials

required to estimate and to direct factors of production represent wasted
factors of production since they could be employed elsewhere to produce.

1.8.8 MIXED ECONOMIC SYSTEM

A mixed economy is an economic system in which part of the resources are owned
and controlled by the government; and part of the resources are owned and
controlled by private individuals. In other words, both public and private institutions
exercise economic control. It combines elements of capitalist and socialist
economic system. In mixed economies, individuals are allowed to invest their
capital for profits but the government comes in with policies such as price control,
taxation and subsidies to control the activities of the private entrepreneurs to
protect the consumers and the economy at large. The government also takes part
directly in the production and distribution of goods and services. Thus in a mixed
market economy:

1.8.9 FUNCTIONS OF ECONOMIC SYSTEM

1. WHAT TO PRODUCE? : The economic system determines the type of goods

to produce in the economy. In the capitalist economy private entrepreneurs are
free to produce the goods they like taking into consideration whether they will
make more profit. In the socialist or planned economy the planning committee
plans the type of goods and services to produce and their quantities. With the
socialist system goods are produced with the aim of satisfying the wants of the
people though profits are sometimes taken into consideration.

2. HOW TO PRODUCE? : The economic system also determines the method of

production as to whether to adopt labour intensive or capital intensive
technique of production. In the capitalist economy, private entrepreneurs aim
at producing at low cost and so will employ the factors of production whose
prices are low. But in the socialist economy, the state aims at promoting

Page 11
 ECONOMICS

economic growth and improving upon the welfare of the people so will like to
give employment to the people. In this case capital may be cheaper but the
state may employ more labour in production in order to reduce unemployment.

3. HOW MUCH TO PRODUCE? : This function relates the amount of a

commodity that should be produced. In the case of a free market economy, it
will depend on the signals that producers get from consumers. In the case of
the centrally planned economy, this will be determined by the central planning
authority.

4. FOR WHOM TO PRODUCE? / HOW TO DISTRIBUTE? : This function relates

to how the goods will be distributed or sold to consumers. In a free market
economy, producers segment the market, target those who have effective
demand and produce the goods for them. Those who do not have effective
demand are therefore neglected. On the other hand, the central planning
committee decides how the goods and services should be distributed to the
people in order to enhance their social welfare.

5. HOW TO ACHIEVE FULL EMPLOYMENT OF RESOURCES? : The economic

system should ensure that there is full employment. In the socialist system, the
level of employment and the volume of output is planned by the planning
committee.

6. HOW TO ACHIEVE ECONOMIC GROWTH? : The economic system has to

see to the growth of the economy. Economic growth may be defined as a
sustained increase in the output of goods and services in a country. Growth in
the economy is usually measured annually.

1.9 IMPORTANCE OF STUDYING ECONOMICS

 Economics teaches us how to maximize satisfaction by making rational
choices through Cost - Benefit Analysis.
 The study of economics makes us realise the need to save part of our
income for future consumption.
 Economics helps us to understand how the economy works. That is to say,
studying economics puts in us in the position to analyse the likely impacts
of government policies.

Page 12
 ECONOMICS

UNIT 2
THE CONCEPT OF DEMAND

2.1 DEFINITION OF DEMAND

Demand is the amount or quantity of a commodity that consumers (households)
are willing and able to buy at a given price within a given period of time. From the
definition, there are two important things to consider.

Firstly, demand is desired quantity (want). This means how much households wish
to purchase but not necessarily how much they actually succeed in purchasing.
Secondly, demand does not refer to a mere wish but rather it is backed by ability
to pay, that is, “effective demand” (backed or supported by purchasing power).

2.2 THE LAW OF DEMAND

The law of demand states that other things being equal (ceteris paribus), the higher
the price of a commodity, the lower the quantity demanded and the lower the price
of a commodity, the higher the quantity demanded.

The law of demand can be presented in three main ways. These are:
 Schedules
 Graphs
 Equations
(NB: It must be noted that the above tools, namely; schedules, graphs and
equations are the basic tools used for analysis in economics)

Demand Schedule:
 Individual demand Schedule: this is a table showing the various quantities of
a commodity that an individual consumer would demand at various prices
within a period of time. An example is illustrated below:

Price (GH¢) Quantity Demand

1 20
2 15
3 10
4 5
5 1

Page 13
 ECONOMICS

 Market Demand Schedule: This is a table that shows the prices of a

commodity and the various quantities demanded by different individuals (all
consumers) in the market over a period of time. In other words, it is the
horizontal summation of all individual demand schedules. An example shown

Price Quantity Quantity Market demand

(GH¢) Demanded (A) Demanded (B) (A+B)
1 20 25 45
2 15 20 35
3 10 15 25
4 5 10 15
5 1 5 6

2.3 DERIVATION OF MARKET DEMAND CURVE

Graphing the market demand schedule, we obtain the market demand curve as
shown below:

MARKET DEMAND CURVE

Individual DD Market DD Curve

Individual DD 5
5
5
4 4
4
3 3
3
2 2
2
1 1
1
D D
D
0 1 5 1 15 20 Qty 0 6 2 25 35 45 Qty
0 1 5 10 15 20 Qty 0 10 15 20 DD
0 DD
DD 2
0
0
From the diagram above, it can be seen clearly that a normal demand curve
slopes from left to right downwards indicating that the quantity demanded of a
commodity is inversely (indirectly or negatively) related to its price.

Page 14
 ECONOMICS

2.4 FACTORS DETERMINING DEMAND FOR A COMMODITY

1. Price of the commodity in question:

Basically, consumers demand for goods and services depend on the price. If the
price of the commodities were high its quantity demanded would be low and vice-
versa. The economic reason is that, at higher prices, poor cannot afford to buy.
Also, when the price of a commodity is high, the consumers’ real income falls.
However, if the price is low, the quantity demanded is likely to be high because the
poor who could not afford to buy at a higher price can now buy the commodity.
While those who were buying it at a higher price can now buy more because their
real income has increased.

2. Price of other related Goods:

Goods may be related either as substitutes or complements.

(a) Substitutes: Two goods are said to be substitutes if one can be used in place
of the other. An example is Milo and Cocoa powder. When the price of one (say
Milo) rises, while that of the other (say Cocoa powder) remains unchanged, less
of it (Milo) would be bought and more of the other (Cocoa powder) would be
bought. The opposite is also true. That is, when the price of Cocoa powder rises,
while that of the Milo remains unchanged, less of Cocoa powder would be
bought and more of Milo would be bought. Hence, in the case of substitutes,
there is a positive or direct relationship between the quantity demanded
of a commodity and the price of its substitutes.

(b) Complements: Goods are said to be complements when they are demanded
together. Examples are car and petrol, DVD player and DVD to mention but a
few. If the price of one, say DVD player falls, more of it would be demanded and
as such, more of DVD would be demanded. This implies that there is a
negative or inverse relationship between quantity demanded of a
commodity and the price of its complements.

3. Household’s (Consumer’s Income): There are three possible relations

between the quantity demanded and the consumer’s income. Firstly, a rise in
income is associated with a rise in the quantity demanded. The effect of changes
in income on quantity demanded is positive. Such a good is called a Normal good
(Necessity and luxury).

Page 15
 ECONOMICS

Secondly, a change (rise) in income might leave the quantity demanded unaffected.
This is in the case of goods for which the desire is completely satisfied after a certain
level of income is obtained. Examples of such commodities are salt and pepper.
The effect of changes in income on quantity demanded is therefore neutral. This
good is a necessity.

Thirdly, there is another relationship in which quantity of the commodity falls as

income rises. The effect of changes in income on quantity demanded is negative.
Such a good is also called Inferior good. These relationships can be illustrated on
the Engel’s curves.

Engel’s Curves
Quantity (units)

(1) luxury
Q3

Q2 (2) Necessity

Q1
(3) Inferior Good

0 Y1 Y2 income

Curve (1) illustrates the case in which a rise in income brings about a rise in
quantity demanded at all levels of income. Curve (2) also illustrates a case in which
purchase rises with income up to a certain point (Y1) and remains unchanged as
income varies above that point. Curve (3) also illustrates the case in which
purchases firs, rise with income up to a certain level (Y1) where quantity was Q2
but then falls as income goes beyond that level.

4. Consumer’s Taste and Preference:

When there is a change in taste in favour of a commodity, consumers will prefer it
and as such, more will be demanded even though price of that commodity, prices
of all other related commodities and the consumers’ income remains unchanged.
However, if a good runs out of fashion, its demand is likely to fall. Taste for
particular commodity is influenced by one’s level of education, age, occupation and
religion, size of the family, nationality, race, sex, and status among others.

Other factors which influence demand are:

5. The Population Size.
6. Availability of Credit facilities.

Page 16
 ECONOMICS

7. Expectation of future changes in Price or Income and

8. The State of the Weather.

2.5 TYPES OF DEMAND

Joint or Complementary Demand: Complementary demand is where two goods
are demanded together before they can serve a purpose. In this case, an increase
in the price of one results in a decrease in demand for the other and a decrease
in the price of one results in an increase in demand for the other. Thus,
complements are inversely related. Examples are car and fuel, tooth paste and
tooth brush, etc.

Competitive Demand: Competitive demand refers to a situation where two or

more commodities serve more or less the same purpose such that an increase in
the price of one results in an increase in the demand for other and vice versa. The
commodities in question here have a positive relationship and are termed as
substitutes. Examples are mutton and beef, Coke and Pepsi, Vodafone chip and
MTN chip, etc.

Derived Demand: It refers to a situation where the demand for a commodity

necessitates the demand for another commodity. In other words, it is where a
commodity is demanded not for its own sake but for the production of another
commodity. For instance, leather may be demanded not for its own sake but for
the production of shoe, wood may also be demanded to manufacture furniture, etc.

Composite Demand: Composite demand is a type of demand where one

commodity serves two or more purposes. For example wood can be used for
furniture, doors, roofing to mention but a few.

2.6 EXCEPTIONAL DEMAND CURVES

A normal demand curve slopes downward from left to right indicating that more is
bought at lower prices and vice-versa. Thus, an exceptional demand curve does
not follow the law of demand and hence does not slope from left to right
downwards. In this case, the higher the price, the higher the quantity
demanded; the lower price, the lower the quantity demanded. Cases of
abnormal demand curves occur in the following instances:

Page 17
 ECONOMICS

a) Ostentatious Goods: These are goods that consumers demand because of the
prestige or recognition associated with their consumption but not because of their
importance. In this case, consumers of those goods feel that they are superior to
those who do not consume them so they buy more even when their prices are high
and vice versa. Examples are jewels, wedding rings, hummer cars, etc.

b) Giffen Goods: These are goods whose demand increases as their prices increase
vis-à-vis (compared with) the income of consumers. Typical examples are staple
foods. This theory was propounded by Sir Robert Giffen who noticed that people
demanded less of Irish potatoes (an inferior good) at lower prices and more at
higher prices. That is to say, if consumers’ incomes are high and the prices of their
staple foods are low, they will demand less. On the other, if consumers’ incomes
are high and the prices of their staple foods are high, they will demand more.

c) Fear of future rise in price: when consumers perceive that prices will go up by a
greater percentage in the future period, they continue to buy more in the current
period even when prices are still rising.

d) Perfectly Elastic and Inelastic Demand Curves: These situations will be

explained under elasticity of demand.

2.7 CHANGES IN DEMAND AND CHANGES IN QUANTITY DEMANDED

A. Changes in Quantity Demanded

A change in quantity demanded which is also called price-induced change in
demand or movement along the same demand curve is brought about mainly
by a change in the commodity’s own price. This therefore corresponds to the law
of demand, which states that all other things being equal, the higher the price the
lower the quantity demanded and the lower the price the higher the quantity
demanded as shown on the below.

Page 18
 ECONOMICS

(i) Changes in Quantity Demanded (ii) Changes in Demand

Price (¢) Price (¢)

P3

P2 P

P1 D1 D2 D3

Qty (units) Qty (units)

0 Q3 Q2 Q1 0 Q1 Q2 Q3

From figure (i), we can observe that on the same demand curve, different
quantities of a commodity are bought at different price. For example, a rise in price
from P2 to P3 leads a reduction of quantity demanded from Q2 to Q1.

2. 8 CHANGES IN DEMAND
This refers to a situation where the commodity’s own price remains the same but
other factors cause the level of demand to increase or decrease. It involves a shift
of the demand curve. A shift to the right signifies an increase in demand whilst a
shift to the left signifies a decrease in demand. A change in demand otherwise
known as autonomous change in demand is caused by a change in demand
condition or other determinants of demand except the price of the commodity.

Factors that influence or cause change demand may include:

 Changes in prices of other related goods.
 Changes in income of the consumer.
 Changes in taste / fashion / preference.
 Changes in population.
 Changes in weather conditions.
 Changes in real incomes.
 New commodities replacing old one, and so on.

Diagram (ii) illustrates a bodily shift of the demand curve. Assume the original
demand curve is D2, a shift of the original demand curve to the right say D3 shows
an expansion in demand. This indicates that more will be bought (from Q 2 to Q3)
at the same price. However, shift to the left from say D 2 to D1 also shows a
contraction in demand. It indicates that less will be bought (from Q2 to Q1) at the
same price at P.

Page 19
 ECONOMICS

UNIT 3
THE CONCEPT OF SUPPLY

3.1 DEFINITION OF SUPPLY

Supply refers to the quantity of a commodity that producers (sellers) are willing and
able to sell (or offer) for sale at a given price over a given period of time. Supply
is different from stock of goods which refers to the entire production of a
firm. It is quite possible for a commodity to be produced and yet not be part of the
supply. The output of a subsistence farmer is not part of the supply, since he
consumes his output himself and it is not put on the market for sale. Also, it is quite
possible for something to be produced and then stored, so that it is not part of
present supply. Similarly, supply can be greater than current output if stocks are
being released and put on the market for sale.

3.2 THE LAW OF SUPPLY

The law supply states that “other things being equal, the higher the price the
greater the quantity supplied; the lower the price, the smaller will be the quantity
supplied”.

Page 20
 ECONOMICS

3.3 SUPPLY SCHEDULE

It is a tabular representation of the quantity of a commodity offered for sale at
various prices in a period of time.

An individual supply schedule is a table that shows the various quantities that a
producer or seller is willing to offer for sale at various prices.

The market supply schedule on the other hand is the total quantity that individual
producers or sellers offer for sale at various prices. Thus market supply schedule
is the horizontal summation of the individuals supply schedules. This is shown
below;

INDIVIDUAL SUPPLY SCHEDULE

PRICE (GH¢) QUANTITY SUPPLY

1 10
2 20
3 30
4 40
5 50

MARKET SUPPLY SCHEDULE

Price GH¢ Quantity Supplied A Quantity Supplied B Market Supply (A+B)

1 10 5 15
2 20 10 30
3 30 15 45
4 40 20 60
5 50 25 75

3.3.3 THE SUPPLY CURVE

The supply curve is a graph showing the quantities of a commodity that would be
supplied at various prices over a period of time.

Page 21
 ECONOMICS

Individual supply curve is a graph that shows the quantities of a commodity offered
for sale by an individual seller or producer at various market prices over a period
of time.

The market supply curve on the other hand is a horizontal summation of the
individual supply curves. It may be defined as a graph showing the quantities of a
commodity offered for sale by all sellers or producers at various market prices over
a period of time. The diagram below illustrates it.

INDIVIDUAL SUPPLY CURVE

Price

S
5

4
3
2
1
S
Qty
0 10 20 30 40 50

Page 22
 ECONOMICS

DERIVATION OF MARKET SUPPLY CURVE

Individual Supply Curve A Individual Supply Curve B Market Supply Curve (A +B)

Price
Price
Price

O 10 20 3 4 5 0 5 10 15 20 25 Qty 0 15 30 45 60

The curve SS is the supply curve, the price per unit is shown on the vertical or ‘Y’
axis and the quantity supplied on the horizontal or ’X’ axis. The supply curve has
a positive slope; it slopes upwards from left to right thus showing that the higher
the price, the greater the quantity which will be supplied and vice-versa. The
supply schedule and the supply curve show the relationship between market prices
and the quantities which producers are prepared to offer for sale. Whereas the
relationship between the price and the quantity demanded was an inverse /
negative one, the relationship between the price and the quantity supplied is
direct / positive; i.e. they move in the same direction.

3.4 FACTORS DETERMINING SUPPLY OF A COMMODITY

Price of the commodity in question
Generally, “all other things being equal” more of a commodity is supplied at a
higher price than at lower prices. The implication is that, at higher prices, it is more
profitable to produce. It can be said that, the price of a good affect quantity through
revenue and profit made by producing firms. Revenue determines the profit of a
firm at a given level of cost. Since price affects profit and profit affects quantity
supplied, it follows that price affects quantity.

The Prices of other Goods

In a situation where two commodities can be produced by using the same
resources and the price of one rises and that of the other remains the same,
producers will shift their resources to produce more of the commodity whose price

Page 23
 ECONOMICS

has risen and less of the one whose price has not changed in order to make higher
profits.

Government Policies
The quantity of a particular good to be produced by firms may largely depend on
the government’s policies, if the government provides better policies such as credit
facilities, tax holidays (tax exemptions), better prices, ready market, better inputs,
incentives like bonus and so on to producing firms in the production of a particular
commodity, it will encourage many producers to reallocate their resources towards
the production of the commodity and hence supply will rise.

Prices of Factors of Production

The supply of a commodity depends on the availability and the price of factors of
production. These factors of production are land, labour, capital and
entrepreneurship. A rise in the price of a factor of production, all other things being
equal, will increase the cost of production resulting in a decrease in profit, suppliers
or producers will therefore decrease their supply because of the low profitability.
Conversely when the cost of production falls due to low price of factors of
production producers will increase their supply of the commodity all other things
being equal.

Climatic Factors
The effect of the weather plays a major role in determining the supply of some
goods especially agricultural products. A good weather such as moderate amount
of rainfall falling at the right time coupled with appropriate amount of sunshine will
result in good harvest. Such harvest, other things being equal will lead to increase
in supply of a commodity. on the other hand, bad weather will result in a poor
harvest resulting in a decrease in supply.

The Level of Technology

The level of technology employed in the production of goods and services can
determine the supply of a commodity. Improvement in technology can increase
productivity thereby reducing the cost of production per unit, all other things being
equal. The high productivity will also lead to increase in supply of the commodity.
On the other hand, low level of technology will lead to low productivity and high
cost per unit of the commodity. the effect would be that supply of the commodity
will decrease, all other things being equal. for example a farmer who uses high

Page 24
 ECONOMICS

technology such as tractors, fertilizers, irrigation, and combined harvesters is likely

to produce more for sale than the one who uses cutlasses and hoes and rely only
on rainfall.

3.5 TYPES OF SUPPLY

There are three types of supply. These are; Joint Supply, Competitive Supply and
Composite Supply.

Joint Supply
A commodity is jointly supplied if the production of one necessarily leads to the
production of another commodity. That is to say the commodities are produced
from the same source. Examples of such goods are wool and mutton, beef and
hide, cocoyam and cocoyam leaves among others. Their economic implication is
that, an increase in the price of one commodity (say cocoyam), will lead to an
increase in the supply other commodity (say cocoyam leaves).

Competitive Supply
A commodity is said to be competitively supplied when two or more commodities
are produced from similar resources. For example, a given farmland can either be
used to produce cocoa or oil palm. The economic implication is that an increase in
the price of one commodity (say cocoa) will induce farmers to use larger proportion
of their farmland and other resources to produce more cocoa instead of palm oil.
As such, the supply of cocoa will be increased while that of its complement (oil
palm) will be reduced.

Composite Supply
Supply of a commodity is composite if it can be obtained from different or several
sources. For example, the supply of energy can be obtained from several sources
such as coal, fuel oil, hydroelectric power and solar systems. The implication is
that, a change in the supply of hydroelectric power will lead to a decrease in supply
of energy obtained from solar systems and vice versa.

Page 25
 ECONOMICS

3.6 EXCEPTIONAL SUPPLY CURVES

Exceptional supply curves occur in situation where the supply curve does not
behave like the normal supply curve. They are exceptions to the law of supply. The
price and quantity supplied are not positively related.
There are three (3 types), namely: Backward sloping Supply Curve, Perfectly
Inelastic and Perfectly Elastic Supply.

Fixed Supply / Perfectly Inelastic Supply

In fixed supply, the quantity supplied of a commodity is such that price has no
effect on the quantity supplied. It has the nature of a commodity with perfectly
inelastic supply. This is commonly found in agricultural products whose supply
cannot instantly be changed in responds to price changes in the short-run. For
example, if the world market price of cocoa increases, quantity supplied of cocoa
cannot be increased instantly during the short-run. It will take about two to three
years before quantity can be increased.

Fixed Supply Curve

Price ()

s
P1

P2

0 Quantity (Units)

The chart above is the fixed supply curve. If for example, the price of cocoa
increases from P0 to P1 quantity supplied will still be at Q. it will take cocoa farmers
about 2 – 3 years before they can respond to the price change.

Backward Bending Supply Curve: The backward bending supply curve slopes
positively like the normal supply curve initially, up to a certain level but slopes
negatively beyond a certain level. This type of supply is typical to the supply of
labour. To some workers, as daily wage rate per day increases, they would be
induced to work for more hours. However, beyond a certain wage rate, they would
prefer leisure to work and as such, the supply of labour bends back. Workers may
adopt some strategies like absenteeism. We can also illustrate this in the chart
below:

Page 26
 ECONOMICS

Wages

W3

W2

W1

0 Labour hours Supplied

L3 L1 L2

We could observe from the diagram that labour supply increased from L 1 to L3 as
wages rose from W 1 to W 2. Beyond W 2, any increase in the wage rate lead to less
labour supplied. For example, as wages rose from W 2 to W 3, labour supplied
declined from L3 to L1.

Reasons: The reasons assigned for such behavior of labour is that:

 The worker has been able to achieve his aim of offering himself to work.
The worker might target to buy certain goods and so far as he is able to buy
such goods, he does not see the reason he should continue to work for
more hours.

 As people become rich or better off, they prefer leisure to work as they need
more time to spend and enjoy their wealth and therefore supply work for
fewer hours.

Perfectly Elastic Supply

In this type of supply, changes in the price induce infinite change in supply. An
increase in price makes supply infinite. However, a fall in price will reduce supply
to zero. Some near examples can be cited from the world market where prices are
fixed by market forces. Individual countries are prepared to export (sell) more if
prices are high.

Page 27
 ECONOMICS

Perfectly Elastic Supply

Price ()

P S

Quantity (units)

From the above diagram, price is fixed at P and the supply curve is S. Producers
are prepared to sell Q0 or Q1 (any quantity) so far as price P is maintained. If the
price is changed, producers’ reaction to the situation will be infinite. In a situation
where the price is reduced, they will not be willing to sell their products at all.
However, if the price is increased, they will rush to sell their products.

3.7 CHANGES IN SUPPLY AND CHANGES IN QUANTITY SUPPLIED

A. Change in Quantity Supplied:

This occurs in a situation where there is a change in the price of the commodity in
question while the other supply conditions remain unchanged. It also involves a
movement along the same supply curve.

Change in Quantity Supplied Change in Supply

S
P3 S3 S1 S2

P2

P1
S
0 0
Q1 Q2 Q3 Q3 Q1 Q2

Page 28
 ECONOMICS

Diagram (i) Diagram (ii)

In diagram (i), we assume that, the initial price is P2 and quantity supplied is Q2. If
price increases to P3, quantity will be increased to Q3. But if price falls to P1,
quantity would also decline to Q1. There is a movement along the same supply
curve.

B. Change in Supply
A change in supply occurs in a situation where there is a change in the other supply
factors apart from the price of the commodity in question. Thus, it is caused mainly
supply conditions such as changes in the price of other commodities, cost of
factors of production, state of technology, weather conditions, sellers’ future
expectations etc. Thus, we hold the price of the commodity constant.
It also involves a bodily shift of the supply curve either to the right to indicate
expansion in supply or to the left, which also indicates contraction in supply. This
is shown in the diagram (ii) above. We assume that the initial supply curve is S 1.
A change in any of the supply conditions as mentioned above would shift the
supply curve either to S1 (contraction) or S3 (i.e. expansion).

UNIT FOUR
PRICE MECHANISM

4.1 HOW PRICE MECHANISM ALLOCATES RESOURCES

Price mechanism refers to how the forces of demand and supply freely interact to
determine prices. In other words, it is an invisible force that helps in allocation of
resources in a free market economy. The scarce resources of the society are
rationed out through changes in price caused by inter-play of demand and supply.

In a free market economy, it is the price mechanism (system) that determines what
to produce, that is to say, whether to produce shirts, maize, computers or any other
commodity. In this case, producers produce according to the demands (taste) of
the consumers. Votes are cast through purchasing to tell producers what to
produce as consumers patronize in buying the goods and services. For instance,

Page 29
 ECONOMICS

if consumers want more rice than wheat, producers will shift from the production
of wheat and allocate their resources in the production of rice. There will be more
rice and as such its price will fall while the price of wheat will be raised as less is
produced. This will be achieved by the price mechanism without the help of the
central planning committee.

Furthermore, the price mechanism regulates the distribution of income of

resources or the factors of production. For example, if the wages or a salary of a
particular occupation (say carpentry) is high more labour will be attracted into that
carpentry occupation and in effect the wage rate would fall in line with other
comparable wages in the other occupation (like masonry).

4.2 THE CONCEPT OF EQUILIBRIUM

Market equilibrium refers to an economic situation where quantity demanded
equals quantity supplied. In other words, it refers to a market situation in which the
plans of buyers and the plans of sellers are exactly the same. When equilibrium is
established, the opposing forces will be in a balance. Thus, equilibrium refers to a
state of stability which has no tendency to change. Once equilibrium is achieved,
the situation will persist over a reasonable period of time.

In a free enterprise economy, the interaction of the forces of demand and supply
determines price movement. Thus, if buyers wish to purchase more than sellers
wish to supply, price will rise. As price rises, buyers reduce the quantities they wish
to purchase and sellers increase the quantities they wish to sell. Similarly, if sellers
wish to sell more than buyers are prepared to take, price falls. This will cause
sellers to reduce quantities they wish to sell and buyers to increase the quantities
they wish to buy until the quantities are again equal.

To understand the concept of equilibrium, let us consider the following market

demand and supply schedules:

Page 30
 ECONOMICS

Determination of Equilibrium Price

Price () Quantity Demanded Quantity Supplied

10 60 120
9 70 110
8 80 100
7 90 90
6 100 80
5 110 70
4 120 60

From the above table, equilibrium price is 7 and the equilibrium quantity
demanded and supplied is 90 units. We can illustrate this in the hypothetical
diagram below:

Determination of Equilibrium

Price ()

Surplus S
P2
E
Pe

P1 D

0 shortage Quantity (Units)

Q1 Qe Q2

From the above chart above, demand and supply intersects at point E and the
equilibrium price is Pe while equilibrium quantity supplied and demanded is Q e. If
the price of the commodity were to be at P1 (i.e. below the equilibrium price Pe)
there would be excess demand over supply and as such there will be shortage at
the market because quantity supplied would be Q1 while quantity demanded would
be Q2. The different Q2 – Q1 is the excess demand. The shortage would bid the

Page 31
 ECONOMICS

price up towards the equilibrium until the market is cleared. Hence a shortage
market is referred to as the sellers’ market.

On the other hand, if the price were to be above the equilibrium price say at P 2,
over demand, thus resulting to surplus at the market. The difference Q 2 – Q1 is the
surplus or excess supply over demand, thus resulting to surplus at the market. The
difference Q2 – Q1 is the surplus or excess supply. Sellers would take the
advantage of the high price by selling more and this will cause the price to fall
towards the equilibrium price. It can therefore be said that where this is a surplus,
there is the tendency for price to fall towards the equilibrium price to the benefit of
consumers. For this reason, a surplus market is referred to as buyers market.

4.3 EFFECTS OF CHANGES IN DEMAND AND SUPPLY ON THE EQUILIBRIUM

PRICE

An increase in Demand: an increase in demand refers to a shift of the demand

curve to the right. It may occur as a result of increase in population size, income,
prices of other related commodities, etc. When the level of demand increases as
a result of the above factors, it will cause the demand curve to shift to the right
thus, increasing the price and quantity as shown in figure (a).

A decrease in Demand: may be as a result of a fall in price of a substitute, will

cause supply to exceed demand. A surplus situation will arise in the market, and
sellers will compete among one another for the limited consumer purchase. Sellers
will have to entice buyers to the commodity by reducing the price. As the price is
reduced, the law of supply will apply to reduce the quantity supplied until it
becomes at par with demand at a lower equilibrium price. The above explanations
are illustrated in the diagrams below:

Page 32
 ECONOMICS

Fig (a) Increase in Demand Fig (b) Decrease in Demand

Price
D D
S D1

P1 P1

P2 P2
D
S D D1

0 quantity 0 quantity
qe q1 qe qe

Thus, an increase in demand would lead to an increase in the equilibrium price,

while decrease in demand causes a decrease in the equilibrium price as illustrated.
In fig. (a) the initial equilibrium is at E1 at a price P1 and quantity q1. Then demand
increases from D1 to D2 leading to an increase in the equilibrium price to P2 which
causes quantity supplied also to increase to q2 to establish a new equilibrium at
E2.

Increase in Supply: as a result of exceptionally good weather for example, will

cause supply to exceed demand, and surplus to occur at the market. The price will
have to fall since the extra output would only be bought at a lower price. A lower
price will cause quantity demanded to increase, in consistent with the law of
demand, and a new equilibrium will occur at a lower price.

Increase in Supply
Price ()

D s0
S1
Pe1

Pe

S0 D
S1
0 Quantity
qe qe1

Page 33
 ECONOMICS

A Decrease in Supply: may be due to an imposition of tax on the commodity, will

cause shortages in the market since demand will exceed supply. This will be bid
up the price, and lead to a fall in quantity demanded in tune with the demand law,
and a new equilibrium will eventually emerge.

Thus, an increase in supply would cause the equilibrium price to fall but equilibrium
quantity to increase, whiles a decrease in supply would cause the equilibrium price
to rise but equilibrium quantity to fall.

Decrease in Supply
Price
D S1
S
Pe1

Pe

S1 D
S

0 Quantity
qe1 qe

Page 34
 ECONOMICS

4.4 PRICE CONTROL

Price legislation or control is a market situation, where the government interferes
with the ruling equilibrium price by making it a law, which fixes a new price for
certain goods and services. The price may be set below or above the equilibrium
price.

4.5 TYPES OF PRICE CONTROL

There are two types of price controls and they are: Maximum Price Control and
Minimum Price Control.

Maximum Price Control

Maximum price legislation is a situation where the government fixes the price of a
commodity below the equilibrium price. It is also referred to as Price Ceiling.

Reasons for Maximum Price Legislation

There are a number of reasons why the government embarks price ceiling. These
are:

 The government may consider the price of the commodity to be too high for
consumers and in order to relieve consumers; the government may decide to
set the price below the equilibrium price.

 Another reason is to reduce the supply of certain commodities and its

consumption and release surplus for the production of commodities, which are
considered as more important.

 Furthermore, the government adopts maximum price legislation to ensure

equal distribution of scarce commodities whose prices are rising at a higher
rate. Since the maximum price is fixed below the equilibrium price, the
commodity can now reach the poor people.

4.6 EFFECTS OF MAXIMUM PRICE LEGISLATION

The prominent effect of price ceiling is that as the government fixes the price below
the equilibrium price, there will be excess demand over supply and that there will
be shortage at the market as consumers will demand more and producers reduce
supply. We can explain this with the aid of the diagram below:

Page 35
 ECONOMICS

Effects of Maximum Price Legislation

Price ()

S
P2
E
Pe

Pmax
D

Quantity (units)
Q1 Qe Q2

From the diagram, the equilibrium price is P0 and quantity is Q0. If the government
fixes the maximum price at Pmax, it could be observed that demand would be Q 2
while supply will also be Q1. There will be excess demand over supply and this will
be shortage or scarcity of goods and this is represented by the difference between
Q2 – Q1.

There are several developments associated with price ceiling. Among them are:

 There would be shortages as a result of excess demand over supply or

Hoarding. When the government fixes the price of a good below the
equilibrium price, some sellers will not be satisfied with the policy, thus; they
would hide their goods and refuse to sell them. The shortages will bring about
several queues in front of shops which will invariably result in the following:

 There would be-first come first-served method of rationing (distributing in

smaller quantities) the scarce goods to the consumers.

 The first come first served system may lead to preference sales or the chit
system. Thus sellers would sell the scarce goods to those they like especially
to relatives and friends.

 There would be conditional sales. Sellers would use the scarce commodity to
sell other commodities which are not in demand

 Black (Parallel) Market: The most serious development on the market is the
black market situation where buyers will compromise with sellers to buy the
commodity at price far above the equilibrium price.

Page 36
 ECONOMICS

Page 37
 ECONOMICS

4.7 MINIMUM PRICE LEGISLATION

Minimum price legislation also known as Price Floor is the fixing of the price of a
good above the equilibrium. Thus, it makes it illegal to sell the good below that
price. This is normally associated with wages for labour of which no employer is
expected to pay wages below the minimum wage.

REASONS / AIMS OF MINIMUM PRICE LEGISLATION

 To ensure a better standard of living, the government may fix price for labor for
higher wages.

 To increase the production of certain specified goods, the government having

discovered that the prices of certain goods are too low may fix a minimum price
to boost production.

4.8 EFFECTS OF MINIMUM PRICE LEGISLATION

The main effect of price floors can be explained by the fact that, as price is fixed
above the equilibrium, sellers would increase production while consumers would
demand less. There would be excess supply over demand, this will create surplus
in the economy.

Effects of Minimum Price Legislation

Price ()

S
Pmin
E
Pe

P1
D

0 Quantity (units)
Q1 Qe Q2

From the diagram above, the equilibrium price is Pe while the quantity is Qe. If the
government fixes the minimum price at Pmin, there would be excess of supply over
demand and this is given by the difference between Q 2 – Q1 because suppliers
would like to sell at Q2 while consumers are willing to buy at Q1 and thus leading
to surplus.

Page 38
 ECONOMICS

The surplus would lead to the following effects:

 There would be conditional sales. Goods which are in high demand would be
sold with commodity with excess supply.
 Free coupons, gifts and discounts techniques would be used to increase sales.
 Some of the sellers would be compelled to sell the commodity even far below
the equilibrium price in order to avoid losses. This is also a black market.

In the real world, minimum price control is normally applied in the labour market.
Thus, the next section focuses on effect minimum wage (the price of labour)
legislation on the economy.

4.9 EFFECTS OF MINIMUM WAGE LEGISLATION

The main effect of an increase in minimum wage is unemployment. As the
government raises the wage rate, many people will be willing to work and that
supply of labour would be increased. Employers with their capital unchanged can
employ only few labourers at the new wage rate. Hence there would be excess
supply of labour over the demand for them.

Effects of Minimum Wage

Wage

Unemployment SL
W min

We

W1
DL

Labour
0 L1 Le L2

From the diagram, the equilibrium minimum wage is W e and Le of labour was
supplied. Now, the minimum wage has been raised to W min. this results in excess
supply of Labour over demand for labour (unemployment).

Page 39
 ECONOMICS

 The situation so created would bring about rural urban migration, congestion in
the cities, social vices such as armed robbery or stealing, prostitution, and other
immoral activities.

 The unemployed labour would secretly offer their services far below the
minimum wage; say W1. This is also a black market.

UNIT FIVE
THE MEASUREMENT OF ELASTICITIES

5.1 ELASTICITY OF DEMAND

Elasticity of demand by definition is the relative responsiveness of quantity
demanded of a commodity to changes in price of the commodity, income of the
consumer, and prices of other related commodities. Hence, there are three
types of elasticity of demand. These are Price Elasticity of Demand, Income
Elasticity of Demand and Cross Elasticity of demand.

5.2.1 Price Elasticity of Demand

Price Elasticity of demand is defined as the relative responsiveness (sensitivity) of
quantity demanded to changes in price of the commodity. In other words, it is the
proportionate or percentage (%) change in quantity demanded resulting from a
proportionate or percentage (%) change in price of the commodity.

Price elasticity of demand is classified under five main headings as follows:

(a) (Fairly) Elastic Demand: If the coefficient of price elasticity of demand (ℓD)
is greater than one (1) demand is said to be price Elastic. That is, a
proportionate change in price brings about a more than proportionate
change in quantity demanded. For example, if the price of a commodity
increases by 10% and quantity demanded falls by 20%, then the ℓD =
0.2/0.1 = 2. This means that for every one unit increase in price quantity
demanded falls by 2 units. Such a commodity is said to have a price elastic
demand.

Page 40
 ECONOMICS

Price Elastic Demand Curve

P

10
8

0 Qty
100 300

(b) Inelastic Demand: Demand is said to be price inelastic when a

proportionate change in price leads to a less than proportionate change in
quantity demanded. In this case, the coefficient of elasticity is less than unit
(1). For example, if the price of a commodity rises by 10% and as a result
of that quantity demanded falls by 5% then ℓD = 0.05/0.1 = 0.5, which means
for a unit change in price of that commodity, quantity demanded falls only
by half of a unit.

Price Inelastic Demand Curve

P
D

10

4
D

0 10 12 Qty

(c) Unitary Elastic: If a proportionate change in price result in equal

proportionate change in quantity demanded we say demand is unit elastic.
In this case the elasticity coefficient is 1. Assuming price falls by 10% and
quantity demanded rises also by exactly 10% then the ℓD = 0.1/0.1 = 1. In

Page 41
 ECONOMICS

the case of unitary elastic demand, the demand curve has the shape of
rectangular hyperbola.

Price

2 D

0 Quantity
8 24

(d) Perfectly Inelastic Demand

Price
D
P2

P1

Qty
O
Q1

The demand for a commodity is said to be perfectly inelastic when a decrease or

an increase in the price of the commodity does not result in any change in quantity
demanded. That is quantity demanded remains the same regardless of the price
level.

(e) Perfectly Elastic Demand

Price

P1

Qty
O
Q1 Q2 Q3
Page 42
 ECONOMICS

The demand for a commodity is perfectly elastic when at a given price quantity
demanded could increase or decrease to infinity. That is quantity demanded
changes at the same price. The implication is that if the price should change, the
reaction of consumers will be infinite or so great.

5.2.2 NUMERICAL MEASUREMENT OF PRICE ELASTICITY OF DEMAND

Mathematically, Price Elasticity of demand is given by:

𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑

𝑃𝐸𝐷 =
𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

or

𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑

𝑃𝐸𝐷 =
𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

5.2.3 METHODS OF MEASURING PRICE ELASTICITY OF DEMAND

There are two main methods used in measuring price elasticity of demand.

A. POINT ELASTICITY OF DEMAND: measures elasticity of demand at a

particular point on the demand curve. It is normally used to measure elasticity
of demand when the changes in price are small. The formula is given as
follows:
∆𝑄 𝑃𝑜
𝐸𝑑𝑝 = × 𝑄𝑜
∆𝑃

Where ∆𝑄 = 𝑄1 − 𝑄𝑜 Po = Initial price

∆𝑃 = 𝑃1 − 𝑃𝑜 P1 = new price

Qo = initial quantity

Q1 = new quantity

Always it is the new price – the old price.

Page 43
 ECONOMICS

Example, the price of a commodity rises from GH¢10.00 to GH¢12.00, and quantity
demanded decreased from 50 units to 20 units, calculate the price elasticity of
demand.

Solution

Po = GH¢ 10.00 ∆𝑃 = 𝑃1 − 𝑃2 ∆𝑄 = 𝑄1 − 𝑄𝑜

P1 = GH¢ 12.00 = 12 − 10 = 20 – 50

Q0 = 50 units ∆𝑃 = 2 ∆𝑄 = −30

Q1 = 20 units

∆𝑄 𝑃0
𝐸𝑑𝑝 = ×
∆𝑃 𝑄0

−30 10
= ×
2 50
= -3

B. ARC OR MIDPOINT ELASTICITY OF DEMAND

It is a measure of elasticity of demand within a range of two points on the

demand curve. In other words it measures the average of the point elasticity
(𝑃𝑜+𝑃1)⁄
∆𝑄
along the demand curve. It is given by 𝐸𝑑𝑝 = × (𝑄𝑜+𝑄1) 2
∆𝑃 ⁄2

∆𝑄 𝑃𝑜 + 𝑃1
×
∆𝑃 𝑄𝑜 + 𝑄1

From the above example,

−30 10 + 12
𝐸𝑑𝑝 = ×
20 50 + 20
−30 22
× 70 = - 4.71
2

Page 44
 ECONOMICS

5.2.4 DETERMINANTS OF PRICE ELASTICITY OF DEMAND

1. Availability of Substitutes:
In a situation where a commodity has several substitutes demand will be
elastic since consumers can easily find an alternative, they will easily react
to the changes in price. On the other hand, if the commodity has few
substitutes, demand will be inelastic since consumers cannot easily react
to changes in price.

2. The Proportion of Consumers’ Income spent on the Commodity:

Very cheap commodities usually have inelastic demand. The smaller the
proportion of consumers’ income spent on a commodity, the smaller the
coefficient of elasticity (inelastic). If consumers spend so much of their
income on a commodity, they will feel any slight increase in price and may
react greatly unlike cheap items. For example, the price of a box of matches,
blade or newspapers may have to rise a great deal before it will have any
telling effect on their demand. These items therefore tend to have inelastic
demand.

3. The Degree of Necessity:

The demand for the necessities of life, that is, those commodities that
people cannot do without; tend to be inelastic in demand. Thus, the basic
necessities of life such as food, shelter and clothing have inelastic demand.
On the other hand, goods classified as luxuries have elastic demand.
Luxuries are non-essentials. Life can go on without such items as ridge, car,
television, etc. hence a slight rise in price tend to send many people away
from using them.

4. Habit formation:
Once certain consumption habits have been formed, it is very difficult to
stop them because of increases in price. Once a person develops a strong
taste for a commodity, he or she will continue to consume the commodity,
no matter the level of price. Therefore, the demand for it responds little to
changes in price. For instance, demand for cigarettes or tobacco is inelastic
since a lot of people easily get addicted to it.

5. Number of Uses of the Commodity

A commodity which has only one (1) use will have inelastic demand. This
is because if there is a decrease in price, due to the fact that it has only one
use the increase in quantity demanded will be proportionately smaller. On

Page 45
 ECONOMICS

the other hand if a commodity has several uses, a decrease in its price will
result in more than proportionate increase in quantity demanded. This is
because the total of the various small uses will lead to a significant increase
in quantity demanded. If a commodity has several uses and the price
increase slightly, there will be a significant decrease in the quantity
demanded therefore, indicating that the demand is price elastic.

6. Time Element

Since it takes time for buyers to discover substitutes and react to price
changes, the demand for commodities may be inelastic in the short run but
elastic in the long run. It takes time for people to change their consumption
habit, or to find substitutes for commodities. In the very short run therefore,
the demand for most commodities may be price inelastic, but in the long run
many times may become elastic.

5.3 INCOME ELASTICITY OF DEMAND

Income elasticity of demand may be defined as the degree of responsiveness of
the demand for a commodity to changes in the income of the consumer. It is an
attempt to measure how changes in the income of consumer affect the demand
for a commodity. Mathematically, income elasticity of demand is the proportionate
or percentage change in demand for a commodity as a result of a proportionate or
percentage change in the income of the consumer. It can be measured using either
point elasticity or arc (midpoint) elasticity of demand. i.e.

∆𝑄 𝑌𝑜
𝑌𝐸𝐷 = 𝑥
∆𝑌 𝑄𝑂

Example;
The demand for a commodity x increased from 100 units to 160 units when the
income of the consumer increased from GHC 50.00 to GHC 100.00 calculate the
income elasticity of demand.

Q0 = 100 ∆𝑄 = 160 − 100

Q1 = 160 = 60

Y0 = 50 ∆𝑌 = 100 − 50

Page 46
 ECONOMICS

Y1 = 100 = 50
∆𝑄 𝑌𝑜
YED = 𝑥
∆𝑌 𝑄𝑂

60 50 3
= 𝑥 = = 0.6
50 100 5

INTERPRETATION OF THE COEFFICIENT

i. Positive Sign – superior or normal good. i.e., as income increases

demand increases.

ii. Negative Sign – inferior good i.e., as income increases demand

decreases.

iii. Zero – neccessity i.e., as income increases demand remains

unchanged.

EXERCISE

1. When the demand for a commodity decreases from 500 units to 100 units as a
result of a rise in income of a consumer from GH¢1000.00 to GH¢5000.00.
Calculate the coefficient of income elasticity of demand and interpret your answer.

2. When the income of a consumer increased from GH¢10.00 to GH¢50.00 the

demand for commodity remain unchanged at 20 units. Calculate the coefficient of
income elasticity of demand and interpret your answer.

3. When the income of a consumer increased from GH¢500 to GH¢1000.00 the

demand for commodity Y increased from 300units to 500 units. Calculate the
elasticity of demand and interpret your answer.

5.4 CROSS ELASTICITY OF DEMAND

Cross Elasticity of demand may be defined as the degree of responsiveness of a
change in demand for a commodity as a result of a change in price of another
commodity. It is the proportionate or percentage change in demand for one
commodity due to a proportionate or percentage change in price of another

Page 47
 ECONOMICS

commodity. Mathematically, cross elasticity of demand for commodities A and B is

equal to
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑟 𝐴
CEDAB = 𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐵

∆ 𝑄𝐴 𝑃𝐵0
CEDAB = 𝑥
∆ 𝑃𝐵 𝑄𝐴0

INTERPRETATION OF THE COEFFICIENT

i. Positive Sign – substitutes i.e., as the price of one increases, demand

for the other increases as well.

ii. Negative Sign – complements i.e., as the price of one increases,

demand for the other decreases.

iii. Zero – unrelated goods i.e., as the price one increases demand for
the other remains unchanged.

Example

1. When the price of commodity A rises from GH¢200.00 TO GH¢400.00. The

demand for commodity B increased from 20 units to 100 units calculate the
cross elasticity of demand and interpret your answer.

SOLUTION;

PA0 = 200 ∆ 𝑃𝐴 = 400 − 200

PA1 = 400 = 200

QB0 = 20 ∆𝑄𝐵 = 100 − 20

Y1 = QB1 = 100 = 80
Page 48
 ECONOMICS

∆𝑄𝐵 𝑝𝐴0
∴ Cross Elasticity of demand of A & B = 𝑥
∆𝑃𝐴 𝑄𝐵0

80 200
= 𝑥
200 20

= 4

Thus, commodity A and commodity B are substitutes because the coefficient is

positive. Also, the demand for the commodities is cross elastic because the
numerical value of the coefficient is greater than one (1)

EXERCISE

2. When the price of commodity x is increased from GH¢5000 to GH¢80.00, the

demand for commodity Y decreased from 50 units to 10 units. Calculate the
coefficient of cross elasticity of demand and interpret the answer.

5.5 IMPORTANCE OF ELASTICITY OF DEMAND

The estimation of Price, Cross and Income elasticity of demand has got
important policy significance.

1. Price elasticity is very important in pricing policy making:

When a businessman wants to change the price of his goods in order to
raise total revenue, he must take into consideration the elasticity of demand.
If the demand for the commodity is elastic then in order to raise his total
revenue, the businessman needs to reduce the price of his commodity sine
the resulting increase in the quantity that will be demanded would exceed
the fall in price in proportionate terms. However, if the demand for the good
is inelastic, it will be prudent for the businessman to increase the price in
order to raise his total revenue. The concept of price elasticity is therefore
a useful guide to the revenue maximizing trader.

2. Price and elasticity is also useful in taxation:

When the policy maker (e.g. the Finance Minister) wants to raise revenue
through taxation, he must assess the price elasticity of the various
consumers. Taxes have the effect of raising the price of the commodity. For
a tax policy to be successful, therefore, it must be levied on goods with

Page 49
 ECONOMICS

inelastic demand since consumers will still buy them despite increase in
price of the good will cause consumers to stop buying the good. The tax will
thus fall if it is meant to raise more revenue but if the policy was meant to
stop the consumption of the goods concerned, then it may have the right
impact.

3. Devaluation policy also needs elasticity of demand for imports and

exports as a guide:
Devaluation is an intentional reduction of the external value of a country’s
currency. The devaluating country expects a reduction in the foreign prices
of her export, but an increase in the domestic prices of her imports. Thus,
devaluation is expected to cause a rise in total receipts from exports but a
fall in total import expenditure. Before a policy maker devaluates the
currency of a country therefore, he needs the concept of price elasticity of
demand to ensure that the country has elastic demand for both import and
export. Without this condition, the objective of devaluation may not be
achieved.

5.6 PRICE ELASTICITY OF SUPPLY

Price elasticity of supply is defined as the degree of responsiveness of quantity
supplied to a change in price. In other words, it is the percentage or proportionate
change in price.

5.6.1 Types of Elasticity of Supply.

(a) Fairly Elastic Supply: The supply of a commodity is said to be fairly elastic
when a change in price induces a more than proportionate change in quantity
supplied of the commodity. That is to say; an increase in the price of the
commodity induces a more than proportionate increase in quantity supplied and
a decreased in price leads to a more than proportionate decrease in quantity
supplied. The coefficient of elasticity of supply will be greater than (1). Again,
total revenue will increase when price increases and will reduce when price
falls. This is shown in the diagram below:

Page 50
 ECONOMICS

Price ()

6 S

5
S

0 Quantity (Units)
10 100

Suppose initial price 5 and quantity supplied is 10 units. We could observe from
the in quantity diagram above that, a smaller change in price from 5 to 6 resulted
to a greater change supplied from 10 to 100 units.

(b) Fairly Inelastic Supply: Supply is said to be fairly inelastic when a large
change in price results in a very small change in quantity supplied. In such
situation, the elasticity co-efficient is less than one. Examples of commodities
that have inelastic supply are commodities that take time to manufacture or
commodities that are very difficult to manufacture such as agricultural products.

Price ()

S
100

50

0 50 60

From the diagram, a large change in price from 50 to 100 resulted to a small
change in quantity supplied from 50 to 60 units. The elasticity co-efficient is 0.3,
which is greater than zero but less than one.

(c) Unitary Elastic Supply: The supply of a commodity is said to be unitary elastic
when a change in the price of the commodity induces an equal change in

Page 51
 ECONOMICS

quantity supplied. In other words the proportionate or percentage change in the

price of the commodity induces an equal percentage or proportionate change
in the quantity supplied. This means, when the price increases, quantity
supplied also increases by the same percentage and when the price falls
quantity supplied also decreases by the same margin. The coefficient of
elasticity of supply is equal to one (1).

Unitary elastic Supply

Price
S

P2

P1

Quantity
0 Q1 Q2

(d) Perfectly Inelastic Supply: The supply of a commodity is said to be perfectly

inelastic when a change in price induces no change in quantity supplied. In
other words supply remains the same no matter the change in the price of the
commodity.

Price
D

P2

P1

Quantity
0 Q1

(e) Perfectly Elastic supply: The supply of a commodity is said to be perfectly

elastic when a change in price induces an infinite change in quantity supplied.
At the fixed price, suppliers are prepared to supply infinite quantity of the
commodity. However, nothing at all will be supplied at a slightly lower price. The
coefficient of elasticity of supply is infinity (es =∞) and the supply curve is
horizontal.

Page 52
 ECONOMICS

Perfectly elastic supply

Price

P1 S

Quantity
0 Q1 Q2

5.7 DETERMINANTS OF PRICE ELASTICITY OF SUPPLY

(a) Factor Mobility: if the factors (of production) used in the production of a
commodity can easily be shifted from one line of production to another line of
production, supply will be elastic since producers can easily influence supply when
price changes. On the other hand, if the factors (of production) used in the
production of a commodity cannot easily be shifted from one line of production to
another line of production, supply will be inelastic since producers cannot easily
influence supply when price changes.

(b) Nature of the commodity: if the commodity can easily be manufactured, supply
is likely to elastic since producers can easily influence supply when price changes.
On the other hand if the commodity cannot be easily manufactured, supply is likely
to inelastic since producers cannot easily influence supply when price changes.

(c) Existence of excess capacity: In a situation where there is surplus capacity,

suppliers can react to price changes more easily and hence supply will be more

Page 53
 ECONOMICS

elastic. However, in a situation where there is full employment of resources,

suppliers cannot react to price changes more easily and hence supply will be
inelastic.

(d) Barriers to entry: supply will tend to be elastic if there is free entry of firms into
the industry. This is because if due to a rise in price the business becomes
lucrative; many firms will like to enter the industry for supply to increase. On the
other hand, if entry is restricted, supply will tend to be inelastic.

UNIT SIX
THEORY OF CONSUMER BEHAVIOUR

6.1 INTRODUCTION
A consumer demands a particular commodity because of the satisfaction he or she
obtains from consuming it. In other words, every individual aims at maximizing
satisfaction from every expenditure decision he or she makes. The law of demand
states that all other things being equal, at higher prices, less is bought and at lower
prices more is bought. Thus, the theory of consumer behaviour explains how the
consumer behaves when the price of a commodity changes.

6.2 CONCEPT OF UTILITY

The term utility is defined as the amount of satisfaction to be derived from the
consumption of a good or service at a particular time. For example, the utility of
bread is the satisfaction obtained from consuming bread at a particular moment of
time. Utility of a commodity has nothing to do with its usefulness; it may or may not
be useful though it yields satisfaction.

Utility is measured in an imaginary unit called utils. Total Utility (TU) is the total
satisfaction a consumer derives from consuming a certain amount of a commodity.

Average Utility (AU) is obtained when Total Utility is divided by the quantity of the
commodity consumed. i.e., (AU = TU/q).

Marginal Utility is the additional satisfaction obtained by consuming one more unit
of a commodity. Mathematically, it is given by ∆TU / ∆Q.

Page 54
 ECONOMICS

6.3 THE LAW OF DIMINISHING MARGINAL UTILITY

The theory of consumer behavior is based on the law of diminishing marginal utility.
According to the law, as more units of a commodity are consumed, the additional
satisfaction derived from successive units decreases. For example, the student
with only one pair of trousers has a high marginal utility for it. When he acquires a
second pair of trousers marginal utility falls, and after acquiring the third, marginal
utility falls again. Eventually, the marginal utility for the pair of trousers will be so
low that an additional pair of trousers will have no utility at all for him.

To understand the law, let us consider a consumer who has just come from a
desert and is given some oranges. The first orange gives him a total utility of ten
utils, the second unit of orange increases his total utility to eighteen utils. By
consuming up to the 7th unit, the total utility reaches twenty eight utils. The table
below represents the above illustration.

Total
Utility Marginal Average
Quantity (TU) Utility (MU) Utility (AU)
1 10 10 10
2 18 8 9
3 24 6 8
4 28 4 7
5 30 2 6
6 30 0 5
7 28 -2 4

From the table above, it can be observed that as the consumer continues to
consume the oranges, his total utility increases, becomes constant and finally falls.
This indicates that the consumer is fully satisfied when the sixth unit is consumed.
Thus, the seventh unit gives him a disutility meaning that the consumer is not
interested to consume the commodity. Though the total utility increases, the extra
or marginal utility received from consuming each additional unit of the commodity
keeps on falling.

Plotting the total and marginal utility schedules of the above table, we get the total
and marginal utility curves below.

Page 55
 ECONOMICS

TU / MU

TU

0
QTY
1 2 3 4 5 6 7

MU

It can be observed from the diagram above that TU rises, attains maximum and
falls. When TU is maximum, MU is zero. This is the Saturation Point. When TU
declines, MU is negative. The falling MU curve illustrates the principle of
diminishing marginal utility.

6.4 EQUILIBRIUM OF THE CONSUMER

For a single commodity, the consumer will maximize his utility or satisfaction when
the price he prepared to pay is equal to the marginal utility he obtains from
consuming the commodity i.e. when P = MU. At this point, the consumer is
completely satisfied about the quantity and price he pays from his limited income
or budget so that he has no intention to neither decrease nor increase his
consumption.

In practice however, consumers do not consume only one commodity, since they
consume several commodities, they tend to allocate their income in such a way
that every cedi expenditure on a product yields an additional satisfaction equal to
that of every cedi expenditure on any other product that the cedi can buy. Thus,
for more than one commodity, equilibrium condition is satisfied when:
𝑀𝑈𝑥 𝑀𝑈𝑦 𝑀𝑈𝑛
= =. … . . … … … . (1)
𝑃𝑥 𝑃𝑦 𝑃𝑛

Page 56
 ECONOMICS

6.5 CONSUMER SURPLUS

Consumer surplus occur if for any quantity of a commodity consumed the actual
price paid for is less than the price that the consumer wished to have paid to obtain
maximum satisfaction. This is true in any situation where all units are sold at the
prevailing market price. Suppose that a person is prepared to pay 30 for a pair
of shoes but they are currently priced at 25 and received the benefit of 5 of ‘free’
utility. The difference between the amount consumer was willing to pay and
what he or actually paid is what is known as consumer surplus.
.

6.6 DERIVATION OF THE DEMAND CURVE

The law of diminishing marginal utility states that, as the consumer acquires larger
quantities of a good, the utility gained from successive units of the good
diminishes. Indeed, and more specifically, the derivation of the demand curve is
based on the law of diminishing marginal utility. When MU is greater than price i.e.
MU > P, the consumer must increase his consumption until MU = P, in other words,
the consumer must purchase more of the commodity until he regains equilibrium.
In the same way, if MU < P the consumer must decrease his consumption or
purchase less of the commodity until MU = P. We will demonstrate this using the
following diagram:

MUx Px

D
MU1 P1

MU2 P2

MU3 P3

D
0 qx 0 qx
X1 X2 X3 MUX X1 X2 X3

Page 57
 ECONOMICS

At X1, the marginal utility is Mu1,. This is equal to P1, by definition (e.g. the
equilibrium condition). Hence, at P1 the consumer demands X1 quantity. Similarly,
at X2, the marginal utility falls to Mu2 which is equal to P2. Hence at P2 the consumer
will buy X2 and so on. If the marginal utility is measured in monetary units, the
demand curve for X is identical to the positive segment of the marginal utility curve.
(We ignore the negative section of the MU curve as being part of the demand curve
since negative prices do not make any sense in economics). The consumer will be
induced to buy more of X only at a lower price because of diminishing marginal
utility.

6.7 PARADOX OF VALUE

This is a concept which explains why consumers pay more for goods, which are
less important to man and pay less for goods, which are more important. For
example, water is more important to man than beer but beer is more expensive
than water.

This paradox can be explained by reference to the law of diminishing marginal

utility. In the first place water is abundant in supply whereas beer is relatively
limited in supply. Also, since water is frequently consumed and in large quantities,
its MU tends to be low. Beer on the other hand is less consumed so it has a high
MU. Thus, paradox of value teaches us that prices of commodities are based
on how scarce they are but not on their relative importance.

6.8 INDIFFERENCE CURVE APPROACH

A single indifference curve shows the combinations of X and Y that yields equal
satisfaction to the consumer among which the consumer is indifferent. Suppose
for example that it makes no difference to the consumer which of the combinations
listed in the table below he consumes:

Y X

A 11 1

B 7 2

C 4 3

D 2 4

E 1 5

Page 58
 ECONOMICS

Plotting the above information on a graph we obtain the indifference curve below:

Qty of Y
11 P

7 Q

4 R

2 S

T
1 I

0
1 2 3 4 5 Qty of X
In the diagram above, units of X per unit of time are measured on the horizontal
axis and units of Y per unit of time are measured on the vertical axis. These
combinations are plotted and joined to form the indifference curve I.

An Indifference Map

An indifference map shows all the indifference curves that rank the preferences of
the consumer. Combinations of goods situated on an indifference curve yield the
same utility. Combinations of goods situated on a higher indifference curve yield
higher level of satisfaction and are preferred.

Good Y

III

II
I

0 Good X Curves
Characteristics or Features of Indifference

 Density of Indifference Curves

 Non-Intersection Indifference Curves
 Convexity of Indifference Curves
 The Slope of the Indifference Curve

Page 59
 ECONOMICS

Consumer Equilibrium with Indifference Curves

a. The principal aim of the consumer is to maximise his satisfaction subject to the
constraint imposed on him by his limited income and the prices of goods or
services, which he cannot influence. The consumer’s indifference map describes
his preferences and establishes a rank ordering of his tastes.

b. It shows also the combinations that the consumer is willing to give of any two goods
and the rate at which he is willing to substitute the commodity for the other. To
determine the consumer’s feasible level of consumption and the quantities X and
Y that he will consumer, we have to superimpose his budget line on his indifference
map.

Let us assume that there are only two goods, X and Y, bought in quantities X and
Y. The consumer is confronted with market determined prices Px and Py of X and
Y, respectively. Finally, the consumer in question has a known and fixed money
income (M) for the period under consideration. Thus the maximum amount he can
spend per period is M, and this amount spent on X (XPx) plus the amount spent
on Y is (YPy). Algebraically, we obtain the equation:

PXX + PYY = M

The above equation is plotted in the diagram below.

Qty of Y M
A Py

M
Px
0
B Qty of X

The first term on the right side of the above equation shows the amount of Y that
be purchased if X is not bought at all. This is represented by the distance OA in
the above figure. Thus, M is the ordinate intercept in the equation.

The line in the above diagram is called THE BUDGET LINE. It is also called the
budget constraint, expenditure line or the consumption possibility line. It is also
called the line of attainable combinations because it represents the locus of

Page 60
 ECONOMICS

combinations of X and Y that can be purchased when the consumer spends the
entire amount of money income available.

A
M Px
Y = -
Py Py

0
B

CONSUMER EQUILIBRIUM: Maximising satisfaction subject to a limited money income

L
Qty of Y
C

P V
Y1
IV
III
A II
I
0
X1 M Qty of X

Consumer Equilibrium

The consumer maximises his satisfaction when he attains the highest feasible
indifference curve. The highest attainable indifference curve is the one which is
tangent to the budget line. The consumer is in equilibrium at the point where the
budget line is tangent to an indifference curve. In our special case, P is the point
of maximum satisfaction with X1 of X and Y1 of Y. From the point of tangency, the
consumer will get on to a lower indifference curve if he moves in either direction.

MRSxy = Px / Py

Page 61
 ECONOMICS

Point of Tangency

The following properties hold at the point of tangency. The slope of the budget line
is given by the ratio PX/PY which measures the opportunity cost of X in terms of Y
or the rate at which X can be substituted (MRSxy) at the point. At the point of
tangency P,

Px/Py = MRSxy

Shifting the Budgeting Line

An increase in money income, the price of X and Y are being constant.

Y
A11

A1

0
B B1 B11 X

In the above case, since price remains constant, the slope of the budget line does
not change. The movement is called parallel shift to the right. If income increases,
it readily follows that a decrease in money income is shown by a parallel shift of
the budget line in the direction of the origin to AB.

The Income Consumption Curve

Y
L11 ICC

L1

L A III
P
II
Q
I
0
M M1 M11 X

Page 62
 ECONOMICS

A change in income with the slope of the budget line constant, leads to a parallel
shift of the budget line inwards towards the origin when income falls, and outward
away from the origin when income rises. For each level of income, there will of
course be an equilibrium position at which an indifference curve is tangent to the
relevant budget line. If we move the budget line through all possible level of
income and to join up all points of equilibrium we will trace out what is called an Income
Consumption Curve (ICC).

Price of X increases or falls with income and the price of Y remaining constant

Qty of Y

0
M2 M M1 Qty of X
The above figure shows the case of the budget line when the prices of X increases
or falls, the money price of Y and money income remaining constant. The slope
of the budget line becomes steeper, revolves around the Y intercept and shift
inwards to LM when price of X increases. With a fall in the price of (X), the budget
line revolves around the Y intercept and shift of L1M1.

The Price Consumption Curve (This occurs as a result of changes in price)

Qty of Y

L
PCC

R
Q III
P II
I

0 M1 M2
X1 X2 X3 Qty of X

Page 63
 ECONOMICS

UNIT SEVEN
THEORY OF PRODUCTION

7.1 DEFINITION OF PRODUCTION

Production may be defined as the process of changing resources into a form which
is needed by the consumer. That is, production is the creation of goods and
services to satisfy a need. Thus the process by which raw materials are
transformed into finished goods to satisfy the requirements of consumers is
production. For instance, a carpenter produces a chair when and if he put pieces
of wood together to obtain the product chair. A tailor also transforms a piece of
cloth into a shirt etc. In order for the process of production to be complete, the
goods must be in the right form in the right place and at the right time. Thus,
production is not complete until the goods get to the final consumer.

Distribution of goods involves all activities through which goods get to the
consumer. Such activities include wholesaling, retailing, and carriage by air, sea
transport, rail transport, road transport. For instance, when a driver transports
goods from the factory or harbour to a warehouse, the driver is engaged in
distribution. When petty traders, hawkers, truck pushers etc go round carrying
goods to other people there is distribution.

7.2 CLASSIFICATION OF ECONOMIC ACTIVITIES

For the purpose of decision making all economic activities are classified into
groups. These are primary, secondary and tertiary activities.

Primary Sector / Activity

The primary sector is concerned with gathering raw materials and or natural
products. Examples are mining, fishing, farming, hunting, quarrying etc. Primary
sector may also be called Extractive Activity.

Secondary Sector/Activity
This is concerned with the changing the form of materials made available by
primary or extractive activities. Secondary activity may also be referred to as the
Page 64
 ECONOMICS

manufacturing activity. Examples are shoe making, drug manufacturing, tailoring,

carpentry, masonry, car building, constructive industries such as building and
construction of roads, railways, bridges etc are also included in this category.

Tertiary Sector/Activity
The tertiary sector is also called the services sector. The people here give direct
services but they have indirect bearing on the production of goods. Examples are
teachers, lawyers, doctors, authors, the police, nurses the armed forces, musicians
and the clergy etc.

7.3 FACTORS / INPUTS OF PRODUCTION (ECONOMIC RESOURCES)

There are four factors of production, namely: Land, Labour, Capital, and
Entrepreneurship.

7.3.1 CLASSIFICATION OF INPUTS USED IN THE PRODUCTION PROCESS

Two main types of inputs in the production process of a firm. These are:

 fixed inputs and

 Variable inputs

Fixed inputs: These are inputs that do not vary with the level of output. Fixed
inputs take relatively long time to build, erect and install. Examples include, factory
buildings, land, rent, plant and equipment and heavy specialised machinery.

Variable Inputs: These are inputs whose supply can be quickly and easily
changed. They vary directly with the level of output. In other words, if a firm wants
to produce more, it can use more of those factors. Examples are fuel, raw
materials and labour.

Time Periods

In economics, the difference between the long run and the short run is based on
the time it takes a firm to change the quantities of the fixed factors it employs.

The Short Run Period: This is the period of time over which at least one of the
factors of production is fixed in supply. In this situation a firm can only change its
output by using more or less of the variable factors. For example, a firm which
prints textbooks may increase its output in the short run by taking on more workers,
using more papers, more ink, and more electricity and so on.

Page 65
 ECONOMICS

The Long Run Period: This is the time a firm needs in order to change the
amounts of all factors of production it uses; both fixed and variable. It is called the
planning period of the firm – time sufficiently long that all factors under the control
of the firm are variable can be changed.

7.4 LAND AS A FACTOR OF PRODUCTION

Definition of Land: Land is defined in Economics as all the free gifts of nature.
These include the earth’s crust and all it contains including mineral deposits; farm
lands, seas, rivers and all the water bodies; forests, deserts, the atmosphere,
sunshine, the climate etc.

7.4.1 Characteristics of land

The characteristics or features that differentiate land from other factors of

production are:

1. Land is relatively fixed in supply, meaning that man can scarcely do

anything to increase or decrease its supply.

2. Land is fixed in location, or is geographically immobile. This means that

where it occurs, it will be there permanently, and cannot be removed from
one location to another.

3. Land is a free gift of nature, meaning that man did nothing to bring about its
existence.

4. Land, far more than the other factors of production, is subject to the Law of
Diminishing Marginal Returns.

5. The reward for land is rent. Thus the payment made by a tenant to a landlord
for the use of his land is called rent.

Page 66
 ECONOMICS

7.4.2 THE LAW OF DIMINISHING MARGINAL RETURNS

This law states that as more units of a variable input (labour) are added to a fixed
input (land), the marginal product of the variable input will eventually decline.

The following assumptions are made to explain the law:

1. Only two factors are being employed, namely, land (the fixed factor) and
labour (the variable factor).

2. All units of variable factor are equally efficient, so the changes in marginal
product are not due to different efficiencies of the variable factor but only to
the number of the variable factor employed on the fixed factor.

3. The level of technology employed is constant, so the increase in marginal

productivity is attributable not to improvement in technology but to the
operation of the law.

In order to understand the law, let us consider the table below:

No. of Total Average Marginal

Land in men Products Product Product
Hectares (Labour) (bags) (bags) (bags)
5 1 1 1 1
5 2 3 1.5 2
5 3 6 2 3
5 4 8 2 2
5 5 9 1.8 1
5 6 9 1.5 0
5 7 8 1.1 -1

Page 67
 ECONOMICS

Plotting TP, AP and MP against Labour, we obtain a similar diagram like this:

TP increases at an
Output of decreasing rate TP falls
product

TP increases at an
TP
increasing rate

0
No. of workers

Marginal
and
average
output Increasing marginal Diminishing Negative marginal
returns marginal returns returns

AP

0 No. of workers
MP

The following points are worth noting about both the table and graph. They show the
nature and relationships between the Total, Average and Marginal products.

Page 68
 ECONOMICS

1. The Total Product increases progressively until the point of negative marginal
returns is reached, when it begins to decline. The increase is very high initially,
showing that increasing marginal returns are being reaped; then less markedly,
showing that diminishing marginal returns are being experienced.

2. Average product rises, attains a maximum, and then falls.

3. Marginal product also arises, attains a maximum, and then falls. When the MP
is rising, it is an indication that increasing returns are being enjoyed; and when
it is falling marginal returns are diminishing.

4. When the AP is rising, it is slower than the MP, but immediately it begins to
falls, it becomes higher than the MP. In other words, the AP becomes exactly
equal to the MP at the highest point of the AP. This is clearly shown in the
diagram. This last point is very important and should always be remembered;
that the MP curve intersects the AP curve at the highest point of the AP.

NB: Both marginal and average product curves rise, reach a maximum and
then fall again. This makes them assume an inverted U shape.

7.4.3 STAGES OF PRODUCTION

1. Increasing Returns (first to third man in the table). These are experienced
because the land is too large for only one or two men to effectively cultivate.
Additional men would therefore effect a more efficient utilization of the land,
and hence the increasing marginal returns.

2. Diminishing returns (from the fourth man). Here the marginal product falls
never to rise again. This is because the number of men employed on the land
has exceeded the optimum, so each man has less than enough work to do.

3. Negative returns (from the seventh man). Here total output itself begins to
decline, meaning that each additional man employed actually causes total
output to fall, i.e. marginal output become so congested on the land that each
cannot get enough space to occupy in order to work effectively.

Graphical Representation of the Stages of Production

Page 69
 ECONOMICS

Page 70
 ECONOMICS

UNIT EIGHT
THEORY OF COST

8.1 INTRODUCTION

In production, the producer organizes factors of production to produce a given

output. In the course of achieving his aim, he makes some expenditures which is

Page 71
 ECONOMICS

termed as cost of production. The cost of production can be grouped under the
following headings:

a) Total Fixed (overhead) Costs (TFC): This refers to the cost of production that
does not change directly with output. They remain fixed over an appreciable
level of output. In most cases, they are even incurred before production
begins. Examples are the costs of fixed inputs or the firm, and include: Cost
of building and machinery, Interest on loans contracted, Depreciation on
machinery, i.e expenses on maintaining machinery, Cost of administration.

b) Total Variable Costs (TVC): This refers to the cost of production that varies
directly with the level of output. That is to say, the greater the output, the
greater the cost, and vice versa. Examples are wages of labour, cost of raw
materials, cost of electricity, etc.

c) Total Cost (TC): is the sum of total variable costs and total fixed costs.

d) Marginal Cost (MC) is the additional cost incurred by producing one more unit
of output. For instance, if a firm produces 10 units of output at a total cost of
200 and the total cost rises to 220 as a result of increasing output to 11
units, then the marginal cost is 20. MC = ∆TC / ∆Q

e) Average Total Cost (ATC): This is simply called average cost. It is what costs
the firm to produce one unit of output on the average. It is obtained by dividing
the total costs by the quantity produced. i.e., Average Total Cost is total cost
per unit of output. ATC = TC / Q

f) Average Fixed Cost (AFC): This is defined as Total Fixed Cost per unit of
output. Mathematically, it is obtained by dividing the Total Fixed Cost (TFC)
by the quantity produced. i.e., AFC = TFC / Q. The Average fixed cost
decreases as output level increases because the same cost is being divided
by greater units of output.

g) Average Variable Cost (AVC) is obtained by dividing the total variable cost
by the number of units of output. i.e., total variable cost per unit of output. AVC
= TVC / Q
The table below illustrates the various costs of production in cedis

Page 72
 ECONOMICS

8.2 GRAPHICAL PRESENTATIONS

1. TOTAL FIXED COST

The TFC curve is a horizontal line indicating that it does not vary when output
varies.

Cost

100 TFC

0
Output

2. TOTAL VARIABLE COST

Page 73
 ECONOMICS

The TVC curve shows a positive relationship between cost and output. In other
words, the TVC increases as output increases. The increase, however is quite
gradual at the lower levels of output, due to increasing returns to scale,
meaning that more is added to output than to cost. It becomes more rapid as
output increases beyond a certain point, indicating that decreasing returns
have now set in. more is now added to cost than to output.

TVC
Cost

Output

3. TOTAL COST

Cost TC
TVC

TFC

0
Output

Page 74
 ECONOMICS

The TC curve is the summation of the TFC and TVC curves, i.e. TC = TFC
+ TVC; as depicted in the diagram. It is parallel to the TVC curve, being
higher by the margin of the TFC.

4. AVERAGE FIXED COST: The AFC curve is a hyperbola: it shows a negative

relationship between cost and output. The AFC decreases as output
increases.

Cost

AFC
Output
O

5. AVERAGE VARIABLE COST: It is the variable cost per unit of output. This
is obtained by dividing the total variable cost by quantity produced. AVC = TVC
/q

Cost
AVC

Output
O

6. MARGINAL COST

Page 75
 ECONOMICS

Cost
MC

0
Output

Relationship between MC and AC

Costs MC
G AC
AVC

Output
O

NB: In the short run, the per unit cost curves AVC, ATC and MC are U-shaped.
The falling part of these curves is due to increasing productivity of the variable
factor whilst the rising part is due to the law of diminishing returns.

8.3 THE LONG RUN AVERAGE COST CURVE (LAC)

As a firm expands its scale of operation, it has a series of short run average cost
curves. When a curve is drawn to ‘envelope’ all the short run cost curves, touching
each of them at its optimum (lowest) point, the curve is the Long Run Average
Cost (LAC) curve for the firm. This is illustrated in the diagram below:

Page 76
 ECONOMICS

LAC
SAC1 SAC2 SAC3 SAC4

c1
c2
c3

0 Q1 Q2 Q3 Q4

In the diagram, 0q1 is the optimum output the firm can produce with its initial plant,
whose average cost curve is SAC1 (i.e. Short Run Average Cost curve 1). If it
wishes to expand output to 0q2, it can do so on SAC1, producing at point a on the
SAC. But unit cost is higher than the minimum, so a lot of profits would be lost.
The economical thing to do is to procure a bigger plant, whose AC curve is SAC2,
which will make possible the production of Oq2 at the minimum average cost. To
produce 0q3 at the minimum AC, the firm moves to SAC3, and so on. The LAC
is therefore the envelope of several SAC curves. It should be noted that the shape
of the LAC is due to economies and diseconomies of scale.

8.4 ECONOMIES OF SCALE

Economies of scale are the advantages a firm enjoys as it expands. This may be
internal or external.

8.4.1 INTERNAL ECONOMIES OF SCALE

These are internal advantages a firm enjoys as it expands due to the firm’s own
efforts. It includes:

1. technical economies
2. managerial economies
3. marketing economies
4. financial economies

8.4.2 EXTERNAL ECONOMIES OF SCALE

These are certain advantages or benefit firms enjoy as a result of
concentration (localization) of industries or firms to a particular area. External
economies also lower the average cost of production and hence lead to a fall of
the LAC curve. These may include:

Page 77
 ECONOMICS

1. Infrastructure facilities already existing e.g. good roads, electricity, water etc.
2. Easy access to skilled labour
3. Organized market
4. Sale of by- products to other firms etc.

In short, external economies include most, if not all, advantages derived from
localization of industries. It also leads to a fall in the LAC curve.

UNIT NINE
MARKET STRUCTURES

9.1 INTRODUCTION

Page 78
 ECONOMICS

In economics market does not necessarily refer to a place where exchange of

goods and services (buying and selling) takes place but rather it refers to any
effective arrangements between buyers and sellers that results in exchange
of goods and services.

However, there are different kinds of markets. In a situation where there are many
sellers and buyers of a commodity, the market structure is called PERFECT
COMPETITION. When there is only one seller of a commodity or service and it
has no close substitute, the market structure called MONOPOLY. Under
DUOPOLY, there are only two sellers; and when there are only a few sellers the
commodity is sold under OLIGOPOLY conditions. A MONOPSONY market is
where there is only one buyer.

9.2 PERFECT COMPETITION

For a market to be described as perfect, the following conditions must prevail:

1. Many buyers and sellers. This condition is necessary to ensure keen

competition. Every buyer or seller is merely atomistic, and so cannot exert any
influence on the market by changing his demand or supply. In other words, the
demand or output decision of a buyer or seller cannot in any way change the
ruling market price.

2. Homogeneous Products: the commodity dealt in at such market must be so

identical that any one unit of it is just like the other. This means that there is no
reason for any buyer to have preference for the product of any particular seller.

3. Freedom of entry and Exit: there must be freedom of entry of new firms which
might be attracted by any high level of profits. Similarly, firms making losses
must be free to leave the industry

4. Perfect knowledge of the market. This implies that all buyers and sellers of
the commodity must have knowledge of conditions prevailing in the market, so
that it doesn’t sell at a higher price at one place than at another. There must be
free, unhindered flow of information so that immediately price changes all
concerned will become aware of the new price and buy and sell at it.

5. No preferential treat: The explanation here is that sellers must sell to all buyer
at the same price, and buyers must buy form any seller without showing
favouritism.

Page 79
 ECONOMICS

6. No transportation and other distribution costs: The implication here is that

if it involves costs like transport, tariff, customs and toll costs to distribute the
commodity, it will certainly have to sell at different price at different places, and
this would render the market imperfect.

9.3 REVENUE CONCEPTS

In the theory of the firm, the word REVENUE means total sales realised from
selling a certain amount of a particular commodity.

TOTAL REVENUE is the total amount realized from the sale of a given quantity
of goods or services and is obtained by multiplying the unit price of the commodity
by the quantity. So, example, if the price of a loaf of bread is 1 and 10 loaves
are sold, then the total revenue would be 1 x 10 = 10

AVERAGE REVENUE is simply the price of a unit of a commodity. It is obtained

by dividing the total revenue by the quantity. In the example above, the average
revenue would be 10,000 ÷ 10 = 1000, which is the price of the commodity.

MARGINAL REVENUE is the additional revenue obtained from the sale of one
extra unit of a commodity. In the earlier example, suppose the seller increases
the quantity sold to 11 as a result total revenue rises to 10900. The marginal
revenue would be 10900 - 10,000 = 900.

9.3.1 AVERAGE AND MARGINAL REVENUE UNDER PERFECT COMPETITION

All characteristics of a perfect market explain above are necessary for the
fulfilment of one objective – that there should be only one price ruling for the
commodity anywhere it is dealt in. This means that every seller is a price taker;
i.e. every firm has to sell only at the ruling market price. This further implies
that in perfect competition demand is perfectly elastic.

Similarly, average revenue does not change, every additional (marginal) unit he
produces sells at the same market price, meaning that his marginal revenue
(additional revenue made by selling one additional unit) is always equal to the
average revenue. These pieces of information are shown in the hypothetical table
and its corresponding diagram below. Unit price is 1000.

Page 80
 ECONOMICS

Price Marginal
Output (Av. Total Revenue
(Units) Rev ) revenue () ()
1 10 10 10
2 10 20 10
3 10 30 10
4 10 40 10
5 10 50 10

Revenue

AR = MR

0
Output

Average and marginal revenue table and curve for the perfect competitor.

THE FIRM AND THE INDUSTRY (An industry refers to a group of firms
producing homogeneous products)

1. Firm 2. Industry

Price D
S

AR P P1
S
D
0 q1 0 q1

Output/Sale Quantity demanded and supplied

Page 81
 ECONOMICS

9.4 SHORT RUN EQUILIBRIUM POSITION OF A PERFECT COMPETITOR

A firm in perfect competitor maximises profits in the short run by producing at the
level of output where marginal cost (MC) equals marginal revenue (MR), MC=MR
(and MC is rising).

This is illustrated below

MC
Price

P = AR = MR
P
Firm increases Firm decreases
output output

P > MC P < MC

O Q Output

NOTE:

The firm will continue to increase output as far as marginal revenue is greater than
marginal costs. It will not produce when marginal revenue is less than marginal
cost.

In the short run, firms that are very efficient enjoy super-normal or abnormal profits,
those that are quite efficient break even (enjoy normal profits) whilst those that
inefficient incur losses. The following diagrams illustrate the various situations.

1. SUPER-NORMAL PROFIT 2. LOSS / SUB-NORMAL

PROFIT

Page 82
 ECONOMICS

MC AC MC AC
Cost

c
LOSS
p AC = MR p AR=MR
c

0 qe 0 qe
Output

3. NORMAL PROFIT

Where the firm’s AC is equal to its AR, the firm breaks-even in the short run as shown in
the diagram below.

A firm breaking MC
even AC
Price

C
P P = AR = MR

O Q Output

9.5 LONG RUN EQUILIBRIUM OF THE PERFECT COMPETITOR

When super normal profits exists in a perfectly competitive industry; i.e. when firms
in the industry are making such profits, those profits will attract other firm to enter
the industry. Because there is freedom of entry, these new firms will enter. Their
entry will raise industry output, and price will fall. In fact, so long as any super
normal profits exist, all the supernormal profits are competed way, and every firm

Page 83
 ECONOMICS

is breaking even, or is earning only normal profits. A firm that is just breaking even
is called a marginal firm, so every firm in a perfectly competitively industry is a
marginal firm in the long run. The situation is shown in the diagram below:

Cost AC
MC
Revenue
P AR = MR

0 qe Output

Advantages of Perfect Competition

1. Competition between firms encourages efficiency.

2. Firms do not spend on advertising because products are homogenous.
3. Consumers gain from low prices since every firm gets normal profit.
4. Consumer sovereignty is guaranteed

Disadvantages of Perfect Competition

1. Economies of scale may not be fully exploited since firms are small.
2. Investment may be discouraged since any extra profit created will tend to be
competed away.
3. Since firms produce homogeneous commodities, this may be boring for
consumers. At the same time, there is limited choice to consumers.
4. Since firms have perfect knowledge there is no incentive to develop new
technology since it can be shared with other companies.

9.6 MONOPOLY
Monopoly can be defined as a market structure in which there is a single seller
selling a product which has no close substitutes.

1. Copyrights and patent rights. When someone produces a book copyright

ownership is conferred on him, meaning that no one else has the legal right to

Page 84
 ECONOMICS

reproduce that book for sale. If such a book happens to be an unequalled

authority on a subject or issue, the owner then becomes a monopolist in its
reproduction and sale. Creators of works of art and music also have copyright
ownership conferred on them, and so may become monopolist. Similarly, when
someone makes an invention, such as of a part of a machine or machine, a
patent right is conferred on him, meaning that he only has the right to reproduce
and sell his invention for a given number of years. This makes him a
monopolist, and enables him to enjoy the fruits of his labour.

2. Public monopoly: Some services, especially public utilities, are so essential

that everyone, both the rich and poor, must get assess to them. If they are left
in private hands, prices may be so high that some consumers cannot afford
them. Here the state usually steps in to monopolise its supply. Examples are
water, highways, electricity and education.

3. High Capital Requirement: The initial capital required in setting up a

production line may be so high that prospective firms are unable to enter the
industry. This may give monopoly power to a firm that has been able to raise
the required capital to start production. Examples in Ghana include cement and
aluminium products.

4. Natural Monopoly: This arises where a country possesses some natural

resources that other countries do not possess. Canada is a virtual monopolist
in nitrate supply in the world; Nigeria has a monopoly of supply of crude oil in
West Africa.

5. Cartels: group of producers of similar products who come together in order to

obtain monopoly power.

9.7 THE DEMAND (AVERAGE REVENUE) CURVE OF THE MONOPOLIST

The perfect competitor is faced with the perfectly elastic demand curve, meaning
that he has only one price and can sell any quantities at that price. This is not so
for the monopolist. His firm is the entire industry, so the slightest change in his
output will affect the price, and the slightest change in his price will affect the
quantity demanded. In other words, he is faced with the normal demand curve,
meaning that he can sell higher quantities only at lower prices. However, this

Page 85
 ECONOMICS

normal curve is usually inelastic due to the fact that the commodity has no close
substitutes.

9.7.1 MARGINAL REVENUE CURVE OF THE MONOPOLIST

Once again, it was seen that the marginal revenue curve of the perfect
competitor is the same as his average revenue curve. This is because he sells
every additional unit at the same price. This once again, is not the case with the
monopolist. Since he can sell more only at a reduced price, the marginal revenue
he makes from the sale of an additional unit must be less than the price. An
example will make this clear. Supposing a farmer sells 10 baskets of cocoyam at
1,000 a basket, making total revenue of 10,000. Suppose further that if he
increases his output to 11 baskets, he will have to reduce price to 950 a basket.
He would then make total revenue of 950 x 11 = 10,450. Average revenue (price)
is 950; but marginal revenue is 10,450 – 10,000 = 450; meaning that the MR is
less than the AR. The MR curve, therefore, must lie below the AR curve. In
practice, the MR curve is drawn mid-way between the revenue (vertical) axis and
the average revenue curve. The hypothetical table and diagram illustrate the above
points. It is assumed that price falls by 100 any time output is increased by one
unit.

Page 86
 ECONOMICS

Average and Marginal Revenue Elements of the Monopolist

Output Price (Av. Total Marginal

(Units) Rev. ) Revenue Revenue
()
1 1000 1000 1000
2 900 1800 800
3 800 2400 600
4 700 2800 400
5 600 3000 200
6 500 3000 0
7 400 2800 -200

Revenue

AR

0
MR
Output

9.7.2 DECIDING WHAT OUTPUT THE MONOPOLIST WILL PRODUCE

It has been explained how the perfect competitor will produce at the output where
his marginal cost equal his marginal revenue and marginal cost is rising. This
would be his most profitable output level. The same thing applies to the monopolist;
i.e. he maximises his profits where his MC = MR. However the fact the monopolist
is faced with different average and marginal revenue curves from the perfect
competitor means that his output and price determination process will differ. The
diagram below shows how output and price are determined under monopoly.

Page 87
 ECONOMICS

Cost MC
p AC
Revenue
c

AR

0
Output
MR

In the diagram, MC = MR at point x; the most profitable output is 0q1; average

cost per unit is AC, and average revenue is AR, both on the vertical axis. Profit
per unit is ACAR, and the shaded portion represents super-normal profits.

Unlike the perfect competitor, however, these super-normal profits would not
be competed away in the long run. His firm is the entire industry, and for some
reasons or another firm cannot enter and compete with him. His short and long
run positions are same – he makes super-normal profits.

9.7.3 LOSS AND BREAK EVEN POSITIONS OF THE MONOPOLIST

It is possible for a monopolist to merely break even, or even make losses, if

ot a very efficient firm. The situations are illustrated in the diagrams below:

A: Loss B: Break-even
AC
c MC AC
p
p
MC

AR

AR
0 qe 0 qe
MR MR

In a diagram A, the monopolist is making losses equal to the shaded portion.

It is a high-cost firm, the average cost curve lying well above the Average

Page 88
 ECONOMICS

Revenue Curve. In diagram B, the firm is breaking even, the AC curve being
tangential to the AR curve at the most profitable output level.

9.7.4 PRICE DISCRIMINATION

Price Discrimination, or discriminating monopoly, means selling identical products
produced at the same unit cost to different buyers at different prices. For example,
if a doctor charges a poor patient a smaller amount of money than a wealthier
patient for similar services rendered, he is practising price discrimination. Another
example is when a cloth manufacturer sells his products at a lower price in a less
fashionable area than he charges in a more affluent area.

9.7.5 CONSUMER’S SURPLUS AND PRICE DISCRIMINATION

The monopolist practices price discrimination because of the existence of
consumer’s surplus; i.e. he tries to take away from the consumer as much
of his surplus as possible. The downward sloping nature of the monopolist’s
demand curve indicates that at whatever price he actually sells his product
he can sell it at a higher price without his demand dropping to zero, as would
be the case with the perfect competitor, though his sale would reduce.

9.7.6 ADVANTAGES OF MONOPOLY

1. Because of the huge profits often earned by the monopolist, and also
his natural desire to make even more profits, he often expands his
output, making it possible to reap the economies of scale and thereby
sell at reduced prices to the public.

2. In case where huge finances are required to establish an industry,

monopoly is often the only way out. In other words, the monopolist can
raise the finance needed for large businesses, and without him the
commodity might not be produced at all. An example is an aluminum
smelter which requires a very large initial capital.

3. In certain cases, competition would be wasteful and unnecessary, and

monopoly is the only means of avoiding this waste of resources.
Examples are the provision of public utilities like sewerage system,
roads, electricity, etc.

Page 89
 ECONOMICS

4. The huge profits made by the monopolist enable him to undertake

research into cost-saving and quality-improving methods of production,
something the competitor may find difficult to finance.

5. The huge profits of the monopolists are often targets of high taxation as
means of raising revenue to finance government expenditure.

9.7.7 DISADVANTAGES AND DISADVANTAGES OF MONOPOLY

1. Because the monopolist is often able to charge high prices and yet get
adequate demand, he often exploits society by deliberately cutting down
on his supply and charging high prices, except when economies of scale
are important to his profit-making motive, or when the demand for his
output is price elastic.

2. The consumer losses his sovereignty since he is compelled to buy from

a single producer even if the price is higher than he finds reasonable, or
the quality falls short of the standard he expects.

3. Monopoly markets are inefficient. This is because the monopolist often

deliberately produces at levels far below the optimum capacity of the
firm, thus causing a waste of the country’s scarce resources.

4. Since there is the total absence of any form of competition, the

monopolist doesn’t often find it necessary to enter into research on how
to improve upon his efficiency or the quality of his product, resulting in
high cost firms and low quality products dominating in the economy.

9.7.8 CONTROL OF MONOPOLY

1. Legal action against monopoly. In this case, the government legislates that
any one or group of people who aims at creating conditions that would make
monopoly emerge has contravened the law and is therefore liable to be
prosecuted.

2. The government may also come out with a maximum price for the product
of the monopolist, in which case he can make higher profits only by
expanding output and not lowering it and raising price.

Page 90
 ECONOMICS

3. The government may directly enter into the production of commodity

produced by the monopolist thereby breaking the monopoly. This is often
very effective since no monopolist can prevent the government form
entering the market, and also high entry cost usually cannot be an
impediment.

4. The government may also use the tool of taxation. One such tool is a system
of tax thereby the government taxes less on high levels of output than on
low levels of output. In other words, if he pays less tax. This makes it
advantageous for him to expand his output and disadvantageous to reduce
it.

9.8 MONOPOLISTIC COMPETITION / IMPERFECT COMPETITION

Monopolistic competition refers to an industry in which there are many producers

(or sellers) of closely related goods (similar but differentiated goods). This type of
market structure is characterised by excessive advertisements and thus, the
actions of one firm affect others. There is also free entry, which implies that if the
industry as a whole is making profit new firms will enter the market to produce
similar products to compete off the profits.

9.8.1 FEATURES OF MONOPOLISTIC COMPETITION

1. Production of similar products which are differentiated through branding.

2. Free entry and exit. i.e. firms are free to enter the industry at any time without
any restriction or exit the industry if they are incurring losses.
3. Heavy expenditure on advertisement due to the excessive competition.
4. Imperfect Information on the market.

9.8.2 PRICE AND OUTPUT UNDER MONOPOLISTIC COMPETITION

Just like a pure monopolist, a monopolistic competitor faces a downward sloping
demand curve and as such can sell additional products only at a lower price.
Therefore, the marginal revenue curve of the monopolistic competitive firm will
always lie below the firm’s demand curve. When marginal revenue is greater than
marginal cost (MR>MC) the firm can increase profits by expanding output. But
when (MR<MC), the firm must reduce output. This process goes on until marginal
cost is equal to marginal revenue.

Page 91
 ECONOMICS

9.8.3 SHORT-RUN PROFIT MAXIMIZATION

In the short-run, a firm in monopolistic competition behaves like a monopolist. The
monopolistic competitive firm maximizes its profit or minimizes its losses by
producing the output at which marginal cost is equal to marginal revenue
(MC=MR). Depending upon the relationship between average cost (AC) and
AR(=P), a firm in the short-run can get profit or loss.

A firm with profits

Price
MC
AC
A
P

C
B
D = AR

MR

0 QTY
Q

The above diagram shows a firm in monopolistic competition making abnormal or

supernormal profits. The firm produces output level OQ and charges price OP.
Total revenue represented by rectangle OPAQ exceeds the firm’s total costs
OBCQ at the profit maximising level of output. The shaded area BPAC represents
the firm’s short-run abnormal profit.

Page 92
 ECONOMICS

9.8.4 SHORT-RUN LOSSES

Price MC AC

B AvC
C
A
P
E
D

D = AR

MR

O Q QTY

Page 93
 ECONOMICS

The monopolistic competitive firm like other firms has no guarantee of economic
profits. A firm in monopolistic competition can make losses when its average cost
(AC) is above its price. This is shown in the diagram below where the best strategy
is to maximize its loss. It does this by producing output OQ where (MC=MR) and
as determined by the demand curve DD and charges price OP. Because price is
less than average total cost, the firm incurs the loss shown by the shaded area
PCBA. Like any other firm, the firm will not close down provided if is covering its
variable costs.

9.8.5 LONG RUN EQUILIBRIUM POSITION OF A FIRM IN MONOPOLISTIC

COMPETITION - ZERO ECONOMIC PROFIT
In the long run, because there are no barriers to entry, short-run economic profits
will attract new firms into the industry. If the firm is making abnormal profit, new
firms will come into the industry attracted by the higher profits. If firms in the
industry are making losses in the short-run, some monopolistic competitive firms
will leave the industry. As firms leave the industry, their customers will switch to
the remaining firms increasing the demand for each remaining firm’s product. As
this goes on, the demand curve for each firm will shift upwards to the point where
average revenue is just equal to average cost and each firm earns normal profit.
The diagram below illustrates the above explanation.

MC
Price AC

A
P

D = AR

MR

0 Q QTY

Page 94
 ECONOMICS

In the diagram the firm produces output level OQ where MC=MR and changes
price P where total revenue is equal to total cost (TR=TC) with each firm earning
normal profit.

9.8.6 THE ADVANTAGES OF IMPERFECT COMPETITION

a) Monopolistic Competition is more realistic and practical than perfect

competition and monopoly, which might be difficult to establish in practice
(more so with Perfect Competition). The world is full of firms of different sizes
in an industry each producing a similar but differentiated good. Most
manufactured goods like cars, wireless sets, TV sets, beverages etc, are
produced under monopolistic competition.

b) Under monopolistic competition the consumer has a choice between varieties

of commodities in the form of substitutes. This choice increases the consumer’s
satisfaction unlike perfect competition and monopoly where the goods being
homogeneous leave the consumer with no choice.

c) In monopolistic competition, competition among producers leads to inventions

and innovations which go to improve the quality of goods for consumption. This
obviously enhances the customers’ standard of living.

d) As firms capture the market through advertisements, they are able to expand
to enjoy economies of scale. The increased earnings that accrue to firms may
be used for research and training programmes.

9.8.7 DISADVANTAGES OF MONOPOLISTIC COMPETITION

a) Monopolistic Competition is associated with competitive advertisement that
may be very wasteful. Each firm tries to out sell the other advertising
intensively. Such adverts are cost to the firm which increases price of the
commodity. It stands to reason that apart from the wastage in adverts,
consumers are exploited unless the producer is prepared to absorb the cost of
adverts.

b) In fragmented markets like West African markets monopolistic competition is

wasteful as firm are incapable of expanding to enjoy economies of scale.

Page 95
 ECONOMICS

c) Monopolistic competition it is argued is associated with excess capacity.

Excess capacity is the increase in present output that is needed to rescue AC
to the minimum. This is therefore the difference between present output and
optimum level of the firm or industry. In monopolistic competition excess
capacity is created by lack of price competition particularly if firms adopt a “live
and let us live” attitude so that present output is less than the optimum output
level. Once there is excess capacity, firms do not derive the benefits of
expansion.

EXERCISES

EXERCISES SET 1

PART I: Which of the following are statements in normative or positive

economics?

1. The president’s economic policies make good sense.

………………………………

2. Unemployment is a more serious problem than inflation. ………………………

3. Poverty in Africa should be reduced. ………………………

4. Inflation next year will be higher in Italy than in Spain.

………………………………

PART II: Each of the following questions is followed by four options lettered A
to D, circle the letter corresponding to correct answer on the question paper.

5. In a free-market economy the allocation of resources is determined by:

(a) votes taken by consumers (b) a central planning authority
(c) by consumer preferences (d) the level of profits of firms

6. Which of the following are considered to be essential characteristics of a

public good?
(a) It must be provided by the government
(b) It must benefit the whole economy
(c) Consumption by one person does not diminish the quantity available for
others

(d) Once the good is provided, it is not possible to exclude people from
consuming it

Page 96
 ECONOMICS

7. Which of the following might be considered to be a characteristic of a

capitalist economy?
(a) All income is completely evenly distributed
(b) Price is relatively unimportant as a means of allocating resources
(c) Goods and services produced reflect consumer sovereignty
(d) There is no incentive for people to work hard

8. Economic growth is depicted by

(a) a shift in the production possibilities frontier outward
(b) a movement from inside the curve toward the curve
(c) a shift in the production possibilities frontier inward
(d) a movement along a production possibilities frontier toward capital goods

9. Which of the following is not a factor of production?

(a) Labour (b) Land (c) Money (d) Capital

10. A rational person does not act unless

(a) the action is ethical
(b) the action produces marginal costs that exceed marginal benefits
(c) the action produces marginal benefits that exceed marginal costs
(d) the action makes money for the person

EXERCISES SET 2

PART I
Indicate whether the following statements are normative or positive.

1. Faster economic growth should result if an economy has a higher level of

investment.………………………

2. Changing the level of interest rates is a better way of managing the economy
than using taxation and government
expenditure.…………………………………………

3. Higher levels of unemployment will lead to higher levels of inflation.

4. The average level of growth in the economy was faster in the 1990s than the
1980s.………………………………

Page 97
 ECONOMICS

PART II

Each of the following questions is followed by four options lettered A to D,

circle the letter corresponding to correct answer on the question paper.

5. One of the things held constant in stating the law of demand is the
(a) Prices of other commodities
(b) Price of the commodity
(c) Quantity demanded of the commodity
(d) Cost of production

6. Which of the following will not shift a country's production possibilities frontier
outward?
(a) an improvement in technology
(b) an increase in the labour force
(c) an increase in the capital stock
(d) a reduction in unemployment

7. Which of the following is part of the opportunity cost of going on holiday?

(a) the money you spent on a theatre show
(b) the money you could have made if you had stayed at home and worked
(c) the money you spent on airline tickets
(d) the money you spent on food

8. If an increase in consumer’s income leads to a decrease in the demand for a

good, then the good is

(a) normal good

(b) an inferior good
(c) a substitute good
(d) a complementary good

9. The law of demand states that an increase in the price of a good

(a) increases the supply of that good

(b) decreases the quantity demanded for that good
(c) decreases the demand for that good
(d) increases the quantity supplied of that good

10. If an increase in the price of blue jeans leads to an increase in the demand
for tennis shoes, then blue jeans and tennis shoes are

Page 98
 ECONOMICS

(a) complements
(b) inferior goods
(c) normal goods
(d) substitutes

EXERCISES SET 3

1. (a) How is price elasticity of demand measured?

(b) Explain four determinants of price elasticity of demand.

2. (a) With the aid appropriate diagrams, clearly differentiate between changes in
demand and changes in quantity demanded of a commodity.

(b) Differentiate between the following:

(i) Microeconomics and Macroeconomics

(ii) Positive Economics and Normative Economics

3. Write short notes on each of the following:

i. Derived demand
ii. Ostentatious Goods
iii. Perfectly Inelastic Supply
iv. Backward Bending Labour Supply Curve

EXERCISES SET 4

Each of the following questions is followed by four options lettered A to D, circle

the letter corresponding to correct answer on the question paper.

1. Which of the following is not a factor of production?

(a) Labour (b) Land (c) Money (d) Capital

2. A rational person does not act unless

(a) the action is ethical

Page 99
 ECONOMICS

(b) he action produces marginal costs that exceed marginal benefits

(c) the action produces marginal benefits that exceed marginal costs
(d) the action makes money for the person

3. In a free-market economy the allocation of resources is determined by:

(a) votes taken by consumers

(b) a central planning authority
(c) by consumer preferences
(d) the level of profits of firms

4. Which of the following statements would you consider to be a normative one?

(a) Faster economic growth should result if an economy has a higher level of
investment
(b) Changing the level of interest rates is a better way of managing the economy
than using taxation and government expenditure
(c) Higher levels of unemployment will lead to higher levels of inflation
(d) The average level of growth in the economy was faster in the 1990s than the
1980s

5. Which of the following are considered to be essential characteristics of a

public good?

(a) It must be provided by the government

(b) Consumption by one person does not diminish the quantity available for
others
(c) Once the good is provided, it is not possible to exclude people from
consuming it
(d) It must benefit the whole economy
6. Which of the following might be considered to be a characteristic of a
capitalist economy?

(a) All income is completely evenly distributed

(b) Price is relatively unimportant as a means of allocating resources
(c) Goods and services produced reflect consumer sovereignty
(d) There is no incentive for people to work hard

7. Economic growth is depicted by

Page 100
 ECONOMICS

(a) shift in the production possibilities frontier outward

(b) a movement from inside the curve toward the curve
(c) a shift in the production possibilities frontier inward
(d) a movement along a production possibilities frontier toward capital goods

8. Which of the following will not shift a country's production possibilities frontier
outward?

(a) an improvement in technology

(b) an increase in the labour force
(c) an increase in the capital stock
(d) a reduction in unemployment

9. Which of the following is part of the opportunity cost of going on holiday?

(a) the money you spent on a theatre show

(b) the money you could have made if you had stayed at home and worked
(c) the money you spent on airline tickets
(d) the money you spent on food

10. Positive statements are

(a) Macroeconomics
(b) Microeconomic
(c) statements of description that can be tested
(d) statements of prescription that involve value judgments

11. Which of the following statements about microeconomics and

macroeconomics is not true?

(a) The study of very large industries is a topic within macroeconomics

(b) Macroeconomics is concerned with economy-wide phenomena
(c) Microeconomics is a building block for macroeconomics
(d) Microeconomics and macroeconomics cannot be entirely separated

12. Which of the following would you expect to shift the demand curve for cars
outward?

(a) A rise in the price of fuel

(b) An increase in the cost of steel
(c) A decrease in public transport prices
(d) A subsidy given to car producers

Page 101
 ECONOMICS

13. An increase (rightward shift) in the demand for a good will tend to cause

(a) an increase in the equilibrium price and quantity

(b) a decrease in the equilibrium price and quantity
(c) an increase in the equilibrium price and a decrease in the equilibrium quantity
(d) a decrease in the equilibrium price and an increase in the equilibrium quantity

14. Which of the following shifts the demand for watches to the right?

(a) an increase in the price of watches

(b) a decrease in the price of watch batteries if watch batteries and watches are
complements
(c) a decrease in consumer incomes if watches are a normal good
(d) a decrease in the price of watches

15. All of the following are determinants of supply except:

(a) Price
(b) Income levels
(c) Objectives of the firm
(d) Level of technology

16. All of the following are determinants of demand except:

(a) Price
(b) Tastes
(c) Supply
(d) Price of other goods

17. If an increase in consumer’s income leads to a decrease in the demand for a

good, then the good is

(a) normal good (b) an inferior good

(b) a substitute good (d) a complementary good
18. The law of demand states that an increase in the price of a good

(a) increases the supply of that good

(b) decreases the quantity demanded for that good
(c) decreases the demand for that good
(d) increases the quantity supplied of that good

Page 102
 ECONOMICS

19. If an increase in the price of blue jeans leads to an increase in the demand for
tennis shoes, then blue jeans and tennis shoes are

(a) Complements
(b) inferior goods
(c) normal goods
(d) substitutes

20. Which of the following statements is true if the government places a price
ceiling on petrol at €1.00 per litre and the equilibrium price is €1.50 per litre?

(a) A significant increase in the demand for petrol could cause the price ceiling
to become a binding constraint.
(b) A significant increase in the supply of petrol could cause the price ceiling to
become a binding constraint
(c) There will be a shortage of petrol
(d) There will be a surplus of petrol

21. Which of the following is an example of a price floor

(a) The minimum wage

(b) Rent controls
(c) Restricting petrol prices to €1.00 per litre when the equilibrium price is €1.50
per litre
(d) All of these answers are price floors

22. If an increase in a consumer's income causes the consumer to increase his

quantity demanded of a good, then the good is

(a) a complementary good (b) a inferior good (c) a normal good (d) a
substitute good

23. When the percentage change in quantity demanded is greater than the
percentage change in price, the demand for the good is

(a) Unitary elastic

(b) inelastic
(c) perfectly inelastic
(d) elastic

24. When the price of a substitute of commodity X falls, the demand for X

Page 103
 ECONOMICS

(a) rises
(b) falls
(c) remains unchanged
(d) any of the above

25. Two goods X and Y are said to be complements when

(a) A fall in the price of X raises the demand for Y

(b) A fall in the price of X causes a decrease in the demand for Y
(c) A fall in the price of X does not affect the demand for Y
(d) A rise in the price of X does not affect the demand for Y

26. Giffen goods are goods

(a) For which demand increases as price increases

(b) Which are in very short supply
(c) For which demand falls as income rises
(d) Which have a very high income elasticity

27. At a price of GH₵10, the quantity bought was 5000 per day, and at a price of
GH₵15, quantity bought was 4,600 per day. What is the coefficient of price
elasticity of demand?

(a) 0.2 (b) 0.4 (c) 0.16 (d) ) 0.5

28. Because food is a necessity, one would expect the demand for food to be
(a) Elastic (b) inelastic (c) unitary elastic (d) perfectly elastic

29. A vertical supply curve may be described as

(a) Relatively elastic (b) perfectly inelastic (c) relatively inelastic (d)
perfectly elastic

30. Instead of allowing the price of a commodity to find its level through the forces
of demand and supply, the government may institute :
(a) Price control
(b) Consumer market
(c) Factor market
(d) Black marke

REFERENCES

 Lipsey, R. G. & Alec, K. C., (1995), An Introduction to Positive Economics, (eighth

edition), Oxford University Press, Oxford.

Page 104
 ECONOMICS

 Donkor, B. B., (2001), Economics: A Comprehensive Approach, Integrity Press

Limited, Accra.

 Akuoni, S., (2007), Introduction to Economics, Institute of Adult Education, Legon.

 Owusu-Bediako, K., (2012), Microeconomics for Academic and Professional

Studies, Sahabia Publications, Accra.

 Otchere, A,(2004), Teach Yourself Economics, Ultimate Publications

 Opuni, F. F.,(2010), Economics, Approacher’s Limited, Kumasi

 Opoku-Afriyie, K.J., (2008), Elements of Economics 1, Institute of Distance

Learning, KNUST, Kumasi

 Mensah, E. K., (2012), Microeconomics, University of Professional Studies, Accra

 Begg, David, Stanley Fisher, and Rudiger Dornbusch: Economics, (4th edition),
McGraw-Hill, London & Newyork

 Abudu, A. O., (1996), Useful Basic Economics.

 Salvator, D., (1983), Principles of Economics.

Page 105