Economics is essentially studies the way in which mankind provides for his material well-being.

It will thus be concerned by the way in which people apply their knowledge, skills and gifts of
nature in order to satisfy their wants.
Meaning
The term economics originally derived from the Greek word “oikonomis” which from the word
“oikonomos” which separates into “oikos” and nomos meaning household and managing or
manager
Adam Smith
Pioneers of the science of economics defined economics as the science of wealth. Adam Smith,
who is known as father of economics, named his famous book on economics as “an enquiry into
the nature and causes of wealth of Nations.” Thus, according to him, economics enquires into the
factors that determine wealth of the country and its growth. In this book Adam Smith analyses
the factors that determine growth of the volume of production. That the emphasis of Adam Smith
is on the wealth and riches of a nation is clear from the following quotation from his book. “ the
great object of political economy of every country.” As the wealth and riches of a country cannot
grow without proper utilization of its resources and this is what forms the subject matter of his
book “the wealth of Nations”. Thus, Adam Smith emphasized the production and expansion of
wealth as the subject matter of economics.
Alfred Marshall,
Political economy or economics is the study of mankind in the ordinary business of life; it
exermines that part of individual and social action which most closely connected to with the
attainment and with the use of the material requisites of well-being. He pointed out that, for
economics, wealth is not an end in itself but it is only a means to an end; the end being the
promotion of human welfare. Thus according, wealth only a secondary thing, it is man and his
business of life which is the primary of the economic study. In fact, marshall tried to make the
study of economics an engine of social betterment.
Assignment
1. Define economics as put by Lionel Robbin.
Definition
Economics is defined as a social science which studies the allocation of scarce resources which
have potential alternative uses. Along competing and virtually limitless wants of the consumers
in the society.
Scope of Economics
As an area of study, economics has two branches,
a) Microeconomics
b) Macroeconomics
Microeconomics
This involves the study of individual households and firms. It is the study of the smallest
economic decision-making unit.
Areas of the study include i. demand and supply
ii. consumer theory
iii. markets etc.
individual, households and firms do not operate in a virtual, they operate in a bigger complex
system referred to as economy.
Macroeconomics
This is the study of this bigger complex of the system.
Major areas under macroeconomics are;
i. National income
ii. Economics growth
iii. Unemployment
iv. Inflation
v. Public finance etc.
Basic economic concepts
1. Human wants
These are the people’s desires of things, goods, services and circumstances that enhances
their material well-being. They are limitless in that, people wish to enjoy as much
material well-being and are not satisfied. Human wants are competitive, recurring and
unsatisfiable.
2. Resources
These are ingredients that are available for the production goods and services. They
include; natural resources, human resources and man-made resources.

Economic resources are also referred to as factors of production. Eg land, labour capital
and entrepreneurship. Land, capital and labour are combined by the entrepreneur to
produce goods and services.

3. Choice
This refers to the want to satisfy from unending list of wants. Choice is necessitated by
the fact that resources are limited.

4. Utility
This is the satisfaction derived from consuming a good or service. Utility derived by one
person is different that the one derived by another person.
Scarcity
If resources available to people are not enough to produce goods and service to satisfy all
their needs and wants then they are said to be scarce. Scarcity is a relative concept which
relates to the extent of peoples wants to the ability of these scarce resources to satisfy
their wants. Scarce resources are referred to as economic resources and goods produced
using them are known as economic goods.
Scarcity also implies that resources have alternative uses thus individuals and the society
cannot be all the things they want. Since human wants are unlimited the resources to
satisfy them are scarce, choices must be made. The choice to satisfy one want implies
that, I has to forgot another want.

Opportunity Cost

It is defined as the value of the benefit expected from the next best forgone alternative. It
is the cost of something in terms of the best alternative forgone. E.g. if I choose to pay
bus fare back home instead of buying lunch the opportunity cost of ridding in a bus back
home is the lunch sacrificed.

Production Possibility frontier/curve

This shows the various contribution of the two products that a country produces e.g
assume country A can only produce manufactured and or agricultural goods in the
following

Agricultural goods Manufactured goods

100 0
80 25
60 40
40 45
20 48
0 50

The PPF shows various combinations of agricultural and manufactured goods attained by
country A. with its limited resources, and at a certain level of technology.

Any point within the PPF such as A means that the economy is operating below capacity
and under-employed.

Any point beyond the curve such as point C is unattainable given the country’s resources
and level of technology.
 Any point along the curve such as points B, X, Y, and Z is attainable and shows full
employment of the capable resources.
The economy can produce 100 units of agricultural or 50 units of manufactured goods of
a combination of both agricultural and manufactured goods.
At point B, if the country gives up 20 units of agriculture it gains 25 units of
manufactured goods.

At point G the country loses 60 units of agricultural goods and gains 45 units of
manufactured goods.

There is opportunity cost be resources are not easily substituted from one form of a
production to the next.

Wealth
This is anything that has the following characteristics;
i. It is scarce
ii. Its consumption leads to some utility
iii. It has money value
iv. It is transferable from one person to another
Wealth can be categorized into classes
i. Social/collective e.g. roads
ii. Business wealth e.g. business assets
iii. Personal wealth e.g. TV
Wealth is the physical asset which makes up our standards of living. One of the primary
concerns of economy is to increase the wealth of the society. Note money is not wealth.
Welfare.
This s the whole stage of well-being. It is not restricted to economic goods. It is in addition
related to public health, hours of work etc.
It is possible to increase the level of wealth while increasing the level of welfare. E.g. if one
works 50% longer in a day, the country’s wealth will increase but 50% work increase would
reduce people’s welfare since it makes people tired and unhealthy.
Ceteris paribus.
It is a Latin word which means other remaining the constant or being equal. Ceteris paribus as a
price of a commodity increases the demand increases.

Basic economic problems

When the term economic problem is used, it refers to the whole story of scarcity of resources.
Every society or country is faced by this problem regardless of the level of development. Each
society has to choose how to make best use out of scarce resources.
Paul Samuelson says that every economic society has to answer three fundamental questions
1. What to produce – a society has to choose what to produce and how much. This is
determined by the cost of production and consumer preference. A society needs to make
a decision on what to produce due to limited resources.
2. How to produce – the society must also choose by whom and by what resources and in
technological manner are the goods going to produced i.e. how will the available
resources be combined to produce the goods.
3. For whom to produce – who is enjoy and get the benefits of the goods and services
produced. This deals with the distribution of goods and services among households
4. How much of a particular goods and service to produce – this is dependent on the
consumer preference.
L.G. Lipsey argues, there are 7 basic questions that arise in all economies that form the basic
economic problem.
1. what products are produced and in what quantities?
2. by what methods are products produced?
3. has the society’s output of goods and services distributed among its members?
4. how efficient is the society’s production and distribution? A method of production becomes
efficient if its possible to produce one or more commodities without simultaneously reducing the
other.
5. are the country’s resources being fully utilized?
6. is the purchasing power of money constant or is it being eroded by inflation?
7. is the economy’s capacity to produce goods and services growing from year to year or is it
static?

Economic Systems
An economic system is the one that ensures a linkage between consumer and the producers to
ensure satisfaction of needs and wants using limited resources.
The economic system determines the following;
1. The goods and services
2. The amount of goods and services to produce
3. How the goods and services are produced
4. How the goods are shared among the households.
Economic system consists of two parts
i. The firms – these are business organizations which decides what type of goods and
services to be produced and the different resources required for production.
ii. Households – these consume the goods and services and supply such resources as
labour to produce these goods and services.
There are three major economic systems
1. Market economy/free enterprise economy/capitalist economy – the emphasis is laid on
the freedom of an individual both as a consumer and supplier of a resource. As a
consumer, an individual chooses the goods and services he wants by the price he is
willing to pay. As a owner of a resource, an individual seeks to maximise the reward he
can get in exchange of his labour. If a3 consumer wants more of a particular good, this is
indicated by a rise in price. A rise in price tends/leads to an increase in profit and
earnings by those factors employed to produce a good.
As a result other resources are attracted into the industry and thus raising supply. If a
consumer didn’t want a particular good, this is indicated by a low price as a result, producers
make loss and withdraw their resources from the industry.
In the free market economy, the consumer is the king and the resources are allocated by the
market mechanism. Through the market system problems of allocation of resources and how
much to produce are solved in the market economy. No intervention by the government.
Merits of market economy
i. Does not require the intervention of the government to allocate resources
ii. Resources are employed efficiently
iii. Consumers get what they want by the price they offer for a particular commodity
Demerits
1. Community goods such as roads, defense cannot be adequately provided for through the
market.
2. the price mechanism may through imperfect knowleddge or immobility of resources
function slackly and supply may be slow to achieve.
3. Private profit motive does not always ensure society’s well-being is maximized
4. Competition may sometimes leads to inefficiency e.g. competitive advertising may waste
resurces.
5. Consumer’s choice may be distorted by persuasive advertising leading to consumption of
unhealthy goods and services.
6. Market economy where individuals decide what to produce is subject to instability in the
overall level of economic growth. Resources may remain unemployed if firms consider
the prospect of profits to be low which bring about trade and economic cycles.
7. Consumers with the highest income have the highest say in the direction that resources
are allocated and actually not the efficient way.
Command economy
The decision regarding what, how much, and to whom are taken by a powerful planning
authority. This authority estimates how much the people demand and allocate the resources to
meet the demand. The authority decides the distribution to use. Economic efficiency depends on
how wants are estimated and resources allocated.
Merits of command economy
1. The planning authority can ensure that the adequate resources are devoted to communual
goods and services.
2. The command economy ensures that the advantages of large scale productivity are
enjoyed rather than maximising profit by restricting output.
3. There is more certainty in production
4. It employs workers in order to keep them occupied
5. It eliminates the inefficiencies resulting from competition
6. It allows for even distribution of wealth when planning what to produce and in rewarding
the producers.
Demerits
1. Estimating satisfaction derived by individuals from consuming different goods is
impossible since prices are controlled and supplies are rationed
2. Officials are required to estimate wants in order to allocate resources. This process can be
slow and sometimes involves corruption
3. Even when wants have been described upon the problem of coordination of resources
becomes difficult since members of various committees in most cases politicians who
might not have experience is running organizations.
4. State ownership of resources, diminishes personal incentives, initiative and effort.
5. Command economy in most cases leads to a very strong central government that may be
sometimes dictatorial.
Mixed economy.
Mixed economy allows both the market forces and government to have a play in the allocation of
resources. The government will help in planning a head and in the distribution of income through
subsidies and taxes. The govt. exerts its influence on allocation of goods and services.
In the mixed economy there is existence of two sectors.
i. Private sector
These consist of those firms which are privately owned and where decisions are taken
in response to market.
ii. Public sector
These include government departments, parastatals, county governments and public
bodies. This sector’s capital is publicly owned and the policies are influenced by the
government.
 The existence of public sector enables the government to exercise some control over
the economy. Decisions on what to produce will be influenced by need rather than
demand.

This is concerned with the determination of prices for goods and services.
The main areas are;
Market
Demand
Supply
Markets is all those buyers and sellers of a good/service who influence it price. The
market fixes the prices at which those who want something can obtain from those
who have it.
A market need not be formed or and in a particular place. Within a market, there is a
tendency of a particular price to prevail for a particular good/service. There are
various forms of market.
1. World market
A commodity is said to trade in the world market if a change in its price in one
part of the world affects price in the rest of the world e.g. oil, gold, silver etc.
For a commodity to obtain a world market status, it has to satisfy certain conditions
i. The commodity must be capable of being transported
ii. The commodity must have a wide market e.g. basic necessity like oil.
iii. The cost of transportation must be small in relations to the values of the commodity
iv. The commodity must be durable

2. Perfect competition
A commodity whose price difference tends to be eliminated quickly is said to be
in the perfect market.
For a market to be perfect, it has to meet the following conditions;
i. Buyers and sellers have exact knowledge of the prices being paid
elsewhere.
ii. Both buyers and sellers must base their actions solely on price and should
not favour a particular person.
If one seller sets it price higher than others buyers will move to the next
seller.
The two conditions really exist together and therefore imperfect markets
result where price difference exist.
3. Organised product Market
These are distinct markets where buying and selling take place.. business in the
market is governed by agreed rules and conventions and often only certain people
are allowed to engage into transactions.
 These markets are highly specialized and developed e.g. coffee and tea auctions in
Mombasa.
Organised markets fulfil 3 functions
i. They enable manufactures and wholesalers to obtain supply easily and at
competitive prices. Since they are composed of specialized buyers and
sellers, prices are sensitive to changes in demand and supply.
ii. Future dealings on those markets enable people to distant themselves form
large loses as a result of price changes.
iii. These organized produce markets are able to even out price fluctuations.
4. Goods and Factor Markets
In the goods market the sellers are the firms and buyers are households. The
factor market, factors of production are bought and sold. The sellers in factor
markets are the owners of factor of production and mostly households and the
buyers are firms.
5. Free and controlled markets
In a free market. Buyers and sellers are free to arrive at any agreement on price
and quantity.
In controlled market, the central authority exerts some influence either on price or
quantity traded.
Demand
An individual’s demand for a good is quantity that he is willing to buy at a given price over a
period of time. Demand takes into account the; ability, time, price specifications
Demand as opposed to wants, need or desire is backed by purchasing power.
Law of demand
It states that ceteris puribus when price of a commodity rises, the quantity demanded decreases
and vise versa. There is therefore an inverse relationship between the price of a commodity and
quantity demanded.
The law of demand is analysed by demand schedules and demand curves.
Demand schedule is a tabular statement showing the quantities demanded of a commodity at
different prices.
Demand schedule for consumer x for mangoes
Quantity demanded for demand schedule
Price Qd for mangoes
10 3
20 2
30 1
40 0
When the price of mangoes increase the quantity demanded decreases and vise versa
Demand curve is a graphical representation of a relationship between price and quantity
demanded. Price is put on the Y-axis and quantity demanded on X-axis.
Draw the curve….

The demand curve slopes down from left to right in conformity with the law of demand.
At p1, quantity demanded is q1. Arise in price to p2 reduces the quantity demanded form q1 to
q2.
Market demand
The market demand for a commodity x is the sum of all the individuals demand for that
commodity e.g. the demand for mangoes by various consumers at various price is given as
follows

Consumer Market demand

Price A B C D sum of quantity demanded
1 60 55 40 49 204
2 50 45 30 39 164
3 40 30 25 27 122
4 20 25 18 17 77
Draw the curve…..

Assumption of demand/other things remaining constant

1. The income of the consumer
2. Tastes and preference of individuals
3. Price of substitutes
4. Future expectations of change in prices
5. Inventions
Exceptions of law of demand
1. In the case of different goods e.g. basic food, the law of demand does not apply here
because such cases, the demand decreases due to fall in price level. In this case, demand
curve moves left to right upwards.
 2. If the marginal utility of any commodity is consumed, then in this case, the law of
demand will not apply.
3. In certain cases due to ignorance about the conditions of the market less is purchased at
lower prices amd more is purchased at higher prices.
4. Goods of ostentations (Veblen goods). This goes with the status. The wealthy are usually
concerned about status believing that only goods at high prices are worth buying and
have the effect on distinguishing them from other consumers.
Determinants of demand
i. Price of a commodity
ii. Population
iii. Prices of related goods and complimentary goods
iv. Level of income
v. Government policy
vi. Taste and fashion
vii. Level of advertisement
viii. Availability of credit to consumers
Abnormal demand curves
Causes of abnormal demand curve is future price expectation when even at higher prices more
will be demanded.
price

quantity demanded
even goods –

shift of demand curve

if a person buys more because the price has fallen, it is only an extension of demand. This canbe
called change in the quantity demanded. But there is no change in the ‘demand’ itself. Extension
and contraction of demand indicate movement a long demand curve. Other things are assumed
constant and the price change is studied in the form of changes in the quantity demanded.

In the figure, any movement on the demand curve DD refers to contraction and expansion of the
quantities demanded. Thus, amount demanded changes only with reference to price. In the figure
when the price is OP, OM amount is demanded. When the price falls to PO1, OM.1 is demanded.
Apart from price, if other factors like population, tastes, changes in incomes, changes in the trade
conditions, it is a change in demand itself. Consequently, the demand curve shifts either upwards
or downwards, as shown in the following figure.

Utility
It is the satisfaction or benefit derived from the consumption of a commodity. A consumer will
attempt to consume those commodity that will give the highest satisfaction subject to hi income.
Cardinalist such as Alfred Marshall believed that utility could be measured in utils. Utility is
however a subjective concept and there are two major problems in an attempt to measure it.
1. It is difficult to find an appropriate unit of measurement e.g. one may enjoy 10 utils from
the consumption of a particular commodity. This enjoyment may not be the same as 10
utils enjoyed by another person.
Utility is personal and cannot be compared among individuals
2. To be able to measure utility derived from the consumption of a commodity one should
be able to hold all other factors that affect utility e.g. when one is sick she does not obtain
the same utility as when he is well.
In the cardinalist approach, if consumption of milk gives 20 utils and that derived from the
consumption of soad is 40 utils cardinalist would conclude that a consumer would obtain twice
as much utility from the consumption as tomilk.
Economists such as Hicks in 1930’s came to the conclusion that utility cannot be measured
cardinally.
These economists have come to be known as ordinalist. They opined that an individual can use a
bundle of goods of goods in order of reference and able to state that he derives more utility from
one bundle that the other but the consumer derives equal utility from two or more bundles.
It is impossible to measure by how much a bundle is preferred for another. A consumer will
prefer soda to milk but cannot attach a numerical value to measure of utility.
Indifference curves and budget lines are the means of approaching the ordinal approach to
demand theory.
Reasons for inverse relationship between price and quantity.

i. Diminishing marginal utility – marginal utility is an the extra utility derived as a

result of consuming one extra unit of a commodity.. the law of diminishing marginal
utility states that as more of a commodity is consumed, the marginal utility derived
from each additional unit eventually decrease.
Due to diminishing marginal utility, as an individual consumes more of a commodity,
the less he is prepared to pay for a unit and therefore the inverse relationship between
the price and quantity demanded.
 Quantity demanded Total utility Marginal utility
0 0 -
1 20 20
2 50 30
3 60 10
4 62 2
5 60 -2

Draw the curve…….

Marginal utility declines as more of a commodity is consumed. A consumer will

therefore be willing to pay less for a unit of the commodity the more of it is
consumed therefore the inverse relationship between price and quantity demanded.

ii. Income
As the price of the commodity rises and holding the income constant, the less the
units of the commodity than the consumer will be able to buy.
The real income has fallen as a result of rise in price. When the price falls holding
the consumers income constant, this leads to a rise in demand since it rises the
consumer real income.
The rise in demand is as a result of price fall is called income effect of price fall
The decrease in demand as a result of price rise is called income effect of price rise.
This then leads to an inverse relationship between price and quantity demanded.

Substitution effect
When the price of a commodity x rises the consumer may give up some units of x for
cheaper substitutes leading to decrease in good for x.
If price of x falls, the consumer may give up some units of a more expensive
substitute in preference for more units of x.

This leads to an increase in demand for x. due to the substitution effect, the quantity
demanded has an inverse relationship to its price.

Market Demand function

A market consists of several individual. Market demand function is obtained by
summing up the demand functions of individuals consisting the market.
Example 1
A market for a commodity consists of three individuals A, B, C whose demand
functions for the commodity are given below

QA = 40-20P
QB = 25.5-0.75P
 QC = 36.5-1.25P
When the individual demand functions are expressed as ‘quantity as a function of its
price’ as is the case in our problem stated above, market demand can be obtained by
summing up the individual functions. Thus, market demand function is

QM = QA+QB+QC
= (40-2P) + (25.5-0.75P) + (36.5-1.25P)
= (40+25.5+36.5) – (2+0.75+1.25)P
= 102-4P
Example2
A) : P = 35-0.5QA
B) : P = 50-0.25QB
C) : P = 40-2.00QC
i) Find out the market demand function for the commodity
ii) If the market supply function is given by QS = 40+3.5P, Determine the equilibrium
price and quantity
Since the individual demand functions are expressed as price as function of quantity, that is, we
are given “ inverse demand functions” we have first to transform them into quantity demanded as
a function of price.’ Transforming the yields the following demand functions
QA = 70-2P
QB = 200-4P
QC = 20-0.5P
Market Demand function=
QD = (70-2P) =(200-4P) + (20-0.5P)
QD = 70+200+20 – (2+4+0.5)P
=290-6.5P
Market supply function Qs = 40+3.5P
In equilibrium QD = Qs
290-6.5P = 40+3.5P
= 10P=250
P = 250/10= 25/=