AS Economic note (1)supply demand (1).pptx

ECONOMIC PROBLEMS
Needs – the essentials of life, such as food and
shelter
 Wants – desires for non-essential items
 Economic Problem – the problem of having
unlimited wants, but limited resources to satisfy
them
Scarcity – the limited nature of resources, which
underlies the basic economic problem
Economic Resources – basic items that are used in
all types of production, including natural, capital,
and human resources

• The foundamental problem from which others
arise is the problem of scarcity. Nearly all
resources are scarce.
• Resources are limited (finite) to satisfy the
unlimited want.
• Economics is the study of allocation of
resources (the choices that are made by
economic agents)

• Due the problem of scarcity economic agents e.g.
consumers, producers and the government have to
make choices which result in an opportunity cost
• Choice refers the act of selecting/choosing between
alternatives.
• Every choice involves a range of alternatives. Choice
can be graded in terms of the benefits to be gained
from each alternative. One choice will be the best and
a rational economic agent will take that alternative,
but all other choices will then be given up.

• Opportunity cost(alternative forgone) is that which
we give up or forgo, when we make a decision or a
choice. e.g. a student might be faced with the
problem of choosing between a book and a sandal.
• If he chooses to buy the book, the opportunity cost
is the benefit which would have been gained from
buying the sandal (i.e. the book)
• If a firm invests in project A rather than project B,
then project B is the opportunity cost.

Oxbridge Tutorial College
Graphical illustration of scarcity choice and
opportunity cost
Consumer Goods
50 A
30 B
25 C
D
15 25 30 Capital Goods
• Due to scarcity of resources, the country can not produce more than 50 units of consumer
Goods or 30 units of capital Goods
• The country may choose to produce on any point i.e. A,B,C,D
• If she chooses to move from point B to C, the opportunity cost of producing 10 units of
capital goods is 5 units of consumer goods forgone.

ASSIGNMENT
• Discuss whether the combination of improved
technology and globalisation will result in
solving the basic economic problem (15)

FUNDAMENTAL QUESTIONS
• Inability of the economy to provide all the
goods and services required leads to the 3
fundamental questions of what, how, and for
whom to produce.

WHAT TO PRODUCE
• Economy can not produce everything, decision has to be
made about what goods and services to be produced/the
combination of goods and services to be produced with the
limited resources. Assuming a firm produces biscuits;
• Should it produce all types of biscuit, or certain types?
• Producers will only produce goods that are profitable to
them.
• Capital goods are goods used to produce other goods and
services.
• Consumer goods are goods produced for present
consumption.

HOW TO PRODUCE
• This has to do with the method of production
• Producers must decide on the most efficient
means of using the resources (capital or labour
intensive method)
• E.g. should the firm make the biscuits by hand or
by machine?
• Firms will want to produce their goods in the
most efficient way in order to minimise costs and
maximise profit.

FOR WHOM TO PRODUCE
• Decision has to be taken on how to distribute the goods and
services among consumers e.g. Should output be equally
distributed? Or what proportion of the goods should go to
the children, workers etc
• E.g. Should the firm make the biscuit for people living in
cities/villages/for the rich/for people on lower incomes?
• In a capitalist/market system, goods will be provided for
consumers who are willing to pay.
• Therefore, consumers decide what to produced. Producers
won’t produce things that nobody wants to buy.

ECONOMIC AS A SCIENCE
• Some Sciences such as physics or chemistry, are
sometimes called hard science; This term doesnt refer
to the fact that physics is more difficult than biology.
It refers to the fact that it is relatively easy to apply
the scientific method to the study of these subjects.
• In physic much of the work can take place in the
laboratries. Observation can be made with some
degree of certainty. Control groups can be
established. It then become relatively easy to accept
or reject a particular hypothesis

• This is much more difficult in social science such as
Economics, sociology, polictics and anthropology. In
economic is often not possible to set up
experiments , establish control groups or to conduct
experiment which enable one factor to be varied
whilst other factors are kept constant.
• The economist have to gata data in everyday word
where variables are changing over any given period
of time it then become difficult to decide whether
the evidence supports or refute particular hypothesis

• Economists sometimes come to very dificult
conclusion when considering a particular set of
data as their interpretation may vary.
• Its sometimes argued that economics cannot
be a science because it studied human
behaviour and human behaviour cannot be
reduced to scientific laws . There is an element
of truth in this, it is very difficult to understand
and predict the behaviour of individual

MICROECONOMICS
• Microeconomics is the study of the behavior of
the individual units (like an individual firm or an
individual consumer) of the economy e.g.
– Demand and Supply of commodities
– Study of costs of producing a good by a firm
– Study of revenue of a firm
– Determining producer's equilibrium (cost & revenue)
– Utility of a consumer : satisfaction from consumption
– Consumer's Equilibrium

MACROECONOMICS
• Macroeconomics studies the behavior
of aggregates/economy as a whole, i.e. it
deals with the problems faced by the
economy as a whole, and not just by an
individual unit for example, unemployment,
Inflation, National Income etc.

NORMATIVE AND POSITIVE STATEMENT
• Economics is generally classified as a social
science. It uses the scientific methods as the
basis of its investigation.
• There are two statements economists can use
for investigation

NORMATIVE STATEMENT
• Normative statements are statements which
contain value judgements. They present value
judgement about the way in which scarce resources
are allocated- they are opinions not facts.
• Normative model or economics describes what
should or ought to be e.g. The government should
reduce fuel tax to reduce the rate of inflation
• or government’s priority is to reduce
unemployment

• It is not possible to say whether the above
statements are true or not- only whether you
agree or disagree with them.
• Normative statements are also important
because value judgment influence economic
decision and government policy.

POSITIVE STATEMENT
Positive statement is a statement of ‘facts’ which
can either be proved (tested) or not proved by
referring to available evidence.
A good positive statement must be capable of
being proved. E.g. an increase in price leads to a
decrease in qty demanded
OR an increase in interest rate leads to an increase
in savings

• Positive statement is value free. It does not
contain any value judgement.
• It is concerned with what is, was, and will be.
It is a statement of ‘if’ e.g. if a firm raises
price, profit will rise.
• Positive statement is a way of testing whether
economic ideas are correct. They are testable.

IDENTIFY POSITIVE AND NORMATIVE
STATEMENTS
1. A fall in incomes will lead to a rise in demand for own-label supermarket foods
2. If the government raises the tax on beer, this will lead to a fall in profits of the
brewers.
3. The government should increase the minimum wage to £7 per hour to reduce
poverty
4. The retirement age should be raised to 70 to combat the effects of our ageing
population
5. The rising price of crude oil on world markets will lead to an increase in cycling
to work
6. A reduction in income tax will improve the incentives of the unemployed to
find work.
7. Unemployment is more harmful than inflation
8. The congestion charge for drivers of petrol-guzzling cars should increase to £25

Meaning of the term ceteris paribus
• Ceteris paribus is a Latin phrase that generally means "all
other things being equal."
• In economics, it acts as a shorthand indication of the effect
one economic variable has on another, provided all other
variables remain the same
• The difficulty with ceteris paribus is the challenge of
holding all other variables constant in an effort to isolate
what is driving change.
• In reality, one can never assume "all other things being
equal."

Short-run, long-run, very long-run
• The short run, long run and very long run are different time periods in
economics.
• Very short run – where all factors of production are fixed. (e.g. on one
particular day, a firm cannot employ more workers or buy more
products to sell)
• Short run – where one factor of production (e.g. capital) is fixed. This is
a time period of fewer than four-six months.
• Long run – where all factors of production of a firm are variable (e.g. a
firm can build a bigger factory) A time period of greater than four-six
months/one year
• Very long run – Where all factors of production are variable, and
additional factors outside the control of the firm can change, e.g.
technology, government policy. A period of several years.

FACTORS OF PRODUCTION
• Factors of production are the resources used in
production. These factors are land, labour, capital
and entrepreneur.
1. land- it includes all the natural resources in and on
it e.g. Renewable resources, non renewable
resources, water and animal (Space to construct a
building, wood, water, fish, crude oil, minerals,
metals etc)

• Characteristics
– A gift of nature
– Limited in supply
– Land is immovable
– The reward is rent

2. Labour is the amount of physical, mental and social effort used to
produce goods and services in an economy.
It supplies the expertise, manpower and service needed to turn raw
materials to finished products.
e.g. Designers, engineers, doctors, teachers, builders etc
Features
-It is perishable- if a labour does not work for a day, his own day’s work
will be lost forever.
-it is an active factor of production
-Labour is mobile
-Labour is not homogeneous
-The reward is salaries/wages

3. Capital- Refers to all non-natural resources
that are used in production e.g. Money,
buildings, machines, furniture, computers,
vehicles etc.
• Features:
– Man made
– It raises the productivity of other factors
– The reward is interest

4. Enterprise- refers to the management,
organisation and planning of the other three
factors of production.
Features
- He organises the other factors of production
- He is a risk bearer
- His reward is profit if successful

DIVISION OF LABOUR AND SPECIALISATION
• Division of labour refers to splitting up of a task into a number of processes and sub-
processes and carrying it out by a person or a group of persons who are best fitted
for it
• Specialization is when a person/group of persons concentrate on a product or task
Advantages of Division of Labour
1. Inventions: When a worker performs the same job again and again he tries to
discover new and better methods of doing the work.
2. Use of machinery: it facilitates mechanization and auto
mation of jobs. Use of
machinery reduces stress and strain on workers.
3. Increased Output: with improvement in efficiency and use of machinery output is
increased.
4. Saves time: There is no time wasted in switching of jobs and thus the momentum of
production can be maintained which leads to less wastage of time.
5. Lower costs: it increases the efficiency of workers. Wasteful duplica
tion of process
and tools is avoided. Therefore, costs of operations are reduced.

DISADVANTAGES OF DIVISION OF LABOUR
• Boredom: Performing the same task over and over again may lead to boredom for the
workers.
• Lack of variety: Though the number of goods produced increases but they are identical
or standardized.
• Low motivation for worker: Repeatedly performing the same task may lead to low
motivation level for the worker. The worker might not have the sense of fulfilling a
complete task as he is performing only a part of the job.
• Lack of mobility: Due to specialisation workers might find it difficult to switch between
occupations.
• Too much interdependence: Failure of the worker/link due to strike, war, breakdown in
transport etc may cause great harm/delay.
• Unemployment-Specialists know only a single process of production. In case of
unemployment, they find is difficult to get jobs.

ECONOMIC SYSTEMS
• Economic systems are the basic arrangements
made by societies to solve the economic
problem. They include: Command economies,
market Economies and so on.
• It is the method used by a society to produce
and distribute goods and services.
• Or, How the government tells us what we can
get and how to get it!

MARKET/capitalist SYSTEM
• Market economy system is an economy where private
individuals take decisions with less government intervention
• Economic questions are answered by individual buyers and
sellers i.e. forces of demand and supply
• Consumers dictate what is produced, how much is produced
• Producers determine how to produce by using the efficient
method of production which will minimize cost and maximize
profit
• People act out of self interest; motive for profit (money) drives
the economy
• Examples, The United States, Western Europe, Japan etc

CHARACTERISTICS OF MARKET ECONOMY
• Private ownership/property- Resources are
owned by individuals.
• Economic decisions are made by individuals
competing to make profit.
• There is individual freedom to buy and own
property
• Economic decisions are determined by the
demand and supply

Advantages Disadvantages
• Freedom of choice
• Lack of government
interference
• Incentive for hard work
• High degree of
consumer satisfaction
• Rewards only productive
people
• Workers and businesses
face uncertainty
• Existence of Market failure
• Unemployment
• Existence of unhealthy
competition

HOW MARKET ECONOMIES ANSWER THE
QUESTIONS
•What will be produced?
–Whatever the consumer wants
•How will it be produced?
–Entrepreneurs will respond to demand and use the
efficient method
•For whom will it be produced?
–Whomever is willing to work for it (or afford it)

2. Command/planned Economy
• The government/ A central authority answers the
basic economic questions
• Government decides the needs of the people,
the best way to produce it and for everyone
• The means of production are publicly owned and
economic activities are controlled by the
government
•There is very little if any input from the people.
• Examples. Vietnam, North Korea, Cuba, Libya

CHARACTERISTICS
• Government makes the decision.
• Change can occur easily.
• There is little individual freedom.
• There is no competition

• Basic Needs taken care of
• Able to act quickly in
emergencies
• Public/essential goods
are provided
• More equal distribution
of income- Provide for
people base on needs
• Very little unemployment
• Doesn’t meet wants
• No incentives to work
hard
• No creativity- New and
different ideas are
discouraged
• No room for individuality
• Inefficient (quality,
quantity)
• Low economic growth

How does command economy answer the
big three questions?
• What is being produced?
– Whatever the government decides
• How is it being produced?
– The government will tell someone/firm to make it
• For whom is it being produced?
– Whomever the government decides needs it

Mixed Economy
• Mixed economy combine the elements of
command and market economies. There are

various degree where government involvement
exist.
• No economy is pure market or pure command,
elements of each appear in all economies, some
have more elements of one economy than another.
Market Mixed Command
USA Great Britain North korean

CHARACTERISTICS OF MIXED ECONOMIES
• Democracy and freedom exist.
• Competition exist between businesses.
Government intervene and passes laws to
improve the running of the economy.
• Provision of public goods
• There is public and private ownership of
businesses

• Freedom of choice.
• There is control of the
economy.
• Improved social
welfare.
• Poverty still exist
• Because of profit
motive there is always
self interest.
• Excessive government
spending may results in
inefficiency.

How Mixed Economy work
• Since markets are not perfect, governments
intervene and often play a major role in the
economy. Some of the goals of government are to:
a. Minimize market inefficiencies
• Provide public goods
• Redistribute income
b. Stabilize the macroeconomy:
• Promote low levels of unemployment
• Promote low levels of inflation

How Mixed Economy work
• The Government and individuals both answer
the basic economic questions
• Producers may determine the amount of
goods and services; government determines
the quality of the goods
• Producers set employee wages; government
sets minimum wage for employees
• Producers determine business hours;
government determines whether it is safe to
be open or not

Classwork/Homework
• Which economic system do you believe is the
best. Consider your needs and wants. All
systems have their advantages and
disadvantages – which one do you support?

CLASSIFICATION OF GOODS AND SERVICES
PRODUCT OR COMMODITY is anything that is use to satisfy
human wants and needs in the society. This can be classified
into two group/categories
Economics good(private goods) and free goods (public goods).
Economic goods are goods that are limited in supply and
opportunity cost Exist e.g Merit goods( schools, hospitals)
and demerit goods( cigratte,Alcohol, fizzy drinks)
Free goods are goods that are unlimited in supply it has zero
opportnity cost and no price attached to it(no price goods)
e.g public goods (depence, street light), quasi public
goods(public park, road etc)

PRODUCTION POSSIBILITY FRONTIER
• Production possibility curve (PPC) or production possibility
frontier (PPF) shows the combination of goods and services
which can be produced in an economy given the existing
level of resources if all the resources are efficiently utilised
i.e. what a country is capable of producing.
• PPC entails the principle of opportunity cost, in order to
produce more of a good less of the other has to be produced
• The negative slope of the PPC curve reflects the law of
increasing opportunity cost. As we increase the production of
one good, we sacrifice progressively more of the other
because resources are limited and are not equally efficient in
the production of both goods

Any combination of goods inside the frontier is
productively inefficient; more of a good could be
produced without producing less of another. This may
be due to unemployment, emigration, recession etc
Any combination outside the frontier is unattainable
with the existing resources. But can be with more
resources or with international trade.
All points on the PPF represent different choices
about how to use the available resources and are
productively efficient.

• Draw PPC for these combinations
COMBINATIONS BICYCLES COMPUTERS
A 14 0
B 12 2
C 9 4
D 6 5
E 5 6
F 0 8

Bikes
Computers
14
12
10
8
6
4
2
0
0 2 4 6 8 10
A
B
C
D
E
G
Inefficient/
Unemployment
Impossible/Unattainable
(given current resources)
Efficient
Production Possibilities
How does the PPG graphically demonstrates scarcity,
trade-offs, opportunity costs, and efficiency?
50

2.The opportunity cost of
moving from b to d is…
moving from f to c is…
moving from d to b is…
5.What can you say about point G?
6. What can you say about point F?
1. The opportunity cost of
moving from a to b is…
To calculate the opportunity cost, Get the
difference between the two Points,
Example:
Opportunity Cost
51

2 Bikes
moving from b to d is…
moving from f to c is…
moving from d to b is…
7 Bikes
4 Computer
0 Computers
5.What can you say about point G?
Unattainable
1. The opportunity cost of
moving from a to b is…
Example:
Opportunity Cost
52

1 Bike
2.The PER UNIT opportunity
cost of moving from b to c is…
cost of moving from d to e is…
cost of moving from c to d is…
1.5 (3/2) Bikes
2 Bikes
2.5 (5/2) Bikes
= Opportunity Cost
Units Gained
1. The PER UNIT opportunity cost
of moving from a to b is…
Example:
PER UNIT Opportunity Cost
How much each marginal
unit costs
NOTICE: Increasing Opportunity Costs 53

Shifts in Production Possibility Curve
• More output is represented by an outward shift in
the production possibility curve.
• Outward shift of PPC indicates ECONOMIC GROWTH
which means increase in output
• It means that it is possible to increase the production
of one good without decreasing the production of
the other.

A B
Outward Shift of Production Possibilities
Curve
Tobacco
0
SHOES
B
A

CAUSES OF OUTWARD SHIFT IN PPC
Economic growth- Economic growth is the quantitative increase in
the production capacity of an economy. With bigger labour force
or better technology, the economy can produce more of all goods.
CAUSES OF ECONOMIC GROWTH
1. Investment – investment in capital goods e.g. machinery will
increase the production capacity of a nation.
2. Discovery of new natural resources- more resources means more
goods and services can be produced.
3. Technology –improved technology allows more goods to be
produced using the same resources.
4. Training of labour- this will increase the productivity of labour
5. Increase in population- net immigration/a rise in birth rate will
increase labour force and productivity

Economic Growth
Economic growth results in
an outward shift of the PPF
because production
possibilities are expanded.
The economy can now
produce more of
everything.
Production is initially at
point A (20 fish and 25
coconuts),  it can move to
point E (25 fish and 30
coconuts).

INWARD SHIFT OF PPF
• Inward shift of production possibility curve
indicates that the economy is operating below
full employment. It also indicates depletion of
resources.
• CAUSES OF INWARD SHIFT OF PPC
1. Fewer resources as a result of natural disaster
2. Economic recession
3. War

B A
Inward Shift of Production Possibilities Curve
(economic recession)
Tobacco
0
SHOES
A
B

Neutral / Total Technological Change
It occurs when the improvement affects all areas of the
economy
Butter
A
B Guns
0
Shifts in the Production Possibility Curve
C
D

Biased (partial) Technological Change
It occurs when the increase affects an area/aspect
of the economy e.g. improved technology affect
(increase) the production of butter not gun.
Shifts in the Production Possibility Curve
0
B
A
Butter
Guns
C

Examples of Shifts in the Production
Possibility Curve
• Test your understanding: (using agricultural and
manufactured goods on the axis)
– A meteor hits the world and destroys half the
earth’s natural resources.
– Nanotechnology is perfected that lowers the cost of
manufactured goods.
– A new technology is discovered that doubles the
speed at which all goods can be produced.
– Global warming increases the cost of producing
agricultural goods.

DEMAND
• Market is the institution that brings buyers and sellers
together to exchange goods and services.
• Demand is the quantity of goods and services a consumer is
willing and ready to buy at a given price at a particular time.
All things being equal
• Effective demand is the "ability" to pay for goods and
services. ( this show how much would be bought at any
given price and not how much buyer would like to buy if
they had unlimited resources).
• There is an inverse relationship between price and demand,
as price reduces, demand increases and vice versa.

DEMAND SCHEDULE AND DEMAND CURVE
• Demand schedule is a way of showing the
relationship between qty demanded and
price.
• DEMAND SCHEDULE FOR CHOCOLATE
• Draw a demand curve for chocolate
Price $ 10 20 30 40 50
Qty dd (M) 100 80 60 40 20

PRICE
50 ----- CONTRACTION
40 ----------------------
30 --------------------------------------
EXTENSION
20 ----------------------------------------------------
10 ------------------------------------------------------------------ Demand
quantity
0 20 40 60 80 100

MOVEMENTS ALONG THE DEMAND CURVE:
EXTENSION & CONTRACTION
• Movement along the demand curve is as a result of a
change in the price which leads to a change in quantity
demanded.
• Decrease in price from $30 to $20 will lead to an increase in
demand from 60 to 80. this is an extension of demand or
movement downward along the demand curve
• Increase in price from $40 to $50 leads to a fall demand
from 40 to 20. this is a contraction of demand or movement
upward along the demand curve.
• So movement along the demand curve is shown by a change
in price.

Individual and Market Demand and supply.
• Individual demand curve: this shows the demand for
an individual consumer, firm or other economic unit
• Individual supply curve: this shows the supply an
individual / firm is willing to supply at a given price.
• Market demand curve is the sum of all the demand
made by different consumers.
• Market supply curve:This is the sum of all supply a
producers/firm are willing and able to spply at a
different price, over a given period of time.

Determinant of Demand
• price
• Change in consumer taste and preference
• Real income
• Change in price of a substitute good/complement goods
• The number of consumer in the market
• Change in propensity to consume
• Future expectation to price
• Change in population
• Channge in legislation

CAUSES OF SHIFT IN DEMAND
Shift in demand occurs as a result of change
in other factors affecting demand, except
price e.g.
1. Real Income- increase in real income will
make consumers buy more of normal goods
causing demand curve to shift to the right.
2. Credit facilities- availability of credit facility
will increase demand for normal goods.

3. Price of other goods- if the price of a competitive
good is high, consumers may demand for the
close substitute e.g. Butter and margarine.
4.Population- Increase in population is likely to
increase demand for goods and services in a
country.
5. Advertisement- a successful advertisement will
lead to an increase in demand while unsuccessful
advertisement may not cause any change in
demand

SUPPLY
• Supply is the quantity of goods and services that producers
are willing and able to sell at various prices per period of time,
other things being equal
• The law of supply says the higher the price, the higher the qty
supplied
• The higher the price, all things being equal the higher the
profit of firms.
• Supply of eggs
• Draw a supply curve
Price 10 20 30 40 50 60
Qty ss 20 40 60 80 100 120

GRAPH OF SUPPLY
Price
Supply
60
50
40
30
20
10
0 20 40 60 80 100 120 QTY

MOVEMENT ALONG THE SUPPLY CURVE
• Extension of supply/upward movement refers to increase
in quantity supplied as a result of increase in price of a
product while a contraction of supply/downward
movement refers to decrease in quantity supplied as a
result of decrease in price.
Price supply
30
contraction
20
extension
10
0 5 10 15 Quantity

DETERMINANT OF SUPPLY
• Price
• Cost of production
• The size and nature of the industry
• Change in price of other goods
• Government policy (taxes, subsidy)

CAUSES OF SHIFT IN SUPPLY
1. Cost of production- an increase in one or more of the cost
of production e.g. Raw materials, labour etc will reduce
producer’s profit, reduce supply and shift supply curve to
the left.
2. Number of suppliers (size of the of the industry)-
increase in the number of suppliers will increase total
supply and cause the curve to shift to the right.
3. Technology- improvement in the performance of
machine, employees or in production process will allow
more to be produced at lower cost. Therefore, technology
increases supply.

4. Government policy- government can encourage
the production of some goods (merit) by giving
subsidy to the producers of such goods which shifts
supply curve to the right and reduce the supply of
some (demerit) by placing taxes this shifts the
curve to the left.
5. Change in the price of other goods- if the price of
e.g. good B reduces, producers may switch to the
production of good A, this will increase the supply
of good A.

CLASSWORK (ECONOMICS)
• For each of the following decide whether the demand curve
or the supply curve will move and in which direction.
1. Consumers are convinced by arguments about the benefits
of organic vegetables.
2. A new process is developed that reduces the amount of
inputs that firms need in order to produce bicycles.
3. There is a severe frost in Brazil that affects the coffee crop
4. The government increases the rate of value added tax
5. Real income increases
6. The price of tea falls: what happens in the market for coffee
7. The price of sugar falls: what happens in the market for
coffee?

ELASTICITY OF DEMAND
• Elasticity of demand measures the sensitivity of demand to
a change in variable.
• The variable might be the price of the good, the price of
other goods, or income.
• If both demand and the variable move in the same
direction, the sign will be positive but if they move in
different directions it will be negative e.g. If demand falls
when price rises, the sign will be negative.
• Normal goods move in different directions while abnormal
( luxury/inferior ) goods move in the same directions. (for
Price Elasticity of Demand)

PRICE ELASTICITY OF DEMAND
• PED measures the sensitivity of demand to a
change in price.
1. Percentage change in quantity demanded
Percentage change in price
2. new qty dd-old qty dd x 100 ÷ new price-old pricex100
old qty old price
3. P (original) x ΔQ
Q {original) ΔP
NOTE- PED is not written as % and it is usually negative.

• PED will be negative for normal good (ignoring the
negative sign) but positive for inferior good
Example- Calculate PED if 7% increase in price leads to 28%
decrease in qty demanded and interpret your result
• PED= % change in quantity demanded
% change in price
= 28 %
7 %
= 4 (elastic). So, 1% increase in price leads to 4%
decrease in qty demanded.

TYPES/DEGREES OF PRICE ELASTICITY OF
DEMAND
1. ELASTIC DEMAND- it occurs when percentage
change in qty demanded is greater than
percentage change in price (GRAPH)
price
Little decrease in price leading to
50 E>1 greater increase in quantity
40 demanded (ignoring the nega-
D tive sign)
0 30 75
The higher the value of PED the more elastic demand is for the good.

2. INELASTIC DEMAND- it occurs when
percentage change in qty demanded is less
than percentage change in price (GRAPH)
price
Greater decrease in price leading to
50 E <1 smaller decrease in quantity
demanded (ignoring the negative
40 sign)
D
0 50 54 Qty

3. UNIT ELASTIC- it occurs when percentage
change in qty demand equals % change in price.
All the price and qty combinations give the same
total revenue. This is called hyperbola triangle.
P
Increase in the price leads to the same
10 E= 1 percentage decrease in quantity
20 demanded.
D
0 20 40 Qty

4. PERFECTLY INELASTIC- % change in qty
demanded equals zero (GRAPH)
price
D No matter how price changes,
quantity
10 E = 0 does not change.
8
6
4
0 10 Qty
It occurs to goods with NO substitute e.g. Air, water

5. PERFECTLY ELASTIC- % change in qty
demanded is infinite (GRAPH)
price
Little change in price leads to
infinite change in quantity
50 D demanded. Buyers will
E = ∞ only buy at one price
and
and no other
0 10 20 30 Qty
Any increase in price will cause demand to drop to zero

PEER WORK
1. Calculate PED if 50% increase in price leads to 25% decrease
in qty demanded and interpret your result.
2. When the price of toy car increased from 50p to 70p the
demand for them fell from 15 cars to 10 cars, calculate PED
(using different formula) and interpret your result.
3. For a change in price from £5 to £4, price elasticity of demand
is: [1]

RULES THAT DETERMINE PED
• Goods with close substitutes tend to have
more elastic demand because it is easier for
consumers to switch from that good to others.
Luxuries/goods that consumers can do
without also have elastic demands
• Necessities/monopoly goods/goods with few
substitute or sometimes new products tend to
have inelastic demands.

PRICE ELASTICITY AND A STRAIGHT LINE
DEMAND CURVE
• Price elasticity will vary on a downward
sloping straight line demand curve from being
elastic on the top left , unit elastic in the
middle and inelastic at the bottom right

Linear Demand Curve
PRICE
P. elastic E∞ This is how elasticity of demand changes as
price reduces
• Elastic E.1
unitary E =1
inelastic E<1
P. inelastic

FACTORS DETERMINING PRICE ELASTICITY OF
DEMAND(Non price factors)
1. Availability of substitutes- This makes demand elastic
because if there are many substitute, consumers can
switch away if a firm raises its price.
2. Period of time- Demand is usually inelastic in the short
time because it may not be easy to find alternatives.
Over time when consumers are able to find substitutes,
demand will be elastic
3. Proportion of income spent on a good- If consumers
spend a small percentage of his income on a good, his
demand for the good will be inelastic e.g. Sweet and
vice- versa.

4. The type of good- some goods are habitual and tend to be price
inelastic e.g. Cigarette, newspapers etc
5. The width of the definition- if we define the goods we are
interested in very widely, demand will be more inelastic e.g. All
cars. But if we look at one brand of the good, demand will be
elastic because consumers can switch to another brand
Narrowly defined markets tend to have more elastic demand
than broadly defined markets, because it is easier to find close
substitutes for narrowly defined goods
6. Brand loyalty- an organisation that enjoys loyal customers
might increase its price and the customers might be less
sensitive (inelastic)

Relationship between PED and total
expenditure on a product
• PED also help to understand how total
expenditure( spending) by consumers due to the changes in
price.
• Total Expenditure = price × quantity
• E.g if a product price is $15 and the quantity purchased is
500 unit per day the total expenditure is (15 ×500) = $7500
per day( this also serve as firm revenue).
• Now price increase to $17 and quantity demanded falls to
300 PED will be 3(elastic)
• If price increase to same amount and quantity demand falls
to 450 PED will be 0.75(inelastic)

So its important that when business plan to make price
change, the management(decision maker) are aware
of the PED
If price is inelastic business are able to increase price in
order to increase their profit(revenue)
Reducing price is not an option because revenue will fall
If price is elastic the business/firm should reduce their
price so as to increase the quantity demanded and
increase revenue. Increasing price would only reduce
quantity and revenue.

INCOME ELASTICITY OF DEMAND
• Income elasticity of demand measures the
degree of responsiveness of demand to a
change in real income.
• YED= % change in qty demanded
% change in income
• if a good is normal, the sign of YED will be
positive. As income rises, qty demanded rises
and the value > 1 e.g. Private health care

• Necessities tend to have small income
elasticities {inelastic). Luxuries tend to have a
large income elasticities (elastic).

GRAPH OF NORMAL/LUXURY GOOD
(ELASTIC)
NORMAL GOODS ARE GOODS WHICH DEMAND INCREASES AS INCOME INCREASES
INCOME YED
23 calculate YED for the graph
18
4 10 Qty
Goods like cloths, shoes, movies, airline travels etc are in this category.
• If a good is income elastic YED will be >1.

GRAPH OF NORMAL GOOD (INELASTIC)
INCOME YED
23 Calculate YED of this graph
18
4 5 Qty
Necessity goods and services fall into this category e.g. Haircuts, water,
electricity, toothpaste

GRAPH OF PERFECTLY INELASTIC
PERFECTLY INELASTIC. YED=0
income
D No matter how high income rises,
demand
10 E = 0 remains constant
8
6
4
0 10 Qty

GRAPH OF INFERIOR GOOD
• if a good is inferior, YED will be negative. As
income rises, demand falls
• GRAPH
Income Goods that are of low quality
are in this category e.g. Second
hand goods, cheaper goods
Y2
Y1 YED
Q 2 Q1 Demand
• INFERIOR GOODS ARE GOODS WHICH DEMAND REDUCES AS INCOME INCREASES

TYPES OF GOODS AND THEIR ELASTICITIES
NORMAL GOODS INFERIOR GOODS
PRICE ELASTICITY NEGATIVE. If price rises,
qty demanded falls.
Downward sloping demand
curve
POSITIVE. If price rises, qty
demanded rises. Upward
sloping demand curve
INCOME ELASTICITY POSITIVE. When income
rises, quantity demanded
increases
NEGATIVE. When income
rises, quantity demanded
falls as consumers switch
to more luxurious products

Factors affecting income elasticity of demand
• Nature of the product
• Level of the income(low/high)
• Percentage of income spent on the product

CROSS ELASTICITY OF DEMAND
• Cross elasticity of demand measures the
sensitivity of demand for one good to a change in
price of another good
• XED= % change in qty demanded of good A
% change in the price of good B
• if two goods are substitutes, XED will be positive.
As the price of one increases, demand for the
other increases

GRAPH OF SUBSTITUTES
PRICE OF XED When the price of one
MILO £ increases, customers
2 will reduce their
purchase and buy the
1 substitute good.
10 20 QTY OF BOURNVITA

• If they are complements, XED will be negative. As
the price of one rises, demand for the other falls.
price of washing machine (£)
when the price of a good increases,
100 demand for the good will fall and
demand for its complement will
70 fall.
XED
0 15 20 qty of washing soap

Factors affecting cross elasticity of demand
• Closeness of substitute/complement:The
closeness the more cross elastic the demand is
• Time period: The greater time /period spent
under consideration the more time for
consumer to find substitute.

CLASSWORK
• There has been a 2% increase in consumer’s
income and that has led to these changes.
Calculate YED and comment on your results.
Original demand ($
10)
New demand ($10)
Product A 100 units 103 units
Product B 100 units 99 units
Product C 100 units 101 units

SIGNIFICANCE OF ELASTICITIES
• Concerning income elasticity of demand, during ECONOMIC
GROWTH i.e. as income increases, producers should produce
more of NORMAL/LUXURY goods and few of inferior goods
should be made in order to increase revenue.
• But if the economy is in RECESSION (less income) producers
can produce more of inferior goods (CHEAP GOODS)
• For cross elasticity of demand, if a firm sells a product that
has close substitute and the price of the substitute drops, the
firm may choose to lower its price to avoid losing its
customers to the other good and also to increase its revenue
• Elasticity of demand enables the government to know which
good to tax and to subsidise. And to know how demand for
goods will change during booms and recessions when they
are setting their policies.

ELASTICITY OF SUPPLY
• Price elasticity of supply measures the
responsiveness of supply to a change in price
• PES= % change in the quantity supplied
% change in the price
• new qty ss – old qty ss x 100 ÷ new price – old x 100
Old quantity Old price
Calculate PES if the price of a Smartphone increase
from £449 to £485 when supply increase from
15000 to 21500
PES is generally positive since the higher the price
the greater the supply

GRAPH OF ELASTICITY OF SUPPLY
• Price Elastic
Unitary
Inelastic
qty

1. Unitary supply- supply is unitary if elasticity is 1. 30% increase in
the price of pork leads to 30% increase in supply. It occurs when
%change in price equals percentage change quantity supplied
price supply
26
E=1 Calculate the
20 PES
10 13 quantity

2. Elastic supply- if the % change in supply is greater than the %
change in price, supply is price elastic.
e.g if 10% rise in the price of bread leads to 50% rise in the
supply of bread, supply is elastic
Price supply - The higher the
value of PES the more
7 E>1 elastic supply is
5 -Calculate the PES
0 2 9 Quantity

3. Inelastic supply-If % change in supply is less
than % change in price then supply is inelastic
GRAPH
• Price supply
If the price of rice increases
15 50% and quantity supplied
E<1 supplied increases by 20 %
10 supply is inelastic.
0 10 12 Quantity -calculate PES

• Perfectly elastic- this occurs if elasticity is
infinity i.e. little increase in price will lead to
unlimited supply
GRAPH
• Price £
E=∞
5
10 20 30 Quantity

• Perfectly inelastic- supply is perfectly inelastic if
elasticity equals zero
GRAPH
price $ supply
4 E=0
3
2
10 Quantity

FACTORS AFFECTING ELASTICITY OF SUPPLY
1. The number of producers- supply will be elastic if
there are many producers because increase in price
will bring about greater increase in quantity
supplied
2. Existence of spare capacity- the more unused
resources (capacity), in the industry, the greater the
supply when there is increase in price.(elastic)
3. Availability of storage facilities- this maintains
inelastic supply especially for durable goods while
non availability leads to elastic supply

4. Factor mobility- the easier it is for resources
to be moved into an industry, the more elastic
supply will be
5. Length of production- the quicker it is to
produce a good, the more elastic supply will
be. If producers are unable to respond to the
price increase, the supply is price inelastic

SUPPPLY IN THE SHORT/LONG RUN
• Over a short period of time firms can find it difficult
to switch production from one production to
another. This means production is likely to be price
inelastic.
• This is also applicable to agricultural industry before
harvest producers may not be able to supply more
even if there is an increase in price.
• In the long run, producers can switch production and
supply in the agricultural market will increase at
harvest making supply elastic.

PRICE MECHANISM
• Price system is the system of the market system/capitalist
market. It determines what, how and for whom to produce
through the interaction of consumers and producers
• In this economy, price mechanism (Consumers and
producers) allocates resources.
• Adam smith presented a powerful case for a free market
system in which the invisible hand of the market would
allocate resources to everyone’s advantage.
• He described price mechanism as an invisible hand which
automatically regulates demand and supply.
• Price is a value at which a good or service is exchanged

FUNCTIONS OF PRICE
1. Rationing-Whenever resources are scarce, demand exceeds
supply and prices are driven up. The effect of such a price rise
is to discourage demand and ration the limited resources.
2. Signalling- Price changes send contrasting messages to
consumers. Rising prices give a signal to consumers to reduce
demand and they give a signal to potential producers to enter
a market.
3. Incentive- An incentive is something that motivates a producer
or consumer to follow a course of action. Higher prices
provide an incentive to existing producers to supply more
because they provide the more revenue and increased profits.

PRICE DETERMINATION (EQUILIBRIUM)
• In a free market supply and demand determine the
equilibrium price and quantity.
• Equilibrium occurs where the qty demanded equals qty
supplied and there is no incentive for change
PRICE £ QUANTITY DEMANDED
OF EGGS
QUANTITY SUPPLIED OF
EGGS
10 70 10
20 60 20
30 50 30
40 40 40
50 30 50
60 20 60
70 10 70

DISEQUILIBRIUM
Disequilibrium occurs when demand is not equal to supply (excess demand and
supply)
Price supply
EXCESS SUPPLY
60
40
20
EXCESS DEMAND
Demand
0 20 40 60 Quantity

• If the price is above the equilibrium price .e.g.
£60 , there will be excess supply; qty supplied is
greater than the qty demanded. For equilibrium
to be restored, price will have to fall.
• If the price is below the equilibrium price, e.g.
£20, there will be excess demand. Qty demanded
will be greater than qty supplied. For equilibrium
to be restored, then the price will have to rise.

condition description solution
Qty demanded > qty
supplied
Excess demand/shortage Price will rise
Qty demanded = qty
supplied
equilibrium Price remains the same
Qty demanded < qty
supplied
Excess supply/surplus Price will fall

CHANGES IN DEMAND AND SUPPLY
• Changes in market prices (equilibrium) will
occur as a result of changes/shift in
demand/or supply of goods.
a. Increase in demand for DVDs- increase in
demand will lead to a shift in demand curve
to the right. Such increase will cause a rise in
equilibrium price and quantity of DVDs.

GRAPH
Price of DVDs
supply
Increase in demand from
p1 D to D1 will increase
quantity
p from Q to Q1 and also push
up the price from P to P1.
D D1
0 Q Q1 quantity of DVDs

b. Decrease in supply of Electricity- decrease in supply
will lead to a shift in supply curve to the left. This will
cause the equilibrium price of electricity to rise and
equilibrium quantity to fall.
price S1 Decrease in supply
P1 S will increase the
P price from P to P1
D
0 Q1 Q Quantity

CLASS WORK
• Show the effect of:
1. Decrease in demand for Android Phones
2. Increase in both demand and supply of
iPhone
3. Decrease in demand and increase in supply
of Air travel.

INTERRELATIONSHIPS BETWEEN MARKETS
1. Joint demand- it occurs when 2 or more
commodities are needed to satisfy a want at
the same time e.g. Car and petrol. A rise in
qty demanded for a good (cars) will lead to a
rise in the demand for its complement
(petrol), resulting in an increase in the price
and qty purchased of its complement (petrol)

DIAGRAM
Market for cars Market for Petrol
Price Price
ss ss
P1 P1
P P
D1 D1
D D
0 qty 0 qty
Q Q1 Q Q1
Increase in demand for cars from D to D1 will increase demand for petrol
thereby increasing the price of petrol.

2. Competitive demand- goods are in
competitive demand if they are substitutes i.e.
Can be replaced by another good to satisfy a
want e.g. Turkey and chicken, coffee and tea
etc. A rise in the price of a good (turkey) will
lead to an increase in the demand and a rise in
the price of its substitute (chicken)

Price Market for Turkey Price Market for Chicken
S1 S
S
P1 P1
P P D1
D D
0 Q1 Q 0 Q Q1
Increase in the price of turkey will lead to increase in demand for
chicken and the price of chicken will eventually increase in its
price.

3. Derived demand- this occurs when demand
for a product occurs as a result of demand for
another e.g. Steel is demanded for ship, cars
etc. An increase in demand for a good e.g.
Cars will lead to an increase in demand and
the price of the derived e.g. Steel

DIAGRAM
Market for ship Market for steel (derived)
Price Price
ss ss
P1 P1
P P
D1 D1
D D
0 qty 0 qty
Q Q1 Q Q1
Increase in demand for ship from D to D1 will increase demand for (raw
materials) steel thereby increasing the price of steel.

4. Composite demand- it occurs when a good is
demanded for two or more uses, e.g. Land
may be demanded to build shops, build
houses or for farming. Increase in demand for
one composite good(land for shops) will lead
to a fall in supply of the other and its price will
increase (land for farming)

• Price of land (shops) price of land(houses)
ss s1 s
P1 P1
P P
D D1
0 Q Q1 qty 0 Q1 Q
qty
Increase in demand for land for shops will lead to a fall in supply of the
land for building thereby increasing the price of land in general.

5. Joint supply- it occurs when 2 or more goods
are produced together e.g. Petrol and
kerosene; an increase in supply of one (petrol)
will lead to an increase in supply of the other
(kerosene) and a decrease in its price

• PRICE MARKET FOR PETROL PRICE MARKET FOR KEROSENE
S S
S1 S1
P P
P1 P1
D D
0 Q Q1 QTY 0 Q Q1 QTY
Increase in supply of petrol will lead to increase in supply of kerosene and
the price of kerosene will fall.

CONSUMER SURPLUS
• Consumer surplus is the difference between the
amount consumers are willing to pay for a
commodity (indicated by the demand curve) and the
amount they actually pay ( market price).
• Demand curve shows how much buyers are willing to
pay for a given quantity of goods. The more buyers
are offered the less value they put on the last one
bought.
• Draw a demand curve from the table below
Price $ 35 30 25 20 15 10 5
Qty demand
(shoe)
1 2 3 4 5 6 7

Price Shoe
35
30
25
20
15
10
5 D
0 1 2 3 4 5 6 7 Quantity

• If there is only 1 shoe in the market , consumers are
willing to pay $35, as the qty of shoes increases,
consumers are willing to pay less.
• If a consumer actually paid $15 because the good is on
special offer, the buyer has gained a surplus of $ (35-
15) = 20. the consumer that prepared to pay $25 will
have a surplus of $10.
• Therefore, any amount above the market price of $15
represent consumer surplus
• If the market price changes, so does consumer surplus.

PRODUCER SURPLUS
• This is the difference between the amount
producers are prepared to supply and the
market price they receive.
• Draw a supply curve from this table below
Price of eggs ($) 5 10 15
Qty supply (crate) 10 20 30

Price supply
15
10
5
10 20 30 Quantity

• Assuming the lowest price a producer is
willing to supply is $5 per crate, but due to
scarcity of eggs in the market, he actually sold
it for $15 each, his surplus will be $15-5 =$10
• Any amount below the market price is
producer surplus
• Consumer and producer surplus can be shown
on demand and supply diagrams

GRAPH
H Consumer
surplus Supply
J G
Producer
surplus Demand
F Quantity
• The equilibrium price is J. Consumer surplus is the area JHG
while producer surplus is shown by JGF

• Anything that causes a shift/change in the
supply or demand curve will lead to a change
in the price of a good which will change the
consumer and producer surpluses.

SHIFT IN SUPPLY
Price V S1
P1 Y S
Pe X
Z
W D
Q1 Qe Qty
• A shift in the supply curve from S to S1 means the price will
increase from Pe to P1 and quantity will decrease from Qe to
Q1. consumer surplus reduced from VPeX to VP1Y and
producer surplus reduced from PeWX to P1ZY. Decrease in
supply reduces consumer surplus.

CHANGE IN DEMAND
Price V S
Z
pe X
p1 Y
w D1 D
0 Q1 Q quantity
A shift in demand curve from D to D1 means the price and quantity will
decrease from Pe to P1 and Qe to Q1 respectively. The consumer surplus
changes from VPeX to ZP1Y and the producer surplus changes from PeWX
to P1WY.
Decrease in demand reduces both consumer and producer surplus

CLASSWORK (ANDERTON)
• Demand for a good is zero at £200. It then rises
to 50 million units at £100 and 75 million at
£50.
a. Draw the demand curve for prices between 0
and £200
b. Shade the area of consumer surplus at a price
of £60.
c. Is consumer surplus larger or smaller at a price
of £40 compared to £60? Explain your answer.

MARKET FAILURE
• Market failure occurs when the price mechanism fails to account for all the
costs and the benefits involve in the production and the consumption of
goods and services.
• It occurs as a result of inefficient production and distribution of goods and
services/ mis-allocation of resources in the society.
SOURCES/TYPES/EXAMPLES
1. Externalities (negative and positive)
2. Public/Quasi Goods
3. Merit and Demerit goods
4. Missing market
5. Asymmetric information
6. Moral Hazard
7. Adverse Selection

2. PUBLIC GOODS
. Public goods- they are goods provided by the
government for the welfare of the people without a
direct cost to the people. The nature of public goods
is that they are consume by everyone and their use
by one person doesn't make it unavailable to others
They are not provided (missing) in a free market
because no one is willing to pay for them. E.g. Street
light, light house, National defence and so on.
With this kind of goods opportunity cost is an issue
since the public goods is competing with types of
government spending.

• Characteristics:
a. Non-rivalry: once provided, it does not diminish
E.g. benefiting from a street light doesn’t reduce
light for others.
b. Non-excludability: once provided, others can not
be prevented from enjoying it.
c. Free riders- people can enjoy the good for free so
no incentive to pay for it. It has positive externality
d. They mostly have positive externalities

Merit goods-are goods which are socially desirable, e.g.
museum, education, insurance etc. They are under
produced and under valued as the full benefit is not
recognised and people lack information about the benefit
which results in low demand.
Merit goods have positive externalities. (graph)
Demerit goods are goods which society feels are
undesirable, e.g. certain drugs, cigarette, fast food,
alcohol, fizzy drinks etc.
They are over valued by consumers, over produced, over
consumed and have negative externalities.
It is assumed that people lack information about their
negative effects. (graph)

GRAPH OF MERIT GOOD
Price S D = market demand
D1 = Ideal demand
P1
P D1 (with information)
D (without information)
0 Q Q1 Qty
There is under production of merit good because demand is low due to
lack of information. When there is proper information, demand will
increase to D1 and the price will also increase to P1. Therefore,
government will need to subsidies for such goods to reduce the price.

GRAPH OF DEMERIT GOOD
Price S D = market demand
D1 = Ideal demand
P
P1 D (without information)
D1 (with information)
0 Q1 Q Qty
There is over production of demerit good because demand is high due to
lack of information. When there is proper information, demand will
reduce to D1 and the price will also reduce to P1. Government needs to
impose tax on this good to increase the price.

SOLUTIONS TO MARKET
FAILURE/GOVERNMENT INTERVENTION
1. Minimum price control: It is used to reduce the
consumption of demerit goods. This will increase the
price and reduce quantity demanded.
It is also set to help producers especially farmers
increase their income. The price is not allowed to fall
below this level. It is set above the equilibrium price.
Limitations 1) excess supply/wastage of resources
2) low demand
3) It depends on the elasticity of demand for the
product.

GRAPH OF MINIMUM PRICE
Price supply
excess supply
P1 If the price is at P1,
demand
will reduce to Q1 while
p supply will increase to Q2.
This may reduce the
standard of living.
Demand
0 Q1 Q Q2 Quantity

2. Maximum price control: It is also used to encourage
the consumption of merit goods. It is set below the
equilibrium price
Government can use law to enforce maximum prices
for goods and services and this set a limit for the
prices. E.g. house rent, foodstuff, utility (water, light).
Limitations 1) black market
2) excess demand
3) Scarcity

GRAPH OF MAXIMUM PRICE
(maximum price is below the equilibrium price and can lead to
Price scarcity and black market)
supply
P
P1 EXCESS DEMAND
Demand
0 Q1 Q Q2 Quantity

3. Buffer stock policy/Price stability- it is used to
stabilise the price. When there is excess supply,
government will buy the excess to avoid falling
prices and when supply is low, government will
sell the stock to prevent higher prices.
limitation- 1) Expensive to maintain
2) Inadequate storage facility
3) Wastage of resources if demand is low

4. Indirect Taxes: these are levies placed on goods and
services. Government can place taxes on the
production of demerit goods or to discourage the
consumption of harmful goods and also equate
private cost and social cost. (internalising the
externalities)
Tax will be given to producers and will be passed on
to consumers in form of higher price. This will
discourage consumption thus reducing negative
externality over time.

GRAPH OF TAX
• Price
S1
S
P1 ----------------
P ----------------------------------
MPB=MSB
0 Q1 Q quantity
Tax will reduce supply to S1 and price will rise to P1 making the good more expensive.

LIMITATIONS OF TAX
1. Depends on the size of tax- if the tax is too small, it might
not reflect on the price.
2. Depends on the elasticity of demand- if demand is
inelastic/addictive, higher price will not really reduce
demand.
3. Government intervention may lead to inefficient allocation
of resources where price will be greater than marginal cost.
4. There may be problems in deciding what is healthy and what
is eligible for tax
5. The appropriate level of tax might be difficult to calculate
due to the complexity of the cost benefit analysis.
6. Fairness argument- some people may see the imposition of
tax as unfair especially if they are addicted to the goods.

GRAPH OF SUBSIDY
• Price
S
S 1
P ----------------
P1 ----------------------------------
MPB=MSB
0 Q Q1 quantity
subsidy will increase supply to S1 and price will fall to P1 making the good more affordable.

LIMITATIONS OF SUBSIDY
1. Depends on the size of subsidy- if the subsidy is too small,
it might not reflect on the price.
2. Depends on the elasticity of demand- if demand is
inelastic, change in price will not really increase demand.
3. Subsidy may encourage inefficiency because the price of
the good may not reflect the true cost.
4. There may be problems in deciding what is healthy and
what is eligible for subsidy
5. The appropriate level of subsidies might be difficult to
calculate due to the complexity of the cost benefit analysis.

6. Provision of information- Government may
provide information on the positive/negative
effects of some goods/services in order to
encourage/discourage the consumption of such
goods.
Information can be inform of advertisement
and so on
Public health announcement and campaigns
Nutrition and allergy information on food
packaging

ADDRESSING INCOME AND WEALTH
INEQUALITY
• Income is a reward of one of the factors of
production
• Income is a flow concept because it changes
over a period of time i.e the returns you get
on the various factors of production are
variable over any given period of time.
Examples are interest on capital, rent, saleries
&wage

• Wealth is describe as the stocks of assests that
someone has built up over time. For examples
gold, jewelries, properties,shares etc. These
assests are there to provide security and also
serve as income flow in the future.

LORENZ CURVE
• Lorenz curve illustrates the distribution of income and
wealth in an economy e.g. 20% of the population
should receive 20% of the national income while 50%
of the population should earn 50% of the income.
• In the diagram, 50% of the population have only 10%
of the income while 90% of the population have 50%
of the country’s income. The remaining 10% of the
population have 50% of the income
• The further the Lorenz curve is from the 45⁰ line , the
greater the income inequality in a society

10 20 30 40 50 60 70 80 90 100
100
90
80
70
60
50
40
30
20
10
Cumulative / % of Population
Cumulative%
of
Wealth World distribution of wealth (PPP) Lorenz Curve
Line of absolute equality

10 20 30 40 50 60 70 80 90 100
100
90
80
70
60
50
40
30
20
10
Cumulative Global Population
Cumulative
Wealth
(PPP) World distribution of wealth (PPP) Lorenz Curve
Line of absolute equality
The richest 10%
possessed 50% of the
world wealth in 1988.
Line of actual distribution

10 20 30 40 50 60 70 80 90 100
100
90
80
70
60
50
40
30
20
10
Cumulative Global Population
Cumulative
Wealth
(PPP) World distribution of wealth (PPP) Lorenz Curve
Line of total integration
The greater this
area the more
unequal the
distribution

Oxbridge Tutorial College 173
GINI COEFFICIENT
This is a measurement of the income distribution of a country's
residents i.e. the degrees of the inequality. This number, which
ranges between 0 and 1(or 0%-100%) is based on residents' net
income and helps define the gap between the rich and the poor, with
0 representing perfect equality and 1 representing perfect inequality.
• Formula = A/(A+B) where A is the area above the Lorenz curve and B
is the area below the Lorenz curve
• Gini index that is less than 0.2 represents perfect income equality,
0.2-0.3 relative equality, 0.3-0.4 adequate equality, 04-0.5 big
income gap and above 0.5 represents severe income gap

Economic Reason for inequality and wealth
• Economist argue that inequality of income and wealth
act as a barrier to economic growth and development
Economic reason for inequality are as follows
Unemployment(lack of job opportunities)
Poor vocational training( local industries cannot obtain
labour needed to get the work done )
Lack of investment in education and health sector
Poor infrastructure
Inability to get funding to start a new business

Policies to redistribute income and wealth
• Minimum wage rate: this is a legal requirement of what employers
must pay an employee either, hourly, weekly or monthly
This is applied to many countries.
Limitations
 Minimum wage rate has no relevence where workers are self employed
or run a small business where the staffs are family members.
 Inflation
 Low skilled workers will be at disadvantages
 Unemployment might increase ( companies might start using machinery
instead of labour)

• Progressive income Tax:progressive tax can be used
to to reduce the level of inequalities whereby those
earning a higher income are taxed higher rate of
their income than the low income earner by this
income differentials are reduced
• Inheritance tax: individual who inherit more than a
certain amount of wealth are ask to pay some of the
value as tax as government.
• Capital gain tax: this tax is charged on a financial gain
a person may have made

LIMITATION
• Low incentive to work
• Tax evasion
• Low government revenue
• Capital flight( moving to other countries to
invest)
• Low economic growth( disincentive to create
wealth)

• Transfer payment: this is a payment from tax revenue
that is recieved by certain individual/ member of the
community
• This policies tend to transfer income to those who are
not able to work i.e empolyed people are tax on their
income to pay the vulnerable groups such as, the
disabled, the unemployed, the retirees
Examples of transfer payment includes
Pension, child benefit, unemployment benefit, housing
allowance etc

Transfer payment leads to a reduction in poverty
and provide more equal distribution of income
but it has its own limitation.
Limitaions
Low incentive to work due to the
unemployment benefit recieved
Unemployement
Low economic growth

• State provision for essentials goods and services another
way government can reduce inequality is to provide some of
people needs for free. Such services will be financied by tax
• If the services are equally used by allthe citizens then those
on the lowest income will gain more therefore inequality is
lowered
Examples of free provision can be in form of healthcare,
education, housing, water, food
The justification is to get everyone to benefit from this and not
just the rich

AS Economic note (1)supply demand (1).pptx

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