Chapter Two

Theory of Demand and Supply

Having learnt about the concept and meaning of economics as a subject and its nature, scope,
different systems and various other fundamentals in the previous chapter, we now resort to a
very important issue in economics. This is the issue of how free markets operate. In this
chapter we will forward our exploration and understanding of the vast field of economics by
focusing on two very powerful tools, namely, theory of demand and theory of supply.

The purpose of this chapter is to explain what demand and supply are and show how they
determine equilibrium price and quantity. We will also show how the concepts of demand and
supply reveal consumers‘and producers‘sensitivity to price change.

Chapter objectives
After covering this chapter, you will be able to:
 understand the concept of demand and the factors affecting it;
 explain the supply side of a market and the determinants of supply;
 understand how the market reaches equilibrium condition, and the possible factors that
could cause a change in equilibrium and
 explain the elasticity of demand and supply

2.1 Theory of demand

1. Are demand and want similar? Why?
2. Why can’t we purchase all that we need or we desire to have?
3. Can we say that, with a decrease in the price of a commodity, a consumer
normally buys more of it? Why?
4. Explain why demand curves always slope downwards from left to right. Are
there any exceptions to this?

Demand is one of the forces determining prices. The theory of demand is related to the
economic activities of consumers-consumption. Hence, the purpose of the theory of demand is
to determine the various factors that affect demand.

In our day-to-day life we use the word ‗demand‘ in a loose sense to mean a desire of a person
to purchase a commodity or service. But in economics it has a specific meaning, which is
different from what we use it in our day to day activities.

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 Demand implies more than a mere desire to purchase a commodity. It states that the consumer
must be willing and able to purchase the commodity, which he/she desires. His/her desire
should be backed by his/her purchasing power. A poor person is willing to buy a car; it has no
significance, since he/she has no ability to pay for it. On the other hand, if his/her desire to buy
the car is backed by the purchasing power then this constitutes demand. Demand, thus, means
the desire of the consumer for a commodity backed by purchasing power. These two factors
are essential. If a consumer is willing to buy but is not able to pay, his/her desire will not
become demand. Similarly, if the consumer has the ability to pay but is not willing to pay,
his/her desire will not be called demand.

More specifically, demand refers to various quantities of a commodity or service that a

consumer would purchase at a given time in a market at various prices, given other things
unchanged (ceteris paribus). The quantity demanded of a particular commodity depends on the
price of that commodity.

Law of demand: This is the principle of demand, which states that , price of a commodity and
its quantity demanded are inversely related i.e., as price of a commodity increases (decreases)
quantity demanded for that commodity decreases (increases), ceteris paribus.
2.1.1 Demand schedule (table), demand curve and demand function

The relationship that exists between price and the amount of a commodity purchased can be
represented by a table (schedule) or a curve or an equation.

Demand schedule can be constructed for any commodity if the list of prices and quantities
purchased at those prices are known. An individual demand schedule is a list of the various
quantities of a commodity, which an individual consumer purchases at various levels of prices
in the market. A demand schedule states the relationship between price and quantity demanded
in a table form.

Table 2.1 Individual household demand for orange per week

Combinations A B C D E

Price per kg 5 4 3 2 1

Quantity demand/week 5 7 9 11 13

2
Demand curve is a graphical representation of the relationship between different quantities of
a commodity demanded by an individual at different prices per time period.

Y
Price
5 A
4 B
3 C

2 D

1 E

0 X Quantity demanded
55 7 9 11 13

Figure 2.1: Individual demand curve

In the above diagram prices of oranges are given on ‗OY‘ axis and quantity demanded on
‗OX‘ axis. For example, when the price per kilogram is birr 1 the quantity demanded is 13
kilograms. From the above figure you may notice that as the price declines quantity demanded
increases and vice-versa.

Demand function is a mathematical relationship between price and quantity demanded, all
other things remaining the same. A typical demand function is given by: Qd=f(P)
where Qd is quantity demanded and P is price of the commodity, in our case price orange.

Example: Let the demand function be Q = a+ bP

Q
b = (e.g. moving from point A to B on figure 2.1 above)
P

75
b=  2, where b is the slope of the demand curve
45
Q = a-2P, to find a, substitute price either at point A or B.

 7= a-2(4), a = 15

Therefore, Q=15-2P is the demand function for orange in the above numerical example.

Market Demand: The market demand schedule, curve or function is derived by horizontally
adding the quantity demanded for the product by all buyers at each price.

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 Table 2.2: Individual and market demand for a commodity

Price Individual demand Market

Consumer-1 Consumer-2 Consumer-3 demand
8 0 0 0 0
5 3 5 1 9
3 5 7 2 14
0 7 9 4 20

The following graph depicts market demand curve at price equal to 3

Price Price Price Price

3 + 3 + 3 = 3

5 Q 7 Q 2 Q 14 Q
Consumer-1 Consumer - 2 Consumer - 3 Market Demand

Figure 2.2: Individual and Market demand curve

Numerical Example: Suppose the individual demand function of a product is given by:
P=10 - Q /2 and there are about 100 identical buyers in the market. Then the market demand
function is given by:

P= 10 - Q /2 ↔ Q /2 =10-P ↔ Q= 20 - 2P and Qm = (20 – 2P) 100 = 2000-200P

2.1.2 Determinants of demand

The demand for a product is influenced by many factors. Some of these factors are:
I. Price of the product
II. Taste or preference of consumers
III. Income of the consumers
IV. Price of related goods
V. Consumers expectation of income and price
VI. Number of buyers in the market

4
When we state the law of demand, we kept all the factors to remain constant except the price of
the good. A change in any of the above listed factors except the price of the good will change
the demand, while a change in the price, other factors remain constant will bring change in
quantity demanded. A change in demand will shift the demand curve from its original location.
For this reason those factors listed above other than price are called demand shifters. A change
in own price is only a movement along the same demand curve.

Changes in demand: a change in any determinant of demand—except for the good‘s price-
causes the demand curve to shift. We call this a change in demand. If buyers choose to
purchase more at any price, the demand curve shifts rightward—an increase in demand. If
buyers choose to purchase less at any price, the demand curve shifts leftward—a decrease in
demand.

When demand increases, demand

Price
curve shifts upward (D1) while a
1 decrease in demand shifts demand
curve downwards (D2).
2 D1

D0
D2
Quantity
Figure 2.3: Shift in demand curve

Now let us examine how each factor affect demand.

I. Taste or preference

When the taste of a consumer changes in favour of a good, her/his demand will increase and
the opposite is true.

II. Income of the consumer

Goods are classified into two categories depending on how a change in income affects their
demand. These are normal goods and inferior goods. Normal Goods are goods whose demand
increases as income increase, while inferior goods are those whose demand is inversely related
with income. In general, inferior goods are poor quality goods with relatively lower price and
buyers of such goods are expected to shift to better quality goods as their income increases.
However, the classification of goods into normal and inferior is subjective and it is usually
dependent on the socio-economic development of the nation.

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 III. Price of related goods

Two goods are said to be related if a change in the price of one good affects the demand for
another good.

There are two types of related goods. These are substitute and complimentary goods.
Substitute goods are goods which satisfy the same desire of the consumer. For example, tea
and coffee or Pepsi and Coca-Cola are substitute goods. If two goods are substitutes, then price
of one and the demand for the other are directly related. Complimentary goods, on the other
hand, are those goods which are jointly consumed. For example, car and fuel or tea and sugar
are considered as compliments. If two goods are complements, then price of one and the
demand for the other are inversely related.

IV. Consumer expectation of income and price

Higher price expectation will increase demand while a lower future price expectation will
decrease the demand for the good.

V. Number of buyer in the market

Since market demand is the horizontal sum of individual demand, an increase in the number of
buyers will increase demand while a decrease in the number of buyers will decrease demand.

2.1.3 Elasticity of demand

1. List some goods/commodities you think that increase in their prices will
not significantly decrease their quantity demanded.
2. Can you list some products for which increase in their prices will
significantly decrease/increase their quantity demanded?

In economics, the concept of elasticity is very crucial and is used to analyze the quantitative
relationship between price and quantity purchased or sold. Elasticity is a measure of
responsiveness of a dependent variable to changes in an independent variable. Accordingly, we
have the concepts of elasticity of demand and elasticity of supply.

Elasticity of demand refers to the degree of responsiveness of quantity demanded of a good to

a change in its price, or change in income, or change in prices of related goods. Commonly,
there are three kinds of demand elasticity: price elasticity, income elasticity, and cross
elasticity.

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 i. Price Elasticity of Demand

Price elasticity of demand means degree of responsiveness of demand to change in price. It

indicates how consumers react to changes in price. The greater the reaction the greater will be
the elasticity, and the lesser the reaction, the smaller will be the elasticity. Price elasticity of
demand is a measure of how much the quantity demanded of a good responds to a change in
the price of that good, computed as the percentage change in quantity demanded divided by the
percentage change in price.

Demand for commodities like clothes, fruit etc. changes when there is even a small change in
their price, whereas demand for commodities which are basic necessities of life, like salt, food
grains etc., may not change even if price changes, or it may change, but not in proportion to the
change in price.

Price elasticity demand can be measured in two ways. These are point and arc elasticity.

a. Point Price Elasticity of Demand

This is calculated to find elasticity at a given point. The price elasticity of demand can be
determined by the following formula.

Ep Percentage change in quantity demanded %Qd

 
d
percentage change in price %P

Q1  Q0
where %Qd 
Q0 X100 and

P1 
%P 
P0 X100

P0

Q1  Q0
X100
Thus, E P Q0 Q1  Q0 P0 Q P0
d  .  .
P1  P 0 P P Q P Q
X100 1 0 0 0
P0

In this method, we take a straight-line demand curve joining the two axes, and measure the
elasticity between two points Qo and Q1 which are assumed to be intimately close to each other.

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 Y
In the diagram ‗RP‘ is the straight-line
R
Pric

demand curve, which connects both axes. In

e

the beginning at the price ON the quantity

N Qo
demanded is OM. Then the price changes to
∆P
N 1 N1 Q1
ON1 and the new quantity demanded will be
∆Q OM1. The symbol ‗∆P‘ represents the change
in price while the symbol ‗∆Q‘ shows the
change in quantity demanded.
O M M1 P Quantity

Figure 2.4: Point elasticity of demand

On a straight-line demand curve we can make use of this formula to find out the price elasticity
at any particular point. We can find out numerical elasticities also on different points of the
demand curve with the help of the above formula. It should be remembered that the point
elasticity of demand on a straight line is different at every point.

b. Arc price elasticity of demand

The main drawback of the point elasticity method is that it is applicable only when we have
information about even the slight changes in the price and the quantity demanded of the
commodity. But in practice, we do not acquire such information about minute changes. We
may possess demand schedules in which there are big gaps in price as well as the quantity
demanded. In such cases, there is an alternative method known as arc method of elasticity
measurement.

In arc price elasticity of demand, the midpoints of the old and the new values of both price and
quantity demanded are used. It measures a portion or a segment of the demand curve between
the two points. An arc is a portion of a curve line, hence, a portion or segment of a demand
curve.

The formula for measuring arc elasticity is given below.

Change
in
E  quantity demanded
 Change in price
d
Original quantity plus new Original price plus
quantity demanded new price
Symbolically, the formula may be expressed thus:
Q1  Q0 P1  P0
Ed  
Qo  Q1 Po  P1

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Here, Qo = Original quantity demanded
Q1 = New quantity demanded
Po = Original price
P1 = New price

We can take a numerical example to illustrate arc elasticity. Suppose that the price of a
commodity is Br. 5 and the quantity demanded at that price is 100 units of a commodity. Now
assume that the price of the commodity falls to Br. 4 and the quantity demanded rises to 110
units. In terms of the above formula, the value of the arc elasticity will be

110  100 45 9 3

Ed =  10 1 =- =
= 
100  110 4 210 9 21 7
5

Note that:
 Elasticity of demand is unit free because it is a ratio of percentage change.
 Elasticity of demand is usually a negative number because of the law of demand. If the price
elasticity of demand is positive the product is inferior.

i) If   1, demand is said to be elastic and the product is luxury product

ii) If 0    1, demand is inelastic and the product is necessity

iii) If   1, demand is unitary elastic.

iv) If   0, demand is said to be perfectly inelastic.

v) If  
Demand is said to be perfectly elastic.
,

Determinants of price Elasticity of Demand

The following factors make price elasticity of demand elastic or inelastic other than changes in
the price of the product.
i) The availability of substitutes: the more substitutes available for a product, the more
elastic will be the price elasticity of demand.
ii) Time: In the long- run, price elasticity of demand tends to be elastic. Because:
 More substitute goods could be produced.
 People tend to adjust their consumption pattern.
iii) The proportion of income consumers spend for a product:-the smaller the
proportion of income spent for a good, the less price elastic will be.
iv) The importance of the commodity in the consumers’ budget :
 Luxury goods  tend to be more elastic, example: gold.
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 Necessity goods  tend to be less elastic example: Salt.

10
 ii. Income Elasticity of Demand

It is a measure of responsiveness of demand to change in income.

%Qd Q I
 dI = = .
%I I Q

Point income elasticity of demand:

i) If   1, the good is luxury good.

I d

 1 ( and positive), the good is necessity good,

ii) If  d
I
 0, (negative), the good is inferior good.
iii) If  d
I

iii. Cross price Elasticity of Demand

Measures how much the demand for a product is affected by a change in price of another good.

 xy Q x  Q x Py
%Qx
 =
Py  P y . Q x
1 o 0

%Py 1 0 0

i) The cross – price elasticity of demand for substitute goods is positive.

ii) The cross – price elasticity of demand for complementary goods is negative.

iii) The cross – price elasticity of demand for unrelated goods is zero.

Example: Consider the following data which shows the changes in quantity demanded of good
X in response to changes in the price of good Y.

Unit price of Y Quantity demanded of X

10 1500
15 1000

Calculate the cross –price elasticity of demand between the two goods. What can you say about
the two goods?

Qx Pyo 1000 1500  10  500 10  0.67

  *  .*  .
x
y Py Qxo   5 1500
15 10 1500

Therefore, the two goods are complements.

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 2.2 Theory of supply
Supply indicates various quantities of a product that sellers (producers) are willing and able to
provide at different prices in a given period of time, other things remaining unchanged.

The law of supply: states that, ceteris paribus, as price of a product increase, quantity supplied
of the product increases, and as price decreases, quantity supplied decreases. It tells us there is
a positive relationship between price and quantity supplied.

2.2.1 Supply schedule, supply curve and supply function

A supply schedule is a tabular statement that states the different quantities of a commodity
offered for sale at different prices.

Table 2.1: an individual seller’s supply schedule for butter

Price ( birr per kg) 30 25 20 15 10

Quantity supplied kg/week 100 90 80 70 60

A supply curve conveys the same information as a supply schedule. But it shows the
information graphically rather than in a tabular form.

In this diagram the quantities of

Supply curve oranges are measured along X axis

and prices along Y axis. The supply
Price

curve slopes upward as we go from

the left to the right. This means, as
the price rises, more is offered for
sale and vice-versa.
Quantity

Figure 2.1 supply curve

The supply of a commodity can be briefly expressed in the following functional relationship:

S = f(P), where S is quantity supplied and P is price of the commodity.

Market supply: It is derived by horizontally adding the quantity supplied of the product by all
sellers at each price.

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 Table 2.1: Derivation of the market supply of good X

Price per Quantity Quantity supplied Quantity Market supply

unit supplied by by seller 2 supplied by per week
seller 1 seller 3
5 11 15 8 34
4 10.5 13 7 30.5
3 8 11.5 5.5 25
2 6 8.5 4 18.5
1 4 6 2 12

2.2.2Determinants of supply

Apart from the change in price which causes a change in quantity demanded, the supply of a
particular product is determined by:

i) price of inputs ( cost of inputs)

ii) technology

iii) prices of related goods

iv) sellers‘ expectation of price of the product

v) taxes & subsidies

vi) number of sellers in the market

vii) Weather, etc.

i) Effect of change in input price on supply of a product

An increase in the price of inputs such as labour, raw materials, capital, etc causes a decrease
in the supply of the product which is represented by a leftward shift of the supply curve.
Likewise, a decrease in input price causes an increase in supply.

ii) Effect of change in Technology

Technological advancement enables a firm to produce and supply more in the market. This
shifts the supply curve outward.

iii) Effect of change in weather condition

A change in weather condition will have an impact on the supply of a number of products,
especially agricultural products. For example, other things remain unchanged, good weather

13
 condition boosts the supply of agricultural products. This shifts the supply curve of a given
agricultural product outward. Bad weather condition will have the opposite impact.

Activity: Discuss how supply is affected by the changes in prices of related goods, taxes
& subsidies, sellers’ expectations of future price of the product, and the number of
sellers in the market?

2.2.3 Elasticity of supply

It is the degree of responsiveness of the supply to change in price. It may be defined as the
percentage change in quantity supplied divided by the percentage change in price. As the case
with price elasticity of demand, we can measure the price elasticity of supply using point and
arc elasticity methods. However, a simple and most commonly used method is point method.

The point price elasticity of supply can be calculated as the ratio of proportionate change in
quantity supplied of a commodity to a given proportionate change in its price. Thus, the
formula for measuring price elasticity of supply is:

𝐸=
% Q Q P
% P ==
PQ *
Like elasticity of demand, price elasticity of supply can be elastic, inelastic, unitary elastic,
perfectly elastic or perfectly inelastic. The supply is elastic when a small change on price leads
to great change in supply. It is inelastic or less elastic when a great change in price induces
only a slight change in supply. If the supply is perfectly inelastic, it will be represented by a
vertical line shown as below. If supply is perfectly elastic it will be represented by a horizontal
straight line as in second diagram.
Price
Price

S
Infiniteelasticityor
Perfectly inelastic or perfectly elastic
zero elasticity
P S

Supply
0 Supply O
Figure 2.2: Perfectly inelastic and perfectly elastic supply curves

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 2.3 Market equilibrium
Having seen the demand and supply side of the market, now let‘s bring demand and supply
together so as to see how the market price of a product is determined. Market equilibrium
occurs when market demand equals market supply.

- At point ‗E‘ market

Price demand equals market
D S
supply (equilibrium point)
H J - P is the market
(P1)
equilibrium (market
(P) E clearing) price.
- M is the market
(P2) G F
equilibrium (market
clearing) quantity.
S D
Quantity
M

Figure 2.3: market equilibrium

In the above graph, any price greater than P will lead to market surplus. As the price of the
commodity increases, consumers demand less of the product. On the other hand, as the price of
increases, producers supply more of the good. Therefore, if price increases to P 1 the market
will have a surplus of HJ. If the price decreases to P 2 buyers demand to buy more and suppliers
prefer to decrease their supply leading to shortage in the market which is equal to GF.

Numerical example: Given market demand: Qd= 100-2P, and market supply: P =( Qs /2) + 10
a) Calculate the market equilibrium price and quantity
b) Determine, whether there is surplus or shortage at P= 25 and P= 35.

Solution:

a) At equilibrium, Qd= Qs

100 – 2P = 2P – 20

4P =120

P  30, and Q  40

b) Qd(at P = 25) = 100-2(25) =50 and Qs(at P = 25 ) = 2(25) -20 =30

Therefore, there is a shortage of: 50 -30 =20 units

Qd( at P=35) = 100-2(35) = 30 and Qs (at p = 35) = 2(35)-20 = 50, a surplus of 20 units

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Effects of shift in demand and supply on equilibrium

Given demand and supply the equilibrium price and quantity are stable. However, when these
market forces change what will happen to the equilibrium price and quantity? Changes in
demand and supply bring about changes in the equilibrium price level and the equilibrium
quantity.

i) when demand changes and supply remains constant

Factors such as changes in income, tastes, and prices of related goods will lead to a change in
demand. The figure below shows the effects of a change in demand and the resultant
equilibrium price and quantity. DD is the demand curve and SS is the supply curve.
Price

S
D1
D
D2 E1
E1
P1

P E
P2 D1
E2
D
D2
S
Quantity

M2 M M1
Figure 2.8: The effect of change in demand on market equilibrium

DD and SS curves intersect at point E and the quantity demanded and supplied is OM at OP
equilibrium price. Given the supply, if the demand increases the demand curve will shift
upward to the right. Due to a change in demand, the demand curve D 1D1 intersects SS supply
curve at point E1. The equilibrium price increases from OP to OP 1 and the equilibrium quantity
from OM to OM1. On the other hand, if demand falls, the demand curve shifts downwards to
the left. Due to a change in demand, the curve D 2D2 intersects the supply curve SS at point E 2.
The equilibrium price decreases from OP to OP2 and the equilibrium quantity decreases from
OM to OM2. Supply being given, a decrease in demand reduces both the equilibrium price and
the quantity and vice versa.

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ii. When supply changes and demand remains constant
Changes in supply are brought by changes in technical knowledge and factor prices. The
following graph explains the effects of changes in supply.

S2
Price

D S
S1

E2
P2
P E
P1 E1

S2 S
S1 D

M2M M1 Quantity

Figure 2.9: The effect of change in supply on market equilibrium

SS and DD intersect at point E, where supply and demand are equal at OM quantity at OP
equilibrium price. Given the demand, if the supply increases, the supply curve shifts to the
right (S1S1). The new supply curve, which intersects DD curve at E 1, reduces the equilibrium
price from OP to OP1 and increases the equilibrium quantity from OM to OM 1. On the
contrary, when the supply falls, the supply curve moves to the left (S 2S2) and intersects the DD
curve at point E2 raising the equilibrium price from OP to OP 2 and reducing the equilibrium
quantity from OM to OM2.

III) Effects of combined changes in demand and supply

When both demand and supply increase, the quantity of the product will increase definitely.
But it is not certain whether the price will rise or fall. If an increase in demand is more than an
increase in supply, then the price goes up. On the other hand, if an increase in supply is more
than an increase in demand, the price falls but the quantity increases. If the increase in demand
and supply is same, then the price remains the same.

When demand and supply decline, the quantity decreases. But the change in price will depend
upon the relative fall in demand and supply. When the fall in demand is more than the fall in
supply, the price will decrease. On the other hand, when the fall in supply is more than the fall
in demand, the price will rise. If both demand and supply decline in the same ratio, there is no
change in the equilibrium price, but the quantity decreases.

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 Activity: Considering the initial market equilibrium of figure 2.9 above, show the new
equilibrium
1. if there is an increase in supply and proportionate increase in demand
2. if the magnitude of an increment in demand is less than an increment
in supply
3. if demand and supply change in the opposite directions

Chapter summary
Demand for a commodity refers to the amount that will be purchased at a particular price
during a particular period of time. Price of the commodity, income of the consumer, prices of
related goods, consumer‘s tastes and preferences, consumers‘ expectations and number of
buyers are considered the main determinants of demand for a commodity. The law of demand
states that, other things remaining constant, the quantity demanded of a commodity increases
when its price falls and decreases when the price rises.

Supply refers to the quantity of a commodity which producers are willing to produce and offer
for sale at a particular price during a particular period of time. Price of a commodity, input
prices, prices of related products, techniques of production, policy of taxation and subsidy,
expectations of future prices, and the number of sellers are the main determinants of supply.
Law of supply states that other things remaining the same, the quantity of any commodity that
firms will produce and offer for sale rises with a rise in price and falls with a fall in price.

Market equilibrium refers to a situation in which quantity demanded of a commodity equals the
quantity supplied of a commodity.

Goods can be categorized as normal good (a good for which the demand increases with
increases in income), an inferior good (a good for which the demand tends to fall with an
increase in the income of the consumer), substitute goods(are those goods which satisfy the
same type of demand and can be used in place of one another), complementary goods( are
those goods which are used jointly or together), and giffen goods(whose demand falls with a
fall in their prices).

Elasticity of demand refers to the degree of responsiveness of quantity demanded of a

commodity to change in any of its determinants. There are three types of elasticity of demand:
Price elasticity of demand, income elasticity of demand and cross price elasticity of demand.
Price elasticity of demand is determined by availability of substitutes, nature of the commodity,
proportion of income spent and time.

18
 Review questions
Part I: Distinguish between the following:
1. Normal goods and inferior goods
2. Complementary goods and substitute goods
3. Market demand and individual demand
4. Individual supply and market supply
5. Excess demand and excess supply

Part II: Short answer and workout

1. Why does the quantity of salt demanded tend to be unresponsive to changes in its price?

2. Why is the quantity of education demanded in private universities much more

responsive than salt is to changes in price?

3. To get the market demand curve for a product, why do we add individual demand curves
horizontally rather than vertically?

4. The market for lemon has 10 potential consumers, each having an individual demand curve
P = 101 - 10Qi, where P is price in dollars per cup and Qi is the number of cups demanded
per week by the ith consumer. Find the market demand curve using algebra. Draw an
individual demand curve and the market demand curve. What is the quantity demanded by
each consumer and in the market as a whole when lemon is priced at P = $1/cup?

5. The demand for tickets to an Ethiopian Camparada film is given by D(p)= 200,000-
10,000p, where p is the price of tickets.If the price of tickets is 12 birr, calculate price
elasticity of demand for tickets and draw the demand curve

6. Given market demand Qd = 50 - P, and market supply P = Qs + 5

A) Find the market equilibrium price and quantity?

B) What would be the state of the market if market price was fixed at Birr 25 per unit?

C) Calculate and interpret price elasticity of demand at the equilibrium point.

19
7. Based on the following table which indicates expenditure of the
household on a commodity, answer the questions that follow ( The
price of the good is Br.10 )

Income Quantity Demanded

( Br. / month) ( units / month )
10,000 50
20,000 60
30,000 70
40,000 80
50,000 90

A) Calculate income elasticity of demand, if income increases from Br.10,

000 to Br. 20,000 and
B) Is this a normal or an inferior or a luxury good? Justify.
C) Does the proportion of household income spent on this good increase or
decrease as income increases? .Why?

8. When price of tea in local café rises from Br. 10 to 15 per cup, demand for
coffee rises from 3000 cups to 5000 cups a day despite no change in coffee
prices.
A) Determine cross price elasticity.
B) Based on the result, what kind of relation exists between the two goods?

20