Economics Unit 3, 4 PDF

Unit Economic Resources and Markets 3 Introduction The vital economic problem that any human society faces is the scarcity of resources. Scarcity refers to the fact that all economic resources that a society needs to produce goods and services are limited in supply. The term scarcity reflects...

Unit Economic Resources and Markets 3 Introduction The vital economic problem that any human society faces is the scarcity of resources. Scarcity refers to the fact that all economic resources that a society needs to produce goods and services are limited in supply. The term scarcity reflects the imbalance between the unlimited human wants and the means to satisfy those wants. This unit deals with types of resources and factor payments, renewable and non-renewable resources, types of markets, circular flow of economic activities and land as economic resource in Ethiopia. Unit Objectives At the end of this unit, students will be able to: 6 Describe resources. 6 Describe the types of resources and factors of payment. 6 Make a distinction between renewable and non-renewable resources. 6 Recognize the important role of land in Ethiopia as a resource. ✍ Start-up Activities 1. Can you explain the meaning of resources? 2. How do you define renewable and non-renewable resources? 3. How do you describe the term “market”? 4. What is the circular flow of economic activities? 5. How do you define land in the context of agriculture in Ethiopia? 👉 Key Concepts Economic resources, free resources, factor payments, fossil fuels, natural gas, non-renewable resources, recycling, renewable resources, renewal process, replenished, solar energy, wind energy, labour market, financial market, households, business firms, government, money flows, real flows, good soil, and suitable climates. 29 Unit 3: Economic Resources and Markets  3 1 Types of Resources and Factor Payments At the end of this section, students will be able to: 6 Define resources. 6 Explain the types of resources and factor payments of each category of resources. ✍ Start-up Activity Can you explain the meaning of resources? Resources are inputs used in the process of production in order to make goods and services available to the society. There are two types of resources; namely, free resources and economic resources. Free resources: A resource is said to be free if the amount available to a society is greater than the amount people desire to have at zero price. In other words, free resources are the free gifts of nature, which are unlimited in supply and have no prices. For example, air, sunshine, solar energy, and a mountain stream. Economic (Scarce) Resources: A resource is said to be economic or scarce when the amount available to a society is less than what people want to have at zero price. Since economic resources are scarce or not available in plenty, they have non-zero prices. Price is the test of whether a resource is an economic or a free good. Examples of scarce resources are: y All types of human resources: manual, intellectual, skilled and specialized labor; y Most natural resources, like land (especially fertile land), minerals, clean water, forests, and wild animals, y All types of capital resources (like machines, intermediate goods, and infrastructure) and y All types of entrepreneurial resources. Generally, we can divide economic resources into four broad categories. These are land, labour, capital, and entrepreneurship. Each of these categories is briefly described below. y Labour: refers to the physical as well as mental efforts of human beings in the production and distribution of goods and services. The reward for labour is wage. y Land: refers to the natural resources, or all the free gifts of nature, used in the production of goods and services. The reward for the services of the land is rent. Unit 3: Economic Resources and Markets 30  y Capital: refers to all the manufactured inputs that can be used to produce other goods and services. Example: equipment, machinery, transport and communication facilities, etc. The reward for the services of capital is interest y Entrepreneurship: refers to a special type of human talent that helps to organize and manage other factors of production to produce goods and services and takes the risk of making losses. The reward for entrepreneurship is profit. Ă Activity 3 1 1. Define resources and point out the two types of resources. 2. Describe the four categories of economic resources and cite their factor payments. 3.2 Renewable and Non-renewable Resources At the end of this section, students will be able to: 6 Define renewable and non-renewable resources. 6 Explain the difference between renewable and non-renewable resources. 6 Describe the concept of conservation of natural resources ✍ Start-up Activity How do you define renewable and non-renewable resources? There are many types of resources that go into producing goods and services. These resources have been broadly classified into two categories: renewable resources and non-renewable resources. Renewable resources are resources that have the potential to be replaced over time through natural processes. The renewal process may be relatively quick, as with sunshine, which comes on a daily basis. Or else, the renewal process may be very slow, as in the formation of soil, which may take hundreds of years. Examples of renewable resources are solar energy, wind energy, soil, trees, grass, geothermal pressure, and ground water. Non-renewable resources are resources whose stock or reserve is limited or fixed, and which are found in the ground. The available supply of non-renewable resources may be replenished through recycling, but the overall supply remains relatively constant. Examples of non-renewable resources are natural gas, coal, steel, aluminum, and oil. All natural resources should be used wisely. We must conserve natural resources. “Conserve means not misusing, spoiling, or wasting things. This is especially true for nonrenewable resources. However, even some renewable natural resources can be 31 Unit 3: Economic Resources and Markets depleted (run out) if they are all killed or overused. We must also protect our natural resources from pollution. Pollution occurs when people put harmful chemicals and other things into nature. Oil spilled into water, toxic chemicals in the air, or garbage dumped on the side of the road are examples of this problem. Conservation of natural resources To conserve natural resources, you can reduce, reuse, and recycle them. For example, turn off the lights when you are not in a room. This will reduce the use of fossil fuels used to generate electricity. Ride your bicycle and walk more, to reduce the amount of gasoline used to transport you. You can reuse things. Things like plastic jugs, jars, paper, and bags can be reused. Each time you reuse something, you conserve the natural resources that would have been used to make the new one. Finally, you can recycle. Recycling means reusing a natural resource or product to make something new. It also means collecting and sending these things for reuse. Items that can be easily recycled include: glass, some plastics, paper, cardboard, aluminum, and steel. Some plastics and metals are hard to recycle. They are often made from mixtures of materials. Mixtures can be hard to separate. Try to buy and use things that you can recycle. In general, natural resources, both renewable and nonrenewable, are important to all of us. We must conserve and carefully use natural resources. Our future depends on them. Ă Activity 3 2 1. What do you mean by renewable and non-renewable resources? 2. What is the difference between renewable and nonrenewable resources? 3. What can you do to take care of natural resources? 3 3 Types of Markets At the end of this section, students will be able to: 6 Define a market. 6 Distinguish among the financial market, goods and services market, and labour market. ✍ Start-up Activity How do you describe the term “market”? A market is an institution where two parties can meet to facilitate the exchange of goods and services. The parties involved are usually buyers and sellers. The market Unit 3: Economic Resources and Markets 32 may be physical, like a retail outlet, where people meet face-to-face, or digital, like an online market, where there is no direct physical contact between buyers and sellers. Although there are many types of markets, in this section we focus on three types of markets. These are the goods and services market, the labor market, and the financial market. We can briefly discuss each of these markets as follows. Goods and services market The goods and services market is where households purchase consumable goods and services and businesses sell their goods and services. This market includes stores, the Internet, and any other place where consumer goods and services are exchanged. When you go to the store, shop on the internet, or even just trade with your friend, you are dealing in the goods and services market. It is in this market that end products are traded. Consumers pay money to businesses to acquire something. Money flows from the consumer to the business firms continuously. Labour market The labour market is a market in which employees provide the labour services and employers provide the employment opportunities for labour. The labour market should be viewed at both the macroeconomic and microeconomic levels. For example, daily labourers, domestic workers, skilled workers, professionals, etc. provide labour services to the labour market. Financial market A financial market is any place where securities, currencies, bonds, and other financial assets are traded between two parties. This market is the basis of capitalist societies, and it provides capital formation and liquidity for businesses. It can be physical or digital. Examples of financial markets include bond, stock, share, etc. Activity 3 3 1. List down the different kinds of markets found in your surroundings and classify them into goods and services markets, labour markets, and financial markets, if any. 2. Explain the difference between the goods and services market and the labor market. 33 Unit 3: Economic Resources and Markets  3.4 Circular Flow of Economic Activities At the end of this section, students will be able to: 6 Define circular flow of income. 6 Explain the models of circular flow. 6 Construct a circular flow of economic activities and interpret them. ✍ Start-up Activity What is the circular flow of economic activities? The circular flow of economic activities is a simplified macroeconomic model of the basic economic relationships in a market economy. This model gives an overview of how households, businesses, and the government interact in different markets by exchanging goods and services, productive resources (inputs or the factors of production), and money. Production, exchange and consumption are three important activities of an economy. As people carry out these economic activities, transactions among different sectors of the economy occur. Because of these transactions, income and expenditure move in a circular way in an economy. This is called circular flow of income or circular flow diagram. Before we illustrate and explain the circular flow of income in an economy, let’s consider the different sectors into which an economy is divided for this purpose. These sectors are also sometimes known as decision-making units of the economy. Generally, they are called economic agents. Definition: A circular flow of income is a visual model of an economy that shows how a currency, such as the Birr, flows through markets among decision- making units. Circular flows of income and expenditure A circular flow is a pictorial representation of the continuous flow of payments and receipts for goods and services and factor services among different sectors of the economy. It also refers to the process whereby the income and expenditure of an economy flow in a circular manner continuously through time. Types of flows Economic transactions, like the sale and purchase of goods and factor services, generate two types of flows, namely, real flows and money flows. Real flow and money flow are the two main aspects of the circular flow of income model. Both refer to exchanges of goods and services for money, but the two concepts differ in how they refer to the opposite sides of these exchanges as they relate to individuals and companies. Unit 3: Economic Resources and Markets 34 Note that real flows and money flows are two sides of the same coin. A real flow of goods and services is matched by an equal but opposite money flow. Real flows Real flows consist of the flows of: y Factor services from the owners of factor services to the producers, and y Goods and services from the producers to the buyers. Money (financial) flows Money flows consist of the flows of: y Money incomes from factor services such as rent, wages, interest, etc., and y Money expenditures incurred for the purchase of goods and services. Figure 3.1 Circular flow of income: Real flow and money flow Models of circular flow For closed economies, we have two types of circular flow models: 1. a two-sector model, consisting of the flows between households and business firms, 2. three-sector model, consisting of the flows among households, business firms, and the government sector. 1. Two-sector circular flow model The two-sector model represents a private, closed economy with only two sectors, namely, the household sector and the business sector (firms). In this model, the underlying assumptions are: i. There are only two sectors in the economy: the household sector and business firms. ii. Household sectors are owners of factors of production, and they supply factor services to firms. iii. Firms produce goods and services and sell their entire output to households. iv. Households receive income for their factor services and spend the entire amount 35 Unit 3: Economic Resources and Markets  on consumption. v. There is no saving in the economy. vi. There is no government sector. vii. It is a closed economy, and therefore, there are no exports or imports. The circular flow in a two-sector economy is illustrated in the figure below. Figure 3.2: Circular flow of income in a two-sector economy Note that the above figure shows the two types of flows—real flow (of factor services and of goods and services) and money flow. There is a continuous flow of factor services (in the form of land, labour, capital, and entrepreneurship) from households to firms in the economy. Firms produce goods and services with the help of these factors and supply them to households for consumption. This is called the “real flow of goods and services.” The inner circle of the diagram shows that real flow. Since, in a monetary economy, all payments are made in money, the real flow is also the money flow of income, which is shown as the outer circle of Figure 3.2. When firms get factor services from households, they make monetary payments against them. Households spend this income on the purchase of goods and services from firms for their own consumption. Because, in this model, households spend all their income on consumption of goods and services, the total money receipts of the firms are the same as the total income of the households. Thus, money flows from firms to households (as payments for factor services) and back from households to firms (as payments for goods and services). This is the money flow of income shown by the outer circle of the diagram in Figure 3.2. Unit 3: Economic Resources and Markets 36  2. Three-sector circular flow model In the three-sector circular flow model, the economy has three sectors: households; firms; and government. In this model, the activities of the government (and those of the other two sectors) influence the flow of income. Government economic activities are divided into two categories: government revenue and government expenditure. The circular flow of income in a three-sector economy is shown in the figure below. Transfer Figure 3.3: Circular flow of income in a three-sector economy The above figure shows that firms make payments to households in return to factor services received from them. Households make payments to firms for goods and services purchased from them. Households’ savings are deposited in the capital market, which in turn, they give their savings to the firms for investment. Government gets its revenue by imposing taxes on households and on firms. Government pays back this revenue to the firms and households by purchasing goods and services from them. Also, government gives subsidies to the firms and transfer payments to the households. In this way, national income flows in a circular form among the three sectors of the economy. Ă Activity 3 4 1. What are the main models of circular flow? 2. Draw a two-sector economy circular flow diagram and discuss the role of each economic agent – the households and business firms. 3. Define circular flow diagram. 37 Unit 3: Economic Resources and Markets  3 5 Land as an Economic Resource in Ethiopia At the end of this section, students will be able to: 6 Explain the important role of land as an economic resource in Ethiopia. 6 Identify the two main soil types found in most of the Ethiopian highlands. ✍ Start-up Activity How do you define land in the context of agriculture in Ethiopia? For a country like Ethiopia, where agriculture is the backbone of the economy, land is a very important economic resource. In the context of agriculture, land refers to areal extent as well as its productivity of food crops and other crops. It is well-known that Ethiopia has a total area of 1,106,000 square kilometers of which 35 per cent is considered to be suitable for agriculture(CSA, 2007). The availability of this amount of land for agricultural purposes is directly or indirectly the result of good soil and suitable climate for the performance of agriculture. As far as the types of soil are concerned, most of the highlands have two main soil types that are generally believed to be suitable for agriculture. These soil types are: y Red-to-reddish brown soils: These soil types are well endowed with the required minerals for crops and they are found in areas of relatively good drainage. Further, these soil types are friable – easy to plough. y Brownish-to-grey and black soils with high clay content: With proper drainage and conditioning, these soils have excellent agricultural potentials. Regarding the climatic aspect, the formation of different agro-ecological zones due to altitude has multiplied the resource potential of the land of Ethiopia. The presence of different agro-climate zones results in the growth of different types of crops that increases Ethiopia’s potential for the production of exportable items in order to earn foreign currency. The Ethiopian people had been struggling for centuries with the inequitable land holdings of the country and effectively removed the feudal system in 1975. The socialist system that came into being in 1975 under the slogan “Land to The Tiller” paradoxically overturned the slogan and ended up in state ownership rather than giving it to the people. The existing government, which controlled power in 1991, was expected to remove land rights problems, among others by giving land to the people in tenure. But it maintained state ownership of land and controls all urban and rural land together with natural resources. Although state controls land ownership, rural peasants and pastoralists are guaranteed lifetime “holding” right that gives all Unit 3: Economic Resources and Markets 38 rights except sale and mortgage. Even if it is not mentioned in the constitution, urban residents are also provided with the right to get land for residence on a 99 years lease based agreement. The state ownership of land in the present-day Ethiopia is far from ideal since it restricts the different land rights of use, rent, lease, endowment, and inheritance for different reasons. Since redistribution of land is highly restricted, access to rural land is also almost non-existent. The constitution is commended for its protection of land holdings against arbitrary state eviction by inserting a provision that gives “commensurate” amount of compensation during expropriation. However, successive implementation of proclamations has violated this protection by denying market value (fair compensation) for loss of property. In short, the amount of compensation in the event of expropriation is insufficient. By creating more access to rural land, liberating the land holding rights, and by compensating fairly the loss of properties during expropriation, the current government could give more secure land rights compared to its predecessors. Ă Activity 3 5 1. Describe the important role of land as an economic resource in Ethiopia. 2. What are the two main soil types found in most Ethiopian highlands? 39 Unit 3: Economic Resources and Markets  Unit Summary Resources can be categorized as free resources (which are free gifts of nature and unlimited in supply) and economic resources (which are scarce in supply like land, labour, capital and entrepreneurship). A resource is said to be free if the amount available to a society is greater than the amount people desire to have at zero price. While a resource is said to be economic when the amount available to a society is less than what people want to have at zero price. Renewable resources are resources that have the potential to be replaced over time through the natural processes. While non-renewable resources are resources whose stock or reserve is limited or fixed, which are found in the ground. The available supply of non-renewable resources may be replenished by recycling but the overall supply remains relatively constant. A market is a place where two parties can meet to facilitate the exchange of goods and services. The parties involved are usually buyers and sellers. The market may be physical like a retail outlet, where people meet face-to-face, or digital like an online market, where there is no direct physical contact between buyers and sellers. There are three markets discussed in this section, namely, goods and services market, labour market, and financial market. The circular flow of economic activities is a simplified macroeconomic model of the basic economic relationships in a market economy. This model gives an overview of how households, businesses and government interact in different markets by exchanging goods and services, productive resources and money. For a country like Ethiopia, where agriculture is the backbone of the economy, land is a very important economic resource. In the context of agriculture, land refers to areal extent as well as its productivity of food crops and other crops. Unit 3: Economic Resources and Markets 40  Review Questions Part I: Write ‘True’ if the statement is correct or ‘False’ if it is not correct for each of the following statements. 1. By labour, we mean only the physical labour involved in the production of goods and services. 2. Recycle means to reuse a natural resource or product to make something new. 3. The goods market is the basis of capitalist societies, and it provides capital formation and liquidity for businesses. 4. The labour market is a market in which employees provide the labour services and employers provide the employment opportunities for labour. 5. Financial market is any place where securities, currencies, bonds, and other financial assets are traded between two parties. 6. Production, saving and making transfers are three important activities of an economy. 7. The two-sector model represents a private closed economy with only two sectors, namely, household sector and the business sector (firms). 8. Government gets its revenue through selling goods to households and firms in the three sector circular flow model. 9. Land is an example of a free resource at present in Ethiopia. 10. For a country like Ethiopia, where agriculture is the backbone of the economy, land is a very important economic resource. Part II: Choose the correct answer among the alternatives for the following questions 1. A resource is said to be free if the amount available is A. less than the amount people desire to have at a non-zero price. B. greater than the amount people desire to have at a non-zero price. C. greater than the amount people desire to have at a zero price. D. less than the amount people desire to have at a zero price. 2. Which of the following statements is correct? A. Air, sunshine, and solar energy are examples of economic resources. B. A resource is said to be economic when the amount available is plenty. C. Price is the test of whether a resource is economic or free. D. Since economic resources are plenty, they have a very low price. 3. All of the following are examples of scarce resources except A. a skilled and specialized labour C. minerals, clean water and forests B. a mountain stream D. all types of capital resources 41 Unit 3: Economic Resources and Markets  4. Which one of the following indicates all the manufactured inputs that can be used to produce other goods and services? A. Labour C. Land B. B. Entrepreneurship D. Capital 5. Which of the following is an example of a renewable resource? A. Solar energy C. Soil and forests B. Wind energy D. all of the above 6. ___________ occurs when people put harmful chemicals and other things into nature. A. Pollution C. Depletion B. B. Conservation D. Preservation 7. Which one of the following measures is necessary to take care of natural resources? A. Reducing their use C. Recycling them B. Reusing them D. All of the above 8. A closed economy does not allow: A. Sale of goods to households C. Sale of goods to other countries B. Sale of goods to government D. Sale of goods to business firms 9. Which of the following does not go with the three-sector circular flow model? A. Investment C. Households B. Firms D. Government 10. In three sector circular flow model, the main government economic activities are: A. Government revenue and expenditure. B. Government saving and payments. C. Government purchases and sales. D. Government transfers and expenditure. Part III: Answer the following questions briefly and to the point. 1. What is the basic difference between free and economic (scarce) resources? 2. Describe the four categories of economic resources. 3. How do you catgorise the types of resources go into producing goods and services? Explain each of the categories briefly and give examples. 4. Explain how pollution occurs and give examples of this problem. 5. What is the difference between financial mark and labour market? 6. Explain circular flows of income. Distinguish between real flows and money flows. 7. Describe circular flows of income in a three-sector economy. 8. Discuss the nature of land ownership rights in the context of Ethiopia during the pre-1974 period, from 1975 to 1991 and from 1991 to the present. Unit 3: Economic Resources and Markets 42  Unit Introduction to 4 Demand and Supply Introduction You may have questions such as next: What does demand mean? What does the law supply say? What does market equilibrium mean? The purpose of this unit 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. This unit deals with the concept of demand, the concept of supply and market equilibrium. Unit objectives At the end of this unit, students will be able to: 6 Define the concepts of demand and supply. 6 Explain the laws governing demand and supply. 6 Describe the equilibrium price and quantity ✍ Start-up Activities 1. How do you describe the term demand? 2. How do you define the term ‘supply’ in economics? 3. Can you define the concept of ‘equilibrium’? 👉 Key Concepts Ceteris paribus, demand, demand schedule, demand curve, demand function, law of demand, supply, supply schedule, supply curve, law of supply, equilibrium, market demand, market supply, market equilibrium, equilibrium price, and equilibrium quantity. 43 Unit 4: Introduction to Demand and Supply  4 1 Concept of Demand At the end of this section, students will be able to: 6 Define the concept of demand 6 Analyse the law of demand ✍ Start-up Activity How do you describe the term demand? Demand The terms demand, desire and want are frequently used synonymously to express what an individual needs and would like to acquire. Demand states that the consumer must be willing and able to buy a commodity which he or she desires at a given price during a given period of time. Accordingly, demand is distinct from a mere desire to acquire something. Human wants are unlimited and desires are numerous. However, only a desire backed up by the ability to pay the price for the commodity and the willingness to purchase it, is called a demand. We can say demand refers to an effective desire. A desire becomes an effective demand only when it is backed by the following three features: y ability to pay for the good desired, y willingness to pay the price of the good desired, and y availability of the good itself Furthermore, demand for a good is constantly stated relative to a specific price and certain time. For instance, an individual may be interested to buy a certain jeans at a price of Birr 500, but he or she could not absolutely demand it if its price is Birr 900. Likewise, an individual may be willing to buy a room heater at a price of Birr 1000 during a cold season, but he or she may not be interested in buying it at this price during a hot season. Based on the aforementioned considerations, we can define demand as follows: Demand for a commodity is the amount of it that a consumer is willing to buy at various given prices and a given moment of time. Quantity Demanded Quantity demanded is the amount of commodity a consumer must be willing and able to buy which he/she desires at a given price during a given period of time. Unit 4: Introduction to Demand and Supply 44 Law of Demand Law of demand states that, ceteris paribus, price of a commodity and its quantity demanded are inversely related. Ceteris paribus means other thing remain the same. In other words, the higher the price, the lower the quantity demanded. The law of demand is a fundamental principle of economics that states that at a higher price consumers will demand a lower quantity of a good. Demand Schedule A demand schedule is a tabular description, which presents various quantities of a commodity that would be demanded at different prices. Demand schedule refers to a tabular representation of the relationship between price and quantity demanded. It demonstrates the quantity of a product demanded by an individual or a group of individuals at specified price and time. Table 4.1: Individual household demand schedule for Oranges per week Price (Birr Per kg) Quantity Demanded/week 5 5 4 7 3 9 2 11 1 13 The above demand schedule shows the different quantities of oranges demanded by an individual household at different prices. At Birr 5 per kg, the consumer demands 5kg of oranges. However, an individual household’s demand becomes 13 kg of Oranges at Birr 1 per kg. Demand Curve A 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. 45 Unit 4: Introduction to Demand and Supply  Figure 4.1: Individual household demand curve Demand Function It is a mathematical representation of the relationship between price and quantity demanded, ceteris paribus. A typical demand function is given by: Qd = f(P) where, Qd is the quantity demanded and P is the commodity’s price, Market demand Market demand describes the demand for a given product and who wants to purchase it. This is determined by the willingness of consumers to spend a certain price on a particular good or service. As market demand increases, price also increases. When it decreases, price will decrease as well. Market demand is derived by a simple horizontal summation of the quantity demanded for a commodity by all buyers at each price. The market demand curve describes the relationship between various quantities of a commodity that consumers are willing to buy at different prices. Market demand curve is the horizontal summation of individual demand curves at the market price. Ă Activity 4 1 1. Define demand and state the law of demand. 2. Explain why the demand curve always slopes downwards from left to right. Unit 4: Introduction to Demand and Supply 46  4 2 Concept of Supply At the end of this section, students will be able to: 6 Define the concept of supply. 6 Analyse the law of supply ✍ Start-up Activity How do you define the term ‘supply’ in economics? Supply In ordinary language the term supply is often misused and confused with the term ‘stock’. Stock is the total volume of a commodity produced during a period less the quantity already sold out. Conversely, supply means the quantity which is actually brought to the market. Most of the time, producers do not offer all of their stock for sale in the market. For example, at the time of harvest, a large part of agricultural product is kept back in cold storage and is taken out during the off-season for sale at better prices. Likewise, a part of industrial product is usually kept back in stock and is offered for sale in the market at the time when it can bring higher prices. Thus, we can say that stock is potential supply and supply may be less than or equal to the stock of a commodity. However, in economics, the term supply has a specific meaning and it is described as: Supply of a commodity refers to the various quantities of it which producers are willing and able to offer for sale at a particular time at various corresponding prices. Quantity Supplied Quantity Supplied indicates various quantities of a commodity that sellers (producers) are willing and able to provide at different prices in a given period of time. In economics, quantity supplied describes the number of goods or services that suppliers will produce and sell at a given market price. The quantity supplied differs from the actual amount of supply as price changes influence how much supply producers actually put on the market. Note that supply shows the relationship between the quantity supplied and price of a commodity, while quantity supplied refers to a specific amount of the commodity, which a producer is willing to sell at a specific price. Law of Supply Like the law of demand, the law of supply demonstrates the quantities sold at a specific 47 Unit 4: Introduction to Demand and Supply price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. The law of supply states that, ceteris paribus, there is a direct or positive relationship between price and the quantity supplied of a commodity. Supply Schedule A supply schedule is a tabular presentation of different quantities of a commodity offered for sale at different prices per time period. Supply schedule is a chart that shows how much product a supplier will have to produce to meet consumer demand at a specified price based on the supply curve. Table 4.2: Individual seller’s supply schedule for oranges Price (Birr Per kg) Quantity Supplied (kg/week 10 60 15 70 20 80 25 90 30 100 The above demand schedule shows the different quantities of Oranges demanded by an individual household at different prices. At Birr 5per kg consumer demands 5kg of Oranges. However, an individual household’s demand becomes 13 kg of Oranges at Birr 1 per kg. Supply curve A supply curve shows the information of a seller’s supply schedule graphically rather than in a tabular form. Figure 4.2 Individual seller’s supply curve for oranges Unit 4: Introduction to Demand and Supply 48 Supply Function A supply function is a mathematical representation of the relationship between price and quantity supplied of a commodity, all other things remaining the same. A typical supply function is given by: QS = f(P) where, QS is quantity supplied and P is the price of the commodity. Market supply Market supply is the total amount of an item producers are willing and able to sell at different prices, over a given period of time. Market supply is derived by horizontally adding the quantity supplied of the commodity by all sellers at each price. The market supply curve indicates the relationship between various quantities of a commodity that sellers are willing to offer for sale at different prices. Market supply curve is the horizontal summation of individual supply curves at the market price. Ă Activity 4 2 1. Define supply and state the law of supply. 2. Why does the supply curve slope upward to the right? 49 Unit 4: Introduction to Demand and Supply  4 3 Market Equilibrium At the end of this section, students will be able to: 6 Define market equilibrium ✍ Start-up Activity Can you define the concept of ‘equilibrium’? In the preceding sections, we have discussed both the consumers’ demand for goods in a market and the firms’ supply of goods in a market independently. Demand and supply curves tell us how much consumers demand and how much producers supply at different prices, respectively. However, they do not tell us the actual price of a good in general. We now come to the important question: How do the forces of demand and supply work together in order to determine market prices? We explain how forces of demand and supply help in attaining ‘equilibrium’, and how the ‘equilibrium price’ is determined. The concept of equilibrium The term “equilibrium” refers to a state of balance. In the physical world, when two opposing forces acting on an object are balanced so that the object is held stationary, the object is said to be in equilibrium. In simple terms, when the object under the action of forces working in opposite directions has no tendency to move in any direction, the object is in equilibrium. Similarly, an economic system is said to be in equilibrium when its important variables show no change, and when no forces are acting on them to produce a change in their values. For instance, after attaining equilibrium, a consumer has no intention of re-allocating his or her money or income. Likewise, a firm is said to be in equilibrium when it has no tendency to change its level of output by either increasing or decreasing it. Thus, there is a tendency to move towards the equilibrium price. This tendency is known as the “market mechanism,” and the resulting balance between supply and demand is called “market equilibrium.” In real world economic activities, equilibrium may never be actually realised. The central feature of equilibrium analysis in economics is the concept that economies tend towards equilibrium when no external forces are acting on them. Market equilibrium In the context of price determination, equilibrium refers to a situation in which the quantity demanded of a commodity equals the quantity supplied of the commodity. In brief, it refers to the balance between opposite forces of demand and supply known as Unit 4: Introduction to Demand and Supply 50 market equilibrium. Equilibrium price The price at which the quantity demanded of a commodity equals the quantity supplied is called ‘equilibrium price’. The forces of demand and supply determine the price of a commodity in a given market. At an equilibrium price, the quantity demanded and the quantity supplied are equal. Equilibrium quantity Equilibrium quantity refers to the quantity of a good supplied in the marketplace when the quantity supplied by sellers exactly matches the quantity demanded by buyers. In other words, the equilibrium quantity is the amount of a commodity that is bought and sold at an equilibrium price. Graphically, we depict market equilibrium as shown in the Figure below. Figure 4.3 Market equilibrium When the demand curve and the supply curve intersect, we have a point where the quantity that consumers are willing to purchase matches the quantity that suppliers are willing to supply at a given price. This point is known as the market equilibrium. From the market equilibrium we can derive market price and market quantity. Note: This market equilibrium is not fixed; it is likely to change over time due to changes in the patterns of demand and supply. Ă Activity 4 3 1. What is the meaning of market equilibrium? 2. Explain the difference between equilibrium price and equilibrium quantity. 51 Unit 4: Introduction to Demand and Supply  Unit Summary Demand for a commodity is the amount that will be purchased at a particular price during a particular period of time. The law of demand states that, other things remaining constant, the quantity demanded of a commodity increases when its price falls and decreases when it rises. The law can be described using a demand schedule, a demand curve, and a demand function. A demand schedule is a table that describes the different quantities of a commodity demanded at different prices. A demand curve is the graphical representation of a demand schedule. Individual demand for a commodity is the amount a single consumer buys at a given price during a particular period of time. Market demand is the total quantity of a commodity that all households are willing to buy at a given price during a given period of time. Supply is the quantity of a commodity that producers are willing to produce and offer for sale at a particular price during a given period of time. The law of supply states that, other things remaining the same, the quantity of a commodity that firms will produce and offer for sale rises with a rise in price and falls with a fall in price. A supply schedule is a tabular description that shows various quantities that producers are willing to produce and sell at various prices during a given period. Individual supply is the quantity of a commodity that one firm is willing to produce and offer for sale at a particular price during a given period of time. Market supply is the quantity of a commodity that all the producers are willing to produce and offer for sale at a particular price during a given period of time. Market equilibrium is a situation in which the quantity demanded of a commodity equals the quantity supplied of the commodity. An equilibrium price is the price at which quantity demanded equals quantity supplied. An equilibrium quantity is the amount of a commodity bought and sold at an equilibrium price. Graphically, the equilibrium price is determined at the point of intersection of the demand curve and the supply curve. Unit 4: Introduction to Demand and Supply 52  Review Questions Part I: Write ‘True’ if the statement is correct or ‘False’ if it is not correct for each of the following statements. 1. The only factor that can cause a change in the quantity demanded of a commodity is a change in the price of the commodity. 2. Demand schedule refers to a tabular representation of the relationship between price and quantity demanded. 3. A change in price of coffee will not affect the quantity demanded of coffee. 4. A change in price of wheat will affect the quantity stored of wheat. 5. Equilibrium price is the price at which quantity demanded equals quantity supplied. 6. An increase in quantity supplied of a commodity leads to a decrease in its price. 7. At equilibrium price, the quantity demanded and quantity supplied are not equal. 8. Market equilibrium is a situation in which quantity demanded of a commodity equals the quantity supplied of the commodity. 9. The amount of a commodity that is bought and sold at a lower price is called the equilibrium quantity. 10. Provided that market demand and supply remain unchanged, the price will neither tend to rise nor fall below this equilibrium price. Part II: Choose the correct answer among the alternatives for the following questions 1. Demand reflects the quantity of a commodity that consumers A. want to buy it at a different price, B. need to buy at alternative prices. C. are willing and able to buy at alternative prices. D. can be bought at alternative prices. 2. A demand schedule shows the relationship between the quantity demanded of a commodity over a given period of time and the _____________ A. price of the commodity. C. income of the consumers. B. taste of the consumers. D. price of related commodities. 3. More of a commodity will be purchased at lower prices because A. consumers substitute this commodity for others whose price has not changed. B. at lower prices, consumers can buy more of this commodity with a given money income. C. more consumers will buy the commodity at lower prices than at higher prices. D. all of the above 53 Unit 4: Introduction to Demand and Supply 4. A change in price of a commodity affects A. the quantity demanded of a commodity. B. consumers’ willingness to buy the good. C. consumers’ ability to buy the good. D. all of the above. 5. Which one of the following is not held constant in defining the demand schedule? A. Number of consumers C. Prices of other goods B. Price of the good in question D. Number of sellers in a market 6. Which of the following statements is not correct? A. Demand curves tell us how much consumers demand at different prices. B. Supply curves tell us how much producers supply at different prices. C. Demand and supply curves can tell us the actual price of a good in general. D. All of the above. 7. An economic system is said to be in equilibrium when. A. its important variables show no change B. no forces are acting on them to produce a change in their values C. A and B D. all of the above 8. The intersection of a market demand curve and a market supply curve for a commodity determines the A. equilibrium price for the commodity. B. equilibrium quantity for the commodity. C. point of neither increase nor decrease in price of the commodity. D. all of the above Part III: Answer the following questions briefly and to the point. 1. Distinguish between the following pair of concepts: a. Individual demand and market demand b. Individual supply and market supply 2. What is the difference between demand and the quantity demanded for a commodity? 3. To get the market demand curve for a product, why do we add individual demand curves horizontally rather than vertically? 4. To get the market demand curve for a product, why do we add individual demand curves horizontally rather than vertically? 5. When is the market said to be in a state of equilibrium? Unit 4: Introduction to Demand and Supply 54