1. ELEMENTARY THEORIES OF DEMAND AND SUPPLY AND THE THEORY OF CONSUMER BEHAVIOUR

LEARNING OBJECTIVES
At the end of the lesson the student should be able to:
Distinguish between demand, desire, need and want.
Know the factors that affect the quantity demanded of a commodity by a household and
the total market demand.
Explain using either the ordinalist or cardinalist approach why consumers buy more at
lower prices, than at a higher one.
Distinguish between supply, existing stock and amount available.
Know the factors that determine the quantity supplied of a commodity in a given market.
Understand how prices are determined in the market.
Explain the various reasons for and methods of government modification of the price
system and equilibrium prices.
Explain the various effects of changes in either quantity demanded or supplied on the
equilibrium price and quantity.
Explain the various types of elasticities and their importance.
CONTENTS
1. Introduction
2. Demand analysis
3. The theory of consumer behaviour
4. Supply analysis
5. Determination of equilibrium price
6. Elasticity demand and supply
ASSIGNED READINGS
MODERN ECONOMICS by Robert Mudida Chapters 2,3,4,5STRATHMORE UNIVERSITY ● STUDY PACK
Lesson Two
19
1. INTRODUCTION
In any economy there are millions of individuals and institutions and to reduce things to a
manageable proportion they are consolidated into three important groups; namely
 Households
 Firms
 Central Authorities
These are the dramatis personae of the economic theory and the stage on which much of their
play is acted is called the MARKET (see lesson three for definition of market).
HOUSEHOLD
This refers to all the people who live under one roof and who make or are subject to others
making for them, joint financial decisions. The household decisions are assumed to be consistent,
aimed at maximizing utility and they are the principal owners of the factors of production. In
return for the factors or services of production supplied, they get or receive their income e.g.
 Labour – wages and salaries
 Capital – interest
 Land – rent
 Enterprise – profit
THE FIRM
The unit that uses factors of production to produce commodities then it sells either to other
firms, to household, or to central authorities. The firm is thus the unit that makes the decisions
regarding the employment of the factors of production and the output of commodities. They are
assumed to be aiming at maximizing profits.
CENTRAL AUTHORITIES
This comprehensive term includes all public agencies, government bodies and other organisations
belonging to or under the direct control of the government. They exist at the centre of legal and
political power and exert some control over individual decisions taken and over markets.
2.
DEMAND ANALYSIS
a. Definition and theoretical basis of demand
Demand is the quantity per unit of time, which consumers (households) are willing and able
to buy in the market at alternative prices, other things held constant.
b. Individual demand versus market demand
(i) Individual and market demand schedule
The plan of the possible quantities that will be demanded at different prices by an individual
is called Individual demand schedule. Such a demand schedule is purely hypothetical, but
it serves to illustrate the First Law of Demand and Supply that more of a commodity
will be bought at a lower than a higher price.Theories of Demand and Supply and Consumer Behaviour
ECONOMICS
20
Price (Kshs)
Quantity demanded per week
20
3
18
3½
16
4
14
5
13
6
12
7
11
8
10
9
Table 2.1: The individual demand schedule
Theoretically, the demand schedule of all consumers of a given commodity can be combined to
form a composite demand schedule, representing the total demand for that commodity at
various prices. This is called the Market demand schedule.
Price (in KShs)
Quantity demanded (per week)
20
100,000
18
120,000
16
135,000
14
150,000
13
165,000
12
180,000
11
200,000
10
240,000
 
9
300,000
 
8
350,000
Table 2.2: The market demand schedule.
These prices are called Demand Prices. Thus, the demand price for 200,000 units per week is
KShs 11 per unit.
(ii) The individual and market demand curves
The quantities and prices in the demand schedule can be plotted on a graph. Such a graph
after the individual demand schedule is called The Individual Demand Curve and is
downward sloping.
An individual demand curve is the graph relating prices to quantities demanded at those
Factors influencing demand for a product
These are broadly divided into factors determining household demand and factors
affecting market demand.
Factors affecting household demand
The taste of the household
The income of the household
The necessity of the commodity, and its alternatives if any
The price of other goods
Factors affecting the total market demand
These are broadly divided into the determinants of demand and conditions of demand.
(a) Own price of the product
This is the most important determinant of demand. The determinants of demand
other than price are referred to as the conditions of demand.
Changes in the price of a product bring about changes in quantity demanded, such
that when the price falls more is demanded. This can be illustrated mathematically as
follows:
Qd = a - bp
Where
Qd is quantity demanded
a is the factor by which price changes
p is the price
Thus, ceteris paribus, there is an inverse relationship between price and quantity
demanded. Thus the normal demand curve slopes downwards from left to right as
follows:
P
 
D
 
Q
Exceptional demand curves
There are exceptions when more is demanded when the price increases. These
happens in the case of:STRATHMORE UNIVERSITY ● STUDY PACK
Lesson Two
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(i) Inferior goods: Cheap necessary foodstuffs provide one of the best examples of
exceptional demand. When the price of such a commodity increases, the consumers may
give up the less essential compliments in an effort to continue consuming the same
amount of the foodstuff, which will mean that he will spend more on it. He may find
that there is some money left, and this he spends on more of the foodstuff and thus ends
up consuming more of it than before the price rise. A highly inferior good is called
Giffen good after Sir Robert Giffen.
(ii) Articles of ostentation (snob appeal or conspicuous consumption): There are
some commodities that appear desirable only if they are expensive. In such cases the
consumer buys the good or service to show off or impress others. When the price rises,
it becomes more impressive to consume the product and he may increase his
consumption. Some articles of jewellery, perfumes- and fashion goods fall in this
category.
(iii) Speculative demand: If prices are rising rapidly, a rise in price may cause more of a
commodity to be demanded for fear that prices may rise further. Alternatively, people
may buy hoping to resell it at higher prices. In all these three cases, the demand curve
will be positively sloped i.e. the higher the price, the greater the quantity bought. These
demand curves are called reverse demand curves (also called perverse or abnormal
demand curve).
(b) Prices of other related commodities.
Related commodities can be compliments or substitutes.
(i) Compliments: The compliments of a commodity are those used or consumed with
it. Suppose commodities A and B are compliments, and the price of A increased.
This will lead to a fall in the quantity demanded of A, and will in turn lead to a fall in
the demand for B. Example are bread and butter or cars and petrol.
(ii) Substitutes: The substitutes of a commodity are those that can be used or consumed
in the place of the commodity. Suppose commodities X and Y are substitutes. If
the price of X increases, the quantity demanded of X falls, and the demand for Y
prices by an individual consumer of a given commodity