SUMMARISED MICRO – ECONOMICS

Economics:economics was derived from a Greek word oikonomia which

means house managing.
Adam smith 1723 – 1790 defined economics as a science that studies the
nature and causes of national wealth
Alfred Marshall 1842 – 1924 defined political economics as the study of
mankind in the ordinary business of life.
Lionel Robins 1898 – 1984 stressed economics as the science which
studies human behavior as a relationship between ends and scarce means
which have alternative uses.
There is no single definition of economics that covers entirely all its diverse
aspects but a working definition is that economics is a social science
which studies the allocation of scarce resources that have potential
alternative uses among the competing and virtually limited wants of
consumers in society.
BRANCHES OF ECONOMICS
Economic is divided into two main branches
1. Micro –economics
2. Macro –economics
Micro-economics: - is a branch of economics that studies the behavior of
individual decision making units such as consumers, resource owners and
business firms as well as individual markets in a free market economy.
The aim of microeconomics is to explain the determination of the prices and
quantities of individual goods or services.
It also considers the impact of the government regulation and taxation on
individual markets.
Macro-economics: -is a branch of economics that studies the behavior of
the economy as a whole whereby the relationship is considered between
brand economic aggregates such as national income, employment and
prices.

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It focuses on economic stabilization whereby government policy is used to
moderate the business cycle and encourage real economic growth.
METHODOLOGY OF ECONOMICS (methods of how economics is applied
and enables one to appreciate the limitations for scope of economics) this is
what is known as the scope of economics
It can either be:-
1) Positive economics
2) Normative economics
Positive economics is concerned with what is or how economics problems
facing society are actually solved. It deals with positive statements that are
real facts e.g. Kenya is a member of EAC
Normative economics refers to that point of economics that deals with
value judgments, meaning it deals with what ought to be or how the
economic problems facing society should be solved e.g. Kenya ought to join
SADC.
WHY STUDY ECONOMICS
Economics is of great importance:-
a) Economics provides the underlining principles of optional resource
allocation and thus enables individuals or firms to make economically
rational decisions.
b) It enables individuals or organizations to appreciate constrains
imposed by the economic environment within the entity it operates
c) Is concerned with reasons why societies develop and means of
accelerating developments
d) Economics is analytical subject and its study can help develop logical
reasoning

ECONOMIC TERMS
 Scarcity: - means less than requirement. A commodity is considered
scarce when it’s limited in supply (Demands exceeds supply). It’s the
main cause of economic problems facing the environment

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  Choice: - giving reference to some wants as compared to others. The
wants which have greater importance will be satisfied first and this
selection is known as choice. Problems of choice are essentially
problems of allocation since people must decide how to allocate
bargains of different uses.
The three fundamental choices are:-
1) Which good and service to be produced and in what quantity.
2) How the goods and services should be produced. Capital
intensive/labour intensive, higher proportion of labour is used relatively
to other factors of production.
3) How the goods or services should be distributed.
The aim to the above allocation decisions are influenced by the economic in
existence in the country at a given time.
Opportunity cost: - opportunity cost of an action is the value of best
forgone alternative action.
It arises because many resources are scarce and have alternative uses the
choice of any action there fore implies that an alternative action will be
foregone e.g. if a consumer has 200/= to spend.
Utility: - is the satisfaction derived from consumption of a commodity all
goods have utility.
Want is any human desire. The satisfaction of human desires is the basis of
all economic
Characteristics of wants
1. Wants are unlimited in numbers
2. Particular wants can be fully satisfied if you have means.
3. Wants are competitive or alternative making it possible to satisfy a
given want through the use of substitutes goods e.g. tea/coffee
4. Wants are complimentary, satisfy ones want has to satisfy one or two
e.g. a car requires petrol, pen – ink
5. They vary in urgency and intensive
6. They are recurrent – tend to occur repeatedly

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Types of wants
There are two major types
1. basic/primary wants
2. Secondary wants
Basic wants are those wants which are essential for human existence e.g.
food, fresh air, clothing and shelter.
Secondary wants:- are wants which aren’t essential for survival of human
beings but satisfaction of these wants improves standards of living and
comfort of human e.g. education and medication.
Economic system: - is that institutional arrangement whereby human and
natural resources of an economy operate with each other to produce goods
or services.
There are three types of economic systems
1. Free market system
2. Centrally planned market system/ command economic system
3. Mixed economy
Free market system is an economic system where by there is absence of
government intervention and whereby the forces are allowed to operate
freely.
Characteristics of free market system:
1. There is ownership of private property – individuals and organizations
have right to own, control and dispose off factors of production.
2. Freedom of choice and enterprise – people are free to buy and hire
economic resources and owning factors of production. May use these
resources as they prefer.
3. There is self interest – each economic agent attempts to do what is
best for itself i.e. firms maximize profits; consumers will attempt to
maximize their utility.
4. There is competition – there are many buyers and sellers hence market
determines the prices.

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 5. There is use of price mechanism – is a fundamental feature of free
market
Advantages of free market system.
1. There is consumers sovergnity – consumer is considered economic
judge of his own welfare
2. There is greater responsiveness in changes in international economic
environment because the maximizing firms are exposed to greater
competition in international markets hence respond faster in changes
in relative prices of commodity for factor inputs
3. Firms have greater incentive to bear risk since profit incentives exist,
which tends to encourage hard work and initiative contributing to
technological innovation i.e. economic growth.
4. May encourage foreign investment because overseas produces expect
higher return on their investment for less government control.
5. Efficiency of firms may increase firms that don’t produce what
consumes want at low prices may go out of market.
6. Consumers have a greater while of producers and lager number of
goods for services to choose from.
Disadvantages of free market system.
1. Tends to give rise to developments of monopolies. A monopoly is a
market situation where there is single supply of commodity
2. Externalities are not taken into account externalities are social cost
and benefits that are not accounted for in a market system.
Social cost include pollution and noise
Social benefits – street lighting, good roads, public hospitals
3. May not produce public goods. These commodities characterized by
non excludability and non-rivalry in consumption. It implies (non-
excludability) that is not possible to exclude individuals who have not
said from consuming the commodities.
4. It under provides for merit goods like health and education. Merit
goods are those commodities which are socially desirable.

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 5. Socially undesirable goods and services known as demerit goods such
as drugs and alcohol may be produced, because demand for such
commodities exists are profitable to provide
6. May generate considerable inequalities in income and wealth because
of price mechanism, operates in factor markets hence the wages and
salaries earned will depend on forces of demand and supply.
7. The system may encourage cyclical unemployment when production
and consumption decisions get out of line.
Centrally planned economies
Is one where the crucial economic resource allocation decisions are
determined by the state through an economic planning body which
implements society major economic goals.
Characteristics of centrally planned economics
1. The allocation of resources is achieved by use of an overall plan that
sets production targets for different sectors of the economy that
determine supply of different commodities for a specified period of
time.
2. Rationing of certain commodities to predetermine the demand for then
rationing is any method of allocating a scarce commodity other than by
means of the price mechanism
3. Fixing of prices and wages by state bodies which are usually not
equilibrium rates e.g. may take form of maximum price controls and
minimum wages
4. Often but not always economic resources are owned by the states i.e.
factors of production owned by state
5. The occasional existence of a conscripted labour market in which
workers take jobs assigned to them.
Advantages of planned economic system.
1. All essential goods and services such as education a health are
provided by state regardless of whether consumers can afford to pay
for them.

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 2. The nations wealth tends to be evenly distributed than in free market
system since means of production are state owned.
3. State provides a check on monopoly power since private monopolies
are not allowed to develop hence public monopolies e.g. railway and
power
4. Takes account of external cost o and benefit in all activities
5. Much lower rates of inflation since prices are fixed than in free market
economy
6. There are less economy fluctuations because of stabilized government
micro-economics qualities.
Disadvantages of planned economic systems
1. There is a greater likelihood of resources since government cant
access consumer demand.
2. Absence of profit motive and no incentive for innovation and herd work
3. Cost of gathering information on what, how and for whom to produce is
high because it requires professional experts i.e. statisticians,
economists, engineers, planners and administrators e.g. soviet union
and north Korea
4. There is a time lag btn collection of information formulation of
production plans based ion that information hence consumer’s
preferences may not be taken into account
5. Limitation of consumers sovereignty
6. Absence of competition reduces efficiency since any law is catered by
the state.
Mixed economy system
Is an economic system that combines features of both free and command
economic system? Allocation of resources between alternative users is
determined by individual actions through price mechanism but the state
plays a role determining the aggregate level of output through fiscal for
monetary policy all economists are mixed in that government planning and
price mechanism share function of dealing with the economic questions.

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 Government can influence allocation of resources in the following.
i. Through use of a system of taxes and subsidies
ii. Government can influence resource allocation by way in which if
spends in come raised in taxes e.g. military equipment, school for
hose
iii. Income distribution where government can levy high taxes on
wealth is transfer money to the less well off sections of society.
iv. Use of maximum and minimum prices i.e. price ceilings and price
floors
Demand
Is ability and willingness of consumer to buy/purchase a given commodity at
a given price over a specified period of time?
Law of demand: states that holding all other factors contact, the higher the
price of a commodity the lower the quantity demanded and the lower the
price of commodity the higher the quantity demand.
Illustrated using the following:-
1. Demand schedule
2. Demand curve
Demand schedule: - is a list of prices and their respective quantity
demanded. E.g
Demand schedule for mangoes
Price quantity demanded
(Kshs) (per kg)
34 200
36 180
40 140
42 120
44 100
Demand curve: is graphical representation of the demand schedule

44
42 Page 8 of 46
rice (kshs)

40
38
 100 120 140 160 180 200
Quantity demanded per Kg
Demand curve slopes downwards from left to right; this implies that there is
an inverse relationship between price of commodity and quantity demanded
Quantity demanded is the demand
Assumptions of law of demand
For the law of demand to hold some assumptions are made
1. No change in income consumers when the price is decreasing or
increasing (changing)
2. Should be no change in taste and preferences of the individuals where
price changes
3. Price of a substitute commodity should not change.
4. Should be no further expected price change in future
5. New products for goods of come type should not be inverted
Two goods are said to be substitute if an increase in price of one commodity
leads to increase in demand for other commodity
Two goods are said to be complementary goods if an increase in price of one
commodity leads to decrease is quantity demanded for the others
commodity and vice versa.
Exceptions of law of demand
In certain law of demand doesn’t hold
These types of demand curves are called
 Regressive demand curves
 Abnormal curves
 Exceptional demand curves
Occur under the following conditions
1. In case of a giffen goods. Giffen goods are basic food stuffs that
constitute a higher propoortion of the budget of law income members.

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 2. Incase of goods ostentation – are goods that have snobs appeal –
attract the highest class in the society i.e. status goods hence when
price of commodity increases, their demand increases since most
members of society can’t afford them.
3. Incase of an expected drastic price change in future when price is
expected to their rise is fall drastically, the quantity demanded will
increase or fall respectively.
Factors that determine demand.
1. Price of a commodity – when price of commodity increases quantity
demand decreases and vice – versa
2. Price of related commodity – 1. Substitute – quantity demand of a
commodity is affected by an increases is decreased in price of
substitute when price of a substitute increases quantity demand of a
commodity increases for vice versa
Complementary goods – when price of complementary goods increases
quantity demanded of commodity decreases and vice versa
3. Consumers disposable income – disposable income I) income after tax.
When disposable income of consumers increases the quantity
demanded of commodity also increases and vice versa
4. Tastes, fashion and preferences – when this are in favour of a
commodity the quantity demanded will increase and vice versa.
5. Availability of credit facilities to consumer - if there is sufficient credit
facilities
6. Level of advertising if there is aggressive advertisement of commodity
and consumer are in favour of then the quantity demanded increases
and vice – versa.
7. Population size – the denser the pop – the higher demand of
commodity
8. Income distribution of consumers – if income distribution is even
quantity demanded will be high unlike when the income distribution is
sparsely
9. Government policy – if government policy is for the wage of a
commodity, the quantity demand will increase and vice – versa. e.g. in
the case when the government made it mandatory for each psv to
have seat bests price shot up.

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 Movement versus shift of demand curve
Movement along the demand curve: - occurs only when price of
commodity changes (change is quantity demanded) change in quantity
demanded – which is due to change in the commodities price leads o either
extension or concentration of demand curve

C
44

40 A Extension
Price

36 B

100 140 180

 When the price increases from 40 – 44 the quantity demanded

decreases from 140 – 100, this decreases in quality demanded due to
increase in price of commodity is called the concentration of demand
curve
 When price increases from 36 – 40 the quantity demand increases fro
m 140 – 180 this is decreases in quantity demanded due to increase
commodity is called extension of demand curve
 Shift in demand curve:- when any other factors other than the price
affects demand, changes shifts in demand curve occurs and is called
( change in demand)

D1 Right hand shift in demand curve

D ( increase in demand)

40p
D1

D
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 140 180

A decrease in demand occurs due to the following factors in

leftward shifts
1. Decrease in price of a substitute commodity
2. Increase in price of a complementary commodity
3. A decrease in a households’ real disposable income
4. Change in tastes/ fashion against a commodity
5. Decreases availability of credit to consumers
6. Government limiting purchase of certain commodities.
Price
d
p D2

D1

D2
Quantity

An increase in demand occurs due to any of the following factors

rightward shifts’
1. An increase in price of a substitute
2. Decrease in price of complementary good
3. Increase in consumes disposableincome
4. Change in tastes or fashions in favor of a commodity
5. A successful advertising campaign
6. Increased availability of credit to consume
7. Government legislation use of certain commodities mandatory.

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Elasticity of Demand
Is the responsiveness of quantity demanded to change in the price of
commodity
propotionate∨% change∈quantity demanded
Ed=
propotionate∨% change ∈ price
Q
X 100
Q
P
X 100
p
Q
Xp
❑
P
XQ
❑
If the ratio i.e. Ed is greater than 1, the demand is elastic that means
quantity demanded changes more than proportionate in response to change
in price. E.g. if the price change (increases by 20% the quantity demanded
will decrease by more than 20%

Price p2
P1

Q1 q2 Quantity

Example: - IF the price of kg tomato costs 10/= quantity demanded is 100. If

the price of the kg of tomato increases to 12% quantity demanded will
decrease to 70 therefore elasticity of demand is
ED =
Q
XP
Q
P
XQ
p
 Q = 100 – 70 = 30
 P = 10 – 12 = -2

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 30 X 10
2 X 20
= 1.5 = Ed >1.5
Ed = 1.5 is greater than 1 implying that commodity has elastic demand
If the ratio Ed< 1 then the commodity has inelastic demand

Pricing D inelastic demand

D
Quantity

This implies that quantity changes less than proportionality in response to

change in rise if commodity. This means an increase of 10% in price will lead
to a less than 10% decrease in quantity demanded of commodity
e.g. if the price of salt is 10= quantity demanded is 200 when price increases
to 15% quantity demanded decreases to 195 find elasticity
Ed =
Q
XP
Q
P
XQ
p
 Q = 200 – 195 = 30 – 5
 P = 10 – 15 - 5

5 X 10
= 0.05
5 X 200
ED = 0.05< 1
If ed is equal to 1 it implies that commodity has a unitary demand meaning
that a change in price of commodity will bring about a proportionate same %

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change in quantity demanded. If price of commodity increases by 20%
quantity demanded will decrease by 20%
Example
If price of a commodity is 10/= quantity is 100 when price increases to 15/=
quantity demanded decreases 50
50−100
15−10
50
5

Ed =1
Implies that commodity has unitary demand

Price D

D quantity Kg

If Ed = 0 it means commodity has perfectly inelastic demand.

Price (ksh) D

Q Quantity (kg)

This means that any change in price causes no change in quantity

demanded.
Perfectly elastic Ed = 

Price d = 

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p
Quantity in kg
It implies that when price changes quantity demanded infinitely changes

Price elasticity of demand

Is the responsiveness of quantity demanded to change in the commodity
−Q X P 1
Ed=
P XQ1
Are two types
1. Arc elasticity of demand
2. Point elasticity of demand
Point:- is price elasticity of demand at a point on the demand curve. It
evaluates price elasticity of demand with complete accuracy point i.e.
−Q X P 1
Ed=
P XQ1
Arc - is the coefficient of price elasticity of demand at two points in the
demand curve.
It measures elasticity of demand on a range of point

ED
−Q X ( P 1+ P 2 ) /2
Ed=
P X (Q1+Q 2)/2
Q2−Q1 P 1+ P 2/2
P 2−P1
X Q1+Q 2/2
Example : if price of Kg of tomato costs 10/=quantity demanded is 100. If the
price of kg increases to 12/= quantity demanded will decrease to 70. Find
the
a) Point elasticity of demand at 12 – 70
b) Arc elasticity demand between 12 + 10

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 ED =
−Q X P 1
P XQ1
-30/2 X 12/70 = - 18 / 7 = 2.57
Ed is 2.57 greater than 1 commodity has elastic demand
Arc:
Q2−Q1 P 1+ P 2/2
P 2−P1
X Q1+Q 2/2
70−100 10+12/2
12−10
X 100+70/2
−30 11
2
X 85
= Ed = 1.941 greater than 1
Commodity has elastic demand
Income elasticity of demand
Is the responsiveness of quantity demanded to change in consumer’s income
Expressed as follows
propotionate∨% change ∈quantity demanded
Edy=
propotionate∨% changeconsumers income

QxY
= ans/ratio
YxQ
If ratio is +ve it implies that commodity is a normal good
If ratio is +ve it implies that commodity is an inferior good.
Edy >1=implies commodity has elastic demand
Edy <1=implies that commodity has unelastic demand
Edy=1=implies that commodity has unitary demand
Cross elasticity of demand
Is the responsiveness of quality demanded of commodity A to changes in
prices of commodity B.
p ropotionate∨% change ∈quantity demanded of commodity A
propotionate∨% change ∈ price of commodity B

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 QA PB
AB =
PB
X QA
If the ratio /AB is +ve the 2 commodities are said to be substitute goods.
When AB is –ve the 2 commodities are complementary goods.
If AB is 0 2 commodities aren’t related.
Example. Book 4 soda
FACTORS THAT DETERMINE PROICE ELASTICITY OF DEMAND
1. Availability of close substitute the more available of close substitute,
the more elastic is the demand of commodity.
2. extent to which commodity is habit farming- the more habit farming
the commodity is, the more elastic demand is.
3. Level of price- If prices are at the upper echelon of demand curve
quantity demanded is likely to be more elastic.

D
Ed> 1 – elasticity of demand
Price Ed = 1 – unilateral demand
Ed < 1 inelastic demand

4. Adjustment time period- length of adjustment time of price – the length

the adjustment time period time period allowed toadjust the prices the
greater is the price elasticity.
5. No of uses of commodity – greater the no. of uses of commodity the
more elastic is the demand of commodity.
6. Proportion of income used to purchase commodity – the greater the
proportion of income used by consumer to purchase commodity the
more elastic the commodity and vice-versa.
Supply

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Is the quantity of a commodity that a producer is willing and able to offer for
sale at a specific price over a period of time.
It should not be confused with distribution i.e. supply is not distribution of
goods and services.
In economics a supplier implies a producer of goods.
Law of supply
States that holding all other factors constant, the higher the price of a
commodity the higher the quality supplied and the lower the price of a
commodity the lower the quantity supplied can be shown musing:-
i. Supply schedule
ii. Supply curve
Supply schedule- Is a list of prices and their corresponding quantity supply
at a given period of time.
Example 1.
Price kshs per kg Quantity per week in kg
30 60
40 80
50 100
60 120
70 140
80 160

Supply curve- Is a graphical representation of supply schedule.

80
70
60
50
40 60 80 100 120 140 160

30

Page 19 of 46
Conclusion- in law of supply, price and quantity supply have a direct
relationship such that when prices is increases.A greater quantity will be
supplied at a higher price than at a lower price.
FACTORS THAT AFFECT SUPPLY OF A COMMODITY
1. Price of commodity – the price of a commodity increase so does the
commodity and vice-versa.
2. Price of factors of production – when price of factors of production
is high e.g. if cost of raw materials is high, then the quantity supplied is
low and vice- versa.
3. State of technology- the better the state of technology the more
efficient production becomes therefore cost of production is low hence
quality supplied will increase and vice-versa.
4. Weather condition- when weather condition is favorable especially in
agricultural production, quality supply may increase unlike in situations
of poor weather conditions.
5. Incidences of strikes- implies the regulatory of industrial strikes
within organizations, the rare the strikes, the more production of goods
which leads to a higher quality supplied in the market and vice-versa.
6. Indirect taxes and subsidies- a tax on a commodity can be
regarded as an increase in the cost of supply in that commodity.
Tax- is an amount levied on a given individual institution or a group by
government.
Subsidies-are a payment by government to producers in order to
lower cost of production and increase quantity supplied.
7. Price of other goods- other goods that can be produced using the
capital, machinery and labor affect quality supplied for that commodity
e.g. when prices increase relative to price of commodity it becomes
too profitable to produce them hence producer will start producing that
commodity.
Movement versus shift in supply.
Movement along supply curve- occurs when only the price of a
commodity changes. It’sreferred to as change in quality supplied e.g.

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 60
50
40
30
60 80 10020
120 140 160

10
When prices increase from 30/= to 40/= quality supplied increase from 80kg
to 100kg thus increase is called movement along supply curve.
Shift in supply curve- occurs when all other factors that affect supply
apart from prices of commodity changes.this known as change in supply.
S1
P1 s

S1 s

Q2 Q1

Left ward shift in supply- brought about by changes in any or all the
following factors:
a. Increase in price of one or more factors of production used in
producing a commodity.
b. Deterioration in state of technology
c. Increase in an indirect tax- leads to increase in cost of production
d. Reduction in government subsidies
e. Increase incidence in strikes
f. Unfavorable weather conditions adversely affect production
N/B leftward shift in supply is called decrease in supply. Because at same
price quality supplied will decrease as shown in above diagram.

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Rightward shift in supply- o.k.increase in supply because at the same
price quality increase from 22 to 23.

s
s2
p2
s

Q2 Q3 Quantity

The following factors bring about rightwards shift supply curve:

a) Improvement in state of technology
b) Improved government subsidies
c) Decreased incidences in strikes
d) Favorable weather conditions.
Elasticity of supply: is the measure if extent to which overly of a good
responds to change one of the influencing factors.
Price elasticity of supply is measure of decrease of responsiveness of quality
supplied to change of price of commodity

s= propotionate∨% change ∈supply

propotionate∨% change ∈ price

Qs p
X
p Qs
❑

Page 22 of 46
 Q2 q 1 p 1
− x
p2 p1 q1
1. When s >1 – supply is elastic
2. When s < 1 – supply is in elastic
3. When s =1 – supply is unilateral

price elastic

Quantity

- inelastic

quantity

unitary

 s = O perfectly elastic

 s = o perfectly Inelastic

Factors that determine price elasticity of supply

1. Adjustment time – the longer the adjustment time the more elastic is
the supply and vice versa
2. Availability of space capacity – the more available the spare capacity
the firm has, the more elastic is the supply for vice versa

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 3. Level of unsold stock – the larger the stock held by producers, the
more elastic is the supply and vice- versa
4. Availability of variable factors of production – if variable factors of
production are easy available – the supply will be more elastic and
vice versa
5. Ease of substitution – supply will tend to be relatively elastic if a firm
can use different combinations of capital and labour to produce a
particular level of product
6. No of firms in the industry – the greater the number of firms the more
elastic is the market or industry in supply
EQUILIBRIUM
Is a state of rest
Market equilibrium:- is a situation in which the forces which determine
the behavior of some variable are in balance and exert no pressure on the
variable to change.
Across when the quantity of commodity demanded in the marker per unit of
time equals the quantity supplied to market after the same period of time.
Quantity and price at which equilibrium exists are called equilibrium price
and equilibrium quantity respectively
Can be represented graphically as follows

Excess supply pe = equilibrium price

P1 Qe equilibrium
Pe
quantity

P2 1. qs > qd
2. Qd > Qs

Q1 Q3 Q2 Q4
Qe

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When the price is at Pe = Quantity demanded is Qe therefore equilibrium
occurs and is called market equilibrium (Qd = Qs) pe
1. At prices above equilibrium price, quantity demanded will be Qq1 while
quantity supplied will be q2. P1 ( 2d/q1 – 2s/q2)
2. At prices below equilibrium price quantity supplied will be q3 while
quantity demanded will be q4 P2 (Q3 4q4). It implies that demand
exceeds supply i.e. q4> q3 and will lead to excess demand for the
commodity due to shortage created by producers. There will be
pressure on the prices to increase until equilibrium price is reached,
it’s called suppliers market coz the competition among buyers will lead
to increase in prices which will benefit the suppliers.

EFFECTS OF SHIFTS IN DEMAND FOR SUPPLY ON MARKET PRICES.

Effects of changes in demand can be stated as follows:
1. S
D1

Pe 1 D

D1
Pe
D
qe
Qe1

1. Holding all other factors constant, an increase in demand leads to an

increase in equilibrium and in increase in quantity supply
2. D S

Pe2
D2 E
D
Pe2 D2
qe1 qe

Holding other factors constant, decrease in equilibrium price leads to

decrease in quantity supplied and can increase in quantity demand
3.
S
S
pe

pe3 S
S D
qe Page 25 of 46
 Qe3

Holding factors constant can increase in supply will lead to a decrease in

S4
equilibrium price (Pe3) and increase in quantity demanded (qe3)
D
4. S

pe4

pe S4 D
S
Qe4 Qe

Holding other factors constant a decrease in supply will lead to increase in

equilibrium price (Pe4) and decrease in quantity demanded (qe4)
Mathematical approach in equilibrium
Equilibrium is the state of balance, meaning that quantity demanded equals
to quantity supplied i.e.
Qd = Qs
Qd = Quantity demanded
Qs = quantity supplied.

QD – is mathematically expressed as
QD = a – bp where a 4 b > 0
Price
B= slope of curve
A= constant
D
2
B change in Q/P = b = O
p
S
Quantity
Price
q
b=
p

O
Quantity

Equilibrium actors when QD = QS

Given Qs = - 10 + 6p

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Qd = 20 – 4p
Solving this , at equilibrium QD = QS
10 + 20 = 10 + 10p + 10
Qs = -10 + 6( 3)
=8
Qs = -a + bp
QD = 20 -4 (3) = 20 – 12 = 8
Given that p + q2 + 3q – 20 = 0 demand function
P - 3q2 + 10q – 5 = 0 supply function
Determine equilibrium price and quantity
Solution
1. Elimination method
2. Substitution method
3. Graphical methods
Elimination
P = q2 – 3q + 20
P+ -q2 – 3q + 20 – 3q2 – 10q + 5
-4q2 + 7q + 15 = 0
4q2 – 7q – 15 = 0

Ax2 + box + c = 0
−b ± √ b2−4 ac
(x1,X2 = -b x=
2a
−7 ± √ 7 2−4 (4 x−15)
A= 4, b = -7 , c = -15 = x=
2(4 )
= 1.25
Substitution
P + q2 + 2q – 20 = 0
-3q2 + 10q – 5 = 0
4q2 – 7q – 15 = 0
4q2 – 7q – 15 =0

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 UTILITY ANALYSIS
Utility is a satisfaction derived from consuming a quantity of an item. It’s
measured in Utile.
Total utility :- is the total satisfaction gained from consuming a
commodity.
Marginal Utility ( extra) – is the extra benefit derived from consuming one
more unit of a commodity when the consumption of other commodity

Point of saturation
Utility /TU/MU

Q2
Q1 Quantity
Consider the consumption of a particular commodity e.g. water or a cup of
tea.
The table below shows what happens to the consumer’s total utility and
marginal utility when he consumes one more unit
QUNATITY TOTAL UTILITY MARGINAL UTILITY
0 0 -
1 20 20
2 50 30
3 60 10
4 62 2
5 60 -2
Law of diminishing marginal utility : states that as the quantity of a
good consumed by an individual increases, marginal utility of the good will
eventuality decrease.
It means that as the consumers initially increases his consumptions of the
commodity X1, additional satisfaction derived from consuming one more unit
however as
Illustrated in fig on the other side

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When the consumer reaches point of saturation, further increase in
consumption of that commodity brings about dis – utility
Consumer equilibrium: - law of diminishing marginal utility is based on
the assumptions that the consumer is rational
A consumer is said to be rational if he behaves in a manner which is
consistent to roles governing reference.
This set of rules of called the assumptions of rationality.

Assumptions of rationality/ axioms of rationality.

1. Axioms of dominance – consumers will always prefer more of a
commodity to less
2. Axioms of selection – consumer aims to get his or her most preferred
state
3. Axioms of completeness – consumes is able to order all available
combinations of goods according to his preference
4. Axioms of transitivity – states that is a consumer prefers good A to B
and B to C by transitivity a consumer should prefer A to C
The objectivity of a rational consumer is said to be in equilibrium, this
condition can be mathematically expressed as follows:-
MVx MVy 1
−
px py

Where MUx – marginal utility of good x

MUY – marginal utility for good y
Px – is the price of good x
Py – the price for good Y

INDEFERENCE CURVE ANALYSIS

Utility analysis (cardinality) – coz they believed some satisfaction can
measured in units which the ordinals belied it wasn’t possible coz ones level

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 of satisfaction differs from another person’s level of satisfaction when
consuming a particular commodity.
The ordinals don’t require the consumers to know the specific units various
commodities in order to make a choice, it’s sufficient for the consumer to be
able to rank various combinations according to the satisfaction derived from
each bundle.
To rank these bundles, they use indifference curves.
Indifferent curve is a graph showing a combination of to commodities that
the same level of satisfaction.

Commodity x

IC3
IC2
IC1
Commodity x

NB: many indifference curves one graph are called indifference maps
Properties of indifference curve:
1. Are convex to the origin – as one commodity is been consumed, we
substitute the consumption of other commodity – consuming more of y
, leads to less consumption of X a.k.a. marginal of substitution (MRS)
2. Indifference curves don’t intersect
3. The higher the indifference curve, the higher is the level of satisfaction
4. They slope downwards from left to right
Budget line - is a locus of point showing a combination of few commodities
that a consumer can buy using his entire income. Indifference curves only
tell us about the consumer’s preference for 2 goods but cannot tell about
which combination of goods the consumer will choose hence need a budget
line.

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How to construct a budget line
Suppose the price of a commodity X is 20/= and that of Y is 10?= and
consumers income is 10,000/= draw the budget line
Px = 20
Py = 10
Income = 10,000
Solving – let x O = 20 (0) + 10y = 10,000
10 y = 10,000
Y = 1000
Let y = o = 20x + 10(0) = 10,000
20 X 10,000
X = 500

Py

1000

500 Px

Consumer equilibrium

Py=10

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1000

500
Py = 20
Py = 10

1000

500 Px = 20

Py = 10
2000

1000 Income consumption curve

500

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250 500 1000Px = 20
Income = 5000 , 20,000
20x + 10y = 5000
10y = 500
Y = 500
20 x + 10(0) = 5000
X = 250

PX = 20
Py = 10
Income = 20,000
20x + 10y = 20,000
20 x + 10(y) = 20,000
20(0) + 10y = 20,000
10y = 200,000
y= 2000
20x + 10(0) = 20,000
20x = 20,000
X = 1000
X = 250

1. Property of budget line: consumers is solid to be at equilibrium

when the budget line is tangent to the indifference curve
Every budget line has a single indifference curve that is tangent to it
10x ,20x and 25x while the price of y remain constant at 10.
20 x + 10y = 10,000

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 Y = 1000
X = 500
10x + 10 y = 10,000
10x + 10(0) = 10,000
10x = 10,000
x= 1,000
10(0) + 10y = 10,000
10y = 10000
Y = 1000
25 x + 10y = 10,000
25x+ 10(0) = 10,000
25 x + 10(0) = 10,000
25 x = 10,000
X = 400

25 x + 10y = 10,000
25(0) + 10y = 10,000
10y = 10,000
Y = 1000

Commodity Y

1000

Price consumption curve QCC

400 500 1000commodity X

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 THEORY OF PRODUCTION
Factors of production are input or resource of society used in the
process of production are classified in for brand categories
1. Land
2. Labour
3. Capital
4. Entrepreneurship
Load : refers to all natural resources over which people is the power of
disposal and which may be used to yield an income. The reward for land is
rent
Labour:- is the exercise of human, mental and physical effort in the process
of production of goods and services. Reward is salaries and wages
Capital: is the man – made input which can be working capital or circulating
capital. Reward is interests.
Entrepreneurship : the organization of all factors of production in the view
of profit making reward is profit

Specialization : is the concentration of activities in those lines of

production where the individual, firm or century has some natural or
acquired advantage.
Forms of specialization
International specialization: Is concentration by a country of its
resources on a specific area of production.
Regional specialization: within a country where factor
endorsements and economic history have led industries to concentrate
in certain areas because it’s difficult for competitive plant to be
established elsewhere e.g. tea production concentration in highlands

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 Specialization between industries: each economy includes many
industries each producing different commodities
Specialization between firms: industries are composed of firms that
can be regarded as units of production.
Specialization between factories: - arises as one firm will often
control many factories and these are usually referred to as plants and
are unit’s production.

Advantages of specialization
1. The fundamental advantage of division of labour is increased output
arising from division of labour
2. Since each person is endured with different attitude and skills , an
economic system that breaks down work into a variety of jobs gives
individual workers opportunity to exploit their particular talents fully.
3. It improves skills and workers given that once a particular person
establishes himself in the job he usually finds that his skill on job
increases with practice
4. No time wasted – not making between jobs hence more will be
produced
5. Saving of time in training of operatives
6. Makes possible the greater use of machinery since breaking up of a
complete process into services of separate for simpler tasks
7. Reduces cost per unit given that not all costs of production rise as
output rises
8. Increases leisure time available – allows same quantity of goods to be
produced for a lower expenditure of resources
9. Enables labour to be released to other industries because he greater
productivity enables units of labour be released in order to develop
greater skills.

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Disadvantages of specialization
1. Involves close interdependence given that no one can specialize in
making part of a product
2. May lead to boredom or monetary –works perform same operation
hundred of time
3. May be accompanied by a decline in craft marking as skills are
transferred from hand of worker o a machine
4. Associated with an increased risk of unemployment specialization
workers don’t have a wide industrial training to make them adoptable
to changes
5. Is economically limited by the extend of market – methods of
production using expensive capital equipment are only worthwhile if
there is a potential demand for mass products
6. Inevitably associated with standardized products

Mobility of factors of production

Occupational mobility:- refers to the ease of movement of factors of
production from one job to another
Geographical mobility:- relates to ease of movement of factors of
production from one location to another.
MARKET STRUCTURE
Market is a situation where there are willing buyers , sellers , commodities to
be exchanged and a medium of exchange
There are two types of markets in economy
In puts - market for factors of production
Outputs – end products in the process of production – goods and services
(commodities)
Different modes of market structures are characterized as:-
a) Perfect market (perfect competition)
b) Imperfect market (imperfect competition)

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Imperfect market structures we have imperfect competition while perfect
market structures have
1. Monopolistic competition
2. Monopoly
3. Duopoly
4. Oligopoly
Revenue concepts in markets structure
1. Marginal Revenue(MR) refers to change in total revenue arising
from sale of additional unit of output.

MR=change∈total revenue(TR)
change ∈quantity

MR=TR
Q

2. total revenue - is revenue arising from sale of a specific quantity.

TR = P x Q = PQ
P = price
Q = quantity in units
3. total costs:- are payments for factors of production
Include fixed costs and variable costs, TC = fixed costs + Variable
costs TC – FC + VC
Fixed costs are costs that don’t vary as output varies i.e. overhead
cost/unavailable costs
Variable costs – are costs that are directly related to output and
include wages of labour, costs of raw materials, fuel and power i.e.
direct/prime costs.
4. Average revenue - Revenue per unit of output
a. AR = TR/Q = PQ/Q = P

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 5. Average costs is the total cost of producing any given output divided
by the one of output produced
ATC = TC/Q = FC+VC?Q = AFC+ AVC
6. Marginal costs:- is the change in total cost per unit change of output
i.e.
change∈total cost
MC =
change ∈quantity
MC=TR
Q
MR=FC +vC
Q

Perfect Competition/perfect market structure

It is the market structure characterized by the following factors.
a) There are many buyers/ sellers so that actions of an individual cant
have a significant impact on the market price.
b) Product is homogeneous (similar) so that buyers don’t have
privilege of products of any particular producers
c) Perfect mobility of factors of production – such that producers can
respond to price signal because there is free entry and exit in
industry
d) Buyers and producers have perfect knowledge – Knowledge of
prevailing market conditions so that price differentialisationdoes
exist.
e) Economic agents are rational such that consumers try to maximize
their utility while producers maximize their profit.
NB: in reality, there is no known market that satisfies conditions of perfect
competition.
Revenue condition for perfect competition:
In perfect competition, firms are price takers therefore they don’t determine
price hence the average revenue and marginal revenue is same and
perfectly elastic.

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 Price (Revenue)

AR = MR

Quality output

Profit maximization condition

Profit is the difference between total revenue and total cost i.e.  (profit) =
TR – TC
For profit maximization to occur, the following conditions are involved:
a) Necessary condition - profit is maximized when marginal revenue is
equal to marginal cost i.e.
 = TR – TC
dm dtr dtc dtr
¿ + = =0 but =MR
dq dq dq dq

MR – mc = 0
MR = MC 1st condition
dtc
=MC
dq
b) Sufficient condition

MC

p AR = MR

q1 Quantity (output)
q2

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 States that profit is maximized when marginal cost curve cuts the marginal
revenue curve from below.
Output of the firm in perfect competition.
 Long run period of production is that time when all factor of production
are variable i.e. all factors of production can be charged in order to
make a specific unit of production and four or above years
 Short run is that period of time in which quantity of at least one factor
of period is fixed ranges between 0 – 5 years
In short run, in the perfect competition firms can make normal profits,
super normal (abnormal) or less
Normal profits are the minimum level of profit which a firm must
acquire in order to induce it to remain in operation.
Normal profit AC = AR

MC = marginal cost
Price

Ac – average cost

Quantity (output)

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 MC
Price
AC

AR = MR

Quantity (output)

AC
price (revenue) MC

AC>AR

Q2 quantity (output)

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In long run, a firm in perfect competition can only make normal profits
hence output of firm should be as follows
LAC

LMC

<AR = <MR

Quantity (output)
LMC
< AC

<AR = <MR

<MC <AC

<AR = <MR

QUANTITY
(OUTPUT)

Page 43 of 46
MONOPOLY: is the market structure by a single supplier who controls
the production of that particle product.
He is the sole source of supply in market for tables a downward
sloping demand curve.

Revenue

AR

MR
Q2 output
Revenue condition in short run - monopoly can only make
abnormal profit coz he is a price giver.

Revenue
AR

MR
Output
Q2
Sources of monopoly power: following factors contribute to
barriers to every source of monopoly power.
1. Legal barriers – take form of statutes /parted right
2. Product differentiation barrier – take form of advertising and
branding e.g. M-Pesa
3. Economics of scale barrier where a firm requires a lot of capital to
invest in that particular industry.

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 4. Transport barrier – transport cost barriers – starts to run when firm
sells products in their local areas where they do not incur transport
hence they sell the product at lower prices.
Price discrimination charging different prices to different customers for
same commodity.
Monopolistic competition: it the form of imperfect competition which lies
between stream of perfect competition and monopoly as the features of both
features from monopoly is
a) Has a certain monopoly power over its own branch coz no one else can
produce it.
b) Firms in monopolistic competition like monopoly has downward sloping
graphs/curves
Features from perfect competition are
a) Many buyers and sellers in market
b) There is free entry and exit from industry.
Each firm in monopolistic competition sells different products thus it has
limited control over the market
Equilibrium condition in short run: monopolistic competitive firm makes
supernormal profits/ abnormal profits, while in large run it makes normal
profits.

AR

MR
output
Characteristics ISoQuants
1. Are downwards sleeping within relevant range
2. Isoquant don’t intersects

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3. Superior isoquants are represented by those for away from graph
origin
4. Isoquants are convex to the origin within relevant range

Page 46 of 46