i. Explain the relationship between price and demand\
Price is any consideration or amount a person is willing to pay for any good/services offered and therefore the higher the price the lower the demand of any commodity and vise versa. Price and demand are correlated and move in the opposite directions.
ii. Explain the relationship between prices and supply
Price affects supply in that when the price is low the supply becomes low since nobody is willing to sell goods at lower prices or pay higher for the same goods. An offer or lower price makes it more marketable.
iii. Ceteris paribus i.e. all other thing s held constant quantity demanded of any good or service will be affected by the price change.
importance of elasticity of supply
• Price elasticity of supply refers to the responsiveness of supply to changes in the price level. where price elasticity of supply is important
inelastic supply response to rising demand – pushes up prices with
respond to depreciation in the exchange rate if export demand grows.
Inelastic supply makes prices more volatile of many hard and soft commodities
especially in markets where there is strong speculative activity i.e inflation.
wage differentials in the Labor market many firms may opt for cheap labour to relieve shortages of labour and improve the elasticity of supply
equilibrium price and quantity
equilibrium price and quantity is where the supply and demand are equal
QD= QS
300-3P=100+5P
Therefore 2P = 200
P = 100 (Equilibrium price)
QS = 100 + 3(100)
= 400 (Equilibrium quantity)
b) Suppose that an increase in consumers’ income resulted in the new demand equation
QD=420-3PCalculate the new equilibrium price and quantity for this product and explain the effect on the demand curve?
QD = QS that is the quantity demanded is equal to the quantity supplied to the market all other factors held constant
Therefore
420 – 3(100)
The equilibrium price therefore is 120
Equilibrium Quantity
100 + 3(120)
460 units
As the income increases/rises so does the demand for commodities since the consumers have a higher spending power? Therefore the demand curve will rise in response to the consumption and the purchasing power.
4) When the price for commodity Y is Kshs 10 the demand for X is 20 units. When the price of
commodity Y increases to Kshs 20 the demand for X is 8units.Calculate the cross elasticity and
interpret your answer.
Cross elasticity measures the response of the quantity demanded of a product when a change in price takes place in another item it is calculated by taking the percentage change in the quantity demanded of one good, divided by the percentage change in price of the substitute good which will l always be positive because for one good will increase if the price of the other product increases
Cross elasticity of demand = Price of X/Quantity of Y x Change in demand of Y/Change in Price of X
= 10/20 x 8/20
= 2%
