Basic Economic Principles: Law of Demand, Supply & Diminishing Returns – SS2 Agricultural Science Lesson Note (Third Term)

Demand, supply and diminishing returns are basic economic principles that explain how consumers and farmers make choices about agricultural goods.

• Law of demand: consumers buy less of a good as its price rises.
• Law of supply: producers offer more of a good as its price rises.
• Law of diminishing returns: adding more of a variable factor to a fixed factor eventually adds less and less to output.

Behavioural objectives

By the end of the lesson, students should be able to:

1. define wants, scarcity, choice, scale of preference and opportunity cost;
2. state the laws of demand and supply and list the factors that affect each;
3. interpret a demand schedule, a supply schedule and their curves, and read the equilibrium price;
4. state the law of diminishing returns and give its cause and importance in agriculture;
5. define fixed factor, variable factor, total product, average product and marginal product.

What are the basic economic concepts?

The basic economic concepts are wants, scarcity, choice, scale of preference and opportunity cost, and they explain the behaviour of consumers of agricultural goods.

• Wants: the desire of man to own goods and services that give satisfaction. Wants are insatiable, but the resources to meet them are limited.
• Basic wants: food, clothing and shelter.
• Scarcity: the limited supply of resources needed to satisfy wants.
• Choice: the act of selecting one want to satisfy out of several alternatives.
• Scale of preference: a list of unsatisfied wants arranged in order of importance. It differs from one person to another.
• Opportunity cost: the value of the next best alternative given up when one want is satisfied. It is also called the real cost.
• Money cost: the amount of money spent to acquire a particular good or service.

What is demand?

Demand is the quantity of a good a consumer is willing and ready to buy at a given price over a given period.

• Effective demand: demand in which the willingness to buy is backed by the ability to pay.

What is the law of demand?

The law of demand states that the higher the price, the lower the quantity demanded, and the lower the price, the higher the quantity demanded.

What is a demand schedule?

A demand schedule is a table showing the relationship between the price and the quantity of a commodity demanded.

• The table below obeys the law of demand.
• As price falls from ₦100 to ₦20, quantity demanded rises from 10 to 50.

What is a demand curve?

A demand curve is a graph showing the relationship between the price and the quantity of a commodity demanded.

• It is drawn from the demand schedule.
• It slopes downwards from left to right.

What are the factors affecting demand?

Eight main factors affect the demand for a good.

1. Price of the good: a higher price lowers the quantity demanded.
2. Price of other commodities: a rise in the price of a substitute raises demand for the good.
3. Income of the consumer: higher income usually raises demand for most goods.
4. Taste of consumers: a change in taste or fashion raises or lowers demand.
5. Population: more people in a market means more demand.
6. Periods of festivals: demand for foodstuff, rams and poultry rises during festivals.
7. Expectation of price changes: if consumers expect prices to rise, they buy more now.
8. Taxation: a tax that raises the price of a good tends to lower demand for it.

What is supply?

Supply is the quantity of a good a producer is willing and ready to offer for sale at a given price over a given period.

• Effective supply: the quantity of goods actually offered for sale in the market.

What is the law of supply?

The law of supply states that the higher the price, the higher the quantity supplied, and the lower the price, the lower the quantity supplied.

What is a supply schedule?

A supply schedule is a table showing the relationship between the price and the quantity of a commodity supplied.

What is a supply curve?

A supply curve is a graph showing the relationship between the price and the quantity of goods supplied.

• It is drawn from the supply schedule.
• It slopes upwards from left to right.

What are the factors affecting supply?

Nine main factors affect the supply of a good.

1. Price of the good: a higher price encourages producers to supply more.
2. Level of technology: improved seeds, machines and methods raise output.
3. Cost of production: higher costs of inputs such as labour and fertiliser reduce supply.
4. Government policy: subsidies encourage supply, while restrictions reduce it.
5. Weather condition: good rainfall raises output, while drought lowers it.
6. Taxation: higher taxes on producers reduce supply.
7. Price of other commodities: a farmer may switch to a crop that pays better.
8. Number of producers: more producers in the market means more supply.
9. Natural disasters: floods and drought destroy crops and reduce supply.

How do demand and supply differ?

Demand is what buyers are ready to buy at each price, while supply is what sellers are ready to sell at each price.

What is equilibrium price?

Equilibrium price is the price at which the quantity demanded equals the quantity supplied.

• On the curves, it is the point where the demand and supply curves meet.
• In the two schedules above, both give 30 units at ₦60, so ₦60 is the equilibrium price.

What is the law of diminishing returns?

The law of diminishing returns states that as more units of a variable factor are added to a fixed factor, output rises at first, but later each extra unit adds less to output than the one before.

• After a certain point, the marginal product falls.
• Example: adding more and more labourers to a one-hectare farm of fixed size.

What causes diminishing returns?

Diminishing returns occur because the fixed factor, such as land, cannot be increased in the short run.

• Crowding of the fixed factor: each extra unit of the variable factor has less of the fixed factor to work with.
• Poor management: using more than the required amount of one or more factors makes them less effective.

What is the importance of the law of diminishing returns in agriculture?

1. Effective combination of factors: it helps managers combine factors of production to reach the best output.
2. Less wastage: it reduces the waste of inputs that add nothing to output.
3. Better input decisions: it helps a farmer decide how much fertiliser, seed or labour to apply.

What are the key terms in diminishing returns?

Five key terms are used to describe production in the short run.

• Fixed factors: resources whose quantity cannot be changed in the short run, e.g. land.
• Variable factors: resources whose quantity can be changed in the short run, e.g. labour, fertiliser and seed.
• Total product (TP or Q): the total quantity of output produced by the farm.
• Average product (AP): the output per unit of variable input, found as TP divided by the number of variable units.
• Marginal product (MP): the change in total product from adding one more unit of variable input.

How does a table show diminishing returns?

The table below shows output when variable factor units are added to a fixed factor of 10.

How to read the table

1. Marginal product rises to 21 kg at the third unit.
2. From the fourth unit, marginal product falls (14, 13, 10): diminishing returns have begun.
3. At the seventh unit, marginal product is 0 and total output stops rising.
4. At the eighth unit, marginal product is negative (-3) and total output falls.

What does the graph of diminishing returns look like?

The graph plots total output against units of the variable factor.

Evaluation

1. Define opportunity cost.
2. State the law of demand and the law of supply.
3. List four factors that affect demand and four factors that affect supply.
4. Using the diminishing returns table, state the number of variable factor units at which marginal product becomes zero.
5. State two importances of the law of diminishing returns in agriculture.

Assignment (WAEC past question)

Use the table below to draw an input-output graph of maize yield against fertiliser used. Then do the following:

1. State the law of diminishing returns.
2. Describe the relationship between fertiliser used and maize yield.
3. Explain the main cause of diminishing returns in agricultural production.