Microeconomics Chapter 3: Demand and Supply – Study Notes

Markets and Prices

Introduction to Markets

A market is any arrangement that enables buyers and sellers to get information and do business with each other. In microeconomics, understanding how markets function is fundamental to analyzing economic outcomes.

• Competitive Market: A market with many buyers and sellers, so no single participant can influence the price.

• Money Price: The amount of money needed to buy a good.

• Relative Price: The ratio of the money price of one good to the money price of the next best alternative; this is the opportunity cost of the good.

Demand

Definition and Determinants

To demand something means:

1. You want it,

2. You can afford it, and

3. You have made a definite plan to buy it.

• Wants: Unlimited desires for goods and services. Demand reflects choices about which wants to satisfy.

• Quantity Demanded: The amount consumers plan to buy during a particular period at a particular price.

The Law of Demand

The law of demand states: Other things remaining the same, the higher the price of a good, the smaller the quantity demanded; the lower the price, the larger the quantity demanded.

• Substitution Effect: As the price of a good rises, people switch to substitutes, decreasing quantity demanded.

• Income Effect: As the price rises relative to income, people cannot afford as much, so quantity demanded decreases.

Demand Curve and Demand Schedule

The demand curve shows the relationship between the price of a good and the quantity demanded, holding other factors constant.

Price (dollars per bar)	Quantity Demanded (millions per week)
0.50	22
1.00	15
1.50	10
2.00	7
2.50	5

Movement along the demand curve: Caused by a change in the price of the good itself.

Shift of the demand curve: Caused by changes in other factors (not the price of the good).

Factors That Change Demand

• Prices of related goods: Substitutes (used in place of another good) and complements (used together with another good).

• Expected future prices: If prices are expected to rise, current demand increases.

• Income: Higher income increases demand for normal goods, decreases for inferior goods.

• Taxes and subsidies

• Expected future income and credit

• Population: Larger population increases demand.

• Preferences: Different tastes lead to different demand levels.

Types of Goods

• Normal Good: Demand increases as income increases.

• Inferior Good: Demand decreases as income increases.

Supply

Definition and Determinants

To supply a good or service, a firm must:

1. Have the resources and technology to produce it,

2. Be able to profit from producing it, and

3. Have a definite plan to produce and sell it.

• Quantity Supplied: The amount producers plan to sell during a given period at a particular price.

The Law of Supply

The law of supply states: Other things remaining the same, the higher the price of a good, the greater the quantity supplied; the lower the price, the smaller the quantity supplied.

• As quantity produced increases, marginal cost increases, so higher prices are needed to cover these costs.

Supply Curve and Supply Schedule

The supply curve shows the relationship between the price of a good and the quantity supplied, holding other factors constant.

Price (dollars per bar)	Quantity Supplied (millions per week)
0.50	0
1.00	6
1.50	10
2.00	15
2.50	22

Movement along the supply curve: Caused by a change in the price of the good itself.

Shift of the supply curve: Caused by changes in other factors (not the price of the good).

Factors That Change Supply

• Prices of factors of production: Higher input prices decrease supply.

• Prices of related goods produced: Substitutes in production and complements in production.

• Expected future prices: If prices are expected to rise, current supply decreases.

• Taxes and subsidies

• Number of suppliers: More suppliers increase supply.

• Technology: Advances increase supply.

• State of nature: Natural disasters decrease supply.

Market Equilibrium

Equilibrium Price and Quantity

Market equilibrium occurs when the quantity demanded equals the quantity supplied at a certain price.

• Equilibrium price: The price at which quantity demanded equals quantity supplied.

• Equilibrium quantity: The quantity bought and sold at the equilibrium price.

Price (dollars per bar)	Quantity Demanded	Quantity Supplied	Shortage/Surplus
0.50	22	0	+22 (shortage)
1.00	15	6	+9 (shortage)
1.50	10	10	0 (equilibrium)
2.00	7	15	-8 (surplus)
2.50	5	22	-17 (surplus)

• If price is below equilibrium, there is a shortage and price rises.

• If price is above equilibrium, there is a surplus and price falls.

• At equilibrium, there is no tendency for price to change unless demand or supply changes.

Predicting Changes in Price and Quantity

Comparative Statics

• Increase in demand: Shifts demand curve right, causing price and quantity to rise.

• Decrease in demand: Shifts demand curve left, causing price and quantity to fall.

• Increase in supply: Shifts supply curve right, causing price to fall and quantity to rise.

• Decrease in supply: Shifts supply curve left, causing price to rise and quantity to fall.

Change	Change in P	Change in Q
Demand Rises	Rises	Rises
Demand Falls	Falls	Falls
Supply Rises	Falls	Rises
Supply Falls	Rises	Falls

Simultaneous Changes in Demand and Supply

• If both demand and supply increase, equilibrium quantity rises, but the effect on price is uncertain.

• If both decrease, equilibrium quantity falls, but the effect on price is uncertain.

• If demand increases and supply decreases, price rises, but the effect on quantity is uncertain.

• If demand decreases and supply increases, price falls, but the effect on quantity is uncertain.

Key Conclusions

• Understand the underlying factors of demand and supply.

• Recognize and analyze changes in demand and supply.

• Identify the equilibrium price and quantity in a market.

• Predict how changes in demand and supply affect market equilibrium.