Microeconomics Chapter 3: Demand and Supply – Structured Study Notes

Markets and Prices

Introduction to Markets

Markets are fundamental to microeconomics, serving as the environment where buyers and sellers interact to exchange goods and services. Understanding market structures and price mechanisms is essential for analyzing economic behavior.

• Market: Any arrangement that enables buyers and sellers to get information and do business with each other.

• 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 a good to the money price of the next best alternative; represents opportunity cost.

Demand

Definition and Determinants

Demand reflects consumers' willingness and ability to purchase goods and services at various prices. It is shaped by several factors and is central to market analysis.

• Demand: The entire relationship between the price of a good and the quantity demanded.

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

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

The Law of Demand

The law of demand describes the inverse relationship between price and quantity demanded, holding other factors constant.

• Law of Demand: Other things remaining the same, as the price of a good rises, the quantity demanded falls; as the price falls, the quantity demanded rises.

• Substitution Effect: When the price of a good rises, consumers seek substitutes, decreasing quantity demanded.

• Income Effect: When the price rises relative to income, consumers cannot afford as much, decreasing quantity demanded.

Demand Curve and Demand Schedule

The demand curve graphically represents the relationship between price and quantity demanded, holding other factors constant.

• Demand Curve: Shows the relationship between quantity demanded and price.

• Demand Schedule: A table showing quantities demanded at different prices.

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

Movements and Shifts in Demand

• 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 (income, preferences, prices of related goods, etc.).

Factors That Change Demand

• Prices of related goods (substitutes and complements)

• Expected future prices

• Income

• Taxes and subsidies

• Expected future income and credit

• Population

• Preferences

Factor	Effect on Demand
Substitute price rises	Demand increases
Complement price falls	Demand increases
Income rises (normal good)	Demand increases
Income rises (inferior good)	Demand decreases

Supply

Definition and Determinants

Supply represents producers' willingness and ability to sell goods and services at various prices. It is influenced by production costs, technology, and other factors.

• Supply: The entire relationship between quantity supplied and price.

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

• Resources and Technology: Determine what is possible to produce.

The Law of Supply

The law of supply describes the direct relationship between price and quantity supplied, holding other factors constant.

• Law of Supply: Other things remaining the same, as the price of a good rises, the quantity supplied rises; as the price falls, the quantity supplied falls.

• Marginal Cost: The cost of producing one more unit; supply increases only if price covers marginal cost.

Supply Curve and Supply Schedule

• Supply Curve: Shows the relationship between quantity supplied and price.

• Supply Schedule: A table showing quantities supplied at different prices.

Price (dollars per bar)	Quantity Supplied (millions of bars per week)
0.50	2
1.00	6
1.50	10
2.00	15
2.50	20

Movements and Shifts in Supply

• 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 (input prices, technology, number of suppliers, etc.).

Factors That Change Supply

• Prices of factors of production

• Prices of related goods produced

• Expected future prices

• Taxes and subsidies

• Number of suppliers

• Technology

• State of nature (e.g., weather, natural disasters)

Factor	Effect on Supply
Input price rises	Supply decreases
Technology improves	Supply increases
Number of suppliers increases	Supply increases
Natural disaster	Supply decreases

Market Equilibrium

Equilibrium Price and Quantity

Market equilibrium occurs when quantity demanded equals quantity supplied, resulting in a stable price and quantity.

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

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

• Shortage: Occurs when quantity demanded exceeds quantity supplied; price tends to rise.

• Surplus: Occurs when quantity supplied exceeds quantity demanded; price tends to fall.

Price	Quantity Demanded	Quantity Supplied	Shortage/Surplus
0.50	22	2	Shortage
1.00	15	6	Shortage
1.50	10	10	Equilibrium
2.00	7	15	Surplus
2.50	5	20	Surplus

Price Adjustments

• At prices below equilibrium, shortages push prices up.

• At prices above equilibrium, surpluses push prices down.

• At equilibrium, no tendency for price to change unless demand or supply shifts.

Predicting Changes in Price and Quantity

Comparative Statics

Changes in demand or supply shift the equilibrium price and quantity. The direction and magnitude depend on which curve shifts and by how much.

• Increase in Demand: Price rises, quantity rises.

• Decrease in Demand: Price falls, quantity falls.

• Increase in Supply: Price falls, quantity rises.

• Decrease in Supply: Price rises, quantity falls.

Change	Price	Quantity
Demand rises	Rises	Rises
Demand falls	Falls	Falls
Supply rises	Falls	Rises
Supply falls	Rises	Falls

Simultaneous Changes

• 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 Formulas

• Relative Price (Opportunity Cost): $\text{Relative Price} = \frac{\text{Money Price of Good}}{\text{Money Price of Next Best Alternative}}$

• Equilibrium Condition: $Q_d = Q_s$

Conclusion

• Understand the underlying determinants of demand and supply.

• Recognize factors that shift demand and supply curves.

• Identify market equilibrium price and quantity.

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