Microeconomics Chapter 3: Demand and Supply – Study Notes

Markets and Prices

Introduction to Markets

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

• Market: Any arrangement that enables buyers and sellers to exchange information and conduct business.

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

• Money Price: The amount of money required to purchase a good.

• Relative Price: The ratio of the money price of one good to another, representing its opportunity cost.

Example: If an energy bar costs $2 and a granola bar costs $1, the relative price of an energy bar is 2 granola bars per energy bar.

Demand

Definition and Determinants

Demand reflects consumers' willingness and ability to purchase goods and services. It is shaped by preferences, income, and other factors.

• To demand something, a consumer must:

  1. Want it

  2. Be able to afford it

  3. Have a definite plan to buy it

• Wants: Unlimited desires for goods and services.

• Quantity Demanded: The amount consumers plan to buy at a specific price over a given period.

The Law of Demand

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

• Law of Demand: As price increases, quantity demanded decreases; as price decreases, quantity demanded increases.

• Two key effects explain this law:

  • Substitution Effect: Higher relative prices lead consumers to substitute away from the good.

  • Income Effect: Higher prices reduce purchasing power, decreasing quantity demanded.

Demand Curve and Demand Schedule

The demand curve graphically represents the relationship between price and quantity demanded, assuming other factors remain unchanged.

• Demand: The entire relationship between price and quantity demanded.

• Demand Curve: Shows quantity demanded at various 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

Example: The demand curve for energy bars slopes downward, illustrating the law of demand.

Movements Along and Shifts of the Demand Curve

• 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 (e.g., income, preferences).

Example: An increase in income shifts the demand curve for normal goods rightward.

Willingness and Ability to Pay

• The demand curve also represents consumers' willingness and ability to pay for additional units.

• The smaller the quantity available, the higher the price someone is willing to pay for another unit.

• Marginal Benefit: The additional benefit from consuming one more unit, measured by willingness to pay.

Factors That Change Demand

• Prices of Related Goods: Substitutes and complements affect demand.

• Expected Future Prices: Anticipated price changes can shift current demand.

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

• Expected Future Income and Credit: Expectations and credit availability can increase current demand.

• Population: Larger populations increase demand.

• Preferences: Changes in tastes and preferences shift demand.

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
Population increases	Demand increases

Change in Quantity Demanded vs. Change in Demand

• Change in Quantity Demanded: Movement along the demand curve due to price change.

• Change in Demand: Shift of the demand curve due to other factors.

Supply

Definition and Determinants

Supply reflects producers' willingness and ability to sell goods and services, determined by resources, technology, and profitability.

• To supply a good, a firm must:

  1. Have resources and technology to produce it

  2. Expect to profit from producing it

  3. Have a definite plan to produce and sell it

• Quantity Supplied: Amount producers plan to sell at a specific price over a given period.

The Law of Supply

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

• Law of Supply: As price increases, quantity supplied increases; as price decreases, quantity supplied decreases.

• This law is due to increasing marginal cost as output rises.

• Producers supply only if price covers marginal cost.

Supply Curve and Supply Schedule

The supply curve graphically represents the relationship between price and quantity supplied, assuming other factors remain unchanged.

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

• Supply Curve: Shows quantity supplied at various prices.

Price (dollars per bar)	Quantity Supplied (millions of bars per week)
0.50	0
1.00	6
1.50	10
2.00	15
2.50	20

Example: The supply curve for energy bars slopes upward, illustrating the law of supply.

Minimum Supply Price and Marginal Cost

• The supply curve is also a minimum-supply-price curve.

• As quantity produced increases, marginal cost rises.

• The lowest price at which a producer is willing to sell an additional unit equals marginal cost.

Movements Along and Shifts of the Supply Curve

• 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 (e.g., technology, input prices).

Factors That Change Supply

• Prices of Factors of Production: Higher input prices decrease supply.

• Prices of Related Goods Produced: Substitutes and complements in production affect supply.

• Expected Future Prices: Anticipated price changes can shift current supply.

• Number of Suppliers: More suppliers increase market supply.

• Technology: Advances increase supply by lowering costs.

• State of Nature: Natural events (e.g., weather) can increase or decrease supply.

Factor	Effect on Supply
Input price rises	Supply decreases
Substitute price falls	Supply increases
Complement price rises	Supply increases
Technology improves	Supply increases
Natural disaster	Supply decreases

Change in Quantity Supplied vs. Change in Supply

• Change in Quantity Supplied: Movement along the supply curve due to price change.

• Change in Supply: Shift of the supply curve due to other factors.

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.

• Price acts as a regulator, adjusting to balance buyers' and sellers' plans.

Surplus and Shortage

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

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

Price Adjustments

• Above equilibrium price: Surplus forces price down.

• Below equilibrium price: Shortage forces price up.

• At equilibrium price: No tendency for price to change unless demand or supply shifts.

Predicting Changes in Price and Quantity

Effects of Shifts in Demand and Supply

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

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

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

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

Simultaneous Changes in Demand and Supply

• Both Increase: Equilibrium quantity rises; effect on price is uncertain.

• Both Decrease: Equilibrium quantity falls; effect on price is uncertain.

• Demand Increases, Supply Decreases: Price rises; effect on quantity is uncertain.

• Demand Decreases, Supply Increases: Price falls; effect on quantity is uncertain.

Change	Equilibrium Price	Equilibrium Quantity
Demand ↑, Supply ↑	Uncertain	↑
Demand ↓, Supply ↓	Uncertain	↓
Demand ↑, Supply ↓	↑	Uncertain
Demand ↓, Supply ↑	↓	Uncertain

Key Equations

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

• Market Equilibrium Condition: $Q_d = Q_s$

Additional info: These notes expand on the textbook slides by providing definitions, examples, and tables for clarity. All equations are presented in LaTeX format for academic rigor.