Microeconomics Chapter 4: Demand, Supply, and Equilibrium

Chapter 4: Demand, Supply, and Equilibrium

Learning Objectives

• Understand the concept of markets and their structure.

• Analyze buyer behavior and the determinants of demand.

• Examine seller behavior and the determinants of supply.

• Explore how supply and demand interact to determine equilibrium.

• Evaluate the effects of government intervention in markets, such as price controls.

Markets

Definition and Structure

A market is a group of economic agents who are trading a good or service, along with the rules and arrangements for trading. Markets can be physical (e.g., supermarkets) or virtual (e.g., online platforms).

• Perfectly Competitive Market: A market in which (1) all sellers offer an identical good or service, and (2) no individual buyer or seller is powerful enough to affect the market price. Additional info: Examples include agricultural products and basic commodities.

• Market Price: The price at which buyers and sellers conduct transactions.

Example: Brown vs. White Eggs

• Brown eggs often cost more than white eggs because they are advertised as healthier, and people are willing to pay more for perceived benefits.

Demand

How Do Buyers Behave?

The demand curve plots the relationship between the market price and the quantity of a good demanded by buyers.

• Quantity Demanded: The amount of a good that buyers are willing to purchase at a given price.

• Demand Schedule: A table reporting the quantity demanded at different prices, holding all else equal.

• Law of Demand: In most cases, the quantity demanded rises as the price falls (holding all else equal).

Market Demand

• The market demand curve is the sum of individual demand curves of all potential buyers.

Shifts vs. Movements Along the Demand Curve

• Movement along the demand curve: Caused only by a change in the product's own price.

• Shift of the demand curve: Caused by changes in:

  • Tastes and preferences

  • Income and wealth

  • Availability and prices of related goods (substitutes and complements)

  • Number and scale of buyers

  • Buyers’ expectations about the future

Normal and Inferior Goods

• Normal goods: Demand increases as income increases.

• Inferior goods: Demand decreases as income increases.

Related Goods

• Substitutes: Goods that can replace each other; an increase in the price of one increases demand for the other.

• Complements: Goods that are used together; an increase in the price of one decreases demand for the other.

Supply

How Do Sellers Behave?

The supply curve plots the relationship between the market price and the quantity of a good supplied by sellers.

• Quantity Supplied: The amount of a good that sellers are willing to sell at a given price.

• Supply Schedule: A table reporting the quantity supplied at different prices.

• Law of Supply: In most cases, the quantity supplied rises as the price rises (holding all else equal).

Market Supply

• The market supply curve is the sum of individual supply curves of all potential sellers.

Shifts vs. Movements Along the Supply Curve

• Movement along the supply curve: Caused only by a change in the product's own price.

• Shift of the supply curve: Caused by changes in:

  • Input prices

  • Technology

  • Number and scale of sellers

  • Sellers’ expectations about the future

Equilibrium

Supply and Demand in Equilibrium

Competitive equilibrium is the point at which the market comes to an agreement about what the price will be (competitive equilibrium price) and how much will be exchanged (competitive equilibrium quantity) at that price.

• At equilibrium, quantity demanded equals quantity supplied.

• If the price is above equilibrium, there is excess supply (surplus).

• If the price is below equilibrium, there is excess demand (shortage).

Equilibrium Formula

• Demand: $Q_d = f(P)$

• Supply: $Q_s = g(P)$

• Equilibrium: $Q_d = Q_s$

Shifts in Equilibrium

• A shift in the demand or supply curve will change the equilibrium price and quantity.

• Examples:

  • If supply decreases (e.g., due to a major exporter ceasing production), the supply curve shifts left, raising equilibrium price and lowering equilibrium quantity.

  • If technology improves, supply increases, shifting the supply curve right, lowering equilibrium price and increasing equilibrium quantity.

  • If demand decreases (e.g., due to environmental concerns), the demand curve shifts left, lowering both equilibrium price and quantity.

  • Simultaneous shifts in both curves can have complex effects on price and quantity.

Government Intervention

Price Controls

• Governments may set price ceilings (maximum prices) or price floors (minimum prices).

• Example: During the 1974 U.S. oil crisis, the government set a price ceiling on gasoline.

• Price controls can lead to shortages (if the controlled price is below equilibrium) or surpluses (if above equilibrium).

Evidence-Based Economics

Application: Gasoline Prices

• Lower gasoline prices (e.g., due to subsidies) increase quantity demanded.

• Higher gasoline prices (e.g., due to taxes) decrease quantity demanded.

• Changes in price result in movements along the demand curve, not shifts of the curve.

• Changes in preferences (e.g., taking up rock climbing and driving more) shift the demand curve.

Summary Table: Factors Affecting Demand and Supply

Factor	Affects Demand?	Affects Supply?	Type of Change
Price of the Good	Movement along curve	Movement along curve	Not a shift
Tastes & Preferences	Shift	No effect	Shift
Income & Wealth	Shift	No effect	Shift
Prices of Related Goods	Shift	No effect	Shift
Number & Scale of Buyers/Sellers	Shift (buyers)	Shift (sellers)	Shift
Expectations about the Future	Shift	Shift	Shift
Input Prices	No effect	Shift	Shift
Technology	No effect	Shift	Shift

Additional info: This table summarizes the main determinants of demand and supply and whether they cause shifts or movements along the respective curves.