Microeconomics: Demand and Supply (Chapter 3) – Study Notes

Markets and Prices

Introduction to Markets

Markets are fundamental to microeconomics, serving as the setting where buyers and sellers interact to exchange goods and services. Understanding how markets function is essential for analyzing economic outcomes.

• 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 buyer or seller 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 good; this is also known as opportunity cost.

Demand

Definition and Key Concepts

Demand represents consumers' willingness and ability to purchase goods and services at various prices during a specific period.

• To demand something: You want it, can afford it, and have made a definite plan to buy it.

• Wants: Unlimited desires or wishes people have for goods and services. Demand reflects decisions about which wants to satisfy.

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

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, the higher the price of a good, the smaller the quantity demanded; the lower the price, the larger the quantity demanded.

• Reasons for the Law of Demand:

  • Substitution Effect: When the relative price (opportunity cost) of a good rises, people seek substitutes, so quantity demanded decreases.

  • Income Effect: When the price of a good rises relative to income, people cannot afford all the things they previously bought, so quantity demanded decreases.

Demand Curve and Demand Schedule

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

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

• Demand Curve: Shows the relationship between quantity demanded and price, with all other influences held constant.

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: As the price of energy bars increases from $0.50 to $2.50, the quantity demanded decreases from 22 million to 5 million bars per week.

Movements Along vs. Shifts of the Demand Curve

• Movement Along the Demand Curve: Caused by a change in the price of the good itself; results in a change in quantity demanded.

• Shift of the Demand Curve: Caused by changes in other factors (not the price of the good), such as income, preferences, or prices of related goods; results in a change in demand.

Factors That Change Demand

• Prices of Related Goods:

  • Substitute: A good that can be used in place of another good. An increase in the price of a substitute increases demand for the good.

  • Complement: A good used together with another good. An increase in the price of a complement decreases demand for the good.

• Expected Future Prices: If the price is expected to rise, current demand increases.

• Income:

  • Normal Good: Demand increases as income increases.

  • Inferior Good: Demand decreases as income increases.

• Expected Future Income and Credit: If income is expected to rise or credit is easier to obtain, demand may increase now.

• Population: A larger population increases demand for all goods.

• Preferences: Different preferences lead to different demand, even with the same income.

Supply

Definition and Key Concepts

Supply represents producers' willingness and ability to sell goods and services at various prices during a specific period.

• To supply a good: A firm must have the resources and technology, expect to profit, and have a definite plan to produce and sell it.

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

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, the higher the price of a good, the greater the quantity supplied; the lower the price, the smaller the quantity supplied.

• Reason: Marginal cost of production increases as quantity produced increases. Producers are willing to supply only if the price covers marginal cost.

Supply Curve and Supply Schedule

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

• Supply: The entire relationship between the price of a good and the quantity supplied.

• Supply Curve: Shows the relationship between quantity supplied and price, with all other influences held constant.

Price (dollars per bar)	Quantity supplied (millions of bars per week)
0.50	0
1.00	4
1.50	7
2.00	10
2.50	15

Example: As the price of energy bars increases from $0.50 to $2.50, the quantity supplied increases from 0 to 15 million bars per week.

Movements Along vs. Shifts of the Supply Curve

• Movement Along the Supply Curve: Caused by a change in the price of the good itself; results in a change in quantity supplied.

• Shift of the Supply Curve: Caused by changes in other factors (not the price of the good), such as input prices, technology, or number of suppliers; results in a change in supply.

Factors That Change Supply

• Prices of Factors of Production: An increase in input prices decreases supply (shifts supply curve left).

• Prices of Related Goods Produced:

  • Substitute in Production: Another good that can be produced using the same resources. If the price of a substitute falls, supply of the good increases.

  • Complement in Production: Goods that must be produced together. If the price of a complement rises, supply of the good increases.

• Expected Future Prices: If the price is expected to rise, current supply decreases.

• Number of Suppliers: More suppliers increase supply (shifts supply curve right).

• Technology: Advances lower production costs and increase supply.

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

Market Equilibrium

Definition and Determination

Market equilibrium occurs when the plans of buyers and sellers are balanced, and there is no tendency for price to change.

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

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

• Price as Regulator: Price adjusts to eliminate shortages and surpluses, moving the market toward equilibrium.

Surplus and Shortage

• Surplus: When the price is above equilibrium, quantity supplied exceeds quantity demanded. This puts downward pressure on price.

• Shortage: When the price is below equilibrium, quantity demanded exceeds quantity supplied. This puts upward pressure on price.

Predicting Changes in Price and Quantity

Effects of Changes in Demand and Supply

• Increase in Demand: Shifts demand curve right. At the original price, there is a shortage, so price rises and quantity supplied increases.

• Decrease in Demand: Shifts demand curve left. At the original price, there is a surplus, so price falls and quantity supplied decreases.

• Increase in Supply: Shifts supply curve right. At the original price, there is a surplus, so price falls and quantity demanded increases.

• Decrease in Supply: Shifts supply curve left. At the original price, there is a shortage, so price rises and quantity demanded decreases.

Simultaneous Changes in Demand and Supply

• Both Increase: Equilibrium quantity increases; effect on price is uncertain (depends on relative magnitude of shifts).

• Both Decrease: Equilibrium quantity decreases; 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.

Key Equations:

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

• Equilibrium Condition: $Q_d = Q_s$ where $Q_d$ is quantity demanded and $Q_s$ is quantity supplied.

Example Application: If the price of energy bars is set above equilibrium, a surplus results, leading to downward pressure on price until equilibrium is restored. If the price is set below equilibrium, a shortage results, leading to upward pressure on price.

Additional info: These notes summarize the core concepts of demand, supply, and market equilibrium, which are foundational for further study in microeconomics, including applications to policy, welfare analysis, and market interventions.