Microeconomics: 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 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 one good to the money price of the next best alternative; this represents the opportunity cost.

Demand

Definition and Determinants

Demand reflects consumers' willingness and ability to purchase goods and services. It is influenced by various factors, including price, income, and preferences.

• 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 decisions about which wants to satisfy.

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.

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

• Income Effect: When the price rises relative to income, people cannot afford all previously bought goods, decreasing quantity demanded.

Demand Curve and Demand Schedule

The demand curve graphically represents the relationship between price and quantity demanded, assuming other factors remain constant. The demand schedule is a table of prices and corresponding quantities demanded.

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

• Demand Schedule: Tabular representation of price and quantity demanded.

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

Equation:

$Q_d = a - bP$

where $Q_d$ is quantity demanded, $P$ is price, and $a$, $b$ are parameters.

Movements Along vs. Shifts of the Demand Curve

A movement along the demand curve is caused by a change in the price of the good itself. A shift of the demand curve is caused by changes in other determinants of demand.

• Movement Along: Change in quantity demanded due to price change.

• Shift: Change in demand due to factors other than price (e.g., income, preferences).

Factors That Change Demand

• Prices of Related Goods: Substitutes (goods used in place of each other) and complements (goods used together).

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

• Income: Demand for normal goods increases with income; demand for inferior goods decreases.

• Expected Future Income and Credit: If future income or credit availability is expected to rise, current demand may increase.

• Population: Larger population increases demand.

• Preferences: Differences in tastes affect demand.

Supply

Definition and Determinants

Supply reflects producers' willingness and ability to sell goods and services. It is determined by factors such as production costs, technology, and expectations.

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

• Quantity Supplied: The amount 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.

• Marginal Cost: The cost of producing one more unit increases as quantity produced increases.

Equation:

$Q_s = c + dP$

where $Q_s$ is quantity supplied, $P$ is price, and $c$, $d$ are parameters.

Supply Curve and Supply Schedule

The supply curve shows the relationship between price and quantity supplied, assuming other factors remain constant. The supply schedule is a table of prices and corresponding quantities supplied.

Price (dollars per bar)	Quantity supplied (millions of bars per week)
0.50	0
1.00	4
1.50	10
2.00	20
2.50	25

Movements Along vs. Shifts of the Supply Curve

• Movement Along: Change in quantity supplied due to price change.

• Shift: Change in supply due to factors other than price (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: If prices are expected to rise, current supply may decrease.

• Number of Suppliers: More suppliers increase market supply.

• Technology: Advances increase supply.

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

Market Equilibrium

Equilibrium Price and Quantity

Market equilibrium occurs when quantity demanded equals quantity supplied. The equilibrium price balances the plans of buyers and sellers.

• Equilibrium Price ($P^*$): The price at which $Q_d = Q_s$.

• Equilibrium Quantity ($Q^*$): The quantity bought and sold at the equilibrium price.

Equation:

Set $Q_d = Q_s$ and solve for $P^*$ and $Q^*$.

Price as a Regulator

• Surplus: If price is above equilibrium, quantity supplied exceeds quantity demanded; price falls.

• Shortage: If price is below equilibrium, quantity demanded exceeds quantity supplied; price rises.

• Adjustment: Price adjusts until equilibrium is reached.

Predicting Changes in Price and Quantity

Changes in Demand

• Increase in Demand: Demand curve shifts right; price and quantity increase.

• Decrease in Demand: Demand curve shifts left; price and quantity decrease.

Changes in Supply

• Increase in Supply: Supply curve shifts right; price falls, quantity increases.

• Decrease in Supply: Supply curve shifts left; price rises, quantity decreases.

Simultaneous Changes in Demand and Supply

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

• 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.

Summary Table: Effects of Changes in Demand and Supply

Change	Equilibrium Price	Equilibrium Quantity
Increase in Demand	Rises	Rises
Decrease in Demand	Falls	Falls
Increase in Supply	Falls	Rises
Decrease in Supply	Rises	Falls
Increase in Demand & Supply	Uncertain	Rises
Decrease in Demand & Supply	Uncertain	Falls
Increase in Demand, Decrease in Supply	Rises	Uncertain
Decrease in Demand, Increase in Supply	Falls	Uncertain

Example: Energy Bars Market

Suppose the price of energy bars rises from 2.00. According to the demand schedule, quantity demanded falls from 10 to 7 million bars per week, illustrating the law of demand. If technology improves, the supply curve shifts right, increasing quantity supplied at each price.