Microeconomics: Demand, Supply, and Market Equilibrium Study Guide

Demand and Supply Analysis

Law of Demand and Law of Supply

The law of demand states that, ceteris paribus, as the price of a good increases, the quantity demanded decreases, and vice versa. The law of supply states that as the price of a good increases, the quantity supplied increases, and vice versa.

• Demand Curve: Downward sloping, showing inverse relationship between price and quantity demanded.

• Supply Curve: Upward sloping, showing direct relationship between price and quantity supplied.

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

• Shift of the curve: Caused by changes in non-price determinants (e.g., income, tastes, prices of related goods).

Example: An increase in consumer income (for a normal good) shifts the demand curve to the right.

Determinants of Demand and Supply

• Demand Determinants: Income, tastes and preferences, prices of related goods (substitutes and complements), expectations, number of buyers.

• Supply Determinants: Input prices, technology, expectations, number of sellers, prices of related goods in production.

Example: A decrease in the price of a substitute (e.g., soda for orange juice) decreases demand for the original good.

Market Equilibrium

Equilibrium Price and Quantity

The market equilibrium occurs where the quantity demanded equals the quantity supplied. The corresponding price is the equilibrium price, and the quantity is the equilibrium quantity.

• Shortage: Occurs when quantity demanded exceeds quantity supplied at a given price (price below equilibrium).

• Surplus: Occurs when quantity supplied exceeds quantity demanded at a given price (price above equilibrium).

Example: If the price is set below equilibrium, a shortage will occur, causing upward pressure on price.

Shifts in Demand and Supply

• Increase in Demand: Shifts demand curve right, raising both equilibrium price and quantity.

• Decrease in Demand: Shifts demand curve left, lowering both equilibrium price and quantity.

• Increase in Supply: Shifts supply curve right, lowering equilibrium price and raising equilibrium quantity.

• Decrease in Supply: Shifts supply curve left, raising equilibrium price and lowering equilibrium quantity.

Example: A technological improvement in production increases supply, shifting the supply curve right.

Elasticity

Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of quantity demanded to a change in price.

• Formula: $E_d = \frac{\%\ \text{change in quantity demanded}}{\%\ \text{change in price}}$

• Elastic Demand: $|E_d| > 1$ (quantity demanded is responsive to price changes)

• Inelastic Demand: $|E_d| < 1$ (quantity demanded is not very responsive to price changes)

• Unit Elastic: $|E_d| = 1$

Determinants: Availability of substitutes, proportion of income spent, time horizon, necessity vs. luxury.

Cross-Price and Income Elasticity

• Cross-Price Elasticity: Measures responsiveness of demand for one good to the price change of another good.

• Formula: $E_{xy} = \frac{\%\ \text{change in quantity demanded of good } x}{\%\ \text{change in price of good } y}$

• Positive value: Substitutes; Negative value: Complements.

• Income Elasticity: Measures responsiveness of demand to changes in income.

• Normal goods: Positive income elasticity; Inferior goods: Negative income elasticity.

Production Possibilities Frontier (PPF) and Opportunity Cost

PPF and Efficiency

The Production Possibilities Frontier (PPF) shows the maximum combinations of two goods that can be produced with available resources and technology.

• Points on the PPF: Efficient production.

• Points inside the PPF: Inefficient production (resources underutilized).

• Points outside the PPF: Unattainable with current resources.

Opportunity Cost: The value of the next best alternative foregone when making a choice.

• Calculation: Opportunity cost of good X = Amount of good Y given up / Amount of good X gained.

Tables and Graphs

Table: Demand and Supply Schedules

Tables are used to show how quantity demanded and supplied change at different prices. Equilibrium is found where quantity demanded equals quantity supplied.

Price	Quantity Demanded	Quantity Supplied
$1.00	500	200
$1.50	400	250
$2.00	300	300
$2.50	200	350
$3.00	150	350

Example: At $2.00, the market is in equilibrium (quantity demanded = quantity supplied = 300).

Table: Production Possibilities

Cookies (dozens)	Coffee (pounds)
1000	350
800	650
600	850
400	1000
200	1150

Example: The opportunity cost of increasing cookie production from 200 to 400 dozens is the decrease in coffee production (from 1150 to 1000 pounds), which is 150 pounds of coffee.

Key Concepts and Definitions

• Normal Good: A good for which demand increases as income increases.

• Inferior Good: A good for which demand decreases as income increases.

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

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

• Elasticity: A measure of responsiveness of quantity demanded or supplied to a change in one of its determinants.

• Shortage: Quantity demanded exceeds quantity supplied at a given price.

• Surplus: Quantity supplied exceeds quantity demanded at a given price.

• Equilibrium: The point where supply equals demand.

• Opportunity Cost: The value of the next best alternative forgone.

Applications and Examples

• Market Shocks: Natural disasters or policy changes can shift demand or supply, affecting equilibrium price and quantity.

• Price Controls: Government-imposed limits on prices can cause shortages (price ceilings) or surpluses (price floors).

• Elasticity in Practice: If the price elasticity of supply is 0.5, a 3% increase in price will increase quantity supplied by 1.5%.

Summary Table: Effects of Shifts in Demand and Supply

Change	Equilibrium Price	Equilibrium Quantity
Increase in Demand	Increases	Increases
Decrease in Demand	Decreases	Decreases
Increase in Supply	Decreases	Increases
Decrease in Supply	Increases	Decreases

Additional info:

• Some questions reference specific figures and tables; the above notes generalize the concepts for broader study use.

• Elasticity calculations and PPF opportunity cost are foundational for microeconomics exams.