Microeconomics: Demand, Supply, Elasticity, and Consumer Choice – Study Notes

Demand, Supply, and Equilibrium

Understanding Demand Curves

The demand curve shows the relationship between the price of a good and the quantity demanded by consumers. It typically slopes downward, indicating that as price decreases, quantity demanded increases, and vice versa.

• 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 non-price factors (income, tastes, prices of related goods, etc.).

• Law of Demand: All else equal, an increase in price leads to a decrease in quantity demanded.

• Example: If the price of running shoes falls, more pairs are demanded, shown as a movement along the demand curve.

Market Equilibrium

Market equilibrium occurs where the quantity demanded equals the quantity supplied at a certain price.

• Equilibrium Price: The price at which the market clears (no shortage or surplus).

• Shifts in Supply or Demand: Cause changes in equilibrium price and quantity.

• Example: If demand increases (shifts right), equilibrium price and quantity both rise.

Elasticity

Price Elasticity of Demand

Price elasticity of demand measures how much quantity demanded responds to a change in price.

• Formula: $\text{Price Elasticity of Demand} = \frac{\%\ \text{Change in Quantity Demanded}}{\%\ \text{Change in Price}}$

• Elastic Demand: Elasticity > 1 (quantity demanded changes more than price)

• Inelastic Demand: Elasticity < 1 (quantity demanded changes less than price)

• Unit Elastic: Elasticity = 1

• Perfectly Inelastic: Elasticity = 0 (vertical demand curve)

• Perfectly Elastic: Elasticity = ∞ (horizontal demand curve)

• Example: If a 10% increase in price causes a 20% decrease in quantity demanded, elasticity = 2 (elastic).

Income and Cross-Price Elasticity

• Income Elasticity of Demand: Measures how quantity demanded changes as consumer income changes. $\text{Income Elasticity} = \frac{\%\ \text{Change in Quantity Demanded}}{\%\ \text{Change in Income}}$

• Cross-Price Elasticity: Measures how quantity demanded of one good changes as the price of another good changes. $\text{Cross-Price Elasticity} = \frac{\%\ \text{Change in Quantity Demanded of Good A}}{\%\ \text{Change in Price of Good B}}$

• Normal Good: Positive income elasticity

• Inferior Good: Negative income elasticity

• Substitutes: Positive cross-price elasticity

• Complements: Negative cross-price elasticity

Consumer Choice and Utility Maximization

Budget Constraints

Consumers face budget constraints, which limit the combinations of goods and services they can purchase given their income and the prices of goods.

• Budget Line Equation: $P_x X + P_y Y = I$ where $P_x$ and $P_y$ are prices of goods X and Y, and $I$ is income.

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

• Example: If socks cost $10 and shoes cost $50, and income is $110, the consumer can buy various combinations such as 1 pair of shoes and 6 pairs of socks.

Marginal Utility and Optimal Choice

Consumers maximize utility by allocating their budget so that the marginal utility per dollar spent is equal across all goods.

• Marginal Utility (MU): The additional satisfaction from consuming one more unit of a good.

• Optimal Consumption Rule: $\frac{MU_x}{P_x} = \frac{MU_y}{P_y}$

• Example: If the marginal utility per dollar spent on socks is higher than that for shoes, the consumer should buy more socks and fewer shoes.

Production, Costs, and Opportunity Cost

Opportunity Cost in Production

Producers must consider both explicit costs (monetary) and implicit costs (opportunity costs of time or resources).

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

• Example: If a factory location is farther from the market, the opportunity cost includes both higher rent and increased transportation time.

Marginal Cost

Marginal cost is the additional cost of producing one more unit of output.

• Formula: $\text{Marginal Cost} = \frac{\text{Change in Total Cost}}{\text{Change in Quantity}}$

• Application: Used to determine the optimal production level and factory location.

Tables and Data Interpretation

Example: Marginal Utility Table

The following table shows how to calculate marginal utility per dollar for two goods (socks and shoes):

Pairs of Socks	Total Utility (Socks)	Marginal Utility (Socks)	Pairs of Shoes	Total Utility (Shoes)	Marginal Utility (Shoes)	Marginal Utility per Dollar (Socks)	Marginal Utility per Dollar (Shoes)
0	0	N/A	0	0	N/A	N/A	N/A
1	40	40	1	100	100	4	2
2	76	36	2	180	80	3.6	1.6
3	108	32	3	240	60	3.2	1.2
4	136	28	4	280	40	2.8	0.8
5	160	24	5	300	20	2.4	0.4
6	180	20	6	300	0	2	0

Additional info: Marginal utility per dollar is calculated by dividing marginal utility by the price of the good.

Graph Interpretation

Demand and Cost Curves

• Demand Curve: Illustrates the relationship between price and quantity demanded for a market or individual.

• Cost Curve: Shows the total cost of different options (e.g., apartments at varying distances from work).

• Application: Used to determine optimal choices based on cost minimization or utility maximization.

Summary Table: Key Microeconomic Concepts

Concept	Definition	Formula
Price Elasticity of Demand	Responsiveness of quantity demanded to price changes	$\frac{\%\ \text{Change in Quantity Demanded}}{\%\ \text{Change in Price}}$
Income Elasticity of Demand	Responsiveness of quantity demanded to income changes	$\frac{\%\ \text{Change in Quantity Demanded}}{\%\ \text{Change in Income}}$
Cross-Price Elasticity	Responsiveness of demand for one good to price changes of another	$\frac{\%\ \text{Change in Quantity Demanded of Good A}}{\%\ \text{Change in Price of Good B}}$
Marginal Utility per Dollar	Additional utility from spending one more dollar on a good	$\frac{MU}{P}$
Marginal Cost	Additional cost of producing one more unit	$\frac{\text{Change in Total Cost}}{\text{Change in Quantity}}$