Microeconomics: Demand, Supply, Market Equilibrium, and Elasticity Study Guide

Demand and Supply

Basic Concepts of Demand

Demand refers to the quantity of a good or service that consumers are willing and able to purchase at various prices over a given period. The law of demand states that, ceteris paribus, as the price of a good increases, the quantity demanded decreases, and vice versa.

• Determinants of Demand: Price, income, prices of related goods (substitutes and complements), tastes and preferences, expectations, and population size.

• Movement vs. Shift: A movement along the demand curve is caused by a change in the good's own price. A shift in the demand curve is caused by changes in other determinants (e.g., income, prices of related goods).

• Example: An increase in consumer income typically shifts the demand curve for normal goods to the right.

Basic Concepts of Supply

Supply refers to the quantity of a good or service that producers are willing and able to offer for sale at various prices over a given period. The law of supply states that, ceteris paribus, as the price of a good increases, the quantity supplied increases.

• Determinants of Supply: Price, input costs, technology, expectations, number of sellers, and prices of related goods.

• Movement vs. Shift: A movement along the supply curve is caused by a change in the good's own price. A shift in the supply curve is caused by changes in other determinants (e.g., input prices, technology).

• Example: An increase in the price of inputs shifts the supply curve to the left.

Market Equilibrium

Equilibrium Price and Quantity

Market equilibrium occurs where the quantity demanded equals the quantity supplied. The equilibrium price is the price at which this occurs, and the equilibrium quantity is the amount bought and sold at this price.

• Surplus: Occurs when quantity supplied exceeds quantity demanded at a given price, leading to downward pressure on price.

• Shortage: Occurs when quantity demanded exceeds quantity supplied at a given price, leading to upward pressure on price.

• Example: After a hurricane, increased demand for bottled water leads to a higher equilibrium price and quantity.

Shifts in Equilibrium

• Increase in Demand: Raises both equilibrium price and quantity.

• Decrease in Demand: Lowers both equilibrium price and quantity.

• Increase in Supply: Lowers equilibrium price and raises equilibrium quantity.

• Decrease in Supply: Raises equilibrium price and lowers equilibrium quantity.

Graphical Analysis

Demand and Supply Curves

Demand and supply curves are typically drawn with price on the vertical axis and quantity on the horizontal axis. Shifts in these curves represent changes in market conditions.

• Rightward Shift: Indicates an increase in demand or supply.

• Leftward Shift: Indicates a decrease in demand or supply.

Production Possibilities Frontier (PPF)

The PPF shows the maximum combinations of two goods that can be produced with available resources and technology.

• Points Inside the PPF: Indicate inefficiency or underutilization of resources.

• Points On the PPF: Indicate efficient use of resources.

• Points Outside the PPF: Are unattainable with current resources.

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

Elasticity

Price Elasticity of Demand

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

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

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

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

• Unit Elastic: Elasticity = 1.

• Determinants: Availability of substitutes, definition of the market, necessity vs. luxury, time horizon.

Price Elasticity of Supply

Price elasticity of supply measures the responsiveness of quantity supplied to changes in price.

• Formula: $\text{Elasticity} = \frac{\% \text{ change in quantity supplied}}{\% \text{ change in price}}$

• Example: If the price elasticity of supply is 0.5 and price rises by 3%, quantity supplied rises by 1.5%.

Cross Elasticity of Demand

Cross elasticity of demand measures the responsiveness of quantity demanded for one good to changes in the price of another good.

• Formula: $\text{Cross Elasticity} = \frac{\% \text{ change in quantity demanded of Good A}}{\% \text{ change in price of Good B}}$

• Substitutes: Positive cross elasticity.

• Complements: Negative cross elasticity.

Tabular Data and Applications

Supply and Demand Schedules

Tables are used to show the relationship between price and quantity demanded or supplied.

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

Additional info: This table illustrates how equilibrium price is found where quantity demanded equals quantity supplied.

Production Possibilities Table

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

Additional info: Opportunity cost is calculated by the decrease in coffee output when cookie production increases.

Special Topics

Normal and Inferior Goods

• Normal Good: Demand increases as income increases.

• Inferior Good: Demand decreases as income increases.

• Example: If demand for fish rises with income, fish is a normal good.

Substitutes and Complements

• 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.

Consumer and Producer Surplus

• Consumer Surplus: The difference between what consumers are willing to pay and what they actually pay.

• Producer Surplus: The difference between the price producers receive and the minimum they are willing to accept.

Opportunity Cost

• Definition: The value of the next best alternative forgone.

• Application: Increasing production of one good on the PPF requires sacrificing production of another good.

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

Key Formulas

• Price Elasticity of Demand: $\text{E}_d = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}$

• Price Elasticity of Supply: $\text{E}_s = \frac{\% \text{ change in quantity supplied}}{\% \text{ change in price}}$

• Cross Elasticity of Demand: $\text{E}_{xy} = \frac{\% \text{ change in quantity demanded of Good X}}{\% \text{ change in price of Good Y}}$

• Opportunity Cost: $\text{Opportunity Cost} = \frac{\text{Loss in Good Y}}{\text{Gain in Good X}}$

Additional info:

• Some tables and figures were inferred and reconstructed for clarity and completeness.

• All major microeconomic concepts relevant to the provided questions are covered for exam preparation.