Microeconomics Study Notes: Demand and Equilibrium

UNIT 1: EQUILIBRIUM

Introduction to Demand

In microeconomics, demand represents the desired purchases of buyers in a market. Understanding how demand responds to various factors is fundamental to analyzing market equilibrium.

• Change in Quantity Demanded: A movement along the demand curve caused by a change in the good's own price.

• Change in Demand: A shift of the entire demand curve due to changes in other factors (e.g., income, prices of related goods, tastes, expectations, number of buyers).

• General Demand Function: $D = D(p \mid p_y, p_e, m, u, n_d)$ where:

  • $p$ = price of the good

  • $p_y$ = price of related goods

  • $p_e$ = expected future price

  • $m$ = income

  • $u$ = tastes/preferences

  • $n_d$ = number of buyers

Key Properties of the Demand Curve

• Reservation Price: The vertical intercept of the demand curve; the price at which the quantity demanded is zero.

• Law of Demand: Price and quantity demanded are inversely related. As price increases, quantity demanded decreases, and vice versa. This is due to diminishing marginal benefits—each additional unit of a good provides less additional satisfaction to consumers.

Quantifying and Illustrating the Demand Curve

Consider the linear demand function:

• $D = 8 - 2p + m$

• When $m_0 = 4$, the demand function becomes $D = 12 - 2p$.

• When $m_1 = 8$, the demand function becomes $D = 16 - 2p$.

Interpretation: An increase in income ($m$) shifts the demand curve to the right, indicating higher quantity demanded at each price.

• Example: At $p = 3$ and $m = 4$, $D = 12 - 2 \times 3 = 6$ units.

• At $p = 3$ and $m = 8$, $D = 16 - 2 \times 3 = 10$ units.

Additional info: The graph (not shown here) would illustrate two parallel demand curves, with the higher income curve lying to the right.

Applications: Interpreting Demand Equations

Classifying Related Goods

Demand equations often include the price of another good ($P_y$), which helps determine whether goods are complements or substitutes:

• If the coefficient of $P_y$ is negative, the goods are complements (increase in $P_y$ decreases demand for $X$).

• If the coefficient of $P_y$ is positive, the goods are substitutes (increase in $P_y$ increases demand for $X$).

Demand Equation	Coefficient of $P_y$	Relationship
$D = 10 - 2P_x - 3P_y + 5M$	-3	Complement in consumption
$D = 10 - 2P_x + 3P_y - 5M$	+3	Substitute in consumption

• Example 1: In $D = 10 - 2P_x - 3P_y + 5M$, since the coefficient of $P_y$ is negative, Good Y is a complement in consumption for Good X.

• Example 2: In $D = 10 - 2P_x + 3P_y - 5M$, since the coefficient of $P_y$ is positive, Good Y is a substitute in consumption for Good X.

Summary Table: Types of Related Goods

Type	Definition	Demand Equation Sign
Complement in consumption	Goods consumed together (e.g., coffee and sugar)	Negative coefficient on $P_y$
Substitute in consumption	Goods that can replace each other (e.g., tea and coffee)	Positive coefficient on $P_y$

Additional info: Complements and substitutes in production refer to relationships in the production process, but in these examples, the focus is on consumption.