Microeconomics Study Notes: Market Equilibrium, Supply & Demand, and Market Interventions

Chapter 3: Demand, Supply, and Market Equilibrium

Supply Shifters

The supply curve shows the relationship between the price of a good and the quantity supplied. Several factors can shift the supply curve, changing the quantity supplied at every price.

• Prices of Inputs: An increase in input prices (e.g., labor, raw materials) raises production costs, shifting supply left (decrease). A decrease shifts supply right (increase).

• Technological Change: Improvements in technology lower production costs, shifting supply right.

• Prices of Related Goods in Production: If a firm can produce multiple goods, a higher price for one may shift supply of the other left (substitutes in production).

• Number of Firms in the Market: More firms increase market supply (shift right); fewer firms decrease it (shift left).

• Expected Future Prices: If firms expect higher future prices, they may decrease current supply (shift left).

• Natural Disasters and Pandemics: These can disrupt production, shifting supply left.

Example: A new machine reduces the cost of making smartphones, shifting the supply curve to the right and lowering equilibrium price while increasing equilibrium quantity.

Substitutes and Complements

Goods are related in consumption as substitutes or complements:

• Substitutes: Goods where a rise in the price of one increases demand for the other (e.g., tea and coffee).

• Complements: Goods where a rise in the price of one decreases demand for the other (e.g., printers and ink cartridges).

Example: If the price of gasoline rises, demand for electric cars (a substitute) increases.

Normal and Inferior Goods

Goods are classified by how demand responds to income changes:

• Normal Goods: Demand increases as income rises (e.g., organic food).

• Inferior Goods: Demand decreases as income rises (e.g., instant noodles).

Example: When incomes rise, people buy more restaurant meals (normal good) and fewer bus rides (inferior good).

Double Shifters

When both supply and demand shift simultaneously, the effect on equilibrium price or quantity may be ambiguous.

• If both shift right (increase), quantity rises, but the effect on price depends on the relative size of the shifts.

• One outcome (price or quantity) may be certain, the other ambiguous.

Example: New technology (supply right) and increased consumer preference (demand right) both increase quantity, but price could rise, fall, or stay the same.

Law of Demand

The law of demand states that, holding other factors constant, as the price of a good falls, the quantity demanded rises, and vice versa.

• Change in Quantity Demanded: Movement along the demand curve due to a price change.

• Change in Demand: Shift of the entire demand curve due to other factors (income, tastes, etc.).

Example: A sale on shoes leads to more shoes bought (movement along the curve), while a fashion trend increases demand at all prices (shift of the curve).

Market Equilibrium and Adjustments

Market equilibrium occurs where quantity demanded equals quantity supplied. If the market is not at equilibrium:

• Surplus (Excess Supply): Occurs when price is above equilibrium; leads to downward pressure on price.

• Shortage (Excess Demand): Occurs when price is below equilibrium; leads to upward pressure on price.

Example: If a concert ticket is priced too high, unsold tickets (surplus) will push the price down.

Demand and Supply as Marginal Curves

The demand curve represents marginal benefit (MB) to consumers, and the supply curve represents marginal cost (MC) to producers. Efficiency occurs where MB = MC.

• At equilibrium, the value to buyers equals the cost to sellers for the last unit traded.

Example: If MB > MC, more should be produced; if MB < MC, less should be produced.

Demand Shifters

Factors that shift the demand curve include:

• Tastes and Preferences

• Income Changes (normal vs. inferior goods)

• Prices of Related Goods (substitutes and complements)

• Expectations about the Future

• Market Size (number of buyers)

Example: A health study favoring apples increases demand for apples at all prices.

Chapter 4: Market Interventions and Efficiency

Price Ceilings and Price Floors

Governments may set legal limits on prices:

• Price Ceiling: Maximum legal price (e.g., rent control). Binding if set below equilibrium price.

• Price Floor: Minimum legal price (e.g., minimum wage). Binding if set above equilibrium price.

Effects:

• Binding ceilings cause shortages (excess demand).

• Binding floors cause surpluses (excess supply).

• Both can create deadweight loss (DWL) and change consumer/producer surplus.

Example: A binding rent ceiling leads to apartment shortages and lower landlord profits.

Taxes

Taxes on goods affect market outcomes and efficiency:

• Tax Incidence: The burden of a tax depends on the relative elasticities of supply and demand, not on whom the tax is levied.

• Graphing a Per-Unit Tax: The supply curve shifts vertically by the amount of the tax.

• Effects: Taxes reduce quantity traded, create deadweight loss, and generate tax revenue for the government.

Formulas:

• Tax Revenue: $\text{Tax Revenue} = \text{Tax per unit} \times \text{Quantity sold}$

• Deadweight Loss: $\text{DWL} = \frac{1}{2} \times (\text{Tax per unit}) \times (\text{Quantity decrease due to tax})$

Example: A $1 per-unit tax on soda reduces sales and creates DWL, with the burden shared by buyers and sellers depending on elasticity.

Consumer Surplus

Consumer surplus (CS) is the difference between what consumers are willing to pay and what they actually pay.

• For one consumer: $\text{CS} = \text{Willingness to pay} - \text{Price paid}$

• For a group: Area below the demand curve and above the price, up to the quantity bought.

Example: If a buyer is willing to pay $10 for a book but pays $7, CS = $3.

Economic Efficiency

Efficiency is achieved when the market trades all units where marginal benefit equals marginal cost (MB = MC).

• Market interventions (ceilings, floors, taxes) move the market away from efficiency, creating deadweight loss.

• On a graph, CS is the area below the demand curve and above price; producer surplus (PS) is above the supply curve and below price; DWL is the lost surplus due to intervention.

Example: A tax reduces both CS and PS, and the lost gains from trade are shown as DWL.

Summary Table: Effects of Market Interventions

Intervention	Binding Condition	Market Outcome	Consumer Surplus	Producer Surplus	Deadweight Loss
Price Ceiling	Set below equilibrium price	Shortage (excess demand)	May rise or fall	Falls	Yes
Price Floor	Set above equilibrium price	Surplus (excess supply)	Falls	May rise or fall	Yes
Tax	Any per-unit tax	Quantity falls	Falls	Falls	Yes

Additional info: In all cases, the area of deadweight loss represents the value of trades that no longer occur due to the intervention, reducing total welfare.