Microeconomics Study Notes: Supply, Demand, Elasticity, and Market Surplus

Supply and Demand: Core Concepts

Definitions and Standard Approach

Microeconomics simplifies the analysis of markets by focusing on the combined actions of buyers and sellers. The supply of a good is the total amount that producers are willing to sell, while demand is the total amount that consumers are willing to buy. The market refers to the specific context in which goods are bought and sold, defined by product, location, and time.

• Supply: Combined amount of a good that all producers in a market are willing to sell.

• Demand: Combined amount of a good that all consumers in a market are willing to buy.

• Market: Specific product, location, and time (e.g., oranges in a city in January).

Four basic assumptions underpin supply and demand analysis:

1. Supply and demand are restricted to a single market.

2. All goods sold in the market are identical.

3. All buyers and sellers have the same information about prices and quality.

4. There are many buyers and sellers, so no one can influence the market price.

Key Terms

• Commodities: Goods traded in markets where varieties are essentially interchangeable (e.g., wheat, oil).

• Substitute: A good that can be used in place of another.

• Complement: A good that is often purchased and used with another good.

Example: If the price of coffee decreases, demand for tea (a substitute) may decrease, while demand for sugar (a complement) may increase.

Demand and Supply Equations

Demand Curve

The demand curve shows the relationship between the price of a good and the quantity demanded, holding other factors constant.

• Demand curve equation: $Q = 1000 - 200P$

• Demand choke price: The price at which quantity demanded is zero.

• Inverse demand curve: $P = 5 - 0.005Q$

Supply Curve

The supply curve shows the relationship between the price and the quantity supplied, holding other factors constant.

• Supply curve equation: $Q = 200P - 200$

• Inverse supply curve: $P = 0.005Q + 1$

• Supply choke price: The lowest price at which firms begin supplying.

Factors Influencing Demand and Supply

Factors that Influence Demand

• Price

• Number of consumers

• Consumers' income or wealth

• Consumer tastes

• Prices of other goods (substitutes and complements)

Factors that Influence Supply

• Price: Higher prices generally increase quantity supplied.

• Suppliers' Costs of Production: Affected by input prices and production technology.

• Production Technology: More efficient processes lower costs and increase supply.

• Number of Sellers: More sellers increase total supply.

Shifts in the Supply Curve

What Causes a Shift?

Any change in factors other than price (e.g., technology, input prices, number of sellers) can shift the supply curve.

• Rightward Shift (Increase in Supply): Example: New technology. $Q = 200P - 200Q$ becomes $Q = 200P - 200Q - 200$

• Leftward Shift (Decrease in Supply): Example: Higher production costs. $Q = 200P - 200$ becomes $Q = 200P - 200$

Market Equilibrium

Definition and Calculation

Market equilibrium occurs where the demand and supply curves intersect, so quantity demanded equals quantity supplied.

• Equilibrium price: The price at which $Q_D = Q_S$.

• Equilibrium quantity: The quantity at which $Q_D = Q_S$.

Example: If $Q_D = 1000 - 200P$ and $Q_S = 200P - 200$, set $Q_D = Q_S$ to solve for equilibrium price and quantity.

Changes in Equilibrium

• Change in quantity supplied: Movement along the supply curve due to a price change.

• Change in supply: Shift of the entire supply curve due to a change in another determinant.

Elasticity

Price Elasticity of Demand and Supply

Elasticity measures the responsiveness of quantity demanded or supplied to a change in price.

• Price elasticity of demand: $E_D = \frac{\%\Delta Q}{\%\Delta P}$

• Price elasticity of supply: $E_S = \frac{\%\Delta Q_S}{\%\Delta P}$

Elasticity formula:

• $E = \frac{\Delta Q}{\Delta P} \times \frac{P}{Q}$

Types of Elasticity

• Unit elastic: Absolute value equals 1.

• Perfectly inelastic: Elasticity equals 0; no change in quantity for any price change.

• Perfectly elastic: Elasticity is infinite; any price change leads to infinite change in quantity.

Market Effects of Elasticity

• In perfectly elastic demand, supply shifts only affect quantity, not price.

• In perfectly elastic supply, demand shifts only affect quantity, not price.

Determinants of Elasticity

• Availability of substitutes

• Time horizon (elasticity increases over time)

• Proportion of income spent on the good

Types of Goods

• Normal good: Quantity demanded rises as income rises.

• Luxury good: Income elasticity greater than 1.

• Inferior good: Quantity demanded decreases as income rises.

• Cross-price elasticity: Measures response of demand for one good to price change in another.

• Own-price elasticity: Measures response of demand for a good to its own price change.

Consumer and Producer Surplus

Definitions

• Consumer surplus: Difference between what consumers are willing to pay and what they actually pay.

• Producer surplus: Difference between the price received and the cost of production.

Consumer and producer surplus are used to measure the benefits of market participation and to analyze market efficiency.

Graphical Representation

Concept	Definition	Graphical Area	Benefit Goes To
Consumer Surplus	Willingness to pay – Actual price paid	Area under demand curve, above price	Consumers
Producer Surplus	Price received – Cost of production	Area above supply curve, below price	Producers

Price Ceilings and Market Effects

• Price ceiling: Highest legal price for a good or service.

• Binding price ceiling: Set below equilibrium price; causes shortages.

• Nonbinding price ceiling: Set above equilibrium price; no effect.

• Deadweight loss: Lost total surplus from trades that no longer occur due to price regulation.

Consumer and Producer Surplus Calculations

• Consumer surplus triangle: $\frac{1}{2} \times \text{quantity sold} \times (\text{demand choke price} - \text{market price})$

• Producer surplus triangle: $\frac{1}{2} \times \text{quantity sold} \times (\text{market price} - \text{supply choke price})$

Summary Table: Types of Price Ceilings

Type of Price Ceiling	Explanation	Effect
Nonbinding	Set above market equilibrium price	No effect on market
Binding	Set below market equilibrium price	Causes shortage

Key Formulas

• Demand curve: $Q = a - bP$

• Supply curve: $Q = cP - d$

• Elasticity: $E = \frac{\Delta Q}{\Delta P} \times \frac{P}{Q}$

• Consumer surplus: $\frac{1}{2} \times \text{base} \times \text{height}$

Additional info: Some explanations and examples have been expanded for clarity and completeness based on standard microeconomics curriculum.