Supply, Demand, and Market Equilibrium: Microeconomics Study Notes

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Supply, Demand, and Market Equilibrium

Introduction

This chapter introduces the foundational concepts of microeconomics: supply, demand, and market equilibrium. Understanding these concepts is essential for analyzing how markets function and how prices are determined.

Demand Side of the Market

Demand Curve

The demand curve shows the relationship between the price of a good and the quantity demanded by consumers over a given period, holding all other factors constant.

Quantity Demanded (Qd): The amount of a product or service that consumers are willing and able to purchase at a specific price.
Demand Schedule: A table showing the quantity demanded at each price.
Demand Curve: A graphical representation of the demand schedule, typically downward sloping.

Example Demand Schedule Table

Price ($)	Quantity Demanded
10	0
8	2
6	4
4	6
2	8
0	10

Additional info: Table values are illustrative; actual values may vary.

The Law of Demand

The Law of Demand states that, ceteris paribus (all else equal), as the price of a good increases, the quantity demanded decreases, and as the price decreases, the quantity demanded increases.

Inverse Relationship: Price (P) ↑ ⇒ Quantity Demanded (Qd) ↓; Price (P) ↓ ⇒ Qd ↑
Negative Slope: The demand curve slopes downward from left to right.

Equation:

Why Do We Have the Law of Demand?

Diminishing Marginal Utility: As consumers consume more units of a good, the additional satisfaction (utility) from each extra unit decreases.
Example: The first cup of coffee provides more satisfaction than the second or third; thus, consumers are willing to pay less for additional cups.

Properties of the Demand Curve

Y-axis Intercept (Price Axis): There is a price so high that quantity demanded is zero.
X-axis Intercept (Quantity Axis): Even at a price of zero, demand is finite due to physical or practical limits.
Negative Slope: Reflects the law of demand.

Change in Demand vs. Movement Along the Demand Curve

Movement Along the Curve: Caused by a change in the price of the good itself (ceteris paribus).
Shift of the Curve: Caused by changes in other factors (income, tastes, prices of related goods, expectations, market size).

Diagram: A movement along the curve is a change from one point to another on the same curve; a shift is a movement of the entire curve to the right (increase in demand) or left (decrease in demand).

Determinants of Demand (Demand Shifters)

Income & Wealth:
- Normal Goods: Demand increases as income increases.
- Inferior Goods: Demand decreases as income increases.
Prices of Related Goods:
- Substitutes: Increase in the price of one leads to an increase in demand for the other (e.g., Coke and Pepsi).
- Complements: Increase in the price of one leads to a decrease in demand for the other (e.g., cars and gasoline).
Tastes & Preferences: Changes in consumer preferences can increase or decrease demand.
Expectations: Expectations of future prices or income can affect current demand.
Market Size: An increase in the number of buyers increases market demand.

Supply Side of the Market

Supply Curve

The supply curve shows the relationship between the price of a good and the quantity supplied by producers over a given period, holding all other factors constant.

Quantity Supplied (Qs): The amount of a product that firms are willing and able to sell at a specific price.
Supply Schedule: A table showing the quantity supplied at each price.
Supply Curve: A graphical representation of the supply schedule, typically upward sloping.

The Law of Supply

The Law of Supply states that, ceteris paribus, as the price of a good increases, the quantity supplied increases, and as the price decreases, the quantity supplied decreases.

Positive Relationship: Price (P) ↑ ⇒ Quantity Supplied (Qs) ↑; Price (P) ↓ ⇒ Qs ↓
Upward Slope: The supply curve slopes upward from left to right.

Equation:

Determinants of Supply (Supply Shifters)

Cost of Production: Includes input prices, technology, and productivity.
Prices of Related Goods: Substitutes and complements in production can affect supply.
Technology: Improvements can lower costs and increase supply.
Taxes and Subsidies: Taxes increase costs (decrease supply); subsidies decrease costs (increase supply).
Expectations: Expected future prices can affect current supply.
Number of Firms: More firms increase market supply.

Change in Supply vs. Movement Along the Supply Curve

Movement Along the Curve: Caused by a change in the price of the good itself (ceteris paribus).
Shift of the Curve: Caused by changes in other factors (input prices, technology, number of firms, etc.).

Market Equilibrium: Putting Demand and Supply Together

Concept of Equilibrium

Market equilibrium occurs at the price and quantity where the quantity demanded equals the quantity supplied. At this point, there is no tendency for price to change.

Equilibrium Price (P*): The price at which Qd = Qs.
Equilibrium Quantity (Q*): The quantity bought and sold at the equilibrium price.

Equation:

Disequilibrium: Surplus and Shortage

Surplus (Excess Supply): Occurs when price is above equilibrium (Qs > Qd); leads to downward pressure on price.
Shortage (Excess Demand): Occurs when price is below equilibrium (Qd > Qs); leads to upward pressure on price.

Price Rationing

When there is a shortage, prices rise to ration the available goods to those willing and able to pay the most.

Changes in Equilibrium

Shifts in demand or supply curves (due to changes in determinants) will change the equilibrium price and quantity.

Increase in Demand: Shifts demand curve right; increases P* and Q*.
Decrease in Demand: Shifts demand curve left; decreases P* and Q*.
Increase in Supply: Shifts supply curve right; decreases P*, increases Q*.
Decrease in Supply: Shifts supply curve left; increases P*, decreases Q*.
Simultaneous Shifts: The effect on P* and Q* depends on the relative magnitude and direction of the shifts.

Perfectly Competitive Market

A perfectly competitive market is characterized by:

Many buyers and sellers
All firms selling identical (homogeneous) products
No barriers to entry or exit for new firms

In such markets, individual buyers and sellers are price takers, meaning they cannot influence the market price.

Summary Table: Demand and Supply Shifters

Determinant	Effect on Demand	Effect on Supply
Income (Normal Good)	Increase shifts demand right	No direct effect
Income (Inferior Good)	Increase shifts demand left	No direct effect
Price of Substitute	Increase shifts demand right	No direct effect
Price of Complement	Increase shifts demand left	No direct effect
Input Prices	No direct effect	Increase shifts supply left
Technology	No direct effect	Improvement shifts supply right
Number of Buyers/Firms	More buyers shift demand right	More firms shift supply right
Expectations	Future price increase shifts demand right	Future price increase may shift supply left

Additional info: This table summarizes the main shifters of demand and supply and their typical effects on the respective curves.