Microeconomics (Module 3): Supply and Demand Fundamentals and Elasticity

Law of Demand

Price ↑ → Quantity Demanded ↓ (inverse relationship)

Law of Supply

Price ↑ → Quantity Supplied ↑ (positive relationship)

Demand Shifters

Income, tastes, substitute/complement prices, expectations, number of buyers

Supply Shifters

Input prices, technology, related good prices, expectations, number of sellers

Equilibrium

Point where Quantity Demanded = Quantity Supplied; no shortage or surplus

Surplus

Quantity Supplied > Quantity Demanded; price above equilibrium

Shortage

Quantity Demanded > Quantity Supplied; price below equilibrium

Price Elasticity of Demand (PED)

% change in quantity demanded / % change in price

Midpoint Method

(Q₂ – Q₁) / [(Q₂ + Q₁)/2] × 100 for % change

Elastic Demand

PED > 1; quantity responds more than proportionally to price

Inelastic Demand

PED < 1; quantity responds less than proportionally to price

Unitary Elastic

PED = 1; quantity responds proportionally to price

Determinants of Elasticity

Substitutes, necessity vs. luxury, share of income, time horizon, broad vs. narrow definition

Total Revenue

Price × Quantity; elastic → price cut raises TR; inelastic → price increase raises TR

Law of Supply

As price of a good increases, quantity supplied increases

Inferior Goods

Goods for which demand decreases as income rises

Price Elasticity of Supply (PES) formula

% change in quantity supplied / % change in price

Elasticity classification

PES > 1 elastic; PES < 1 inelastic; PES = 1 unit elastic

Determinants of PED

Time horizon, definition of the market, necessity vs. luxury, availability of substitutes

If price of Dunkin' coffee rises (substitute)

Demand for Starbucks increases (shifts right)

Price gouging video – Florida gas station price

$7.20 per gallon