Learn: Introductory Economics: Scarcity, Supply and Demand, Equilibrium, and Price Elasticity

Scarcity

Resources are limited, but human wants are unlimited.

Economics

The study of how society manages its scarce resources.

Opportunity cost

The value of the next-best alternative given up when making a choice.

Explicit cost

A direct monetary payment made to obtain something.

Cost-benefit principle

Take an action when its additional benefit is at least as large as its additional cost.

Marginal analysis

Comparing the additional benefit and additional cost of one more unit or action.

Marginal benefit (MB)

The additional benefit from consuming or doing one more unit.

Marginal cost (MC)

The additional cost from producing or doing one more unit.

Marginal decision rule

Continue an activity while marginal benefit is at least as large as marginal cost.

Total benefit

The combined benefit from all units consumed or actions taken.

Total cost

The combined cost of all units produced or actions taken.

Law of demand

Other things equal, when price rises, quantity demanded falls.

Law of supply

Other things equal, when price rises, quantity supplied rises.

Demand

The relationship between a good's price and the quantity consumers are willing and able to buy.

Quantity demanded

The amount consumers are willing and able to buy at a particular price.

Supply

The relationship between a good's price and the quantity producers are willing and able to sell.

Quantity supplied

The amount producers are willing and able to sell at a particular price.

Change in demand

A shift of the entire demand curve caused by a non-price factor.

Change in quantity demanded

Movement along the same demand curve caused by a change in the good's own price.

Change in supply

A shift of the entire supply curve caused by a non-price factor.

Change in quantity supplied

Movement along the same supply curve caused by a change in the good's own price.

Demand shifter: income

For a normal good, higher income increases demand; lower income decreases demand.

Demand shifter: substitutes

If a substitute's price rises, demand for the good increases.

Demand shifter: complements

If a complement's price rises, demand for the good decreases.

Demand shifter: preferences

A change in consumer tastes can shift demand.

Demand shifter: number of buyers

More buyers increase market demand; fewer buyers decrease it.

Supply shifter: input costs

Higher production costs decrease supply; lower costs increase supply.

Supply shifter: technology

Improved production technology generally increases supply.

Supply shifter: number of sellers

More sellers increase market supply; fewer sellers decrease it.

Equilibrium

The point where quantity demanded equals quantity supplied.

Equilibrium price

The price at which quantity demanded equals quantity supplied.

Equilibrium quantity

The quantity bought and sold at the equilibrium price.

Shortage

Quantity demanded exceeds quantity supplied; price tends to rise.

Surplus

Quantity supplied exceeds quantity demanded; price tends to fall.

Demand increases: equilibrium effect

Equilibrium price rises and equilibrium quantity rises, other things equal.

Demand decreases: equilibrium effect

Equilibrium price falls and equilibrium quantity falls, other things equal.

Supply increases: equilibrium effect

Equilibrium price falls and equilibrium quantity rises, other things equal.

Supply decreases: equilibrium effect

Equilibrium price rises and equilibrium quantity falls, other things equal.

Market demand

The sum of quantities demanded by all buyers at each price.

Market supply

The sum of quantities supplied by all sellers at each price.

Price elasticity of demand (PED)

Measures how responsive quantity demanded is to a percentage change in price.

Price elasticity of demand formula

PED = percentage change in quantity demanded ÷ percentage change in price.

Elastic demand

Absolute value of elasticity is greater than 1; quantity responds proportionally more than price.

Inelastic demand

Absolute value of elasticity is less than 1; quantity responds proportionally less than price.

Unit-elastic demand

Absolute value of elasticity equals 1; quantity and price change by equal percentages.

Perfectly inelastic demand

Quantity demanded does not change when price changes; elasticity is 0.

Perfectly elastic demand

Demand is infinitely responsive to price at a particular price level.

Interpreting negative PED

The negative sign reflects the usual inverse relationship between price and quantity demanded.

Elasticity percentage-change shortcut

Percentage change in quantity ≈ elasticity × percentage change in price.

Short-run gasoline demand

If elasticity is −0.3 and price rises 20%, quantity demanded falls about 6%.

What makes demand more inelastic?

Fewer close substitutes, necessity, and less time to adjust generally make demand more inelastic.

Consumer surplus

The difference between what buyers are willing to pay and what they actually pay.

Producer surplus

The difference between the price sellers receive and the minimum they would accept.

Total surplus

Consumer surplus plus producer surplus.

Consumer surplus under a linear demand curve

The triangular area below demand and above market price, up to the quantity bought.

Triangle area formula

Area = 1/2 × base × height.

Producer surplus under a linear supply curve

The area above supply and below market price, up to the quantity sold.

Market efficiency

An allocation is efficient when it maximizes total surplus.

Three insights about efficient markets

Goods go to highest-value buyers; production goes to lowest-cost sellers; quantity maximizes total surplus.

Opportunity cost of a concert

Ticket price plus the value of the best alternative forgone, such as wages not earned.

Marginal benefit table decision

Buy units while each unit's marginal benefit is at least its price.

Market equilibrium using equations

Set quantity demanded equal to quantity supplied, then solve for price and quantity.

Quantity demanded equation example

If Qd = 20 − 2P, substitute the price to calculate quantity demanded.

Quantity supplied equation example

If Qs = 4P − 4, substitute the price to calculate quantity supplied.

Market quantity demanded from a table

Add all buyers' quantities demanded at the specified price.

Quantity supplied by sellers with different costs

At a given price, count sellers whose costs are at or below that price.

Demand curve equation P = 50 − Q

At price $20, quantity is 30; maximum willingness to pay at Q = 0 is $50.

Consumer surplus example: P = 50 − Q, price $20

Q = 30; surplus = 1/2 × 30 × ($50 − $20) = $450.

Producer surplus example

If a seller's minimum acceptable price is $300 and sale price is $450, producer surplus is $150.

Externality

The effect of one person's or firm's actions on the well-being of a bystander.

Negative externality

An external cost imposed on others, such as pollution.

Positive externality

An external benefit received by others, such as protection from vaccination.

Marginal private cost (MPC)

The additional cost paid by the producer for one more unit.

Marginal social cost (MSC)

The full additional cost to society, including external costs.

Marginal social cost formula

MSC = MPC + marginal external cost.

Marginal private benefit (MPB)

The additional benefit received by the direct consumer.

Marginal social benefit (MSB)

The full additional benefit to society, including external benefits.

Negative production externality

MSC exceeds MPC; the unregulated market typically produces too much.

Positive consumption externality

MSB exceeds MPB; the unregulated market typically provides too little.

Socially efficient quantity

The quantity where marginal social benefit equals marginal social cost.

Market quantity vs. efficient quantity with pollution

Market quantity is typically higher than the socially efficient quantity.

Deadweight loss (DWL)

Total surplus lost because the market quantity differs from the socially efficient quantity.

Deadweight loss from a negative externality

The lost-surplus area between MSC and demand, between the efficient and market quantities.

Why the invisible hand can fail

Private decisions may ignore external costs or benefits affecting bystanders.

Freeway game externality

Drivers ignored the delay their own car imposed on other drivers.

Pollution and market efficiency

If nearby residents bear pollution costs, not all costs fall on buyers and sellers.

Vaccination external benefit

Social benefit exceeds private benefit, so the market tends to provide too few vaccinations.

Negative externality example equations

Demand P = 60 − 2Q; MPC = 12 + Q; marginal external cost = 6.

MSC for the negative externality example

MSC = 18 + Q.

Equilibrium with linear demand and supply

Set Qd = Qs, solve for equilibrium, then substitute to find price.

Price change vs. curve shift

A good's own price changes quantity demanded or supplied; other factors shift the curve.

Complements vs. substitutes

Complements are used together; substitutes can replace each other.

How to calculate marginal benefit from total benefit

Subtract the previous total benefit from the new total benefit for each additional unit.

How to choose quantity using a marginal benefit table

Purchase each unit with MB ≥ price; stop before the next unit whose MB is below price.

How to calculate opportunity cost of work forgone

Hours of work forgone × hourly wage.

How to calculate total surplus

Consumer surplus + producer surplus.

How to identify a shortage on a graph

At the current price, Qd > Qs.

How to identify a surplus on a graph

At the current price, Qs > Qd.

How to identify a demand shift

Look for a non-price change affecting buyers' willingness or ability to buy.

How to identify a supply shift

Look for a non-price change affecting sellers' costs or ability to produce.