Chapter 1–3: Demand, Supply, Equilibrium – Key Concepts and Exam Prep

Exam logistics and study setup

Date and time: next Tuesday, September 2; 8:00 AM – 9:15 AM (75 minutes)
Exam format: 25 multiple-choice questions; one attempt
Exam software: lockdown browser with webcam; ensure a personal computer with webcam and a stable Internet connection; plug device into power during the exam
Practice exam: to test your setup
- Practice is available as a dummy exam on D2L Quizzes
- Use it to verify that lockdown browser, webcam, and computer function properly before the actual exam to avoid technical issues.
Exam coverage: chapters 1, 2, and 3 (these are the ones we will finish today)
Study guides: two options provided
- Exam 1 Review: lists major key concepts and points to know before the exam, serving as a checklist for your study.
- Practice Exam: contains 25 questions with answer keys attached at the end for review, mirroring the real exam's structure and question types.
Administration notes: the actual exam will be online on the quizzes tool; you’ll complete it remotely with stable Internet and a quiet, secure environment, free from distractions.
Homework reminder: this week = Homework 3, essential for reinforcing chapter concepts.
Next meeting cadence: after today, next class meeting is one week later on Thursday; exam is next Tuesday.
Quick study approach: you may want to create flashcards for major points from Exam 1 Review, focusing on definitions and cause-and-effect relationships. The practice questions resemble the format and difficulty but are not identical to the real exam questions; they are meant to test your understanding of concepts, not memorize specific answers.
Office hours/clarifications: ask questions if anything is unclear before the exam; we will cover practice questions later in class if time allows, providing guided explanations.

Quick recap of core topics to cover in chapters 1–3

What is economics? Differing perspectives are covered in the slides, including macro vs micro and the circular flow diagram.
- Microeconomics focuses on individual decisions (households, firms) and specific markets.
- Macroeconomics examines the economy as a whole, dealing with aggregate phenomena like inflation, unemployment, and economic growth.
- The circular flow diagram illustrates the interdependence of firms and households in resource and product markets.
Economic systems are major examples of how economies organize production and distribution, varying from command to market-based systems.
Demand and its determinants; supply and its determinants; how they interact to form market outcomes, particularly equilibrium price and quantity.

Demand: core concepts

Definition: Demand is the behavior of buyers, representing the entire relationship between two variables: price (P) and quantity demanded (Q_d), the amount buyers are willing and able to buy at various prices.
Inverse relationship: When price increases (P ext{ rises}), quantity demanded decreases (Qd ext{ falls}); when price decreases (P ext{ falls}), quantity demanded increases (Qd ext{ rises}). This is known as the Law of Demand.
Key explanations for buyer behavior (from the lecture) that contribute to the downward-sloping demand curve:
- Income effect: A decrease in price increases the purchasing power of consumers' incomes, allowing them to buy more of the good (and vice versa).
- Substitution effect: When the price of a good falls, it becomes relatively cheaper compared to its substitutes, leading consumers to substitute away from other goods and towards this now-cheaper good.
- Diminishing marginal utility: As a consumer consumes more units of a good, the additional satisfaction (marginal utility) derived from each successive unit decreases. Consequently, consumers are only willing to buy additional units if the price is lower.
Demand curve shape: generally downward-sloping due to the inverse relationship between P and Q_d, graphically illustrating the Law of Demand.
Important note on learning: use graphs to understand how changes in price or non-price determinants affect quantity demanded. These visual tools are critical for applying economic principles.

Supply: core concepts

Definition: Supply is the relationship between price (P) and quantity supplied (Q_s), representing the amount producers are willing and able to provide at various prices.
Positive relationship: As price increases (P ext{ rises}), suppliers are willing to produce and sell more (because it's more profitable); as price decreases (P ext{ falls}), they sell less.
Law of supply: higher price (P ext{ increases}) → higher quantity supplied (Q_s ext{ increases}); this is often explained by increasing marginal costs of production, where higher prices are needed to incentivize producers to incur higher costs for additional output.
Supply curve shape: typically upward-sloping due to the positive relationship between P and Q_s, reflecting the Law of Supply.

Movements vs. shifts in the curves

Type 1 change (movement along the curve):
- Caused solely by a change in price (P), assuming Ceteris Paribus (i.e., all else equal). This means only price changes, not any of the non-price determinants.
- For supply: a price increase (P ext{ increases}) → move up along the same supply curve (quantity supplied, Qs, increases). For a price decrease (P ext{ decreases}) → move down along the same supply curve (Qs decreases).
- For demand: a price increase (P ext{ increases}) → move up along the same demand curve (Qd decreases). For a price decrease (P ext{ decreases}) → move down along the same demand curve (Qd increases).
- This does not shift the curve; it’s a change in the quantity supplied or demanded at a different point on the existing S or D curve.
Type 2 change (shift of the entire curve):
- Caused by non-price determinants (determinants of supply or demand), which change the entire relationship between price and quantity.
- The entire curve shifts to a new position: a rightward shift means an increase in supply or demand (more is offered/desired at every price); a leftward shift means a decrease (less is offered/desired at every price).
- For supply: a shift to the right means higher quantities supplied at every price; a shift to the left means lower quantities supplied at every price.
- For demand: a shift to the right means higher quantities demanded at every price; a shift to the left means lower quantities demanded at every price.

Determinants of supply (non-price factors)

These factors cause the entire supply curve to shift.

Production costs and related factors:
- Resource prices: Cheaper resources (e.g., raw materials, labor) lower production costs and increase supply (shift right); higher resource costs increase production costs and decrease supply (shift left).
- Technology improvements: Better technology or production methods lowers production costs or increases efficiency, allowing producers to supply more at each price, thus shifting supply right.
- Availability of resources: Easier or greater access to necessary resources can increase supply.
Government policy:
- Subsidies: Government payments to producers effectively lower production costs, shifting supply right.
- Taxes: Taxes on production raise production costs, shifting supply left.
Prices of other goods: If producers can switch to producing more profitable goods with the same resources (e.g., a farmer switching from corn to soybeans due to higher soybean prices), the supply of the current good may decrease.
Prices of related goods: When producers can produce multiple goods (e.g., beef and leather), a change in the price of one can affect the supply of the other due to shared production processes or opportunity costs.
Expectations about future prices: If prices are expected to rise in the future, producers may restrict current supply to sell more later at higher prices (shift current supply left). Conversely, if prices are expected to fall, they might increase current supply.
Number of sellers: More sellers (firms) entering the market directly increase overall market supply (shift right); fewer sellers decrease supply (shift left).
Weather and natural events: Good weather or favorable growing conditions (for agricultural products) increase supply; bad weather, natural disasters, or disruptions decrease supply.
Production cost summary in the lecture form:
- If resource prices decline → production costs decline → supply increases → S shifts right.
- If production costs rise (e.g., higher wages, higher energy costs) → production costs increase → supply decreases → S shifts left.
- Other cost factors (e.g., minimum wage increases) can reduce supply due to higher payroll costs.
- Taxes/subsidies, number of sellers, and prices of other goods also influence the overall supply level.
- Expectation about future production or prices also affects present supply decisions.

Determinants of demand (non-price factors)

These factors cause the entire demand curve to shift.

Income and wealth effects on buyers:
- For normal goods, an increase in income leads to an increase in demand (shift right).
- For inferior goods, an increase in income leads to a decrease in demand (shift left).
Prices of related goods (substitutes and complements):
- Substitutes (e.g., tea vs coffee): If the price of a substitute good increases, demand for the original good increases (shift right). If the price of a substitute good decreases, demand for the original good decreases (shift left).
- Complements (e.g., cars and gasoline): If the price of a complementary good increases, demand for the original good decreases (shift left). If the price of a complementary good decreases, demand for the original good increases (shift right).
Tastes and preferences: Changes in consumer preferences, fads, or awareness can shift demand. An increase in desirability shifts demand right; a decrease shifts demand left.
Expectations about future prices or income:
- If consumers expect higher prices in the future (e.g., a planned sale ending), current demand may increase (shift right).
- If consumers expect higher income in the future, current demand for normal goods may increase.
Number of buyers in the market: More consumers (buyers) entering the market increase overall demand (shift right); a decrease in the number of buyers decreases demand (shift left).
The lecture emphasizes that many of these determinants can cause the demand curve to shift right (increase) or left (decrease), altering the quantity demanded at every price.

Graphical intuition: shifts and equilibrium

If demand increases (D shifts right) and supply stays constant, equilibrium moves to the upper-right: both price and quantity rise.
If demand decreases (D shifts left) and supply stays constant, equilibrium moves to the lower-left: both price and quantity fall.
If supply increases (S shifts right) and demand stays constant, equilibrium moves to the lower-right: price tends to fall and quantity rises.
If supply decreases (S shifts left) and demand stays constant, equilibrium moves to the upper-left: price tends to rise and quantity falls.
When both demand and supply shift, the outcome on equilibrium price and quantity depends on the relative magnitudes of the shifts. One variable (price or quantity) will be determinant, while the other may be indeterminate without knowing the exact size of the shifts.

Market equilibrium and efficiency

Equilibrium: The state where demand equals supply (epilograft in the lecture), representing a balance of market forces.
- Graphically: the intersection of the demand and supply curves.
- At equilibrium: Qd = Qs, and there is a single market price (P^) and quantity (Q^). At this point, the market clears, meaning there is no excess supply or demand, and no inherent pressure for price to change.
Surplus (gluts): occurs when the market price is above the equilibrium price (P > P^*).
- At P > P^*, quantity supplied (Qs) is greater than quantity demanded (Qd); this creates an excess supply of goods.
- The amount of surplus can be expressed as ext{Surplus} = Qs(P) - Qd(P) > 0.
- Market tends to push price downward toward P^* as sellers compete to sell their excess inventory, leading to price reductions.
Shortage: occurs when the market price is below the equilibrium price (P < P^*).
- At P < P^*), quantity demanded (Qd) is greater than quantity supplied (Qs); this creates an excess demand for goods.
- The amount of shortage can be expressed as ext{Shortage} = Qd(P) - Qs(P) > 0.
- Market tends to push price upward toward P^* as buyers compete for the limited availability of goods, driving prices up.
Efficiency (productive and allocative): These are two pillars of economic welfare generally achieved at or near equilibrium in perfectly competitive markets.
- Productive efficiency: Occurs when goods are produced at the lowest possible cost.
- Allocative efficiency: Occurs when the mix of goods produced matches the preferences of consumers, meaning society is producing what it most desires, and resources are allocated to their highest valued uses.

Worked intuition: combining demand and supply changes

Example: housing market (illustrative)
- If a strong economy increases incomes (shifting demand right) and construction costs remain constant: demand increases (D shifts right), leading to higher equilibrium price and higher equilibrium quantity.
Example: gasoline market (illustrative with the lecture narrative)
- If demand falls (D shifts left) due to a recession and supply rises (S shifts right) due to new oil discoveries: price will unambiguously fall. However, the effect on quantity is ambiguous without knowing the magnitudes of the shifts. If the supply shift is larger, quantity may rise; if the demand shift is larger, quantity may fall.
Example with subsidies and global supply dynamics
- Suppose a consumption subsidy increases demand (D shifts right) and a major producer (e.g., OPEC) increases supply (S shifts right). Both curves move. The new equilibrium price could go up, down, or stay about the same depending on the relative magnitudes of the shifts (e.g., if demand increases more than supply, price rises). Quantity, however, will unambiguously increase.
General takeaway: for any combination of shifts, the best approach is to visualize or redraw the new demand and supply curves, find the new intersection to read off the new equilibrium price and quantity. This graphical method helps to determine both the direction of change and any ambiguities.

Practical exam preparation tips (as discussed in the lecture)

Practice exam approach
- Complete the 25-question practice set first on your own, under timed conditions if possible, and then check against the answer key to identify weaknesses and areas needing further review.
- The practice exam shares the format and similar difficulty with the real exam, but it is not the exact same set of questions; focus on understanding the concepts behind the questions.
Graph-first learning: when reviewing questions about shifts and market outcomes, always redraw the demand and supply curves, shift them according to the given scenario, and locate the new equilibrium to precisely read off the new price and quantity. This method helps prevent errors.
Calculator and scratch paper: a basic calculator will be available in the lockdown browser; you may also use your own scratch paper for worked calculations or drawing graphs.
Review strategy: focus on understanding how non-price determinants cause shifts of the entire curve, and how price changes cause movements along curves. This distinction is fundamental to many exam questions.

Key equations and formal relationships to remember

Demand slope relation: rac{ ext{d}Q_d}{ ext{d}P} < 0 (indicating an inverse relationship)
Supply slope relation: rac{ ext{d}Q_s}{ ext{d}P} > 0 (indicating a positive relationship)
Equilibrium condition: Qd(P^) = Qs(P^), where P^* is the equilibrium price.

Quick glossary reminders from today’s topics

Demand: The entire relationship between price (P) and quantity demanded (Q_d); represents buyers’ behavior; graphically, it is downward-sloping when drawn.
Supply: The entire relationship between price (P) and quantity supplied (Q_s); represents producers’ behavior; graphically, it is upward-sloping when drawn.
Movement vs shift: A movement along a curve is due to a change in price only, while a shift of the entire curve is due to a change in one of the non-price determinants.
Equilibrium: The price-quantity pair where Qd = Qs; the market clears, meaning there is no excess supply or demand, and no inherent pressure for price changes in a perfectly competitive market.
Efficiency (productive and allocative): Two pillars of economic welfare generally achieved at or near equilibrium. Productive efficiency means producing at the lowest cost, while allocative efficiency means producing the goods society desires most.

Quick practice prompts to test understanding (to try on your own)

If the price of a key input falls, what happens to the supply curve and why? What is the expected effect on the equilibrium price and quantity?
If a popular substitute good becomes much cheaper, how might demand for the original good respond? Draw the shift and explain the new equilibrium implications.
If both demand and supply increase by different magnitudes, what determines whether the price rises or falls? What can you say about the likely effect on quantity?
When might you expect a surplus to occur? When might you expect a shortage to occur? How do prices respond in each case?

Summary note

This set of notes consolidates today’s lecture content: it covers exam logistics, the structure of the upcoming interim, the two fundamental market sides (demand and supply), the difference between movements and shifts, the determinants of each side, how equilibrium and efficiency are defined and achieved, and how combined shifts shape final outcomes. The emphasis throughout is on graphing the relationships and using the equilibrium framework to predict price and quantity changes under various scenarios, utilizing detailed explanations for each concept.