In some cases supply may be greater than quantity demanded, which results in a surplus.
In some cases quantity demanded may be greater than quantity supplied, which results in a shortage.
In a free market, these disequilibria do not persist for long; prices adjust and the market moves toward equilibrium.
Equilibrium is the point where the market clears: price P* and quantity Q* satisfy Q<em>d(P<em>)=Q</em>s(P</em>)
where $Qd$ is quantity demanded and $Qs$ is quantity supplied.
If the market is out of equilibrium, forces push prices and/or quantities toward the equilibrium.
Efficiency, Surplus, and Gains from Trade
We measure market efficiency using consumer surplus (CS) and producer surplus (PS).
Consumer surplus (CS): the difference between what consumers are willing to pay (the demand curve) and what they actually pay (the market price) across the units bought.
Producer surplus (PS): the difference between what producers receive (the market price) and the minimum they would be willing to accept (the supply curve) across the units sold.
Total surplus (gains from trade) = CS + PS; this is the total measure of efficiency in the market.
If the market produces more than the efficient quantity (e.g., producing at 80 units when the efficient quantity is 50), there is deadweight loss due to wasted resources.
Intuition: misallocated inputs (labor, capital, materials) could be redirected elsewhere in the economy, potentially producing more welfare.
One Event, One Curve: Shifts vs Movements
Key principle: one event, one curve. When a single change occurs, it typically shifts either the supply or the demand curve, not both.
If only one curve shifts, we update the graph by moving that curve while keeping the other curve fixed.
When there are two simultaneous events, both curves can shift, and the outcome depends on the relative magnitudes of the shifts.
It is common to confuse quantity changes with shifts. Distinguish:
Change in quantity demanded: movement along the same demand curve due to a price change.
Change in demand: the entire demand curve shifts due to a non-price determinant.
The phrase “price expectations” can affect either producers or consumers, depending on who is being discussed.
Practical tip: sketch the graph when studying or taking exams. A quick sketch helps avoid mixing up which curve shifts.
Mislabeling curves (e.g., calling a shift a “change in quantity” or vice versa) leads to incorrect conclusions about price and quantity changes.
Examples: How Shifts and Movements Work
Decrease in supply (a leftward shift of the supply curve):
Leads to higher price and lower equilibrium quantity.
Example dialogue: When there is a decrease in supply, the price rises and the equilibrium quantity falls.
Demand and supply shifts can interact with price expectations or external shocks (e.g., Middle East turmoil affecting demand or capacity):
A single event can shift one curve (e.g., demand shifts right or left) and alter the equilibrium.
Change in quantity supplied (a movement along the existing supply curve) occurs when the price changes but the supply curve itself does not shift.
Example with soybeans and tofu:
A rise in the price of soybeans (a key input for tofu) reduces tofu supply, shifting the tofu supply curve to the left, raising the price of tofu and reducing its quantity in the market.
Changes in demand can be of varying magnitudes:
If demand shifts by a large amount while supply shifts by a smaller amount, price moves in the direction of the larger shift.
If demand and supply shift by the same magnitude, the price may not change, though quantity may rise or fall depending on the specifics.
Important caveat: when both curves move, the final price effect is indeterminate without knowing the sizes of the shifts.
Real-World Applications and Anecdotes
Gas market example: identify whether a price or a shift reflects changes in demand vs supply, and who is affected (consumers vs producers).
Tesla price bubble during the pandemic: price dynamics in new-car demand and how the market adjusts as demand cools.
Parking spaces market: apps that allow renting unused parking spaces illustrate a market solution to a scarcity issue (a hole in the market spurs a new service).
Education economics example: housing prices in districts with better public schools reveal how public education can affect household decisions and housing demand; this links to concepts of normal vs inferior goods and the difficulty of causal interpretation in observational data.
Acknowledgement of data limitations: correlation vs causality; income effects on family size are complex and require careful identification to draw causal conclusions.
Summary takeaway from data discussions: sometimes income and demand patterns suggest one thing, but underlying costs (like housing and education quality) drive observed relationships; the evidence about whether children are a normal or inferior good can be context-dependent.
Elasticity: Price Responsiveness
Elasticity measures how responsive quantity demanded is to a price change.
Elasticity of demand is defined as: E<em>d=extpercentchangeinpriceextpercentchangeinquantitydemanded=PrianglePQdriangleQ</em>d.
Key properties:
The relationship between price and quantity demanded is negative: as price rises, quantity demanded falls (and vice versa).
Elasticity is a unitless index (a dimensionless measure), sometimes described as a “unit-free” or scale-invariant quantity.
The typical sign convention yields a negative value for most downward-sloping demand curves, though the magnitude is what matters for interpretation.
Alternative (longhand) expression: the elasticity can be written in terms of the inverse demand function if desired, and there are equivalent differential forms for infinitesimal changes.
Practical uses of elasticity:
Determine how revenue responds to price changes: Revenue = Price × Quantity, so elasticity helps predict whether a price increase will raise or lower total revenue.
Policy implications: elasticity informs the likely effectiveness and unintended consequences of interventions (e.g., war on drugs, gun buyback programs).
Helps explain market outcomes under different policy scenarios and how substitution and income effects interact.
The course emphasizes that there will be more math in elasticity, including analyses across different goods (e.g., dairy elasticity is a recurring example).
In class practice: elasticity is introduced after building intuition about demand, supply, and equilibrium, then extended to deeper quantification.
Notable Concepts and Terminology to Remember
Change in quantity demanded vs change in demand
Change in quantity supplied vs change in supply
Movement along a curve vs shift of a curve
Price expectations as a determinant of behavior for both buyers and sellers
Gains from trade as the total welfare gain from market exchanges
Surplus and shortage as deviations from equilibrium and their market-clearing implications
Elasticity as a measure of price responsiveness and its use in revenue and policy analysis
Causality vs correlation in empirical data; the importance of identification in economic interpretation
Quick Study Tips Mentioned in the Transcript
Always sketch the graph when analyzing market changes; keep a little diagram handy on a cheat sheet.