Demand, Supply and Market Equilibrium—Comprehensive Study Notes
Demand, Supply and Market Equilibrium
This set of notes compiles key ideas, concepts, definitions, and examples from the transcript to serve as a comprehensive study aid for demand, supply, equilibrium, and related topics.
Demand: core concepts
Demand: Quantities of a particular good or service that consumers are willing and able to buy at different possible prices.
Expressed as a function of price: Q_d = f(P) with the law of demand indicating an inverse relationship between price and quantity demanded.
Quantity Demanded: The actual amount consumers are willing and able to buy at a specific price and at a specific point in time.
Demand schedule vs. Demand curve: Both show the same data; a schedule is a table, a curve is the graphical representation.
Law of Demand: There is a negative (inverse) relationship between price and quantity demanded. Mathematically: rac{ ext{d}Q_d}{ ext{d}P} < 0
Determinants of Demand (demand shifters): factors that shift the entire demand curve, not just move along it. Key determinants include:
Price of related goods:
Substitutes (e.g., coffee vs. tea): if the price of one rises, demand for the substitute tends to rise.
Complements (e.g., ice cream and toppings): if the price of one falls, the demand for its complement can rise.
Income: for normal goods, higher income shifts demand right; inferior goods see a demand decrease when income rises.
Number of buyers: more buyers shifts demand right; fewer buyers shifts left.
Consumer preferences: favorable changes increase demand; unfavorable changes decrease it.
Expectations of future prices or income: if higher future prices are expected, current demand may rise; if higher future income is expected, current demand may rise; conversely for declines.
Taxes: Higher taxes on the item make it more expensive and tend to decrease demand.
Substitute Goods: Goods used in place of each other. e.g., Coke vs. Pepsi; iPhone vs. Galaxy; Nike vs. Adidas. If Coke’s price rises, demand for Pepsi tends to rise (indicating substitutes).
Complementary Goods: Goods often used together (e.g., cars and gasoline; iPhone and covers; coffee and cheesecake). A price change in one affects the demand for its complement.
Normal vs. Inferior Goods:
Normal Goods: demand increases as income rises.
Inferior Goods: demand decreases as income rises.
Individual vs. Market Demand: Market demand is the horizontal sum of individual demand curves. It is derived by adding all individual quantities demanded at each price:
Market demand schedule is the sum of all individual demand schedules.
Reservation price (concept): the maximum price a buyer is willing to pay (for a buyer) or the minimum price a seller is willing to accept (for a seller).
Consumer surplus (CS): Welfare measure for consumers; the difference between what consumers are willing to pay (area under the demand curve) and what they actually pay (market price). In a diagram, CS is the area under the demand curve and above the price.
Formula (for a linear demand curve):
CS = igg( ext{max price} - P^igg) imes Q^/2 ext{ if the demand curve is linear up to } Q^*.General formulation:
CS = igg( ext{Area under } D(q) ext{ from } 0 ext{ to } Q^* igg) - P^* Q^* = igg( igint_{0}^{Q^} D(q)\,dq igg) - P^ Q^*.
Producer surplus (PS): Welfare measure for producers; the difference between the price received and the minimum price producers are willing to accept. In a diagram, PS is the area above the supply curve and below the price.
General formulation:
PS = P^* Q^* - igg( igint_{0}^{Q^*} S(q)\,dq igg).
Equilibrium concept (in markets): The price-quantity pair where quantity demanded equals quantity supplied, i.e., where the two curves intersect.
Equilibrium condition:
Qd(P^) = Qs(P^).
Shortage vs. Surplus (at a given price):
Shortage: when quantity demanded exceeds quantity supplied ($Qd > Qs$) at the current price.
Surplus: when quantity supplied exceeds quantity demanded ($Qs > Qd$) at the current price.
Demand, movement along the curve, and shifts
A change in the price of item X causes a movement along the demand curve (movement along). This does not shift the curve.
A change in any determinant of demand (other than price) shifts the demand curve itself (shift). A rightward shift indicates an increase in demand; leftward indicates a decrease.
Determinants of demand (recap): price of related goods, income, number of buyers, consumer preferences, expectations, taxes.
The chapter emphasizes that shifts are caused by non-price factors and are represented by moving the entire curve left or right.
The supply side
What is Supply?: The quantity of a good or service a firm is willing to produce and sell at different possible prices over a specified time.
Quantity Supplied: The actual amount producers are willing and able to offer at a particular price at a given time.
Supply Schedule & Curve: A table and its graphical representation of the relationship between price and quantity supplied. Upward-sloping in typical cases.
Law of Supply: As price rises, quantity supplied rises, and as price falls, quantity supplied falls (ceteris paribus).
Mathematical intuition: rac{ ext{d}Q_s}{ ext{d}P} > 0.
Determinants of Supply (supply shifters): factors that shift the supply curve are:
Price of other items that could be produced with the same resources (opportunity costs).
Production costs (price of inputs, wages, regulation, taxes). Higher costs reduce supply.
Expectations of future prices: if higher prices are anticipated, producers may restrict current supply to sell more later at higher prices.
Number of sellers: more sellers increase market supply.
Technology: improvements reduce costs and raise supply.
Taxes: higher taxes reduce supply.
Movements vs. Shifts (supply): a movement along the supply curve occurs with price changes holding other determinants constant; a shift occurs when a determinant changes.
Market equilibrium and how to analyze changes
Market Equilibrium: The point where the market supply and demand curves intersect; at this point, the quantity supplied equals the quantity demanded, and the market clears.
Equilibrium price: P^*
Equilibrium quantity: Q^*
Shifts and equilibrium outcomes:
Increase in demand: higher equilibrium price and higher equilibrium quantity.
Increase in supply: lower equilibrium price and higher equilibrium quantity.
Decrease in demand: lower equilibrium price and lower equilibrium quantity.
Decrease in supply: higher equilibrium price and lower equilibrium quantity.
The 4-step process to analyze external events (predict effects on equilibrium):
1) Draw a demand and supply model representing the pre-event situation.
2) Decide whether the event affects demand or supply.
3) Determine the direction of the shift (right or left) for the relevant curve and redraw.
4) Identify the new equilibrium and compare with the original equilibrium price and quantity.Examples illustrating the four-step process:
Example 1: Newspapers vs. internet. A shift from print toward digital news reduces demand for print news. Result: demand shifts left; equilibrium price and quantity fall (P↓, Q↓).
Example 2: Weather favorable for salmon fishing. Likely increase in supply (more fish available); equilibrium price falls and quantity rises (P↓, Q↑).
Example 3: USPS. Dual shifts: more digital communication reduces demand for snail mail; higher wage costs increase costs of production. Both demand and supply shift left. Result: equilibrium quantity falls; the direction of price change is indeterminate without magnitudes (Q↓, P unclear).
Example 4: Yogurt market. If health news raises demand for yogurt and milk prices (an input) rise (reducing supply), you may have demand shift right and supply shift left. This scenario tends to raise the price, with the effect on quantity depending on relative magnitudes.
Combined shifts: intuition on outcomes:
When both demand and supply shift in the same direction, price effects depend on magnitudes; quantity moves in the direction of the shift that dominates.
When shifts oppose (e.g., demand up, supply down), price moves depending on which effect is stronger; quantity will move in the direction of the stronger shift.
Short-run welfare concepts
Reservation price (revisited): the maximum price a buyer will pay or the minimum price a seller will accept.
Consumer Surplus (CS): the welfare gain to consumers from buying at a price lower than what they are willing to pay.
Producer Surplus (PS): the welfare gain to producers from selling at a price higher than the minimum they would accept.
In equilibrium, CS and PS can be visualized as the areas between the demand and supply curves and the price line, respectively.
Practical interpretation: CS + PS equals total welfare from market transactions minus any deadweight loss due to taxes, price controls, or externalities.
Price controls: ceilings and floors
Governments sometimes regulate prices to influence outcomes:
A price ceiling is the maximum price sellers may charge for a good or service.
A price floor is the minimum price buyers must pay for a good or service.
Price Ceilings: typical reasons include crises (wars, harvest failures, natural disasters) when price spikes harm many but benefit a few. Examples from the transcript:
Aluminum and steel ceilings during World War II in the U.S.
Rent control in New York.
Federal limits on payments to physicians.
Effects of a Price Ceiling:
Causes a shortage when set below the market-clearing price because quantity supplied is lower than quantity demanded.
Common consequences: persistent shortage, inefficient allocation, wasted resources, poorer quality, and potential black markets.
Example: Rent controls can disproportionately benefit a small, organized group while harming many others; long-run effects may differ from short-run intuition.
Price Floors: examples include the minimum wage and agricultural price supports.
A price floor creates a surplus when set above the equilibrium price because quantity supplied exceeds quantity demanded.
Consequences: persistent surplus, inefficiency in allocation (e.g., high-quality goods at high prices when consumers would prefer lower quality at lower prices), and potential illegal sales below the floor.
Wider welfare implications:
Price controls alter consumer and producer surplus by changing the area under the curves and the price level, often creating deadweight loss when not set at equilibrium.
Selected illustrative graphs and numbers (conceptual):
A price ceiling can produce a shortage measured as the gap between quantity demanded and quantity supplied at the ceiling price. In models, this is depicted as a downward-sloping demand meeting a lower-supply level than the market-clearing point.
A price floor (e.g., market for wheat) can produce a surplus equal to the difference between quantity supplied and quantity demanded at the floor price. The size of the surplus depends on how far the floor is above the equilibrium price.
Key takeaways on price controls:
Ceiling: vertical constraint on price; typically creates a shortage at non-equilibrium prices.
Floor: floor on price; typically creates a surplus when above equilibrium quantity.
Both can lead to inefficiencies and black markets if enforced rigidly.
Welfare in equilibrium: a quick recap
At the equilibrium price and quantity, the market clears (no inherent pressure for price to change).
Consumer and producer surplus capture the welfare distribution between buyers and sellers under perfect competition and no externalities or price controls.
Government interventions (taxes, price controls, subsidies) alter surpluses and can create deadweight loss, depending on the nature and magnitude of the intervention.
Quick reference to selected numerical examples from the transcript
Pizza market example (illustrates movement vs. shift on a supply/demand diagram):
Price per slice and quantity supplied/demanded data: egin{array}{c|c} ext{Price ( ext$/slice)} & ext{Quantity Supplied (slices)}\ \ 2.50 & 14\ 2.00 & 11\ 1.50 & 8\ 1.00 & 5\ 0.50 & 2 \ \ \end{array}
Demonstrates the upward-sloping supply curve: higher price leads to higher quantity supplied.
Milk market (example of market demand schedules): a table demonstrates how multiple consumers’ demands add up to form market demand; illustrates the principle of horizontal summation to obtain market demand from individual demands.
Wheat price floor example: shows surplus created when price is held above the market-clearing price; inputs include price and quantity supplied/demanded at various price points to illustrate the surplus.
Summary of key formulas and concepts (LaTeX)
Demand and supply relations:
Qd = f(P), ext{ with } rac{ ext{d}Qd}{ ext{d}P} < 0
Qs = g(P), ext{ with } rac{ ext{d}Qs}{ ext{d}P} > 0
Equilibrium:
Qd(P^) = Qs(P^) \ P^, Q^ ext{ denote the equilibrium price and quantity}
Consumer surplus (CS):
CS = igg( igint_{0}^{Q^} D(q)\,dq igg) - P^ Q^*
Producer surplus (PS):
PS = P^* Q^* - igg( igint_{0}^{Q^*} S(q)\,dq igg)
Shortage and surplus at a given price $P$:
Shortage: Qd(P) - Qs(P) > 0
Surplus: Qs(P) - Qd(P) > 0
Four-step process for analyzing events:
1) Draw the pre-event model; 2) Decide whether demand or supply is affected; 3) Determine shift direction and redraw; 4) Identify new equilibrium and compare with the original.
If you’d like, I can tailor these notes to a specific topic order (e.g., place price controls at the end for quick review) or expand any section with more worked numerical examples.