Demand, Supply, Elasticity and Market Equilibrium
This is the most numerically examined domain. Expect diagram-based questions, elasticity calculations, and applied questions on tax incidence, price controls and shifts in equilibrium in Cameroonian markets such as cocoa, fuel and rice.
Demand and supply
- Law of demand: price and quantity demanded move inversely, other things equal. A change in price is a movement along the curve; changes in income, tastes, prices of related goods, expectations or number of buyers shift the curve.
- Supply shifters: input costs, technology, taxes and subsidies, weather, number of firms. A specific tax shifts supply vertically upwards by the tax per unit.
- Equilibrium exists where quantity demanded equals quantity supplied; a surplus pushes price down, a shortage pushes it up.
The four elasticities
- PED = percentage change in quantity demanded divided by percentage change in price. Ignore the negative sign when judging size: above 1 is elastic, below 1 inelastic.
- PES rises with the time producers have to adjust; supply is more elastic in the long run.
- YED: above 1 is a luxury, between 0 and 1 a necessity, negative an inferior good.
- XED: positive for substitutes, negative for complements.
Applications
- Tax incidence depends on relative elasticities: the more inelastic side bears the larger share of the tax, and the burden is always shared unless one side is perfectly inelastic.
- A price ceiling below equilibrium creates a shortage, queues and black markets; a price floor above equilibrium creates a surplus, as with a minimum wage.
Worked example
A mobile operator cuts price from 250 to 200 XAF per bundle and sales rise from 100,000 to 130,000 bundles.
- Percentage change in quantity = 30,000/100,000 = 30 per cent.
- Percentage change in price = 50/250 = 20 per cent.
- PED = 30/20 = 1.5, elastic.
- Revenue before = 25 million XAF; revenue after = 26 million XAF. Because demand is elastic, the price cut raises total revenue, which confirms the calculation.
Traps that cost marks
- Confusing a shift of the demand curve with a movement along it, especially when the good's own price changes.
- Reporting PED as a minus number and then calling 1.5 inelastic.
- Assuming a tax is fully passed to consumers regardless of elasticity.
- Drawing a price ceiling above equilibrium, where it has no effect, or a floor below.
- Forgetting that equilibrium price and quantity change together when both curves shift, which requires knowing the relative size of the shifts.