Methodology: Demand and Supply
What this domain tests
CAPE Unit 1's methodology domain asks you to model scarcity and choice with the circular flow, PPC and demand-supply diagrams, and to distinguish positive from normative statements. The exam rewards correct ceteris paribus reasoning, labelled diagrams and elasticity calculations, not descriptive prose.
Core rules
- A demand curve shows the quantity buyers plan to buy at each price, ceteris paribus; a change in price moves along it, while income, tastes, prices of substitutes/complements, expectations or population shift it.
- Supply is the planned quantity sellers offer; input costs, technology, taxes/subsidies, expected prices and number of firms shift supply. Price changes cause movements.
- Equilibrium is where Qd = Qs; a surplus pushes price down, a shortage pushes it up.
- Price elasticity of demand = %ΔQd / %ΔP. Use the midpoint formula when the question gives two price-quantity pairs: (ΔQ/avg Q)/(ΔP/avg P). Elasticity is not slope.
- A PPC illustrates opportunity cost, efficiency and growth; points inside are inefficient, outside unattainable with current resources.
Worked example
Qd = 120 − 3P and Qs = 30 + 2P. Set equal: 120 − 3P = 30 + 2P, so 90 = 5P, P = 18, Q = 120 − 54 = 66. A per-unit tax on sellers changes supply to Qs = 30 + 2(P − 6) = 18 + 2P. New equilibrium: 120 − 3P = 18 + 2P, 102 = 5P, P = 20.4, Q = 58.8. Buyers pay 20.4, sellers keep 14.4, so the tax is shared; the steeper side bears more. If demand were Qd = 120 − 0.5P, equilibrium price would rise less, showing elastic demand bears less tax.
Traps
- Shifting the demand curve when price changes; price is on the axis, so price changes are movements.
- Writing 'supply falls' when quantity supplied falls along a fixed supply curve.
- Using point elasticity at a different price or forgetting the negative sign on demand elasticity.
- Treating a PPC shift outward as free lunch; growth has opportunity cost.
- Confusing positive ('a minimum wage raises unemployment') with normative ('the government should raise the minimum wage').