Demand, Supply and Market Equilibrium
Demand and supply is the analytical engine of the whole paper. Elasticity, market failure, taxation and macroeconomic adjustment all assume you can shift a curve for the right reason and read off the new price and quantity. Expect questions that give a scenario (a heatwave, a new tax on producers, a rise in tourist arrivals) and ask for the effect on equilibrium, plus questions distinguishing movement along a curve from a shift of it.
Demand
- The law of demand states an inverse relationship between price and quantity demanded over a period, ceteris paribus.
- Non-price determinants shift the curve: income (normal versus inferior goods), tastes and advertising, prices of substitutes and complements, population size and age structure, expectations of future prices, distribution of income.
- A change in the good's own price moves you along the curve; it changes quantity demanded, not demand.
Supply
- Supply is directly related to price because higher prices cover rising marginal costs.
- Shift factors: input costs (fuel, animal feed, wages), technology, taxes and subsidies on producers, number of firms, weather and seasonality, expectations.
Equilibrium and comparative statics
- Equilibrium is where quantity demanded equals quantity supplied. Above it, a surplus drives price down; below it, a shortage drives price up.
- Demand rises: price and quantity both rise. Supply rises: price falls, quantity rises. Both shifting together leaves one variable indeterminate: if both rise, quantity certainly rises but price may rise, fall or stay put.
Price controls
- A binding price ceiling below equilibrium creates a shortage, queues, black markets and reduced quality - rent controls on old buildings are a standard example.
- A binding price floor above equilibrium creates a surplus requiring state purchase or storage, as with agricultural support prices.
Worked example
Demand is Qd = 100 − 5P and supply Qs = 10 + 5P. Setting them equal: 100 − 5P = 10 + 5P, so 90 = 10P, P = €9 and Q = 55. A successful advertising campaign shifts demand to Qd = 120 − 5P. Now 120 − 5P = 10 + 5P, giving P = €11 and Q = 65. The shift raises price by €2 and quantity by 10 units; the higher quantity is a movement along the existing supply curve, not a shift of supply.
Traps that cost marks
- Shifting demand when the scenario changes the good's own price.
- Forgetting ceteris paribus: if an input cost changes, demand does not shift.
- Claiming price is always indeterminate when two curves shift; it is only indeterminate when the shifts pull price in opposite directions.
- Confusing a shortage at a controlled price with scarcity.