Microeconomics: Demand, Supply, Elasticity, Intervention and Market Failure
What the exam tests
Demand and supply, elasticity, government intervention and market failure dominate microeconomics. You must shift curves correctly, calculate and interpret PED, PES, YED and XED, and evaluate taxes, subsidies, price controls and externality policies.
Core rules
- Demand slopes down; supply slopes up. A change in price causes movement along; a change in non-price determinants shifts the curve.
- PED = % change in Qd / % change in price; use absolute value. Tax incidence falls more on the side with fewer substitutes or more inelastic behaviour. PES depends on time, spare capacity and storability.
- A price ceiling below equilibrium creates shortage, rationing and black markets. A floor above equilibrium creates surplus and requires government purchase.
- An indirect tax shifts supply up by the tax; a subsidy shifts supply down. Both create deadweight loss, but can correct negative or positive externalities.
- Market failure includes externalities, public goods, merit and demerit goods, asymmetric information and common-access resources. Efficiency requires MSB = MSC.
Worked example
A $10 per-unit tax on a good has PED = -0.4 and PES = 1.2. Consumer incidence = PES / (PES - PED) = 1.2 / 1.6 = 75%, so consumers pay $7.50 and producers absorb $2.50. Because demand is inelastic, the quantity fall is proportionally small, tax revenue is relatively stable, and the policy is regressive if low-income households spend a larger budget share on the good. Evaluation should compare this with a subsidy or regulation.
Traps
Do not shift demand when price changes. Do not use the negative PED sign in incidence calculations without care. A price ceiling does not shift supply. Do not call a public good merely a good provided publicly; it must be non-rival and non-excludable. Explain deadweight loss with marginal social benefit and cost, not just less quantity.