Microeconomics: competitive markets, elasticity and efficiency
What this domain tests
Competitive markets questions test demand and supply, equilibrium, elasticity and allocative efficiency. Expect calculations of equilibrium price and quantity, PED/PES/YED/XED, and explanation of how shifts change price and quantity and welfare.
Core rules
- Demand curve slopes down; supply slopes up. A change in price causes movement along; changes in non-price determinants shift curves.
- Equilibrium sets Qd=Qs. A surplus pushes price down; a shortage pushes price up.
- PED = %ΔQd/%ΔP; PES = %ΔQs/%ΔP. YED: positive normal, negative inferior. XED: positive substitutes, negative complements.
- Allocative efficiency occurs where marginal benefit equals marginal cost (P=MC); consumer plus producer surplus is maximised. Deadweight loss arises when quantity differs from efficient level.
Worked example
Qd = 100 - 2P and Qs = 20 + 3P. Set equal: 100 - 2P = 20 + 3P, so 80=5P, P=16, Q=68. Now price rises from 10 to 12: Qd falls from 80 to 76. PED = (-4/80)/(2/10) = -0.05/0.2 = -0.25, inelastic. Reason: the percentage quantity response is smaller than the price change, so total consumer spending rises when price rises.
Traps
Elasticity is not the slope. PED is usually negative; use absolute value for "elastic/inelastic" but keep sign for complements/substitutes. A tax shifts supply, not demand; a subsidy shifts supply right. Do not double-count a movement and a shift. At equilibrium there is no shortage or surplus, but there may still be market failure.