Demand, Supply, Equilibrium, Elasticity and Price Controls
This section covers demand, supply and market equilibrium, elasticity, and price controls. The exam tests your ability to distinguish movements from shifts, calculate elasticities, and predict shortages or surpluses created by intervention.
Core rules
- Demand curve slopes downward: at lower prices, quantity demanded rises, ceteris paribus. A change in price causes a movement along the curve; changes in income, tastes, prices of substitutes or complements, or expectations shift the curve.
- Supply slopes upward. Equilibrium occurs where quantity demanded equals quantity supplied; above it there is a surplus, below it a shortage.
- Price elasticity of demand = percentage change in quantity demanded divided by percentage change in price. Demand is elastic if the absolute value is greater than 1, inelastic if less than 1. Determinants include substitutes, necessity, share of income and time.
- A price ceiling below equilibrium creates a shortage and may require rationing. A price floor above equilibrium creates a surplus, as with some agricultural supports.
Worked example
Price falls from €10 to €8; quantity demanded rises from 100 to 130. PED = (30/100) divided by (-2/10) = 0.30 divided by (-0.20) = -1.5. Demand is elastic. Total revenue rises from €1,000 to €1,040, which is consistent with elastic demand when price falls.
Traps
Do not shift a curve when price changes. Do not drop the negative sign without explanation. Do not confuse a price ceiling with a floor. Do not assume revenue always rises when price falls: it depends on elasticity.