Demand and Supply Analysis
Domain 2 covers the law of demand, determinants of demand and supply, shifts versus movements, market equilibrium, and simple comparative statics. The exam expects you to solve demand-supply equations and explain shortages and surpluses.
Core rules and concepts
- Law of demand: other things equal, quantity demanded falls as price rises; the demand curve slopes downward.
- A change in own price causes movement along the curve; a change in income, tastes, related-good prices, or expectations shifts the curve.
- Supply curves slope upward because higher prices cover higher marginal costs; supply shifts with input prices, technology, taxes, and subsidies.
- Equilibrium occurs where quantity demanded equals quantity supplied; above equilibrium there is a surplus, below it a shortage.
- A price ceiling below equilibrium creates persistent shortage; a price floor above equilibrium creates surplus.
Worked example
Take Qd = 100 − 2P and Qs = 20 + 3P. Set 100 − 2P = 20 + 3P, so 80 = 5P and P = ₹16; Q = 68. At P = ₹10, Qd = 80 and Qs = 50, a shortage of 30 units, which pushes price up. At P = ₹20, Qd = 60 and Qs = 80, a surplus of 20 units, which pushes price down. If income rises and demand becomes Qd = 120 − 2P, equilibrium becomes 120 − 2P = 20 + 3P, so P = ₹20 and Q = 80: the demand shift raised both price and quantity.
Traps that cost marks
Do not shift a curve when only price changes. Do not write supply when you mean quantity supplied. Remember that a tax on sellers shifts supply upward by the tax. Do not call a shortage a surplus, and check units and algebra.