Demand, Supply, Elasticity and Market Equilibrium
What the domain tests
Demand, supply, elasticity and market equilibrium tests how prices coordinate decisions, how equilibrium changes when curves shift, and how PED, PES, YED and XED shape revenue, tax incidence and policy effects.
Core rules
- Demand: inverse relationship between price and quantity demanded, ceteris paribus. A price change moves along the curve; changes in income, tastes, substitutes, complements or expectations shift it.
- Supply: direct price-quantity relationship. Costs, technology, taxes, subsidies and number of firms shift supply.
- Equilibrium is where quantity demanded equals quantity supplied; surplus pushes price down, shortage pushes it up.
- PED = %ΔQd/%ΔP. Demand is elastic if |PED|>1. With elastic demand, a price rise reduces total revenue; with inelastic demand it raises revenue.
- PES measures responsiveness of quantity supplied; time and spare capacity matter.
- YED: positive for normal goods, negative for inferior goods. XED: positive for substitutes, negative for complements.
Worked example
A 10% price rise reduces quantity demanded by 25%. PED = −25/10 = −2.5, so demand is elastic. Total revenue falls: the percentage loss of sales outweighs the higher price. A firm wanting revenue should cut price in this elastic range. For a tax, the burden falls more on the side that is less elastic; if demand is inelastic and supply elastic, consumers bear most of the tax.
Traps
Drop the minus sign when judging elasticity magnitude but keep it for interpretation. Use percentage changes, not absolute changes. Do not confuse a shift in demand with a movement along it. Elasticity varies along a straight-line demand curve; do not assume it is constant.