Demand and Supply

This is Unit Two of Principles of Microeconomics, part one of two: demand, supply, equilibrium, and what a government does when it sets a price by law. Carry one idea. A good's own price moves buyers and sellers along their curves; everything else shifts a curve. Every market question turns on telling those apart, and this part builds the model and tests that distinction. By the end you will be able to define demand and supply and state the two laws. To find equilibrium from a schedule or two equations and name a surplus or shortage. To tell a shift from a movement along. To predict price and quantity from one shift or two, including a related good's price. And to say whether a control binds and what it causes.

Five entries on the market and its two sides: what a market is, demand and its law, supply and its law.

What a market is.

MIC 0101 What a Market Is

A market is any arrangement bringing buyers and sellers together: a building, a website or a phone call, and demand and supply is the model of how a market sets a price. The model assumes many buyers and sellers, none able to set the price alone; later units relax that.

The buyers' side.

MIC 0102 Demand and Quantity Demanded

Demand is the whole relationship between price and the quantity buyers are willing and able to buy, other things unchanged; quantity demanded is the amount at one particular price. A demand schedule lists the pairs and a demand curve draws them. Willing and able: a wish without the money to pay is not demand.

The direction the curve slopes.

MIC 0103 The Law of Demand

The law of demand says that, other things unchanged, a higher price lowers the quantity demanded and a lower price raises it, so demand curves slope down. A store with too many running shoes holds a sale to move more pairs. It holds for nearly every good; unit five meets the rare exception.

The sellers' side.

MIC 0104 Supply and Quantity Supplied

Supply is the whole relationship between price and the quantity sellers are willing to offer, other things unchanged; quantity supplied is the amount at one price. Supply is what sellers would bring at each price, not what sits in stock: a warehouse is not a supply curve.

The direction that curve slopes.

MIC 0105 The Law of Supply

The law of supply says that, other things unchanged, a higher price raises the quantity supplied and a lower price reduces it, so supply curves slope up. A higher oil price makes marginal wells worth pumping. It has more exceptions than demand's: fixed land cannot rise with price, and unit three meets a curve that bends back.

Four entries on where the curves meet: equilibrium, what happens away from it, and reading it off a table or two equations.

Where the two curves meet.

MIC 0106 Equilibrium

Equilibrium is the price at which quantity demanded equals quantity supplied, where the two curves cross, and the equilibrium quantity is the amount traded there. It is the only price with no pressure to change; every other price sets off a correction.

What happens away from it.

MIC 0107 Surplus and Shortage

Above equilibrium, quantity supplied exceeds quantity demanded: a surplus, and sellers cut the price. Below it, demand exceeds supply: a shortage, and the price is bid up. A surplus is not too much of a good, only too much at this price, and the price fixes it.

Reading it off a table.

MIC 0108 Finding Equilibrium from a Schedule

A schedule lists prices with the quantity demanded and supplied at each; read down for the price where the two match. Elsewhere the gap is a surplus above equilibrium and a shortage below. Bagels: four hundred demanded and one hundred supplied at one dollar, three hundred and two hundred at two, two hundred and two hundred at three, one hundred and three hundred at four. The quantities match at three dollars and two hundred bagels; one dollar leaves a shortage of three hundred, four dollars a surplus of two hundred. Read the gap at a single price, never across rows.

The same answer from two equations.

MIC 0109 Solving a Market with Algebra

With demand and supply as equations, set quantity demanded equal to quantity supplied, solve for the price, then substitute back for the quantity and check that the other equation returns the same number. Demand one hundred minus five p, supply twenty plus three p: eighty equals eight p, so the price is ten, and both equations give fifty. The market clears at ten dollars and fifty units. A sign error makes two lines that never meet, and on the diagram each equation is drawn with price solved out.

Six entries on the distinction everything turns on: shift against movement, then what shifts demand and what shifts supply.

The distinction every question turns on.

MIC 0110 Shift Versus Movement Along

A change in the good's own price moves along its curve, a change in quantity demanded or supplied; anything else changing shifts the whole curve, a change in demand or supply. A sale moves along the demand curve; a heat wave shifts demand for ice cream. The good's own price never shifts its own curve.

The first thing that shifts demand.

MIC 0111 Income: Normal and Inferior Goods

For a normal good, higher income raises demand and shifts the curve right; for an inferior good, higher income lowers demand, because buyers move to something they prefer. Fresh fruit is usually normal; canned fruit and long bus rides are often inferior. Inferior is not a judgment of quality, only the direction demand moves with income.

Prices of other goods.

MIC 0112 Substitutes and Complements

Two goods are substitutes when a higher price for one raises demand for the other, and complements when a higher price for one lowers demand for the other. Tea and coffee are substitutes; coffee and doughnuts are complements. The change is in the other good's demand, a shift; the good whose price changed moves along its own curve.

The remaining demand shifters.

MIC 0113 Tastes, Population and Buyer Expectations

Three more demand shifters: tastes and preferences, the size and makeup of the population, and buyers' expectations about future prices or their own future income. An expected price rise tomorrow fills gas tanks today, shifting demand right now. The price that shifts demand is the future price, not today's.

The supply side's shifters.

MIC 0114 What Shifts Supply

Supply shifts through the cost of production: input prices, technology, natural conditions, and government taxes, regulations and subsidies. Higher cost shifts supply left; lower cost shifts it right. A leftward shift of supply is also an upward one: each unit now costs more to bring to market.

Two shifters the anchor leaves out.

MIC 0115 Seller Expectations and the Number of Sellers

Two more supply shifters: sellers' expectations and the number of sellers. A seller expecting a higher price holds stock back now, shifting supply left; more sellers shift it right. A third is the return from alternative uses of inputs: if chickens sell better, fewer are kept for eggs, so egg supply falls.

Five entries on working a question: four steps, which curve and which way, a related good, two shifts, and the commonest error.

The routine for any market question.

MIC 0116 The Four-Step Process

Four steps answer any market question: draw the market before the event; decide whether demand or supply shifts; decide which way and draw it; compare the new equilibrium with the old. Step two is the hard one: does the event change what buyers would buy at each price, or what sellers would sell?

Step two in practice.

MIC 0117 Which Curve Shifts, and Which Way

Given an event, name the shifter, the curve and the direction. Income, tastes, population, related prices and expectations shift demand; costs, technology, conditions, policy, seller expectations and the number of sellers shift supply. Demand right raises both price and quantity; demand left lowers both; supply right lowers price and raises quantity; supply left does the reverse. For bicycles: higher incomes, demand right, both rise; a welding robot, supply right, price down and quantity up; a per-bicycle tax, supply left, price up and quantity down; cheaper bus passes, demand left, both fall. Two errors recur: a cost change put on the demand curve, and demand shifted by the good's own price.

The exam's favorite version.

MIC 0118 A Related Good's Price Changes

When a related good's price changes, only one of two things is a shift. The good whose price changed moves along its own demand curve; the related good's demand shifts, left if they are substitutes and the first got cheaper, right if they are complements. Apples, a close substitute, get cheaper: buyers move along the apple curve, some leave oranges, and orange demand shifts left, so the orange market's price and quantity both fall; complements would have shifted it right. Answer for the market asked about: that more apples were demanded is true and is not the answer.

When both curves move.

MIC 0119 When Both Curves Shift

When both curves shift, work each separately and combine. Where both push a variable the same way its direction is certain; where they push opposite ways it depends on which shift is larger, and without sizes it is indeterminate. Both right: quantity rises, price indeterminate. Demand right and supply left: price rises, quantity indeterminate. For streaming rentals, dearer cinema tickets shift demand right while higher staff wages shift supply left: each raises the price, so price rises for certain, while quantity could go either way. The correct exam answer says indeterminate rather than guessing.

The error the model catches most.

MIC 0120 A Shift in One Curve Moves Along the Other

When one curve shifts, the price changes, and that change moves along the other curve; it never shifts the other curve, or the first one back. The tempting error is that fewer peas means less demand, so demand shifts; it does not, because buyers want the same at each price.

Five entries on prices set by law: controls, ceilings, floors, whether a control binds, and the most studied ceiling.

What a government can do to a price.

MIC 0121 Price Controls

A price control is a law that sets a price instead of letting the market find it; a ceiling is a legal maximum and a floor a legal minimum. A control moves neither curve: buyers and sellers keep the same intentions and are forbidden to act on them at some prices.

Ceilings.

MIC 0122 Price Ceilings

A price ceiling set below equilibrium creates a shortage: at the legal price buyers want more than sellers offer, and the price is not allowed to rise to clear it. The shortage persists, and without a rising price to ration the good something else does: waiting lists, favoritism or side payments.

Floors.

MIC 0123 Price Floors

A price floor set above equilibrium creates a surplus: at the legal price sellers offer more than buyers want, and the price is not allowed to fall to clear it. The surplus persists too, and somebody must absorb it: a government that buys it, or sellers who cannot sell.

Whether a control does anything at all.

MIC 0124 Binding or Not

A control matters only if it forbids the equilibrium price. A ceiling below equilibrium binds and causes a shortage; a ceiling above changes nothing. A floor above equilibrium binds and causes a surplus; a floor below does not bind. Tutoring hours clear at twenty dollars with eight hundred traded. A ceiling of twenty-five binds nothing. A ceiling of fifteen binds: students want one thousand hours, tutors offer six hundred, a shortage of four hundred. A floor of twenty-five binds the other way: tutors offer one thousand, students want six hundred, a surplus of four hundred. Ask first whether the equilibrium price is legal.

The most studied ceiling.

MIC 0125 Rent Control

Rent control holds rent below the market level. Landlords offer fewer units than tenants want, and over time convert, neglect or withdraw apartments, so the shortage grows. Sitting tenants gain; newcomers, the people the control was meant to help, are the ones who cannot find a unit.

Look at what you can now do. You can define demand and supply and state that demand slopes down and supply up. You can find equilibrium where the quantities match and name the gap elsewhere as a surplus or shortage. You can tell a shift from a movement along: the good's own price moves along, and everything else shifts. You can predict price and quantity from one shift, name the ambiguous variable when two collide, and answer a related-good question in the right market. And you can say whether a control binds by asking whether the equilibrium price is legal. Part two turns to the floors governments use most, the surplus trades create, and what a control destroys.