Demand and Its Determinants

Law of Demand

The law of demand states that, holding all else constant (ceteris paribus), when the price of a product falls, the quantity demanded increases, and when the price rises, the quantity demanded decreases.

• Key Point: There is an inverse relationship between price and quantity demanded.

• Example: If the price of coffee decreases, more consumers will buy coffee.

Demand Schedule and Demand Curve

A demand schedule is a table showing the relationship between the price of a product and the quantity demanded. The demand curve is a graphical representation of this relationship.

• Formula: , where is quantity demanded and is price.

• Example: A table listing how many units of ice cream are bought at various prices.

Shifts in Demand

When consumers decide to buy more of a good without a change in price, the demand curve shifts to the right. Factors that can shift the demand curve include:

• Income (normal and inferior goods)

• Prices of related goods (substitutes and complements)

• Tastes and preferences

• Demographics

• Expectations about future prices

Note: The supply of the product does not shift the demand curve.

Normal and Inferior Goods

• Normal good: Demand increases as income increases.

• Inferior good: Demand decreases as income increases.

• Example: As income rises, people may buy more steak (normal good) and less instant noodles (inferior good).

Substitution and Income Effects

• Substitution effect: Consumers buy more of a cheaper product instead of a more expensive one.

• Income effect: When the price of a good falls, consumers can afford to buy more with the same income.

Ceteris Paribus

Ceteris paribus means "all else equal"—a condition used to isolate the effect of one variable by holding others constant.

Supply and Its Determinants

Law of Supply

The law of supply states that, holding all else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

• Formula: , where is quantity supplied and is price.

• Example: If the price of wheat rises, farmers are willing to supply more wheat.

Supply Schedule and Supply Curve

A supply schedule is a table showing the relationship between the price of a product and the quantity supplied. The supply curve is its graphical representation.

Shifts in Supply

Factors that can shift the supply curve include:

• Prices of inputs (e.g., labor, raw materials)

• Technological change

• Number of firms in the market

• Prices of substitutes in production

• Expectations about future prices

Example: A decrease in input prices or a positive technological change shifts the supply curve to the right (increase in supply).

Market Equilibrium

Definition and Determination

Market equilibrium occurs where the quantity demanded equals the quantity supplied. The equilibrium price is where the demand and supply curves intersect.

• Formula: at equilibrium price .

• Example: If at , both buyers and sellers agree to trade 100 units.

Surplus and Shortage

• Surplus: Quantity supplied exceeds quantity demanded at a given price. Leads to downward pressure on price.

• Shortage: Quantity demanded exceeds quantity supplied at a given price. Leads to upward pressure on price.

• Example: If the price of shoes is set above equilibrium, a surplus results; if below, a shortage occurs.

Shifts in Demand and Supply: Effects on Equilibrium

Additional info: If demand increases more than supply, price rises; if supply increases more than demand, price falls.

Key Market Concepts

• Competitive Market: Many buyers and sellers, no single buyer or seller can influence the price.

• Perfectly Competitive Market: Many buyers and sellers, identical products, no barriers to entry.

• Market Demand: The total demand by all consumers for a good or service.

• Market Equilibrium: The point where quantity demanded equals quantity supplied.

Additional Microeconomic Concepts

• Opportunity Cost: The highest-valued alternative that must be given up to engage in an activity.

• Factors of Production: Labor, capital, natural resources, and entrepreneurship used to produce goods and services.

• Property Rights: The rights individuals or businesses have to the exclusive use of their property.

• Economic Models: Simplified versions of reality used to analyze real-world situations.

• Marginal Analysis: Comparing marginal benefits and marginal costs to make decisions.

• Allocative Efficiency: Production is in accordance with consumer preferences; every good is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of production.

• Productive Efficiency: Goods or services are produced at the lowest possible cost.

• Voluntary Exchange: Both buyer and seller are made better off by the transaction.

• Mixed Economy: Most decisions result from market interactions, but government plays a significant role in resource allocation.

• Positive vs. Normative Analysis: Positive analysis describes what is; normative analysis describes what ought to be.