Chapter 2 · Microeconomics
Interaction of Demand and Supply
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Key Definitions
- Supply
- The quantity of a good producers are willing and able to sell at each price, ceteris paribus.
- Demand
- The quantity of a good consumers are willing and able to buy at each price, ceteris paribus.
- Consumer surplus
- Maximum willingness to pay minus the price actually paid.
- Producer surplus
- Price received minus the minimum price producers are willing to accept.
- The price mechanism
- The signalling and incentive functions of price in a free market that allocate scarce resources.
Core Concepts
Market equilibrium
- A surplus is eliminated by downward price pressure.
- A shortage is eliminated by upward price pressure.
- Equilibrium is where quantity demanded equals quantity supplied.
Supply determinants (WET PIGS)
- Weather.
- Expectations of future prices.
- Technology.
- Prices of related goods and the prices of factors.
- Size of the industry.
- Government policies: taxes reduce supply, subsidies increase it, and quotas limit it.
Demand determinants (EGYPT)
- Expectations of future prices and income.
- Government policies.
- Income, interest rates and the availability of credit.
- Prices of related goods and population.
- Tastes and preferences.
Normal vs inferior goods
- Normal goods: demand rises when income rises.
- Inferior goods: demand falls when income rises.
Diagram Notes
Downward-sloping demand and upward-sloping supply intersect at the equilibrium price and quantity. A surplus sits to the right of equilibrium and pushes price down; a shortage sits to the left and pushes price up.
Consumer surplus is the area between the demand curve (willingness to pay) and the market price. Producer surplus is the area between the market price and the supply curve. Together they measure total welfare in the market.