Supply and demand Study Guide

📖 Core Concepts Supply & Demand Model – Determines the market‑clearing price where quantity supplied equals quantity demanded. Market‑clearing price – The price at which the market “clears”; no excess supply or demand. Economic equilibrium – The price‑quantity pair that satisfies both the supply and demand schedules. Perfect competition – No single buyer or seller can affect the market price; each takes the price as given. Supply curve – Shows quantities a firm will sell at each price; under perfect competition firms supply where price ≥ marginal cost. Demand curve – Shows quantities buyers will purchase at each price; buyers purchase when marginal utility ≥ price. Law of Demand – Higher price → lower quantity demanded (downward‑sloping curve). Shifts vs. movements – Shifts = change in non‑price determinants; movements = change along a curve due to price change. --- 📌 Must Remember Equilibrium: Intersection of supply & demand curves → market‑clearing price & quantity. Increase in demand → rightward shift → higher price and higher quantity. Decrease in demand → leftward shift → lower price and lower quantity. Increase in supply → rightward shift → lower price and higher quantity. Decrease in supply → leftward shift → higher price and lower quantity. Supply shift left = higher input costs → less supplied at every price. Supply shift right = lower production costs → more supplied at every price. Partial equilibrium isolates one market, holding all others constant. Consumer surplus = willingness‑to‑pay – actual price. Producer surplus = actual price – minimum acceptable price. Deadweight loss = loss of total welfare when equilibrium is not achieved (e.g., taxes, price caps). --- 🔄 Key Processes Deriving Market Supply – Horizontally sum all individual firm supply curves at each price. Deriving Market Demand – Vertically add all individual demand curves at each price. Comparative Statics: Identify which curve (supply or demand) shifts. Determine direction of shift (right/left). Draw new equilibrium; note changes in price & quantity. Partial‑Equilibrium Policy Evaluation: Introduce a tax/subsidy → shift supply or demand curve. Re‑compute equilibrium → measure new price, quantity, and welfare changes (CS, PS, DWL). --- 🔍 Key Comparisons Supply shift vs. movement along supply Shift: caused by input price, technology, expectations, number of firms. Movement: caused by change in market price alone. Demand shift vs. movement along demand Shift: caused by income, tastes, prices of related goods, expectations, number of buyers, advertising. Movement: caused solely by price change. Veblen good vs. Giffen good (exceptions to law of demand) Veblen: higher price ↑ desirability (status). Giffen: inferior good where price rise ↑ quantity demanded because income effect dominates substitution effect. --- ⚠️ Common Misunderstandings “Supply curve always upward sloping.” – True only when marginal cost rises with output; a leftward shift due to higher input costs does not change the slope, only the position. “Demand curve never shifts.” – Ignoring income, preferences, or related‑good price changes leads to missed shifts. “Partial equilibrium gives full picture.” – It ignores spill‑over effects; results may be inaccurate for interconnected markets. “Higher price always means higher revenue for sellers.” – Revenue depends on price elasticity; if demand is elastic, higher price can reduce total revenue. --- 🧠 Mental Models / Intuition “Water‑level model”: Imagine the market as a container; price is the water level. Supply adds water (quantity) from the left, demand drains water from the right. Equilibrium is the level where inflow = outflow. “Shift‑vs‑Move” shortcut: If something other than price changes → shift the whole curve. If price changes → move along the existing curve. --- 🚩 Exceptions & Edge Cases Backward‑bending labor supply: At very high wages, workers may supply fewer hours (preference for leisure). Perfectly inelastic supply (vertical) – Quantity supplied does not respond to price (e.g., fixed money supply). Perfectly elastic supply (horizontal) – Firms can supply any amount at a given price (rare in reality). Macroeconomic demand may violate law of demand – Aggregate demand can slope upward in some theoretical debates. --- 📍 When to Use Which Partial equilibrium – When analyzing a single market’s response to a tax, subsidy, or price control and cross‑market effects are negligible. Aggregate demand‑aggregate supply (AD‑AS) – For macro‑level questions about total output, price level, or policy that affects the whole economy. Linear functional form – Use for quick comparative‑static calculations; slope = ΔP/ΔQ. Constant‑elasticity (isoelastic) form – Use when price elasticity is assumed constant across price ranges (log‑log specification). --- 👀 Patterns to Recognize Rightward demand shift + unchanged supply → price ↑ & quantity ↑ (common in income‑rise scenarios). Leftward supply shift + unchanged demand → price ↑ & quantity ↓ (typical when input costs rise). Tax on sellers → supply curve shifts upward by the tax amount → price to buyers rises, price to sellers falls, quantity falls → creates DWL. Subsidy to buyers → demand curve shifts rightward by subsidy amount → price to sellers falls, price to buyers rises, quantity rises → reduces DWL (may create excess cost). --- 🗂️ Exam Traps Confusing a shift with a movement: Answer choices that attribute a price change to a “shift” when only the price moved along the curve are wrong. Veblen/Giffen vs. normal goods: Distractors may label any upward‑sloping demand as “Veblen” without the status‑signal rationale. Partial equilibrium vs. general equilibrium: Questions that ask for economy‑wide effects but only give a partial‑equilibrium diagram will be misleading. Deadweight loss mis‑calculation: Choices that ignore the reduction in both consumer and producer surplus when a tax is imposed will overstate welfare. Elasticity omission: Some items list “price ↑, quantity ↑” and claim it’s a demand increase; actually it could be a supply increase. Look at which curve moved. ---