Topic 2: The Price System and the Microeconomy

2.1 Demand and Supply Curves

• Demand = quantity consumers are willing + able to buy at different prices (ceteris paribus).
• Supply = quantity producers are willing + able to sell at different prices.
• Determinants of demand: income, tastes, prices of substitutes/complements, expectations.
• Determinants of supply: production costs, technology, taxes/subsidies, expectations.
• Movements vs shifts:
• Movement = change in price → move along curve.
• Shift = change in other factors → whole curve moves.

Memory cue: Demand = desire + dollars; Supply = stuff + sellers.

 

2.2 Price Elasticity of Demand (PED)

• Measures responsiveness of demand to price changes.
• Formula: % change in Qd ÷ % change in Price.
• Elastic (>1): demand changes a lot (luxuries, substitutes).
• Inelastic (<1): demand changes little (necessities).
• Perfectly elastic = horizontal line; perfectly inelastic = vertical line.

Mnemonic: Elastic = easy to stretch (responsive). Inelastic = stiff (not responsive).

 

2.3 Price Elasticity of Supply (PES)

• Responsiveness of supply to price changes.
• Factors: spare capacity, time period, mobility of factors, stock levels.
• Short run → supply less elastic; long run → more elastic.

 

2.4 Income Elasticity of Demand (YED)

• Measures responsiveness of demand to income changes.
• Normal goods: positive YED (demand rises with income).
• Inferior goods: negative YED (demand falls with income).
• Luxury goods: YED > 1 (demand rises faster than income).

 

2.5 Cross Elasticity of Demand (XED)

• Measures the responsiveness of demand for one good to the price change of another.
• Substitutes: positive XED.
• Complements: negative XED.

 

2.6 Consumer and Producer Surplus

• Consumer surplus = difference between what consumers are willing to pay vs what they actually pay.
• Producer surplus = difference between price received vs minimum price producers would accept.
• Both show welfare gains from trade.

 

2.7 Market Equilibrium

• Occurs where demand = supply.
• Disequilibrium → shortage (excess demand) or surplus (excess supply).
• Price mechanism restores equilibrium by adjusting prices.