SMARTLY

MICROECONOMICS I: SUPPLY AND DEMAND

FUNDAMENTALS OF SUPPLY AND DEMAND

Introducing Microeconomics

Microeconomics: The study of how individuals, households, and

firms make decisions about using limited resources.
Economic resources include:
Human resources: Workers and managers.
Nonhuman resources: Land, technology, minerals, oil, etc.
Microeconomists assume that people and firms are rational and
seek to maximize benefits.
Trade-offs: Choosing one thing requires giving up another.
Scarcity: The existence of limited resources.
When an individual or group makes a decision, their opportunity
cost is equal to the value of the foregone option(s).
Economic units: People, households, and firms.
Marginal benefits: Small, incremental benefits.

Supply and Demand

The law of demand: When the price of a good increases,

demand for it decreases, and vice versa. price = demand
Demand schedule: Lists the quantity demanded of a product or
service at various prices.
price = demand
Market demand schedule: A demand schedule that
encompasses the entire market’s demand for a good or service
at various price points.
Demand curve (DC): Plots the quantity of a good or service
demanded at different prices.
Market demand curve: Shows the market demand schedule. $10

$8 Market
When demand curves shift: Olga’s DC
Price

Ivan’s DC
$6 DC
to the left—market demand has decreased.
$4

to the right—market demand has increased. 1 2 3 4 5 6 7 8 9

Quantity Demanded
10 11 12 13 14 15 16 17

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MICROECONOMICS I: SUPPLY AND DEMAND SMARTLY

Supply and Demand (cont.)

Market price: The price at which a good or service is offered in

the marketplace.
Law of supply: When the market price for a good increases, the
quantity that suppliers produce and sell increases, and vice versa.
Supply schedule: Lists the quantity of a product supplied at
various price points.
Supply curve (SC): Plots the supply schedule.
Market supply: The summation of all of the individual supplies of a
good or service.
$8
Market supply curve: Shows how the total quantity supplied of a
good changes as its price changes. $7

Market Price
Pablo’s
When supply curves shift: $6 New SC

to the left—market supply has decreased. $5

$4
to the right—market supply has increased. 100 200 300 400 500 600
Ounces of Catnip Supplied (in Thousands)

Factors Contributing to Equilibrium

Equilibrium: When the amount of goods supplied is equal to the

quantity demanded.
Equilibrium price: The price where equilibrium occurs ($9 on $10
the chart). Demand Supply
Market Price

$9 Curve Curve
Equilibrium quantity: The quantity where equilibrium occurs
(400 on the chart). $8
Equilibrium point (EP): The point at which the price and quantity
demanded is equal to the price and quantity supplied. $7

Price acts as a motivator: 100 200 300 400 500 600 700

When there is a low price for goods or services, consumers buy Market Supply of Bacon Shakes
more and sellers supply less.
When there is a high price for goods or services, consumers buy
less and sellers supply more.

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MICROECONOMICS I: SUPPLY AND DEMAND SMARTLY

Factors Contributing to Equilibrium (cont.)

Law of supply and demand: The price of any good will naturally Which is
adjust until market equilibrium is reached. greater?
Su
nd pp
ma ly
De
Supply > demand: There is a surplus. Prices will drop until
equilibrium is met. Price Increases Price Decreases

Demand Supply Demand Supply

Demand > supply: There is a shortage. Prices will rise until Decreases Increases Increases Decreases
equilibrium is met.
Supply = demand: The market has reached equilibrium. Demand = Supply

To recognize events that alter equilibrium:

$4
1. Identify a shift in the DC and/or the SC.
Demand
$3 Curve EP 2
2. Determine if the curve(s) shift left or right. Shift Supply

Price
Curve
3. Use a graph to see how the shifts change the EP. Shift
$2
EP 1

$1

1 2 3 4 5 6 7 8
Cool Stuff

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MICROECONOMICS I: SUPPLY AND DEMAND SMARTLY

UTILITY AND ELASTICITY

Demand

Utility: The satisfaction gained from consuming a good or service.

A consumer’s total utility can be positive or negative.
Utils: Theoretical units used to measure satisfaction.
Marginal utility: Utility gained from consuming one more unit of
a good.
When the increase in price of one good increases demand for Q: Quantity demanded
another, they are substitute goods (e.g., cookies and cupcakes). P: Price

When the increase in price of one good decreases demand for Percent change using the
another, they are complementary goods (e.g., flashlights and mid-point method:
batteries).
P2 P1
Independent good: A good unaffected by the increase in price of % Change in P = P2 + P1
another (e.g., paper and laundry detergent). 2
Sellers often use Price Elasticity of Demand (PED) to determine
the potential loss of customers if prices are raised. Q2 Q1
% Change in Q = Q2 + Q1
Price 2
% Change in Q
Elasticity
of Demand % Change in P Elastic Demand
(PED)
% Change in Q % Change in P
PED is a measure of how demand for a good changes in relation
to a change in price. If a good is: Inelastic Demand

Elastic: Demand changes greatly in response to price changes % Change in Q % Change in P

(PED will be greater than 1 if demand is elastic).
Unit elastic: When the percentage change in quantity demanded
is equal to that in price. Cross-Price
Elasticity of % Change in Q (Good X)
Inelastic: Demand changes slightly in response to price changes Demand % Change in P (Good Y)
(PED will be less than 1 if demand is inelastic). (CPED)
Cross-price elasticity is a measure of the effect a price change for
one substitute good can have on the demand for another.

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MICROECONOMICS I: SUPPLY AND DEMAND SMARTLY

Demand (cont.)

Profit = Total Revenue − Total Cost

Total cost = fixed costs + variable costs.
Fixed costs: Costs that do not change as the quantity produced
changes.
Variable costs: Costs that do change as the quantity produced
changes.
Production function: The relationship between the quantity of
inputs and the quantity of outputs.
Marginal product: The increase in output resulting from adding
one more unit of input.
Diminishing marginal product: When marginal product begins to
decrease for each new unit of output.
Marginal profit: Profit earned on each subsequent unit sold. La-Z- Total Fixed Variable Avg. Marginal
Bots/ Cost Cost Cost Total Cost
Marginal profit = marginal revenue – marginal cost day Cost
2 $300 $100 $200 $150
$100
Marginal cost: The cost of producing one additional unit of a good. 3 $400 $100 $300 $133
$100
4 $500 $100 $400 $125
$117
Marginal revenue (MR): The revenue generated by each unit sold. 5 $617 $100 $517 $123
$117
6 $733 $100 $633 $122
Average revenue: Total revenue ÷ total number of units sold. 7 $850 $100 $750 $121
$117
$117
8 $967 $100 $867 $121
Profit maximization: The quantity produced at which marginal 9 $1,117 $100 $1,017 $124
$150
revenue equals marginal cost.
If marginal revenue > marginal cost, increase production.
If marginal revenue < marginal cost, decrease production.

Supply

Price elasticity of supply (PES): PES is inelastic if a price change Price

has little effect on the quantity supplied of a good. It is elastic if a Elasticity % Change in Q
price change has a large effect on the quantity supplied. of Supply % Change in P
(PES)
For some goods (e.g., cars, apartments) the market is inelastic in
the short run but elastic in the long run.
For others (e.g., aquarium fish that become endangered) market
supply is elastic in the short run but inelastic in the long run.
The supply elasticity curve graphs PES values from price point to
price point.

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