3.1 Topics in Demand and Supply Analysis - 3.1 Topics in Demand and Supply Analysis

Key Concepts

• Demand
• Supply
• Market Equilibrium
• Price Elasticity of Demand
• Price Elasticity of Supply

Demand

Demand refers to the quantity of a good or service that consumers are willing and able to purchase at various prices during a given period. The law of demand states that there is an inverse relationship between the price of a good and the quantity demanded, assuming all other factors remain constant.

Example: If the price of a smartphone decreases, more consumers are likely to purchase it, increasing the quantity demanded.

Supply

Supply refers to the quantity of a good or service that producers are willing and able to sell at various prices during a given period. The law of supply states that there is a direct relationship between the price of a good and the quantity supplied, assuming all other factors remain constant.

Example: If the price of wheat increases, farmers are likely to plant more wheat, increasing the quantity supplied.

Market Equilibrium

Market equilibrium occurs where the quantity demanded equals the quantity supplied. At this point, there is no surplus or shortage, and the market clears. The price at which this equilibrium occurs is called the equilibrium price, and the quantity exchanged is the equilibrium quantity.

Example: In a competitive market for apples, if the price is too high, there will be a surplus (excess supply), and if the price is too low, there will be a shortage (excess demand). The equilibrium price is where the quantity of apples demanded by consumers equals the quantity supplied by producers.

Price Elasticity of Demand

Price elasticity of demand measures how much the quantity demanded of a good responds to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. Goods with a high price elasticity of demand are sensitive to price changes, while those with a low elasticity are not.

Example: Luxury cars have a high price elasticity of demand because consumers can easily delay or forgo purchasing a luxury car if the price increases. On the other hand, basic food items like bread have a low price elasticity of demand because consumers need to purchase them regardless of price changes.

Price Elasticity of Supply

Price elasticity of supply measures how much the quantity supplied of a good responds to a change in its price. It is calculated as the percentage change in quantity supplied divided by the percentage change in price. Goods with a high price elasticity of supply can be easily increased in production in response to price increases, while those with a low elasticity cannot.

Example: Agricultural products like fruits and vegetables have a high price elasticity of supply because farmers can quickly increase or decrease the amount of land they use for planting in response to price changes. In contrast, goods like custom-made furniture have a low price elasticity of supply because increasing production requires more time and resources.