Difficulty: Introductory | Prerequisites: None
This material covers the foundational mechanics of how buyers behave in markets: what drives the quantity they want, how sensitive that quantity is to price changes, and what happens when governments interfere with prices. These concepts sit at the very beginning of any microeconomics course because every later topic (market structures, firm behaviour, welfare analysis) assumes you already think in terms of demand curves, elasticity, and equilibrium. If you are coming in cold, start here.
The law of demand says people buy less when prices rise. Elasticity measures exactly how much less (or more). When governments cap prices below equilibrium, shortages follow; when they set floors above it, surpluses result.
Law of demand
When the price of a good rises, the quantity demanded falls, all else being equal. When the price falls, the quantity demanded rises. This is the most basic behavioural regularity in economics.
In simple terms, this means: as something gets more expensive, people want less of it.
Quantity demanded
The specific amount of a good that buyers are willing and able to purchase at a given price during a given period.
In simple terms, this means: the number of units people would buy at one particular price point.
Determinants of demand (demand shifters)
Factors other than the good's own price that change the entire demand curve. These include consumer income, tastes and preferences, the price of the product itself (as listed in the source), the price of related goods (substitutes and complements), expectations about future prices, and the number of buyers in the market.
In simple terms, this means: anything besides the sticker price that makes people want more or less of something.
Elasticity of demand (price elasticity of demand)
A measure of how much the quantity demanded of a good responds to a change in its price. Formally, it is the percentage change in quantity demanded divided by the percentage change in price.
In simple terms, this means: how dramatically buyers react when the price moves. A large reaction is "elastic"; a small reaction is "inelastic."
Elastic demand
Demand where the percentage change in quantity demanded is greater than the percentage change in price (elasticity > 1 in absolute value). Goods with many substitutes or that are luxuries tend to have elastic demand.
Think of it as: buyers are price-sensitive and will walk away quickly if the price rises. Luxury cars are a classic example, because cheaper alternatives exist.
Inelastic demand
Demand where the percentage change in quantity demanded is smaller than the percentage change in price (elasticity < 1 in absolute value). Necessities with few substitutes tend to be inelastic.
Think of it as: buyers keep purchasing roughly the same amount even when the price moves. Prescription medications are the textbook example, because patients need them regardless of cost.
Price ceiling
A legal maximum price that sellers may charge for a good, set by the government. When the ceiling is below the equilibrium price, it is binding and creates a shortage.
In simple terms, this means: the government says "you cannot charge more than £X," and if £X is below where supply meets demand, more people want the good than sellers are willing to supply.
Price floor
A legal minimum price, set by the government. When it sits above the equilibrium price, it is binding and creates a surplus.
In simple terms, this means: the government says "you cannot charge less than £X," and if £X is above equilibrium, sellers want to sell more than buyers want to buy.
Shortage
A situation where quantity demanded exceeds quantity supplied at the prevailing price. Shortages are the predictable result of a binding price ceiling.
Surplus
A situation where quantity supplied exceeds quantity demanded at the prevailing price. Surpluses are the predictable result of a binding price floor.
Equilibrium price
The price at which quantity demanded equals quantity supplied. No pressure for the price to change.
The demand curve slopes downward from left to right, reflecting the inverse relationship between price and quantity demanded
A movement along the demand curve happens when the good's own price changes
A shift of the entire curve happens when a determinant of demand (income, tastes, related goods' prices, expectations, number of buyers) changes
"Price of the product" appears in the source as a determinant of demand; strictly speaking, a change in the good's own price causes a movement along the curve, while the other determinants shift it. Exam questions may test this distinction
Elastic goods: luxury items, goods with close substitutes, goods that take a large share of the buyer's budget
Example: luxury cars. A price increase pushes buyers toward cheaper alternatives
Inelastic goods: necessities, goods with few or no substitutes, goods that take a small share of the budget
Example: prescription medications. Patients continue buying because there is no close substitute
Elasticity exists on a spectrum, not as a binary. "Elastic" and "inelastic" are the two ends; "unit elastic" (elasticity = 1) sits in the middle
A price ceiling below equilibrium creates a shortage: buyers want more than sellers will supply at the capped price
Real-world example: rent controls in major cities often lead to housing shortages and long waiting lists
A price floor above equilibrium creates a surplus: sellers want to sell more than buyers will purchase
Real-world example: agricultural price supports can lead to unsold crops
If a ceiling is set above equilibrium or a floor below it, the control is non-binding and has no effect on the market
Price elasticity of demand (PED)
PED = (% change in quantity demanded) / (% change in price)
|PED| > 1 → elastic
|PED| < 1 → inelastic
|PED| = 1 → unit elastic
Elasticity is why petrol stations can raise prices without losing many customers (inelastic, few substitutes for fuel in the short run), but a small price increase at one coffee shop sends regulars to the competitor next door (elastic, close substitutes everywhere). Price ceilings explain the queues and black markets seen in economies with government-mandated price caps on essentials.
Students often confuse a movement along the demand curve (caused by a price change) with a shift of the demand curve (caused by a change in income, tastes, or another determinant). These are different things, and exams test the distinction frequently.
Students sometimes think "inelastic" means demand does not change at all. It does change, just by a smaller percentage than the price change.
A price ceiling above the equilibrium price does nothing. Students often assume any price ceiling creates a shortage, but only a binding ceiling (set below equilibrium) does.
Elasticity is not the same as slope. Two demand curves with the same slope can have different elasticities at different price points.
⚠️ The law of demand (price up, quantity demanded down) is the single most tested concept in introductory micro. Know it cold.
⚠️ Expect a question distinguishing between a shift of the demand curve and a movement along it. The trigger word "determinant" points to a shift.
⚠️ Elasticity questions often ask for real-world examples. Have one elastic example and one inelastic example ready (luxury cars and prescription medications work well).
⚠️ Price ceiling below equilibrium = shortage. Price floor above equilibrium = surplus. This pair comes up in nearly every introductory exam.
True or False: Inelastic demand means that consumers are highly responsive to price changes.
Answer: False. Inelastic demand means consumers are relatively unresponsive.
Fill in the blank: A price ceiling set ______ the equilibrium price causes a shortage.
Answer: below
True or False: The demand curve slopes upward from left to right.
Answer: False. It slopes downward.
Fill in the blank: If PED = 0.4, demand is described as ______.
Answer: inelastic (because 0.4 < 1)
True or False: A change in consumer income shifts the demand curve rather than causing movement along it.
Answer: True.
Q: What does the law of demand state?
A: The law of demand states that, all else being equal, as the price of a good increases, the quantity demanded decreases, and vice versa.
Q: Which of the following is a determinant of demand: cost of production, price of the product, number of sellers, or government policies?
A: Price of the product. (Note: the other options are determinants of supply, not demand.)
Q: Explain the concept of elasticity of demand. Provide an example of a product with elastic demand and one with inelastic demand.
A: Elasticity of demand measures how much the quantity demanded responds to a change in price. Luxury cars have elastic demand because consumers can switch to cheaper alternatives when the price rises. Prescription medications have inelastic demand because patients need them regardless of price, and there are no close substitutes.
Q: When a government imposes a price ceiling below the equilibrium price, what is the likely outcome?
A: A shortage. At the capped price, quantity demanded exceeds quantity supplied.
This material connects directly to supply and market equilibrium: once you understand demand, you pair it with supply to find the equilibrium price and quantity. Elasticity reappears when studying tax incidence (who bears the burden of a tax depends on relative elasticities of supply and demand). Price controls lead naturally into welfare analysis and the concept of deadweight loss.
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