Difficulty: Introductory | Prerequisites: None
Source: Module 1 Glossary, Microeconomics, University of Illinois at Urbana-Champaign
Tags: demand, supply, equilibrium, demand curve, supply curve, shortage, surplus, price controls, tax incidence, ceteris paribus, microeconomics, ECON 101
This is the opening chapter of microeconomics: how individual markets work. Everything else in the course (elasticity, costs, market structures, welfare) builds on the demand-and-supply framework introduced here. If you can draw a supply-and-demand diagram and explain what happens when something shifts, you have the single most reusable tool in economics. No prior knowledge is needed, but comfort with simple graphs (price on the vertical axis, quantity on the horizontal) will help.
Demand is how much buyers want at each price; supply is how much sellers will offer. Where the two meet is the equilibrium price, and the market clears. When outside forces (government controls, taxes, changes in tastes or costs) push things away from equilibrium, shortages or surpluses appear.
Demand
The quantity of a good or service that buyers wish to purchase at each possible price, with all other influences on demand remaining unchanged.
In simple terms, this means: the full schedule of "how much would people buy at price X, price Y, price Z?" while everything else (income, tastes, other prices) stays the same.
Quantity demanded
The amount purchased at a particular price.
Think of it as one specific point on the demand schedule, not the whole schedule.
Law of demand
All other things being equal, more of a good is demanded the lower its price is.
In simple terms, this means: when the price drops, people buy more. When it rises, they buy less. This is why demand curves slope downward.
Demand curve
A graphical expression of the relationship between price and quantity demanded, with other influences remaining unchanged.
Think of it as the demand schedule drawn on a graph: price on the vertical axis, quantity on the horizontal, and the line slopes downward left to right.
Market demand
The horizontal sum of individual demands.
In simple terms, this means: at every price, add up what each individual buyer wants. The total is market demand.
Supply
The quantity of a good or service that sellers are willing to sell at each possible price, with all other influences on supply remaining unchanged.
Think of it as the mirror image of demand, but from the seller's side: "how much would firms offer at price X, price Y, price Z?"
Quantity supplied
The amount supplied at a particular price.
Think of it as one specific point on the supply schedule.
Supply curve
A graphical expression of the relationship between price and quantity supplied, with other influences remaining unchanged.
In simple terms, this means: the supply schedule drawn on a graph. It typically slopes upward: higher prices make firms willing to produce more.
Equilibrium price
The price at which quantity demanded equals the quantity supplied; it equilibrates the market.
Think of it as the price where the demand curve and supply curve cross. No shortage, no surplus, the market "clears."
Excess demand (shortage)
Excess demand exists when the quantity demanded exceeds quantity supplied at the going price.
In simple terms, this means: the price is too low, buyers want more than sellers are offering, and you get queues or empty shelves.
Excess supply (surplus)
Excess supply exists when the quantity supplied exceeds the quantity demanded at the going price.
In simple terms, this means: the price is too high, sellers have stock they cannot shift, and you get unsold inventory.
Complementary goods
When a price reduction (rise) for a related product increases (reduces) the demand for a primary product, that related product is a complement.
Think of it as goods that go together: printers and ink, cars and petrol. Cheaper printers mean more demand for ink.
Substitute goods
When a price reduction (rise) for a related product reduces (increases) the demand for a primary product, that related product is a substitute.
Think of it as goods that replace each other: Coke and Pepsi, butter and margarine. Cheaper Coke means less demand for Pepsi.
Comparative static analysis
Compares an initial equilibrium with a new equilibrium, where the difference is due to a change in one of the factors that lie behind the demand curve or the supply curve.
In simple terms, this means: "what was equilibrium before, what is it after something shifted, and how do the two compare?" The word "static" means you are comparing two snapshots, not tracking the journey between them.
Price controls
Government rules or laws that inhibit the formation of market-determined prices.
Think of it as ceilings (maximum prices) or floors (minimum prices) that stop the market from reaching its own equilibrium.
Tax incidence
Describes how the burden of a tax is shared between buyer and seller.
In simple terms, this means: when a tax is imposed, part of it falls on consumers (higher price) and part on producers (lower revenue). Who bears more depends on the relative elasticities of demand and supply.
The demand schedule lists how much of a good buyers would purchase at each possible price, holding everything else constant (ceteris paribus).
The demand curve plots this on a graph. Price is on the y-axis, quantity on the x-axis. It slopes downward because of the law of demand.
A change in price causes a movement along the demand curve (change in quantity demanded).
A change in something other than price (income, tastes, prices of related goods, expectations, number of buyers) causes the entire demand curve to shift.
Shift right = increase in demand (more bought at every price).
Shift left = decrease in demand (less bought at every price).
Complements move together: if the price of good A falls, demand for good B rises (e.g. cheaper consoles, more game sales).
Substitutes move in opposite directions: if the price of good A falls, demand for good B falls (e.g. cheaper tea, less coffee demand).
This distinction is tested frequently. The key question: does a price change in one good cause demand for the other to move in the same direction (complement) or the opposite direction (substitute)?
The supply schedule lists how much sellers are willing to offer at each price, ceteris paribus.
The supply curve typically slopes upward: higher prices make production more profitable, so firms supply more.
A change in price = movement along the supply curve.
A change in input costs, technology, expectations, or number of sellers = shift of the entire supply curve.
Equilibrium is where the demand curve and supply curve intersect.
At the equilibrium price, quantity demanded equals quantity supplied. The market clears.
If price is below equilibrium: excess demand (shortage). Buyers bid the price up.
If price is above equilibrium: excess supply (surplus). Sellers cut the price.
The market tends to self-correct toward equilibrium unless something prevents it.
A standard exam technique: draw the initial equilibrium, shift one curve, find the new equilibrium, and compare.
Always state which curve shifts, which direction, and what happens to equilibrium price and quantity.
Example: a new technology reduces production costs. Supply shifts right. Equilibrium price falls, equilibrium quantity rises.
A price ceiling (maximum price) set below the equilibrium creates a shortage. Buyers want more than sellers will offer at that price.
A price floor (minimum price) set above the equilibrium creates a surplus. Sellers want to offer more than buyers will take.
If a ceiling is set above the equilibrium or a floor below it, the control is non-binding and has no effect.
A tax on a good creates a wedge between what the buyer pays and what the seller receives.
The burden does not depend on whether the tax is legally imposed on buyers or sellers. It depends on the relative elasticities of demand and supply.
The more inelastic side of the market bears more of the tax burden.
Students often confuse a "change in demand" (the whole curve shifts) with a "change in quantity demanded" (movement along the curve caused by a price change). These are different things, and exams test the distinction heavily.
Students sometimes think that if a price ceiling is imposed, it always creates a shortage. It does not. A ceiling set above the equilibrium price is non-binding and has no effect.
Many students assume the legal payer of a tax bears all the burden. The economic incidence depends on elasticities, not on who writes the cheque.
Complementary goods and substitute goods are frequently mixed up. Remember: complements move together (price of A down, demand for B up), substitutes move in opposite directions (price of A down, demand for B down).
The demand-and-supply diagram is the backbone of nearly every topic in this course. If you can shift curves and read the new equilibrium quickly, you will save time on virtually every problem set and exam question.
Comparative static analysis ("what was equilibrium, what shifted, what is the new equilibrium") is the single most common exam format in introductory micro.
Distinguishing between a shift of a curve and a movement along a curve is tested in almost every exam at this level.
Price controls and tax incidence are classic policy-application questions. Expect at least one on any midterm or final.
True or false: A fall in the price of a good causes an increase in demand for that good.
False. It causes an increase in quantity demanded (movement along the curve), not an increase in demand (shift of the curve).
Fill in the blank: When quantity demanded exceeds quantity supplied at the current price, this is called ________.
Excess demand (or a shortage).
True or false: A price floor set below the equilibrium price will cause a surplus.
False. A floor below equilibrium is non-binding and has no effect on the market.
Fill in the blank: If the price of butter falls and the demand for margarine also falls, butter and margarine are ________ goods.
Substitute.
True or false: Tax incidence depends on who is legally required to pay the tax.
False. It depends on the relative elasticities of demand and supply.
Q: A new study shows that coffee causes health problems. Using demand and supply analysis, explain what happens to the equilibrium price and quantity of coffee.
A: Demand for coffee shifts left (decrease in demand). At the original equilibrium price there is now excess supply. The equilibrium price falls and the equilibrium quantity falls.
Q: The government imposes a price ceiling on rental housing below the market equilibrium rent. What outcome does this produce?
A: A shortage (excess demand). At the capped price, the quantity of housing demanded exceeds the quantity supplied. Some people who want to rent at that price will be unable to find housing.
Q: Smartphones and smartphone cases are complementary goods. If a technological advance reduces the cost of producing smartphones, what happens to the market for smartphone cases?
A: The supply of smartphones shifts right, lowering the equilibrium price of smartphones. Because smartphones and cases are complements, the fall in smartphone prices increases the demand for cases. The demand curve for cases shifts right, raising the equilibrium price and quantity of cases.
Q: Explain the difference between a change in quantity supplied and a change in supply.
A: A change in quantity supplied is a movement along the existing supply curve caused by a change in the good's own price. A change in supply is a shift of the entire supply curve caused by a change in something other than the good's own price (e.g. input costs, technology, number of sellers).
Q: A tax of $2 per unit is imposed on sellers of petrol. Does the price consumers pay rise by exactly $2?
A: Not necessarily. The price consumers pay rises by less than $2 unless demand is perfectly inelastic. The tax burden is shared between buyers and sellers depending on the relative elasticities of demand and supply.
This connects directly to elasticity (Part 2 of these notes), because how steep or flat the demand and supply curves are determines how much prices and quantities change when curves shift, and who bears the burden of a tax. It also connects to costs and production theory (Part 3): the supply curve is built on the firm's marginal cost curve, so understanding costs explains why the supply curve has the shape it does. Consumer theory (utility, indifference curves) provides the deeper foundation for why the demand curve slopes downward.
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