Source: Pindyck & Rubinfeld, Ch. 2 | Microeconomic Theory, Texas A&M University
Tags: supply curve, demand curve, equilibrium, market mechanism, surplus, shortage, shift vs movement, ceteris paribus, substitutes, complements, production costs
Supply and demand curves describe how much buyers want and sellers offer at each price, holding everything else constant. A change in price moves you along a curve; a change in any other factor (income, preferences, costs) shifts the entire curve. The market clears where the two curves cross, and price adjusts toward that point whenever there is a surplus or shortage.
Demand curve
The relationship between the price of a good and the quantity consumers are willing to buy, all else equal. Written as Q_D = Q_D(P).
Supply curve
The relationship between the price of a good and the quantity producers are willing to sell, all else equal. Written as Q_S = Q_S(P).
Movement along a curve
A change in quantity caused solely by a change in the good's own price. You slide along the existing curve; the curve itself stays put.
Shift of a curve
The entire curve moves left or right because something other than the good's own price has changed (e.g. income, preferences, input costs).
Substitutes
Two goods where a rise in the price of one increases demand for the other. Example: chicken and beef.
Complements
Two goods where a rise in the price of one decreases demand for the other. Example: cars and petrol.
Surplus (excess supply)
Quantity supplied exceeds quantity demanded. Occurs when the market price is above the equilibrium price.
Shortage (excess demand)
Quantity demanded exceeds quantity supplied. Occurs when the market price is below the equilibrium price.
Equilibrium price and quantity
The price and quantity at which the supply and demand curves intersect. At this point Q_D = Q_S, and there is no pressure for price to change.
The demand curve slopes downward: higher prices lead to lower quantities demanded, and vice versa.
It is drawn holding constant all factors other than the good's own price (ceteris paribus).
A price change causes a movement along the demand curve, not a shift.
Three main factors shift demand to the right (increase) or to the left (decrease):
Preference changes: if consumers want or need the good more, demand shifts right. Example: PPE demand during COVID.
Income changes: for normal goods, higher income shifts demand right. Example: buying more steak when income rises.
Price of related goods:
Substitute price rises → demand for this good shifts right (chicken price rises, beef demand increases).
Complement price falls → demand for this good shifts right (cheaper cars, more petrol demanded).
Reverse each of these to get a leftward (decrease) shift.
The supply curve slopes upward: higher prices make it profitable for producers to supply more.
Like the demand curve, it is drawn ceteris paribus.
A price change causes a movement along the supply curve, not a shift.
Production cost changes are the primary shifter. Lower costs (e.g. improved technology) shift supply to the right, meaning more is supplied at every price.
Higher costs (e.g. raw material price increases) shift supply to the left.
If the price is above equilibrium, quantity supplied exceeds quantity demanded, creating a surplus. Sellers compete by lowering prices.
If the price is below equilibrium, quantity demanded exceeds quantity supplied, creating a shortage. Buyers bid the price up.
The market tends toward the equilibrium point where the supply and demand curves meet.
Demand function (general): Q_D = Q_D(P)
Supply function (general): Q_S = Q_S(P)
Equilibrium condition: Q_D(P*) = Q_S(P*), where P* is the equilibrium price.
Diagrams to review from the chapter:
Standard downward-sloping demand curve with movement along it (price change) vs. a rightward shift (demand increase).
Standard upward-sloping supply curve with movement along it vs. a rightward shift (supply increase due to lower production costs).
Surplus and shortage regions on a supply-and-demand diagram, showing how price adjusts toward equilibrium.
⚠️ The single most common mistake: confusing a shift of a curve with a movement along a curve. A change in the good's own price moves you along the curve. Everything else shifts the curve.
⚠️ Know the direction of demand shifts for substitutes vs. complements. If the price of a substitute rises, demand increases (rightward shift). If the price of a complement rises, demand decreases (leftward shift). Students mix these up under time pressure.
⚠️ Supply shifts are driven by production costs, not by the good's own price. A new technology that lowers costs shifts supply right, even if the market price has not changed.
⚠️ Surplus and shortage are defined relative to equilibrium. Be precise: surplus means Q_S > Q_D at the current price, shortage means Q_D > Q_S.
Q: If the price of chicken rises, what happens to the demand for beef, assuming the two are substitutes?
A: The demand curve for beef shifts to the right (demand increases). Consumers switch from the now more expensive chicken to beef.
Q: A new manufacturing process reduces the cost of producing smartphones. What happens to the supply curve for smartphones?
A: The supply curve shifts to the right (supply increases). At every price, producers are willing to supply more because their costs are lower.
Q: If the market price is currently above the equilibrium price, what exists and what pressure does the market face?
A: There is a surplus (excess supply). Producers cannot sell all they want at that price, so they reduce prices, moving toward equilibrium.
Q: A consumer's income rises and they begin buying more organic groceries. What kind of shift is this, and in which direction?
A: This is a rightward shift of the demand curve for organic groceries, driven by an income increase (assuming organic groceries are a normal good).
Q: What is the difference between a movement along the demand curve and a shift of the demand curve?
A: A movement along the demand curve is caused by a change in the good's own price. A shift of the demand curve is caused by a change in some other factor, such as income, preferences, or the price of a related good.
demand curve, supply curve, equilibrium, market clearing, surplus, shortage, excess supply, excess demand, shift vs movement, ceteris paribus, substitutes, complements, normal goods, inferior goods, production costs, technology change, preference change, income effect on demand, ECON 323, microeconomic theory, Pindyck Rubinfeld Chapter 2