Unit 1: Supply and Demand

The first unit of this course is designed to introduce you to the principles of microeconomics and familiarize you with supply and demand diagrams, the most basic tool economists employ to analyze shifts in the economy. After completing this unit, you will be able to understand shifts in supply and demand and their implications for price and quantity sold. You will also learn how to analyze how consumers respond to a shift in the price of the goods they consume. This understanding of the basic forces of supply and demand will serve as a foundation for the economic analysis you will undertake in the remainder of this course.

Introduction to Microeconomics

Image courtesy of ninanord on Flickr.

Gasoline prices.

Applying Supply and Demand

Image courtesy of Aaron Tyo-Dikerson on Flickr.

Store aisle for toilet paper.

Elasticity

Image courtesy of Nic Stage on Flickr.

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Session Overview

You may not realize it, but every time you purchase something, you are participating in a market for that good. Some people supply it, and some people—you!—demand it. In this lecture, we will examine how to analyze supply and demand curves and the impact changes in market conditions and government policy can have on market equilibrium.

Government intervention can impact gasoline prices. Image courtesy of Aaron Tyo-Dikerson on Flickr.

Keywords: Supply and demand; equilibrium; demand shift; supply shift; government interference.

Session Activities

Readings

Read the recitation notes, which cover new content that adds to and supplements the material covered in lecture.

Recitation: Supply-Demand Analysis (PDF)

Before watching the lecture video, read the course textbook for an introduction to the material covered in this session:

[R&T] Chapter 3, “Demand and Supply.”
[R&T] Chapter 4, “Applications of Demand and Supply.” Sections 4.1-4.2.
[Perloff] Chapter 2, “Supply and Demand.” (optional)

Lecture Videos

View video page
- Download video
- Download transcript

Resources

Graphs and Figures (PDF)

Further Study

Question 1

What determines the price and quantity of a good in a perfectly competitive market?

The government. close

The intersection of the supply and the demand curve. check

The position of the demand curve. close

The presence or absence of substitute goods. close

In a perfectly competitive market, the equilibrium price and quantity sold is given by the intersection of the supply and demand curves. The position of the demand curve and the presence or absence of substitute goods are also relevant, but these answers are incomplete.

Question 2

Assume that people enjoy eating either apples or oranges. What happens in the market for oranges when the price of apples goes up?

The demand curve shifts left. close

The demand curve shifts right. check

The supply curve shifts left. close

There is no change in the demand curve. close

When the price of apples increases, more people will eat oranges because they are more affordable. This causes the demand curve to shift right: at any given price point, people will consume more oranges.

Question 3

Now, assume there is a frost in Florida that destroys part of the orange crop. What happens to the market for oranges in this case?

The demand curve shifts right. close

The supply curve shifts down. close

The supply curve shifts up. check

There is no shift in the demand or supply curves. close

When part of the orange crop is destroyed, there are less oranges available at any price; the supply curve shifts left to a new equilibrium with lower quantity and higher price. An alternative way to conceptualize the change is that the cost of growing fruit, per orange sold, has now increased for the farmers; they are still paying to run their farm, but are selling fewer oranges. For each orange they now sell, they need to charge more.

Question 4

The government imposes a minimum wage for workers. Which of the following phenomena is NOT a consequence of this policy change?

A decline in the average wage paid. check

Decreased demand for labor by employers. close

Increased supply of labor by workers. close

Unemployment. close

The minimum wage leads to an increase, not a decline, in the average wage paid. At the same time, however, it leads to an increased supply of labor by workers and a decreased demand by employers, which results in unemployment.

Question 5

What is a potential cost of disequilibrium in a market?

All of these. check

Cost of determining allocation for goods that are highly demanded. close

Cost of waiting for people queuing for a good that is in demand. close

Efficiency loss (trades that don’t get made). close

Market disequilibrium introduces a variety of costs. First, there may be efficiency loss when trades don't get made (e.g., consumer is willing to buy gas at below the minimum price, and a supplier is willing to sell gas at that price, but no sale occurs.) Second, it may be costly for the gas supplier to decide who should receive gas when demand exceeds supply. Third, people may waste time waiting for gas that they could productively use working. However, government interventions that decrease efficiency may also increase equity. This will be discussed more in later lectures.

These optional resources are provided for students that wish to explore this topic more fully.

Study Materials

See the course website for Econ 302, Intermediate Microeconomics taught at Penn State in 2011.

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Session Overview

Everyone knows the unpleasant feeling that results from the price of something you’ve been longing to buy increasing – or the excitement of seeing your favorite snack go on sale! When the price of a good changes, consumers’ demand for that good changes. We can understand these changes by graphing supply and demand curves and analyzing their properties.

Toilet paper is an example of an elastic good. Image courtesy of Nic Stage on Flickr.

Keywords: Elasticity; revenue; empirical economics; demand elasticity; supply elasticity.

Session Activities

Readings

Before watching the lecture video, read the course textbook for an introduction to the material covered in this session:

[R&T] Chapter 5, “Elasticity: A Measure of Response.”
[Perloff] Chapter 3, “Applying the Supply-and-Demand Model.” (optional)

Lecture Videos

View video page

Resources

Graphs and Figures (PDF)

Further Study

Question 1

Which of the following accurately characterize perfectly inelastic demand?

Demand does not change regardless of what happens to price. close

The demand curve is horizontal. close

The demand curve is vertical but does not change regardless of what happens to price. check

The demand curve is vertical. close

A vertical demand curve means that if the supply curve shifts, only the price changes; there is no change in quantity demanded.

Question 2

When do we expect to see a perfectly elastic demand curve?

When a good has a perfect substitute. check

When a good has many complements. close

When a good has no substitutes. close

When there is limited supply of a good. close

When a good has a perfect substitute (for example, hamburgers at different fast food chains), then if there is a price increase at one store, consumers will simply switch to purchasing from another store. This results in a perfectly elastic demand curve. A good that has no substitutes will have perfectly inelastic demand. The existence of complementary goods and the nature of the supply curve do not affect the elasticity of demand.

Question 3

Lets say a researcher makes a study of patients in hospitals and finds they are much sicker than the average person in the population. Then he concludes that hospitals make patients sick. The researcher is mixing up two concepts; what are they?

Correlation and causation. check

Demand and supply. close

Shifts along the demand curve and shifts in the demand curve. close

Theory and empirics. close

Being in the hospital is correlated with being ill, because primarily ill patients are admitted to the hospital, but this is not the cause of the illness. The primary challenge of empirical economics is to distinguish correlation and causation.

Question 4

If the elasticity of demand for a good is sufficiently negative, firms may actually lose revenues when they raise the price of the good. Why is this?

Consumers substitute from other goods to buy this firms good. close

Fewer people buy the good at the higher price, and so overall revenues are lower. check

The elasticity of demand changes. close

The supply curve shifts in. close

The elasticity of demand does not change when price changes, and we have not discussed any change on the supply side. If revenue is declining that means that consumers are shifting away from this firms good (now that is newly expensive) and purchasing goods made by other firms, not vice versa.

Question 5

What is an example of a supply shock in the orange market that would enable us to estimate demand elasticity?

A new government tax on orange growers. close

A plant disease that hits orange crops. close

All of these. check

An early frost in Florida that destroys crops. close

Any shock to the supply of a good caused by weather or government policy will shift the supply curve, and this will allow us to use the resulting changes in price and quantity sold to estimate the elasticity of demand.

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Session Overview

Economics may have a reputation as a dismal science, but in fact it addresses some of the most fundamental problems we face: How to make the best decision given that resources are limited. You can use the tools of microeconomics to decide how best to spend your income; how best to divide your time among leisure activities; or how many people to hire in the business you run. Life is full of choices. Microeconomics can help you decide how to make them.

Economics can’t help you make a selection from this box of chocolates, but can be a vital tool in other decision-making situations. Image courtesy of ninanord on Flickr.

Keywords: Microeconomics; prices; normative economics; positive economics; microeconomic applications.

Session Activities

Readings

Before watching the lecture video, read the course textbook for an introduction to the material covered in this session:

[R&T] Chapter 1, “Economics: The Study of Choice.”
[Perloff] Chapter 1, “Introduction.” (optional)

Lecture Videos

View video page
- Download video
- Download transcript

Check Yourself

Concept Quiz

This concept quiz covers key vocabulary terms and also tests your intuitive understanding of the material covered in this session. Complete this quiz before moving on to the next session to make sure you understand the concepts required to solve the mathematical and graphical problems that are the basis of this course.

Question 1

Which of the following is an accurate description of the primary theme of microeconomics?

A set of constrained optimization problems. close

All of these. check

Analyzing tradeoffs. close

Studying how individuals and firms make themselves as well off as possible given conditions of scarcity. close

All three of these answers encapsulate the main theme of microeconomics in a different way: constrained optimization problems allow us to analyze how individuals and firms can make themselves as well off as possible given scarcity. This entails analyzing the trade-offs between investing in different activities.

Question 2

What is a model?

A description of an economic phenomenon that makes no extra assumptions. close

A full description of a particular economic phenomenon. close

An empirical study that analyzes how a certain part of the economy works. close

Any description of the relationship between two or more economic variables. check

Models do not provide a complete description of a particular economic phenomenon; instead, they make simplifying assumptions that render the model more tractable to work with. While empirical studies may make use of models, they are not identical.

Question 3

What is the key assumption in microeconomics?

Firms maximize profits. close

Firms maximize sales. close

Individuals maximize their income. close

Individuals maximize utility and firms maximize profits. check

Though it is accurate to say that firms maximize profits, it is incomplete. Individuals dont solely maximize income, rather utility, and sales and profits for a firm are not identical.

Question 4

What is the distinction between empirical and theoretical economics?

Theoretical economics analyzes individuals and empirical economics analyzes firms. close

Theoretical economics analyzes long-term phenomena and empirical economics analyzes short-term. close

Theoretical economics builds models, and empirical economics test them. check

Theoretical economics tests models, and empirical economics builds them. close

Both theoretical and empirical economics can analyze either individuals or firms, and either short-term or long-term phenomena.

Question 5

Which of the following statements represents normative, rather than positive analysis?

People should not be allowed to purchase bodily organs, because it allows the rich access to a life-saving procedure that the poor may not have access to. check

Since the supply of gems is limited, their price is very high. close

Since the supply of water is very large, the price of water is very low. close

The demand for organ transplants currently far exceeds the supply. close

This is a normative statement that is based on an assumption of equity (we want rich and poor to have equal access to treatment.) The others answers are positive statements that are based on facts about the supply and demand of goods in different markets.

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Preparation

The problem set is comprised of challenging questions that test your understanding of the material covered in the course. Make sure you have mastered the concepts and problem solving techniques from the following sessions before attempting the problem set:

Problem Set and Solutions

Problem Solving Video

In the video below, a teaching assistant demonstrates his approach to the solution for problems 1 and 4 from the problem set. The teaching assistant notes common mistakes made by students and provides problem solving techniques for approaching similar questions on the problem set and exams.

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Principles of Microeconomics

Session Overview

Session Activities

Readings

Lecture Videos

Resources

Further Study

Question 1

Question 2

Question 3

Question 4

Question 5

Study Materials

Session Overview

Session Activities

Readings

Lecture Videos

Resources

Further Study

Session Overview

Session Activities

Readings

Lecture Videos

Check Yourself

Concept Quiz

Question 1

Question 2

Question 3

Question 4

Question 5

Preparation

Problem Set and Solutions

Problem Solving Video

Course Info

Instructor

Departments

As Taught In

Level

Topics

Learning Resource Types