ECON5001 · Microeconomic Theory
Markets, Demand, Supply & Elasticity
This is the toolkit the whole unit stands on. Week 1 of ECON5001 lays down the market vocabulary every later chapter reuses: the market-structure spectrum (perfect competition → monopolistic competition → oligopoly → monopoly) that decides which model you reach for, the demand and supply functions plus the all-important inverse demand you actually plot, the single competitive equilibrium price that clears the market, binding vs non-binding price floors and ceilings, and elasticity — the unit-free number that measures responsiveness. None of it is hard, but precision here pays off all term, because consumer choice, monopoly and oligopoly are all built from exactly these objects. The exam rewards setting up and solving the standard problems cleanly, not reciting definitions.
What this chapter covers
- 011. Market-structure spectrum — sellers, differentiation, barriers decide the model
- 022. Market demand & inverse demand — quantity-of-price vs the price-of-quantity you plot
- 033. Law of demand (∂Q/∂p ≤ 0) & the Giffen exception — when demand slopes up
- 044. Market supply & the law of supply (∂Q/∂p ≥ 0) — and the supply-shifters
- 055. Comparative statics — move ALONG vs SHIFT the curve
- 066. Competitive equilibrium p* — set Qd = Qs; excess demand/supply adjustment
- 077. Price floors & ceilings — a control only bites on the wrong side of p*
- 088. Horizontal aggregation & point elasticity — sum quantities; ε = (∂Q/∂p)(p/Q)
Inverse demand, point elasticity & revenue maximisation
- +2(a) Invert. Solve Q = 240 − 4P for P: 4P = 240 − Q, so P = 60 − 0.25Q. (Plot this — vertical intercept 60, not 240.)
- +1(b) Quantity at P = 40. Q = 240 − 4(40) = 80. The slope is ∂Q/∂P = −4.
- +1Point formula. ε = (∂Q/∂P)(P/Q) = (−4)(40/80) = −2.
- +1Classify. |ε| = 2 > 1, so demand is elastic at P = 40 — cutting price here would raise total revenue.
- +1(c) Total revenue. TR = P·Q = (60 − 0.25Q)Q = 60Q − 0.25Q².
- +2Maximise. MR = 60 − 0.5Q = 0 ⇒ Q = 120, P = 60 − 0.25(120) = 30, giving TR = 3,600.
Key terms
- Inverse demand function
- Price written as a function of quantity, p = D⁻¹(Q), obtained by rearranging the demand function Q = D(p). It is the curve you actually plot (price on the vertical axis) and the object that becomes a monopolist's average-revenue curve later. Confusing it with the demand function gives the wrong intercepts.
- Law of demand
- ∂Qd/∂p ≤ 0 — quantity demanded falls as price rises, so demand slopes down. Driven by the substitution effect (the good is now relatively dearer) and the income effect (a price rise cuts real purchasing power).
- Giffen good
- The rare exception to the law of demand: a strongly inferior good whose negative income effect outweighs the substitution effect, so demand slopes UP (∂Qd/∂p > 0) over a range. Not every inferior good is Giffen — the income effect must dominate.
- Competitive equilibrium
- A price p* at which quantity demanded equals quantity supplied, Qd(p*) = Qs(p*), so the market clears. Above p* there is excess supply (price falls); below it there is excess demand (price rises).
- Price ceiling vs price floor
- A ceiling is a legal maximum price; it binds only if set BELOW p*, creating a shortage (Qd > Qs). A floor is a legal minimum price; it binds only if set ABOVE p*, creating a surplus (Qs > Qd). On the other side of p* the control does nothing.
- Horizontal aggregation
- Market demand is the horizontal sum of individual demands — add the QUANTITIES every buyer wants at each price, QM(p) = Σ qm(p). Because buyers hit their choke prices at different points, the market curve is piecewise with a kink at each entry/exit.
- Point (price) elasticity of demand
- ε = (∂Q/∂p)(p/Q): the percentage change in quantity per percentage change in price — a unit-free measure of responsiveness. Categories by |ε|: perfectly inelastic (0), inelastic (<1), unit-elastic (1), elastic (>1), perfectly elastic (∞).
- Budget set
- The competitive budget set B(p, m) = {x ≥ 0 : p·x ≤ m} — all bundles a consumer can afford at prices p with income m. Its boundary, the budget line p·x = m, has slope −p₁/p₂ and intercepts m/p₁ and m/p₂; a non-competitive budget (bulk discounts, vouchers) is kinked.
Markets, Demand, Supply & Elasticity FAQ
Is elasticity the same as the slope of the demand curve?
No — and this is the most common Week-1 mistake. The slope ∂Q/∂p depends on units and is constant along a linear demand curve, while elasticity ε = (∂Q/∂p)(p/Q) is unit-free and changes at every point because the ratio p/Q changes. On a straight-line demand curve, demand is elastic at high prices, unit-elastic at the midpoint, and inelastic at low prices.
How do I tell whether a price control actually does anything?
Compare it to the equilibrium price p*. A price ceiling (maximum) binds only if it is set below p*, where it creates a shortage. A price floor (minimum) binds only if it is set above p*, where it creates a surplus. A ceiling above p* or a floor below p* is non-binding — the market simply clears at p* and the answer is 'no effect'. Computing a shortage or surplus for a non-binding control is a guaranteed lost mark.
When I combine consumers, do I add their demand curves vertically or horizontally?
Horizontally — add the quantities each buyer wants at each price, not the prices. Write each buyer's choke price first (the price above which they buy nothing), because market demand kinks wherever a group enters or exits. Vertical (price) summation is reserved for public goods, a much later topic.
Why does the unit start with demand and supply if it is about optimisation?
Because every later model is built from these objects. The market-structure spectrum tells you which model to use (price-taker in perfect competition vs price-setter monopolist), inverse demand becomes the monopolist's average-revenue curve, and the elasticity formula reappears for income and cross-price classification in consumer theory. Getting the Week-1 language exact makes the rest of the unit far easier.
What is the difference between a change in demand and a change in quantity demanded?
A change in the good's OWN price is a movement ALONG a fixed demand curve — a change in quantity demanded. A change in any shifter (income, prices of related goods, tastes, number of buyers) moves the WHOLE curve — a change in demand. Mixing these up loses easy comparative-statics marks; for a demand shift, price and quantity move the same way, while for a supply shift they move in opposite directions.
Exam move
Treat Chapter 1 as a checklist of five mechanical moves you can run on autopilot, because the exam tests whether you can set them up cleanly under time pressure. (1) Always invert Q-of-P into P-of-Q before plotting, so your intercepts are right. (2) Find an equilibrium by setting Qd = Qs, solving for p*, then back-substituting for Q*. (3) For any price control, compare it to p* first — wrong side means no effect. (4) Aggregate demand horizontally, writing choke prices before you add so you know where the kinks fall. (5) For elasticity, use the point formula ε = (∂Q/∂p)(p/Q), then read the SIZE for own-price (elastic vs inelastic) but the SIGN for income and cross-price (normal/inferior, substitute/complement). Practise each on a numerical problem until the setup is automatic, and never quote a slope as an elasticity — that single confusion accounts for a surprising share of dropped Week-1 marks.
