BEO6600 · Business Economics
Supply, Demand and Elasticity
Supply and demand is the engine of the whole unit, and elasticity is the number that makes it quantitative. The law of demand (price up, quantity demanded down) and the law of supply (price up, quantity supplied up) cross at the equilibrium (P*, Q*) where the market clears. The signature skill — and the spine of the individual assignment — is distinguishing a movement along a curve (caused by the good's own price) from a shift of the whole curve (caused by any of the five demand or four supply shifters), then running the three-step comparative-static method. Elasticity turns a curve's slope into a unit-free responsiveness number: BEO6600 computes it by the midpoint (arc) method, classifies demand as elastic, inelastic or unit-elastic, applies the total-revenue test, and reads income and cross-price elasticities by sign. The session closes with price controls: a binding ceiling causes a shortage, a binding floor a surplus.
What this chapter covers
- 012.1-2.2 The demand and supply curves; the 5 demand and 4 supply shifters
- 02Movement ALONG vs SHIFT — the signature trap
- 032.3 Market equilibrium, shortage and surplus
- 042.4-2.5 The 3-step method and the four comparative-static cases
- 05Solving linear demand and supply algebraically
- 063.1-3.4 Midpoint price elasticity of demand; the total-revenue test
- 073.5-3.7 Income, cross-price and supply elasticity (signs)
- 083.8-3.9 Price ceilings and floors: when a control binds
Worked example: midpoint elasticity and the total-revenue test
- +1(a) %ΔQ by the midpoint method: (180 − 200) ÷ [(200+180)/2] = −20 ÷ 190 = −0.105.
- +1%ΔP by the midpoint method: (10 − 8) ÷ [(8+10)/2] = 2 ÷ 9 = +0.222.
- +1PED = −0.105 ÷ 0.222 = −0.47; |PED| < 1, so demand is inelastic.
- +1(b) Total revenue: TR before = $8 × 200 = $1,600; TR after = $10 × 180 = $1,800. Price rose and TR rose — on an inelastic good, raise price to lift revenue.
- +1(c) Same price move, Q 200 → 100: %ΔQ = −100 ÷ 150 = −0.667; PED = −0.667 ÷ 0.222 = −3.0 → elastic.
- +1Revenue implication: with |PED| > 1, the quantity effect dominates, so the same price rise would cut total revenue. To lift revenue on an elastic good, cut price instead.
Key terms
- Movement along vs shift
- A change in a good's OWN price moves you along a fixed curve (a change in quantity demanded or supplied). A change in any other determinant — one of the five demand shifters or four supply shifters — shifts the whole curve (a change in demand or supply). True/false and MCQ items live almost entirely on this distinction.
- Market equilibrium
- The single price P* at which quantity demanded equals quantity supplied, with matching quantity Q*; at this price the market clears. Above P* a surplus pushes price down; below P* a shortage pushes it up — which is why the crossing point is the one we solve for.
- Midpoint (arc) elasticity
- BEO6600's method for elasticity: each percentage change is the change divided by the average of the start and end values, not the starting value. Its virtue is direction-independence — the elasticity from $8 to $10 equals the elasticity from $10 to $8 — which is exactly why the course uses it.
- Total-revenue test
- Because TR = P × Q, a price rise lifts P but cuts Q. If demand is inelastic, raising price raises TR; if elastic, raising price lowers TR; at the unit-elastic point TR is unchanged (its maximum). To raise revenue, push price toward the inelastic region.
- Binding price control
- A price ceiling (legal maximum) binds only when set below equilibrium → a shortage (Qd > Qs). A price floor (legal minimum) binds only when set above equilibrium → a surplus (Qs > Qd). A control on the harmless side of equilibrium does nothing; the minimum wage is the textbook binding floor.
Supply, Demand and Elasticity FAQ
What is the difference between a movement along the demand curve and a shift of it?
A change in the good's own price is a movement along the curve — a change in quantity demanded. A change in any of the five demand shifters (income, prices of related goods, tastes, expectations, number of buyers) shifts the whole curve — a change in demand. The same logic applies to supply with its four shifters. Getting this right is the single highest-frequency exam skill in the unit.
When demand shifts, do price and quantity move the same way or opposite ways?
When demand shifts, equilibrium price and quantity move the SAME way (both up if demand rises, both down if it falls). When supply shifts, they move OPPOSITE ways (supply rises → price down, quantity up). Commit those two lines to memory and most comparative-static MCQs answer themselves. If both curves shift at once, only one of P* or Q* is pinned down and the other is ambiguous — saying so with a reason earns the mark.
Why does BEO6600 use the midpoint method instead of a simple percentage change?
The midpoint (arc) method divides each change by the average of the two values, which makes the elasticity direction-independent: you get the same number whether price rises $8→$10 or falls $10→$8. A plain percentage-change formula gives two different answers depending on which price you start from. Match the midpoint method exactly — divide each change by the average, take the absolute value, and classify against 1.
How do I tell whether a price ceiling or floor actually does anything?
Check which side of equilibrium it sits on. A binding ceiling (a legal maximum set below P*) creates a shortage; a binding floor (a legal minimum set above P*) creates a surplus. A ceiling above P* or a floor below P* does nothing at all — the market simply clears at equilibrium. The size of the shortage or surplus is the gap between quantity demanded and supplied at the controlled price.
Exam move
First, drill the movement-along vs shift distinction until it is automatic — it is the most-tested idea in the unit and underpins the whole individual assignment. For comparative statics, memorise 'demand shifts → P and Q the same way; supply shifts → opposite ways', and always run the three steps: which curve, which direction, read the new equilibrium. For elasticity, use the midpoint method every time (change ÷ average), take the absolute value, classify against 1, then apply the total-revenue test for revenue questions. For income and cross-price elasticities the marks are in the sign, not a precise number. For price controls, check the side of equilibrium before you write 'shortage' or 'surplus'. Solve linear D and S by setting quantities (not prices) equal, then label a clean diagram.
