Principles of Microeconomics: Demand and Supply
DEMAND AND SUPPLY
This lecture examines the basic Demand/Supply model that is central to microeconomics.
We do so by defining the relationship between Price and Quantity in Demand and Supply
without analyzing the cause of those relationships. We analyze the cause of the relationships
later in the course. We begin with a definition of Microeconomics and Partial Equilibrium
Analysis before explaining the importance of Demand/Supply for markets.
Definition: Microeconomics is the study of individual units in an economy (households, firms,
markets, etc.) and their relationships. This entails the study of the allocation of resources
and the distribution of income.
Modern economics relies heavily on two methodological tools: partial equilibrium analysis
Definition: Equilibrium is a state of rest with no tendency to change given existing forces
Definition: Partial Equilibrium Analysis is the analysis of the relationship between two
variables while holding other relevant variables constant (ceteris paribus = other things
equal), then examining the effect of the other variables by systematically examining their
Example At what temperature does water boil? Most people would answer 100 C but in fact
this is only true holding at least two other variables constant: atmospheric pressure (sea
level) and purity of the water (not salty, for example). Scientists use partial equilibrium
analysis all the time to isolate relationships before they analyze the variations caused by
changes in other variables.
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Definition: General Equilibrium Analysis is the analysis of the relationship between all
variables simultaneously. (We wont use this approach in this class)
General Equilibrium analysis is highly prized because it analyzes all the variables at once
but this is a disadvantage because it requires more sophisticated mathematics and it doesnt tell
us about the cause-effect relationships between specific variables. We can approximate general
equilibrium analysis by relaxing successively relaxing the ceteris paribus assumptions of partial
Definition: Atomism is the perspective that society (whole) is the sum of its parts (households
Modern economics builds theory by analyzing the behaviour of the basic components of
consumption (households) and production (firms). Demand is the aggregation of the behaviour
of the individual consumers (households) and Supply is the aggregation of the behaviour of the
individual producers (firms). Late in the course we will examine some of the issues that arise
theoretically because of this methodological approach.
Types of Economic Systems:
There have been various types of economic systems historically, such as patriarchal, slave,
feudal, socialist, and communistic. This course concentrates on the market system.
Definition: Purchase and sale transactions between economic actors (households and firms)
determine the allocation of resources in a market.
=> Price mechanism determines the allocation of resources in a market.
Governments affect the allocation of resources in market economies in 5 ways.
1. Government Spending (roads, education, transfer payments, and wars, for example)
2. Taxation (income, sales, and property taxes, for example
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3. Public Enterprises (e.g., Ontario Hydro, LCBO, TTC, etc.)
4. Regulation (e.g., environmental, building, etc.)
5. Monetary Policy (control of money supply effects prices, interest rates, and exchange rates)
Definition: Competition is Price Taking
Analysis of competition dates from at least Aristotle. Adam Smith described competition as
many buyers and sellers in his revolutionary discussion of the benefits of competitive markets
in his 1876 The Wealth of Nations, but it was only at the end of the nineteenth century that
economists formulated the modern analytic definition. The modern definition captures Smiths
meaning that buyers or sellers cannot influence price in a competitive market. It also simplifies
the analysis of competitive behaviour since households and firms respond to a given price with
no ability to change that price.
Imperfect competition occurs when a buyer or seller can influence price. The most extreme
examples are monopoly (single seller), which we shall discuss later in the course, and
monopsony (single buyer).
We shall see that Demand and Supply determine price in a competitive market.
DEMAND (function, curve, schedule)
Definition: Demand is the quantities of goods and services demanded by consumers
(households) at each market price ceteris paribus.
Demand is the relationship between 2 variables, price (P) and quantity demanded (q for the
household and Q for the market), holding all other variables constant. The most important of the
1 Economists analyse households as the smallest unit of consumption rather than consumers because there
are consumers such as babies that do not make economic decisions.
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