2. The price system and the microeconomy

A demand schedule links price to quantities demanded, holding other relevant factors constant. Income, expectations, tastes and related-good prices can change demand at every price.

A student may want a laptop but becomes an effective demander only when they can pay or obtain finance at the stated price.

Market curves depend on the number and characteristics of buyers or sellers. A change in the population or firms can change the market curve even if each individual curve is unchanged.

At £2, three consumers demand 2, 1 and 4 units, so market demand is 7 units at £2.

For coffee, a fall in coffee's own price causes an extension of demand along the existing demand curve. A rise in the price of tea, a substitute, increases demand for coffee and shifts its demand curve right. The same test applies to supply: own price gives movement; costs, technology or other production conditions give shifts.

If A's price rises 10% and its quantity demanded falls 20%, $PED=-20/10=-2$. If income rises 5% and demand rises 2%, $YED=2/5=+0.4$. If B's price rises 8% and demand for A rises 4%, $XED_{A,B}=4/8=+0.5$.

$XED=+0.6$ indicates substitutes with a moderate positive response. $YED=-1.2$ identifies an inferior good whose demand changes more than proportionally in the opposite direction to income.

A PED of $-1.5$ is elastic, $-1.0$ is unitary and $-0.4$ is inelastic because PED categories use absolute magnitude. The description applies at the relevant point or range, not automatically to an entire market curve.

Near the price intercept, a given quantity change is large relative to the small starting quantity, while the corresponding price change is small relative to the high starting price. Near the quantity intercept, the reverse is true.

Time is especially important when behaviour or durable assets must change. Petrol demand may be inelastic in the short run when commuting options are fixed, but more elastic later as households change vehicles, routes or location.

A 10% price rise with a 20% quantity fall lowers expenditure because demand is elastic. A 10% price rise with only a 5% quantity fall raises expenditure because demand is inelastic.

A bus operator considering a fare rise uses PED to estimate the passenger and revenue response. A luxury retailer uses YED when planning for an expansion or recession. An electric-car producer uses XED to assess changes in petrol-car prices or charging costs.

A large PES means producers can change output proportionally more than price changes; a small PES means production constraints keep the quantity response proportionally smaller. PES is unit-free because it compares two percentages.

If price rises by 12% and quantity supplied rises by 18%, $PES=18/12=1.5$. Quantity responds proportionally more than price, so supply is elastic over this change.

The formula can also recover output. If PES is 0.5 and price rises from $10 to$12, price rises by 20%, so quantity supplied rises by $0.5\times20\%=10\%$. Starting from 100 units, new output is 110 units.

$PES=0.4$ is inelastic; $PES=1.3$ is elastic. Meaningful comparisons must use the same time horizon and market definition because both can change producers' ability to respond.

Hotel rooms are almost fixed tonight, but supply can become more elastic over years as buildings and firms enter. A large stock of machinery alone is not enough if planning permission, specialist labour or raw materials remain fixed.

A meal service with available staff and ingredients may add output within hours. An oil exploration project may need years before additional investment produces output. The second can face a sustained price rise with little short-run quantity response even if firms want to expand.

If price is above equilibrium, a surplus puts downward pressure on price; if below, a shortage puts upward pressure, assuming prices can adjust.

At £5, buyers want 100 units and firms offer 100: equilibrium. At £3, demand may exceed supply, creating a shortage and pressure for price to rise.

With simultaneous shifts, treat each effect separately and combine only directions that agree. If demand and supply both fall, equilibrium quantity falls, but price is ambiguous because lower demand pushes it down while lower supply pushes it up; relative shift sizes and elasticities decide the result.

Start with the named change, identify whether it changes demand or supply in the linked market, then trace equilibrium adjustment there. Keep the relationship direction explicit: substitutes and complements link demand; derived demand links an output market to an input; joint supply links outputs from one process.

If electricity becomes scarce, a higher price can ration current use, signal that supply is tight relative to demand, encourage households to conserve and attract producers to expand generation. The same price movement therefore performs all three functions through different channels.

The mechanism works better when participants receive reliable information, prices can adjust, entry and switching are possible, and external costs or benefits are reflected. Taxes and subsidies can alter relative prices and therefore incentives.

On a standard market diagram, demand represents marginal willingness to pay. Consumer surplus is therefore the area below the demand curve and above the market-price line, from zero to the quantity traded. For linear demand, a triangular area can be calculated as $\tfrac12\times base\times height$.

Three buyers value a ticket at £10, £8 and £5. At a £6 price, only the first two buy, so total consumer surplus is $(10-6)+(8-6)=£6$. The £5 valuation adds nothing because that trade does not occur.

Consumer surplus is a monetary measure of the net benefit buyers obtain from market exchange. It helps compare how price changes or policies affect consumers, but it is not a complete measure of wellbeing, distribution or fairness.

On a standard market diagram, supply represents marginal willingness to sell or marginal variable cost. Producer surplus is the area above the supply curve and below the market-price line, from zero to the quantity traded. With linear boundaries, use the appropriate triangle or trapezium area.

If three units have minimum supply prices of £2, £4 and £7 and the market price is £6, only the first two are sold. Producer surplus is $(6-2)+(6-4)=£6$.

Producer surplus indicates the return available to cover fixed costs and provide profit, and helps show producers' gains from trade or policy changes. Under the usual competitive-cost interpretation, total producer surplus equals revenue minus variable cost.

A subsidy or lower production cost shifts supply right, so consumer surplus rises. Producer surplus must be read from the new supply curve and price; it cannot be inferred from the lower buyer price alone. An indirect tax shifts supply left/up, normally reducing consumer surplus and changing producer surplus while also creating tax revenue.

If only the market price changes along unchanged curves, a price fall increases consumer surplus through a gain on existing purchases plus surplus on extra units. A price rise reduces it by the loss on existing units plus surplus lost on units no longer bought. Apply the mirror logic to producer surplus for movements along an unchanged supply curve.

To compare two markets, hold the shock and starting conditions constant, draw the relevant elastic and inelastic curves, locate each new equilibrium, and compare the full old and new surplus areas. For example, the same specific tax causes the greatest consumer-surplus reduction when demand is relatively inelastic and supply relatively elastic because more of the tax appears in the buyer price.

Elasticity affects both parts of a surplus change: the transfer on units still traded and the surplus lost or gained as quantity changes. A small price change can coexist with a large quantity change, so neither the price movement nor elasticity label alone is enough.