Basics of Demand and Supply and Forms of Market Competition: formula sheet

Key formulas

Law of demand

Price ↑ ⇒ Quantity demanded ↓; Price ↓ ⇒ Quantity demanded ↑ (ceteris paribus)

Inverse relationship. Always state the 'other things equal' condition.

Market demand

Market demand at a price = Σ individual demands at that price

Add quantities across buyers at the same price, not the prices.

Demand function

Dx = f(Px)

Quantity demanded of good X depends on its own price, other factors held constant.

Assumptions of the law

Constant income, tastes, related goods' prices, expectations, number of buyers

Learn these as the 'ceteris paribus' list.

Demand function

Dx = f(Px, Py, Y, T, E, N)

Px = own price, Py = price of related goods, Y = income, T = tastes, E = expectations, N = number of buyers. Only a change in Px moves along the curve.

Movement along the curve

Own price ↓ → extension; own price ↑ → contraction

Other factors are assumed constant (ceteris paribus). Also called change in quantity demanded.

Shift of the curve

Any other determinant changes → increase (right shift) or decrease (left shift)

Also called change in demand. Quantity changes at every price.

Direction of effects

Normal good: income ↑ → demand ↑. Inferior good: income ↑ → demand ↓. Substitute price ↑ → demand ↑. Complement price ↑ → demand ↓.

Learn these four pairs for MCQ-style and short-answer questions.

Price elasticity of demand (Ed)

Ed = (% change in quantity demanded) ÷ (% change in price)

Ignore the negative sign when comparing with 1. % change = (change ÷ original) × 100.

Price elasticity (direct form)

Ed = (ΔQ ÷ Q) ÷ (ΔP ÷ P) = (ΔQ ÷ ΔP) × (P ÷ Q)

P and Q are the original values. ΔQ and ΔP are the changes.

Income elasticity (Ey)

Ey = (% change in quantity demanded) ÷ (% change in income)

Positive: normal good. Negative: inferior good. Greater than 1: luxury.

Cross elasticity (Exy)

Exy = (% change in quantity demanded of X) ÷ (% change in price of Y)

Positive: substitutes. Negative: complements. Zero: unrelated.

Point elasticity on a straight-line demand curve

Ed = lower segment ÷ upper segment of the curve at that point

Equals 1 at the midpoint, above 1 in the upper half, below 1 in the lower half.

Total expenditure method

Total expenditure = Price × Quantity demanded

Price falls and expenditure rises: Ed > 1. Expenditure unchanged: Ed = 1. Expenditure falls: Ed < 1.

Law of supply

Price ↑ → Quantity supplied ↑ (other things equal)

Direct relationship. Own price change moves you along the curve.

Price elasticity of supply (percentage method)

Es = (% change in quantity supplied) ÷ (% change in price)

Es is normally positive because price and quantity supplied move together.

Percentage change

% change = (Change ÷ Original value) × 100

Use the original value as the base unless the question gives another method.

Elasticity by change in quantity and price

Es = (ΔQ ÷ Q) ÷ (ΔP ÷ P) = (ΔQ ÷ ΔP) × (P ÷ Q)

Δ means change. P and Q are the original price and quantity.

Types of elasticity of supply

Es > 1 elastic; Es = 1 unitary; Es < 1 inelastic; Es = 0 perfectly inelastic; Es = ∞ perfectly elastic

A straight supply line through the origin has Es = 1 at every point.

Equilibrium condition

Qd = Qs

Solve this equation for P to get the equilibrium price.

Equilibrium quantity

Q* = Qd at P* = Qs at P*

Put the equilibrium price into either function. Both must give the same answer.

Excess demand

Qd - Qs > 0 (when price is below equilibrium)

Pushes price up.

Excess supply

Qs - Qd > 0 (when price is above equilibrium)

Pushes price down.

Demand increase (supply unchanged)

P ↑, Q ↑

Reverse for a fall in demand.

Supply increase (demand unchanged)

P ↓, Q ↑

Reverse for a fall in supply.

Profit-maximising condition

MR = MC (MC cuts MR from below)

Applies to every market structure, including perfect competition and monopoly.

Perfect competition: firm's revenue

Price (P) = AR = MR

The demand curve is horizontal. Each extra unit sells at the same price.

Perfect competition: equilibrium

P = MR = MC

In the long run, P = minimum AC, so firms earn normal profit.

Monopoly: revenue

AR = P, and MR < AR

Demand slopes downward, so MR falls faster than price.

Monopoly: equilibrium

MR = MC, and P > MC

Price is read from the demand (AR) curve at the equilibrium output.

Total and average revenue

TR = P × Q; AR = TR ÷ Q; MR = change in TR ÷ change in Q

Use these to find MR from a table.

Profit

Profit = TR − TC = (AR − AC) × Q

If AR > AC the firm earns abnormal profit; if AR = AC, normal profit.

Monopolistic competition features

Many sellers + differentiated product + free entry and exit + selling costs

Demand curve slopes downward and is fairly elastic. Long-run profit is normal.

Oligopoly features

Few sellers + interdependence + barriers to entry + non-price competition

Product can be identical (pure oligopoly) or differentiated (differentiated oligopoly).

Kinked demand curve

Above kink: elastic demand (rivals do not follow a price rise). Below kink: inelastic demand (rivals follow a price cut).

Explains price rigidity. It shows why price stays stable, not how the first price was set.

Profit-maximising condition

MR = MC

Applies to both markets. In the kinked model, MR has a gap at the kink, so MC can change within the gap without changing price.

Quick revision

• Law of demand: other things constant, when price rises, quantity demanded falls, and the reverse.
• A price change causes a movement along the curve; a change in any other determinant shifts the curve.
• Determinants of demand include income, prices of related goods, tastes, expectations and number of buyers.
• Price elasticity of demand = % change in quantity demanded ÷ % change in price.
• Law of supply: other things constant, when price rises, quantity supplied rises.
• Supply shifts with input costs, technology, taxes, subsidies and number of sellers.
• Equilibrium is where quantity demanded equals quantity supplied.
• Price above equilibrium leads to surplus; price below equilibrium leads to shortage.
• Perfect competition: many sellers, identical product, free entry and exit, sellers are price takers.
• Monopoly: single seller, no close substitutes, high entry barriers, strong price control.
• Monopolistic competition: many sellers, differentiated products, free entry, some price control.
• Oligopoly: few large sellers, interdependence in decisions, and often non-price competition such as advertising.

Common mistakes

• Defining demand as only the desire to buy. Fix: Always include ability to pay and willingness to pay, and mention price and time period.
• Leaving out 'other things remaining equal' in the law. Fix: End the law with ceteris paribus and list income, tastes and related prices as constant.
• Calling a price-driven change an 'increase in demand'. Fix: If own price caused it, write 'extension in quantity demanded'. Use 'increase in demand' only for a shift.
• Shifting the curve when own price changes. Fix: Own price moves you along the same curve. Only other factors shift it.
• Using the new value instead of the original value as the base for percentage change. Fix: Always divide the change by the original (starting) price, income or quantity unless the question asks for the arc method.
• Comparing a negative price elasticity with 1 without removing the sign. Fix: Take the absolute value for price elasticity before deciding elastic or inelastic.
• Calling a change caused by a tax or new technology a 'contraction' or 'extension' of supply. Fix: Only the good's own price causes extension or contraction. All other factors cause increase or decrease, that is a shift.
• Drawing a downward-sloping supply curve. Fix: Supply has a direct relationship with price, so the curve slopes upward. Label axes every time.
• Treating a change in the good's own price as a shift of the demand curve. Fix: Own-price change means movement along the curve. Only other factors shift the curve.
• Showing a fall in supply as price down. Fix: Less supply means scarcity, so price rises and quantity falls.

Exam tips

• Write the definition of demand with all three elements; examiners look for ability to pay and willingness to pay.
• Always draw the DD curve with labelled axes. A neat diagram often earns separate marks.
• In schedule questions, show the addition for each price row so partial marks are safe.
• Keep the reasons for the downward slope as separate numbered points, not one long paragraph.
• Do not confuse a movement along the curve (price change) with a shift of the curve; that belongs to determinants of demand.
• Write both pairs of terms in your answer: extension/contraction and increase/decrease. Examiners check the correct word.
• In a 'distinguish between' question, use a two-column point list covering cause, curve, terms and effect.
• Draw a small diagram if asked: one curve with an arrow along it for movement, and two curves for a shift.