ECC02 — Demand, Supply and Market

Inferior goods have a negative income elasticity of demand. As income rises, consumers switch to better-quality substitutes: bajra → wheat, bus travel → personal car, cheaper noodles → restaurant meals. The negative income effect dominates, reducing quantity demanded despite unchanged price.

MSP is a Price Floor — a minimum price set ABOVE the equilibrium market price to protect farmers from price crashes. If the government didn't intervene, farm prices might fall below production costs during bumper harvests. MSP is announced by the government on the recommendation of CACP. Current MSP covers 23 crops.

Substitute Goods: goods that can replace each other in consumption — as the price of one rises, demand for the other increases (positive cross-elasticity of demand). Tea and coffee; Pepsi and Coke; butter and margarine. Complementary goods: used together — as price of one rises, demand for BOTH falls (negative cross-elasticity).

Movement along the same demand curve = Extension (when price falls, demand extends/expands) or Contraction (when price rises, demand contracts). This is caused only by a change in the price of the good. Shift in the demand curve = caused by changes in factors OTHER than price: income, tastes, substitute prices, expectations.

Essential medical goods like insulin for diabetics have highly inelastic demand (close to 0) — patients must consume them regardless of price because there is no substitute and the need is critical. Luxury goods have elastic demand. The price elasticity formula: PED = % change in Qd ÷ % change in Price.

The supply curve slopes upward (positive relationship between price and quantity supplied) because higher prices make production more profitable, motivating producers to supply more. Law of Supply: as price rises, quantity supplied rises, ceteris paribus. Exception: backward-bending labour supply curve.

Rightward shift in supply curve = INCREASE in supply — at every price level, producers are willing and able to supply more. Causes: fall in input costs, technological improvement, more producers entering the market, government subsidies. Leftward shift = decrease in supply (supply curve shifts left).

The 'Invisible Hand' concept was introduced by Adam Smith in The Wealth of Nations (1776) — the idea that individuals pursuing their self-interest in free markets inadvertently promote the public good. Price signals coordinate economic activity without central direction. Smith is called the 'Father of Economics.'

Cross Price Elasticity of Demand = % change in quantity demanded of Good X ÷ % change in price of Good Y. Positive cross elasticity → substitutes. Negative cross elasticity → complements. Zero cross elasticity → unrelated goods. Tea and coffee have positive cross-price elasticity.

Natural Monopoly = occurs when a single firm can produce total market output at a lower cost than multiple competing firms, due to very high fixed costs and low marginal costs (e.g., power grids, water supply, railways). Duplication of infrastructure is wasteful — hence natural monopoly is often regulated by government.

Leftward shift of demand curve = DECREASE in demand at every price level. Caused by: fall in consumer income (for normal goods), fall in population, adverse change in tastes, fall in price of substitutes, rise in price of complements, negative price expectations. A fall in income → demand for normal goods falls.

When Price falls and Total Revenue (Price × Quantity) rises, demand is elastic (PED > 1) — the % rise in quantity demanded exceeds the % fall in price. TR and price move in opposite directions for elastic demand. For inelastic demand (PED < 1), TR and price move in the same direction.

Price Ceiling = maximum legal price BELOW equilibrium. Since price is kept below what the market would set, quantity demanded exceeds quantity supplied → shortage. Examples: rent control, essential goods price caps. Price Floor (above equilibrium) → surplus. Examples: MSP, minimum wage.

Equilibrium: Qd = Qs at the equilibrium price. At this price, the market clears — no unsatisfied buyers or sellers. Above equilibrium price → Qs > Qd → surplus → price pressure downward. Below equilibrium price → Qd > Qs → shortage → price pressure upward. Alfred Marshall developed the supply-demand model.

National Defence is a pure public good: non-rival (one citizen's protection doesn't reduce others') and non-excludable (cannot exclude citizens from protection). The free-rider problem makes it impossible to provide through the market — government provision is necessary. Cinema screening = private (rival and excludable).

Income Elasticity of Demand (YED) > 1 for luxury goods (income elastic) — as income rises by 1%, demand rises by MORE than 1%. Normal necessities: 0 < YED < 1. Inferior goods: YED < 0. Examples of luxury goods: foreign holidays, premium smartphones, designer clothing.

Monopsony = a market with a single buyer who has significant power over the price paid for inputs. Example: a large company being the sole employer in a small town (labour monopsony). Monopoly = one seller; Monopsony = one buyer. The monopsonist can pay lower wages/prices than in competitive markets.

Deadweight Loss = reduction in total surplus (consumer + producer surplus) due to market inefficiency — caused by taxes, price controls, monopoly pricing, or externalities. It represents transactions that would have been mutually beneficial in competitive equilibrium but don't occur due to the distortion. Measured as a triangle on supply-demand diagram.

For Giffen goods: when price rises, the income effect (consumers become poorer, buy more of the cheap good) outweighs the substitution effect (switching away from the now-dearer good). Net result: demand rises with price. This requires the good to be a very inferior good with no close substitutes, consuming a large share of the budget.

Decrease in supply (leftward shift of supply curve) with demand unchanged → equilibrium price rises and equilibrium quantity falls. Increase in supply → price falls. Increase in demand → price rises. Supply decrease + demand unchanged = classic case of price rising (e.g., drought reducing crop supply → food prices rise).