Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- The supply and demand model explains what sets prices and quantities, and why they differ across markets and change over time.
- Equilibrium: the price at which the quantity buyers want equals the quantity sellers offer. No shortage, no surplus: the market clears.
- Above equilibrium there is a surplus, so the price falls; below it there is a shortage, so the price rises. The equilibrium is stable.
- The equilibrium price is a signal: it rations the good to buyers who value it most and gives sellers an incentive to move resources towards what people want.
- Consumer surplus (CS): willingness to pay minus price, summed over units bought.
- Producer surplus (PS): price minus minimum acceptable price, summed over units sold.
- Total surplus = CS + PS. With no market failures, it is largest at the competitive equilibrium, so the market is efficient.
Key relationships
| Relationship | How to use it |
|---|---|
| Equilibrium: Qd = Qs | find the row or the crossing point |
| Height of demand = willingness to pay = marginal benefit | for each unit |
| Height of supply = minimum acceptable price = marginal cost | for each unit |
| CS = ½ × Q × (demand price intercept − P)** | straight-line demand |
| PS = ½ × Q × (P − supply price intercept)** | straight-line supply |
| Spending = P* × Q* | not the same as CS |
| Quantity traded | Marginal benefit vs marginal cost | Effect of one more unit on total surplus |
|---|---|---|
| below equilibrium | MB > MC | raises it |
| at equilibrium | MB = MC | none left to gain |
| above equilibrium | MB < MC | lowers it |
Assumptions
- A perfectly competitive market: many buyers and sellers, an identical good, no one can set the price.
- No market failures: demand and supply reflect all benefits and costs.
Mistakes to avoid
- Forgetting the ½ in a triangle area.
- Measuring CS height from zero instead of from the price.
- Calling total spending “consumer surplus”.
- Assuming CS and PS are equal at equilibrium.
- Writing “demand equals supply” instead of “quantity demanded equals quantity supplied”.
- Shading surplus beyond the quantity actually traded.
Quick self-check
- Demand meets the price axis at $40, supply at $16, and equilibrium is $25 and 300 units. Find CS and PS. (CS = ½ × 300 × 15 = $2,250; PS = ½ × 300 × 9 = $1,350.)
- A buyer would pay up to $18 and the price is $12. What is her consumer surplus? ($6.)
- Why does producing beyond equilibrium lower total surplus? (Each extra unit costs more to make than buyers value it: MC > MB.)
Next: practice questions.