Supply-demand model

The demand curve shows how much of a good people are willing to buy at a given price. It is generally downward sloping because people are willing to buy more of a good if it is cheaper.

The supply curve shows how much of a good firms are willing to sell for a given price. It is generally upward sloping.

The market equilibrium occurs where the supply and demand curve meet.

$$ \varepsilon = \frac{\Delta Q / Q_0}{\Delta P / P_0} \leq 0 $$

• $\Delta Q$: change in quantity
• $Q_0$: initial quantity
• $\Delta P$: change in price
• $P_0$: initial price

Perfectly inelastic demand: $\varepsilon = 0$

• No substitute is available
• Demand curve is vertical
• Quantity is fixed

Perfectly elastic demand: $\varepsilon = \infty$

• Perfect substitutes are available
• Demand curve is vertical
• Price is fixed

Elasticity of goods is determined by their substitutability.

$$ \gamma = \frac{\Delta Q / Q_0}{\Delta Y / Y_0} $$

• $Q$: quantity of good
• $Y$: income