This mini-lesson works through the core of Unit 2 — Microeconomics: demand and supply, market equilibrium, the four elasticities (PED, YED, XED, PES), market failure and externalities, and government intervention (indirect taxes, subsidies and price controls).
Work through each screen, answer the questions as you go (some are wordy, several are real calculations) and collect ⭐ stars. Watch for the Key concept flags. Press Start when you are ready.
Markets · demand & supply
Demand and supply
A market is any arrangement where buyers and sellers interact. Two behaviours drive it:
Law of demand — as price rises, quantity demanded falls (and vice versa), ceteris paribus. The demand curve slopes downward.
Law of supply — as price rises, quantity supplied rises. The supply curve slopes upward.
Demand slopes down, supply slopes up; they cross at the market equilibrium.
Shift vs movement: a change in the good’s own price causes a movement along a curve. A change in any other factor (income, tastes, input costs, technology, taxes) shifts the whole curve.
Markets · equilibrium
Market equilibrium
Equilibrium is the price where quantity demanded = quantity supplied. The market clears — no shortage, no surplus.
If price is above equilibrium there is a surplus (excess supply): price is bid down.
If price is below equilibrium there is a shortage (excess demand): price is bid up.
Price acts as a signal and incentive, and rations scarce resources — this is the price mechanism reaching allocative efficiency, where price equals marginal cost (P = MC).
Key concept — efficiency: in a competitive market, resources are allocated to their most valued use when the marginal benefit to consumers equals the marginal cost of production.
Quick check
A poor harvest
?A severe drought destroys much of the wheat crop. Ceteris paribus, what happens to the equilibrium price and quantity of wheat?
Elasticity · PED
Price elasticity of demand (PED)
PED measures how responsive quantity demanded is to a change in the good’s own price.
PED = %Δ quantity demanded ÷ %Δ pricedemand curves obey the law of demand, so PED is negative — we usually quote the magnitude
|PED| > 1 — elastic (quantity responds a lot; e.g. luxuries, many substitutes).
Price rises from $4 to $5, so %Δprice = (5−4)/4 = +25%.
Quantity demanded falls from 200 to 160, so %ΔQd = (160−200)/200 = −20%.
PED = 20 ÷ 25 = 0.8 → inelastic, so total revenue rises when price rises.
Calculate
Your turn — PED
1When the price of a train ticket rises from $4 to $5, weekly quantity demanded falls from 200 to 160. Calculate the PED (give the magnitude, to one decimal place).
YED > 0 — normal good. If YED > 1 it is income-elastic (a luxury); if 0 < YED < 1 it is a necessity.
YED < 0 — inferior good (demand falls as income rises).
XED = %Δ Qd of good A ÷ %Δ price of good B
XED > 0 — substitutes (tea and coffee).
XED < 0 — complements (cars and petrol).
Signs matter: the sign of YED tells you normal vs inferior; the sign of XED tells you substitute vs complement. Always state it.
Calculate
Your turn — YED
2Average income rises from $30,000 to $36,000. A household’s demand for restaurant meals rises from 50 to 65 per year. Calculate the YED (one decimal place).
3The price of tea rises from $2.00 to $2.40. The quantity of coffee demanded rises from 80 to 92. Calculate the XED (one decimal place) — its positive sign confirms the goods are substitutes.
Supply is more elastic when firms can raise output easily — spare capacity, storable goods, plenty of time, and mobile resources. It is more inelastic for goods that take a long time to produce (e.g. agricultural crops, rare minerals).
Worked example
Price rises from $8 to $10 → %ΔP = 2/8 = +25%.
Quantity supplied rises from 200 to 260 → %ΔQs = 60/200 = +30%.
PES = 30 ÷ 25 = 1.2 → elastic supply.
Calculate
Your turn — PES
4When the price of a product rises from $8 to $10, the quantity supplied rises from 200 to 260. Calculate the PES (one decimal place).
Tap a change, then tap what it does to the market for a good. Only a change in the good’s own price moves you along a curve.
↔ Shifts demand
↕ Shifts supply
➡ Movement along
Market failure · externalities
Market failure & externalities
Market failure is when a free market allocates resources inefficiently — too much or too little is produced relative to the social optimum. A major cause is externalities: costs or benefits that fall on third parties.
Negative externality — MSC > MPC (production pollution) or MSB < MPB (consumption of demerit goods). The market over-produces.
A negative production externality: MSC lies above MPC, so the free-market output exceeds the social optimum, creating a welfare loss.Quick check
Who pays for the smoke?
?A steel plant emits smoke that harms nearby residents, but the firm pays nothing for that harm. This is best described as a:
Intervention · taxes, subsidies, price controls
Government intervention
Governments intervene to correct market failure or pursue equity:
Indirect (specific) tax — shifts supply left/up by the tax per unit; internalises a negative externality. The burden is shared between consumers and producers depending on relative elasticities.
Subsidy — shifts supply right/down; encourages goods with positive externalities.
Price ceiling (below equilibrium) — e.g. rent controls → shortage.
Price floor (above equilibrium) — e.g. minimum wage → surplus.
Tax incidence
A specific tax of $6 raises the price consumers pay from $20 to $24 (consumer burden = $4).
Producers keep $24 − $6 = $18, i.e. $2 less than before → producer burden = $2.
Calculate
Your turn — tax incidence
5A specific tax of $6 per unit is imposed. The price consumers pay rises from $20 to $24. Calculate the tax burden per unit that falls on producers, in dollars.
?A city sets a maximum rent below the equilibrium rent for flats. In this market, the most likely direct result is a:
Match it
Match each elasticity to its definition
Tap a definition on the left, then its elasticity on the right.
Definition
Elasticity
Welfare · consumer & producer surplus
Efficiency, consumer and producer surplus
Consumer surplus is the gap between what buyers are willing to pay and the price they actually pay. Producer surplus is the gap between the price received and the minimum firms would accept.
At the competitive equilibrium, the sum of consumer and producer surplus (community/social surplus) is maximised and allocative efficiency holds at P = MC. Taxes, subsidies, price controls or externalities move the market away from this point, creating a welfare (deadweight) loss.
Key concept — economic well-being: welfare loss measures the value society loses when output is not at the allocatively efficient level.
Quick check
Allocative efficiency
?In a competitive market with no externalities, allocative efficiency is achieved at the output where:
Recap
The big ideas to know
Markets: demand slopes down, supply slopes up; equilibrium where Qd = Qs; own-price = movement, other factors = shift