Supply, demand, equilibrium — Microeconomics Module 1

Markets are the central institution of microeconomics. Supply and demand is the model that explains how prices and quantities get determined when many buyers and many sellers interact. The standard textbook treatment can feel mechanical; the real intuition is what survives when the textbook assumptions break down in African market contexts.

Demand: what buyers want

The demand curve maps the price of a good to the quantity buyers want to purchase. It slopes downward: higher prices → less quantity demanded. Three reasons: the substitution effect (at higher prices, buyers switch to alternatives), the income effect (higher prices effectively make buyers poorer in real terms), and the law of diminishing marginal utility (each additional unit consumed delivers less value).

The demand function

Q_d = f(P, P_substitutes, P_complements, Income, Tastes, Expectations, Population) • Q_d = quantity demanded • P = price of the good • P_substitutes, P_complements = prices of substitute and complementary goods • Income = consumer income (with the good being normal — demand rises with income — or inferior — demand falls with income) • Tastes, Expectations, Population = shifters A change in P moves you ALONG the demand curve. A change in any other variable SHIFTS the demand curve.

Supply: what sellers offer

The supply curve maps price to quantity supplied. It typically slopes upward: higher prices → more quantity supplied, because (a) producing the marginal unit is profitable only at higher prices given rising marginal costs, and (b) at higher prices, more producers find it worth entering the market.

Equilibrium: where they meet

Market equilibrium is the price and quantity where Q_d = Q_s. At equilibrium, buyers want to buy exactly what sellers want to sell. No tendency to change.

If P > equilibrium price: Q_s > Q_d → surplus → sellers cut prices to clear inventory → P falls toward equilibrium. If P < equilibrium price: Q_d > Q_s → shortage → buyers bid prices up → P rises toward equilibrium. The market 'clears' at equilibrium.

Price elasticity of demand

ε_d = (% change in Q_d) / (% change in P) By convention, expressed as the ABSOLUTE VALUE because demand slopes downward (% change in Q is negative when % change in P is positive). • ε_d > 1: ELASTIC. Buyers respond strongly to price changes. Total revenue falls when price rises • ε_d = 1: UNIT-ELASTIC. Total revenue unchanged when price changes • ε_d < 1: INELASTIC. Buyers respond weakly to price changes. Total revenue rises when price rises Determinants of elasticity: • Availability of substitutes — more substitutes → more elastic • Time horizon — longer horizon → more elastic (more time to adjust) • Share of budget — bigger share → more elastic (more incentive to economise) • Necessity vs luxury — necessities are inelastic; luxuries elastic

Common African-market elasticity estimates (from World Bank studies, central-bank research, and academic estimates):

Maize (Kenya retail): ε_d ≈ 0.3-0.5 (inelastic — staple food)
Petrol (Kenya retail, short run): ε_d ≈ 0.2-0.3 (very inelastic — limited short-run substitutes)
Petrol (long run): ε_d ≈ 0.6-0.8 (more elastic — vehicle choice, transport-mode substitution)
Mobile-money transactions: ε_d ≈ 0.15-0.3 (inelastic — strong network effects)
Restaurant meals: ε_d ≈ 1.5-2.5 (elastic — substitutes with home cooking)
Bread (Kenya retail): ε_d ≈ 0.4-0.7 (inelastic but with substitutes — ugali, chapati, githeri)

Comparative statics

The workhorse of microeconomic analysis: predicting how equilibrium prices and quantities respond to changes in underlying conditions.

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Scenario: 2024 Kenya drought reduces maize harvest by 25%.

Step 1: Identify which curve shifts. Lower harvest = supply shifts LEFT.
Step 2: Predict the new equilibrium. New equilibrium has HIGHER price
        and LOWER quantity.
Step 3: Magnitude. Depends on elasticities:
        • If demand inelastic (0.4): price rises a lot to clear small
          quantity reduction → price might rise 40%+
        • If demand elastic: price rises less, quantity falls more

The Kenya 2024 episode saw retail maize prices rise ~50% over six months
— consistent with inelastic demand and a substantial supply shock.

When markets don't clear

The textbook equilibrium assumes price freely adjusts to clear the market. Real African markets often violate this:

Price controls — government caps on retail price (fuel, maize meal in some episodes) prevent the price from reaching equilibrium. Result: shortages, black markets, queuing, informal premiums
Imperfect information — buyers and sellers don't perfectly know prices and quality across the market. Search costs prevent perfect arbitrage. Price dispersion persists
Transactions costs — moving goods from rural surplus to urban demand requires roads, intermediaries, storage. High transactions costs separate markets and prevent the law of one price
Monopolistic structure — when there are few sellers (telecoms, banking) or one buyer (parastatal monopoly for sugar or coffee historically), prices are set strategically, not by competitive supply-demand
Sticky prices — many prices adjust slowly. Wages especially. Labour markets often have persistent unemployment because wages don't fall to clear

When competitive analysis applies

The supply-demand framework works well when: many buyers, many sellers, easy entry and exit, low transactions costs, freely-flexible prices, good information. It works POORLY when those conditions don't hold. In African contexts, agricultural commodity markets (especially after the establishment of warehouse-receipt systems and electronic exchanges) often approximate competitive conditions; banking, telecoms, fuel, sugar often don't. Use the framework where it fits; use the imperfect-competition or asymmetric-information frameworks (covered later) where it doesn't.

Exercise

Kenya in 2022 introduced a maize-import duty waiver to ease food prices that had risen 30% YoY. The waiver allowed duty-free imports of yellow maize for animal feed. Six months later, retail maize prices for ugali-grade white maize had stabilised but were still 20% above the pre-shock level. (1) Apply supply-demand analysis: why did the import waiver work for some prices but not others? (2) Estimate the elasticities at play. (3) Predict what would happen if the waiver were rescinded in a normal harvest year vs a poor harvest year. (4) Propose a more effective policy response to maize-price shocks.