Unit 2 Supply, Demand, and Elasticity

Law of Demand

As the price of a good decreases, the quantity demanded increases, and vice versa.

Substitution effect

As the price of a good rises, consumers may replace it with cheaper alternatives.

Income effect

As the price changes, it affects consumers' real income and subsequently the quantity demanded.

Individual demand curve

A graph that shows the relationship between the price of a good and the quantity demanded by an individual.

Market Demand Curve

A graph that shows the total quantity demanded for a good by all consumers at various prices.

5 factors that change the demand of a good

Consumer preferences, income levels, prices of related goods, expectations, and number of buyers.

1 factor that changes the quantity demanded of a good

The price of the good itself.

Complementary goods

Goods that are consumed together; an increase in the price of one leads to a decrease in demand for the other.

Substitution

When consumers replace one good with another due to a change in price.

Price Elasticity of Demand

A measure of how much the quantity demanded of a good responds to a change in price; calculated as the percentage change in quantity demanded divided by the percentage change in price.

Elastic demand

When the quantity demanded changes significantly with a change in price (elasticity value > 1).

Inelastic demand

When the quantity demanded changes little with a change in price (elasticity value < 1).

Perfectly Inelastic demand

Demand that does not change regardless of price changes (elasticity value = 0).

Perfectly elastic demand

Demand that changes infinitely with any change in price (elasticity value = ∞).

Unit elastic demand

When the quantity demanded changes exactly as the price changes (elasticity value = 1).

Total Revenue Test

If total revenue increases when price decreases, demand is elastic; if total revenue decreases when price decreases, demand is inelastic; if total revenue remains unchanged, demand is unit elastic.

Law of supply

As the price of a good increases, the quantity supplied increases, and vice versa.

Supply schedule

A chart showing the relationship between price and the quantity supplied of a good.

Market supply schedule

A chart that shows the total quantity of a good supplied by all producers at various prices.

Price Elasticity of Supply

A measure of how much the quantity supplied of a good responds to a change in price; calculated as the percentage change in quantity supplied divided by the percentage change in price.

Elastic supply

When the quantity supplied changes significantly in response to a price change (elasticity value > 1).

Inelastic supply

When the quantity supplied changes little with a price change (elasticity value < 1).

Income Elasticity of Demand

Measures how the quantity demanded of a good changes as consumer income changes; formula: % change in quantity demanded / % change in income.

Normal Goods

Goods for which demand increases as income increases (income elasticity > 0).

Inferior Goods

Goods for which demand decreases as income increases (income elasticity < 0).

Cross elasticity of demand

Measures how the quantity demanded of one good responds to a change in the price of another good; formula: % change in quantity demanded of good A / % change in price of good B.

Xed Substitutes

Estimated to have a positive cross elasticity value, indicating that an increase in price of one good leads to an increase in the quantity demanded of a substitute.

Xed Complement

Estimated to have a negative cross elasticity value, indicating that an increase in price of one good leads to a decrease in quantity demanded of a complement.

Equilibrium Price

The price at which the quantity demanded equals the quantity supplied in the market.

Shortage

A situation where the quantity demanded exceeds the quantity supplied at a given price.

Surplus

A situation where the quantity supplied exceeds the quantity demanded at a given price.