AP Microeconomics U2

Market

Where buyers and sellers interact to exchange goods and services

Quantity Demanded

when a good/service is cheap, people tend to buy more of it

Law of Demand

Price of an item determines the quantity demanded. Lower the price, higher the demand.

TRIPE

T(taste and preferences)

R(related goods: complementary/substitute)

I(income: normal/inferior)

P(population)

E(expectations)

impacts demand

Supply

Producers willingness and ability to sell a good

Quantity Supplied

Higher the price, higher the quantity supplied

Law of Supply

price of an item determines the quantity supplied

Ex. Is price goes up, quantity supplied goes down

NICEG

N(natural/manmade phenomena)

I(input costs)

C(competition)

E(expectations)

G(government action)

impacts supply

Market equilibrium

Where supply=demand

Shortage

Quantity supplied > quantity demanded —> price falls

Price ceiling

Causes shortages

Surplus

Quantity demanded > quantity supplied —> price rises

Price floor

Creates surpluses

Price elastic

demand for a good is said to be elastic if the quantity demanded responds a lot to change in demand

Price inelastic

Demand for good is said to be inelastic if the quantity demanded responds a little to a change in price

Elasticity Determinants

Availability of substitutes: more substitutes, more elastic

Necessity vs. Luxury: Luxury = elastic, Necessity = inelastic

Income: higher amount of income spent, more elastic

Time Horizon: longer time, more elastic

Market Definition: narrowly defined goods (ie. Kellogg cereal) = more elastic, broadly defined goods (ie. Food) = more inelastic

Price Elasticity of Demand

measures how sensitive quantity demanded of a good or service is to a change in price.

Formula: %change in quantity demanded/%change in price

Elastic

Price elasticity > 1

Inelastic

Price elasticity < 1

Substitutability

If a product has many substitutes, consumers can easily switch if the price rises —> more elastic.

If a product has few/no substitutes, consumers have less alternatives —> more inelastic.

Proportion of Income spent

If a product takes up a large portion of your income —> elastic

If a product takes up less portion of your income —> inelastic

Time Horizon

Long run: consumers have time to adjust —> demand is more elastic

Short run: consumers may not have time to find substitutes or change habits —> demand is more inelastic

Luxury

Elastic because people dont have to buy it if the price rises

Necessity

Inelastic because people need to buy it no matter what

Habit-Forming

Products that consumers regularly use and find hard to give up —> inelastic because they continue to purchase it out of habit/addiction

Total Revenue

Quantity x Price

If price and TR are in same direction = inelastic

If price and TR are in diff. Direction = elastic

Is price and TR is unchanged = unit elastic

Income Elasticity (Normal vs. Inferior)

Positive = normal, Negative = inferior

Formula: %change in quantity demanded/change in income

Ie. 20%/10%=2 —> elastic

-10%/20%=-0.5 —> inelastic

Cross Price Elasticity (Substitute vs. Complementary)

Positive = Substitute, Negative = Complement

Formula = %change in quantity of Good A/%change in price of Good B