Unit 2: Supply and Demand

decrease in price of the good causes (law of demand)

an increase in the quantity demanded

increase in price of the good causes (law of demand)

a decrease in the quantity demanded

quantity demanded refers to

one specific point on the demand curve

demand refers to

the entire demand curve

what does “merit” refer to

reasons for change in demand

“m” in merit

market size

“e” in merit

expectations

“r” in merit

related goods and services (substitutes and complementary goods)

“i” in merit

income levels (normal goods, inferior goods)

“t” in merit

tastes and preferences

substitute goods

if the price of one good increases, the demand of the other good will increase (coffee and tea)

complementary goods

goods that go together. if the price of one good increases, the demand of the other good decreases (peanut butter and jelly)

normal goods

as income increases, demand decreases

inferior goods

as income increases, demand decreases (eat less McDonald’s and more steak)

law of supply

the higher the price of a good, a higher amount of the good will be supplied

quantity supplied

specific point on the supply curve

supply

entire curve

what does “trice” refer to

reasons for change in supply

“t” in “trice”

technology

“r” in “trice”

related goods (complements and substitutes)

“i” in “trice”

input wages

“c” in “trice”

competition (# of producers in a market)

“e” in “trice”

expectations

example of complements in related prices

oil drillers will also produce natural gas as a by-product of oil production

example of substitutes in related prices

heating oil and gas are co-produced. if the price of oil increases, gas will be produced less and oil will be produced more

what are factors of input wages

1. anything used to produce a good or service (includes nominal wages)

2. increase in input prices leads to a decrease in supply

what does more competition in supply mean

the more producers in the market, the more supply availible

what do expectations in supply mean

producers produce more of what is expected to sell for a better profit

price elasticity of demand

measure of how responsive the quantity demanded is to changes in the price

elasticity of demand formula

(% change in quantity demanded)/(% change in price)

percent change formula

(new-old)/old x 100

when is demand elastic?

1. when price and total revenue are inverse

2. when there are many substitutes

3. ed>1

when is demand unit elastic in the ed formula?

ed=1

when is demand perfectly elastic in the ed formula? what will the graph look like?

ed=∞, horizontal line (quantity demand changes with price)

when is demand inelastic?

1. if a good is a necessity (people have/will buy it no matter what)

2. when price and total revenue correlate

when is demand perfectly inelastic in the ed formula? what will the graph look like?

ed=0, vertical line (quantity demanded doesn’t change with price)

revenue formula

price x quantity

what is the formula for elasticity of supply?

(% change in quantity supplied)/(% change in price)

when is supply elastic in the es formula?

es>1

when is supply perfectly elastic in the es formula?

es=infinity, horizontal line

when is supply perfectly inelastic in the es formula? what does the graph look like?

es=0, vertical line

when is supply inelastic in the es formula?

es<1

income elasticity of demand formula

(% quantity demanded)/(% change in income)

if income ed is positive, that means

it’s a normal good

if income ed is negative, that means

it’s an inferior good

cross price elasticity of demand formula

(% quantity demanded of good x)/(% change in price of good y)

if cross price elasticity of demand is positive, that means

the goods are substitutes

if cross price elasticity of demand is negative, that means

the goods are complements

if cross price elasticity of demand is zero, that means

the goods are unrelated

consumer surplus formula

willing to pay (wtp) - actual price (pe)

producer surplus formula

actual price (pe) - willing to sell (wts)

what happens when demand increases?

price increases, quantity increases

what happens when demand decreases?

price decreases, quantity decreases

what happens when supply increases?

price decreases, quantity increases

what happens when supply decreases?

price increases, quantity decreases

what happens when supply and demand increases?

price is indeterminant, quantity increases

what happens when supply and demand decrease?

price is indeterminant, quantity decreases

what happens when supply increases and demand decreases?

price decreases, quantity is indeterminant

what happens when supply decreases and demand increases?

price increases, quantity is indeterminant

what happens when quantity demanded>quantity supplied?

shortage

what happens when quantity demanded<quantity supplied?

surplus

price floor creates a

surplus

price ceiling creates a

shortage

causes of deadweight loss

1. loss in economic efficiency

2. lost consumer or producer surplus

3. whenever a market is not in equilibrium

4. government intervention

excise tax

a per unit tax

what happens to surplus when a price ceiling is put in place

consumer surplus grows, producer surplus shrinks

what happens to surplus when a price floor is put in place

consumer surplus shrinks, producer surplus grows

if demand and supply are equally price elastic, then the tax burden

will be shared evenly between buyers and sellers

if demand is less price elastic than supply, then the tax burden

will be beared by buyers

if supply is less price elastic than demand, then the tax burden

will be beared by sellers

quantity imported formula

quantity demanded-quantity supplied