Principles of Economy: Chapter 4-6

Competitive Market

A market with so many buyer and sellers that each has little effect on market price (PRICE TAKERS)

Monopoly

A market with only one seller who sets the price (Price Maker)

The Law of Demand

All else equal, when price falls, Quantity demanded rises

The Law of Supply

All else equal, when price rises, Quantity supplied rises

What are common causes of shifts in the the Demand Curve?

• Income changes

  • Normal vs Inferior goods

• Change in price of Substitutes/complements

• Tastes/ preferences

• Expectations change

• Increased amount of buyers

Normal vs Inferior goods (defintion+ examples)

• Normal goods: when income rises, demand rises

  • Demand increases (Not Quantity of Demand) so the whole demand curve shifts

  • Ex: Luxury sports car

• Inferior goods: when income rises, demand falls

  • Ex: Public transport tickets

Substitutes vs Complements (definition + examples)

• Substitutes: two similar, interchangeable goods ==> Price₁ rises, Demand₂ rises

• Complements: two goods often bought together ==> Price1 rises, Demand₂ falls

What are common causes of shifts in the Supply Curve?

• Price/accessibility of inputs

• Technology improves

• Expectation change

• Number of sellers in the market

What happens to Price and Quantity when Supply or Demand shifts?

Increased Supply + no changed demand ==> P down, Q up

Decreased Supply + no changed demand ==> P up, Q down

Increased Demand + no changed supply ==> P up, Q up

Increased Demand + no changed supply ==> P down , Q down

Properties of Equilibrium (Graph, Quantity)

• Supply and demand curves intersect

• Qs and Qd are equal (No shortages or surplus)

Consumer Surplus (definition + formula)

• Difference between what consumers are willing to pay and what they actually pay

• ½(Q*)(P_max - P*)

Producer Surplus (definition + formula)

• Difference between the price received and sellers’ cost of production

• ½ (Q*)(P*- P_min)

Total Surplus (Definition + formula)

• overall net benefit or economic welfare gained by buyers and sellers in a market

• ½ (Q*)(P_max - P_min)

Deadweight Loss (definition + key rule + formula)

• Surplus lost when actual quantity traded doesn’t equal Q*

• changing quantity ==> creates/destroys DWL

• ½ (P_b - P_s)(Q* - Q_t)

Why Equilibrium is Efficient (Graph)

• Left of Q*: MB (Deman) > MC (supply)

  • that unit is worth making, but isn’t made so surplus turns into DWL

• Right of Q*: MC > MB

  • that unit costs more than it’s worth, shouldn’t be made

• At Q*: MB = MC exaclty

  • every worthwhile unit made, no wasteful ones, so surplus is maximized

Price Elasticity of Demand (definition + formula)

• How much quantity demanded changes when price changes

• Increased elasticity = small changes in price lead to large changes in quantity demanded

Price Elasticity of Supply (definition + formula

• How much the quantity supplied changes when price changes

• Increased elasticity = small changes in price leads to large changes in quantity supplied

Elasticity landmarks

• Elasticity = 0: Perfectly inelastic

• 0 < Elasticity < 1: Inelastic

• Elasticity = 1: Unit elastic

• 1 < Elasticity < infinity: Elastic

• Elasticity = infinity: Perfectly Elastic

Determinants of Price elasticity of Demand

• Narrowly defined vs Broadly defined

• Availability of close substitutes

• Luxury Goods (unnecessary)

• Long time horizon: bigger time interval shows more elasticity

Elasticity (in relation to revenue)

• Revenue = (P)(Q)

• If demand is inelastic, a price increase will raise revenue

• if demand is aielastic, a price increase will lower revenue

Income elasticity of demand

• How much quantity demanded changes when income changes

• Increased elasticity = small change in income leads to large change in demand

Cross Price elasticity of demand

• How much quantity demanded of good Y changes when the price of good X changes

• Increased elasticity = small changes in price of good X leads to large change in demand of good Y

Price ceiling (definition + who it helps + effect when binding + example)

• a level above which price is not allowed to rise

• Helps consumers

• Binding price ceiling (below P*) ==> shortage (Q_d > Q_s)

  • Q_s = the actual quantity sold

  • Surplus transfers from PS to CS on units still being sold

  • DWL on units no longer made

• Ex: Rent Control

Price floor (definition + who it helps + effect when binding + example)

• a level below which price is not allowed to fall

• Helps producers

• Binding price floors (above P*) ==> surplus (Q_s > Q_d)

  • Q_d = the actual quantity sold

  • Surplus transfers from CS to PS on units still sold

  • DWL on units no longer sold

• Example: minimum wage (surplus = unemployment)