AP microecon unit 2

Law of Demand

• If ↑ price then ↓ quantity demanded

• If ↓ price then ↑ quantity demanded

market =

forms when multiple parties exchange things of value

strong property rights =

1. exclusively owned

2. enforceable against thieves

3. transferrable

demand =

all demand in the economy, the entire downward sloping curve

quantity demand =

# of goods demanded at a certain price point on demand curve

factors affecting demand

1. expectations of future price

2. income

3. population

4. preferences

5. substitution

normal good =

w/ more money ppl buy more, w/ less money ppl buy less

inferior good =

more money ppl buy less, buy more of another better good

market graph (draw)

expectations of future price (D)

1. expect to be higher = demand inc

2. expect to be lower = demand dec

income (D)

1. income inc = demand inc

2. income dec = demand dec

*only for normal goods

population (D)

1. pop inc = demand inc

2. pop dec = demand dec

preferences (D)

1. preference/popularity inc = demand inc

2. preference/popularity dec = demand dec

substitution

1. other products prices go up = demand inc (ours is cheaper)

2. other products prices go down = demand dec (theirs is cheaper)

substitution effect

people may not actually want more of a good, it might be a better deal compared to other goods 

law of supply

• If price  inc → quantity supplied inc

• If price  dec → quantity supplied dec

factors affecting supply

1. price of input

2. price of related goods

3. # of suppliers

4. technology

5. expected future prices

6. taxes/subsidies

price of input aka land,labor,capitol (S)

• price of inputs inc = supply dec

• price of inputs dec = supply inc

price of related goods (S)

• price of related good inc = supply dec (more lucrative to produce other good)

• price of related good dec = supply inc (more lucrative to produce our good)

number of suppliers (S)

• number of suppliers dec = supply dec

• number of suppliers inc = supply inc

technology (S)

• tech devolves = supply dec

• tech evolves = supply inc

expected future prices (S)

• prices expected to inc = supply dec (sell later at higher price)

• prices expected to dec = supply inc (sell now at higher price)

taxes/subsidies (S)

• inc taxes/dec subsidies= supply dec

• dec taxes/inc subsidies = supply inc

*subsidies mean govt gives money

Elastic (D) =

small price change → big quantity change

Inelastic (D) =

big price change → small quantity change

price elasticity of demand =

measuring how sensitive quantity is to price changes (very sensitive = elastic, not sensitive = inelastic)

high elasticity =

more horizontal demand curve

low elasticity =

more vertical curve

determinants of price elasticity of demand

1. substitutes

2. timeframe

3. income share

4. luxury v. necessity

5. narrowness do the market

substitutes (PEoD)

• Many = more elasticity

• Few = less elasticity

timeframe (PEoD)

• Short time frame = less elasticity

• Long time frame = more elastic

income share (PEoD)

• Lower income share (less of ppl’s budget) = less elastic

• Higher income share (more of ppl’s budget) = more elastic

luxury v. necessity (PEoD)

• Necessity = less elastic (b/c need it so always need similar amount like prescriptions)

• Luxury = more elasticity

narrowness of market (PEoD)

• Narrower definition of market (apples) = more elasticity

• broader definition of market (food) = less elasticity

perfect inelasticity

(within reason) any change in price will not change the quantity purchased

perfect inelasticity =

0

perfect elasticity =

infinity (∞)

constant unit elasticiy

• % dec/inc in price = % inc/dec in quantity

Ex. 10% dec in price → 10% inc in quantity 

total revenue =

price * quantity

When elastic, a change in price means

• Price dec = total revenue inc

• Price inc = total revenue dec

When inelastic, a change in price means

• price dec = total revenue dec

• Price inc = total revenue inc

When unit elastic, a change in price means

• total revenue stays the same between the 2 prices

  • region between 2 numbers is unit elastic

midpoint =

unit elastic

above midpoint =

elastic

below midpoint =

inelastic

Price Elasticity of Demand formula (write =

Q = quantity demanded

inelastic situation =

|E| < 1

elastic situation

|E| > 1

unit elastic situation

|E| = 1

% change =

(new-old)/old *100

explanation for elasticity

when price of inc/dec by %, quantity demand of dec/inc by %

elastic & taxes

• producers assume most of the burden (b/c quantity demanded dec but price stay the same)

  • some DWL, but only from producerse

inelastic & taxes

• consumers assume most of the burden (b/c have to buy same amount but more expesnive

  • no DWL

Price Elasticity of Supply (write) formula

Q = quantity supplied

Price elasticity of supply determinants

1. time frame

time frame (PEoS)

• long run = more elastic (b/c can get more resources)

• short run = less elastic (b/c can’t get more resources)

Income Elasticit of Demand (formula)

• determins normal v. inferior goods

pos v. neg elasticity (IEoD)

• positive elasticity = normal good

• negative elasticity = inferior

elastic & positive (IEoD)

normal luxury

inelastic & positive (IEoD)

normal necessity

Cross Price Elasticity of Demand

• determines if substitutes, complements, or unrelated

perfect substitutes (CED)

• E = infinity/ E>0 = near perfect substitutes

complements (CED)

• E<0 & negative

• demand of A and price of B are inverse

no relation (CED)

E = 0

midpoint elasticity formula

• works for all types of elasticity

* use ALL THE TIME

Total Revenue Test (check elasticity)

• elastic = P & TR are inverse

• inelastic = P & TR go in same direction

market equilibrium (draw)

consumer surplus

• total marginal benefit that consumers get above price paid (equilibrium)

  • b/c you could have paid higher (willingness) but you paid less (equilibrium price) so you “save money” so you have a benefit 

producer & consumer surplus formula

½(b*h)

producer surplus

• total marginal benefit above supply line (below supply curve = marginal cost) & below price

  • Needed certain price to produce a certain quantity (supply line) but are getting paid more to produce same quantity (b/c of equilibrium) so get more money aka benefit

consumer & producer surplus graph

total revenue graph

shifting supply & demand

• changes P or Q

• if inc/dec on both graph = inc/dec

• one will always be indeterminate (on one graph inc, on another dec)

Price Ceilings =

max price set by government

*usually below equilibrium

Dead Weight Loss (DWL)

surplus loss b/c of price control (not efficient)

non-binding v. binding price ceilings

• non-binding = doesnt prevent market from reaching equilibrium

• binding = prevents market from reaching equilibrium

Price ceiling graph

shortage =

Qd > Qs

shortage amount =

Qd - Qs

price floors =

• minimum price set by govt

*usually above equilibrium (has no effect below)

price floor graph

surplus =

Qs > Qd = surplus

surplus amount

Qs - Qd

who suffers in price floor/ceiling

• price ceiling = most producers suffer b/c sell at lower price

• price floor = all consumers suffer b/c high prices

*ASK GPT

Tax Graph

• Pt = price consumers pay

• Ps = price suppliers pay

• Qt = quantity supplied q/ tax

• CS & PS dec

total tax revenue =

size of tax * Qt

tax incidence (burden of tax on market)

• (old price - new price) * quantity

• shared by buyers & sellers, shows how much surplus dec from CS & PS to become tax revenue

tax on seller/buyer

• ta on seller = supply curve move up/down

• tax on buyer = demand curve move up or down

country exporting =

producers win, consumers lose (consumers pay higher price b/c new equilibrium, but producers sell more product)

country importing =

consumers win, producers lose (consumers pay lower price, producers don’t get as much revenue)

country import graph

• beneficial to everyone except domestic producers b/c total surplus increases

• shortage, so importing meets consumer demand

country export graph

• beneficial to everyone except domestic customers b/c total surplus increases

• surlus, so exporting meets producer needs

trade w/ tariffs graph

• total tariff/govt rev. = size of tariff * import amount (Qd-Qs)