Ap micro u2
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79 Terms
What is a competitive market?
A market characterized by large numbers of buyers and sellers acting independently.
What are the three geographic scales of markets mentioned?
Local (e.g., Farmer's Market)
2. National (e.g., U.S. Real Estate)
3. International (e.g., New York Stock Exchange).
What two conditions must consumers meet to be part of the demand for a good?
Consumers must be willing and able to purchase the good.
When deriving a demand curve, what assumption is made regarding factors other than price?
What is the Law of Demand?
Other things equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls.
What kind of relationship exists between price and quantity demanded?
An inverse relationship (downward-sloping).
How does diminishing marginal utility explain the Law of Demand?
As a consumer consumes more units of a good, the added satisfaction (utility) decreases. Therefore, consumers will only buy additional units if the price is lower to compensate for the lower utility.
What is the income effect?
A lower price increases the purchasing power of a consumer's money income, enabling them to buy more without giving up other goods.
What is the substitution effect?
A lower price gives consumers an incentive to substitute the cheaper good for now relatively more expensive similar goods.
How is market demand derived from individual demand?
Market demand is the horizontal summation of the individual demand curves of all consumers in the market.
What is the difference between a change in demand and a change in quantity demanded?
A change in demand is a shift of the entire curve caused by a determinant. A change in quantity demanded is a movement along a fixed curve caused by a change in the product's price.
What are the five determinants of demand that shift the curve?
Consumer tastes and preferences
2. Number of buyers
3. Income
4. Prices of related goods
5. Consumer expectations.
How does a change in income affect the demand for normal goods?
Demand increases as income increases and decreases as income falls.
How does a change in income affect the demand for inferior goods?
Demand decreases as income increases and increases as income falls.
What are complementary goods and how do their prices interact?
Goods consumed jointly (e.g., tuition and textbooks). If the price of one increases, the demand for its complement decreases.
What are substitute goods and how do their prices interact?
Goods used in place of one another (e.g., Nike and Reebok). If the price of one increases, the demand for its substitute increases.
How do consumer expectations of future prices affect current demand?
If consumers expect future prices to be higher, current demand increases. If they expect future prices to be lower, current demand decreases.
What is the Law of Supply?
Other things equal, as the price rises, the quantity supplied rises, and as the price falls, the quantity supplied falls.
What kind of relationship exists between price and quantity supplied?
A direct relationship (upward-sloping).
Why does the supply curve slope upward?
Profit incentive: Higher prices mean greater potential profits.
2. Increasing costs: Beyond certain output levels, producers face increasing costs per unit, requiring higher prices to justify more production.
What are the six determinants of supply?
Resource (input) prices
2. Technology
3. Number of sellers
4. Taxes or Subsidies
5. Prices of other goods
6. Producer expectations.
How do taxes and subsidies affect the supply curve?
Subsidies: Decrease costs and increase supply (shift right).
What is market equilibrium?
The point where the supply and demand curves intersect; the quantity demanded equals the quantity supplied (( Qd = Qs )).
What occurs when the market price is above the equilibrium price?
A surplus (excess quantity supplied).
What occurs when the market price is below the equilibrium price?
A shortage (excess quantity demanded).
What is the rationing function of prices?
The ability of competitive forces to establish a price that coordinates the decisions of buyers and sellers, eliminating surpluses and shortages.
What is productive efficiency?
Production of a good in the least costly way using the best technology and right mix of resources.
What is allocative efficiency?
Production of the particular mix of goods most highly valued by society; occurs where ( MB = MC ).
Effect of a simultaneous increase in demand and decrease in supply?
Equilibrium price increases; the effect on equilibrium quantity is indeterminate.
Effect of a simultaneous increase in demand and increase in supply?
Equilibrium quantity increases; the effect on equilibrium price is indeterminate.
What is a price ceiling and where must it be set to be effective?
A legal maximum price. To be effective (binding), it must be set below the equilibrium price.
What is the primary market result of a binding price ceiling?
A persistent shortage (( Qd > Qs )).
What are five negative effects of price ceilings?
Shortages
2. Inefficient allocation to consumers
3. Wasted resources (time/effort)
4. Inefficiently low quality
5. Black markets.
What is a price floor and where must it be set to be effective?
A legal minimum price. To be effective (binding), it must be set above the equilibrium price.
What is the primary market result of a binding price floor?
A persistent surplus (( Qs > Qd )).
What are six negative effects of price floors?
Surplus
2. Inefficiently low quantity
3. Inefficient allocation of sales among sellers
4. Wasted resources (government buying/destroying surplus)
5. Inefficiently high quality
6. Illegal activity (bribery).
What is a quantity control (quota)?
An upper limit on the quantity of a good that can be legally transacted.
What is quota rent?
The difference between the demand price (( Pd )) and the supply price (( Ps )) at the quota limit; it is the earnings that accrue to the license-holder.
What is the Price Elasticity of Demand (( E_d ))?
A measure of the responsiveness of consumers to a change in price.
What is the formula for the Price Elasticity Coefficient (( E_d ))?
[ Ed = \frac{\% \Delta Qd}{\% \Delta P} ]
What is the Midpoint Formula for elasticity and why is it used?
Used to ensure consistent results regardless of the direction of the price change:
[ Ed = \frac{\frac{Q2 - Q1}{(Q1 + Q2)/2}}{\frac{P2 - P1}{(P1 + P_2)/2}} ]
How do you interpret ( E_d ) values?
\( E_d < 1 \): Inelastic (insensitive)
\( E_d = 1 \): Unit Elastic.
What is perfectly inelastic demand?
Demand where quantity does not change regardless of price (( E_d = 0 )); represented by a vertical line (e.g., insulin).
What is perfectly elastic demand?
Demand where a tiny price change causes quantity to go from zero to all obtainable (( E_d = \infty )); represented by a horizontal line.
What is the Total Revenue (TR) Test?
A way to judge elasticity: Total Revenue = Price (\times) Quantity.
How does TR change if demand is inelastic?
Price and TR move in the same direction (P up (\to) TR up).
How does TR change if demand is elastic?
Price and TR move in opposite directions (P up (\to) TR down).
What four factors determine the Price Elasticity of Demand?
Substitutability (More substitutes = more elastic)
2. Proportion of Income (Higher proportion = more elastic)
3. Luxuries vs. Necessities (Luxuries = more elastic)
4. Time (More time = more elastic).
How does time affect the Price Elasticity of Supply (( E_s ))?
Supply is more elastic over time as producers gain flexibility to shift resources:
1. Immediate Market Period: Perfectly inelastic.
2. Short Run: Fixed plant size, but can adjust variable inputs (more elastic).
3. Long Run: All inputs are variable (most elastic).
What is Cross-Price Elasticity of Demand (( E_{xy} ))?
Measures how the quantity demanded of one good (X) responds to a change in the price of another good (Y).
How do you interpret Cross-Price Elasticity values?
Negative (\( E_{xy} < 0 \)): Complements.
Zero: Independent goods.
What is Income Elasticity of Demand (( E_i ))?
Measures how quantity demanded responds to a change in consumer income.
How do you interpret Income Elasticity values?
Negative (\( E_i < 0 \)): Inferior Good.
What is Consumer Surplus?
The difference between the maximum price a consumer is willing to pay and the actual price they do pay.
What is Producer Surplus?
The difference between the actual price a producer receives and the minimum acceptable price (cost).
What is Total Surplus and where is it maximized?
The sum of Consumer and Producer Surplus (( CS + PS )); it is maximized at market equilibrium.
What is Deadweight Loss (DWL)?
The efficiency loss to society when the total surplus is reduced because the market is not producing at the equilibrium quantity.
Define Progressive, Regressive, and Proportional taxes.
Progressive: Average tax rate increases as income increases.
2. Regressive: Average tax rate declines as income increases.
3. Proportional: Average tax rate stays the same as income changes.
What is Tax Incidence?
The distribution of the tax burden; essentially, who really pays the tax regardless of who it is levied on.
How does elasticity affect the incidence of an excise tax?
The tax burden falls more heavily on the less elastic (more inelastic) party.
If demand is inelastic and supply is elastic, who pays more of the tax?
The consumer bears most of the burden.
If supply is inelastic and demand is elastic, who pays more of the tax?
The producer bears most of the burden.
What is the formula for Tax Revenue on a graph?
What is the U.S. Federal Tax System classified as?
What are U.S. State and Local Tax structures generally classified as?
What does a wedge created by a tax or quota represent?
A difference between the price paid by buyers and the price received by sellers, leading to inefficiency.
How do you calculate Consumer Surplus from a table?
For each unit: Willingness to Pay - Market Price. Sum these for all units traded.
Why is reallocating consumption among consumers inefficient?
It takes goods from those with a higher willingness to pay and gives them to those with a lower willingness to pay, reducing total consumer surplus.
Why is reallocating sales among sellers inefficient?
It prevents low-cost producers from selling and allows high-cost producers to sell, increasing total production costs and reducing producer surplus.
What is the normative argument for price controls?
That the equilibrium price is "unfair" to a specific group (e.g., the poor needing housing or farmers needing higher income).
What is Allocative Efficiency in terms of surplus?
It occurs when Total Surplus is maximized and no further mutually beneficial trades can be made.
How does an excise tax shift the supply curve?
It shifts the supply curve upward (or left) by the exact amount of the per-unit tax.
What happens to Total Surplus after a tax is imposed?
It decreases; part becomes government revenue, and part becomes deadweight loss.
Why do luxuries have higher price elasticity of demand?
Consumers can easily go without them if the price rises, unlike necessities (e.g., vacation vs. medicine).
If ( E_d = 0.5 ), how much does quantity change if price increases by 10%?
Quantity demanded will decrease by 5% (( 0.5 = X / 10\% )).
What is the Immediate Market Period in supply?
A period so short that producers cannot adjust quantity at all; supply is perfectly inelastic.
In the Long Run, why is supply most elastic?
Producers have enough time to adjust all inputs, including plant capacity, and new firms can enter or exit the industry.
What is an example of a perfectly inelastic supply application?
What determines the degree of deadweight loss from a tax?
The elasticity of supply and demand; more elastic curves result in larger deadweight losses as the quantity traded drops more significantly.