E&S topic 1

What is producer surplus?

The total revenue producers receive in excess of the minimum payment required to induce them to produce the good.

What is consumer surplus?

The difference between the amount consumers are willing to pay for a good and the amount they actually pay.

What is social surplus?

The sum of consumer surplus and producer surplus; it represents the total welfare benefit to consumers and producers.

What assumptions are made for market equilibrium analysis?

The market is perfectly competitive and there is no government intervention.

What is market equilibrium?

A situation in which the price balances buyers' and sellers' plans: quantity demanded equals quantity supplied.

What is the general demand function and its components?

Qd = f(P, M, W, PR, T, PE), where P = current price; M = income; W = wealth/net worth; PR = prices of related goods; T = tastes/preferences; and PE = expected future price.

What is a normal good?

A good for which an increase in income or wealth causes quantity demanded to increase, ceteris paribus.

What is an inferior good?

A good for which an increase in income or wealth causes quantity demanded to decrease, ceteris paribus.

What are substitutes in demand?

Two goods for which an increase in the price of one causes demand for the other to increase, all else equal.

What are complements in demand?

Two goods for which an increase in the price of one causes demand for the other to decrease, all else equal.

What is the direct demand function?

Qd = f(P): the relationship between quantity demanded and the product's price when all other demand determinants are held constant.

What is the law of demand?

Ceteris paribus, as price rises quantity demanded falls; as price falls quantity demanded rises.

What is the inverse demand function?

P = f(Qd): a function expressing price in terms of quantity demanded.

What does a point on a demand curve show?

The maximum quantity consumers will buy at a given price, or the maximum price they will pay for a given quantity.

What causes a movement along the demand curve?

A change in the good's own price, with all other demand determinants unchanged.

What causes a shift in the demand curve?

A change in a non-price determinant: income, wealth, prices of related goods, tastes, expected future price, or number of consumers.

What does a market demand curve show?

The total quantity all consumers are willing and able to buy at each price. It is the horizontal sum of individual demand curves.

What is the general supply function and its components?

Qs = f(P, PI, Pr, T, PE), where P = current price; PI = input prices; Pr = prices of related goods in production; T = technology; and PE = expected future price.

What are substitutes in production?

Goods for which a rise in the price of one causes producers to produce more of that good and less of the other good.

What are complements in production?

Goods for which a rise in the price of one causes producers to increase production of both goods.

What is the direct supply function?

Qs = f(P): the relationship between quantity supplied and the product's price when all other supply determinants are held constant.

What is the inverse supply function?

P = f(Qs): a function expressing price in terms of quantity supplied.

What does a point on a supply curve show?

The maximum quantity firms will offer for sale at a given price, or the minimum price needed to induce producers to supply a given quantity.

What causes a movement along the supply curve?

A change in the good's own price, with all other supply determinants unchanged.

What causes a shift in the supply curve?

A change in input prices, prices of related goods in production, technology, expected future price, or number of firms.

What does a market supply curve show?

The total quantity all producers are willing and able to supply at each price. It is the horizontal sum of individual supply curves.

What is total consumer value?

The sum of the maximum amounts consumers are willing to pay; graphically, the area under the demand curve up to the quantity purchased.

What is total expenditure?

The amount consumers actually spend: market price × quantity purchased.

What is total revenue?

The amount firms receive from sales: market price × quantity sold.

What is the minimum payment required?

The minimum amount producers must receive to be willing to produce a quantity; it equals the cost of producing that output.

Is producer surplus above or below the supply curve?

Above the supply curve and below the market-price line, up to the quantity sold.

How does price adjust the market toward equilibrium?

Above equilibrium, a surplus pushes price down. Below equilibrium, a shortage pushes price up.

What are consumer and producer surplus in a competitive market?

Consumer surplus is below demand and above price. Producer surplus is above supply and below price, both up to equilibrium quantity.

What can be said about social surplus in a perfectly competitive market?

It is maximised, so resources are allocated efficiently.

What is a Veblen good?

A luxury/status good for which a higher price can increase demand because the price signals prestige.

What is a Giffen good?

An inferior staple good for which a price increase can raise quantity demanded because the income effect outweighs the substitution effect.

What is the law of supply?

Ceteris paribus, as price rises quantity supplied rises; as price falls quantity supplied falls.

How do you derive a market demand curve from individual demand curves?

At each price, add the quantities demanded by every consumer. This is a horizontal sum.

How do you derive a market supply curve from individual supply curves?

At each price, add the quantities supplied by every firm. This is a horizontal sum.

What does “market clears” mean?

Quantity demanded equals quantity supplied, so all planned purchases and sales at that price can occur.

How do you calculate consumer surplus geometrically?

Consumer surplus = total consumer value − total expenditure.

How do you calculate producer surplus geometrically?

Producer surplus = total revenue − minimum payment required.

How do you derive a direct demand or supply function from a general function?

Hold every non-price variable at a fixed value, leaving quantity as a function of price alone.

Why can a market demand or supply curve be step-wise?

For discrete goods such as cars, fractional units cannot be bought or sold.