AP Econ: Comparative Adv. & Gains from Trade, Demand, Supply, & Market Equilibrium

absolute advantage

the producer who can produce the most output or requires the least amount of inputs

comparative advantage

the producer with the lowest opportunity cost

when do countries trade

if they have a relatively lower opportunity cost

• they should specialize in the good that is “cheaper” to produce

how to find the comp adv for output

OOO

(output other under)

how to find the comp adv for input

IOU

(input other under)

Terms of trade

the agreed upon conditions that would benefit both countries

demand

the different quantities of goods that consumers are willing and able to buy at different prices

law of demand

there is an inverse relationship btwn price & quantity demanded

Why does the law of demand occur

1. substitution effect

2. income effect

3. law of diminishing marginal utility

substitution effect

if the price goes up for a product consumers buy less of that product & more of another product

income effect

if the price goes down for a product the purchasing power increases for consumers allowing them to purchase more

law of diminishing marginal utility

• utility = satisfaction

• we buy goods because we get satisfaction from them

• the law of diminishing marginal utility states that as you consume anything the additional satisfaction that you will receive will eventually start to decrease

shifts in demand

a shift means that at the same prices more people are willing & able to purchase that good

• change in demand NOT q demanded

PRICE DOES NOT SHIFT THE CURVE

5 shifters of demand

• income

• # of consumers

• future expectations

• price of related goods

• tastes & preferences

INEPT

substitutes

goods used in place of one another

complements

2 goods that are bought & used together

income effect on normal goods

• when income increases, demand increases

• when income decreases, demand decreases

income effect on inferior goods

as in come increases demand decreases

supply

the different quantities of a good that sellers are willing and able to sell (produce) at different prices

law of supply

there is a direct relationship btwn price & quantity supplied

• as price increases the quantity producers make increases and vice versa

5 shifters (determinants) of supply

1. gov action- taxes & subsidies

   1. taxes up → supply down

   2. subsidy up → supply up

2. resource prices/availability

3. expectations of future profit

4. number of sellers

5. technology

surplus

there is more supply than demand

shortage

there is more demand than supply

double shift rule

if 2 curves shift at the same time, either price or quantity will be indeterminate

price ceiling

max legal price a seller can charge for a product

• when below equilibrium results in black market

price floor

minimum legal price a seller can sell a product