Unit 2 AP Mircoeconomics

Law of Demand

There is an inverse relationship between price and quantity demanded

The substitution effect

If the price goes up for a product, the consumer buys less of that product and more of another substitute product

The income effect

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

The law of diminishing marginal utility

As you consume anything, the additional satisfaction that you will receive will eventually start to decrease. Consumers are only willing to buy more if the price falls.

What are the 5 shifters in demand?

Tastes and preferences, number of consumers, price of related goods (substitutes, complements), income (normal goods, inferior goods), future expectations

How does taste and preference shift demand?

Trends impact demand

How does the number of consumers shift demand?

More consumers (market size), more demand

How do substitutes shift demand?

If the price of on increased, the demand for the substitute will increase.

How do complements shift demand?

If the price of one increased, the demand for the other will decrease.

How does income shift demand for normal goods?

If income increases, the demand increases.

How does income shift demand for inferior goods?

If income increases, the demand decreases.

How do future expectations shift demand?

If the price is expected to rise in the future, the demand increases today!

Demand

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

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 between price and quantity supplied

Why does the law of supply work?

At higher prices, profit seeking firms have an incentive to produce more.

What are the 5 shifters of supply?

Price or availability of inputs, number of sellers, technology, government action (taxes and subsidies), expectations of future profit.

How do prices/availability of inputs (resources) shift supply?

If input prices fall, supply increases and if there are more/better inputs, supply increases

How does the number of sellers shift supply?

If there are more sellers, there is more competition, so supply increases

How does technology shift supply?

Advancements in technology increase supply

How do taxes shift supply?

If taxes increased, less supply.

How do subsidies shift supply?

If subsidies increase, more supply

How do expectations of future profit shift supply?

If more profit is expected, supply increases.

What is price elasticity of demand?

Measures how sensitive quantity demanded is to a change in price.

Inelastic demand

Quantity is insensitive to a change in price

What are general characteristics of inelastic goods for PED?

Few substitutes, necessities, small portion of income, required now rather than later, elasticity coefficient less than 1

Elastic demand

Quantity is sensitive to a change in price

What are general characteristics of elastic goods for PED?

Many subsititutes, luxuries, large portion of income, plenty of time to decide, elasticity coefficient greater than 1

Formula for percent change

(new-old)/old x 100

What is the elasticity coefficient for a perfectly inelastic product?

0 and graph is completely vertical

What is the elasticity coefficient for a perfectly elastic product?

infinity and the graph is completely horizontal

If the elasticity coefficient is greater than one, it is…

relatively elastic

If the elasticity coefficient is less than one, it is…

relatively inelastic

If the elasticity coefficient is one, it is…

unit elastic

What is another way to determine the elasticity of demand for a good?

Total revenue (price x quantity)

How does an inelastic demand change total revenue?

Price increase causes TR to increase. Price decrease causes TR to decrease.

How does an elastic demand change total revenue?

Price increase causes TR to decrease. Price decrease causes TR to increase.

How does unit elastic change total revenue?

Price changes and TR remains unchanged.

How to calculate PED?

(percent change in quantity)/(percent change in price)

What is price elasticity of supply?

Measures how sensitive quantity supplied is to a change in price.

Elasticity of supply is based on _____ limitations. Producers need _____ to produce more.

time

Most goods in the short-run have an ________ supply

inelastic

Most foods in the long-run have an _______ supply

elastic

Perfectly inelastic supply caused the quantity supplied to

not change

What are general characteristics of inelastic supply for PES?

hard to produce, high barriers to entry, high cost or specialized inputs, hard to switch from producing alternative goods, elasticity coeff is less than 1

What are the general characteristics of elastic supply for PES?

Easier to produce, low barriers to entry (many firms), low cost or generic inputs, easy to switch from producing alternative goods, elasticity coeff greater than 1.

Cross-Price elasticity of demand (XED)

Measures how sensitive quantity demanded of one product is to a change in price of a different product.

What does XED show?

If two goods are substitutes or complements

How to calculate XED?

(percent change in quantity of product b)/(percent change in price of product a)

If the coefficient for XED is positive, then the goods are _______.

substitutes (direct relationship)

If the coefficient for XED is negative, then the goods are _____.

complements (inverse relationship)

Income elasticity of demand (YED)

Measures how sensitive quantity demanded is to a change in income

What does YED show?

if two goods are normal or inferior

YED formula

(percent change in quantity)/(percent change in income)

If coefficient for YED is positive, then the good is _____.

normal (direct relationship)

If the coefficient for YED is negative, then the good is ______.

inferior (inverse relationship)

If the quantity demanded is less than quantity supplied, is there a surplus or shortage?

surplus

If the quantity demanded is greater than quantity supplied, is there a surplus or shortage?

shortage

How do producers respond to a surplus?

lowering the price

How do producers respond to a shortage?

Increasing the price

Consumer surplus

The difference between what you are willing to pay and what you actually pay

Producer surplus

The difference between the price the seller received and how much they are willing to sell it for.

What is deadweight loss?

The reduction in total surplus when not in equilibrium

Is consumer surplus the top or bottom half of the triangle that is total surplus on the graph?

top

For double shifts in a price-quantity graph, what is true about either price of quantity.

One of them has to be indeterminate/ambiguous.

Price ceiling

Maximum legal price a seller can charge for a product

What is the goal of a price ceiling?

Make affordable by keeping price from reaching equilibrium.

What is the result of a price ceiling (shortage or surplus)?

shortage

Price floor

Minimum legal price a seller can sell a product.

What is the goal of a price floor?

Keep prices high by keeping price from falling to equilibrium.

What is the result of a price floor (shortage or surplus)?

surplus

What makes a market efficient?

To be efficient, a market must maximize consumers and producers surplus.

Is deadweight efficient?

No, it’s inefficient.

Exercise tax

A per unit tax on producers

What is the goal of excise taxes?

The goal is for them to make less of the goods that the government deems dangerous or unwanted.

What is lump sum tax?

one time only

Example of excise taxes:

cigarettes or alcohol, environmentally unsafe products

Tax incidence (burden)

Who ends up paying for the tax

Is a price ceiling above or below equilibrium?

below

Is a price floor above or below equilibrium?

above

What is total expenditures?

amount spent (multiply price by quantity)

How is total revenue different than total expenditures?

Before tax, they are the same but after tax, total revenue does not count consumer burden while total expenditures does.

World price

Countries can buy products at their own domestic price or they can buy the products at a cheaper world price

Tariff

tax imports that increases the world price

Quota

A limit on number of imports

What is the purpose of tariffs and quotas

To protect domestic producers from a cheaper world price and to prevent domestic unemployment.