Unit Two: Microeconomics

Law of Demand

As the price of a good or service decreases, the quantity demanded increases, and vice versa, assuming all other factors remain constant.

Demand Schedule

Shows the relationship between the price of a good and the quantity demanded at different price levels.

Demand vs. Quantity Demanded

Demand refers to the entire relationship between price and quantity demanded, while quantity demanded refers to a specific point on the demand curve.

Demand Curve

A graph that typically slopes downwards from left to right, showing the inverse relationship between price and quantity demanded.

Change in Price on Demand Curve

Results in movement along the demand curve rather than shifting the curve itself.

Shift in Demand Curve

An increase in demand shifts the curve right, while a decrease in demand shifts it left.

Five Shifters of Demand

1. Consumer income 2. Consumer tastes and preferences 3. Prices of related goods (substitutes and complements) 4. Market size (number of buyers) 5. Expectations of future prices.

Substitute Goods Example

Coke and Pepsi.

Complementary Goods Example

Peanut butter and jelly.

Normal Good Example

Steak, where demand increases as income increases.

Inferior Good Example

Instant noodles, where demand decreases as income increases.

Elasticity of Demand

Measures how much the quantity demanded of a good responds to a change in price.

Elasticity Equation

Elasticity = (% change in quantity demanded) / (% change in price), where Elastic >1, Inelastic

Elasticity Calculation Example

Elasticity = [(250-220)/220] / [(3.40-4.40)/4.40] = -0.6 (Inelastic demand).

Elasticity and Revenue

If demand is elastic, a price decrease increases total revenue; if inelastic, a price increase increases total revenue.

Factors Affecting Elasticity

1. Availability of substitutes 2. Necessity vs. luxury 3. Time horizon 4. Proportion of income spent.

Elastic Demand Example

Airline tickets.

Inelastic Demand Example

Insulin.

Law of Supply

As price increases, the quantity supplied also increases, assuming all else remains constant.

Higher Prices and Supply

Higher prices create an incentive for producers to produce more to maximize profits.

Supply Curve

Typically represented as an upward-sloping line.

Change in Price on Supply

Causes movement along the supply curve, not a shift.

Shifters of Supply

1. Cost of inputs 2. Technology improvements 3. Number of sellers 4. Expectations of future prices 5. Government policies (taxes, subsidies).

Supply Schedule

Shows quantity supplied at different prices; market supply is the sum of all individual supply schedules in a market.

Elasticity of Supply Calculation

Elasticity = (% change in quantity supplied) / (% change in price).

Short Run vs. Long Run

Short run: At least one input is fixed; Long run: All inputs are variable.

Fixed Input Example

Factory building.

Variable Input Example

Raw materials.

Fixed Cost Example

Rent.

Variable Cost Example

Wages.

Marginal Product of Labor

The additional output from adding one more worker.

Marginal Returns

Increasing: Additional workers improve efficiency; Diminishing: Each added worker contributes less additional output; Negative: Additional workers decrease output.

Marginal Cost Equation

Marginal cost = Change in total cost / Change in quantity produced.

Profit Maximization Rule

Produce until marginal cost = marginal revenue.

Equilibrium Definition

Occurs where supply and demand intersect.

Benefits of Equilibrium

Both consumers and producers benefit from stable pricing.

Types of Disequilibrium

1. Surplus (excess supply) 2. Shortage (excess demand).

Price Ceiling Example

Rent control; causes shortages.

Price Floor Example

Minimum wage causes surplus of labor.

Equilibrium as a Moving Target

It changes due to shifts in supply and demand.

Effects of Changes in Supply or Demand

Shifts cause new equilibrium points.

Price System Benefits

Provides efficiency and signals for buyers and sellers.

Bartering System Issues

Lacks standardization and efficiency.

Supply Shock and Rationing

Supply shocks disrupt equilibrium; rationing allocates limited goods fairly.

Black Market and Rationing

A black market emerges when goods are rationed, leading to illegal sales at higher prices.