AP Macroeconomics Unit 1 Notes: How Markets Use Prices to Allocate Resources

Demand

The relationship between the price of a good/service and the quantity consumers are willing and able to buy over a given time period, holding other factors constant.

Willing and able

Condition for demand: consumers must both want the good and have the ability (e.g., income) to purchase it; desire alone is not demand.

Demand schedule (or demand curve)

A table or graph showing the quantities demanded at various prices; illustrates demand as a relationship, not a single number.

Linear demand equation

A simplified mathematical model of demand such as Qd = a − bP, where quantity demanded falls as price rises.

Law of demand

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

Ceteris paribus

“All else equal”; the assumption that other determinants are held constant when analyzing the effect of one change (like price).

Substitution effect

When a good’s price rises, consumers switch toward substitutes, decreasing quantity demanded of the now-more-expensive good.

Income effect

A price increase reduces consumers’ effective purchasing power, leading them to buy less (lower quantity demanded).

Diminishing marginal utility

As more units are consumed, additional satisfaction tends to fall, so consumers require lower prices to buy additional units.

Quantity demanded

The specific amount consumers buy at a particular price; changes only due to a change in the good’s own price (movement along demand curve).

Change in demand

A shift of the entire demand curve caused by a non-price determinant (e.g., income, tastes, expectations), meaning different quantities are demanded at every price.

Demand shifters (determinants of demand)

Non-price factors that shift demand, including income, prices of related goods, tastes/preferences, expectations, and number of buyers.

Normal good

A good for which demand increases when consumer income increases (and decreases when income falls).

Inferior good

A good for which demand decreases when consumer income increases (and increases when income falls).

Substitutes

Related goods that can replace each other; if the price of a substitute rises, demand for the other good rises.

Complements

Related goods consumed together; if the price of a complement rises, demand for the other good falls.

NICE mnemonic (demand)

Memory aid for demand shifters: Number of buyers, Income, Complements/substitutes, Expectations (often with tastes/preferences added).

Supply

The relationship between the price of a good/service and the quantity producers are willing and able to sell over a given time period, holding other factors constant.

Linear supply equation

A simplified mathematical model of supply such as Qs = c + dP, where quantity supplied typically rises as price rises (d > 0).

Law of supply

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

Quantity supplied

The specific amount producers sell at a particular price; changes only due to a change in the good’s own price (movement along supply curve).

Change in supply

A shift of the entire supply curve caused by a non-price determinant (e.g., input costs, technology, taxes/subsidies), meaning different quantities are supplied at every price.

Supply shifters (determinants of supply)

Non-price factors that shift supply, including input prices, technology/productivity, taxes/subsidies, number of sellers, expectations, and regulation/trade conditions.

Market equilibrium

The price and quantity where quantity demanded equals quantity supplied (Qd = Qs), creating no built-in pressure for price to change.

Disequilibrium (shortage or surplus)

A situation where the market price is not at equilibrium, creating either a shortage (Qd > Qs, price below equilibrium) or a surplus (Qs > Qd, price above equilibrium).