micro unit 2

Demand

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

Law of demand

As price increases, demand decreases. As price decreases, demand increases

substitution effect

If the price goes up for a product, consumer buy less of that product and more of another substitute product (and vice versa)

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 utility 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; The more you buy of ANY GOOD the less satisfaction you get from each new unit consumed

Shifts in demand

1. Ceteris paribus - “all other things held constant”

2. When ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts

3. A shift means that at the same prices, more people are willing and able to purchase that good

4. This is a change in demand, not a change in quantity demanded 

5. Price doesn’t shift the curve

5 shifters of demand

taste/preferences, price of related goods (substitute and complementary), income (normal and inferior good), number of consumers, future expectations

Price of related goods

1. Demand curve for one good can be affected by a change in the price of ANOTHER related good

2. Substitutes are goods used in place of one another

   1. If the price of one increases, the demand for the other will increase (vise versa)

3. Complements are two goods that are bought and used together

   1. If the price of one increase, the demand for the other will fall (vise versa)

Income

1. The incomes of consumer change the demand, but how depends on the type of good

2. Normal Goods

   1. Ex: Luxury cars, seafood, jewelry, homes

   2. As income increases, demand increase

   3. As income falls, demand falls

3. Inferior Goods

   1. Ex: Top Ramen, used cars, used clothes

   2. As income increases, demand falls

   3. As income falls, demand increases

Explain how the law of diminishing marginal utility causes the law of demand

The more you consume, the less marginal utility you get. The bigger the price, the less consumed. The smaller the price the more consumed and less marginal utility with each additional unit

Supply

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

Law of supply

As price increases, the quantity producers make increases; As price falls, the quantity producers make falls; At higher prices profit seeking firms have an incentive to produce more

5 shifters of supply

Number of sellers, tech, price of input/availability of resources, expectations of future profit, government action (taxes and subsidies)

Free market

1. FREE MARKET system automatically pushes the price toward equilibrium

   1. When there is a surplus, producers lower prices

   2. When there is a shortage, producers raise prices

Consumer surplus

1. Consumer Surplus is the difference between what you are willing to pay and what you actually pay

   1. CS=Buyer’s Maximum - Price

Producer surplus

1. Producer Surplus is the difference between the price the seller received and how much they were willing to sell it for

   1. PS= Price - Seller’s Minimum

How to find the total quantity demanded

add all values demanded

Change in quantity demanded

movement from one point to another point;Cause: increase or decrease in price of product

Law of supply

as price increases, quantity supplied increases; price falls, quantity supplied decreases

How to determine market supply

add all to see how much in total

Price of input

An increase in price of sand will increase the cost of production of concrete which will reduce its supply; A lower resource prices reduce production costs and increase profits

Govt action

Taxes are bad for businesses; increase production costs and reduce supply; Subsidies lower production costs and increase supply

Price of other goods

Higher prices of other goods may entice suppliers to switch production and produce other goods, reducing supply of the previous good. Prices of other good decline, suppliers switch their production to original good to increase their supply

Equilibrium price

price where the intentions of buyers and sellers match, price where quantity demanded equals quantity supplied, indicated by intersection of supply and demand curve

Equilibrium quantity

quantity at which the intentions of buyers and sellers match

Surplus

excess supply; drive prices down; quantity supplied exceeds quantity demanded

Shortage

excess demand; drive prices up; quantity demanded exceeds quantity supplied

Productive efficiency

production of any particular good in the least costly way

Allocative efficiency

particular mix of goods most highly demanded by society (minimum-cost production assumed)

What does demand reflect

Demand reflects marginal benefit of the good, based on utility received

What does supply reflect

Supply reflects marginal cost of producing the good

Changes in supply, demand curves and equilibrium

1. Supply constant, demand increases → increases equilibrium price and quantity

2. Supply constant, demand decreases →decreases equilibrium price and quantity

3. Demand constant, supply increases →lower equilibrium price, higher equilibrium quantity

4. Demand constant, supply decreases, higher equilibrium price, lower equilibrium quantity

What would happen if both increase/decrease

Decrease/increase in demand and decrease/increase in supply will cancel out, equilibrium price will be zero, price will not change

Price ceilings

maximum legal price a seller may charge for a good; price at or below ceiling is legal, price above is illegal

Price floors

minimum price fixed by the government; price at or above is legal, price below is illegal

Where is consumer surplus

Below demand curve and above equilibrium

Where is producer surplus

Above supply curve, below equilibrium price

Producer min equals what

Producer’s minimum acceptable price for a unit = producer’s marginal cost for a unit

What does the point of intersection mean

Point of intersection between demand and supply curves = allocative efficient 

Total surplus

triangle formed by consumer surplus and producer surplus triangle

Deadweight losses

reductions of combined consumer and producer surplus resulting from underproduction and overproduction

Goal of price ceiling

Make affordable by keeping price from reaching equilibrium

Goal of price floor

Keep price high by keeping price from falling to equilibrium

Excise tax

a per unit of tax on producers

1. For every unit made, the producer must $ NOT a Lump Sum (one time

only) Tax

2. The goal is for them to make less of the goods that the government

deems dangerous or unwanted

a) Cigarettes, Alcohol, Environmentally Unsafe Products

3. Tax is the vertical distance between supply curve

Tax incidence

who ends up paying for an excise tax - producers or consumers?

World price

countries can buy products at their own domestic price or they can

buy the products at a cheaper world price

Tariff

tax on imports that increases the world price

Quota

a limit on number of imports

Purpose on tariffs and quotas

To protect domestic producers from a cheaper world price

2. To prevent domestic unemployment

Elasticity

Elasticity is about determining how much more or how much less people are buying

Price elasticity of demand

Knowing how consumers will respond to a change in price is extremely useful to firms

D. Why does elasticity matter?

1. It helps them decide what to charge and when, if ever, to have sales

2. It helps them determine how many substitutes are in the market

3. It is also used by the government to decide when and how much to tax

Inelastic demand

INelastic Demand - quantity is INsensitive to a change in price

2. If price increases, quantity demanded will fall a little

3. If price decreases, quantity demanded increases a little

a) In other words, people will continue to buy it

4. An INELASTIC demand curve is steep

Characteristics of inelastic goods

Few substitutes

b) Necessities

c) Small portion of income

d) Required now, rather than later

e) Elasticity coefficient less than 1

Elastic demand

Elastic Demand - quantity is sensitive to a change in price

2. If price increases, quantity demanded will fall a lot

3. If price decreases, quantity demanded increases a lot

a) In other words the amount people buy is sensitive to price

4. An elastic demand curve is flat

Characteristics of elastic goods

Many substitutes

b) Luxuries

c) Large portion of income

d) Plenty of time to decide

e) Elasticity coefficient greater than 1

Total revenue test (P x Q)

Uses Elasticity to show how much changes in price will affect total revenue (TR)

a) If demand for gas is inelastic, what will happen to total revenue for

gas stations if price increases

2. Inelastic Demand

a) Price increase causes TR to increase

b) Price decrease causes TR to decrease

3. Elastic Demand

a) Price increase causes TR to decrease

b) Price decrease causes TR to increase

4. Unit Elastic

a) Price changes and TR remains unchanged

Price elasticity of supply

Measures how sensitive quantity supplied is to a change in price

Price Elasticity of Supply - elasticity of supply shows how sensitive producers are to a change in price

1. Elasticity of supply is based on time limitations; Producers need time to produce more

C. Inelastic =Insensitive to a change in price

1. Most goods have inelastic supply in the short-run

D. Elastic = Sensitive to a change in price

1. Most goods have elastic supply in the long-run

E. Perfectly Inelastic Supply = QS doesn’t change - Set quantity supplied (Vertical Line)

Inelastic supply characteristics

Hard to Produce

2. High barriers to entry in industries (few firms)

3. High cost or specialized inputs

4. Hard to switch from producing alternative goods

5. Elasticity coefficient less than 1

Elastic supply characteristics

Easier to produce

2. Low barriers to entry in industries (many firms)

3. Low cost or generic inputs

4. Easy to switch from producing alternative goods

5. Elasticity coefficient greater than 1

Cross price elasticity (XED)

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

2. Cross-Price elasticity of demand shows how sensitive a product is to a change in price of another good

3. 4. It shows if two goods are substitutes or complements

If coefficient is positive (shows direct relationship) then the goods are substitutes → t’s in substitutes look like positive

5. If coefficient is negative (shows inverse relationship) then the goods are complements

Income elasticity of demand (YED)

Measures how sensitive quantity demanded is to a change in income

Income elasticity of demand shows how sensitive a product is to a change in INCOME

4. If coefficient is positive (shows direct relationship) then the good is normal

If coefficient is negative (shows inverse relationship) then the good is Inferior

Calculate PED

PED form, Midpoint form, TRT

is a good more elastic in the short run or long run

Long run —> more time to plan

If quantity demanded doesn’t change what is the elasticity

Perfectly inelastic bc coefficient is 0