economics supply and demand test

law of demand

when the price of a good increases the quantity demanded decreases, ceteris paribus

law of supply

when the price of a good increases the quantity supplied increases

ceteris paribus

latin for all other things held constant - nothing else changes except price

income effect

demand increases when income increases for normal goods

inferior good

demand decreases when income increases

complements

goods that are used together — if the price of coffee increases then the demand for cream goes down

substitutes

one replaces the other, if coke prices goes up then the pepsi demand goes up

taste

if something becomes more popular the demand will go up

expectations

if people expect prices to rise soon then the current demand will go up

market size/# of buyers

if there are more buyers the demand goes up

price of inputs

if input cost increases then the supply decreases (shifts left)

labor productivity

more productivity means lower costs per unit so the supply goes up (shifts right)

govt subsidies

govt gives more money —> lowers costs so the supply goes up (shifts right)

excise tax

tax on production or sale means that costs rise and supply goes down (shifts left)

government regulations

more rules means higher costs so supply goes down

technology

better technology means more efficiency so supply goes up (shift right)

producer expectations

if producers expect higher future prices then their current supply will go down

number of producers

more producers more supply (shifts right)

fixed input

doesnt change w output for example - factory and machinery - even if the company produced 100 units the fixed input stays the same - cant be easily changed in the short run

variable input

something that changes with the level of input

workers, ingredients, electricity, packaging materials

short run

in the short run at least one input is fixed which is usually capital

buildings and machinery

long run

all inputs are variable so firms can change anything and nothing is fixed (investing in new tech, exiting in or out the market etc)

marginal product of labor

the amount where the total output increases when one or more worker is hired

diminishing marginal productivity

each extra worker adds less additional output after a point

the decrease in the marginal product of a variable input as more is combined with a fixed input

law of diminishing returns

as mor eof a variable input is added to fixed input the output increases at a decreasing rate

fixed costs

doesnt change and stays consistent (rent and insurance)

variable costs

changes with outputs (wages and materials)

marginal costs

additional cost of producing one mroe unit of output

change in total cost/change in output

marginal revenue

additional revenue a firm receives from selling another unit of output

price per unit

When a firm is most profitable

when marginal costs equal marginal revenue

shortage

where quantity demanded is greater than quantity supplied —> when it happens below equilibrium — price ceiling

surplus

quantity supplied is greater than quantity demanded — happens above equilibrium - price floor

market failure

when the market fails to allocate resources efficiently

price floor

the minimum wage — can only go higher and is above equilibrium - surplus

price ceiling

the maximum legal price and causes shortage if below equilibrium (rent control)

card krueger study

studied fast food restaurants when new jersey raised the minimum wage and pennsylvania didn’t — economists believed that employment would drop but it didn’t

anti gouging laws

creates shortages and discourage supply increases — makes a price ceiling

high demand and no incentive to increase supply —> shortage

protects consumers from sellers who are excessively pricing goods in the time of needs

sticky prices

prices that don’t adjust quickly to changes in demand or supply

contratc sand menu costs —> have long term expectations or fear of losing customers - cost of printing new menus

elasticity of demand

quantity demanded changes a lot when price changes

inelasticity of demand

quantity demanded changes a little —> gas and insulin

unit elastic (demand)

% change in quantity demanded = % change in price

demand elasticity formula

%change in quantity demanded/%change in price

necessity

inelastic

luxury

elastic

availability of substitutes

more substitutes mean they are more elastic

share of income spent on the good

if it takes up a bigger potion of your income then its more elastic

time

longer time —> more elastic since more time passes and people have more options to adjust and change their habits

elasticity of supply

when producers can easily change production of output as price changes

if output rises significantly —> elastic supply

inelasticity of supply

hard to change output if they cant adjust output easily then they have inelastic supply (oil, farmland and housing)

until elastic (supply)

when change in quantity supplied = change in price

simple manufacturing with adjustable production

elasticity of supply formula

% change in quantity supplied/ % change in price

Five conditions for market efficiency

1. rational decision makers

2. perfect competition

3. goods are excludable and real

4. no externalities

5. sufficient information

market failure

when one or more conditions arne’t met —> inefficiency

private good

excludable and rival (food and clothing)

public good

non rival and non excludable (national defense and public parks)

excludable

people can be prevented from using it

rival

one persons use reduces the availability for others

free rider problem

people benefit from a good without paying for it

externaility

a side effect that affects people other than the people who purchased the good (pollution and education)

asymmetric information

one party knows more than the other

adverse selection

higher risk people end up buying the market while lower risk people leave the market which causes the market to break down