AP Micro Test 2

Market

A group of producers and consumers who exchange a good or service for payment

Perfectly Competitive Market

Assumes that there are many buyers and sellers in the market so that no one seller can influence the price of the product

Supply and Demand Model

A model of how a perfectly competitive market works

6 Components of S&D Model

Demand Curve

Set of factors that shift demand curve

Supply Curve

Set of factors that shift supply curve

Market Equilibrium (includes equilibrium price and equilibrium quantity)

The way the market equilibrium changes when the supply or demand curve changes

Demand Schedule

Table that displays the quantity demanded at different prices for a good or service

Quantity Demanded

Actual amount of a good or service consumers are willing and able to buy at some specific price

Demand Curve

Graphical representation of the demand schedule

Shows relationship between quantity and price

Law of Demand

All other things being equal, people demand less of a good or service at higher prices

Change in Demand

Shift of the demand curve, which changes the quantity demanded at any given price

Movement Along Demand Curve

Change in the quantity demanded of a good that is the result of a change in that good’s price

Increase in Demand

Demand Curve shifts to right

Decrease in Demand

Demand Curve shifts to left

Market Demand Curve

The horizontal sum of the individual demand curves of all consumers in that market

5 Factors for Demand Curve Shift

Tastes, Related Goods, Income, Buyers, Expectations

Change in Taste

Fads, changes in beliefs, or changes in culture that shift the demand curve for a good or service

Change in Prices of Related Goods or Services

Changes in prices of a related good or service shift demand differently depending on whether they are substitutes or complements

Substitute Good (Demand)

Two goods are considered substitutes if a rise in the price of one of the goods leads to an increase in the demand for the other good (sweatpants instead of jeans)

Complement Good (Demand)

Two goods are complements if a rise in the price of one of the goods leads to a decrease in the demand for the other good (peanut butter so also jelly)

Change in Income

Changes in income can shift demand for a good differently, depending on whether it is a normal or inferior good

Normal Good

When a rise in income increases the demand for a good

Inferior Good

When a rise in income decreases the demand for a good

Change in Buyers

Changes in the number of buyers or consumers can shift the demand curve

Left for decreased buyers

Right for increased buyers

Change in Expectations

Changes in expectations of how prices will change in the future can shift the demand curve

Expectations of a coming fall in price can cause a decrease in demand today (and vice versa)

Quantity Supplied

The actual amount of a good or service people are willing to sell at a specific price

Supply Schedule

Shows how much of a good or service producers will supply at different prices

Supply Curve

Graphical representation between the quantity supplied and the price

Law of Supply

Other things being equal, the price and quantity supplied of a good are positively related

Change in Supply

Shift of the supply curve, which indicates a change in the quantity supplied at any given price

A decrease in supply means a leftward shift of the supply curve

An increase in supply means a rightward shift of the supply curve

Movement Along Supply Curve

Change in the quantity supplied of a good arising from a change in the good’s price

Changes in Input Prices

Change in the price of an input, a good or service used to produce another good or service

Sugar and cream are inputs for ice cream. If the price of sugar or cream rises, the ice cream supply curve shifts left

Oil is one input for airline fuel. If the price of oil goes down, the supply curve for flights shifts right.

Input

Good or service that is used to produce another good or service

Change in Price of Related Goods Or Services

A change in the price of a related good or service (substitutes or complements in production by the same producer)

Substitute Goods (Supply)

Goods are substitutes if an increase in the price of one causes suppliers to supply less of the other

If the price of heating oil rises, refiners supply less gasoline, shifting the supply curve for gasoline to the left.

Complement Goods (Supply)

Goods are complements if an increase in the price of one causes suppliers to supply more of the other

If natural gas is a by-product of crude oil drilling, and the price of natural gas goes up, suppliers may supply more of both products. Thus, they are complements in production.

Changes in Producer Expectations

Changes in expectations of how the price of a good or service will change in the future

Expectations of a coming price increase can cause suppliers to decrease the amount they supply today

Expectations of a coming price decrease can cause suppliers to increase the amount they supply today

Changes in Number of Producers

Change in the number of producers of a good or service can shift the supply curve

If many of one good producer go out of business the supply curve will shift left

If new producers come into the market the supply curve will shift right

Changes in Technology

Changes in technology used to produce a good or service

If new techniques doubles the amount of a good produced the supply curve will shift right

If technology banned or removed makes the amount of a good produced reduce the supply curve will shift left

Individual Supply Curve

Relationship between quantity supplied and price for an individual producer

Market Supply Curve

Shows how the combined total quantity supplied by all individual producers in the market depends on the market price of that good

Price Elasticity of Demand

Ratio of the percentage change in the quantity demanded to the percentage change in the price as we move along the demand curve (dropping minus sign)

Substitution Effect

The change in the quantity of that good demanded as the consumer substitutes the good that has become relatively cheaper for the good that has become relatively more expensive

Income Effect

The change in the quantity demanded that results from a change in the consumer’s purchasing power when the price of the good changes

Real Income

When income is adjusted to reflect its true purchasing power

Total Effect

Combination of income and substitution effect

Calculate Price Elasticity

(% change in quantity demanded) / (% change in price)

% Change in Quantity Demanded

[(Change in Quantity Demanded) / (Initial Quantity Demanded)] * 100

% Change in Price

[(Change in price) / (Initial price)] * 100

Law of Demand (Price Elasticity)

A positive percentage change in the price leads to a negative percentage change in the quantity demanded, and vice versa

Midpoint / Arc Method

[(Final Quantity - Initial Quantity) / (Initial + Final Quantity) / 2] / [(Final Price - Initial Price) / (Initial + Final Price) / 2]

Elastic Demand

When the consumer is very responsive to change. PEoD > 1

Unit Elastic

The percentage change in quantity demanded or supplied is exactly equal to the percentage change in price

PEoD = 1

Inelastic Demand

When the consumer is not nearly as responsive to change. PEoD < 1

Perfectly Inelastic

When the quantity demanded does not respond at all to changes in the price (vertical line)

Perfectly Elastic

When any price in crease will cause the quantity demanded to drop to zero (horizontal line)

Total Revenue

Total value of sales of a good or service. Price multiplied by quantity sold

4 Factors for Price Elasticity of Demand

Close Substitutes, Income, Necessity vs Luxury, Time

Close Substitutes

Increases if there are close substitutes(pizza)

Decreases if there are no close substitutes(bypass surgery)

Share of Income

Price elasticity falls of spending is a small share of income (eggs)

Price elasticity rises if spending is a large share of income (houses)

Necessity vs Luxury Good

Low for necessities(epipens)

High for luxuries(teslas)

Time

Price elasticity increases as consumers have more time to adjust to price change, so long-run elasticity is usually higher than short-run elasticity.

Unit-Elastic Demand in Total Revenue

A price rise does not change total revenue. The quantity effect and the price effect exactly offset each other

Inelastic Demand in Total Revenue

A price rise increases total revenue. The price effect is stronger than the quantity effect

Elastic Demand in Total Revenue

A price rise decreases total revenue. The price effect is weaker than the quantity effect

Price Elasticity of Supply

Measure of the responsiveness of the quantity of a good supplied to changes in the price of that good

Calculate Price Elasticity of Supply

% change in quantity supplied / % change in price

Inelastic Supply

When the price elasticity of supply is less than 1

Elastic Supply

When the price elasticity of supply is greater than 1

Unit Elastic Supply

When the price elasticity of supply is equal to 1

Perfectly Inelastic Supply

When the price elasticity of supply is 0

Graph is a vertical line

Perfectly Elastic Supply

When the price elasticity of supply is infinite (at a certain price, producers will supply any quantity. Below, none. Above, extremely large amounts)

Graph is a horizontal line

5 Factors For Price Elasticity of Supply

Time, Existing Inventories, Availability, Substitutability, and Excess Capacity

Time (supply)

Price elasticity of supply increases as producers have more time to respond to price changes. Long-run elasticity is thus higher than short run elasticity

Existing Inventories

Price elasticity of supply increases as producers have a larger quantity of products on hand. Inventories refer to the stock of products available for sale

Availability of Inputs

Price elasticity of supply rises when inputs can be put into or out of production at low cost. But, price elasticity of supply lowers when inputs are fixed or when it is costly to put inputs into or out of production

Substitutability of Inputs

Price elasticity of supply increases as producers have more options available for substitutes when making a product, for example, soda can be sweetened with sugar or corn syrup

Excess Capacity

Measures the producer’s ability to increase output in their current facilities

Price elasticity of supply will increase if there are higher degrees of excess capacity

Cross-Price Elasticity of Demand

Measures how the demand for a good is affected by prices of other goods

Calculate Cross-Price

% change in quantity of A demanded / % change in price of B

Income Elasticity of Demand

Measures how the demand for a good is affected by changes in income

Calculate Income Elasticity

% change in quantity demanded / % change in income

Negative Cross Price Elasticity

Identifies a complement(a good you buy less of when the price of another goes up)

Positive Cross Price Elasticity

Identifies a substitute(a good you buy more of when the price of the other goes up)

Negative Income Elasticity

Identifies an inferior good (a good you buy less of when income rises)

Positive Income Elasticity

Identifies a normal good (a good you buy more of when income rises)

Income-Elastic

Income elasticity of demand for a certain good is greater than 1

Demand for income-elastic goods rises faster than income (luxury goods)

Income-Inelastic

Income elasticity of demand for a certain good is less than 1

Demand for income-inelastic goods rises slower than income (food and clothing)

Consumer’s Willingness to Pay

The maximum price a consumer will buy that good

Individual Consumer Surplus

Net gain a buyer achieves from the purchase of a good

Willingness to pay - price paid

Total Consumer Surplus

Sum of individual consumer surpluses

Equal to the area below the demand curve but above the price

Cost

The lowest price a seller is willing to sell the good

Individual Producer Surplus

Net gain between the price the seller gets and the cost

Price received - cost

Total Producer Surplus

Sum of individual producer surpluses

Equal to the area above the supply curve but below the price

Equilibrium

An economic situation when no individual would be better off doing something different

Where the supply and demand curves intersect

Equilibrium price

The price at the point where the supply and demand curves intersect

Equilibrium quantity

The quantity of the good where the supply and demand curves intersect

Disequilibrium

When the market place is above or below the equilibrium point

Surplus

When the quantity supplied exceeds the quantity demanded. This occurs when the price is above the equilibrium level

To move back, the price of the good will fall

Shortage

When the quantity demanded exceeds the quantity supplied. This occurs when the price is below the equilibrium level

To move back, the price of the good will rise

Demand Curve Shifts Right in Equilibrium

Assuming the supply curve remains the same, when demand for a good or service increases, the equilibrium price and equilibrium quantity of the good or service both rise

Demand Curve Shifts Left in Equilibrium

Assuming the supply curve remains the same, when demand for a good or service decreases, the equilibrium price and equilibrium quantity of the good or service both fall