AP Micro Unit 2

Demand

The different quantities of goods that consumers are willing and able to buy at different price points

Law of Demand

Inverse relationship

P↑=Q_d↓

The Substitution Effect

As the price of a product increases, consumers buy less of that product and substitute it for another, cheaper product

The Income Effect

As the price of a product increases, the purchasing power decreases for consumers, forcing them to purchase less of the product

Law of Diminishing Marginal Utility

As you consume more of a product, the additional benefit you receive will eventually begin to decrease

The 5 Determinants of Demand

• Change in consumer preference

• Change in the price of substitute and/or complement goods

• Changes in income

• Change in number of buyers

• Future expectations

Substitute Goods

Goods that are used in place of one another

Complement Goods

Goods that are bought and used together

Normal Goods

When income increases, consumers buy more of these

Inferior Goods

When income increases, consumers buy less of these

The 6 Determinants of Supply

• Change in price/availability of resources

• Change in technology

• Govt intervention

• Change in price of related goods

• Change in expectations

• Change in the number of sellers

Law of Supply

Direct relationship

P↑=Q_s↑

Price Elasticity of Demand (PED)

Measures how sensitive Q_d is to a change in price

Equation for PED

% change in quantity/ % change in price

Inelastic Demand

Quantity is INsensitive to a change in price

If price increases, Q_d will fall a little and vice versa for decreasing

Inelastic Goods

Few substitutes

Necessities

The elasticity coefficient is less than one

Elastic Demand

Quantity is sensitive to a change in price

If price decreases, Q_d will fall a lot and vice versa for increasing

Elastic Goods

Many substitues

Luxuries/non-essentials

Elasticity coefficient greater than 1

Inelastic Demand for Total Revenue

P↑= TR↑

Elastic Demand for Total Revenue

P↑= TR↓

Unit Elastic Demand for Total Revenue

P↑= TR stays the same

Price Elasticity of Supply

Measures how sensitive quantity supplied is to a change in price

Inelastic Supply

Quantity is INsensitive to a change in price

If price increases, Q_s will increase a little and vice versa

Most goods have an inelastic supply in the short run

Inelastic Supply Characteristics

Hard to produce

High costs

Specialized resources

Elasticity coefficient less than 1

Elastic Supply

Quantity is sensitive to a change in price

If price increases, Q_s will increase a lot and vice versa

Most goods have an elastic supply in the long run

Elastic Supply Characteristics

Easier to produce

Low costs

Generic resources

Elasticity coefficient greater than 1

Cross Price Elasticity

Measures how sensitive a product is to a change in the price of another good

Determines if goods are substitutes or complements

Cross Price Elasticity Equation

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

Positive Cross Price Elasticity

They’re substitute goods

Negative Cross Price Elasticity

They’re complement goods

Income Elasticity of Demand

Measures how sensitive a product is to a change in income

Determines if goods are normal or inferior

Income Elasticity of Demand Equation

% change in quantity of good B/ % change in income

Postive Income Elasticity of Demand

They’re normal goods

Negative Income Elasticity of Demand

They’re inferior goods

What happens when there is a surplus?

Producers lower prices

What happens when there is a shortage?

Producers raise prices

Excise Taxes

A per-unit tax on producers

The goal is for the producer to make less of the good

When demand is perfectly inelastic, who pays the tax?

Tax is paid entirely by consumers

When demand is relatively inelastic, who pays the tax?

Tax is mostly paid by consumers

When demand is unit elastic, who pays the tax?

Tax is equally shared by consumers and producers

When demand is relatively elastic, who pays the tax?

Tax is mostly paid by producers

When demand is perfectly elastic, who pays the tax?

Tax is paid entirely by consumers

World Price

Price paid by countries to import goods
Would pay this price if its cheaper than producing domestically

Quota

A limit on the number of imports

What is the purpose of Tariffs and Quotas?

To protect domestic producers from a cheaper world price