AP_Microeconomics Unit 2 Notes

2.1 Demand:

Demand Definition: Quantities of a good consumers are willing to buy at various prices over a given period, assuming all other factors are constant (ceteris paribus).
Key Concepts:
- Law of Demand: An inverse relationship between price and quantity demanded. As price increases, quantity demanded decreases, and vice versa; thus, demand curves slope downward.
- Determinants of Demand (Shifters): Factors causing entire demand curves to shift. These include:
  - Income Changes: For normal goods, demand increases with income. For inferior goods, demand decreases with income.
  - Prices of Related Goods:
    - Substitutes: Goods used in place of one another. An increase in the price of a substitute increases demand for the original good.
    - Complements: Goods used together. An increase in the price of a complement decreases demand for the original good.
  - Population Changes (Number of Buyers): An increase in the number of consumers typically increases market demand.
  - Consumer Expectations: Beliefs about future prices or income can influence current demand.
  - Changes in Tastes and Preferences: Shifts in consumer preferences can increase or decrease demand.
Demand Curve:
- Shift vs. Movement:
  - A shift in the demand curve (change in demand) occurs when a determinant of demand changes, moving the entire curve left or right.
  - A movement along the demand curve (change in quantity demanded) occurs solely due to a change in the good's own price, as consumers move to a different point on the same curve.
Market Demand: The sum of all individual demand curves in a market. It is derived by horizontally adding the quantities demanded by all consumers at each specific price level.

- 2.2 Supply:

Supply Definition: Quantities of a good that sellers are willing and able to produce and sell at different prices over a given period, ceteris paribus.
Law of Supply: A direct (positive) relationship between price and quantity supplied. As price increases, quantity supplied increases, and vice versa; thus, supply curves slope upwards.
Determinants of Supply (Shifters): Factors causing entire supply curves to shift. These include:
- Input Costs: Changes in the prices of resources (labor, raw materials, energy) used in production. Higher input costs generally decrease supply.
- Technology: Improvements in technology typically reduce production costs and increase supply.
- Number of Sellers: An increase in the number of producers in a market increases market supply.
- Producer Expectations: Beliefs about future prices can influence current supply decisions.
- Government Policies: Such as taxes (decrease supply) and subsidies (increase supply).
Market Supply: The sum of all individual suppliers' quantities at each price. It is derived by horizontally adding the quantities supplied by all producers at each specific price level.
Change in Supply vs. Change in Quantity Supplied:
- A change in supply refers to shifts in the entire supply curve (due to non-price factors like production costs, technology, etc.).
- A change in quantity supplied refers to movements along the supply curve (due solely to price changes of the good itself).

- 2.3 Price Elasticity of Demand:

Price Elasticity of Demand (PED): A measure of how responsive the quantity demanded of a good is to a change in its price, expressed as the ratio of percentage changes.
- Formula: $PED=\frac{\%\Delta Q_{d}^{}}{\%\Delta P}$
Elastic vs. Inelastic Demand:
- Elastic Demand (PED > 1): Quantity demanded changes significantly in response to a price change. Consumers are very responsive.
- Inelastic Demand (PED < 1): Quantity demanded changes only slightly or not at all in response to a price change. Consumers are not very responsive.
- Unit Elastic Demand (PED = 1): Quantity demanded changes by the same percentage as the price change.
- Perfectly Elastic Demand (PED = $\infty$ ): Consumers will buy an infinite quantity at a specific price, but none at a slightly higher price (horizontal demand curve).
- Perfectly Inelastic Demand (PED = 0): Quantity demanded does not change at all, regardless of price changes (vertical demand curve).
Determinants of PED: Factors influencing price responsiveness:
- Availability of Substitutes: More and closer substitutes lead to more elastic demand.
- Necessity vs. Luxury Goods: Necessities generally have inelastic demand, while luxuries have elastic demand.
- Percentage of Budget Spent: Goods that command a large portion of a consumer's budget tend to have more elastic demand.
- Time Period for Adjustment: Demand tends to be more elastic in the long run than in the short run as consumers have more time to find substitutes or adjust their behavior.
Total Revenue Test: Used to determine PED by observing changes in total revenue (Price x Quantity) when price changes.
- Elastic Demand: Price and Total Revenue move in opposite directions.
- Inelastic Demand: Price and Total Revenue move in the same direction.
- Unit Elastic Demand: Total Revenue remains unchanged when price changes.

- 2.4 Price Elasticity of Supply:

Price Elasticity of Supply (PES): A measure of how responsive the quantity supplied of a good is to a change in its price, expressed as the ratio of percentage changes.
- Formula: $PES=\frac{\%\Delta Q_{s}^{}}{\%\Delta P}$
Elastic vs. Inelastic Supply:
- Elastic Supply (PES > 1): Quantity supplied changes significantly in response to a price change.
- Inelastic Supply (PES < 1): Quantity supplied changes only slightly or not at all in response to a price change.
- Unit Elastic Supply (PES = 1): Quantity supplied changes by the same percentage as the price change.
- Perfectly Elastic Supply (PES = $\infty$ ): Producers will supply an infinite quantity at a specific price, but none at a slightly lower price (horizontal supply curve).
- Perfectly Inelastic Supply (PES = 0): Quantity supplied does not change at all, regardless of price changes (vertical supply curve).
Determinants of PES: Factors influencing supply responsiveness:
- Availability of Alternative Inputs: Ease of switching resources to produce a different good. More flexible inputs lead to more elastic supply.
- Time Horizon for Adjustment: Supply is generally more elastic in the long run than in the short run, as producers have more time to adjust production capacity.
- Producer/Inventory Levels: Firms with large inventories can respond more elastically to price changes.
- Excess Capacity: Firms with idle production capacity can increase output more easily, leading to more elastic supply.
- Mobility of Factors of Production: The ease with which factors of production can be moved to different uses.

- 2.5 Other Elasticities:

Income Elasticity of Demand (IED): Measures the response of quantity demanded to changes in consumer income.
- Formula: $IED=\frac{\%\Delta Q_{d}^{}}{\%\Delta I}$
- Normal Goods: Have a positive income elasticity (IED > 0); demand increases as income rises. Luxury goods are a type of normal good with IED > 1.
- Inferior Goods: Have a negative income elasticity (IED < 0); demand decreases as income rises.
Cross-Price Elasticity of Demand (XED): Measures how the quantity demanded of one good (A) responds to price changes of another good (B).
- Formula: $XED=\frac{\%\Delta Q_{d_{A}}^{}}{\%\Delta P_{B}}$
- Substitutes: Have a positive cross-price elasticity (XED > 0); an increase in the price of Good B increases demand for Good A.
- Complements: Have a negative cross-price elasticity (XED < 0); an increase in the price of Good B decreases demand for Good A.
- Unrelated Goods: Have a zero or near-zero cross-price elasticity (XED = 0)

- 2.6 Market Equilibrium:

Market Equilibrium: A state where the quantity demanded (Qd) exactly equals the quantity supplied (Qs) at a specific equilibrium price (Pe) and a specific equilibrium quantity (Qe). At this point, there are no shortages or surpluses, and the market is stable.
Consumer Surplus (CS): The difference between the maximum price consumers are willing to pay for a good and the actual market price they pay. Graphically, it's the area below the demand curve and above the equilibrium price.
Producer Surplus (PS): The difference between the actual market price producers receive for a good and the minimum price they are willing to accept to supply that good. Graphically, it's the area above the supply curve and below the equilibrium price.
Total Economic Surplus (Total Welfare): The sum of consumer surplus and producer surplus. At market equilibrium, total economic surplus is maximized, indicating an efficient allocation of resources where no deadweight loss occurs.
- Formula: $ES_{{total}}=CS+PS$

- 2.7 Market Disequilibrium:

Disequilibrium: A condition in the market where the quantity demanded does not equal the quantity supplied. This imbalance leads to either surpluses or shortages, and market forces will typically work to restore equilibrium.
Surplus (Excess Supply): Occurs when the market price is set above the equilibrium price, causing quantity supplied to be greater than quantity demanded (Q_{s}>Q_{d}^{} his typically leads to downward pressure on prices as sellers compete for buyers.
Shortage (Excess Demand): Occurs when the market price is set below the equilibrium price, causing quantity demanded to exceed quantity supplied (Q_{d}>Q_{s}^{} typically leads to upward pressure on prices as buyers compete for limited goods.

- 2.8 Government Intervention in Markets:

Price Controls: Government-mandated limits on how high or low a price can be charged for a good or service.
- Price Ceilings: A legal maximum price. If set below the equilibrium price (binding), it creates a shortage and can lead to non-price rationing, black markets, and reduced product quality (e.g., rent control).
- Price Floors: A legal minimum price. If set above the equilibrium price (binding), it creates a surplus and can lead to inefficient allocation or government purchases of excess supply (e.g., minimum wage, agricultural price supports).
Deadweight Loss (DWL): The loss of total economic efficiency or total surplus (consumer and producer surplus) when the equilibrium quantity of a good or service is not produced or consumed. It represents the value of transactions that do not occur due to market distortions, such as price controls, taxes, or monopolies. Graphically, DWL is often the area of a triangle that represents lost gains from trade.
Tax and Subsidy Impact:
- Taxes: A per-unit tax (e.g., excise tax) on goods typically increases the cost of production, shifting the supply curve to the left (decreasing supply). This leads to a higher equilibrium price and a lower equilibrium quantity, creating deadweight loss.
- Tax Incidence: How the cost of a tax is distributed between consumers and producers. It's determined by the relative price elasticities of demand and supply.
  - The side of the market (consumers or producers) that is less elastic (less -responsive to price changes) will bear a larger portion of the tax burden.
  - Conversely, the side that is more elastic will bear a smaller portion of the tax burden because they can more easily adjust their behavior or find alternatives.
- Subsidies: A per-unit payment from the government to producers (or consumers) for a good. Subsidies decrease the cost of production, shifting the supply curve to the right (increasing supply). This leads to a lower equilibrium price and a higher equilibrium quantity, though they can also create deadweight loss if they encourage overproduction beyond the efficient level.

- 2.9 International Trade and Public Policy:

Rationale for Trade: Nations engage in international trade to benefit from specialization and comparative advantage, leading to increased overall production and consumption beyond what's possible with autarky.
Tariffs: Taxes imposed on imported goods. Tariffs increase the domestic price of imports, reducing the quantity imported, increasing domestic production, and typically generating government revenue. They often lead to deadweight loss by distorting market efficiency.
Quotas: Numerical limits on the quantity of a good that can be imported. Quotas achieve similar effects to tariffs (higher domestic prices, reduced imports, increased domestic production) but do not generate tax revenue for the government; instead, quota rents may accrue to foreign producers or domestic importers holding licenses. Quotas also create deadweight loss.
Arguments for Trade Restrictions: Common arguments include protecting domestic jobs, national security, infant industry protection, and preventing unfair competition (e.g., from countries with lower labor standards or environmental regulations).
Arguments Against Trade Restrictions: Trade restrictions generally lead to higher consumer prices, reduced choices, inefficiency, and can provoke retaliatory measures from other countries, ultimately reducing overall welfare.
Autarky: A scenario where a country is economically self-sufficient and does not engage in international trade. Under autarky, a country's consumption possibilities are limited to its domestic production possibilities, often resulting in lower overall welfare compared to an open economy with trade.

- 2.10 Important Formulas:

Price Elasticity of Demand (PED): $PED=\frac{\%\Delta Q_{d}^{}}{\%\Delta P}$
Price Elasticity of Supply (PES): $PES=\frac{\%\Delta Q_{s}^{}}{\%\Delta P}$
Income Elasticity of Demand (IED): $IED=\frac{\%\Delta Q_{d}^{}}{\%\Delta I}$
Cross-Price Elasticity of Demand (XED): $XED=\frac{\%\Delta Q_{d_{A}}^{}}{\%\Delta P_{B}}$
Total Economic Surplus: $ES_{{total}}=CS(Consumerext{ }Surplus)+PS(Producerext{ }Surplus)$

- 2.11 Key Definitions:

Demand Definition: Quantities of a good consumers are willing to buy at various prices.
Law of Demand: The inverse relationship between price and quantity demanded.
Determinants of Demand: Non-price factors that cause the entire demand curve to shift.
Supply Definition: Quantities of a good that sellers are willing to produce and sell at different prices.
Law of Supply: The direct relationship between price and quantity supplied.
Determinants of Supply: Non-price factors that cause the entire supply curve to shift.
Price Elasticity of Demand (PED): A measure of how quantity demanded responds to price changes.
Elastic Demand: When PED > 1, indicating a significant response to price changes.
Inelastic Demand: When PED < 1, indicating minor responsiveness to price changes.
Unit Elastic Demand: When PED = 1, quantity demanded changes by the same percentage as price.
Perfectly Elastic Demand: When PED = ext{infinity}, demand curve is horizontal.
Perfectly Inelastic Demand: When PED = 0, demand curve is vertical.
Price Elasticity of Supply (PES): A measure of how quantity supplied responds to price changes.
Income Elasticity of Demand (IED): Measures the response of quantity demanded to income changes.
Normal Goods: Goods with a positive income elasticity of demand.
Inferior Goods: Goods with a negative income elasticity of demand.
Cross-Price Elasticity of Demand (XED): Measures how the quantity demanded of one good responds to price changes of another.
Substitutes: Goods with a positive cross-price elasticity of demand.
Complements: Goods with a negative cross-price elasticity of demand.
Market Equilibrium: The point where quantity supplied equals quantity demanded, with no shortages or surpluses.
Consumer Surplus (CS): The difference between what consumers are willing to pay and what they actually pay.
Producer Surplus (PS): The difference between what producers receive and their minimum acceptable price.
Total Economic Surplus: The sum of consumer surplus and producer surplus, maximized at equilibrium.
Disequilibrium: Occurs when supply and demand are out of balance.
Surplus (Excess Supply): Quantity supplied is greater than quantity demanded, occurring when price is above equilibrium.
Shortage (Excess Demand): Quantity demanded exceeds quantity supplied, occurring when price is below equilibrium.
Price Controls: Government-mandated maximum (ceilings) or minimum (floors) prices.
Price Ceiling: A legal maximum price that can be charged for a good or service.
Price Floor: A legal minimum price that can be charged for a good or service.
Deadweight Loss (DWL): Loss of economic efficiency or total surplus due to market distortion.
Taxes: Mandatory payments to the government, often leading to reduced supply and deadweight loss.
Subsidies: Government payments to producers or consumers, often leading to increased supply.
Tariffs: Taxes on imported goods.
Quotas: Limits on the amount of goods that can be imported.
Autarky: A self-sufficient economy with no international trade.