AP Economics Unit 5: Demand & Elasticity Vocabulary

Demand and Supply: Key Concepts

Demand (AP Economics: Unit 5): The amount of a particular good or service consumers are willing and able to buy at different possible prices at a particular time; ceteris paribus.
Demand vs. Want: Demand and Want are not the same in economics. You might want a car but you must be able to purchase it for it to be a demand.
Law of Demand: When the price of a product increases, the quantity demanded falls; ceteris paribus.
Supply: The Law of Supply—Manufacturers will produce more when prices rise and produce less when prices fall; ceteris paribus.
Equilibrium and Market Clearing Price: The price at which the quantity supplied equals the quantity demanded; the market clears.

Demand and the Demand Curve

Demand video (contextual)
Demand is the relationship between price and quantity demanded, holding all else constant (ceteris paribus).
Demand curve characteristics:
- Demand curves slope downward (to the right).
- Quantity demanded is the variable on the horizontal axis (dependent variable).
- Prices appear on the vertical axis (independent variable).
Law of Demand (re-stated): Consumers buy less of something at higher prices than they do at lower prices; effects on decisions reflect this inverse relationship.
Price affects consumer decisions; trend: higher price leads to lower quantity demanded, under ceteris paribus.

Buying Power and the Income Effect

Buying Power: When prices go down, people have more buying power; when prices rise, buying power falls.
Income Effect: The change in consumption patterns due to the change in purchasing power.

Diminishing Concepts in Demand

Diminishing Personal Value:
1) As prices rise, consumers prioritize what is most important.
2) Consumers choose what has more value as prices inflate.
Diminishing Marginal Utility: 1) No matter the price, the usefulness of additional units tends to decrease.
- This explains why demand is not limitless.
- There is a limit to how much of a good a consumer will want.
  2) The next unit consumed provides less extra satisfaction than the previous unit.
  3) Lower prices or economic incentives are needed to increase the quantity demanded.
Example: Pizza for sale
- First two slices: $5.00 total
- Third slice: $1.00 (diminished marginal utility, price drop can spur continued purchase if value is perceived)

Substitutes and Complementary Goods

Substitutes: Goods or services that can replace one another.
- If the price of one good rises, the demand for the substitute increases.
- Example: If the price of butter rises, demand for margarine may rise.
Complements: Goods that are often consumed together.
- If the price of one good rises, the demand for its complement falls.
- Example: Printers and ink cartridges.
The general rule:
- Substitutes: a rise in price of good A increases demand for good B.
- Complements: a rise in price of good A decreases demand for good B.
Substitutes example prompt: Is there a substitute for gasoline?

Price Elasticity of Demand (PED/PEoD)

Demand can be elastic or inelastic:
1) Elastic demand: Large price changes lead to large changes in quantity demanded.
2) Inelastic demand: Small price changes lead to small changes in quantity demanded.
Price Elasticity of Demand (PED or PEoD):
- A measure of the responsiveness of quantity demanded to a price change.
- Formula: ext{PEoD} = rac{rac{ ext{Δ}Q}{Q}}{rac{ ext{Δ}P}{P}} = rac{rac{ΔQ}{Q1}}{rac{ΔP}{P1}}
- A common representation (percent-change form): ext{PEoD} = rac{ ext{ ext{%}
  ΔQ}}{ ext{ ext{%}
  ΔP}} where the % changes are calculated using the initial values.
PED provides the sensitivity of quantity demanded to price changes; elastic if |PED| > 1, inelastic if |PED| < 1, unit elastic if |PED| = 1.

Determinants of Elasticity of Demand

Availability of Substitutes (the fundamental determinant):
- More substitutes → more elastic demand.
- Fewer substitutes → more inelastic demand.
Time Horizon:
- Short-run: less elastic (less time to adjust).
- Long-run: more elastic (more time to adjust).
Category of Product (breadth of the category):
- Broader category → less elastic.
- Narrow/specific category → more elastic.
Necessities vs Luxuries:
- Necessities → inelastic.
- Luxuries → elastic.
Purchase Size relative to the consumer's budget:
- Small purchases → more inelastic.
- Large purchases → more elastic.

Summary of Determinants: Elasticity Spectrum

Less Elastic vs More Elastic factors:
- Fewer Substitutes → Less Elastic; More Substitutes → More Elastic
- Short Run (less time) → Less Elastic; Long Run (more time) → More Elastic
- Necessities → Less Elastic; Luxuries → More Elastic
- Small Part of Budget → More Inelastic; Large Part of Budget → More Elastic

Elasticity Classifications (Key Metrics)

Relatively Elastic: relatively small changes in price cause relatively large changes in quantity; |ε| > 1.
Unit Elastic: the percentage change in quantity demanded equals the percentage change in price; |ε| = 1.
Perfectly Elastic: any price increase drives quantity demanded to zero; |ε| = ∞.
Relatively Inelastic: percentage change in quantity demanded is smaller than the percentage change in price; |ε| < 1.
Perfectly Inelastic: quantity demanded does not change with price; ε = 0.

Elasticity Scale (for quick reference)

Relatively Inelastic < 1 < Unit Elastic < ∞ (conceptual scale)
Diagram reference: Elasticities are often summarized as
- Relatively Inelastic (<1)
- Unit Elastic (1)
- Relatively Elastic (>1)
- Perfectly Elastic (∞)
- Perfectly Inelastic (0)

Calculating Price Elasticity of Demand (PEoD)

You will need to gather 4 facts:
- Old price and new price
- Old quantity demanded and new quantity demanded
Steps:
1) Calculate % Change in Quantity Demanded: ext{ ext{%}
ΔQ} = rac{Q2 - Q1}{Q1} 2) Calculate % Change in Price: ext{ ext{%} ΔP} = rac{P2 - P1}{P1}
3) Compute PEoD: ext{PEoD} = rac{ ext{ ext{%}
ΔQ}}{ ext{ ext{%}
ΔP}}
Note on signs: The sign of PEoD indicates direction (e.g., price up typically yields negative ΔQ for normal goods), but elasticity magnitude is often considered in absolute value for classification.

Shifts in the Demand Curve vs Movements Along the Curve

Movement Along the Demand Curve: caused by a change in the good’s own price; quantity demanded changes, but the curve itself does not shift.
Shift of the Demand Curve: caused by non-price determinants; the entire curve shifts to the right (increase in demand) or to the left (decrease in demand).
- Rightward shift indicates demand increases at every price; leftward shift indicates demand decreases.
- Note: The instruction sometimes mentions “upward shift” in error; standard terminology is rightward (increase) or leftward (decrease).

Factors That Shift the Demand Curve (Table 5.1 Concepts)

Income:
- Increase in income shifts demand to the right for a normal good; to the left for an inferior good.
- Decrease in income shifts demand to the left for a normal good; to the right for an inferior good.
Prices of Related Goods:
- Substitutes: An increase in the price of a substitute shifts demand to the right for the original good.
- Complements: A decrease in the price of a complement shifts demand to the right for the original good.
- Conversely: A decrease in the price of a substitute shifts demand to the left; an increase in the price of a complement shifts demand to the left.
Tastes (Preferences):
- Increase in tastes for a product shifts demand to the right; a decrease shifts demand to the left.
Expectations:
- If buyers expect prices to rise in the future, current demand shifts to the right.
- If buyers expect prices to fall in the future, current demand shifts to the left.
Number of Buyers:
- An increase in buyers shifts market demand to the right; a decrease shifts demand to the left.

Practical Examples (From Table 5.1 Context)

When the price of a substitute rises: demand for the original good increases (D1 → D2).
When the price of a substitute falls: demand for the original good decreases (D1 → D2).
When the price of a complement falls: demand for the original good increases (D1 → D2).
When income rises:
- For a normal good: demand increases (D1 → D2).
- For an inferior good: demand decreases.
When income falls:
- For a normal good: demand decreases.
- For an inferior good: demand increases.
When tastes change in favor of a good: demand increases (D1 → D2).
When the price is expected to rise in the future: current demand increases (D1 → D2).
When the market demand for the good increases due to more buyers: demand increases (D1 → D2).

Quick Reference: Demand Shifts vs Movements Along the Curve

Movement along the curve: caused by price changes of the good itself; shows a change in quantity demanded.
Shift of the curve: caused by non-price determinants; shows a change in demand at every price.

Notation and Graphical References (Notes from Slides)

The graph typically displays: Demand curves (D) shifting to D2 from D1 when a determinant increases demand, or moving from a point on D to another point on the same curve when price changes.
The table and diagrams in the transcript illustrate how shifts occur and how to label D1 vs D2 in demand tables.

Summary Takeaways

Demand reflects willingness and ability to buy at various prices, holding everything else constant.
The Law of Demand explains the inverse relationship between price and quantity demanded, with the downward-sloping demand curve.
The Income Effect (Buying Power) explains how purchasing power changes with price, influencing consumption.
Diminishing Marginal Utility explains why quantity demanded is not infinite; each additional unit provides less satisfaction.
Substitutes and Complements affect demand depending on price changes of related goods.
Price Elasticity of Demand measures how responsive quantity demanded is to price changes and is determined by substitutes, time horizon, product category, necessities vs luxuries, and budget share.
Elasticity classifications help predict how demand will respond to price changes and guide business pricing and policy decisions.
Shifts in the demand curve occur due to non-price factors; the direction of the shift is determined by the specific determinant.

ext{PEoD} = rac{ ext{ ext{%}
ΔQ}}{ ext{ ext{%}
ΔP}} \\text{ ext{%}
ΔQ} = rac{Q2 - Q1}{Q1}, \ ext{ ext{%} ΔP} = rac{P2 - P1}{P1}

Elasticity categories (absolute values):
- Relative(ly) Elastic: |ε| > 1
- Unit Elastic: |ε| = 1
- Relative(ly) Inelastic: |ε| < 1
- Perfectly Elastic: ε = ∞
- Perfectly Inelastic: ε = 0