Knowt
AP Microeconomics Unit 2
Law of Demand 💸
The Law of Demand states that, ceteris paribus (all other things being equal), consumers buy more of a good at low prices and less of a good at higher prices. This results in a downward sloping demand curve.
"Price changes quantity demanded, price does not change demand." - Remember this key concept!
Non-Priced Determinants of Demand (Demand Shifters)
These factors cause a shift in the demand curve:
Tastes and Preferences: An increase in consumer taste for a good shifts the demand curve to the right, while a decrease shifts it to the left.
Market Size: An increase in the number of buyers increases demand, while a decrease decreases demand.
Prices of Related Goods:
Substitutes: When the price of one good increases, demand for the other good increases (e.g., jam and honey).
Complements: When the price of one good increases, demand for the other good decreases (e.g., jelly and peanut butter).
Changes in Income: For most goods, an increase in income increases demand, while a decrease decreases demand. However, for inferior goods, an increase in income decreases demand.
Expectations: Consumer expectations about future prices or availability can impact current demand.
Why Demand Curves Slope Downward
The demand curve slopes downward due to two main effects:
Substitution Effect: An increase in price makes substitutes look relatively less desirable, and a decrease in price makes alternatives more attractive.
Income Effect: An increase in price reduces purchasing power, while a decrease in price increases it.
Supply Curves 📈
Supply curves are the opposite of demand curves, with a direct relationship between price and quantity supplied. The Law of Supply states that, ceteris paribus, producers produce and sell more at high prices and less at low prices.
"Price changes quantity supplied, price does not change supply." - Another key concept to remember!
Non-Priced Determinants of Supply (Supply Shifters)
These factors cause a shift in the supply curve:
Input Prices: An increase in the price of resources used in production decreases supply, while a decrease increases supply.
Government Tools:
Taxes per Unit: Decrease supply.
Subsidies: Increase supply.
Regulations: Typically decrease supply.
Number of Sellers: An increase in the number of businesses producing a good increases supply, while a decrease decreases supply.
Technology: Increases in technology increase supply.
Prices of Other Goods: Can impact supply if the price of a related good changes.
Producer Expectations: Expectations about future prices or availability can impact current supply.
Price Elasticity of Demand 📊
Price elasticity of demand measures how responsive quantity demanded is to a change in price. There are six tests to determine price elasticity:
Test | Description | Elastic or Inelastic |
|---|---|---|
1. Do you need it? | Essential goods tend to be inelastic, while non-essential goods are elastic. | Inelastic or Elastic |
2. How many substitutes are there? | Few substitutes lead to inelastic demand, while many substitutes lead to elastic demand. | Inelastic or Elastic |
3. How much income does it take to purchase the good? | Cheap goods tend to be inelastic, while expensive goods are elastic. | Inelastic or Elastic |
4. Steepness of the demand curve | Vertical curves indicate inelastic demand, while horizontal curves indicate elastic demand. | Inelastic or Elastic |
5. Total Revenue Test | If price falls and total revenue rises, demand is elastic. If price falls and total revenue falls, demand is inelastic. | Elastic or Inelastic |
6. Time | Demand tends to be more elastic in the long run than in the short run. | Elastic or Inelastic |
Note: These tests are not mutually exclusive, and a good may exhibit characteristics of both elastic and inelastic demand depending on the situation.## Demand and Elasticity 📊
Unit Elastic Demand
A change in price leads to a proportional change in quantity demanded.
Total revenue is maximized at this point.
Marginal Revenue Curve
Plotted below the demand curve, it shows the change in total revenue as price falls.
The marginal revenue curve has three sections:
Elastic portion: marginal revenue is positive, total revenue increases as price falls.
Unit elastic portion: marginal revenue is zero, total revenue does not change as price falls.
Inelastic portion: marginal revenue is negative, total revenue decreases as price falls.
Elasticity Coefficient
"A measure of how responsive the quantity demanded or supplied of a good is to a change in its price or other influential factors."
Calculated as the percentage change in quantity divided by the percentage change in price.
The preferred formula for the AP exam is: (new - old) / old × 100.
Elasticity Types
Elasticity Type | Description | Coefficient |
|---|---|---|
Perfectly Elastic | Infinite demand or supply at a specific price. | ∞ or undefined |
Perfectly Inelastic | Zero demand or supply at a specific price. | 0 |
Relatively Elastic | Demand or supply responds significantly to price changes. | > 1 |
Relatively Inelastic | Demand or supply responds slightly to price changes. | < 1 |
Unit Elastic | Demand or supply responds proportionally to price changes. | 1 |
Price Elasticity of Supply
Calculated similarly to demand elasticity.
Supply curves have a positive coefficient due to the direct relationship between price and quantity.
Coefficient interpretation:
1: relatively elastic supply curve.
= 1: unit elastic supply curve.
< 1: relatively inelastic supply curve.
Other Elasticities
Income Elasticity
Measures how changes in income affect demand.
Calculated as the percentage change in quantity divided by the percentage change in income.
Coefficient interpretation:
Positive: normal good.
Negative: inferior good.
Cross Price Elasticity
Measures the effect of a change in one good's price on the demand for another good.
Calculated as the percentage change in quantity divided by the percentage change in the other good's price.
Coefficient interpretation:
Positive: substitutes.
Negative: complements.
Market Equilibrium 📈
Finding Equilibrium
The point where the supply and demand curves intersect.
The equilibrium price and quantity are the point where the quantity supplied equals the quantity demanded.
Shifts in Supply and Demand
Shift | Effect on Equilibrium Price | Effect on Equilibrium Quantity |
|---|---|---|
Increase in Demand | ↑ | ↑ |
Decrease in Demand | ↓ | ↓ |
Increase in Supply | ↓ | ↑ |
Decrease in Supply | ↑ | ↓ |
Double Shifts
When two variables change, causing two curves to shift.
Can result in indeterminate changes in equilibrium price or quantity.
Consumer and Producer Surplus 🍔
Consumer Surplus
"The difference between the value to the customer and the price the customer pays."
Calculated as the difference between the marginal utility and the price.
Example: if the marginal utility is 8����ℎ��������8andthepriceis6, the consumer surplus is $2.
Producer Surplus
"The difference between the price received and the marginal cost of production."
Calculated as the difference between the price and the marginal cost.
Example: if the price is 6����ℎ���������������6andthemarginalcostis4, the producer surplus is $2.
Economic Surplus
The sum of consumer surplus and producer surplus.
May also include tax revenue.## Allocative Efficiency and Government Intervention 📈
Allocative Efficiency
Allocative efficiency is reached when the marginal cost of a product equals its marginal benefit, resulting in maximum economic surplus.
Deadweight Loss
Deadweight loss occurs when there is a reduction in economic surplus due to a failure to reach equilibrium. It can be calculated by finding the marginal cost and marginal benefit of a quantity and comparing it to the allocatively efficient point.
Price Floor ⬆
A price floor is a government intervention that establishes a minimum price for a product, making it illegal to charge less. For a price floor to be effective or binding, it must be above equilibrium.
Quantity Demanded | Quantity Supplied | |
|---|---|---|
Without Price Floor | q1 | q1 |
With Price Floor | q2 | q3 |
The quantity demanded (q2) is lower than the quantity supplied (q3), resulting in a surplus.
Consumer surplus is small, while producer surplus is large.
Deadweight loss occurs due to the failure to reach equilibrium.
Price Ceiling ⬇
A price ceiling is a government intervention that establishes a maximum price for a product. For a price ceiling to be effective or binding, it must be below equilibrium.
Quantity Demanded | Quantity Supplied | |
|---|---|---|
Without Price Ceiling | q1 | q1 |
With Price Ceiling | q3 | q2 |
The quantity demanded (q3) is greater than the quantity supplied (q2), resulting in a shortage.
Consumer surplus is large, while producer surplus is small.
Deadweight loss occurs due to the failure to reach equilibrium.
Per Unit Excise Tax 📊
A per unit excise tax is a tax imposed on each unit of a good sold. It shifts the supply curve, resulting in a new equilibrium with a lower quantity and higher price.
Price Paid by Buyers | Price Received by Sellers | |
|---|---|---|
Without Tax | p1 | p1 |
With Tax | p2 | p1 - tax |
Tax revenue is the vertical distance between the two supply curves multiplied by the quantity sold.
Producer surplus is small, while consumer surplus is large.
Deadweight loss occurs due to the failure to reach equilibrium.
Tax Incidence 🤝
Tax incidence refers to who bears the burden of a tax. The less elastic curve will pay more of the tax.
Elasticity | Tax Incidence | |
|---|---|---|
Demand Curve | Less Elastic | Buyers |
Supply Curve | Less Elastic | Sellers |
International Trade and Tariffs 🌎
International trade occurs when countries trade goods with each other. Tariffs are taxes imposed on imported goods.
World Price | Domestic Price | |
|---|---|---|
Without Tariff | pw | pw |
With Tariff | pw + tariff | pw + tariff |
The world supply curve shifts upward due to the tariff, resulting in a higher price and lower quantity imported.
Producer surplus grows, while consumer surplus shrinks.
Tariff revenue is generated, but there is also an efficiency loss due to the deadweight loss.
AP Microeconomics Unit 2
Law of Demand 💸
The Law of Demand states that, ceteris paribus (all other things being equal), consumers buy more of a good at low prices and less of a good at higher prices. This results in a downward sloping demand curve.
"Price changes quantity demanded, price does not change demand." - Remember this key concept!
Non-Priced Determinants of Demand (Demand Shifters)
These factors cause a shift in the demand curve:
Tastes and Preferences: An increase in consumer taste for a good shifts the demand curve to the right, while a decrease shifts it to the left.
Market Size: An increase in the number of buyers increases demand, while a decrease decreases demand.
Prices of Related Goods:
Substitutes: When the price of one good increases, demand for the other good increases (e.g., jam and honey).
Complements: When the price of one good increases, demand for the other good decreases (e.g., jelly and peanut butter).
Changes in Income: For most goods, an increase in income increases demand, while a decrease decreases demand. However, for inferior goods, an increase in income decreases demand.
Expectations: Consumer expectations about future prices or availability can impact current demand.
Why Demand Curves Slope Downward
The demand curve slopes downward due to two main effects:
Substitution Effect: An increase in price makes substitutes look relatively less desirable, and a decrease in price makes alternatives more attractive.
Income Effect: An increase in price reduces purchasing power, while a decrease in price increases it.
Supply Curves 📈
Supply curves are the opposite of demand curves, with a direct relationship between price and quantity supplied. The Law of Supply states that, ceteris paribus, producers produce and sell more at high prices and less at low prices.
"Price changes quantity supplied, price does not change supply." - Another key concept to remember!
Non-Priced Determinants of Supply (Supply Shifters)
These factors cause a shift in the supply curve:
Input Prices: An increase in the price of resources used in production decreases supply, while a decrease increases supply.
Government Tools:
Taxes per Unit: Decrease supply.
Subsidies: Increase supply.
Regulations: Typically decrease supply.
Number of Sellers: An increase in the number of businesses producing a good increases supply, while a decrease decreases supply.
Technology: Increases in technology increase supply.
Prices of Other Goods: Can impact supply if the price of a related good changes.
Producer Expectations: Expectations about future prices or availability can impact current supply.
Price Elasticity of Demand 📊
Price elasticity of demand measures how responsive quantity demanded is to a change in price. There are six tests to determine price elasticity:
Test | Description | Elastic or Inelastic |
|---|---|---|
1. Do you need it? | Essential goods tend to be inelastic, while non-essential goods are elastic. | Inelastic or Elastic |
2. How many substitutes are there? | Few substitutes lead to inelastic demand, while many substitutes lead to elastic demand. | Inelastic or Elastic |
3. How much income does it take to purchase the good? | Cheap goods tend to be inelastic, while expensive goods are elastic. | Inelastic or Elastic |
4. Steepness of the demand curve | Vertical curves indicate inelastic demand, while horizontal curves indicate elastic demand. | Inelastic or Elastic |
5. Total Revenue Test | If price falls and total revenue rises, demand is elastic. If price falls and total revenue falls, demand is inelastic. | Elastic or Inelastic |
6. Time | Demand tends to be more elastic in the long run than in the short run. | Elastic or Inelastic |
Note: These tests are not mutually exclusive, and a good may exhibit characteristics of both elastic and inelastic demand depending on the situation.## Demand and Elasticity 📊
Unit Elastic Demand
A change in price leads to a proportional change in quantity demanded.
Total revenue is maximized at this point.
Marginal Revenue Curve
Plotted below the demand curve, it shows the change in total revenue as price falls.
The marginal revenue curve has three sections:
Elastic portion: marginal revenue is positive, total revenue increases as price falls.
Unit elastic portion: marginal revenue is zero, total revenue does not change as price falls.
Inelastic portion: marginal revenue is negative, total revenue decreases as price falls.
Elasticity Coefficient
"A measure of how responsive the quantity demanded or supplied of a good is to a change in its price or other influential factors."
Calculated as the percentage change in quantity divided by the percentage change in price.
The preferred formula for the AP exam is: (new - old) / old × 100.
Elasticity Types
Elasticity Type | Description | Coefficient |
|---|---|---|
Perfectly Elastic | Infinite demand or supply at a specific price. | ∞ or undefined |
Perfectly Inelastic | Zero demand or supply at a specific price. | 0 |
Relatively Elastic | Demand or supply responds significantly to price changes. | > 1 |
Relatively Inelastic | Demand or supply responds slightly to price changes. | < 1 |
Unit Elastic | Demand or supply responds proportionally to price changes. | 1 |
Price Elasticity of Supply
Calculated similarly to demand elasticity.
Supply curves have a positive coefficient due to the direct relationship between price and quantity.
Coefficient interpretation:
1: relatively elastic supply curve.
= 1: unit elastic supply curve.
< 1: relatively inelastic supply curve.
Other Elasticities
Income Elasticity
Measures how changes in income affect demand.
Calculated as the percentage change in quantity divided by the percentage change in income.
Coefficient interpretation:
Positive: normal good.
Negative: inferior good.
Cross Price Elasticity
Measures the effect of a change in one good's price on the demand for another good.
Calculated as the percentage change in quantity divided by the percentage change in the other good's price.
Coefficient interpretation:
Positive: substitutes.
Negative: complements.
Market Equilibrium 📈
Finding Equilibrium
The point where the supply and demand curves intersect.
The equilibrium price and quantity are the point where the quantity supplied equals the quantity demanded.
Shifts in Supply and Demand
Shift | Effect on Equilibrium Price | Effect on Equilibrium Quantity |
|---|---|---|
Increase in Demand | ↑ | ↑ |
Decrease in Demand | ↓ | ↓ |
Increase in Supply | ↓ | ↑ |
Decrease in Supply | ↑ | ↓ |
Double Shifts
When two variables change, causing two curves to shift.
Can result in indeterminate changes in equilibrium price or quantity.
Consumer and Producer Surplus 🍔
Consumer Surplus
"The difference between the value to the customer and the price the customer pays."
Calculated as the difference between the marginal utility and the price.
Example: if the marginal utility is 8����ℎ��������8andthepriceis6, the consumer surplus is $2.
Producer Surplus
"The difference between the price received and the marginal cost of production."
Calculated as the difference between the price and the marginal cost.
Example: if the price is 6����ℎ���������������6andthemarginalcostis4, the producer surplus is $2.
Economic Surplus
The sum of consumer surplus and producer surplus.
May also include tax revenue.## Allocative Efficiency and Government Intervention 📈
Allocative Efficiency
Allocative efficiency is reached when the marginal cost of a product equals its marginal benefit, resulting in maximum economic surplus.
Deadweight Loss
Deadweight loss occurs when there is a reduction in economic surplus due to a failure to reach equilibrium. It can be calculated by finding the marginal cost and marginal benefit of a quantity and comparing it to the allocatively efficient point.
Price Floor ⬆
A price floor is a government intervention that establishes a minimum price for a product, making it illegal to charge less. For a price floor to be effective or binding, it must be above equilibrium.
Quantity Demanded | Quantity Supplied | |
|---|---|---|
Without Price Floor | q1 | q1 |
With Price Floor | q2 | q3 |
The quantity demanded (q2) is lower than the quantity supplied (q3), resulting in a surplus.
Consumer surplus is small, while producer surplus is large.
Deadweight loss occurs due to the failure to reach equilibrium.
Price Ceiling ⬇
A price ceiling is a government intervention that establishes a maximum price for a product. For a price ceiling to be effective or binding, it must be below equilibrium.
Quantity Demanded | Quantity Supplied | |
|---|---|---|
Without Price Ceiling | q1 | q1 |
With Price Ceiling | q3 | q2 |
The quantity demanded (q3) is greater than the quantity supplied (q2), resulting in a shortage.
Consumer surplus is large, while producer surplus is small.
Deadweight loss occurs due to the failure to reach equilibrium.
Per Unit Excise Tax 📊
A per unit excise tax is a tax imposed on each unit of a good sold. It shifts the supply curve, resulting in a new equilibrium with a lower quantity and higher price.
Price Paid by Buyers | Price Received by Sellers | |
|---|---|---|
Without Tax | p1 | p1 |
With Tax | p2 | p1 - tax |
Tax revenue is the vertical distance between the two supply curves multiplied by the quantity sold.
Producer surplus is small, while consumer surplus is large.
Deadweight loss occurs due to the failure to reach equilibrium.
Tax Incidence 🤝
Tax incidence refers to who bears the burden of a tax. The less elastic curve will pay more of the tax.
Elasticity | Tax Incidence | |
|---|---|---|
Demand Curve | Less Elastic | Buyers |
Supply Curve | Less Elastic | Sellers |
International Trade and Tariffs 🌎
International trade occurs when countries trade goods with each other. Tariffs are taxes imposed on imported goods.
World Price | Domestic Price | |
|---|---|---|
Without Tariff | pw | pw |
With Tariff | pw + tariff | pw + tariff |
The world supply curve shifts upward due to the tariff, resulting in a higher price and lower quantity imported.
Producer surplus grows, while consumer surplus shrinks.
Tariff revenue is generated, but there is also an efficiency loss due to the deadweight loss.
