AP Macroeconomics Unit 1 Notes: How Markets Use Prices to Allocate Resources

Demand

What demand is (and what it is not)

Demand is the relationship between the price of a good or service and the quantity that consumers are willing and able to buy over a given time period, holding other factors constant.

Two parts of that definition matter a lot:

1. “Willing and able” means demand is not the same as desire. You might want a new phone, but if you can’t afford it, that desire does not show up as demand in the market.
2. “Relationship” means demand is not a single number. It’s a schedule (or curve) showing how quantity demanded changes at different prices.

A common way to represent demand is with a demand schedule or demand curve. Sometimes you’ll also see a simple linear demand equation such as:

Q_d = a - bP

Here, Q_d is quantity demanded, P is price, a sets the intercept (demand when P = 0 in that simplified model), and b is the slope term that captures how sensitive demand is to price.

Why demand matters in macroeconomics

Even in AP Macroeconomics, where you’ll spend a lot of time on economy-wide measures (GDP, inflation, unemployment), the logic of demand is foundational because:

• The price system is a major way market-based economic systems allocate scarce resources. Prices coordinate millions of decisions without central planning.
• Later macro models (like aggregate demand) build on the same idea: when the “price” of something changes, behavior changes.
• Policy discussions often rely on demand logic—taxes, subsidies, price controls, and supply shocks all show up first as changes in incentives to buy.

How demand works: the law of demand

The law of demand states that, ceteris paribus (all else equal), as price rises, quantity demanded falls; as price falls, quantity demanded rises.

This inverse relationship happens for several intuitive reasons:

• Substitution effect: When a good becomes more expensive, you switch toward substitutes.
• Income effect: A higher price makes your purchasing power effectively smaller, so you buy less.
• Diminishing marginal utility: The extra satisfaction from additional units tends to fall, so consumers require a lower price to buy more units.

Important: “All else equal” is not a throwaway phrase. Demand curves slope downward because we’re isolating the effect of price while holding other determinants fixed.

Quantity demanded vs. demand (movement vs. shift)

Students often mix up these two ideas:

• Quantity demanded changes when price changes and you move along a given demand curve.
• Demand changes when a non-price determinant changes and the entire demand curve shifts.

If the question says “price of the good changed,” you should think movement along the curve. If it says “income changed” or “tastes changed,” you should think shift.

Determinants of demand (what shifts the curve)

A shift in demand means that at every price, consumers want to buy a different quantity than before.

Common demand shifters you’re expected to know:

• Income
  • For normal goods, higher income increases demand.
  • For inferior goods, higher income decreases demand.
• Prices of related goods
  • Substitutes: If the price of a substitute rises, demand for this good rises.
  • Complements: If the price of a complement rises, demand for this good falls.
• Tastes and preferences (trends, advertising, changing preferences)
• Expectations (about future prices or income)
  • If you expect prices to rise soon, current demand may increase.
• Number of buyers (population growth, demographics)

A quick memory aid many teachers use is “NICE”: Number of buyers, Income, Complements/substitutes, Expectations (and you can mentally add tastes/preferences too).

Demand in action: examples and a worked problem

Example 1 (movement along demand): If the price of coffee falls, more people buy coffee. That is an increase in quantity demanded, not an increase in demand.

Example 2 (shift in demand): If a study finds coffee reduces health risks, more people want coffee at every price. That is an increase in demand (curve shifts right).

Worked problem (interpreting a linear demand equation):
Suppose the market demand for movie tickets is:

Q_d = 120 - 4P

• If P = 10, then:
  • Substitute into the equation:

Q_d = 120 - 4(10)

Q_d = 80

Interpretation: at a price of 10 (in whatever currency units), consumers demand 80 tickets (in whatever quantity units).

• If price rises from 10 to 15, you are moving along the same demand curve:

Q_d = 120 - 4(15)

Q_d = 60

Quantity demanded falls from 80 to 60 due to the higher price.

What commonly goes wrong with demand

A few high-frequency misconceptions:

• Confusing demand with quantity demanded: A price change never “shifts demand” by itself.
• Forgetting ceteris paribus: If both price and something else changed, you need to separate the effects.
• Mixing up substitutes vs. complements: If the price of peanut butter rises, demand for jelly (a complement) tends to fall, not rise.

Exam Focus

• Typical question patterns
  • Given a scenario (income rises, tastes change, substitute price changes), identify whether demand shifts left/right or whether there is movement along the curve.
  • Interpret or compute quantities from a demand schedule/graph.
  • Explain, in words, why the law of demand holds (substitution and income effects).
• Common mistakes
  • Calling an increase in quantity demanded an “increase in demand” when the only change is price.
  • Shifting the curve in the wrong direction for substitutes/complements.
  • Ignoring the time period (short run vs. long run language sometimes appears, even in basic questions).

Supply

What supply is (and how it differs from “how much exists”)

Supply is the relationship between the price of a good or service and the quantity that producers are willing and able to sell over a given time period, holding other factors constant.

Supply is not the same thing as:

• Inventory (how much is currently sitting on shelves)
• Production capacity (the maximum possible output)

Instead, it’s about how much firms choose to bring to market at different prices, given costs and incentives.

A simple linear form looks like:

Q_s = c + dP

Here, Q_s is quantity supplied, P is price, and d is positive for a typical upward-sloping supply curve.

Why supply matters in macroeconomics

Supply is essential for understanding how economies respond to:

• Cost changes (wages, commodity inputs, energy prices)
• Productivity and technology improvements
• Shocks like natural disasters or supply chain disruptions

In a market system, supply responses help determine how scarce resources (labor, raw materials, capital) get allocated across industries.

How supply works: the law of supply

The law of supply states that, ceteris paribus, as price rises, quantity supplied rises; as price falls, quantity supplied falls.

This positive relationship is largely about incentives and costs:

• A higher price can make production more profitable, so firms expand output.
• Producing more often requires using resources that are increasingly costly or less efficient (rising marginal cost), so firms generally need a higher price to justify greater quantities.

Quantity supplied vs. supply (movement vs. shift)

Just like demand:

• Quantity supplied changes when price changes (movement along the supply curve).
• Supply changes when a non-price determinant changes (supply curve shifts).

A price increase causes a movement up along supply—not a rightward shift.

Determinants of supply (what shifts the curve)

A shift in supply means that at every price, producers are willing and able to sell a different quantity than before.

Key supply shifters:

• Input prices (wages, rent, raw materials)
  • Higher input prices decrease supply (left shift).
• Technology and productivity
  • Better technology increases supply (right shift) by lowering costs per unit.
• Taxes and subsidies
  • A tax on producers tends to decrease supply; a subsidy tends to increase supply.
• Number of sellers
  • More firms entering increases supply.
• Expectations
  • If firms expect higher future prices, they may reduce current supply to sell later.
• Regulation and trade conditions
  • More restrictive regulation can raise costs and reduce supply; easier access to imported inputs can increase supply.

Supply in action: examples and a worked problem

Example 1 (movement along supply): If the price of wheat rises, farmers plant more wheat and bring more to market—an increase in quantity supplied.

Example 2 (shift in supply): A drought reduces crop yields. At every price, farmers can supply less wheat—supply decreases (curve shifts left).

Worked problem (compute quantities from a supply equation):
Suppose market supply is:

Q_s = 20 + 3P

• If P = 10:

Q_s = 20 + 3(10)

Q_s = 50

• If price rises to 15 (movement along the curve):

Q_s = 20 + 3(15)

Q_s = 65

Quantity supplied increases because the price increased.

What commonly goes wrong with supply

• Mixing up a supply decrease with lower quantity supplied: If price falls, quantity supplied falls (movement). If costs rise, supply falls (shift).
• Thinking “more demand causes more supply”: Demand can lead to a higher equilibrium price and quantity, which may result in a higher quantity supplied, but that is not the same as a shift in the supply curve.
• Forgetting that policies can shift supply: Per-unit taxes on producers, compliance costs, or subsidies are classic AP-style shifters.

Exam Focus

• Typical question patterns
  • Identify whether an event (input price change, new technology, tax/subsidy) shifts supply left/right.
  • Read a supply graph and explain how quantity supplied responds to a price change.
  • Use supply schedules/equations to compute quantities supplied at given prices.
• Common mistakes
  • Shifting supply when the prompt only changes the product’s own price.
  • Shifting in the wrong direction for input costs (higher costs reduce supply).
  • Ignoring that “more sellers” is a supply shifter, not a demand shifter.

Market Equilibrium, Disequilibrium, and Changes

What equilibrium means in a market

A market brings together buyers (demand) and sellers (supply). Market equilibrium occurs at the price where quantity demanded equals quantity supplied.

Equilibrium is important because it describes a situation with no built-in pressure for price to change. That doesn’t mean “perfect” or “best,” and it doesn’t mean nothing changes—just that, at that price, the plans of buyers and sellers are consistent.

At equilibrium:

Q_d = Q_s

The corresponding price is the equilibrium price, and the corresponding quantity is the equilibrium quantity.

Why equilibrium matters (the big picture)

Equilibrium is the core of how the price system allocates scarce resources in a market economy:

• Prices act like signals: they summarize scarcity and incentives.
• When conditions change (tastes, technology, input costs), equilibrium changes—resources shift across markets.
• Later in AP Macro, you’ll use similar logic to understand overall price level changes and output changes (aggregate supply and aggregate demand), so mastering micro-style equilibrium here pays off.

How equilibrium is found (graphically and algebraically)

Graphically:

• Demand slopes downward.
• Supply slopes upward.
• The intersection is equilibrium.

Algebraically (when given equations): set Q_d = Q_s and solve for P, then substitute back to get Q.

Worked equilibrium problem:
Suppose:

Q_d = 100 - 2P

Q_s = 10 + 3P

1) Set quantity demanded equal to quantity supplied:

100 - 2P = 10 + 3P

2) Solve for price:

90 = 5P

P = 18

3) Find equilibrium quantity by substituting P = 18 into either equation:

Q = 100 - 2(18)

Q = 64

So equilibrium is P = 18 and Q = 64.

Disequilibrium: shortages and surpluses

A market is in disequilibrium when the price is not at the equilibrium level. That creates either a shortage or a surplus.

Shortage (excess demand)

A shortage occurs when:

Q_d > Q_s

This typically happens when the price is below equilibrium. Buyers want more than sellers are willing to provide.

Adjustment logic: When buyers compete for the limited goods, sellers can raise prices. As price rises:

• quantity demanded falls (movement along demand)
• quantity supplied rises (movement along supply)

This pushes the market back toward equilibrium.

Surplus (excess supply)

A surplus occurs when:

Q_s > Q_d

This typically happens when the price is above equilibrium. Sellers want to sell more than buyers want to purchase.

Adjustment logic: Sellers compete to get rid of unsold goods, which tends to push prices down. As price falls:

• quantity demanded rises
• quantity supplied falls

Again, the market tends to move back toward equilibrium.

Changes in equilibrium: shifts in demand and supply

When either demand or supply shifts, equilibrium price and quantity change. AP exam questions often test whether you can predict the direction of change without doing heavy math.

1) Increase in demand (demand shifts right)

If demand increases and supply stays the same:

• equilibrium price rises
• equilibrium quantity rises

Intuition: more buyers (or stronger willingness to buy) bid up prices, and firms respond by increasing quantity supplied along the same supply curve.

2) Decrease in demand (demand shifts left)

If demand decreases and supply stays the same:

• equilibrium price falls
• equilibrium quantity falls

3) Increase in supply (supply shifts right)

If supply increases and demand stays the same:

• equilibrium price falls
• equilibrium quantity rises

Intuition: producers can provide more at every price (often because costs fell), pushing prices down while increasing the amount sold.

4) Decrease in supply (supply shifts left)

If supply decreases and demand stays the same:

• equilibrium price rises
• equilibrium quantity falls

This is a classic “negative supply shock” pattern (for example, an input price spike).

Simultaneous shifts (why some outcomes are ambiguous)

When both demand and supply shift, one of the equilibrium outcomes may be indeterminate without more information.

A helpful way to reason is to separate outcomes:

• Demand shifts primarily push price and quantity in the same direction.
• Supply shifts push price and quantity in opposite directions.

So if both demand and supply increase:

• quantity definitely increases (both shifts raise quantity)
• price is ambiguous (demand pushes price up, supply pushes price down)

If demand increases while supply decreases:

• price definitely increases (both shifts raise price)
• quantity is ambiguous

Table: directional effects (one shift at a time)

Changes vs. movements: putting it all together with a scenario

Consider gasoline:

• If the price of gasoline rises because of an oil refinery disruption, that is typically a decrease in supply (left shift), which raises the equilibrium price and lowers equilibrium quantity.
• After the price rises, drivers may cut back—this is a decrease in quantity demanded (movement along the demand curve), not a demand shift.

This two-step thinking is exactly what AP questions often want: identify the shock (shift) and then the response to the new price (movement).

What commonly goes wrong with equilibrium and shifts

• Labeling the disequilibrium backwards: A price ceiling below equilibrium creates a shortage, not a surplus.
• Forgetting which curve shifts: “More buyers enter the market” shifts demand, not supply.
• Assuming both price and quantity always move: With simultaneous shifts, one variable can be ambiguous.
• Thinking equilibrium means “fair” or “optimal”: Equilibrium is a descriptive outcome of market interaction, not a moral judgment.

Exam Focus

• Typical question patterns
  • Given demand and supply equations or a graph, find equilibrium price and quantity.
  • Given a price above/below equilibrium, identify surplus vs. shortage and explain the pressure on price.
  • Given a real-world change (input costs, consumer income, expectations), show the correct shift(s) and predict the direction of equilibrium changes.
• Common mistakes
  • Confusing a shift (change in demand/supply) with a movement along a curve (change in quantity demanded/supplied due to price).
  • Predicting the wrong price/quantity direction for supply shifts (remember: supply shifts make price and quantity move opposite).
  • Treating ambiguous outcomes as definite when both curves shift.