AP Micro Unit 2

Unit 2 - Supply and Demand

2.1 - Demand

Law of Demand

An inverse relationship exists between price and quantity demanded

  • As price falls, quantity demanded rises
  • As price rises, quantity demanded falls
  • Demand Curve, downward sloping
    • Market Demand
    • Horizontal Summation of Individual Demands (ask people individually, how many of good would you be willing to pay for $1)

Downward sloping

  • Diminishing marginal Utility (first buy the best feeling)
  • Income effect (toilet paper, low % of income, buy in bulk) (car, one car, high % of income)
  • Substitution effect (most good have a substitute, similar good, coke/pepsi)

Determinants of Demand (causes that incr or decr)

  • Tastes (preference) (mostly through advertising) (celebrity endorsement)
  • Prices of related goods
    • Substitutes(coke/pepsi) & complements (goods you buy together
      • (sub) If the price of coke goes up, people buy less coke, but you must say the quantity demanded decreased. Since we aren't buying coke, we say demand for pepsi shifted right, or increased
      • (comp) Hotdogs and Buns, if hotdog price goes down, quantity demanded goes up, buns shifted right or went up bc hotdogs went up.
    • Unrelated Goods
  • Income
    • Normal (superior) & inferior goods
      • (Normal) Incomes go up, you buy more or demand for normal goods go up, incomes go down, you buy less or demand for normal goods go down
      • (Inferior goods), as income rises, demand goes down, income falls, demand goes down (generic vs name brand)
  • Number of buyers
    • Goes up or down
      • Immigration (in, more buyers)
      • Emmegration (out, less buyers)
  • Expectations
    • Expect something to happen in future(stock up on it before)(buy after sale)
  • T.R.I.B.E

2.2 - Supply

Law of Supply

A direct relationship exists between price and quantity supplied

  • As price rises, quantity supplied rises
  • As price falls, quantity supplied falls

Determinants of Supply

  • Resources Prices
    • Can buy more materials with same amount of money
    • Could also be energy, could be wages,
    • Or resources you can buy less materials with same money
  • Prices of Other Goods
    • Robots and pizza, half workers make robotos, half pizzas, robot market price goes up so make more robots so increase quantity supplied, shift up. But now that more robot workers, less pizza workers. At first ½ and ½ but now R ⅔ and P ⅓, supply for pizza goes down, shift left
  • Technology
    • Tech means econ growth, can produce more of a good, supply goes outward
  • Taxes & Subsidies
    • Govt gets involved, tax gov says i want a percentage of the good you're selling in money so some money to govt and some towards good instead of all to good.
    • Subsidies, govt gives money to business to make something, ex covid tests and vaccines
  • Expectations
    • Business owner POV, future business conditions, ex you're running factory and news economists say recession coming then you decrease your supply now to sell everything you can before the recession hits
    • Economists on news say strong econ growth around corner, dont wait, increase supply now so that when it comes you're ready
  • Number of Sellers
    • Someone enters market, supply increase
    • Business goes bankrupt, decrease in supply
  • R.O.T.T.E.N

2.3 Price Elasticity of Demand

Law of Demand says

  • Consumers will buy more when prices go down and less when prices go up

How much more or less?

  • Price Elasticity provides an answer

Determinants of Price Elasticity of Demand

  • Need vs Want
    • Wants = more elastic
    • Needs = less elastic
  • Substitutability
    • More substitutes = more elastic
      • Soft drinks, very elastic
      • Insulin, highly inelastic
  • Percentage of Income
    • Higher percentage = more elastic
      • Cars, vacations
    • Lower percentage = inelastic
  • Time
    • More time = more elastic
      • Plenty of time for a sale or comparison shop
        • Plane, business pay lots because flight buy 48 hours in advance while normal buy months in advance
      • Insulin, button beeps, you need insulin

Total Revenue at a Lemonade Stand

  • You sell 24 glasses for $.50 each
  • P x Q = Total Revenue
  • $.50 x 24 = $12 = Total Revenue
  • -$4 = Total Cost
  • $8 = profit
  • Total Revenue (TR): the total dollars received by a firm for selling a product.
  • TR = consumer expenditures
  • TR = P x Q

2.4 - Price of Elasticity of Supply

Determinants of Price Elasticity of Supply

  • Input substitutability
    • More substitutes = more elastic
  • Time
    • More time = more elastic

2.5 - Other Elasticities

Cross Price of Elasticity of Demand

  • Positive sign
    • Goods are substitutes
    • Larger the value, more substitutes
  • Negative Sign
    • Goods are complementary
    • Larger the number, closer to being complements
  • Zero/Near Zero
    • Goods are unrelated

Income Elasticity

  • Positive
    • Goods are Normal (Superior)
    • Goods are inferior

2.6 - Market Equilibrium and Consumer & Producer Surplus

Market Demand - notes

Market Equilibrium

  • Equilibrium Price & Quantity where two curves intersect
  • Rationing function of prices
    • Free markets finding equilibrium all on their own, no gov needed
  • Change in Demand vs Change in Quantity Demanded
  • Change in Supply vs Change in Quantity Supplied

Welfare Economics

  • Welfare Economics is the study of economic well-being meaning go into markets quantify benefit of consumers and quantify benefits of producers
  • Market Equilibrium maximizes the welfare(utility) of buyers and sellers

Consumer Surplus

  • Consumer surplus is the price the buyer is willing to pay minus the market price of the good
    • You on way to target, you expect price of item to be $20, but on clearance for $15, you get item and walk about with $5
  • Willing to pay $10 for 1st unit, $8 for 2nd, and $6 for 3rd
  • Price is $5
    • $10-$5=$5
    • $8-$5=$3
    • etc
  • Consumer surplus = $5+$3+$1=$9

Producer Surplus

  • Producer surplus is the market price minus the price the seller is willing to sell at
  • Same math if given three points, just find diff of three then add up

Market efficiency

  • Consumer Surplus + Producer Surplus = total surplus
  • Free markets maximize efficiency (total surplus) at equilibrium

2.7 Market Disequilibrium & Changes in Equilibrium

Taxation & Deadweight Loss

  • Review
    • Buyers and sellers benefit from markets (CS& PS)
    • Equilibrium maximizes total surplus
  • When a tax is levied on a good, price paid by buyers rises, price received by sellers falls
  • A tax places a wedge between the price buyers pay and sellers receive
  • Qd&Qs decrease
  • T * Q = Tax Revenue
  • Changes in Welfare
    • Deadweight loss (DWL) is the loss in total surplus
  • What determines whether the deadweight loss from a tax is large or small?
    • More elastic S and/or D curves have more loss

Tax Incidence

  • How is the tax split between buyers and sellers?
    • The more inelastic curve (S or D) pays more / steeper slope
    • more INelastic/INcidence

2.8 - Price Controls (The Effects of Government Intervention in Markets)

Price controls

  • Enacted when policymakers believe the market price is unfair to buyers or sellers.
  • Price Ceiling
    • A legal maximum on the market price
  • Price Floor
    • A legal minimum on the market price
  • Two Possibilities
    • Not binding (doesn’t change equilibrium)
      • If gov suspects something, pass law now to protect in the future
    • Binding (changes equilibrium)
  • A binding price ceiling creates
    • A shortage because Qd>Qs
    • Non-price rationing
      • Long lines
      • Discrimination
  • A binding price floor creates
    • A surplus because Qs > Qd
    • Non-price rationing

2.9 International Trade & Public Policy

International Trade

  • A closed economy (Autarchy) is one that does not trade
  • An open economy is one that trades freely

The Effects of a Tariff

  • A tariff is a tax on foreign goods sold domestically
  • Tariffs raise the price of imported goods

Other Trade Mechanisms

  • An import quote is a limit on the quantity of imports
  • An export subsidy lowers the domestic costs of production
    • Not on ap exam dont need to know

Lessons from Trade Policy

Tariffs and quotas

  • Rais e domestic prices
  • Reduce imports
  • Reduce domestic CS
  • Increase cosmetic PS
  • Reduce TS (create DWL)

FRQ: Binding ceiling or floor