AP Microeconomics Unit 2: Supply and Demand

AP Microeconomics Unit 2: Supply and Demand

2.1 Demand

• Demand Characteristics:

  • Demand curve slopes downward.
  • When demand increases/decreases:
  • Moves right (increase) or left (decrease).
  • Use arrows indicating direction.

• Price vs. Quantity Demanded:

  • Inversely related.
  • Substitution Effect:
    • Price decrease leads consumers to substitute cheaper goods for expensive ones.
    • Price increase leads to less substitution for cheaper goods.
  • Law of Diminishing Marginal Utility: As consumption increases, marginal utility decreases.
  • Income Effect:
    • Depends on good type; normal goods see increased demand with income, inferior goods see decreased demand (e.g., computers vs. cup noodles).

• Law of Demand:

  • A decrease in price results in an increase in quantity demanded, while an increase in price results in a decrease in quantity demanded.

2.2 Changes in Demand

• Changes can occur due to:

  • Change in Income:
  • Normal goods: increased income increases demand.
  • Inferior goods: increased income decreases demand.
  • Change in Price of Substitutes:
  • Price decrease of good X decreases demand for good Y and vice versa.
  • Change in Price of Complements:
  • Lower price of good X increases demand for good Y (e.g., burgers and fries).
  • Change in Number of Buyers: An increase in buyers increases demand.
  • Change in Expectations: Anticipation of future price rise will increase current demand.
  • Change in Tastes/Styles: Changes in preferences can increase or decrease demand.

• Demand Curves Slope Downward:

  • Due to diminishing marginal utility; additional satisfaction decreases as more is consumed.
  • Marginal Utility: Extra satisfaction from one additional unit.

2.3 Supply

• Supply Characteristics:

  • Supply curve slopes upward.
  • When supply increases/decreases:
  • Moves right (increase) or left (decrease).
  • Producers supply more when prices are higher (Profit Motive).

• Law of Supply:

  • As prices increase, quantity supplied increases; price changes affect quantity supplied, not supply itself.

• Changes in Supply: Can be influenced by:

  • Production Costs: Higher costs decrease supply; lower costs increase supply.
  • Technology Improvements: Increased productivity raises supply.
  • Number of Producers: More producers lead to increased supply.
  • Producer Expectations: If prices are expected to rise, current supply may decrease.

2.4 Price Elasticity of Demand

• Definition: Measures how responsive quantity demanded is to price changes.

  • Elasticity (ED) Interpretations:
  • ED > 1: Demand is elastic.
  • ED < 1: Demand is inelastic.
  • ED = 1: Unit elastic.
  • ED = 0: Perfectly inelastic.
  • ED = ∞: Perfectly elastic.

• Inelastic Demand: Minimal response to price changes.

• Elastic Demand: Significant quantity demanded response.

• Determinants of Elasticity:

  • Availability of substitutes: More substitutes lead to more elastic demand.
  • Necessity vs. Luxury: Luxuries are more elastic.
  • Percentage of Budget: Larger share makes demand more elastic.
  • Time: More time leads to more elastic demand.

• Revenue Test:

  • P↑ & TR↑: Inelastic.
  • P↓ & TR↓: Inelastic.
  • P↑ & TR↓: Elastic.
  • P↓ & TR↑: Elastic.

2.5 Price Elasticity of Supply

• Definition: Responsiveness of quantity supplied to price changes.
  • ES interpretations similar to ED.
• Determinants:
  • Ease of production adaptation.
  • Market Period: Inelastic.
  • Short-Run: Some elasticity.
  • Long-Run: Highly elastic due to capacity changes.

2.6 Other Elasticities

• Cross-Price Elasticity of Demand:
  • Measures demand response to price changes of related goods.
  • Positive value: substitutes.
  • Negative value: complements.
• Income Elasticity of Demand:
  • Positive: normal good.
  • Negative: inferior good.

2.7 Market Equilibrium

• Equilibrium: Where supply and demand intersect.
• Consumer Surplus: Difference between willingness to pay and actual price.
• Producer Surplus: Difference between revenue per unit and marginal cost of production.
• Deadweight Loss (DWL): Efficiency loss when equilibrium is not met; occurs due to price floors/ceilings or externalities.

2.8 Market Disequilibrium**

• Shortage: Price lower than equilibrium.
  • Result: Quantity demanded > quantity supplied.
• Surplus: Price higher than equilibrium.
  • Result: Quantity supplied > quantity demanded.

2.9 Government Intervention**

• Quantity Controls: Quotas and licenses limiting market activities.
• Protectionism: Use of tariffs, quotas, and embargoes to protect domestic producers.
  • Tariffs lead to higher consumer prices, reduced consumer surplus, and increased domestic output, but also create inefficiencies.
• Quotas limit imports and can create deadweight loss.