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Flashcards · AP® Microeconomics · Unit 2

Unit 2: Supply and Demand flashcards

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2.1 Demand

What is demand?
The quantities buyers are willing and able to buy at each price in a period, other things equal (ceteris paribus).
What is the law of demand, and why does the demand curve slope down?
When a good's own price rises, quantity demanded falls, and the reverse. Reasons: the substitution effect, the income effect and diminishing marginal utility.
What is the difference between a change in demand and a change in quantity demanded?
A change in the good's own price moves along the curve: "quantity demanded rises or falls". A change in a determinant shifts the curve: "demand increases (right) or decreases (left)".
What are the determinants that shift demand?
Income (normal good: a rise shifts it right; inferior good: left), prices of substitutes and complements, tastes and preferences, expected future price (an expected rise shifts demand right now) and the number of buyers.
The price of printer ink rises. What happens to the demand for printers?
It decreases (shift left), because ink is a complement. Note also that a cheaper substitute reduces demand.
How do you find market demand from individual demands?
Add every buyer's quantity demanded at each price (add horizontally on a graph). Never average. Buyers wanting 5 and 4 units at $2 give a market quantity of 9.
Why is the demand curve a marginal benefit curve?
A buyer buys each unit while MB ≥ price, so the height of the demand curve at a quantity is the marginal benefit of the last unit bought.
Graph: incomes rise and the good is normal. How do you draw it?
Price on the vertical axis and quantity (per period) on the horizontal, both with units. Shift demand right from D₁ to D₂, label both curves and add an arrow: at every price, quantity demanded is now larger.

2.2 Supply

What is the law of supply, and why does the supply curve slope up?
When a good's own price rises, quantity supplied rises. Marginal cost rises as output rises, because resources are not equally suited, so sellers make extra units only if the price covers the higher cost.
How does a seller decide how many units to supply?
It produces each unit while price ≥ marginal cost. With MC of $6, $9, $12 and $16 for units 1 to 4, it supplies 3 units at $12. The height of supply at a quantity is the MC of the last unit.
What shifts supply to the left?
Higher input prices (wages, materials, energy), a per-unit tax on sellers, a rise in the price of another good the seller could make, fewer sellers, an expected future price rise (storable goods) and bad natural conditions.
What shifts supply to the right?
Better technology or productivity, a per-unit subsidy and more sellers.
Graph: how do you draw a decrease in supply?
Price on the vertical axis, quantity on the horizontal. Shift S₁ to the left, which is also up, to S₂ and label both. A decrease is never drawn as a shift down: down and to the right is an increase.
Why can a rise in the price of wheat reduce the supply of barley?
Farmers switch land and labour to the more profitable crop, so at every barley price they offer less barley.
How is market supply found?
Add every seller's quantity supplied at each price. Sellers offering 10 and 25 units at $3 give a market quantity supplied of 35.

2.3 Price Elasticity of Demand

What is price elasticity of demand (PED)?
How strongly quantity demanded responds to a change in the good's own price: PED = % change in quantity demanded ÷ % change in price. It is negative, so quote and compare its magnitude, |PED|.
How is demand classified by elasticity?
|PED| above 1: elastic. Below 1: inelastic. Equal to 1: unit elastic. |PED| = 0 is perfectly inelastic (vertical curve); infinite is perfectly elastic (horizontal curve). Each label applies to a price range.
How does the midpoint method work?
% change = change ÷ average of the two values × 100, for quantity and for price. It gives the same answer whether price rises or falls.
Price falls from $9 to $7 and quantity rises from 30 to 50. Find |PED| by the midpoint method.
Quantity: 20 ÷ 40 = 50%. Price: 2 ÷ 8 = 25%. |PED| = 50 ÷ 25 = 2, so demand is elastic over this range.
What is the total revenue test?
Elastic demand: price and total revenue move in opposite directions. Inelastic: they move in the same direction. Unit elastic: total revenue does not change. TR = P × Q, which is also buyers' total spending.
Why is slope not the same as elasticity?
A straight-line demand curve has a constant slope, but demand is elastic above its midpoint, unit elastic at it and inelastic below it, because the same raw change is a different percentage at different prices and quantities.
What makes demand more price elastic?
Many close substitutes (the main factor), a luxury rather than a necessity, a large share of the buyer's income, more time to adjust, and a narrowly defined market (one brand rather than the whole product).

2.4 Price Elasticity of Supply

What is price elasticity of supply (PES)?
PES = % change in quantity supplied ÷ % change in price. It is positive. Above 1: elastic; below 1: inelastic; 1: unit elastic. PES = 0 is a vertical supply curve; infinite is a horizontal one.
Price rises from $15 to $25 and quantity supplied from 60 to 100. Find PES.
Midpoint method: quantity 40 ÷ 80 = 50%; price 10 ÷ 20 = 50%. PES = 1, unit elastic.
What makes supply more elastic?
More time to adjust (new firms can enter), spare capacity, extra inputs available at a steady price, goods that can be stored, and goods that can be made quickly.
Graph: how do short-run and long-run supply curves compare?
Price on the vertical axis, quantity on the horizontal. Through the same point, the long-run supply curve is flatter (more elastic) than the short-run curve, because all inputs can change and firms can enter or leave. Never draw it steeper.
What does perfectly inelastic supply look like?
A vertical supply curve with PES = 0, such as tickets for one match in a full stadium: quantity stays at capacity whatever the price.
Does the total revenue test apply to supply?
No. Along a supply curve, a higher price always raises sellers' revenue, because price and quantity supplied rise together.

2.5 Other Elasticities

What is income elasticity of demand (YED), and what does its sign show?
YED = % change in quantity demanded ÷ % change in income. Keep the sign: positive means a normal good, negative an inferior good.
What is cross-price elasticity of demand (XED)?
XED = % change in quantity demanded of X ÷ % change in the price of Y. Positive: substitutes. Negative: complements. Zero: unrelated. A large size means close substitutes or strong complements.
Income rises 10% and quantity demanded falls 5%. Find YED and the type of good.
YED = −5 ÷ 10 = −0.5, so it is an inferior good.
The price of Y rises 20% and quantity demanded of X rises 30%. Find XED.
XED = 30 ÷ 20 = +1.5, so X and Y are substitutes.
Does a change in income or in a related good's price move along demand or shift it?
It shifts the demand curve. Higher income shifts demand for a normal good right; a higher price of a substitute shifts it right; a higher price of a complement shifts it left.
What mistakes cost marks with YED and XED?
Dropping the minus sign (turning an inferior good into a normal one, or complements into substitutes), dividing raw changes instead of percentages, and putting the cause on top: quantity always goes in the numerator.

2.6 Market Equilibrium and Consumer and Producer Surplus

What is market equilibrium?
The price at which quantity demanded equals quantity supplied, so there is no shortage or surplus and the market clears. Above it a surplus pushes the price down; below it a shortage pushes it up.
What are consumer surplus and producer surplus?
Consumer surplus: willingness to pay minus price, summed over units bought. Producer surplus: price minus minimum acceptable price, summed over units sold. Total surplus = CS + PS.
Graph: where are consumer and producer surplus on a supply and demand graph?
Price on the vertical axis, quantity on the horizontal. CS is the triangle below demand and above the equilibrium price, from 0 to the quantity traded. PS is the triangle above supply and below that price. Never shade beyond the quantity traded.
Demand meets the price axis at $40, supply at $16; equilibrium is $25 and 300 units. Find CS and PS.
CS = ½ × 300 × (40 − 25) = $2,250. PS = ½ × 300 × (25 − 16) = $1,350.
Why is the competitive equilibrium efficient?
Below it MB exceeds MC, so one more unit raises total surplus; beyond it MC exceeds MB, so extra units lower it. At equilibrium MB = MC and total surplus is largest, if there are no market failures.
How does the equilibrium price act as a signal?
It rations the good to the buyers who value it most and gives sellers an incentive to move resources towards what people want.

2.7 Market Disequilibrium and Changes in Equilibrium

What are a shortage and a surplus?
Shortage (excess demand): Qd exceeds Qs at a price below equilibrium, and buyers bid the price up. Surplus (excess supply): Qs exceeds Qd at a price above equilibrium, and sellers cut the price. Measure both in units, not dollars.
Does any curve shift while the price moves to equilibrium?
No. The price changes and both quantities move along their curves until Qd = Qs. A curve shifts only when a determinant changes.
How much is traded at a disequilibrium price?
The smaller of Qd and Qs. Total surplus is lower than at equilibrium.
What happens to price and quantity when only one curve shifts?
Demand increases: P and Q rise. Demand decreases: both fall. Supply increases: P falls and Q rises. Supply decreases: P rises and Q falls.
What can you predict when both curves shift?
Same direction: quantity is certain (both up: rises; both down: falls) and price is indeterminate. Opposite directions: price is certain (D up, S down: rises; D down, S up: falls) and quantity is indeterminate.
Qd = 90 − 3P and Qs = 6P − 36. Find the equilibrium, and the situation at $10.
90 − 3P = 6P − 36, so 9P = 126: P = $14 and Q = 48. At $10, Qd = 60 and Qs = 24: a shortage of 36 units, so the price rises.
Graph: a new machine cuts production costs. Describe the graph.
Price on the vertical axis, quantity on the horizontal. Supply shifts right from S₁ to S₂; demand does not move. At the old price there is a surplus, so the price falls. New equilibrium: a lower price and a larger quantity.
How does elasticity affect the result of a shift?
The more elastic the curve that does not shift, the more the effect shows up in quantity and the less in price.

2.8 The Effects of Government Intervention in Markets

When is a price ceiling or a price floor binding, and what does it cause?
A ceiling (legal maximum) binds only below equilibrium: a shortage, with quantity traded = Qs. A floor (legal minimum) binds only above equilibrium: a surplus, with quantity traded = Qd. Neither shifts a curve.
How does a per-unit tax on sellers change the market?
Supply shifts up by the tax t. The price buyers pay rises, the price sellers keep = buyers' price − t, and quantity falls. Revenue = t × new Q; deadweight loss = ½ × t × fall in quantity.
Who bears more of a tax?
The more inelastic side, whichever side hands the tax over. Buyers' share is the rise in the price they pay; sellers' share is the fall in the price they keep.
Qd = 100 − 2P, Qs = 3P − 50, with a $5 tax on sellers. Find the prices, quantity, revenue and DWL.
Before: $30 and 40 units. After: 100 − 2P = 3(P − 5) − 50 gives buyers $33, sellers $28, Q = 34. Revenue = 5 × 34 = $170. DWL = ½ × 5 × 6 = $15. Buyers bear $3 of the $5.
What does a per-unit subsidy do in a competitive market?
Supply shifts down by s. Quantity rises, buyers pay less and sellers receive buyers' price + s. CS and PS rise, but the subsidy costs s × new Q, more than their gain, so there is a deadweight loss.
What does a quota do?
It sets a legal maximum quantity. Buyers pay the demand price at the quota, and the gap above the supply price at that quantity goes to licence holders. Total surplus falls.
Graph: describe a binding price ceiling.
Price on the vertical axis, quantity on the horizontal. A horizontal line below the equilibrium price. At the ceiling Qd exceeds Qs: the gap is the shortage. Quantity traded is Qs, and the deadweight loss triangle lies between demand and supply from Qs to the equilibrium quantity.

2.9 International Trade and Public Policy

What happens when the world price is below the autarky price?
In a small open economy the domestic price falls to the world price, Pw. Imports = Qd − Qs at Pw. Consumer surplus rises, producer surplus falls and total surplus rises.
What happens when the world price is above the autarky price?
The domestic price rises to Pw and the country exports Qs − Qd. Producer surplus rises, consumer surplus falls and total surplus rises. Free trade has losers: name the group.
Graph: how do you show a tariff on a small importing country?
Price on the vertical axis, quantity on the horizontal, with domestic D and S. Draw a horizontal line at Pw and a higher one at Pw + t; do not shift domestic supply. At Pw + t, Qs rises, Qd falls and imports shrink. Revenue = t × imports; the two triangles beside it are deadweight loss.
At a world price of $7, Qd = 500 and Qs = 200. A $2 tariff then cuts imports to 180. Find imports before the tariff and the tariff revenue.
Imports before = 500 − 200 = 300 units. Tariff revenue = 2 × 180 = $360: a transfer to the government, not a loss.
How does an import quota differ from a tariff?
Both raise the domestic price and domestic output, cut imports and lower CS and total surplus. A quota earns the government no revenue. You explain a quota in words; you do not graph it.
When is a tariff prohibitive?
When t ≥ autarky price − Pw: the domestic price reaches the autarky price and imports fall to zero.

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