Microeconomics Unit 2: Supply and Demand

Normal Good

A good whose demand varies directly with consumers' incomes.

Inferior Good

A good whose demand varies inversely with consumers' incomes.

Excise Tax (definition)

A per-unit tax on the production of a good or service. Excise taxes tend to reduce supply, decreasing quantity of a good that is sold and increasing the price that buyers pay.

Effective Price Ceiling (definition)

A price ceiling is a legal maximum price set below the equilibrium price. This results in the quantity demanded exceeding the quantity supplied at the ceiling price. Hence a shortage exists in the market.

Effective Price Floor (definition)

A price floor is a legal minimum price set above the equilibrium price. This results in the quantity supplied exceeding the quantity demanded at the floor price. Hence a surplus exists in the market.

Income Effect

Consumers' buying power changes inversely to changes in price. This is one reason for the inverse relationship expressed in the law of demand. Consumers buy fewer units at higher prices because their same nominal income has less purchasing power.

Elastic

Describes a rate of change in quantity that is greater (in percentage terms) than the rate of change in price.

Inelastic (definition

Describes a rate of change in quantity that is less (in percentage terms) than the rate of change in price.

Diminishing Marginal Utility

Each additional unit of a good or service that is consumed gives less additional satisfaction or utility than the previous unit that was consumed. One of the reasons why price and quantity demanded have an inverse relationship.

Complementary Goods

Goods that are consumed together, such as cars and gasoline or peanut butter and jelly.

Substitute Goods

Goods which are used in place of each other. For example, margarine is a substitute for butter.

Consumer

People who buy goods and services. Often a household is considered to be a fundamental unit of consumption.

Producer

People who make and sell goods and services; suppliers.

Quantity Demanded

The amount of a good or service that consumers are willing and able to buy at a given price in a specified period of time.

Equilibrium (definition)

The condition that exists in the market when a single price and quantity result from the intersection of supply and demand. The natural price-quantity combination at which neither a shortage nor a surplus exists.

Shortage

The condition that exists when the quantity demanded exceeds the quantity supplied. Indication of price being lower than equilibrium level.

Surplus

The condition that exists when the quantity supplied exceeds the quantity demanded. Indication of price being higher than equilibrium level.

Consumer Surplus (definition)

The difference between the equilibrium price in the market and the price consumers are actually willing to pay for a good or service. On a graph, consumer surplus is represented as the area beneath the demand curve, above the price paid, and to the left of the quantity purchased.

Producer Surplus

The difference between the market equilibrium price and the price producers would willingly accept for a good or service. On a graph, producer surplus is represented by the area beneath the price received, above the supply (or marginal cost) curve, and to the left of quantity sold.

Deadweight Loss

The loss of consumer and producer surplus that occurs when a quantity other than the equilibrium quantity prevails in the market. Deadweight loss results from over- or underproduction of a good and is associated with allocative inefficiency.

Cross Price Elasticity

The percentage change in the quantity demanded for one good divided by the percentage change in the price of a related good. Cross-price elasticity determines whether goods are complements (if negative) or substitutes (if positive).

Law of Demand

The price and quantity demanded of a good are inversely related because of income effect, substitution effect, and diminishing marginal benefits.

Law of Supply

The price and quantity supplied of a good are directly related. Higher prices induce increased production quantities.

Price Elasticity of Demand

The responsiveness of quantity changes relative to price changes; the percentage change of quantity demanded divided by the percentage change in price.

Elasticity (definition)

The sensitivity of quantity changes relative to changes in other factors, often prices.

Substitution Effect

The tendency of consumers to substitute lower-priced items for higher-priced items. A reason why the law of demand is true; consumers purchase fewer units at higher prices because substitutes (whose prices are unchanged) seem relatively cheaper.

Utility

The want-satisfying power that goods and services provide. The amount of usefulness or satisfaction that a consumer gets from consuming a good or service.

Demand

The willingness and ability of consumers to buy goods and services at the various prices that exist in the market within a specified time frame. Describes the inverse relationship between the quantity demanded and the price that is often expressed as a graphical curve or a tabular schedule.

Supply

The willingness and ability of producers to offer a good or service for sale at the various prices which exist in the market within a certain time frame. The positive or direct relationship between quantity supplied and price that is often displayed on a graphical curve or in a tabular schedule.