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AP Microeconomics Unit 2: Supply and Demand

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| % change in quantity demanded / % change in price |

What is the formula for calculating the price elasticity of demand?

percent change in quantity supplied / percent change in price

What is the formula for calculating the price elasticity of supply?

As price increases, the quantity demanded for a good or service will decrease, and vice versa.

What is the law of demand?

As the price of goods and services increases, sellers will want to supply more of those goods and services, and vice versa.

What is the law of supply?

to protect domestic producers from a cheaper world price, and to prevent domestic unemployment

What is the purpose of tariffs and quotas?

on the producers

When the price elasticity of demand is high, where does the burden of the tax fall?

on the consumers

When the price elasticity of demand is low, where does the burden of the tax fall?

demand schedule

a table that shows the relationship between the price of a good and the quantity demanded

supply schedule

a table that shows the relationship between the price of a good and the quantity supplied

market

an institution or mechanism that brings buyers and sellers into contact

tax shifting

businesses passing taxes to consumers in the form of higher prices

total surplus

consumer surplus + producer surplus =

BCDE + the trapezoid beneath

What area on the graph represents total revenue after the tax?

EDG + the two trapezoids below the supply curve

What area on the graph represents total revenue before the tax?

B and D

What areas on the graph represent deadweight loss?

equilibrium price and equilibrium quantity both fall

What happens to the equilibrium price and equilibrium quantity when the demand for a good or service decreases?

equilibrium price and equilibrium quantity both rise

What happens to the equilibrium price and equilibrium quantity when the demand for a good or service increases?

equilibrium price is indeterminate and equilibrium quantity decreases

What happens to the equilibrium price and equilibrium quantity when the supply decreases and the demand decreases?

equilibrium price increases and equilibrium quantity is indeterminate

What happens to the equilibrium price and equilibrium quantity when the supply decreases and the demand increases?

equilibrium price rises and equilibrium quantity falls

What happens to the equilibrium price and equilibrium quantity when the supply for a good or service decreases?

equilibrium price falls and equilibrium quantity rises

What happens to the equilibrium price and equilibrium quantity when the supply for a good or service increases?

equilibrium price decreases and equilibrium quantity is indeterminate

What happens to the equilibrium price and equilibrium quantity when the supply increases and the demand decreases?

price x quantity

What is the equation to find total revenue?

lump-sum tax

a tax that is the same amount for every person

When the demand curve shifts, is there a change in price?

a change in one of the determinants of demand / supply

A change in demand / supply is caused by...

a shift of the demand / supply curve

A change in demand / supply results in...

a change in price

A change in quantity demanded / supplied is caused by...

movement along the demand / supply curve

A change in quantity demanded / supplied results in...

perfectly elastic

A good is said to be ___________ ___________ when there will be a major change in quantity demanded when there is a small percent change in price.

perfectly inelastic

A good is said to be ___________ ___________ when there will be no change in quantity demanded no matter what the percent change in price.

quota

A limit placed on the quantities of a product that can be imported

tariff

A tax on imported goods

relatively elastic

At points above the unit elastic point, will demand be relatively elastic or relatively inelastic?

relatively inelastic

At points below the unit elastic point, will demand be relatively elastic or relatively inelastic?

the amount consumers actually pay and the amount they would have been willing to pay

Consumer surplus is the difference between...

larger

Demand is elastic if a given percent change in price is accompanied by a relatively ___________ change in quantity demanded.

smaller

Demand is inelastic if a given percent change in price is accompanied by a relatively ___________ change in quantity demanded.

The income effect states that changes in price affect the purchasing power of consumers' income; the higher the price, the less units they can buy of the good.

Describe how the income effect explains why the demand curve is downward sloping.

The law of diminishing marginal returns states that as you continue to consume a given product, you will eventually get less additional satisfaction (utility) from each unit you consume.

Describe how the law of diminishing marginal returns explains why the demand curve is downward sloping.

The substitution effect states that increases in price motivate consumers to buy relatively cheaper substitute goods, decreasing their quantity demanded as price increases.

Describe how the substitution effect explains why the demand curve is downward sloping.

Do lump sum taxes distort incentives or create deadweight loss?

a shortage, because a price ceiling keeps the price low and does not allow the market to drive the price up, keeping buyers in the market that otherwise would have gotten out.

Does a price ceiling create a surplus or a shortage? Why?

a surplus, because a price floor keeps the price above equilibrium, so suppliers are willing to increase quantity supplied while buyers are driven out of the market.

Does a price floor create a surplus or a shortage? Why?

percent change in quantity demanded / percent change in income

What is the formula for calculating the income elasticity of supply?

A rise in average household income shifts the demand curve for most commodities to the right, indicating that more will be demanded at each possible price.

Explain how a change in consumer incomes shifts the demand curve.

A rise in population will shift the demand curve for commodities to the right, indicating that more will be bought at each price.

Explain how a change in population shifts the demand curve.

If people prefer more of a product, there will be an increase in demand and more will be bought at each price, and vice versa.

Explain how changes in consumer tastes and preferences shifts the demand curve.

A rise in the price of inputs shifts the supply curve to the left, indicating that less will be supplied at any given price

Explain how changes in resource prices shifts the supply curve.

An increase in the number of sellers will shift the supply curve for the product to the right.

Explain how changes in the number of sellers shifts the supply curve.

If consumers expect overall incomes to rise, then demand will increase now, and vice versa

Explain how consumer expectations about income shifts the demand curve.

If consumers expect the price to increase in the future, they will increase demand for the good now, and vice versa

Explain how consumer expectations about price shifts the demand curve.

If suppliers expect future profits of their good to rise, they will decrease the supply of the good now, and vice versa.

Explain how seller expectations shift the supply curve.

An increase in subsidies decreases the costs of production and will shift the supply curve to the right.

Explain how subsidies shift the supply curve.

An increase in taxes will increase the costs of production and shift the supply curve to the left.

Explain how taxes shift the supply curve.

A decrease in production costs will increase the profits that can be earned at any given price of the commodity. This change sifts the supply curve to the right.

Explain how technological change shifts the supply curve.

Goods that are necessities tend to be inelastic, because sellers can raise the price and people will continue to buy the good. Goods that are luxuries tend to be elastic.

Explain how the difference between luxury vs necessary goods influences the price elasticity of demand.

The greater percentage of income a good requires to purchase, the more elastic the good: a 10% change in the price of a car produces a much greater change in behavior than does a 10% change in the price of gum

Explain how the income effect influences the price elasticity of demand.

A fall in price of a complementary commodity will shift a commodity's demand curve to the right (ex: a fall in the price of peanut butter will increase demand for jelly) and vice versa

Explain how the price of complementary goods shifts the demand curve.

A rise in the price of a substitute good shifts the demand curve for the commodity to the right (ex: an increase in the price of margarine leads to an increase in the demand for butter) and vice versa

Explain how the price of substitute goods shifts the demand curve.

If a good has few substitutes, it is said to be inelastic (ie gasoline)

Explain how the substitution effect influences the price elasticity of demand.

All goods become more elastic over time because substitutes are developed.

Explain how time influences the price elasticity of demand.

the parallel vertical distance between the two supply curves tells the magnitude of the tax

How can you determine the magnitude of the tax from the supply and demand graph?

Use the formula 1/2(base*height) where the base is the change in price and the height is the change in quantity.

How do you calculate deadweight loss?

they should cut the price of the good until it reaches the unit elastic point

How should the seller of an elastic good try to maximize total revenue?

they should raise the price of the good until it reaches the unit elastic point

How should the seller of an inelastic good try to maximize total revenue?

consumer surplus is the blue triangle above the world price + tariff and producer surplus the red triangle below the world price + tariff. Producers benefit from the implementation of the tariff.

Identify consumer and producer surplus after implementation of the tariff. Who benefits from the tariff?

Consumer surplus is the triangle with base at the world price; producer surplus is the small red triangle beneath it. Consumers benefit from trade.

Identify consumer and producer surplus prior to the tariff. Who benefits in this scenario from trade?

Qd < Qs

Identify consumer surplus, producer surplus, and deadweight loss on the graph. Is quantity demanded greater than or less than quantity supplied?

Qd > Qs

Identify consumer surplus, producer surplus, and deadweight loss on the graph. Is quantity demanded greater than or less than quantity supplied?

inelastic

If consumers do not respond (relatively) to a change in price, the good is said to be...

elastic

If consumers respond (relatively) to a change in price, the good is said to be...

If demand is elastic, a change in price will result in a change in total revenue in the opposite direction: a decrease in price will result in an increase in total revenue and vice versa

If demand is elastic, how will a change in price affect total revenue?

If demand is inelastic, a change in price will result in a change in total revenue in the same direction: a decrease in price will result in an decrease in total revenue and vice versa

If demand is inelastic, how will a change in price affect total revenue?

If demand is unit elastic, a change in price will have no change in total revenue.

If demand is unit elastic, how will a change in price affect total revenue?

too low

If there is shortage in a market, has the producer set the price too high or too low?

too high

If there is surplus in a market, has the producer set the price too high or too low?

when the prices of a good or service bring the quantity supplied and the quantity demanded into balance. Buyers wish to purchase the same quantity that the sellers wish to provide, and there is neither a shortage or surplus of goods.

In a perfectly competitive market, when is equilibrium achieved?

higher

In the case of shortage, quantity demanded is much ___________ than quantity supplied.

lower

In the case of surplus, quantity demanded is much ___________ than quantity supplied.

Qst is domestic production, and the difference between Qst and Qdt is imported goods

In this scenario, after the implementation of the tariff, what quantity is bought from domestic sellers and what quantity is imported?

Qs is domestic production, and the difference between Qs and Qd is imported goods

In this scenario, prior to the tariff, what quantity is bought from domestic sellers and what quantity is imported?

below

Is a price ceiling set above or below the market equilibrium?

above

Is a price floor set above or below the market equilibrium?

trade

The gap between domestic supply and demand is filled by...

Price floors below the market price have no impact on the market

What is the effect of a price floor set below the market price / equilibrium?

The more elastic the supply and demand curves, the ___________ deadweight loss.

larger

The more inelastic the demand for the product, the ___________ the portion of the tax shift forwarded to the consumer.

higher prices

The tax incidence for buyers takes the form of...

reduced income

The tax incidence for sellers takes the form of...

percent change in the quantity demanded of good Y / percent change in the price of good X

What is the formula for calculating the cross-price elasticity of supply?

the unit elastic point

Total revenue is maximized at...

minimum prices fixed by the government above equilibrium prices

What are price floors?

inefficient allocation of resources, wasted resources, inefficiently low quality, and black markets

What are some negative effects of price ceilings?

inefficient allocation of sales among sellers, wasted resources, inefficiently high quality, and illegal activity

What are some negative effects of price floors?

monies paid to buyers or sellers in order to increase demand and/or supply in a market

What are subsidies?

What area on the graph represents consumer surplus after the tax?

ABCF

What area on the graph represents consumer surplus before the tax?

What area on the graph represents deadweight loss after the tax?

What area on the graph represents producer surplus after the tax?

DEG

What area on the graph represents producer surplus before the tax?

EDG

What area on the graph represents producer surplus before the tax?

What area on the graph represents revenue kept by producers after the tax?

What area on the graph represents tariff revenue collected by the government?

BCD

What area on the graph represents tax revenue collected by the government?

What area on the graph represents the amount of tax paid by consumers?

What area on the graph represents the amount of tax paid by producers?

The triangle formed in between the supply and demand curves above the world price.

What area on the graph represents the change in the total surplus as a result of people buying at the world price (pre-tariff) instead of the domestic equilibrium?

equilibrium price is indeterminate and equilibrium quantity increases

What happens to the equilibrium price and equilibrium quantity when the supply increases and the demand increases?

the buyer achieves an individual consumer surplus

What happens when a buyer pays a price less than their willingness to pay?

the maximum legal price a seller may charge for a product or service

What is a price ceiling?

a per-unit tax applied to a specific item

What is an excise tax?

the difference between the price consumers are willing to pay for a unit of a good and the price they do pay

What is consumer surplus?

how sensitive consumer purchases of one product are to the changes in price of some other product

What is measured by cross-price elasticity of demand?

the percent change in quantity demanded that results from the percent change in consumer income.

What is measured by income elasticity of demand?

the sensitivity of consumers to a change in the price of a product

What is measured by the price elasticity of demand?

the difference between the price sellers receive for a unit of a good and the price they are willing to accept

What is producer surplus?

Price ceilings above the market price have no impact on the market

What is the effect of a price ceiling set above the market price / equilibrium?

The domestic supply increases until equilibrium is reached with the world price. Since the world price is higher than the domestic price, producers will continue to sell in the worldwide market rather than the domestic market until the domestic price increases to the world price; thus, domestic demand will decline.

What is the result of a world price set above domestic equilibrium?

the goods are independent and are unrelated

What is true if cross-price elasticity is near zero?

Quantity demanded of good Y varies inversely with the price of good X, so X and Y are complementary goods.

What is true if cross-price elasticity is negative?

Quantity demanded of good Y varies directly with the price of good X, so X and Y are substitute goods.

What is true if cross-price elasticity is positive?

The good is inferior: the higher the income, the less of a product a person will purchase

What is true if income elasticity is negative?

The good is normal: the higher the income, the more of a product a person will purchase

What is true if income elasticity is positive?

the supply is inelastic

What is true if suppliers are not responsive to price changes (% change in price > % change quantity supplied)?

the supply is elastic

What is true if suppliers are responsive to price changes (% change in price < % change quantity supplied)?

Total consumer surplus at a given price is equal to the area below the demand curve but above that price

What region on the graph represents consumer surplus?

Total producer surplus at a given price is equal to the area above the supply curve but below that price

What region on the graph represents producer surplus?

perfectly elastic; ED = infinite