🤑AP Microeconomics Unit 2 – Supply and Demand

Key Concepts

• Supply represents the quantity of a good or service that producers are willing and able to offer at various prices
• Demand represents the quantity of a good or service that consumers are willing and able to purchase at various prices
• Market equilibrium occurs when the quantity supplied equals the quantity demanded, resulting in a stable price
• Elasticity measures the responsiveness of supply or demand to changes in price or other factors (income, prices of related goods)
• Price controls, such as price ceilings and price floors, can distort market outcomes and lead to shortages or surpluses
• Shifts in supply or demand curves occur when factors other than price change, causing the entire curve to move
• Movements along supply or demand curves happen when only the price changes, leading to a change in quantity supplied or demanded

Supply and Demand Curves

• Supply curves are typically upward-sloping, indicating that as price increases, producers are willing to supply more of a good or service
  • This relationship is known as the law of supply
  • Higher prices incentivize producers to increase production to maximize profits
• Demand curves are typically downward-sloping, indicating that as price increases, consumers are willing to purchase less of a good or service
  • This relationship is known as the law of demand
  • Higher prices reduce the affordability of goods and services, leading to lower quantity demanded
• The slope of the supply or demand curve represents the elasticity of supply or demand
  • Steeper curves indicate less elastic (more inelastic) supply or demand
  • Flatter curves indicate more elastic supply or demand
• Factors that can shift the supply curve include changes in input prices, technology, expectations, and the number of sellers
• Factors that can shift the demand curve include changes in income, preferences, expectations, and the prices of related goods (substitutes or complements)

Market Equilibrium

• Market equilibrium is the point where the supply and demand curves intersect, determining the equilibrium price and quantity
• At equilibrium, there is no shortage or surplus, and there is no tendency for price or quantity to change
• The equilibrium price is the price at which the quantity supplied equals the quantity demanded
• The equilibrium quantity is the quantity bought and sold at the equilibrium price
• If the market price is above the equilibrium price, a surplus will occur, putting downward pressure on the price
• If the market price is below the equilibrium price, a shortage will occur, putting upward pressure on the price
• Changes in supply or demand can lead to a new equilibrium price and quantity

Shifts vs. Movements

• A shift in the supply or demand curve occurs when a factor other than price changes, causing the entire curve to move to a new position
  • For example, an increase in consumer income may shift the demand curve to the right, indicating a higher quantity demanded at every price level
• A movement along the supply or demand curve happens when only the price changes, leading to a change in the quantity supplied or demanded
  • For example, a decrease in the price of a good will lead to a movement along the demand curve to a higher quantity demanded
• It is essential to distinguish between shifts and movements to accurately analyze changes in market conditions
• Shifts in supply or demand can lead to new equilibrium prices and quantities, while movements along the curves do not change the equilibrium

Elasticity

• Elasticity measures the responsiveness of supply or demand to changes in price or other factors
• Price elasticity of demand (PED) measures the percentage change in quantity demanded in response to a percentage change in price
  • Elastic demand (PED > 1) indicates that quantity demanded is highly responsive to price changes
  • Inelastic demand (PED < 1) indicates that quantity demanded is less responsive to price changes
  • Unit elastic demand (PED = 1) indicates that the percentage change in quantity demanded equals the percentage change in price
• Price elasticity of supply (PES) measures the percentage change in quantity supplied in response to a percentage change in price
  • Elastic supply (PES > 1) indicates that quantity supplied is highly responsive to price changes
  • Inelastic supply (PES < 1) indicates that quantity supplied is less responsive to price changes
• Income elasticity of demand measures the responsiveness of demand to changes in consumer income
• Cross-price elasticity of demand measures the responsiveness of demand for one good to changes in the price of another good (substitute or complement)

Price Controls and Market Interventions

• Price controls are government-imposed restrictions on the prices that can be charged in a market
• A price ceiling is a legal maximum price that can be charged for a good or service
  • If the price ceiling is set below the equilibrium price, it will lead to a shortage (quantity demanded > quantity supplied)
  • Examples of price ceilings include rent controls and maximum prices for essential goods during emergencies
• A price floor is a legal minimum price that can be charged for a good or service
  • If the price floor is set above the equilibrium price, it will lead to a surplus (quantity supplied > quantity demanded)
  • Examples of price floors include minimum wages and agricultural price supports
• Taxes and subsidies can also affect market outcomes
  • A tax increases the cost of production, shifting the supply curve to the left and leading to a higher equilibrium price and lower equilibrium quantity
  • A subsidy reduces the cost of production, shifting the supply curve to the right and leading to a lower equilibrium price and higher equilibrium quantity

Real-World Applications

• Understanding supply and demand is crucial for businesses when making production and pricing decisions
  • Firms must consider the elasticity of demand for their products to optimize revenue and profits
  • Changes in market conditions, such as shifts in consumer preferences or input prices, require firms to adapt their strategies
• Policymakers use the principles of supply and demand to analyze the potential impacts of regulations, taxes, and subsidies on markets
  • For example, assessing the effects of a minimum wage increase on employment and prices in the labor market
  • Evaluating the efficiency and distributional consequences of price controls or other market interventions
• Consumers can make more informed purchasing decisions by understanding how prices are determined by the interaction of supply and demand
  • Anticipating how changes in market conditions may affect the availability and prices of goods and services
  • Considering the elasticity of demand when making budgeting and consumption choices

Common Mistakes to Avoid

• Confusing shifts in supply or demand with movements along the curves
  • Remember that shifts are caused by factors other than price, while movements are caused by price changes alone
• Misinterpreting the effects of price controls
  • Price ceilings lead to shortages, not surpluses, and price floors lead to surpluses, not shortages
• Ignoring the role of elasticity in determining the magnitude of changes in price and quantity
  • More elastic supply or demand will result in larger changes in quantity and smaller changes in price compared to less elastic supply or demand
• Failing to account for the indirect effects of market interventions, such as taxes or subsidies
  • Consider how these interventions may affect incentives, resource allocation, and market efficiency
• Assuming that all markets operate identically
  • Different goods and services may have unique supply and demand characteristics, such as the degree of competition, the availability of substitutes, or the presence of externalities