Lesson 16:
Key Ideas: In a market economy production decisions and prices are primarily
determined by the Laws of Supply and Demand. The Law of Demand shows that
LOW PRICES tend to be incentives for buyers. The Law of Supply shows that
HIGH PRICES tend to be incentives for sellers.
The Law of Demand: Ceteris paribus, as price increases, quantity
demanded decreases. As price decreases, quantity demanded
increases. This trend creates the curve shown in the graph to the
left. The downward slope of the demand curve illustrates this
inverse relationship between price and quantity.
When prices change, we move along the demand curve. This is
referred to as a change in quantity demanded.
The Law of Supply: Ceteris paribus, as price increases, quantity supplied
increases. As price decreases, quantity supplied decreases. This behavior
creates the curve shown in the graph to the left. The positive slope of the
supply curve illustrates the direct relationship between price and quantity.
When price changes, we move along the supply curve. This is referred to
as a change in quantity supplied.
**Given a curve, you should be able to differentiate between a supply curve
and a demand curve. You should also be able to read and interpret
coordinating price and quantities.
Lesson 17:
Key Ideas: When you graph the supply curve and the demand curve in the same
space, the curves will intersect. This intersection is called EQUILIBRIUM.
EQUILIBRIUM occurs when quantity supplied and quantity demanded are the same.
The price at which equilibrium occurs is called the MARKET CLEARING PRICE.
If the market is not in equilibrium, it is in DISEQUILIBRIUM.
If the price is above equilibrium, the type of disequilibrium created is a
SURPLUS. Quantity supplied will be greater than quantity demanded. This
makes sense since sellers are willing to produce more at higher prices.
If the price is below equilibrium, the type of disequilibrium created is a
SHORTAGE. Quantity demanded will be greater than quantity supplied.
This makes sense since buyers are willing to purchase more at lower prices.
Lesson 18:
Key Ideas: Sometimes, government leaders do not think that prices are “fair”
or equitable. Politicians will step in and try to control prices rather than
let equilibrium be reached. These types of controls are known as price
floors and price ceilings. Note that both types of price controls place
markets in disequilibrium.
Price Floor: A minimum price that can legally be charged for a resource
good, or service. Price floors are set because politicians think the
equilibrium price is too low, so they want to make the price higher. The
classic example of this is a minimum wage. Politicians think it is
unreasonable for someone to work for $5 per hour, so they place a pric
floor on wages.
Notice that price floors will create surpluses. In the case of minimum
wage, it creates a surplus of workers.
Price Ceiling: A maximum that can legally be charged for a product.
Politicians will set price ceilings when they feel a market price is unfairly
high. This will artificially lower the price of the product, but it will create
shortage. Note that historically, politicians have placed price ceilings on
goods and services that are viewed as necessities. This might include
certain foods, gasoline, or more recently, housing as with rent control in
New York City.
** You need to be able to examine a graph and tell if a price is a floor or a
ceiling. You also need to be able to determine if the disequilibrium created
is an example of a shortage or a surplus. Keep in mind, only in economics
are floors above ceilings.
Lesson 19:
Key Ideas: Various factors can cause demand for a product to change. When
demand changes, it means that the willingness of an individual to purchase
that product has changed at all prices. That said, it should be clear that
PRICE DOESN’T SHIFT THE CURVE!! (Remember, a change in price simply leads to
movement along the demand curve.)
What can change demand? Tastes and preferences, the prices of related goods
(substitutes, complements), income, the number of buyers in the market, and
expectations of future prices.
When demand increases, the curve shifts right. When demand decreases the
curve will shift to the left. Remember IRDL (Increase, Right: Decrease,
Left)
Increase in Demand
Decrease in Demand
** You need to be able to read the changes in price and quantity that result
when a demand curve shifts. For example, if demand increases, price and
quantity will rise. If demand decreases, price and quantity will fall.
Lesson 20:
Key Ideas: Many factors can cause the supply of a product to change. This
means that the willingess and ability of a supplier to produce a product has
changed at ALL PRICES. Since it changes at all price, you should know that
PRICE DOESN’T SHIFT THE CURVE!
What will shift the supply curve? Changes in technology, changes in input
costs, changes in the prices of other goods a producer could produce, changes
in taxes, subsidies, or regulations, changes in expectations of future
prices, changes in the number of sellers.
When supply increases, the curve shifts to the right.
the curve shifts to the left. IRDL works here too!
When supply decreases,
**
You need
to be able to read what happens to price and quantity when supply
Increase
in Supply
Decrease in Supply (Don’t say shift up!)
changes. For example, when supply increases, price falls and quantity
increases. When supply decreases, price rises and quantity falls.
Lesson 21:
Key Ideas: Elasticity of demand and supply simply measure how responsive
people are to a change in price. For example, we know that if price rises,
people tend to buy less of a product. But how much less? A little less? A
lot less? When we ask these questions, we are asking about the elasticity of
demand or supply for a product.
Elasticity of Demand:
price
Measures how responsive buyers are to a change in
Elastic Demand- When price changes, buyers change how much they buy by
A LOT. This
is true of things that are not necessities and things that have a lot
of
substitutes.
Inelastic Demandamount.
When price changes, buyers still buy about the same
This is true of things that are necessities (medicine) and items with
virtually no
substitutes. For example, if you need a medication to live, and the
price of that medicine doubles, you are going to buy the same amount of
that medicine no matter the price.
Elasticity of Supply- measures how responsive suppliers are to a change in
price. The main thing that affects the elasticity of supply is time needed
to product the product. I can easily provide more haircuts if the price
doubles, but the supply of cargo planes will be more inelastic because it
takes more time to produce them.
AP Extensions
Consumer surplus is the benefit to a buyer from the purchase of a good. It is equal to the difference between the buyer's willingness to pay and the price paid. When looking at a market
demand curve, the total consumer surplus is found above the market price, up to the demand curve, and over to the amount of the product sold.
Producer surplus is the benefit to a seller from the sell of a good. It is equal to the differnce between what the seller was willing to accept as payment and the price paid. When looking at a
markeet supply curve, the total producer surplus is found below the market price, down to the supply curve, and over to the amount of the product sold.
Together, at the equilibrium price, total surplus and production is maximized, creating the most efficient outcome.
When a price floor is imposed on a market, we will see a loss of efficiency. Dead weight loss will result as fewer units of the good are consumed.
Double Shifts – When you have a situation where Supply and Demand are shifting for a product AT the
SAME TIME, you will be asked about the impact on price and quantity. In the case of a DOUBLE SHIFT,
either the impact on price or quantity will ALWAYS be indeterminate.
For example:
S and D both increase: If supply increases, price falls, quantity rises. If demand increases, price rises,
quantity increases. Hence quantity will definitely increase, but we don’t know what will happen to
price. Therefore, the impact on price in indeterminate.
Possible Combinations
Supply Increase
Price falls
Quantity rises
Demand increase
Price rises
Quantity rises
Supply decrease
Price rises
Quantity falls
Demand decrease
Price falls
Quantity falls
To solve a double shift, shift each curve individually and examine the impact on price and quantity. Find
the one that moves in the same direction for both. That indicator will move in the indicated direction.
Then, find the one that shows movement in two different directions. That is the one that is
indeterminate.