Supply and Demand - Unit 2 Overview

Introduction

• Presenter: Jay Breed from ReviewEcon.com
• Purpose: Summarize key points of supply and demand in preparation for the test.

Law of Demand

• Definition: Ceteris paribus, consumers buy more at lower prices and less at higher prices.
  • Demand Curve: Downward sloping due to inverse relationship between price and quantity demanded.
• Key Point: Price changes the quantity demanded, not demand itself.

Non-Price Determinants of Demand

• Tastes and Preferences: Increase shifts demand right; decrease shifts left.
• Market Size: More buyers increase demand; fewer buyers decrease it.
• Prices of Related Goods:
  • Substitutes: Price increase in one, increases demand for the other.
  • Complements: Price increase in one, decreases demand for the other.
• Income:
  • Normal Goods: Higher income increases demand.
  • Inferior Goods: Higher income decreases demand.
• Future Expectations: Expectations can alter demand today.

Demand Curve Effects

• Substitution Effect: Price increase makes substitutes less desirable.
• Income Effect: Price changes affect purchasing power.

Supply Curves

• Law of Supply: Direct relationship between price and quantity supplied.
  • Supply Curve: Upward sloping.
• Key Point: Price changes quantity supplied, not supply itself.

Non-Price Determinants of Supply

• Input Prices: Increase in input prices decreases supply.
• Government Tools:
  • Taxes: Decrease supply.
  • Subsidies: Increase supply.
  • Regulations: Generally decrease supply.
• Number of Sellers: More sellers increase supply.
• Technology: Advances increase supply.
• Prices of Other Goods: Resource allocation can affect supply.
• Producer Expectations: Future expectations can shift supply.

Price Elasticity of Demand

• Definition: Measures how much the quantity demanded responds to price changes.
• Tests for Elasticity:
  1. Necessity: Inelastic vs. elastic.
  2. Substitutes: Few = inelastic; many = elastic.
  3. Income Proportion: Cheap = inelastic; expensive = elastic.
  4. Curve Steepness: Vertical = inelastic; horizontal = elastic.
  5. Total Revenue Test: Opposite directions = elastic.
  6. Elasticity Coefficient: Calculated as % change in quantity / % change in price.
• Extremes:
  • Perfectly Elastic: Horizontal curve.
  • Perfectly Inelastic: Vertical curve.

Price Elasticity of Supply

• Similar calculation to demand elasticity.
• Positive coefficient due to direct relationship.

Income and Cross-Price Elasticities

• Income Elasticity: Positive for normal goods, negative for inferior goods.
• Cross-Price Elasticity: Substitutes have positive coefficients; complements have negative ones.

Market Equilibrium

• Definition: Where quantity supplied equals quantity demanded.
• Surplus and Shortage: Occur when prices are above or below equilibrium.
• Shifts in Curves:
  • Demand increase: Price and quantity increase.
  • Demand decrease: Price and quantity decrease.
  • Supply increase: Price decreases, quantity increases.
  • Supply decrease: Price increases, quantity decreases.

Consumer and Producer Surplus

• Consumer Surplus: Difference between what consumers are willing to pay and what they pay.
• Producer Surplus: Difference between production cost and price received.
• Economic Surplus: Sum of consumer and producer surplus.
• Deadweight Loss: Reduction in economic surplus when not at equilibrium.

Government Interventions

• Price Floors: Minimum price, effective if above equilibrium, causing surplus.
• Price Ceilings: Maximum price, effective if below equilibrium, causing shortage.
• Excise Taxes: Shifts supply, affects equilibrium, creating tax revenue and deadweight loss.
• Tax Incidence: Burden depends on elasticity of the curves.

Trade and Tariffs

• Impact: Lower world prices increase consumer surplus but may hurt domestic producers.
• Tariffs: Increase domestic prices, decrease imports, create tariff revenue, but cause efficiency loss.

Conclusion

• Preparation Advice: Graph shifts and effects to understand changes.
• Recommendation: Review additional materials and practice problems for better exam performance.