Transcript for:
Unit 2

hi everybody jay breed here from reviewecon.com today we're going to be looking at unit 2. it's all about supply and demand we're going to summarize the key points of the entire unit so that you're ready for test day this video goes along with the total review booklet from review econ.com if you're interested in picking that up check out the links below like and subscribe and if you have any questions ask them in the comments let's get into the content this is gonna be awesome we're gonna start off by talking about the law of demand the law of demand tells us that ceteris paribus consumers buy more of a good at low prices and less of a good at higher prices that means that we have a downward sloping demand curve when we graph it out because there's an inverse relationship between the price and the quantity demanded so when price rises that causes movement along the curve decrease in price causes a movement down that curve and increases quantity demanded special thing to note is that price changes quantity demanded price does not change demand it's a key thing that pops up over and over again and it will trick you if you aren't paying attention price changes quantity not demand remember it there are some things besides price that do shift demand curves here are some of our non-priced determinants of demand or demand shifters as they're often called first we've got tastes and preferences when there's an increase in consumer taste it will shift our demand curve to the right increasing that demand if there's a decrease in tastes and preferences like something becomes unpopular or it falls out of fashion that will cause a decrease in demand or a shift to the left if there are more buyers also called market size that will cause an increase in the demand for a product if there are fewer buyers available that will cause a decrease in the demand the next one we have is prices of related goods when it comes to prices of related goods there are two types that you need to be aware of first of all we've got substitutes when it comes to substitutes when the price of one goes up demand for the other one also goes up substitutes mean that one good can replace the other so when the price of one goes up people buy less of that good and they buy more of the other one instead things like jam and honey i can use either one on my peanut butter and jelly sandwiches or peanut butter and honey sandwiches either one works so in this example they would be substitutes for each other if the price of jelly goes up the demand for honey is going to go up as well for compliments that means one goes with the other when the price of one goes up demand for the other actually goes down here we have the compliments jelly and peanut butter when the price of jelly goes up people buy less jelly but it also causes us to decrease our demand for peanut butter because they go hand in hand bread and butter toothpaste and toothbrushes ice cream and ice cream cones all different examples of complementary goods next we have changes in income for most goods like shoes when you have more income you buy more of that product so an increase in consumer income will increase the demand and a decrease in consumer income will decrease the demand the other type of good is called inferior goods with inferior goods when incomes rise people buy less of those products so incomes rise and demand actually decreases those are things like one ply toilet paper or top ramen or condensed soup when incomes rise people buy less of those products the last one is expectations for the future sometimes guesses about what's going to happen later on impact consumer behavior today that's why when it comes to buying a television i'm going to wait until black friday for when they're on sale so i demand fewer today decrease my demand and then i buy more later so that expectation for the future changes demand today if any of those things change it can cause our demand curve to shift if we have a shift to the right that is an increase a rightward shift is an increase that means there is a higher quantity demanded at all prices not just at one particular price if we have a shift to the left that is a decrease a lower quantity demanded at all available prices shift to the left so the next thing we need to do is figure out why it is that demand curve's downward slope the first reason why demand curves downward slope is called the substitution effect that tells us that an increase in price causes substitutes to look relatively less desirable and where there's a decrease in price that makes the alternative substitutes more attractive so for example when the price of ice cream goes up i buy less ice cream partly because i'm going to buy more popsicles instead that's the substitution effect the next reason why is called the income effect the income effect tells us that there's an increase or decrease in purchasing power as a result of a change in price another way of saying this is that when the price goes up i can't afford as much when the price goes down i can afford more so if the price of candy bars is a dollar and i've got ten dollars in my pocket then my income of ten dollars is worth ten candy bars but if the price of candy bars doubles to two dollars now the purchasing power of my ten dollars worth of income decreases to five candy bars worth and if the price of candy bars plummets all the way down to 50 cents that's how much they cost back in my day then the purchasing power of my 10 worth of income will increase to 20 candy bars worth and that's the income effect another way of saying this is that when prices go up i can afford less and when prices go down i can afford more that's the income effect in a nutshell now let's talk about supply curves supply curves are the opposite of demand curves before there was an inverse relationship between price and quantity with supply there's a direct relationship ceteris paribus producers produce and sell more at high prices and less at low prices it's true so often it's the law of supply it gives us an upward sloping supply curve and when prices go up we see an increase in the quantity supplied stone as movement up that supply curve if price goes down it shows movement down that curve which gives us a decrease in the quantity supplied special note just like with demand price changes quantity or quantity supplied in this case price does not change supply make sure you know that it will trick you on your test but there of course are things that do shift supply we call those non-price determinants of supply these are your supply shifters first of all we've got input prices those are the things that go into the production if the price of a resource that goes into the production goes up it will decrease supply if it goes down it will increase supply then we've got government tools taxes per unit taxes decreased supplies we've got subsidies subsidies increase supply and the last thing is regulations regulations will generally depending on the type of regulation decrease supply the third thing we've got is the number of sellers all right sometimes people say competition for this one an increase in the number of businesses that are producing a product will increase the supply a decrease in the number of businesses producing a product will decrease the supply the next one we've got is technology increases in technology also increase supply prices of other goods can sometimes impact supply as well if the price of wheat goes up farmers may make more wheat and decrease their supply of corn as a result the last one is producer expectations just like with consumers the future impacts what businesses do today if any of those things change it actually causes a shift in the supply curve right word shift just like with demand is going to be an increase make sure you understand the left and right instead of up and down because a downward shift for supply is actually a rightward shift and that's an increase on the other side a leftward shift is going to be a decrease we're talking about lower quantities supplied at every price next thing we're going to look at is the price elasticity of demand as you already know when price goes up consumers buy less and when price goes down consumers buy more elasticity asks how much less or how much more that's what we're looking at here when it comes to determining the price elasticity of demand there are six tests we're going to look at each of those tests now the first test is do you need it if the answer is yes odds are this product has inelastic demand like life-saving medications if the answer is no odds are we have elastic demand like a cookie the second test is how many substitutes are there if there are very few substitutes like for a heart transplant not much else you can do if you're in the market for a heart transplant then we're going to have inelastic demand if we have many substitutes like soft drinks then we will have elastic demand if the price of one soft drink goes up i just buy one of the others the third test is how much income does it take to purchase this good if the item is cheap the product tends to be inelastic if it's expensive on the other hand like a car versus a pencil then we have elastic demand for the fourth test we're looking at the steepness of that demand curve if the demand curve is very vertical at least more vertical than horizontal then a large change in price will cause a small change in quantity demanded we call that inelastic demand if we have a curve that is more horizontal than vertical then a small change in price will cause a larger change in quantity demanded and that is an elastic demand curve the fifth test is the total revenue test in order to do the total revenue test you have to do a little bit of math price times quantity that's total revenue and then you look at what's happening between price and total revenue for a particular range of the demand curve if price falls and total revenue rises they're going in opposite directions that's an elastic demand curve if price falls and total revenue falls now they're going in the same direction both up or both down that's the inelastic portion of that demand curve if there's no change in total revenue as there is an increase or decrease in price we call that a unit elastic demand we can apply the total revenue test to an actual demand curve as that demand curve downward slopes we have changes in total revenue we call that marginal revenue and we can graph it with a marginal revenue curve below that demand you will see that later on in unit 4 when you learn about monopolies at the top of the demand curve as price falls and quantity increases marginal revenue is positive that means total revenue is increasing as price falls that tells us we have an elastic portion of the demand curve up there where marginal revenue is zero that means total revenue is not changing as we continue to produce more and decrease price that is the unit elastic portion of this demand curve further down where marginal revenue becomes negative price is falling quantity is increasing and total revenue is falling because marginal revenue which is the change in total revenue is negative here that gives us an inelastic portion of this demand curve in fact all downward sloping demand curves that are straight or linear will have these three sections an elastic portion at the top where marginal revenue is positive a unit elastic point in the middle where marginal revenue is zero and an inelastic range near the bottom where marginal revenue is negative take a look at that marginal revenue curve and it will tell you what the demand curve is above regarding elasticity on to our sixth test and this one can be the most complicated at times it's calculating an elasticity coefficient in order to calculate a coefficient for elasticity you need to find the percentage change in quantity and divide that by the percentage change of price in order to find percentage change and that can be tricky for some people the preferred formula for the ap exam is new minus old divided by old times 100 make sure you follow the direction of the numbers for this type of question so if the price increases from a hundred dollars to 110 dollars that's an increase of 10 percent so make sure you calculate that out there is a better more exact method that is not the preferred method for the ap exam and that is called the midpoint method see the links below to find out how to do that once you have calculated the coefficient you find the absolute value so drop the negative in fact all demand curves will have a negative price elasticity coefficient which shows us the inverse relationship between price and quantity if we have a absolute value that is greater than one then that demand curve at least in that section is relatively elastic if it is equal to one that's proportional changes between quantity and price then that's the unit elastic portion of the demand curve if we have an elasticity coefficient that is absolute value less than one that means it's the decimal then we are looking at a relatively inelastic demand curve now we have a couple of extremes here are the extreme versions perfectly elastic is a completely horizontal perfectly horizontal demand curve and that will have an elasticity coefficient of infinity or undefined if we have a vertical demand curve that means at any price one specific quantity will be demanded that gives us an elasticity coefficient of zero those are the perfectly elastic and perfectly inelastic curves anything else we call relatively elastic or relatively inelastic now we're going to look at some other elasticities the first elasticity we're going to look at is the price elasticity of supply the calculation of the coefficient is just like it was for those demand curves we have the percentage change in quantity divided by the percentage change in price and just like before the preferred method for calculating percentage change is new minus old divided by old times 100 you do that for both the quantity and the price and then calculate your coefficient supply curves will always have a positive coefficient because there's a direct relationship between price and quantity and if the absolute value of that coefficient is greater than one it is a relatively elastic supply curve if it is equal to one it's a unit elastic supply curve and if it is less than one it is a relatively inelastic supply curve here's what they look like visually first we got some extreme ones we call this perfectly elastic that's a horizontal supply curve a vertical supply curve is perfectly inelastic that'll be a coefficient of zero where the horizontal one was a coefficient of infinity or undefined the next one is a relatively elastic one it's more horizontal than vertical and then the last one is a relatively inelastic supply curve which is more vertical than horizontal this is just the kind of thing we were seeing back with demand if you recall two other types of elasticities we have to know the first one is income elasticity here we're looking at how much a change in income impacts how many people buy at every price here we have a percentage change in quantity divided by the percentage change in income if we have a positive coefficient that indicates a direct relationship between the quantities people buy and the changes in their income that's a normal good if we see a negative coefficient that indicates a inverse relationship between the quantity people buy and their income that would be an inferior good the last type of elasticity you need to know is called cross price elasticity cross price elasticity is about substitutes and complements it's about the interaction of the price of one good compared to the demand for another good here we calculate the coefficient by taking the percentage change in quantity demanded and dividing it by the percentage change for the other good positive coefficients indicate that these are substitutes because when the price of one substitute goes up demand for the other one also goes up there's a direct relationship when it comes to a negative coefficient that means that there's a inverse relationship between the price of one good and demand for the other good that means these products are complements because when the price of one goes up demand for the other one goes down the next thing we're going to do is talk about market equilibrium we find market equilibrium when we mix supply and demand on the same graph where the two curves intersect gives us our equilibrium price and equilibrium quantity it's the price where the quantity supplied equals the quantity demanded the market seeks that equilibrium price and quantity sometimes prices are above equilibrium and that causes quantity supplied to be greater than quantity demanded that means we have a surplus and prices will eventually fall back to equilibrium sometimes we have a price that's below equilibrium when that happens we will have a shortage where the quantity supplied is less than the quantity demanded prices will eventually rise seeking that equilibrium point of course the equilibrium price and quantity can change when there's a shift in either demand or supply an increase in demand causes the equilibrium price to increase and the equilibrium quantity to increase a decrease in demand causes the equilibrium price and equilibrium quantity to both decrease an increase in the supply will cause the equilibrium price to decrease and the equilibrium quantity to increase a decrease in the supply will cause the equilibrium price to increase and the equilibrium quantity to decrease now i don't suggest you memorize all these shifts just when in doubt graph it out sketch out your little graph and see what happens to equilibrium price and equilibrium quantity on your paper most of the time when you get a question one variable will change and one curve will shift occasionally you could have two variables change when that occurs it is possible you could have two curves shifting double shifts get a little bit tricky because one of the axes will be indeterminate here we have a decrease in supply that caused the price to go up and the quantity to go down so we move from one equilibrium point to another equilibrium point if we add another shift a increase in demand here we now have a third equilibrium point how does this combined double shift impact the price and quantity well both shifts increased the price that means we know for sure that the price is going to be increased but on the x-axis there the first shift decreased the quantity and the second shift increase the quantity since these shifts contradict it really depends on the size of the shifts as to where the final equilibrium quantity is and as a result that axis will be indeterminate here's another example of a different double shift we're starting off with an increase in demand this time which causes the equilibrium point to move increasing the price and increasing the quantity if we add another shift this time it's a increase in supply we now have a third equilibrium point and here on that x-axis the quantity increased on both shifts whereas the price increased with one shift and decreased with the other shift equilibrium quantity will be determined as an increase but the equilibrium price will be indeterminate on to a new concept this is called consumer surplus consumer surplus is the difference between the value to the customer and the price the customer pays one of my favorite lunches is cheeseburgers my marginal utility for the next cheeseburger is eight dollars but if i only pay six dollars i have a consumer surplus of two dollars it's the difference between my marginal utility and the price i pay on the flip side we have producer surplus producers have the marginal cost of production and the price they charge the difference between the two is producer surplus if the marginal cost of that cheeseburger was four dollars while the price was six the producer will have a producer surplus of two dollars here's what it looks like on the graph for consumer surplus you find the equilibrium price in this case or the price that consumers are paying you go out until you hit the quantity that consumers are getting and you go all the way up until you hit that demand curve in this case it's a triangle there and you could calculate the area of the triangle to determine the amount of consumer surplus on the flip side we have the producer surplus you find the price that producers are getting for this product in this case it is the equilibrium price and you go to the quantity that they are selling the equilibrium quantity here and you drop all the way down to the supply curve that area there is the producer surplus and you could also calculate the area of this if there were numbers economic surplus is the consumer surplus and the producer surplus added together a little side note you could have tax revenue also and that would be part of the economic surplus as well when markets without externalities are in equilibrium we have what's called allocative efficiency allocative efficiency means that we are getting the right number of this good or service that is most valued given the marginal cost and the marginal benefit of the product we reach allocative efficiency when we hit equilibrium for a product that has no externalities that is where economic surplus is maximized if we don't reach equilibrium we will have dead weight loss deadweight loss occurs when there is a reduction of economic surplus here's an example here we're selling at p1 that price it's above equilibrium and we are only getting q1 for the quantity here our consumer surplus would be this small triangle it's the price till we hit the quantity that we're at all the way up to the demand curve for the producer surplus we go to that quantity that we're getting here all the way down to the supply curve those two areas together are our economic surplus but we have some deadweight loss the way you find the deadweight loss is you go from the quantity that we are getting in this market and find the marginal cost of that quantity we find that on the supply curve the supply curve is the marginal cost curve we find another point above on the demand curve that is the marginal benefit of the quantity for this product the third point we're looking for is the allocatively efficient point that is where the marginal cost equals the marginal benefit it's equilibrium on this graph those three points together give us our dead weight loss we could calculate the values of all of these shapes if there were numbers here now we're going to look at how government intervention in the market system can impact consumer surplus producer surplus and dead weight loss first let's take a look at a price floor a price floor is a government intervention that establishes a minimum price for a product it makes it illegal to charge less minimum wage is an example of a price floor if a price floor is going to be effective or binding it must be above equilibrium that's right the floor is up high here's what it looks like on the graph there's our supply and demand curve without any government intervention and the government puts a price floor above equilibrium at that higher price there is a lower quantity demanded higher quantity supplied but the difference between those two is our surplus not economic surplus not consumer surplus not producer surplus it's a surplus that means the quantity supplied is greater than the quantity demanded at that higher price the quantity demanded which is the lower of the two is the amount that is actually sold here so that is the quantity we get in this market with the price floor at that higher price we have just a small triangle of consumer surplus we have a pretty large section of producer surplus the producers here might like this price floor but we have dead weight loss here and that's because we do not reach the efficient outcome of reaching equilibrium another government control we could get is a price ceiling price ceilings are maximum prices for a product if a price ceiling is going to be effective or binding it will be below equilibrium by the way if they aren't below equilibrium when they're price ceiling or they aren't above equilibrium when they're a price floor that means they are ineffective and we just go to equilibrium so here's what a price ceiling looks like on the graph the price ceiling goes below equilibrium because it's going to be binding in this example and at that artificially low price the quantity supplied is less than the quantity demanded that causes a shortage where the quantity demanded is greater than the quantity supplied that's what we call it a shortage now at that artificially low price the quantity supplied the lower of the two is all we're going to get in this market because we don't get to buy more than is going to be produced there is our producer surplus it is a small triangle there based on where that price ceiling is all the way down to that supply curve and then we have a big area there of consumer surplus but since we aren't reaching equilibrium at the quantity we've got we have a triangle there of deadweight loss we could calculate the area of all these shapes if numbers were given now we're going to look at the impact of per unit excise taxes on a market there's our equilibrium again we've got our equilibrium price and quantity if the government imposes a per unit tax on this good it will shift the supply curve the vertical distance of that tax and we will have a new equilibrium which has a lower quantity with the tax also at that new intersection there we get the price that buyers will pay that is the price you see at the store when there is a tax on this particular good if you follow that new equilibrium down to the old supply curve and then out to the price axis that gives you the price that the sellers receive after paying the government the tax we could shade in that box there that is the amount of the tax it's the vertical distance between the two supply curves the supply and the supply plus the tax times the distance or the base there which is the quantity we sell at with the tax so that gives us our tax revenue box we can calculate that and find out how much money the government is bringing in as a result putting a tax on this item we have just a small area of producer surplus since ps is all that producers get you go till you hit that original supply curve drop down and that gives us the producer surplus we have as a result of this tax the consumer surplus is up there it's where the price the buyers pay until we hit the quantity we're at and then up above until you hit that demand curve and then we have a triangle of deadweight loss right remember a little side note little helpful reminder is that the triangle of deadweight loss points to the allocatively efficient quantity which here is the equilibrium quantity you can calculate the area of all those shapes if there were numbers for sure the next thing we're going to do is take a look at tax incidence or tax burden what we're looking at here is who pays the tax when the government imposes a per unit tax on a particular good there's a myth out there that all of the cost of attacks will be passed on to consumers but it really depends on the elasticities of the supply and demand curves the way you figure it out is the less elastic curve will pay more of the tax here we have the demand curve is less elastic than the supply curve and as a result the consumers have a bigger portion of the tax incidence how do you figure it out you divide the tax revenue box from the old equilibrium the top portion is the buyer's loss and the bottom portion is the seller's loss that tells you who is paying a bigger portion of this tax if we have the supply curve that is the less elastic of the two then the sellers will have a bigger tax incidence than the buyers here are the extremes here we have a perfectly elastic curve none of the tax when the supply curve is perfectly elastic all of the tax will fall on buyers if one of the curves is perfectly inelastic like this demand curve here then all of the tax will go on that curve in this case the burden is falling entirely on consumers if we have a perfectly inelastic supply curve then the entire burden falls on sellers the last topic for this unit is trade and tariffs we're going to take the ideas we've already learned supply and demand and apply them to international trade and tariffs let's take a look at the supply and demand curve for international trade we have an upward sloping domestic supply and a downward sloping domestic demand and then we're going to add in a world supply curve at a lower world price than would be for the domestic equilibrium price and equilibrium quantity at that low price we have q1 is the quantity that producers will actually produce or make at this low price q2 is how much consumers will want to buy at that price and the difference is imported q2 is how much consumers get q1 is all that's produced so that gap the gap between there q2 minus q1 is the amount that will be imported from the international markets to find the producer surplus at that world price you go from that world price until you hit the supply curve because q1 is all that producers are getting to produce domestic producers that is and that gives us a triangle of domestic producer surplus for consumer surplus it's not just until you hit that equilibrium we go all the way till we hit q2 so this whole area here is our domestic consumer surplus with international trade now this scenario is pretty good for consumers but if you are a manufacturer of this product you'll notice that the producer surplus is pretty small so these producers may lobby congress and the president to install some tariffs on this good if we put tariffs on this good that will cause the world price to shift upward we now have the world price plus the tariff which gives us the world supply plus the tariff at that new higher price we have a lower quantity that's imported price goes up for the domestic producers so they produce q3 they produce more now but less gets imported and consumers don't get to consume as much they will consume q4 so q4 minus q3 here that is the amount that will now be imported so there's a lower amount that's imported as a result of the tariff producer surplus grows a bit consumer surplus shrinks a bit but there is another benefit and that is some tariff revenue the amount that is imported times the height of that tariff the gap between pw and pw plus the tariff that is our tariff or tax revenue as a result of the import tax but here's a downside and this is efficiency loss we have two little triangles of dead weight loss as a result of the efficiency lost from the tariff that's surplus we could have had but we lose out on as a result of the tariff and of course you could calculate the values of all of these if there were numbers on the graph we made it through it now that's everything you need to know for that unit if you already knew all of that stuff you are on your way to doing really well on your next exam if you still need some help head down to the links below and head over to reviewecon.com where there are lots of games and activities to help you practice and relearn those skills that you need to know if you want to support this channel please like and subscribe below and then head over to reviewecon.com and purchase the total review booklet with all of the