Microeconomics Unit 2 Summary: Supply and Demand

Overview

• Law of Demand: Negative relationship between price and quantity demanded.
• Law of Supply: Positive relationship between price and quantity supplied.
• Elasticity: Measures responsiveness of one economic variable to changes in another.
• Consumer Surplus, Producer Surplus, Deadweight Loss: Analyze market efficiency and welfare effects.
• Government Intervention: Taxes, subsidies, tariffs, and price controls analyzed using supply and demand.

Key Concepts

Demand

• Definition: Quantities consumers are willing and able to buy at different prices.
• Law of Demand: Inverse relationship between price and quantity demanded.
  • Price up, demand down; Price down, demand up.
• Reasons for Law of Demand:
  1. Substitution Effect: As price rises, consumers buy substitutes.
  2. Income Effect: Price rise reduces purchasing power, leading to lower demand.
  3. Law of Diminishing Marginal Utility: Less satisfaction with more units consumed.
• Demand Curve: Downward sloping; price changes move along the curve, other factors shift the curve.
• Shifters of Demand:
  • Taste and preferences
  • Number of consumers
  • Price of related goods (substitutes and complements)
  • Income changes (normal vs. inferior goods)
  • Future expectations

Supply

• Definition: Quantities producers are willing and able to sell at different prices.
• Law of Supply: Direct relationship between price and quantity supplied.
  • Price up, supply up; Price down, supply down.
• Supply Curve: Upward sloping; affected by:
  • Price of resources
  • Number of producers
  • Technology
  • Government intervention (taxes, subsidies, regulation)
  • Future profit expectations

Elasticity

• Price Elasticity of Demand: Sensitivity of quantity demanded to price changes.
  • Formula: % change in quantity / % change in price
  • Elastic: Greater than 1, quantity is sensitive.
  • Inelastic: Less than 1, quantity is less sensitive.
  • Unit Elastic: Equal to 1, proportional sensitivity.
• Price Elasticity of Supply: Similar to demand; sensitivity of quantity supplied to price changes.

Cross Price and Income Elasticity

• Cross Price Elasticity of Demand: Sensitivity to price change of another good.
  • Positive: Substitutes
  • Negative: Complements
• Income Elasticity of Demand: Sensitivity to income changes.
  • Positive: Normal goods
  • Negative: Inferior goods

Equilibrium

• Equilibrium Price and Quantity: Where supply equals demand in a competitive market.
• Surplus and Shortage:
  • Surplus: Price above equilibrium, leads to price fall.
  • Shortage: Price below equilibrium, leads to price rise.
• Consumer and Producer Surplus:
  • Consumer surplus: Benefit above equilibrium price.
  • Producer surplus: Benefit below equilibrium price.
• Total Surplus: Consumer + producer surplus; maximized at efficient market.
• Deadweight Loss: Loss due to inefficiency, producing too much/little.

Government Intervention

• Price Controls:
  • Price Ceiling: Below equilibrium, causes shortages.
  • Price Floor: Above equilibrium, causes surplus.
• Taxes:
  • Shifts supply curve left, increases cost for producers.
  • Tax Incidence: Shared burden between consumers and producers, depends on elasticity.
• International Trade:
  • Benefits consumers, can harm domestic producers.
  • Tariffs: Increase prices, create government revenue, cause deadweight loss.

Practice

• Study Guide: Fill out relevant topics in study guide.
• Elasticity Questions: Practice calculations and applications.
• Market Changes: Predict impact on price and quantity with shifts in supply and demand.

Summary

• Understanding supply and demand is crucial for analyzing market behaviors and outcomes.
• Elasticity offers insight into how sensitive consumers and producers are to price changes.
• Government policies affect markets and can cause inefficiencies, analyzed through economic models.