AP Macro Notes Unit 1 part C

Micro Unit 2 Lesson 1
(2 days)

Demand
Market: an institution or mechanism, which brings together buyers ("demanders") and sellers ("suppliers") of particular goods and services.

Notice that the remainder of this unit assumes a perfectly competitive market. This means that there are a large number of independently acting buyers and sellers.

Three questions the market can answer. Any economic system should be able to answer these questions.
1) The market decides what will be produced.
2) The market decides how things will be produced?
3) The market decides for whom the products will be produced.

Demand-
The number of units of a good or service that a buyer
is willing (I am not willing to buy sweet potatoes)
and able (I am not able to buy a Porsche)
to buy at various prices. (a range of prices)

Quantity Demanded: the total amount of a commodity that all households wish to purchase. (These commodities must meet the definition of demand.)

Suppose you owned a C.D. player and c.d.'s cost $50 a piece. How many a year would you buy? Now suppose they cost $35 a piece. How many a year would you buy then? What if the cost was $20 dollars a year? Finally how many would you buy if they cost $5 a piece. Let’s look at this on a chart.

Price ($) Quantity Demanded
50 2
35 5
20 13
5 25

This is what we call a demand schedule. It is a table that shows how much consumers are willing and able to purchase at various prices.

You can have a demand schedule for an individual or a market. The market demand curve is just the summation of all the individual demand curves.

In looking at the table you will notice that as the price decreases quantity demanded (notice not your demand) increases. As price increases your quantity demanded for C.D.'S. This is called the law of demand.

The law of demand: as price increases your quantity demanded for a good or service will decrease and vice versa









This is what is called a DEMAND CURVE: A graph of a demand schedule: a demand curve is drawn on the assumption that everything except the commodity's own price is held constant (ceteris paribus); a change in any of the variables previously held constant will shift the demand curve to a new positions.

There are two main reasons for a downwardly sloping demand curve.
1) The income and substitution effect and
2) The Law of Diminishing Marginal Utility.

Income effect: The lower the price the more one can afford of a good without giving up other goods. If you make $20 per week you could buy 10 steaks at $2 per steak. If the price decreased to $1 per steak your income has in effect increased because your purchasing power has increased. You can now buy 20 steaks. At the same time, if the price of steaks went down you have more money to buy steaks and more money to buy other goods.

Substitution effect: at a lower price, you have the incentive to substitute the cheaper goods for similar goods, which are now relatively more expensive. If steaks now drop in price to $1 per pound you have an incentive to substitute steak for hamburger.


Utility: Satisfaction derived from consuming a commodity. Measured with “Utils”

TOTAL UTILITY: The total satisfaction from consuming some commodity

MARGINAL UTILITY: The change in satisfaction resulting from consuming a little more or a little less of a commodity


LAW OF DIMINISHING MARGINAL UTILITY: The utility any household derives from successive units of a particular commodity diminishes as total consumption of the commodity increases while the consumption of all other commodities remains constant

UTILITY THEORY OF DEMAND: Each household demands each good up to the point at which the marginal utility per dollar spent on it is the same as the marginal utility of the dollar spent on another good. When this condition is met, the household cannot shift a dollar of expenditures from one commodity to another and still increase its utility.

MUx = MUy
px py

This says that the household will allocate its expenditure so that the utility gained from the last dollar spent on a commodity is equal.






Change in Quantity Demanded







A decrease in price leads to an increase in Quantity Demanded





An increase in price leads to a decrease in Quantity Demanded







DETERMINANTS OF DEMAND:

When a determinant changes the demand curve shifts. The direction of the shift comes from the determinant that causes the change.




1) CONSUMERS’ INCOMES: a rise in average household income shifts the demand curve for most commodities to the right. This indicates that more will be demanded at each possible price. The direction of the shift depends on whether the good is inferior or normal (also called superior).

SUPERIOR GOODS (also called normal): those goods whose demand varies directly with income. (Examples: Steak, Luxury cars...)

Increase in income will lead to increase in demand for the normal good

Decrease in income will lead to decrease in demand for the normal good

INFERIOR GOODS: those goods whose demand varies inversely with income. (Ex: Hamburgers, used cars...)

2) CONSUMERS’ TASTES AND PREFERENCES: A change in tastes and preferences in favor of a commodity shifts the demand curve to the right more will be bought at each price. (C.d.'s change demand for records)

If people prefer more of a product you will get an increase in demand. If they prefer less of a product you will get a decrease in demand.

3) THE PRICE OF COMPLEMENTARY GOODS:

A fall in the price of a complementary commodity will shift a commodity’s demand curve to the right.
Example: A decrease in the price of baked potatoes means the demand curve for sour cream will increase. Notice this means more sour cream will be bought at each price.



Decrease in price of baked potatoes


Increase in demand for sour cream
An increase in the price of baked potatoes will cause demand curve for sour cream to decrease.
(Can you graph this?)

4) THE PRICE OF SUBSTITUTES:
A rise in the price of a substitute for a commodity shifts the demand curve for the commodity to the right.
Example: An increase in the price of margarine leads to an increase in the demand for butter.



Increase in price of margarine



Increase in demand for butter


A decrease in the price of beef leads to a decrease in demand for pork.

5) CHANGE IN POPULATION:

A rise in population will shift the demand curves for commodities to the right, indicating that more will be bought at each price. (THIS ALSO INCLUDES NEW MARKETS.) (Baby boom, Germany)

A decrease in population will shift the demand curve for the commodity to the left.

6) CONSUMER EXPECTATIONS ABOUT PRICE:
If consumers expect prices to rise in the near future the demand for goods will increase. (Increase in Demand)
If consumers expect prices to fall in the near future the demand for goods will decrease. (Decrease in Demand)

7) CONSUMER EXPECTATIONS ABOUT INCOME: If consumers expect overall incomes to fall the demand will decrease now.
(Ex: an announced increase in future sin taxes will increase demand for those goods before the tax goes in effect.)
When students are in their last year of college they often get job offers a few months before they graduate. They then run out and buy new clothes, a new car… because they expect higher wages.

SPEND TIME MAKING SURE YOU UNDERSTAND THE DIFFERENCE BETWEEN A CHANGE IN DEMAND AND A CHANGE IN QUANTITY DEMANDED.







Micro Unit 2 Lesson 2 & 3

SUPPLY: The number of units of a good or service that a seller is willing and able to sell at various prices.

SUPPLY SCHEDULE: A table that shows how much sellers are willing and able to supply at various prices.

LAW OF SUPPLY: As price of goods and services increase, sellers usually will want to supply more of those goods or services, and vice versa

Supply curve







A decrease in price leads to a decrease in Quantity Supplied.






A increase in price leads to a increase in Quantity Supplied.



Increase in Supply



Decrease in Supply











DETERMINANTS OF SUPPLY

1) RESOURCE PRICES:
A rise in the price of inputs shifts the supply curve to the left indicating that less will be supplied at any given price.
A fall in the price of inputs shifts the supply curve to the right.

2) TECHNOLOGICAL CHANGE:
A decrease in production costs will increase the profits that can be earned at any given price of the commodity. This change shifts the supply curve to the right.

An increase in production costs will decrease the profits that can be earned at any given price of the commodity. This change shifts the supply curve to the left.

3) TAXES
An increase in the taxes will shift the supply curve to the left.

4) SUBSIDIES:
A subsidy is a payment to a company to produce (or not produce) something. This makes it cheaper for the company to produce so the supply curve shifts to the right.

5) EXPECTATIONS:
If the supplier expects future profits of their good to rise they will decrease the supply of the good now. This will shift the curve to the left.

If the supplier expects future profits of their good to fall they will increase the supply of the good now. This will shift the curve to the right.

6) NUMBER OF SELLERS:
An increase in the number of sellers will shift the supply curve for the product to the right.








The price at which the quantity demanded equals the quantity supplied is called the equilibrium price.


Notice that equilibrium is defined as a state of balance between opposing forces








Shortage:

In this case the producer has set the price too low. This means quantity demanded is much higher than quantity supplied.

This market is not in equilibrium. As sellers realize they can not keep the product on the shelves, they will raise the price. The market will work its way to equilibrium.




Surplus

In this case the producer has set the price too high. This means quantity demanded is much lower than quantity supplied.

This market is not in equilibrium. As sellers realize they are not selling as much of their product as they want at this price, they will lower the price. The market will work its way to equilibrium.






What happens to equilibrium when one of the determinants of demand change?




In this case a determinant of demand causes an increase in demand. This caused the price to increase and the quantity to increase.





Decrease in Demand







Can you draw a decrease in demand?




What happens to equilibrium when the one of the determinants of supply change?


In this case a determinant of supply causes an increase in supply. This caused the price to decrease and the quantity to increase.










Can you draw a decrease in supply?


PRICE CEILING: The maximum legal price a seller may charge for a product or service.

This allows people to purchase G&S at a lower price than they would have otherwise been able to get it for. This allows many a chance to afford these things.

A price ceiling is below equilibrium point.

Notice that a ceiling keeps the price low and does not allow the market to drive the price up. This keeps buyers in the market that would have otherwise gotten out. At that price the quantity supplied and the quantity demanded cannot reach equilibrium. Hence a shortage.




















PRICE FLOORS: Minimum prices fixed by government which are above equilibrium prices.

Ex: minimum wage, price floors of agriculture products.


Notice that the floor keeps the price above the equilibrium. Suppliers are willing to increase Qs at this artificial price while some demanders are driven out of the market. The net result is a surplus.












Consumer Surplus: the difference between the market price and the maximum price the consumer would pay to obtain that unit













Producer Surplus: the difference between the market price and the minimum price the producer would be willing to take for the product.


What happens when both supply and demand change?

In economics we do not deal with absolute terms. That means we do not really know how far the curves shift. This means that any time you shift both curves, either Quantity or Price will not be able to be determined. (Indeterminant)







With and increase in S and an increase in D Quantity increases and price is indeterminant.






With and decrease in S and an decrease in D Quantity decreases and price is indeterminant.





Decrease D and Increase supply means that Price decrease and Q is indeterminant.








Increase D and Decrease supply means that Price increase and Q is indeterminant.


Dead weight loss from price ceilings









Consumer Surplus before the ceiling






Producer Surplus before ceiling






Combined consumer and producer surplus before ceiling
Combined consumer and producer surplus after the ceiling

Therefore bfc is the dead weight loss. It is lost consumer and producer surplus.














Unit 2: Lesson 5 (Activities 20-23)

Discuss the subject of the slope of a line. How is it found? (rise over run) or the vertical axis divided by the horizontal axis. Notice that this is elasticity.

The responsiveness, or sensitivity, of consumers to a change in the price of a product is measured by the concept of Price elasticity of demand. Simply put, if consumers respond (relatively) to a change in price it is said to be elastic. If they do not respond (relatively) to a change in price the product is said to be inelastic.

There are four things that go into determining the elasticity of a demand curve.

1) Luxuries versus necessities. This is what we have been discussing. Your quantity demanded for heart surgery will not change much with the change in price.

Ex of elastic demands: Sports cars, riding lawn mowers, V.C.R's.
Ex of inelastic demands: food, electricity, health care.

2) Availability of substitutes. The greater the number of substitute the more elastic the product. If the price of beef went way up you would just switch to chicken. Therefore we can say that the demand curve for beef is very elastic. Its quantity demanded changes with a change in price.
elastic: c.d.'s, sugar,
inelastic: U.S. mail, local telephone company, gasoline

3) Proportion of income. The greater the price of a good relative to one's budget, the greater the elasticity of demand. If the price for candy bars increased 10% (or 4 cents) your quantity demanded would not change much. However if the price of a 100,000-dollar house increase 10% (or $10,000) your quantity demanded would most likely change a lot. A house would have an inelastic demand curve.
elastic: automobiles, houses, boats
inelastic: soft drinks, computer disks

4) Time: The longer the time period the more elastic a demand curve becomes. A person will not run out and buy a smaller car if the price of gas goes up. Instead they will wait until their older car wears out.

Have students do Activity 21. Answer any questions they have about elasticity.

Examples of Elastic curves: steak, ice cream, riding lawn mowers...
Examples of Inelastic curves: water, electricity, medicine...


Ask what happens when price decreases? Qd increases. The measurement of the responsiveness to this price change is elasticity.

What would you expect elasticity to be if the price decreased by 1% and Qd increased by 4%. (ELASTIC)

A one percent change in price leads to a smaller change in Qd is inelastic.

Percent Change: Old-New
Old

Ed= % change in quantity demanded of product X
% change in price of product X

This is the same as saying

Ed= change in quantity demanded of X / change in price of X
original quantity demanded of X original price of X

Midpoint Formula:

Ed = change in quantity demanded divided by change in price
sum of quantities/2 sum of prices/2

Because of the law of demand this number will always be negative. Ignore negatives.

This number tells us that a 1% change in price leads to a x percent change in Qd.

Less than one is inelastic. More than one is elastic. One is unitary.

(Notice that this will always yield a negative number. Ignore this.)

Demand is elastic if a given percentage change in price results in a larger percentage change in quantity demanded. ( a 4% increase in price results in a 8% decline in QD.)

Demand is inelastic if a given percentage change in price is accompanied by a relatively smaller change in quantity demanded. ( a 4% increase in price results in a 2% decline in Q.D.)




When a given percentage change in price is accompanied by an identical change in quantity demanded this is said to be unitary elastic.

A good is perfectly inelastic when there will be no change in quantity demanded no matter what the % change in price. ex. medicine

A good is perfectly elastic when there is a major change in quantity demanded when there is a small % change in the price. ex:
The Total-Revenue Test
If demand is elastic a decrease in price will result in an increase in total revenue. This means that at the lower price more units are being bought. This offsets the lower price.

TR = P x Q

When you calculate TR you can look at it graphically.



If demand is elastic a change in price will result in a change in TR in the opposite direction.
If a 3% decrease in price leads to a 5% increase in Q. 5% divided by 3% is elastic. This means TR will be going up.

If demand is inelastic a change in price will result in a change in TR in the same direction. (Ex: If price increases total revenue will also increase. People cannot do without the product so they will buy it no matter how high the price.) If a 5% decrease in price leads to a 3% increase in Q. 3% divided by 5% is inelastic. This means TR will be going down.

If demand is unitary elastic a change in price will have no change in total revenue.


Price Elasticity of Supply:

If suppliers are responsive to price changes the supply is elastic.

If suppliers are not responsive to price change the supply is inelastic.

This is the exact formula used in Ed except you substitute supply for demand.


Es = change in quantity supplied divided by change in price
sum of quantities/2 sum of prices/2

1) Suppliers cannot respond immediately to price changes (as can demanders) once a computer is made the supplier will sell it even if the prices drop drastically. (They will take a large loss rather than a total loss.)

Notice because of the law of supply this number will always be positive so you do not have to worry about negatives.

In dealing with price elasticity you are dealing with movement along the curves. For Cross Elasticity and Income Elasticity you are dealing with movement along the curves.

CROSS ELASTICITY OF DEMAND: measures how sensitive consumer purchases of one product are to the change in price of some other product.

Exy= % change in quantity demanded of product X
% change in price of product Y

DO NOT IGNORE NEGATIVES HERE

If cross elasticity is positive: quantity demanded of X varies directly with the price of Y then X and Y are substitute goods.
Ex: If the price of steak increase then people will buy more hamburger.

If cross elasticity is negative: quantity demanded of X varies inversely with the price of Y then X and Y are complementary goods.
Ex: If the price of CD's goes way up then the quantity purchases of CD players will go down.

If the cross elasticity is near zero then the goods are independent goods and are unrelated.
Ex: If the price of sugar goes up it will have no effect on the price of paper.

INCOME ELASTICITY OF DEMAND: measures the percent change in quantity of product demanded which results from the percent change in consumer income.

Ey= % change in quantity demand
% change in income

DO NOT IGNORE NEGATIVES HERE

Remember that income is one of the determinants of demand. When income changes you get a change in demand rather than a chance in quantity demanded.

For normal or superior goods the higher the income the more of a product a person will purchase. (The higher the Ei the more likely that people will purchase the good as the income increases.) This will yield a positive number.

For inferior goods the Ei will be low. The higher the income the less likely they will purchase the good or service. (used cloths, ...) This will yield a negative number.