Unit 2: Supply and Demand

Demand

The relationship between a good’s price and the quantity consumers are willing and able to buy at each price, holding other factors constant.

Demand schedule

A table showing the quantity demanded at different prices.

Demand curve

A graph of the demand schedule showing the relationship between price and quantity demanded.

Law of demand

All else equal, when price rises quantity demanded falls, and when price falls quantity demanded rises.

Movement along a curve

A change in quantity demanded or quantity supplied caused only by a change in the good’s own price.

Shift of a curve

A change in demand or supply caused by a non-price determinant; the entire curve moves left or right.

Determinants (shifters) of demand

Non-price factors that shift demand, such as preferences, income, prices of related goods, expectations, and number of buyers.

Substitution effect

When a good’s price rises, consumers switch toward relatively cheaper substitutes, reducing quantity demanded of the now-higher-priced good.

Income effect

When a good’s price rises, purchasing power falls, so consumers buy less (and when price falls, purchasing power rises, so they buy more).

Law of diminishing marginal utility

As more units are consumed, the additional satisfaction from each extra unit tends to decrease, helping explain downward-sloping demand.

Normal good

A good for which demand increases when income increases (and decreases when income decreases).

Inferior good

A good for which demand increases when income decreases (and decreases when income increases).

Substitutes

Goods that can replace each other in consumption; if the price of one rises, demand for the other increases.

Complements

Goods consumed together; if the price of one rises, demand for the other decreases.

Market demand

The horizontal sum of all individual demands (add quantities across consumers at each price).

Supply

The relationship between a good’s price and the quantity producers are willing and able to sell at each price, holding other factors constant.

Law of supply

All else equal, when price rises quantity supplied rises, and when price falls quantity supplied falls.

Determinants (shifters) of supply

Non-price factors that shift supply, including input prices, technology, taxes/subsidies, number of sellers, expectations, and regulation/policy.

Input prices (resource costs)

Costs of land, labor, capital, raw materials, energy, etc.; higher input prices tend to decrease supply.

Technology (as a supply shifter)

Improvements that lower costs or raise productivity, typically increasing supply (shifting supply right).

Subsidy

A per-unit government payment that encourages buying or selling; it tends to increase quantity and can shift supply right (or demand right, depending on who receives it).

Substitutes in production

Goods that can be produced using the same resources; producing more of one often means producing less of the other when relative prices change.

Market equilibrium

The price and quantity where quantity demanded equals quantity supplied (Qd = Qs).

Shortage

A situation where quantity demanded exceeds quantity supplied (Qd > Qs), creating upward pressure on price.

Surplus

A situation where quantity supplied exceeds quantity demanded (Qs > Qd), creating downward pressure on price.

Double shift

A simultaneous shift in both demand and supply, making either equilibrium price or equilibrium quantity ambiguous unless the relative sizes of shifts are known.

Elasticity

A measure of responsiveness of one variable to changes in another, usually using percent changes.

Price elasticity of demand (PED)

The percent change in quantity demanded divided by the percent change in price (often discussed in absolute value terms).

Midpoint method

A way to compute percent changes using the average of the two values: (new−old)/[(new+old)/2], avoiding direction problems.

Total revenue (TR)

Total spending on a good: TR = P × Q; how TR changes with price depends on demand elasticity.

Cross-price elasticity of demand

Measures how quantity demanded of one good responds to a price change in another good; positive implies substitutes, negative implies complements.

Income elasticity of demand

Measures how quantity demanded responds to income changes; positive implies normal, negative implies inferior.

Price elasticity of supply (PES)

The percent change in quantity supplied divided by the percent change in price.

Consumer surplus (CS)

The difference between what consumers are willing to pay and what they actually pay; area under demand and above market price up to the quantity traded.

Producer surplus (PS)

The difference between the market price producers receive and the minimum price they would accept (marginal cost); area above supply and below market price up to the quantity traded.

Deadweight loss (DWL)

Lost gains from trade (mutually beneficial transactions that do not occur) when the market is prevented from reaching the efficient quantity; often shown as a triangle on graphs.

Price ceiling

A legal maximum price; if set below equilibrium it is binding and creates a shortage.

Non-price rationing

Methods of allocating goods during shortages (e.g., waiting lines, favoritism, lotteries, first-come-first-served) rather than using price.

Price floor

A legal minimum price; if set above equilibrium it is binding and creates a surplus.

Per-unit (excise) tax

A fixed tax on each unit bought/sold that creates a wedge between the price buyers pay and the price sellers receive, reducing quantity traded.

Tax wedge

The vertical gap created by a per-unit tax between the consumer price and producer price; Pc = Pp + t.

Tax incidence

How the burden of a tax is split between buyers and sellers; the less elastic side bears more of the burden.

Tax revenue

Government revenue from a per-unit tax, equal to (tax per unit) × (quantity traded after the tax).

Quota

A quantity control: an upper limit on the amount of a good that can be bought or sold.

License

A right that allows the owner to supply a good or service; limiting licenses can restrict entry and reduce market supply.

Demand price

At a given quantity, the price consumers are willing to pay (read from the demand curve at that quantity).

Supply price

At a given quantity, the price producers require to supply it (read from the supply curve at that quantity).

Tariff

A tax on an imported (or exported) good; in typical AP Micro trade graphs it raises domestic price, reduces imports, and generates government revenue.

Import quota

A restriction on the quantity of a good that can be imported (a quantity control, not a price control).

Quota rent

The difference between the demand price and supply price created by a binding quota; the economic value of being allowed to sell under the restricted quantity.