Unit 2: Supply and Demand

a. Define (using graphs as appropriate) key terms and factors related to consumer decision making and the law of demand. b. Explain (using graphs as appropriate) the relationship between price and quantity demanded and how buyers respond to incentives and constraints.

• A well-defined system of property rights is necessary for the market system to function well.
• Economic agents respond to incentives.
• Individuals often respond to incentives, such as those presented by prices, but also face constraints, such as income, time, and legal and regulatory frameworks.
• The law of demand suggests that a change in the own-price causes a change in quantity demanded in the opposite direction and a movement along a demand (marginal benefit) curve.
• The conceptual relationship between price and quantity stated by the law of demand leads to downward-sloping demand curves explained by the income effect and substitution effect and/or by diminishing marginal utility.
• The market demand curve (schedule) is derived from the summation of individual demand curves (schedules).
• Enduring understanding MKT-3: Individuals and firms respond to incentives and face constraints.

Explain (using graphs as appropriate) buyers’ responses to changes in incentives and constraints.

• Changes in the determinants of consumer demand can cause the demand curve to shift.
• Enduring understanding MKT-3: Individuals and firms respond to incentives and face constraints.

a. Define (using graphs as appropriate) the law of supply. b. Explain (using graphs as appropriate) the relationship between price and quantity supplied.

• A change in own-price causes a change in quantity supplied in the same direction and a movement along a supply curve.
• The market supply curve (schedule) is derived from the summation of individual supply curves (schedules). The market supply curve is upward-sloping.
• Enduring understanding MKT-3: Individuals and firms respond to incentives and face constraints.

Explain (using graphs as appropriate) producers’ (sellers’) responses to changes in incentives and technology.

• Changes in the determinants of supply can cause the supply curve to shift.
• Enduring understanding MKT-3: Individuals and firms respond to incentives and face constraints.

a. Define measures of elasticity. b. Explain (using graphs where appropriate) measures of elasticity and the impact of a given price change on total revenue or total expenditure. c. Calculate (using data from a graph or a table as appropriate) measures of elasticity.

• Economists use the concept of elasticity to measure the magnitude of percentage changes in quantity owing to any given changes in the own-price, income, and prices of related goods.
• Price elasticity of demand is measured by the percentage change in quantity demanded divided by the percentage change in price or the responsiveness of the quantity demanded to changes in price. Elasticity varies along a linear demand curve, meaning slope is not elasticity.
• Ranges of values of elasticity of demand are described as elastic or inelastic with the separating benchmark being a magnitude of 1, where the change in the price and the change in the quantity demanded are proportional. a. When the magnitude of the value of elasticity is greater than 1, the demand is described as being elastic with respect to that price in the range of the given change. b. When the magnitude of the value of elasticity is less than 1, the demand is described as being inelastic with respect to that price in the range of the given change. c. When the magnitude of the value of elasticity is equal to 1, the demand is described as being unit elastic with respect to that price in the range of the given change.
• The price elasticity of demand depends on certain factors such as the availability of substitutes.
• The impact of a given price change on total revenue or total expenditure will depend on whether demand is elastic, inelastic, or unit elastic.
• Enduring understanding MKT-3: Individuals and firms respond to incentives and face constraints.

a. Define measures of elasticity. b. Explain (using graphs where appropriate) measures of elasticity and the impact of a given price change on total revenue or total expenditure. c. Calculate (using data from a graph or a table as appropriate) measures of elasticity.

• Price elasticity of supply is measured by the percentage change in quantity supplied divided by the percentage change in price, or the responsiveness of the quantity supplied to changes in price.
• Ranges of values of elasticity of supply are described as elastic or inelastic with the separating benchmark being a magnitude of 1, where the change in the price and the change in the quantity supplied are proportional. a. When the magnitude of the value of elasticity is greater than 1, the supply is described as being elastic with respect to that price in the range of the given change. b. When the magnitude of the value of elasticity is less than 1, the supply is described as being inelastic with respect to that price in the range of the given change. c. When the magnitude of the value of elasticity is equal to 1, the supply is described as being unit elastic with respect to that price in the range of the given change.
• The price elasticity of supply depends on certain factors such as the price of alternative inputs.
• Enduring understanding MKT-3: Individuals and firms respond to incentives and face constraints.

a. Define measures of elasticity. b. Explain (using graphs where appropriate) measures of elasticity and the impact of a given price change on total revenue or total expenditure. c. Calculate (using data from a graph or a table as appropriate) measures of elasticity.

• Elasticity can be measured for any determinant of demand or supply, not just the price.
• Income elasticity of demand is measured by the percentage change in the quantity demanded divided by the percentage change in consumers’ income. Economists use the income elasticity of demand to determine whether a good is normal or inferior.
• Cross-price elasticity of demand is measured by the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good. Economists use the cross-price elasticity of demand to determine whether goods are substitutes, complements, or not related.
• Enduring understanding MKT-3: Individuals and firms respond to incentives and face constraints.

a. Define (using graphs as appropriate) market equilibrium, consumer surplus, and producer surplus. b. Explain (using graphs as appropriate) how equilibrium price, quantity, consumer surplus, and producer surplus for a good or service are determined. c. Calculate (using data from a graph or table as appropriate) areas of consumer surplus and producer surplus at equilibrium.

• The supply-demand model is a tool for understanding what factors influence prices and quantities and why prices and quantities might differ across markets or change over time.
• In a perfectly competitive market, equilibrium is achieved (and markets clear with no shortages or surpluses) when the price of a good or service brings the quantity supplied and quantity demanded into balance, in the sense that buyers wish to purchase the same quantity that sellers wish to provide.
• Equilibrium price provides information to economic decision-makers to guide resource allocation.
• Economists use consumer surplus and producer surplus to measure the benefits markets create to buyers and sellers and understand market efficiency.
• Market equilibrium maximizes total economic surplus in the absence of market failures, meaning that perfectly competitive markets are efficient.
• Enduring understanding MKT-4: Although equilibria are stable, an economy can move from one equilibrium to another if market conditions change.

a. Define a surplus and shortage. b. Explain (using graphs where appropriate) how changes in underlying conditions and shocks to a competitive market can alter price, quantity, consumer surplus, and producer surplus. c. Calculate (using data from a graph or table as appropriate) changes in price, quantity, consumer surplus, and producer surplus in response to changes in market conditions or market disequilibrium.

• Whenever markets experience imbalances—creating disequilibrium prices and quantities, surpluses, and shortages—market forces drive price and quantity toward equilibrium.
• Factors that shift the market demand and market supply curves cause price, quantity, consumer surplus, producer surplus, and total economic surplus (within that market) to change. The impact of the change depends on the price elasticities of demand and supply.
• Enduring understanding MKT-4: Although equilibria are stable, an economy can move from one equilibrium to another if market conditions change.

a. Define forms of government price and quantity intervention. b. Explain (using graphs where appropriate) how government policies alter consumer and producer behaviors that influence incentives and therefore affect outcomes. c. Calculate (using data from a graph or table where appropriate) changes in market outcomes resulting from government policies.

• Some government policies, such as price floors, price ceilings, and other forms of price and quantity regulation, affect incentives and outcomes in all market structures.
• Governments use taxes and subsidies to change incentives in ways that influence consumer and producer behavior, shifting the supply and demand curves accordingly.
• Taxes and subsidies affect government revenues or costs.
• Government intervention in a market producing the efficient quantity through taxes, subsidies, price controls, or quantity controls can only decrease allocative efficiency.
• Deadweight loss represents the losses to buyers and sellers as a result of government intervention in an efficient market.
• The incidence of taxes and subsidies imposed on goods traded in perfectly competitive markets depends on the elasticity of supply and demand.
• Enduring understanding POL-1: Government policies influence consumer and producer behavior and therefore affect market outcomes.

a. Define tariffs and quotas. b. Explain (using graphs where appropriate) how markets are affected by public policy related to international trade. c. Calculate (using data from a graph or table as appropriate) changes in market outcomes resulting from public policy related to international trade.

• Equilibria in competitive markets may be altered by the decision to open an economy to trade with other countries; equilibrium price can be higher or lower than under autarky, and the gap between domestic supply and demand is filled by trade. Opening an economy to trade with other countries affects consumer surplus, producer surplus, and total economic surplus.
• Tariffs, which governments sometimes use to influence international trade, affect domestic price, quantity, government revenue, and consumer surplus and total economic surplus.
• Quotas can be used to alter quantities produced and therefore affect price, consumer surplus, and total economic surplus. Exclusion: The graphing of quotas is beyond the scope of the course and the AP Exam, but understanding how quotas affect quantities produced is within the scope.
• Enduring understanding POL-1: Government policies influence consumer and producer behavior and therefore affect market outcomes.