Demand, Supply, Market Equilibrium, and Welfare Analysis Rapid Review for AP Economics
A more in-depth review of these concepts can be found at:
Law of Demand: holding all else equal, when the price of a good rises, consumers decrease their quantity demanded for that good.
All else equal: to predict how a change in one variable affects a second, we hold all other variables constant. This is also referred to as the "ceteris paribus" assumption.
Absolute (or money) prices: the price of a good measured in units of currency.
Relative prices: the number of units of any other good Y that must be sacrificed to acquire the first good X. Only relative prices matter.
Substitution effect: the change in quantity demanded resulting from a change in the price of one good relative to the price of other goods.
Income effect: the change in quantity demanded that results from a change in the consumer's purchasing power (or real income).
Demand schedule: a table showing quantity demanded for a good at various prices.
Demand curve: a graphical depiction of the demand schedule. The demand curve is downward sloping, reflecting the Law of Demand.
Determinants of demand: the external factors that shift demand to the left or right.
Normal goods: a good for which higher income increases demand.
Inferior goods: a good for which higher income decreases demand.
Substitute goods: two goods are consumer substitutes if they provide essentially the same utility to the consumer. A Honda Accord and a Toyota Camry might be substitutes for many consumers.
Complementary goods: two goods are consumer complements if they provide more utility when consumed together than when consumed separately. A 35 mm camera and a roll of film are complementary goods.
Law of Supply: holding all else equal, when the price of a good rises, suppliers increase their quantity supplied for that good.
Supply schedule: a table showing quantity supplied for a good at various prices.
Supply curve: a graphical depiction of the supply schedule. The supply curve is upward sloping, reflecting the Law of Supply.
Determinants of supply: one of the external factors that influences supply. When these variables change, the entire supply curve shifts to the left or right.
Market equilibrium: exists at the only price where the quantity supplied equals the quantity demanded. Or, it is the only quantity where the price consumers are willing to pay is exactly the price producers are willing to accept.
Shortage: also known as excess demand, a shortage exists at a market price when the quantity demanded exceeds the quantity supplied. The price rises to eliminate a shortage.
Disequilibrium: any price where quantity demanded is not equal to quantity supplied.
Surplus: also known as excess supply, a surplus exists at a market price when the quantity supplied exceeds the quantity demanded. The price falls to eliminate a surplus.
Total welfare: the sum of consumer surplus and producer surplus. The free market equilibrium provides maximum combined gain to society.
Consumer surplus: the difference between your willingness to pay and the price you actually pay. It is the area below the demand curve and above the price.
Producer surplus: the difference between the price received and the marginal cost of producing the good. It is the area above the supply curve and under the price.
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