SUPPLY AND DEMAND

AP MICROECONOMICS - UNIT 2
“If resources weren't scarce, it wouldn't matter what we did with them because they would never run out. But
because they are scarce, we have to decide what to do with them, and those choices have consequences.
Without scarcity, the field of economics would be unnecessary.”

LESSON 1: DEMAND
A.​MARKET AND PROPERTY RIGHTS
I.​ MARKET
1.​ Defining ‘market’;
Market: A place (physical or virtual) where multiple parties exchange things of value. The key
element is the voluntary exchange of goods or services based on perceived value.
Examples:
-​ Stock market: Buyers and sellers exchange shares of ownership in companies. Price is
determined by supply and demand.
-​ Supermarket: Consumers exchange money for goods. Prices are set by the seller, but
influenced by consumer demand.

2.​ Property rights: The foundation of markets

Property rights: The legal rights that individuals or entities have to possess, use, and transfer
assets. These rights are essential for a functioning market economy. Without clearly defined
and enforceable property rights, markets cannot efficiently allocate resources.
3 key dimensions of property rights
1)​ Exclusivity: The owner has the right to exclude others from using the asset. This is
fundamental to the concept of ownership. For example, the owner of a piece of land
can prevent others from building on it or using its resources.
2)​ Enforceability: The legal system must protect property rights from infringement (e.g.
theft, trespass)
3)​ Transferability: The owner has the right to sell, lease, or otherwise transfer ownership
of the asset to another party.

B.​LAW OF DEMAND
I.​ RELATED TERMS
-​ Demand: The amount of some good or service consumers are willing and able to
purchase at each price. When talking about demand, economists refer to the whole
curve
 -​ Quantity demanded: The total number of units that consumers would purchase at a
price. When talking about quantity demanded, economists refer to a specific point on
the demand curve.

II.​ PRINCIPLE
a.​ Explanation for “Why do we have downward sloping demand curve” :
There are many factors affecting demand such as price or customer preferences (income,
taste etc.). But the most considerable factor is price of the product, which leads to a shift in
demand.
-​ Price goes up, demand goes down
-​ Price goes down, demand goes up.
However, there are many more factors that
economists put into consideration
1)​ Other related products’ price
-​ If the substitutes for the product’s price
goes up, demand for that very product
goes up, shifting the chart to the right of
the xy-plane
-> Substitutes’ price goes up, demand goes up.
-​ If the related product that support the
product’s price goes up, demand goes
down, shifting the chart to the left of the
xy-plane
-> Supporting products price goes up, demand goes down
2)​ Customer’s expectation for future price:
-​ As customers expect the price to go up in the future (for products that they can store
e.g.), their demand to buy those products at the moment will go up, shifting the
demand curve to the right of the xy-plane.
=> Expecting future price goes up -> Demand goes up
-​ As customers expect the price to go down in the future (sales for clothes, electronic
device e.g.), they are less likely to buy the product at the moment, shifting the demand
curve to the left of the xy-plane
-> Expecting future price goes down -> Demand goes down

3)​ Other factors such as income, population and preferences do affect the shifting of
the whole demand curve.

b.​ Explanation for “Why do we have downward sloping demand curve” :

𝑀𝑈
As the price goes up, the 𝑃
goes down, resulting in the scenario that consumers are left with
𝑀𝑈
other options that has higher 𝑃
maximize their total utility with the budget constraint they
have. This makes the quantity demanded shrink.
1)​ Substitution effect
The decrease in the price of one product will make it relatively more desirable then the
others, which leads to a decrease in the demand for other products.
Keyword: relatively, substitution, decrease
2)​ Income effect
When a product’s price drops, the market would have an extra amount of money to buy other
things.

c.​ “Inferior goods” and “Normal” goods

1)​ Inferior goods
People purchase this type of product typically when their income is low. Inferior goods
generally represent the cheapest options for meeting a consumer’s needs, being the lowest
quality products available.

2)​ Normal goods

When an individual’s income rises, he will stop buying inferior goods and switch to buying
normal goods, which cost more than inferior goods and typically are higher quality.

3)​ Effect of a change in income on the purchasing of 2 types of goods

-​ Inferior goods: An inverse relationship
As people’s incomes rise, they will be less likely to buy inferior goods since they have better
options, which leads to the overall drop in the demand for these goods, shifting the demand
curve to the left on the xy-plane.
=> Income rises, demand drops.
Vice versa, as people’s incomes drop, they will be more likely to buy inferior goods in order to
be more economical, which leads to the overall surge in demand for these goods, shifting the
demand curve to the rise of the xy-plane.
=> Income drops, demand rises.

-​ Inferior goods: An direct relationship

Common sense here, I’ll write no less
=> Income rises, demand rises
=> Income drops, demand drops

d.​ Change in demand and change in quantity demanded

1)​ Change in price results in change in quantity demanded
As quantity demanded refers to the numbers of product demanded at a single price on the
demand curve, a shift in price will cause a shift in quantity demanded, resulting in a
movement along the demand curve.
Eg. Since car dealerships slash prices by 10%, quantity demanded will go up, resulting in a
movement along the demand curve (not shifting the whole demand curve)

2)​ Change in external factors results in change in demand

These factors include related product’s prices, customers’ expectation for future prices.
Eg
-​ The price of gasoline increase
-​ Prices of public transport goes down
-​ The state lowers vehicle registration fees
-​ A recession leads to falling household incomes
-​ Consumers expect new car prices to rise next year.

III.​ Prices of Related Goods

a.​ Substitute goods
Substitute goods are goods that are similar to one another and can be consumed in place of
one another
When the price of a good falls (rises), the demand for its substitute good decreases
(increases)
Eg. Pork’s price rises, which makes the demand for its substitutes such as beef,
chicken, rises.
b.​ Complementary goods (Combination(
Complementary goods are goods that are consumed in conjunction with one another
When the price of a good falls (rises), the demand for its complementary good
increases (decreases).

LESSON 2: SUPPLY
I.​ DEFINING THE “LAW OF SUPPLY”
1.​ Definition
Law of Supply states that, all other factors being equal, as the price of a good or service
increases, the quantity supplied of that good or service will increase, and vice versa.
-> Direct relationship between price and quantity supplied.
Explanation: A rise in price incentivizes the producers to offer more goods in order to make
more profit. Conversely, a price drop reduces profitability, leading to a decrease in the
quantity supplied.
Exception: A firm might temporarily increase supply even if prices fall if it anticipates future
price increases or needs to clear out inventory.
2.​ The Supply Curve
A supply curve is a graphical representation of the
supply schedule, showing the relationship between
price and quantity supplied. It’s typically
upward-sloping, reflecting the direct relationship
between price and quantity supplied. The axes are
Price (vertical) and Quantity supplied (horizontal).

3.​ Determinants of Supply

 -​ Resource prices
-​ Technology
-​ Taxes and subsidies
-​ Prices of other goods
-​ Expectations
-​ Numbers of sellers
-​ Weather
-​ etc.
4.​ Change in Supply VS Change in Quantity Supplied
a)​ Change in quantity supplied
Movement along the curve: A change in price causes a movement along the supply curve
When price drops, supply also drops because producers make less profit.
b)​ Change in supply
Shift of the curve: A change in any factor other than price (e.g., input cót, technology,
expectations) causes the entire supply curve to shift left or right.

LESSON 3: PRICE ELASTICITY OF DEMAND

I.​ UNDERSTANDING THE CONCEPT
1.​ DEFINITION
“Price Elasticity of Demand” (PED) is a measure for economists to understand how sensitively
quantity demanded responds to changes in prices.
𝐷 %∆𝑄
𝐸𝑃 = || %∆𝑃 ||
∆ 𝑟𝑒𝑝𝑟𝑒𝑠𝑒𝑛𝑡𝑠 𝑎𝑛 𝑖𝑛 𝑐𝑟𝑒𝑎𝑠𝑒
𝐷
As 𝐸𝑃 presents changes in both quantity demanded and price, its original value can be
negative, which explains the need for the involvement of absolute value.
2.​ CALCULATING PED
Point Price Quantity D. %∆P %∆Q 𝐷
𝐸𝑃

A 9 2 1
- 9 × 100%
1
× 100% 9
2

B 8 4

C 2 16 1
- 2 × 100%
1
× 100% 0.25
8

D 1 18

3.​ PERFECT ELASTICITY AND INELASTICITY

a.​ Perfect inelasticity
-​ Definition: No matter how significant the prices
change, customers still demand the same amount
of products as they consider the product as vital
necessities, making their demand inelastic and is a
vertical line
-​ Explanation from the equation
For an perfectly inelastic demand, there are no change in
𝐷
demand, so ∆𝑄 = 0, which in turn makes 𝐸 = 0 < 1.
𝑃
-​ Example: A customer needs 100 insulin vials per
day in order to live normally because without
those vials, they would die. If the providers raise or
lower the price they are gonna buy just 100 vials
everyday.
b.​ Perfect elasticity
-​ Definition: This phenomenon occurs in perfectly competitive markets, where sellers
sell the exact same products without any distinctions. It captures the concept where
price increase results in zero quantity demanded, and price decrease results in infinite
quantity demanded, making it a horizontal line.
-​ Explanation from the equation
4.​ INTERPRETING PRICE ELASTICITY OF DEMAND

𝐷
-​ Elastic demand - [𝐸𝑃 > 1]:
+​ A small change in price leads to a
relatively large change in quantity demanded, and
vice versa.
+​ Customers are very sensitive to price
changes
+​ Total revenue will decrease with a price
increase and increase with a price decrease.
 𝐷
-​ Inelastic demand - [𝐸𝑃 < 1]:
+​ A change in price leads to a relatively small change in quantity demanded, and
vice versa
+​ Customers are not very sensitive to price changes
+​ Total revenue will increase with a price increase and decrease with a price
decrease.
5.​ COMMON MISCONCEPTION
-​ Constant slope = Constant PED: Elasticity changes along the a linear demand curve
-​ Confusing slope and PED: While related, slope and elasticity are distinct concepts.
Slope measures the change in quantity demanded for a unit change in price, while
elasticity measures the percentage change in quantity demanded for a percentage
change in price.

II.​ DETERMINANTS OF PRICE ELASTICITY OF DEMAND

The question is: Do they REALLY need that product, considering their own preferences and
budget constraints? The more they need it, the lower the price elasticity of demand, and vice
versa.
1.​ Luxury v.s. Necessity
-​ Luxury - Higher elasticity: Consumers are likely to reduce their purchases when
prices rise, as they are more sensitive about price changes and people don’t need
luxuries that much. Eg. Designer handbags
-​ Necessity - Lower elasticity: Customers are likely to continue purchasing these
products even if prices rise. Eg. insulin
2.​ Availability of Substitutes
-​ Abundant substitutes - Higher elasticity: If the price of one good rises, customers
tend to switch to more affordable substitutes. Eg. Different brands of soda
-​ Few substitutes - Lower elasticity: Customers have limited alternatives if the prices
rise. Eg. insulin for diabetics
3.​ Income Share
-​ Significant share of income - Higher elasticity: A price change notably affects their
purchasing decisions as it affects their budget.
-​ Insignificant share of income - Lower elasticity: A price change has minimal impact
on their budget. Eg: gum
4.​ Time frame
-​ A longer time frame - Higher elasticity: The longer time frame provides customers
with more time to search for other substitutes or to reconsider their own needs. Eg.
Umbrellas in a whole sunny month
-​ A shorter time frame - Lower elasticity: Customers with immediate needs are usually
not really often conscious with the price changes, as they need it, IMMEDIATELY. Eg.
Umbrellas on a rainy day
 5.​ Narrowness of Market
-​ The narrower market: Customers are more likely to switch to other substitutes in
other markets as that one product’s price goes up. Eg. switching from apples to
bananas.
-​ The broader market: Customers are less likely to switch to products in other markets
as that one product’s price rises because there aren’t many substitutes. Eg. people
can’t substitute napkins for food, right?

III.​ OTHER ELASTICITIES

1.​ Income Elasticity of Demand
a)​ Definition
𝐼
Income Elasticity of Demand, 𝐸𝐷, is a measure of an agent’s responsiveness to purchasing a
product due to a change in their income.
𝐼 % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄 (𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑)
𝐸𝐷 = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐼 (𝐼𝑛𝑐𝑜𝑚𝑒)

b)​ Interpreting Income Elasticity of Demand

𝐼
-​ 𝐸𝐷 < 0 - Inferior goods: Demand is highly responsive to income changes in the
opposite direction. A small increase in income leads to a proportionally larger
decrease in quantity demanded. Consumers switch to higher-quality substitutes as
their income rises. Eg. generic brands, used clothing,..
𝐼
-​ 𝐸𝐷= 0: Demand is completely unresponsive to changes in income. This is rare
𝐼
-​ 0 < 𝐸𝐷 < 1 - Normal-Necessity goods: An increase in income leads to an increase in
𝐼
quantity demanded. This is the most common scenario. The higher the 𝐸𝐷, the more
sensitive demand is to income changes.
𝐼
-​ 𝐸𝐷 = 1: A 1% change in income leads to a1% change in quantity demanded. This is
called unitary elasticity
𝐼
-​ 1 < 𝐸𝐷 - Normal-Luxury goods: Demand is highly responsive to income changes. A
small increase in income leads to a proportionally larger increase in quantity
demanded

LESSON 4: PRICE ELASTICITY OF SUPPLY

I.​ DEFINING “PRICE ELASTICITY OF SUPPLY”
Price Elasticity of Supply is a measure of the responsiveness of quantity supplied to a change
in price. It quantifies the percentage change in quantity supplied resulting from 1 percent
change in price.
𝑆 %∆𝑄
𝐸𝑃 = || %∆𝑃 ||
 𝑆
-​ 𝐸𝑃 > 1 - Elastic supply: A small percentage change in price leads to a larger percentage
change in quantity supplied. Producers are highly responsive to price changes
𝑆
-​ 𝐸𝑃 < 1 - Inelastic supply: A percentage change in price leads to a smaller percentage
change in quantity supplied. Producers are not very responsive to price changes.
𝑆
-​ 𝐸𝑃 = 0 - Perfectly Inelastic supply: Quantity supplied does not respond to price
changes at all. The supply curve is a vertical line.
𝑆
-​ 𝐸𝑃 = ∞ - Perfectly Elastic supply: Any change in price leads to an infinite change in
quantity supplied. The supply curve is a horizontal line.

LESSON 6: MARKET EQUILIBRIUM

I.​ DEFINING “MARKET EQUILIBRIUM” - “SỰ CÂN BẰNG THỊ TRƯỜNG”
1.​ Definition
a.​ Market equilibrium is achieved at the price at which quantities demanded and
supplied are equal -> A joint of 2 curves
​ Market equilibrium determines
+​ Equilibrium price P*
+​ Equilibrium price Q*
Market equilibrium changes when there is a change in market conditions
-​ Change in supply
-​ Change in demand
-​ Change in supply and demand
b.​ 2 typical situations
-​ Shortage: Where the quantity demanded
exceeds the quantity supplied at a given price.
This typically leads to upward pressure on prices
-​ Surplus: Where the quantity supplied
exceeds the quantity demanded at a given price.
This typically leads to a downward pressure on
prices. (Neither customer surplus nor producer surplus, this
is excess supply, which is inefficient speaking rationally)

2.​ Sample question

Demand and supply in a market can be described by
the following functions
𝑄𝐷 = 120 − 2𝑃​
𝑄𝑆 = 20 + 3𝑃
Calculate the equilibrium price and equilibrium
quantity in this market
P*: 120 − 2𝑃 = 20 + 3𝑃 ⇔ 𝑃𝐸 = 20
Q*: 𝑄𝐸 = 120 − 2 * 20 = 80

3.​ Market Analysis

Market analysis studies the fluctuations in the market price and quantity as a result of
changes in market conditions

II.​ SURPLUS
1.​ Consumer surplus
a.​ Definition
A consumer surplus happens when the price consumers
pay for a product or service is less than the price they’re
willing to pay, which indicates the additional satisfaction
a consumer gains from buying the product at a lower
price.
It is depicted visually by economists as the
triangular area under the demand curve between market
price and what consumers would be willing to pay:
-​ So, the demand curve indicates the price
customers are willing to pay for units of the
product, which represents the marginal utility.
-​ The demand curve has a downward slope, because
marginal utility is always diminishing.
Typically, the more of a good that consumers have, the less they’re willing to spend for more of it,
due to the diminishing marginal utility.
b.​ Calculating the Consumer Surplus
The total consumer surplus is the sum of all price points, which equals to the area of the
triangular
1
-​ Linear curve: 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = 2
× 𝑄𝐸 × ∆𝑃
+​ 𝑄𝐸 = the quantity at the equilibrium or the price that producer decided to sell
at.
+​ ∆𝑃 = (the price a consumer is willing to pay) - (the price at the equilibrium or
the price that producer decided to sell at)
-​ Quadratic curve: Calculus

2.​ Producer surplus

a.​ Opportunity cost
The opportunity cost of producing a good is the value of the next best alternative that is
given up in order to produce that good. If the price for that product is lower than the
opportunity cost, the dedicated resources would be used for next best alternatives.
​ “The opportunity cost is the minimum price that a producer must receive in order to be
willing to produce a good, as it represents the value of the next best alternative use of the
resources”

b.​ Producer surplus

The producer surplus simply is the
benefit the producer receives for selling
the goods in the market, which is the
difference between the total benefit and
the opportunity cost.
The consumer surplus can be calculated
as the area of a triangle, where the base
is the quantity supplied and the height is
the difference between the market price
and the opportunity cost.
-​ Linear:
1
𝑃𝑟𝑜𝑑𝑢𝑐𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 = 2
× 𝑄𝑠 × ∆𝑃
+​ 𝑄𝑠: Quantity supplied
+​ ∆𝑃: The difference between the market price and the lowest value of the
opportunity cost.
-​ Quadratic: Calculus

III.​ MARKET DISEQUILIBRIUM

Market disequilibrium is often caused by the imbalance between supply and demand
1.​ Market surplus
When the price of the product is higher than
the equilibrium price, supply exceeds demand
(𝑄𝑠 > 𝑄𝐷), as
+​ Higher price makes costumes’ marginal
benefit lower (they want to buy less in
response to the price) -> 𝑄𝐷<<<
+​ Higher price makes producers’
marginal cost higher (they want to
produce more in response to the price)
-> 𝑄𝑆 >>>
=> There are more supplied units than demanded units
=> Created excess supply
=> Surplus
 2.​ Market shortage
When the price of the product is lower than the
equilibrium price, demand exceeds supply (
𝑄𝐷 > 𝑄𝑆), as:
-​ Lower price makes customers’ marginal
benefit higher (they want to buy more in
response to the price): 𝑄𝐷 >>>
-​ Lower price makes producers’ marginal
benefit lower (they want to produce less in
response to the price): 𝑄𝑆 <<<
=> There are more demanded units than supplied
units
=> Created excess demand
=> Shortage

IV.​ CHANGES IN MARKET EQUILIBRIUM

LESSON 8: THE EFFECT OF GOVERNMENT

INTERVENTIONS IN MARKET
I.​ DEADWEIGHT LOSS
1.​ Definition
Deadweight loss is a loss to society which occurs
when demand and supply are not in equilibrium,
making the total surplus not fully. Because goods
are either overvalued or undervalued, market
inefficiency happens.

For example, an overpriced product may benefit

the marginal cost of the producers, but it reduces
the marginal benefits for consumers, which creates
both deadweight loss and a surplus.

2.​ Cause
a.​ Minimum wages and living wage laws
Minimum wages and living wage laws can create a deadweight loss by causing employers to
overpay for employees and preventing low-skilled workers from securing jobs. Particularly,
they set a price floor above the equilibrium wage rate in the labor market, creating a
deadweight loss. At the higher price, fewer jobs are offered by employers, which creates
redundancy in displaced workers and job seekers, resulting in inefficiencies and lost
economic opportunities.

b.​ Price ceilings and rent controls

Price ceilings and rent control cause deadweight loss when they’re below the markets’
equilibrium price, creating:
-​ Reduction in supply: At lower price, suppliers (landlords) are less incentivized to offer
goods or services and may convert rental units into other uses.
-​ Increased demand: The artificially low price encourages more consumers to demand
the good or service, exacerbating the shortage.
As they disrupt the natural balance of supply and demand, price ceilings and rent controls
implemented by governments may cause deadweight loss if placed below the equilibrium
price.

II.​ TAXATION
1.​ Its effect on deadweight loss
As governments impose taxes on particular
products, they’re making the product more
expensive to produce, which in turn shift the
supply curve to the right, result in a new
equilibrium, and cause:
+​ Decreased supply
+​ Increased price.
The product of the taxes’ value and the quantity
demanded after taxes is the government’s tax
revenue.
The customers’ surplus and producers’ surplus will be reduced due to the government’s
earnings.