Study Guide Econ Law of Demand: Holding all else equal, when the price of a good rises, consumers

decrease their quantity demanded for that good. There is an inverse negative relationship. 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 the quantity demanded resulting from a change in consumers purchasing power: real income. Determinants of Demand: influence consumer willingness and ability to purchase 1. Consumer Income -normal good: when income increases, demand for these goods increase (vice versa) - Inferior good: when income increases, demand for these goods decrease. (vice versa) 2. The price of a substitute good 3. The price of a complimentary good 4. Consumer tastes and preferences 5. Consumer expectations about future prices 6. Number of buyers in the market Law of Supply: Holding all else equal, when price of a good rises, suppliers increase their quantity supplied for that good. Determinants of Supply: 1. Input Costs 2. Technology and Productivity 3. Taxes and Subsidies 4. Producer expectations about the future 5. Price of other goods that could be produced 6. Number of Producers Consumer Surplus: The difference between your willingness to pay and the price you actually pay. Producer Surplus: The difference between the price received and the marginal cost of producing a good. Elasticity: Measures the sensitivity of a persons consumption to the external change (price or income). When Price of a good increases, quantity demanded decreases, when price of a good decreases, quantity of demand increases. If its greater than 1, its elastic:

Inelastic: When the initial change in price exceeds the responsiveness of the consumer, Ed is less than one. Determinants of Elasticity: 1. Number of Substitute goods: ie orange juice has many substitutes, if price increases, there will be a significant decrease in quantity demanded, (elastic). 2. Proportion of Income: If price of a good increases, the consumer loses purchasing power. If the product takes up a large proportion of income, then the response to a change in price is going to be more elastic. 3. Time: As more time passes, people have more time to search for a less expensive substitute. In the short run, time is inelastic. Total Revenue Test: Inelastic: Price up, TR increase (still demand same quantity) Elastic: Price up, TR down (quantity demanded decreases) Unit Elastic: Price up, TR remains the same. Cross Price Elasticity of Demand: The Sensitivity of consumption of good X to a change in the price of good y. Price floor: Installed when producers feel market equilibrium is too low Creates a permanent surplus Govt purchases surplus, tax payers pay Reduces net benefit by over allocating resources to production of a good Price Ceiling: Installed when marke equilibrium is too high Permanent shortage More price elastic, the greater the shortage d