Study Guide for Exam 1
Study Guide for Exam 1 EC 110
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This 23 page Study Guide was uploaded by Matt Owens on Thursday January 29, 2015. The Study Guide belongs to EC 110 at University of Alabama - Tuscaloosa taught by Kent O. Zirlott in Spring2015. Since its upload, it has received 921 views.
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Date Created: 01/29/15
Matt Owens Principles of Microeconomics Zirlott January 29th 2015 Study Guide For Exam 1 Chapter 1 What Economics is All About Scarcity The limited nature of society s resources Economics The study of how society manages its scarce resources 0 How people decide what to buy how much to work save and spend 0 How firms decide how much to produce how many workers to hire 0 How society decides to divide its resources between national defense consumer goods protecting the environment and other needs I Roughly 40 of the United States federal budget goes towards national defense 0 Economics is not just the study of money or business however those are pieces of the subject How People Make Decisions All decisions involve tradeoffs 0 Examples I Going to a party the night before your midterm leaves less time for studying I Having more money to buy stuff requires working longer hours which leaves less time for leisure I Protecting the environment requires resources that could otherwise be used to produce consumer goods Society faces an important tradeoff o Efficiency vs equality Efficiency When society gets the most from its scarce source 0 Bang for your buck Equality When prosperity is distributed uniformly among society s members 0 We all get an equal share Tradeoff of efficiency and equality To achieve greater equality we could redistribute income from wealthy to poor But this reduces incentive to work and produce shrinks the size of the economic quotpiequot Making decisions requires comparing the costs and benefits of alternative choices The Opportunity Cost of any item is whatever must be given up to obtain it o What is your opportunity cost for coming to this class I Working The opportunity cost of going to college for a year is not just the tuition books and fees but also the foregone wages o The Opportunity cost of seeing a movie is not just the price of the ticket but the value of the time you spend in the theater 0 Opportunity Cost is measured as the highest valued alternative given up It is the relevant cost for decision making Rational people 0 Systematically and purposefully do the best they can to achieve their objectives I Rational model only does that which makes us better I According to a COMPLETELY rational model Nobody would smoke Nobody would have unprotected sex 0 Make decisions by evaluating costs and benefits of marginal changes 0 Marginal Changes incremental adjustments to an existing plan Examples 0 When a student considers whether to go to college for an additional year he compares the fees and foregone wages to the extra income he could earn with the extra year of education 0 When a manager considers whether to increase output she compares the cost of the needed labor and materials to the extra revenue Incentive Something that induces a person to act ie the prospect of a reward or punishment Rational people respond to incentives Examples 0 Amari Cooper Star football player for University of Alabama leaving college football early to go into the NFL 0 When gas prices rise consumers buy more hybrid cars and fewer gas guzzling SUVs 0 When cigarette taxes increase smoking falls o What is the incentive for having a playoff system in college football January 2015 I Increase revenue and increase ratings 0 You are selling your 1996 Mustang You have already spent 1000 on repairs At the last minute the transmission dies You can pay 600 to have it repaired or sell the car as isquot In each of the following scenarios should you have the transmission repaired I Blue book value is 6500 if transmission works 5700 if it doesn t Benefit of fixing the transmission is 800 so fix the transmission I Blue book value is 6000 if transmission works 5500 if it doesn t You would lose 100 if you fixed the transmission before selling it So sell it as is Rather than being selfsufficient people can specialize in producing one good or service and exchange it for other goods Countries also benefit from trade and specialization 0 Example Apple makes products in China for VERY cheap yet sells them in US for hundreds of dollars 0 Get a better price abroad for goods they produce 0 Buy other goods more cheaply from abroad than could be produced at home Market A group of buyers and sellers need not be in a single location Organize economic activityquot means determining 0 mt goods to produce 0 How to produce them 0 How much of each to produce 0 Who gets them A Market Economy allocates resources through the decisions of many households and firms as they interact in markets The invisible hand works through the price system 0 Adam Smith The Bible of Economics 0 The interaction of buyers and sellers determines prices 0 Each price re ects the goods value to buyers and the cost of producing the good 0 Prices guide selfinterested households and firms to make decisions that in many cases maximize society s economic wellbeing Important role for government enforce property rights with police courts People are less inclined to work produce invest or purchase if large risk of their property being stolen Market Failure When the market fails to allocate society s resources efficiently Causes 0 Externalities When the production or consumption of a good affects bystanders eg pollution 0 Market Power A single buyer or seller has substantial in uence on market price eg monopoly In such cases public policy may promote efficiency Example Government restricted ATampT and TMobile from merging because they would control over 60 of that market and therefore have a monopoly in the cellular field Government may alter market outcome to promote equity equality If the market s distribution of economic wellbeing is not desirable tax or welfare policies can change how the economic quotpiequot is divided The most important determinant of living standards Productivity Productivity the amount of goods and services produced per unit of labor GDP Gross Domestic Product Measure of productivity Productivity depends on the equipment skills and technology available to workers Other factors labor unions competition from abroad have far less impact on living standards US has the highest GDP and highest standard of living In ation Increases in the general level of prices In the long run in ation is almost always caused by excessive growth in the quantity of money which causes the value of money to fall 0 Gas prices dominate in ation and de ation The faster the government creates money the greater the in ation rate 0 US is not doing this Most money printed today is used to replace money that is worn out and create new bills to prevent counterfeit bills Phillips Kerr discovered the correlation In the shortrun 12 years many economic policies push in ation and unemployment in opposite directions Other factors can make this tradeoff more or less favorable but the tradeoff is always present Last recession was focused completely on jobs aspect of economy 0 VERY close to becoming a depression Chapter 2 Assumptions amp Models Assumption simplify the complex world make it easier to understand 0 Example To study international trade assume two countries and two goods Unrealistic but simple to learn and gives useful insights about the real world Model A highly simplified representation of a more complicated reality 0 Economists use models to study economic issues 0 Supply and demand 0 Game Theory Model 1 The CircularFlow Diagram The CircularFlow Diagram A visual model of the economy shows how dollars ow through markets among households and firms Two types of quotactorsquot o Households us 0 Firms Two markets 0 The market for goods and services The market for factors of productionquot input 0 Factors of Production The resources the economy Input Basically the uses to produce goods and services including Stuff we USE t0 make I Labor us more stuff I Land raw materials Corn Sugar I Capital buildings and machines used in production Machines in a bottling factor in a CocaCola Factory Delivery trucks I Entrepreneurship idea behind the business All businesses started with an idea Households 0 Own the factors of production I Sellrent them to firms for income 0 Buy and consume goods and services Firms 0 Buyhire factors of production use them to produce goods and services 0 Sell goods and services Households 9 Markets for Factors of Production 9 Factors of production 9 Firms Firms 9 Wages rent interest profit 9 Markets for factors of production 9 Income 9 Households Households 9 Spending 9 Markets for goods and services 9 Revenue 9 Firms Firms 9 Goods and services sold 9 Markets for Goods and Services 9 Goods and services bought 9 Households Model 2 The Production Possibilities Frontier The Production Possibilities Frontier PPF A graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology The PPF and Opportunity Cost c 0 Recall The Opportunity Cost of an item is g what must be given up to obtain that item 3 0 Moving along a PPF involves shifting 2 0 resources eg labor from the production of one good to the other A 0 Society faces a tradeoff Getting more of one good requires sacrificing some of the other O The Slope 0f the PPF tells you the ResourceDepletmg Pxoxlnctmu opportunity cost of one good in terms of the Other Example of a PPF Graph I Slope RiseRun The Shape of the PPF The PPF could be a straight line or bowshaped Depends on what happens to the opportunity cost as economy shifts resources from one industry to the other 0 If opportunity cost remains constant PPF is a straight line Essentially the same resources are equally useful for producing in either industry I Wheat and barley use the same resources Same sunlight Same fields Same water Same farmer I With additional resources or an improvement in technology the economy can produce more barley more wheat or any combination in between o If opportunity cost of a good rises as the economy produces more of the good PPF is bowshaped Essentially the resources are specialized and not easily adaptable for producing in either industry I Production of beer and bikes use completely different resources Bikes aren t fermented Beer doesn t require tar Etc I As the economy shifts resources from beer to mountain bikes PPF becomes steeper Opportunity cost of mountain bikes increases I So PPF is bowshaped when different workers have different skills different opportunity costs of producing one good in terms of the other I The PPF would also be bowshaped when there is some other resource or mix of resources with varying opportunity costs eg different types of land suited for different uses The PPF Important Notes The PPF shows all combinations of two goods that an economy can possibly produce given its resources and technology The PPF illustrates the concepts of trade off and opportunity cost efficiency and inefficiency unemployment and economic growth A bowshaped PPF illustrates the concept of increasing opportunity cost A straight line PPF illustrates constant opportunity costs Microeconomics and Macroeconomics Microeconomics The study of how households and firms make decisions and how they interact in markets Macroeconomics The study of economywide phenomena including in ation unemployment and economic growth These two branches of economics are closely intertwined yet distinct they address different questions The Economist as Policy Advisor As scientists economists make Positive Statements 0 Positive Statements Attempt to describe the world as it is As policy advisors economists make Normative Statements 0 Normative Statements Attempt to prescribe how the world should be Examples 0 Prices rise when the government increases the quantity of money I Positive describes a relationship could used data to confirm or refute o The government should print less money I Normative this is a value judgment cannot be confirmed or refuted o A tax cut is needed to stimulate the economy I Normative another value judgment 0 An increase in the price of burritos will cause an increase in consumer demand for tacos I Positive describes a relationship The PPF What We Know So Far Points on the PPF 0 Possible 0 Efficient all resources are fully utilized Points under the PPF 0 Possible 0 Not efficient some resources are underutilized eg workers unemployed factories idle Points above the PPF 0 Currently unobtainable Chapter 3 A Parable For the Modern Economy Two goods 0 Meat 0 Potatoes Two people 0 Rancher 0 Farmer If the rancher produces only meat 0 And the farmer only produces potatoes 0 Both gain from trade If both the rancher and farmer produce both meat and potatoes 0 They are selfsufficient I Robinson Crusoe model Somebody is both the producer and the consumer 0 However they still gain from specialization and trade The Production Possibilities Frontier a 0 Minutes needed to make 1 ounce of I Meat Farmer 60 minutesounce Rancher 20 minutes ounce I Potatoes Farmer 15 minutesounce Rancher 10 minutes ounce 0 Amount produced in 8 hours I Meat Farmer 8 ounces Rancher 24 ounces I Potatoes Farmer 32 ounces Rancher 48 ounces 0 Panel a shows the production opportunities available to the farmer and the rancher I Rancher is better at producing meat AND potatoes absolute advantage The Production Possibilities Frontier bc o b The Farmer s production possibilities frontier I If there is no trade the farmer chooses this production and consumption 0 ounces of potatoes 8 ounces of meat 16 ounces of potatoes 4 ounces of meat 32 ounces of potatoes 0 ounces of meat o c The Rancher s production possibilities frontier I If there is no trade the rancher chooses this production and consumption 0 ounces of potatoes 24 ounces of meat 24 ounces of potatoes 12 ounces of meat 48 ounces of potatoes 0 ounces of meat 0 Panel b shows the combinations of meat and potatoes that the farmer can produce Panel c shows the combinations of meat and potatoes that the rancher can produce Both production possibilities frontiers are derived assuming that the farmer and rancher each work 8 hours per day If there is no trade each person s production possibilities frontier is also his or her consumption possibilities frontier Specialization and Trade 0 Farmer specialize in growing potatoes I More time growing potatoes I Less time raising cattle o Rancher Specialize in raising cattle I More time raising cattle I Less time growing potatoes 0 Trade I 5 ounces of meat for 15 ounces of potatoes 0 Both gain from specialization and trade How trade expands the set of consumption opportunities ab 0 a The Farmer s production and consumption I 0 ounces of potatoes 8 ounces of meat I 16 ounces of potatoes 4 ounces of meat Farmer s production and consumption without trade Point A I 17 ounces of potatoes 5 ounces of meat Farmer s consumption with trade Point A I 32 ounces of potatoes 0 ounces of meat Farmer s production with trade 0 b The Rancher s production and consumption I 0 ounces of potatoes 24 ounces of meat I 12 ounces of potatoes 18 ounces of meat Rancher s production with trade I 24 ounces of potatoes 12 ounces of meat Rancher s production and consumption without trade Point B I 27 ounces of potatoes 13 ounces of meat Rancher s consumption with trade Point B I 48 ounces of potatoes 0 ounces of meat O The proposed trade between the farmer and the rancher offers each of them a combination of meat and potatoes that would be impossible in the absence of trade In panel a the farmer gets to consume at point A rather than point A In panel b the rancher gets to consume at point 3 rather than point B Trade allows each to consume more meat and more potatoes How Trade Expands the Set of Consumption Opportunities c o c The gains from trade A summary Without trade 0 Production and consumption I Farmer 4 ounces of meat 16 ounces of potatoes I Rancher 12 ounces of meat 24 ounces of potatoes With trade 0 Production I Farmer 0 ounces of meat 32 ounces of potatoes I Rancher 18 ounces of meat 12 ounces of potatoes 0 Trade I Farmer Gets 5 ounces of meat Gives 15 ounces of potatoes I Rancher Gives 5 ounces of meat Gets 15 ounces of potatoes 0 Consumption I Farmer 5 ounces of meat 17 ounces of potatoes I Rancher 13 ounces of meat 27 ounces of potatoes Gains from trade 0 Increase in consumption I Farmer 0 1 ounce in meat 0 1 ounce in potatoes I Rancher 0 1 ounce in meat 0 3 ounces in potatoes Comparative Advantage Absolute Advantage Produce a good using fewer inputs than another producer 0 If you re given a certain amount of inputs and you can produce more with it you also have absolute advantage Opportunity Cost 0 Whatever must be given up to obtain some item 0 Measures the trade off between the two goods that each producer faces 0 The opportunity cost of meat and potatoes I Opportunity cost of 1 ounce of meat 0 Farmer 4 ounces of potatoes I If a farmer wants to produce an additional ounce of meat he has to give up 4 ounces of potatoes 0 Rancher 2 ounces of potatoes I If a rancher wants to produce and additional ounce of meat he has to give up 2 ounces of potatoes 1 ounce ofpotatoes 0 Farmer 1 ounce of meat I If a farmer wants to produce an additional ounce of potatoes he has to give up 11 an ounce of meat 0 Rancher 12 ounce of meat I If a rancher wants to produce an additional ounce of potatoes he has to give up 12 an ounce of meat Comparative Advantage Produce a good lower opportunity cost than another producer 0 Re ects relative opportunity cost 0 America s Got Talent is a show that is all about comparative advantages I Different talents are comparative advantages David Ricardo Father of comparative advantage Principle of comparative advantage 0 Each good produced by the individual that has the smaller opportunity cost of producing that good One person 0 Can have absolute advantage in both goods 0 Cannot have comparative advantage in both goods For different opportunity costs 0 One person comparative advantage in one good 0 The other person comparative advantage in the other good Opportunity cost of one good 0 Inverse of the opportunity cost of the other Gains from specialization and trade 0 Based on comparative advantage 0 Total production in economy rises I Increase in the size of the economic pie I Everyone better off Trade benefit everyone in society 0 Allows people to specialize in activities I Have a comparative advantage 0 The price of trade I Principle of rationality we assume people and countries are rational You would not agree to terms of trade that would leave you worse off Principle of comparative advantage explains o Interdependence o Gains from trade 0 Applications of Comparative Advantage Should the US trade with other countries 0 Imports Goods produced abroad and sold domestically 0 Exports Goods produced domestically and sold abroad Principle of comparative advantage 0 Foundation of international trade 0 Each good produced by the country I Smaller opportunity cost 0 f producing that good 0 Specialization and trade I All countries greater prosperity Example Output of labor per hour 0 Food I US 40 I Mexico 10 0 Clothing I US 40 I Mexico 20 US o Opportunity cost of 1 unit of food is 4040 1 unit of clothing 0 Opportunity cost of 1 unit of clothing is 4040 1 unit of food 0 Mexico 0 Opportunity cost of 1 unit of food is 2010 2 units of Whatever clothing you re taking 0 Opportunity cost of 1 unit of clothing is 1020 12 units the Opportunity of food cost of goes in US has complete advantage in food because 1 is less than 2 the Mexico has complete advantage in clothing because 12 is less denominator than 1 Chapter 4 In this chapter look for the answers to these questions O O O Q What factors affect buyers demand for goods What factors affect sellers supply of goods How do supply and demand determine the price of a good and the quantity sold How do changes in the factors that affect demand or supply affect the market price and quantity of a good How do markets allocate resources Markets and Competition Market A group of buyers and sellers of a particular product Competitive Market one with many buyers and sellers each has a negligible effect on price Demand The Quantity Demanded QD is the amount of the good that buyers are willing and able to purchase at a specific price 0 QD is a point on the demand curve The Demand Curve is a set of various quantities demanded QD at corresponding prices 0 It is the curve itself Law of Demand the claim that the quantity demanded of a good falls when the price of the good rises other things equal 0 When price goes up you buy less 0 When price goes down you buy more The Demand Schedule Demand Schedule A table that shows the relationship between the price of a good and the quantity demanded 0 Example Helen s demand for lattes When drawing a supply demand graph Price of Lattes Quantity of Lattes Demanded PRICE always 000 16 goes on the 1 14 vertical axis 200 12 QUANTITY 300 10 always goes on 400 8 the horizontal 500 6 ax1s 4 0 Notice that Helen s preference obey the Law of Demand Market Demand Versus Individual Demand The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price Suppose Helen and Ken are the only two buyers in the latte market Q01 quantity demanded Price Helen s Qd Ken s Qd Market Qd 000 16 8 24 100 14 7 21 200 12 6 18 300 10 5 15 400 8 4 12 500 6 3 9 600 4 2 6 Most missed Demand Curve Shlfters question on exam 1 deals The demand curve shows how price affects quantity demanded other with things being equal A change in the price of the good changes QD and movement results in a movement along the D curve along the curve vs shifting the curve These other thingsquot are nonprice determinants of demand ie things that determine buyers demand for a good other than the goods price 0 Changes in them shift the D curve 0 Demand Curve Shifters Number of Buyers 0 Increase in number of buyers increases quantity demanded at each price shifts D curve to the right 0 Demand for pizza in Tuscaloosa shifts to the left during the summer because students leave town during the summer I 30 of population leaves Tuscaloosa o The demand curve for beer shifts WAY to the right on game day in Tuscaloosa I Population triples Demand Curve Shifters Income 0 Demand for a Normal Good is a positively related to income I Increase in income causes increase in quantity demanded at each price shifts D curve to the right I Example Eating at a sitdown restaurant 0 Demand for an Inferior Good is negatively related to income I An increase in income shifts D curves for inferior goods to the left I Ramen noodles would be inferior good for college students I Public Transportation 0 Normal goods vs inferior goods are subjective some normal goods might be inferior goods to others and vice versa Demand Curve Shifters Prices of Related Goods 0 Two goods are Substitutes if an increase in the price of one causes an increase in demand for the other 0 Example Crest and Colgate I An increase in the price of Crest toothpaste increases demand for Colgate toothpaste shifting the Colgate demand curve to the right o Other Examples Coke and Pepsi laptops and desktop computers Most missed butter and margarine CDs and music downloads question on 0 Two goods are Complements if an increase in the price of one exam 1 deals causes a fall in demand for the other With I You consume them together movement 0 Example Computers and Software along the I If price of computers rises people buy fewer computers curve VS and therefore less software Software demand curve shifts Shifting the 19ft curve 0 Other examples College tuition and textbooks bagels and cream KNOW THE cheese peanut butter and jelly hot dogs and hot dog buns DIFFERENCE Demand Curve Shifters Tastes amp Preferences 0 Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right 0 Example I The Atkins diet became popular in the 90s caused an increase in demand for eggs shifted the egg demand curve to the right I Cant have carbs on Atkins curve shifted to the left for cereal companies bread companies etc 0 Also tablet computers such as the iPad are currently very popular so the demand curve for these computers has shifted to the right as well 0 Anything that causes a shift in tastes away from a good will decrease demand for that good and shift its D curve to the left 0 Demand Curve Shifters Expectation o Expectations affect consumers buying decisions 0 Examples I If people expect their incomes to rise their demand for meals at expensive restaurants may increase now I If the economy sours and people worry about their future job security demand for new autos may fall now Summary Variables That In uence Buyers Variable A change in this variable Price Causes a movement along the D curve Number of buyers Shifts the D curve Income Shifts the D curve Price of related goods Shifts the D curve Tastes Shifts the D curve Expectations Shifts the D curve Active Learning Draw a demand curve for digital cameras What happens to it in each of the following scenarios Why 0 A The price of memory cards fall I Digital cameras and memory cards are complements I A fall in price of memory cards shifts the demand curve for digital cameras to the right 0 B The price of digital cameras falls I The D curve does NOT shift I Move down along to a point with lower P higher Q o C The price of smartphones falls I Smartphones and digital cameras are substitutes of one another I A fall in price of smartphones shifts demand for digital cameras to the left Supply Quantity Supplied QS The amount that sellers are willing and able to sell of any good at a specific price 0 QS is a point on the supply curve Supply Curve A set of various quantities supplied QS at corresponding prices Law of Supply The claim that the quantity supplied of a good rises when the price of the good rises other things equal The Supply Schedule Supply Schedule A table that shows the relationship between the price of a good and the quantity supplied Example Starbucks supply of lattes Price of Lattes Quantity of Lattes Supplied 000 0 100 3 200 6 300 9 400 12 500 15 600 18 Notice that Starbucks supply schedule obeys the Law of Supply Market Supply Versus Individual Supply The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price Suppose Starbucks and Crimson Caf are the only two sellers in this market QS Quantity Supplied Price Starbucks Crimson Caf Market QS 000 0 0 0 100 3 2 5 200 6 4 10 300 9 6 15 400 12 8 20 500 15 10 25 600 18 12 30 Supply Curve Shifters The supply curve shows how price affects quantity supplied other things being equal A change in the price of the good changes QS and results in a movement along the S curve These other thingsquot are nonprice determinants of supply 0 Changes in them shift the S curve Supply Curve Shifters Input Prices 0 Examples of input prices I Wages prices of raw materials A fall in input prices makes production more profitable at each Most missed question on exam 1 deals with movement along the curve vs shifting the curve KNOW THE DIFFERENCE output price so firms supply a larger quantity at each price and the S curve shifts to the right When input prices go up it makes production less profitable and the curve shifts to the left Supply Curve Shifters Technology 0 Technology determines how much inputs are required to produce a unit of output A costsaving technological improvement has the same effect as a fall in input prices shifts S curve to the right A technological advance makes production more efficient always and forever the S curve shifts to the right Whenever technology is destroyed is the only time the curve will shift to the left I Natural Disasters War Etc Supply Curve Shifters Number of Sellers 0 An increase in the number of sellers increases the quantity supplied at each price shifts S curve to the right Supply Curve Shifters Expectations 0 Effects demand and supply 0 Example I Events in the Middle East lead to expectations of higher oil pr1ces O I In response owners of Texas oilfields reduce supply now save some inventory to sell later at the higher price I S curve shifts left 0 In general sellers may adjust supply if the good is not perishable when their expectations of future price change Summary Variables that In uence Sellers Variable A change in this variable Price Causes a movement along the S curve Input Prices Shifts the S curve Technology Shifts the S curve Number of Sellers Shifts the S curve Expectations Shifts the S curve Active Learning Supply Curve Draw a supply curve for steel What happens to it in each of the following scenarios 0 A Steel producers cut the price of steel I S curve does not shift I Moves along the curve to a lower P and lower Q o B A technological advance allows steel to be produced at lower cost I S curve shifts to the right I At each price Q increases 0 C Aluminum alloy producers raise the price of the metals they produce I This shifts the demand curve for steel not the supply curve Substitutes only affect demand Supply and Demand Together Equilibrium Price has reached the level where quantity supplied equals quantity demanded 0 Q8 and QD are equal Market Clearing Another term for equilibrium Equilibrium Price The price that equates quantity supplied with quantity demanded Equilibrium Quantity The quantity supplied and quantity demanded at the equilibrium price Surplus aka excess supply When quantity supplied is greater than quantity demanded 0 Example I If P 5 then Q 9 lattes and Q5 25 lattes resulting in a surplus of 16 lattes 0 Facing a surplus sellers try to increase sales by cutting price 0 This causes QD to rise and Q5 to fall which reduces the surplus 0 Prices continue to fall until market reaches equilibrium Shortage aka excess demand When quantity demanded is greater than quantity supplied 0 Example I If P 1 then Q 21 lattes and Q5 5 lattes resulting in a shortage of 16 lattes 0 Facing a shortage sellers raise the price causing QD to fall and Q5 to rise which reduces the shortage 0 Prices continue to rise until market reaches equilibrium Three Steps to Analyzing Changes in the Equilibrium To determine the effects of any event 0 1 Decide whether event shifts S curve D curve or both 0 2 Decide in which direction the curves shift 0 3 Use supplydemand diagram to see how the shift changes equilibrium P and Q Example The Market in Hybrid Cars 1 A Shift in Demand Event to be analyzed 0 Increase in price of gas Step 1 o D curve shifts because price of gas affects demand for hybrids Determinant is taste preferences Step 2 o D shifts rightbecause high gas price makes hybrids more attractive relative to other cars Step 3 o The shift causes an increase in price and quantity of hybrid cars Notice 0 When P rises producers supply a larger quantity of hybrids even though the S curve has not shifted Always be careful to distinguish between a shift in a curve and a movement along the curve 2 A Shift in Supply Event 0 New technology reduces cost of producing hybrid cars Step 1 o S curve shifts because event affects cost of production D curve does not shift because production technology is not tone of the factors that affect demand Step 2 o S shifts right because event reduces cost makes production cheaper Step 3 o The shift causes price to fall and quantity to rise 3 A Shift in Both Supply and Demand Events 0 Price of gas rises AND new technology reduces production costs Step 1 0 Both curves shift Step 2 0 Both curves shift to the right Step 3 0 Q rises but effect on P is ambiguous or uncertain because the representation is abstract not able to tell without specific data Active Learning Shifts in Supply and Demand Use the 3 step method to analyze the effects of each event on the equilibrium price and quantity of ice cream 0 Event A Fall in price of frozen yogurt I D curve shifts I D curve shifts E I P and Q both fall 0 Event B Fall in milk prices I S shifts I S shifts Ligm I P falls Q rises 0 Event C Fall in price of frozen yogurt and fall in milk prices I Both curves shift I D shifts left S shifts right I P unambiguously falls Effect on Q is ambiguous The fall in demand reduces Q the increase in supply increases Q Terms for Shift vs Movement Along Curve Changes in Supply A shift in the S curve occurs when a nonprice determinant of supply changes like technology or costs Change in the Quantity Supplied A movement along a fixed S curve occurs when P changes Change in Demand A shift in the D curve occurs when a nonprice determinant of demand changes like income or number of buyers 0 Change in the Quantity Demanded A movement along a fixed D curve occurs when P changes
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