Supply & Demand

2.1 Demand

In economics, demand isn't just "wanting" something. It represents the behavior of buyers. Specifically, it tracks how much people are willing and able to buy at different price points.

Why does the curve slope down?

It seems obvious that we buy more at lower prices, but as an AP student, you need to know the three specific reasons why this happens:

1. Substitution Effect: As the price of a good rises, it becomes expensive relative to other goods. Consumers switch to cheaper alternatives (substitutes).
2. Income Effect: When the price of a good falls, your money goes further. You effectively have more "purchasing power," so you can afford to buy more.
3. Diminishing Marginal Utility: The more you consume of something (like slices of pizza), the less satisfaction you get from each additional unit. You will only agree to buy that 4th or 5th slice if the price is low enough to match your lower satisfaction.

Shifters of Demand (The "MERIT" Acronym)

If the Price changes, we move along the curve. If anything else changes, the entire curve shifts left or right. Use the acronym MERIT to remember these factors:

• Market Size: The number of consumers. If the population grows, the curve shifts Right.
• Expectations: If you expect prices to go up next week, you will buy more today (Shift Right).
• Related Goods:
  • Substitutes: If Pepsi gets expensive, people switch to Coke (Demand for Coke shifts Right).
  • Complements: If Peanut Butter gets expensive, people buy less Jelly (Demand for Jelly shifts Left).
• Income:
  • Normal Goods: Richer people buy more new cars (Shift Right).
  • Inferior Goods: Richer people buy less instant ramen (Shift Left).
• Tastes & Preferences: Trends, advertising, and seasons affect desire.

2.2 Supply

Supply represents the behavior of producers (businesses). Their goal is to maximize profit.

Shifters of Supply

Remember, "Price" only moves you along the curve. These factors shift the curve (Cost is the biggest one!):

• Input Costs: This is the #1 shifter. If ingredients (sugar, flour) get expensive, it costs more to make cookies. Supply decreases (Shift Left).
• Technology: New machines make production faster and cheaper. Supply increases (Shift Right).
• Government Action:
  • Taxes: Act like an increase in cost (Shift Left).
  • Subsidies: Free money from the gov; acts like a decrease in cost (Shift Right).
• Number of Sellers: More bakeries opening up means more total supply (Shift Right).

2.3 Market Equilibrium

The market naturally wants to be at equilibrium—the price where the amount buyers want exactly matches the amount sellers want to sell.

2.4 Price Controls

Sometimes the government interferes with the market price. This always leads to "inefficiency" (Deadweight Loss).

1. Price Ceiling (The "Rent Control" Example)

The government sets a maximum price to help consumers. To have an impact, it must be set BELOW the equilibrium.

2. Price Floor (The "Minimum Wage" Example)

The government sets a minimum price to help sellers (or workers). To be binding, it must be ABOVE equilibrium.

Note: Think of the floor as the literal ground. You can stand on the floor (equilibrium can be above it), but if the floor is built above your head, you hit it!

2.7 Consumer Choice (Utility)

How do we decide what to buy? We implicitly do math in our heads to see which item gives us the "most bang for our buck."