AP Microeconomics Unit 2: Supply and Demand | Notes and practice

Notes

Law of demand: price up, quantity demanded down (substitution and income effects). Demand shifts with income (normal vs inferior goods), prices of substitutes and complements, tastes, expectations and the number of buyers.
Law of supply: price up, quantity supplied up. Supply shifts with input costs, technology, taxes and subsidies, the prices of other goods the firm could make, expectations and the number of sellers.

An increase in demand raises both equilibrium price and quantity.

Price elasticity of demand $\displaystyle = \frac{\%\Delta Q_d}{\%\Delta P}$ (use the absolute value). Greater than 1: elastic; less than 1: inelastic; equal to 1: unit elastic.
Demand is more elastic with many substitutes, for luxuries, for a large share of income, and over more time.
Total revenue test: if demand is elastic, lowering the price raises total revenue; if inelastic, raising the price raises total revenue.
Income elasticity: positive for normal goods, negative for inferior goods. Cross-price elasticity: positive for substitutes, negative for complements.
Price elasticity of supply is greater over longer time periods.

Equilibrium is where $Q_d = Q_s$.
Consumer surplus: the area below demand and above price. Producer surplus: above supply and below price. Their sum is total surplus, maximized at equilibrium.
Both curves shifting: if both shift, one of price or quantity is indeterminate unless you know the sizes.

A binding price ceiling (below equilibrium) causes a shortage. A binding price floor (above equilibrium, like a minimum wage) causes a surplus. Both create deadweight loss.
An excise tax shifts supply left (or opens a wedge between buyer and seller prices), raising the price buyers pay, lowering quantity, and creating deadweight loss. The side with more inelastic demand or supply bears more of the tax incidence.
Tariffs and quotas raise domestic prices and reduce imports; they help domestic producers but reduce total surplus.

A binding price ceiling causes a shortage.

If the price of coffee rises, the demand for tea (a substitute) will:

When incomes rise, demand for an inferior good:

The price of a good rises 10% and quantity demanded falls 20%. Demand is:

A business's demand is inelastic. To increase total revenue, it should:

Which good likely has the most inelastic demand?

A binding price floor above equilibrium creates:

An excise tax on a good with very inelastic demand is paid mostly by:

Demand increases and supply increases at the same time. What definitely happens?

Write your answer first, then open the scoring guide.

Free-response question

The market for gasoline is in equilibrium. The government places a per-unit excise tax on sellers.

(a) Explain the effect on the price consumers pay and the quantity sold.

Show the answer and scoring guide

The tax shifts supply left (up by the tax), so the price consumers pay rises and the equilibrium quantity falls.

Check off the points you earned:

(b) Explain what happens to consumer surplus and why.

Show the answer and scoring guide

Consumer surplus decreases because buyers pay a higher price and buy fewer units.

Check off the points you earned:

(c) Demand for gasoline is relatively inelastic. Who bears more of the tax burden? Explain.

Show the answer and scoring guide

Consumers bear more, because they don't reduce their purchases much when the price rises, so sellers can pass most of the tax on.

Check off the points you earned: