AP Economics

Miles Kim
Ch. 2
Specialization/Trade, Absolute/Comparative Adv., Supply & Demand
The PPC & Efficiency
• Productive Efficiency-
• Products are being produced in the least costly way.
• This is any point ON the Production Possibilities Curve
• Allocative Efficiency-
• The products being produced are the ones most
desired by society.
• This optimal point on the PPC depends on the desires
of society.
Example
• Which points are productively efficient?
• Which are allocatively efficient?
• Productively Efficient combinations are A through D
• Allocative Efficient combinations depend on the wants of society
Why do we care about 2 types of efficiency?
• Is combination “A” efficient?
• Yes and No. It is productively efficient but it is not the combination
society wants
2008 Audit Question
2008 Audit #2
What are the shifters of PPC?
• 4 Key Assumptions Revisited
• Only two goods can be produced
• Full employment of resources
• Fixed Resources (4 Factors)
• Fixed Technology
• What if there is a change?
• 3 Shifters of the PPC
• 1. Change in resource quantity or quality
• 2. Change in Technology
• 3. Change in Trade
 Production Possibilities
What happens if
there is an increase
in population?
Computers

Pizzas
8
 Production Possibilities
What happens if
there is an increase
in population?
Computers

Pizzas
9
 Production Possibilities
What if there is a
technology improvement
in pizza ovens
Computers

Pizzas
10
 Production Possibilities
What if there is a
technology improvement
in pizza ovens
Computers

Pizzas
11
 Capital Goods and Future Growth
Countries that produce more capital goods will have
more growth in the future.
Panama – Favors Mexico – Favors
Consumer Goods Capital Goods
Current
PPC Future
PPC
Capital Goods

Future

Capital Goods
PPC
Current
PPC

Consumer goods Consumer goods

Panama Mexico
12
 PPC Practice
Draw a PPC showing changes for each of the
following:
Pizza and Computers (3)
1. New computer making technology
2. Decrease in the demand for pizza
3. Mad cow disease kills 85% of cows
Consumer goods and Capital Goods (4)
4. Destruction of power plants leads to severe
electricity shortage
5. Faster computer hardware
6. Many workers unemployed
7. Significant increases in education
13
 Question #1
New computer making
technology

Computers A shift only for

computers

Pizzas 14
 Question #2
Decrease in the demand for pizza

The curve doesn’t shift!

Computers A change in demand
doesn’t shift the curve

Pizzas 15
 Question #3
Mad cow disease kills 85% of cows

Computers A shift inward only for

Pizza

Pizzas 16
 Question #4
Destruction of power plants

Capital Goods (Guns)

Decrease in resources
decrease production
possibilities for both

Consumer Goods (Butter) 17

 Question #5
Faster computer hardware
Quality of a resource

Capital Goods (Guns)

improves shifting the
curve outward

Consumer Goods (Butter) 18

 Question #6
Many workers unemployed
The curve doesn’t shift!
Capital Goods (Guns)
Unemployment is just a
point inside the curve

Consumer Goods (Butter) 19

 Question #7
Significant increases in education

Capital Goods (Guns)

The quality of labor is
improved. Curve shifts
outward.

Consumer Goods (Butter) 20

Specialization and Trade
Why do people trade?

21
 Why do people trade?
1. Assume people didn’t trade. What things would
you have to go without?
Everything you don’t produce yourself!
(Clothes, car, cell phone, bananas, heath care, etc)
The Point: Everyone specializes in the production
of goods and services and trades it to others
2. What would life be like if cities couldn’t trade
with cities or states couldn’t trade with states?
Limiting trade would reduce people’s choices and
make people worse off.
The Point: More access to trade means more
choices and a higher standard of living. 22
Absolute and Comparative
Advantage

23
 Per Unit Opportunity Cost Review
Per Unit Opportunity Cost = Opportunity Cost
Units Gained
Assume it costs you $50 to produce 5 t-shirts. What is
your PER UNIT cost for each shirt?
$10 per shirt
Now, take money our of the equation. Instead of
producing 5 shirts you could have made 10
hats.
1. What is your PER UNIT OPPORTUNITY COST for
each shirt in terms of hats given up?
1 shirt costs 2 hats
2. What is your PER UNIT OPPORTUNITY COST for
each hat in terms of shirts given up? 24
 Per Unit Opportunity Cost Review
Ronald McDonald can produce 20 pizzas or 200 burgers
Papa John can produce 100 pizzas or 200 burgers
1. What is Ronald’s opportunity cost for one pizza in
terms of burgers given up? 1 pizza cost 10 burgers
2. What is Ronald’s opportunity cost for one burger in
terms of pizza given up? 1 burger costs 1/10 pizza
3. What is Papa John’s opportunity cost for one pizza in
terms of burgers given up? 1 pizza costs 2 burgers
4. What is Papa John’s opportunity cost for one burger
in terms of pizza given up? 1 burger costs 1/2 pizza
Ronald has a COMPARATIVE ADVANTGE in the production of
burgers
Papa John has a COMPARATIVE ADVANTAGE in the
production of pizza 25
Absolute and Comparative Advantage
Absolute Advantage
• The producer that can produce the most output OR
requires the least amount of inputs (resources)
• Ex: Papa John has an absolute advantage in pizzas
because he can produce 100 and Ronald can only
make 20.
Comparative Advantage
• The producer with the lowest opportunity cost.
• Ex: Ronald has a comparative advantage in burgers
because he has a lowest PER UNIT opportunity cost.
Countries should trade if they have a
relatively lower opportunity cost
They should specialize in the good that is “cheaper” for
them to produce 26
Benefits of Specialize
and Trade

27
 International Trade
Trade: 1 Wheat for 1.5 Sugar
S W S W
0 30 45 USA Brazil 20 0
1.5 29 40 18.5 1
3 28 17 2
35 The US Specializes and Brazil Makes
4.5 27 15.5 3
30
makes ONLY Wheat 30 ONLY Sugar
6 26 14 4

Sugar (tons)
Sugar (tons)

7.5 25 25 25 12.5 5
9 24 11 6
20 20
10.5 23 9.5 7
12 22 15 15 8 8
13.5 21 10 10 6.5 9
15 20 5 10
5 5
16.5 19 3.5 11
18 18 0 0
5 10 15 20 25 30 5 10 15 20 28
19.5 17 Wheat (tons) Wheat (tons)
 International Trade
TRADE SHIFTS THE PPC!
45 USA Brazil
40

35
AFTER TRADE
30 30

Sugar (tons)
Sugar (tons)

25 25

20 20 AFTER TRADE
15 15

10 10

5 5

0 0
5 10 15 20 25 30 5 10 15 20 29
Wheat (tons) Wheat (tons)
 Wheat Sugar
USA 30 (1W costs 1S) 30 (1S costs 1W)
Brazil 10 (1W costs 2S) 20 (1S costs 1/2W)
Which country has a comparative advantage in wheat?
45

40
1. Which country should EXPORT Sugar?
35
2. Which country should EXPORT Wheat?

Sugar (tons)
Sugar (tons)

30
30
3. Which country should IMPORT
25 Wheat?
25
20
20
15
15
10

5 10 15 20 25 30 5 10 15 20
Wheat (tons) Wheat (tons) 30
 Output Questions:
OOO=
Output: Other goes Over

31
 Input Questions
(The variable is
resources or time)
IOU=
Input: Other goes Under

32
 Terms of Trade
Both countries can benefit from trade if they
each have relatively lower opportunity costs.
Terms of Trade- The agreed upon conditions
that would benefit both countries
Ex: Trade 1 ton of wheat for 1.5 tons of sugar
33
 Pineapples Radios
Kenya 30 10
India 40 40
1. Who has an absolute advantage in Radios?
2. What is the cost of one radio for India?
3. What is the per unit opportunity cost for 1
pineapple for Kenya?
4. Who has a comparative advantage in pineapples?
5. Who has a comparative advantage in radios?
6. Who should import pineapples?
7. Trading 1 radio for how many pineapples would
benefit both countries?
 Pineapples Radios
Kenya 30(1P costs 1/3R) 10 (1R costs 3 P)

India 40 (1P costs 1R) 40 (1R costs 1P)

Kenya wants Radios
If the terms of trade for 1 radio is greater than 3
pineapples then Kenya is worse off and should make
radios on their own.
India wants Pineapples
If the terms of trade for 1 radio is less than 1
pineapple then India is worse off and should make
pineapples on their own.
What terms of trade benefit both countries?
 Pineapples Radios
Kenya 30(1P costs 1/3R) 10 (1R costs 3 P)

India 40 (1P costs 1R) 40 (1R costs 1P)

Trading 1 radio for 2 pineapples will benefit both

If Kenya produces radios by themselves, they give up
3 Pineapples for each radio. If they can trade 2
pineapples for each radio they are better off.
If India produces pineapples by themselves, they
give up 1 pineapple for one radio. If they can get 2
pineapples for one radio they are better off.
The countries trade at a lower opportunity cost than
if they made the products themselves!
2008 Audit Exam
2008 Audit Exam
2008 Audit Exam
 Comparative Advantage Practice
Create a chart for each of the following problems.
• First- Identify if it is a output or input question
• Second-Identify who has the ABSOLUTE ADVANTAGE
• Third-Identify who has a COMPARATIVE ADVANTAGE
• Fourth- Identify how they should specialize
1. Sara gives 2 haircuts or 1 perm and hour. Megan gives 3 haircuts
or 2 perms per hour.
2. Justin fixes 4 flats or 8 brakes per day. Tim fixes 1 flats or 5
brakes per day.
3. Hannah takes 30 minutes to wash dishes and 1 hour to vacuum
the house. Kevin takes 15 minutes to wash dishes and 45 minutes to
vacuum.
4. Americans produce 50 computers or 50 TVs per hour. Chinese
produce 30 computers or 40 TVs per hour. 40
Input or Output Question?
Number caught per day
Deer Antelope
Henry 4 6
John 24 12

Months to produce one

Car Plane
Canada 8 10
Japan 15 12
Acres to produce 100 bushels
Corn Rice
Henry 9 3
John 8 2 41
 Absolute Advantage?
Number caught per day
Deer Antelope
Henry 4 6
John 24 12

Months to produce one

Car Plane
Canada 8 10
Japan 15 12
Acres to produce 100 bushels
Corn Rice
Henry 9 3
John 8 2 42
Comparative Advantage?
Number caught per day
Deer Antelope
Henry 4 6 OOO
John 24 12

Months to produce one

Car Plane
Canada 8 10 IOU
Japan 15 12
Acres to produce 100 bushels
Corn Rice
Henry 9 3 IOU
John 8 2 43
Comparative Advantage?
Number caught per day
Deer Antelope
Henry 4 (1D=3/2A) 6 (1A =2/3D OOO
John 24 (1D=1/2A) 12(1A=2D)

Months to produce one

Car Plane
Canada 8 10 IOU
Japan 15 12
Acres to produce 100 bushels
Corn Rice
Henry 9 3 IOU
John 8 2 44
Comparative Advantage?
Number caught per day
Deer Antelope
Henry 4 (1D=3/2A) 6 OOO
John 24 (1D=1/2A) 12

Months to produce one

Car Plane
Canada 8 (1C=4/5P) 10 (1P=5/4C) IOU
Japan 15(1C=5/4P) 12 (P=4/5C)
Acres to produce 100 bushels
Corn Rice
Henry 9 3 IOU
John 8 2 45
Comparative Advantage?
Number caught per day
Deer Antelope
Henry 4 (1D=3/2A) 6 OOO
John 24 (1D=1/2A) 12

Months to produce one

Car Plane
Canada 8 (1C=4/5P) 10 IOU
Japan 15(1C=5/4P) 12
Acres to produce 100 bushels
Corn Rice
Henry 9 (1C=3R) 3 IOU
John 8 (1C=4R) 2 46
 The Circular Flow
Model
The Product Market-
•The “place” where goods and services
produced by businesses are sold to households.
The Resource (Factor) Market-
•The “place” where resources (land, labor,
capital, and entrepreneurship) are sold to
businesses.
48
 D Resource Market $
(Fa $$ I SU
N
A $ cto nco PP
EM sts $$ r p me
ay $ LY
D $$ Co Re
m $$
en
$ o urces (Fa sou
ts)
Res Pr cto rce
od rs s
uc of
$$$ tio
n)
Taxes Taxes

Subsidies Transfer Payments

Public Goods Public Goods

Businesses Government Individuals
Go $$$
o
Se ds a and
rvi nd o ds ces
$$ ce
s Go ervi
$R S
SU ev
en g$
$$
PP ue
$$ pen
di n
D
LY $
$$$
S
A N
Product Market DEM 49
Circular Flow Model Vocab
Private Sector- Part of the economy that is run by
individuals and businesses
Public Sector- Part of the economy that is controlled by the
government
Factor Payments- Payment for the factors of production,
namely rent, wages, interest, and profit
Transfer Payments- When the government redistributes
income (ex: welfare, social security)
Subsidies- Government payments to businesses

50
2012 Exam

51
2008 FRQ #3

52
Macro 2013 (“Secured Documents Exam”)

53
54
55
56
 DEMAND DEFINED
What is Demand?
Demand is the different quantities of goods
that consumers are willing and able to buy at
different prices.
(Ex: You are able to purchase diapers, but if you
aren’t willing to buy then there is NO demand)

What is the Law of Demand?

There is an INVERSE relationship between
price and quantity demanded
57
Example of Demand
I am willing to sell several A’s in AP
Economics. How much will you pay?

Price Quantity
Demanded

Demand
Schedule

58
Why does the Law of Demand occur?

The law of demand is the result of three

separate behavior patterns that overlap:
1.The Substitution effect
2.The Income effect
3.The Law of Diminishing Marginal
Utility
We will define and explain each…
59
Why does the Law of Demand
occur?
1. The Substitution Effect
• If the price goes up for a product, consumer
buy less of that product and more of another
substitute product (and vice versa)

2. The Income Effect

• If the price goes down for a product, the purchasing
power increases for consumers -allowing them to
purchase more.
60
Why does the Law of Demand occur?
3. Law of Diminishing Marginal Utility
• Utility = Satisfaction
• We buy goods because we get utility from them
• The law of diminishing marginal utility states that as you consume
anything, the additional satisfaction that you will receive will
eventually start to decrease
• In other words, the more you buy of ANY GOOD the less satisfaction
you get from each new unit consumed.
Discussion Questions:
1. What does this have to do with the Law of Demand?
2. How does this effect the pricing of businesses?

61
Can you see the Law of Diminishing Marginal
Utility in Disneyland’s pricing strategy?
Graphing Demand

63
 The Demand Curve
• A demand curve is a graphical representation of a
demand schedule.
• The demand curve is downward sloping showing the
inverse relationship between price (on the y-axis) and
quantity demanded (on the x-axis)
• When reading a demand curve, assume all outside
factors, such as income, are held constant. (This is called
ceteris paribus)
Let’s draw a new demand curve for milk…

64
GRAPHING DEMAND
Demand Price of Milk Draw this large
Schedule $5
in your notes
Quantity
Price Demande 4
d

$5 10 3

$4 20 2

$3 30
1
$2 50
$1 80 10 20 30 40 50 60 70 80 Q
Quantity of Milk 65
GRAPHING DEMAND
Demand Price of Milk
Schedule $5

Quantity
Price Demande 4
d

$5 10 3

$4 20 2

$3 30
1

$2 50 Demand

$1 80
10 20 30 40 50 60 70 80 Q
Quantity of Milk 66
Where do you get the Market Demand?
Billy Jean Other Individuals Market
Price Q Demd Price Q Demd Price Q Demd Price Q Demd

$5 1 $5 0 $5 9 $5 10
$4 2 $4 1 $4 17 $4 20
$3 3 $3 2 $3 25 $3 30
$2 5 $2 3 $2 42 $2 50
$1 7 $1 5 $1 68 $1 80
P P P P

$3 $3 $3 $3

D D D D
3 Q 2 Q 25 Q 30 Q
 Shifts in Demand
• Ceteris paribus-“all other things held constant.”
• When the ceteris paribus assumption is dropped,
movement no longer occurs along the demand curve.
Rather, the entire demand curve shifts.
• A shift means that at the same prices, more people are
willing and able to purchase that good.
This is a change in demand, not a change in
quantity demanded
PRICE DOESN’T SHIFT THE CURVE

68
Change in Demand
Demand Price of Milk
Schedule $5
What if milk
Price
Quantity makes you
Demande 4
d smarter?
$5 10 3

$4 20 2

$3 30
1

$2 50 Demand

$1 80
10 20 30 40 50 60 70 80 Q
Quantity of Milk 69
Change in Demand
Demand Price of Milk
Schedule $5
What if milk
Price
Quantity makes you
Demande 4
d smarter?
$5 10 3

$4 20 2

$3 30
1

$2 50 Demand

$1 80
10 20 30 40 50 60 70 80 Q
Quantity of Milk 70
Change in Demand
Demand Price of Milk
Schedule $5

Quantity
Price Demande 4
d

$5 10 30 3

$4 20 40 2

$3 30 50
1

$2 50 70 Demand

$1 80 100
10 20 30 40 50 60 70 80 Q
Quantity of Milk 71
Change in Demand
Demand Price of Milk
Schedule Increase in Demand
$5
Prices didn’t change but
Quantity people want MORE Milk
Price Demande 4
d

$5 10 30 3

$4 20 40 2
D1
$3 30 50
1

$2 50 70 Demand

$1 80 100
10 20 30 40 50 60 70 80 Q
Quantity of Milk 72
Change in Demand
Demand Price of Milk
Schedule $5
What if milk
Price
Quantity makes causes
Demande 4
d baldness?
$5 10 3

$4 20 2

$3 30
1
Demand
$2 50
$1 80
10 20 30 40 50 60 70 80 Q
Quantity of Milk 73
Change in Demand
Demand Price of Milk
Schedule $5
What if milk
Price
Quantity makes causes
Demande 4
d baldness?
$5 10 3

$4 20 2

$3 30
1
Demand
$2 50
$1 80
10 20 30 40 50 60 70 80 Q
Quantity of Milk 74
Change in Demand
Demand Price of Milk
Schedule $5

Quantity
Price Demande 4
d

$5 10 0 3

$4 20 5 2

$3 30 20
1
Demand
$2 50 30
$1 80 60
10 20 30 40 50 60 70 80 Q
Quantity of Milk 75
Change in Demand
Demand Price of Milk
Schedule $5
Decrease in Demand
Quantity
Prices didn’t change but
Price Demande 4
d people want LESS Milk

$5 10 0 3

$4 20 5 2

$3 30 20
1
D2 Demand
$2 50 30
$1 80 60
10 20 30 40 50 60 70 80 Q
Quantity of Milk 76
Change in Demand
Demand Price of Milk
Schedule $5 What happens to
Quantity the demand for milk if
Price Demande 4
d the price of milk
$5 10 3 goes up?
$4 20 2
NOTHING!
$3 30 The demand
1
stays the same Demand
$2 50
$1 80
10 20 30 40 50 60 70 80 Q
Quantity of Milk 77
Change in Qd vs. Change in Demand
There are two ways to increase
Price of Milk quantity from 10 to 20
P 1. A to B is a change
in quantity
demand (due to a
change in price)
A C
$3 2. A to C is a change
in demand (shift in
B the curve)
$2
D2
D1
10 20 Q Milk
Quantity of Milk
What Causes a Shift in Demand?
5 Shifters (Determinates) of Demand:
1. Tastes and Preferences
2. Number of Consumers
3. Price of Related Goods
4. Income
5. Future Expectations
Changes in PRICE don’t shift the curve. It
only causes movement along the curve. 79
 Prices of Related Goods
The demand curve for one good can be affected by a
change in the price of ANOTHER related good.
1. Substitutes are goods used in place of one
another.
• Ex: If price of Pepsi falls, demand for coke will…
• If the price of one increases, the demand for the
other will increase (or vice versa)

2. Complements are two goods that are bought

and used together.
• Ex: If price of hot dogs falls, demand for hot dog
buns will...
• If the price of one increase, the demand for the
other will fall. (or vice versa) 80
 Income
The incomes of consumer change the demand, but
how depends on the type of good.
1. Normal Goods
• Ex: Luxury cars, Sea Food, jewelry, homes
• As income increases, demand increases
• As income falls, demand falls
2. Inferior Goods
• Ex: Top Ramen, used cars, used clothes
• As income increases, demand falls
• As income falls, demand increases

81
 Supply Defined
What is supply?
Supply is the different quantities of a good that sellers
are willing and able to sell (produce) at different prices.
What is the Law of Supply?
There is a DIRECT (or positive) relationship between
price and quantity supplied.
• As price increases, the quantity producers make
increases
• As price falls, the quantity producers make falls.
Why? Because, at higher prices profit seeking
firms have an incentive to produce more.
EXAMPLE: Mowing Lawns 82
 Example of Supply
You own an lawn mower and you are
willing to mow lawns.
How many lawns will you mow at these prices?
Price per Quantity
Supply lawn mowed Supplied

Schedule $1
$5
$20
$50
$100
$1000
83
GRAPHING SUPPLY
Supply Price of Milk Draw this large
Schedule $5
in your notes
Quantity
Price
Supplied 4

$5 50
3
$4 40
2
$3 30
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 84
GRAPHING SUPPLY
Supply Price of Milk
Schedule $5 Supply
Quantity
Price
Supplied 4

$5 50
3
$4 40
2
$3 30
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 85
GRAPHING SUPPLY
Supply Price of Milk
Schedule $5 Supply
Quantity
Price
What if there are new
Supplied 4

$5 50
$4 40
and more
3
productive
$3 30 milking
2
machines?
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 86
Change in Supply
Supply Price of Milk Supply
Schedule $5

Quantity
Price
Supplied 4

$5 50
3
$4 40
2
$3 30
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 87
Change in Supply
Supply Price of Milk Supply
Schedule $5

Quantity
Price
Supplied 4

$5 50
3
$4 40
2
$3 30
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 88
Change in Supply
Supply Price of Milk Supply
Schedule $5

Quantity
Price
Supplied 4

$5 50 70
3
$4 40 60
2
$3 30 50
1
$2 20 40
$1 10 30 10 20 30 40 50 60 70 80 Q
Quantity of Milk 89
Change in Supply
Supply Price of Milk Supply
Schedule $5 S2
Quantity
Price
Supplied 4

$5 50 70
3
$4 40 60
2
Increase in Supply
$3 30 50 Prices didn’t change but
1 there is MORE milk
$2 20 40 produced
$1 10 30 10 20 30 40 50 60 70 80 Q
Quantity of Milk 90
Change in Supply
Supply Price of Milk
Schedule $5 Supply
Quantity
Price
What if the price for
Supplied 4

$5 50
$4 dairy
40 cows increases
3

drastically?
2
$3 30
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 91
Change in Supply
Supply Price of Milk Supply
Schedule $5

Quantity
Price
Supplied 4

$5 50
3
$4 40
2
$3 30
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 92
Change in Supply
Supply Price of Milk Supply
Schedule $5

Quantity
Price
Supplied 4

$5 50
3
$4 40
2
$3 30
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 93
Change in Supply
Supply Price of Milk Supply
Schedule $5

Quantity
Price
Supplied 4

$5 50 30
3
$4 40 20
2
$3 30 10
1
$2 20 1
$1 10 0 10 20 30 40 50 60 70 80 Q
Quantity of Milk 94
Change in Supply
Supply Price of Milk Supply
Schedule $5 S2
Quantity
Price
Supplied 4

$5 50 30
3
$4 40 20 Decrease in Supply
2 Prices didn’t change but
$3 30 10 there is LESS milk
produced
1
$2 20 1
$1 10 0 10 20 30 40 50 60 70 80 Q
Quantity of Milk 95
Change in Supply
Supply Price of Milk
Schedule $5 Supply
Quantity
Price
Supplied 4

$5 50
What if there is a
$4 40
increase
3
in the number
$3 30
of milk
2
producers?
1
$2 20
$1 10 10 20 30 40 50 60 70 80 Q
Quantity of Milk 96
5 Shifters (Determinants) of Supply
1. Prices/Availability of inputs (resources)
2. Number of Sellers
3. Technology
4. Government Action: Taxes & Subsidies
Subsidies
A subsidy is a government payment that supports a business or market.
Subsidies cause the supply of a good to increase.

Taxes
The government can reduce the
supply of some goods by placing an
excise tax on them. An excise tax
is a tax on the production or sale of
a good.
Regulation
Regulation occurs when the
government steps into a market to
affect the price, quantity, or quality of
a good. Regulation usually raises
costs.

5. Expectations of Future Profit

Changes in PRICE don’t shift the curve. It only
causes movement along the curve.

97
 Practice Questions
1. Which of the following will cause the
quantity supplied for milk to decrease?
A. Decrease in the price of a key resource
B. A decrease in the number of milk
producers
C. A decrease in the price of milk
D. An increase in the price of milk
E. A subsidy for milk producers

98
 Supply Practice
Identify the determinant (shifter) then decide if
supply will increase or decrease
Increase or
Shifter Left or Right
Decrease
1
2
3
4
5
6
99
 Supply Practice
1. Which determinant (SHIFTER)?
2. Increase or decrease?
3. Which direction will curve shift?
Analyze Hamburgers
1. Strange virus kills 20% of cows
2. Price of hamburgers increase 30%
3. Government taxes burger producers
4. New bun baking technology cuts production time in half
5. The government subsidizes beef producers
6. Minimum wage increases to $20

100
Supply and Demand are put together to determine
equilibrium price and equilibrium quantity
Demand P Supply
S Schedule
Schedule $5
P Qd 4
P Qs
$5 10 $5 50
3
$4 20 $4 40
2
$3 30 $3 30
$2 50 1
D $2 20
$1 80 $1 10
10 20 30 40 50 60 70 80 Q
101
Supply and Demand are put together to determine
equilibrium price and equilibrium quantity
Demand P Supply
S Schedule
Schedule $5
P Qd 4
P Qs
$5 10 $5 50
3 Equilibrium Price = $3
$4 20 (Qd=Qs) $4 40
2
$3 30 $3 30
$2 50 1
D $2 20
$1 80 $1 10
10 20 30 40 50 60 70 80 Q
Equilibrium Quantity is 30 102
Supply and Demand are put together to determine
equilibrium price and equilibrium quantity
Demand P Supply
S Schedule
Schedule $5
P Qd 4
P Qs
$5 10
3
What if the price $5 50
$4 20 $4 40
2 increases to $4?
$3 30 $3 30
$2 50 1
D $2 20
$1 80 $1 10
10 20 30 40 50 60 70 80 Q
103
 At $4, there is disequilibrium. The quantity
demanded is less than quantity supplied.
Demand P Supply
S Schedule
Schedule $5 Surplus
(Qd<Qs)
P Qd 4
P Qs
$5 10 How much is the $5 50
3 surplus at $4?
$4 20 Answer: 20 $4 40
2
$3 30 $3 30
$2 50 1
D $2 20
$1 80 $1 10
10 20 30 40 50 60 70 80 Q
104
 How much is the surplus if the price is $5?
Demand P Supply
S Schedule
Schedule $5
P Qd 4
P Qs
$5 10
3
What if the Answer:
price 40 $5 50
$4 20 $4 40
2 decreases to $2?
$3 30 $3 30
$2 50 1
D $2 20
$1 80 $1 10
10 20 30 40 50 60 70 80 Q
105
 At $2, there is disequilibrium. The quantity
demanded is greater than quantity supplied.
Demand P Supply
S Schedule
Schedule $5
P Qd 4
P Qs
$5 10 How much is the $5 50
3 shortage at $2?
$4 20 Answer: 30 $4 40
2
$3 30 $3 30
Shortage
$2 50 1 (Qd>Qs) D $2 20
$1 80 $1 10
10 20 30 40 50 60 70 80 Q
106
How much is the shortage if the price is $1?
Demand P Supply
S Schedule
Schedule $5
P Qd 4
P Qs
$5 10 Answer: 70 $5 50
3
$4 20 $4 40
2
$3 30 $3 30
$2 50 1
D $2 20
$1 80 $1 10
10 20 30 40 50 60 70 80 Q
107
The FREE MARKET system automatically pushes the
price toward equilibrium.
Demand P Supply
S Schedule
Schedule $5
When there is a
P Qd 4
surplus, producers P Qs
lower prices
$5 10 $5 50
3 When there is a
$4 20 shortage, producers $4 40
2 raise prices
$3 30 $3 30
$2 50 1
D $2 20
$1 80 $1 10
10 20 30 40 50 60 70 80 Q
108
2008 Audit Exam
 Supply and Demand Analysis
Easy as 1, 2, 3
1. Before the change:
• Draw supply and demand
• Label original equilibrium price and quantity
2. The change:
• Did it affect supply or demand first?
• Which determinant caused the shift?
• Draw increase or decrease
3. After change:
• Label new equilibrium?
• What happens to Price? (increase or decrease)
• What happens to Quantity? (increase or decrease)
Let’s Practice! 110
 S&D Analysis Practice
1. Before Change (Draw equilibrium)
2. The Change (S or D, Identify Shifter)
3. After Change (Price and Quantity After)
Analyze Hamburgers
1. New grilling technology cuts production time in half
2. Price of chicken sandwiches (a substitute) increases
3. Price of hamburgers falls from $3 to $1.
4. Price for ground beef triples
5. Human fingers found in multiple burger restaurants

111
1. New grilling technology cuts production
time in half
Price
S
S1

Pe P decrease
Q increase
P1
D
Qe Q1 Quantity
112 112
2. Price of chicken sandwiches (a
substitute) increases
Price
S

P1 P increase
Pe Q increase

D1
D
Qe Q1 Quantity
113
3. Price of hamburgers falls from $3 to $1.

Price
S

Shortage
Pe Qd increase
Qs decrease
P1
D
Qs Qe Qd Quantity
114
4. Price for ground beef triples

Price
S1 S

P1
Pe P increase
Q decrease

D
Q1 Qe Quantity
115
5. Human fingers found in multiple burger
restaurants
Price
S

P decrease
Pe Q decrease
P1
D1 D
Q1 Qe Quantity
116
Double Shifts
• Suppose the demand for milk increased at
the same time as production technology
improved.
• Use S&D Analysis to show what will
happen to PRICE and QUANTITY.
Double Shift Rule:
If TWO curves shift at the same
time, EITHER price or quantity
will be indeterminate (ambiguous). 117
Demand increases AND supply increases
Price
S
S1

P1 Pe

D1
D
P indeterminate Qe Q1 Quantity
Q increase 118
 Trick: Draw it out
separately and
combine the results

P indeterminate
Q increase

119
 What if supply
increases and
demand falls?

P decrease
Q indeterminate

120
 What if supply
decreases and
demand falls?

P indeterminate
Q decrease

121