User:Papasmurf0810/AP Macroeconomics Test

Chapter 2
Chapter 2: Demand, Supply, Market Equilibrium, and Welfare Analysis consists of the following topics:
 * Demand
 * Supply
 * Market Equilibrium
 * Welfare Analysis

Demand
The law of demand is described as: "holding all else equal, when the price of a good rises, consumers decrease their quantity demanded for that good." There is an inverse relationship between the price and quantity demanded of the good. If a consumer becomes more willing, or able, to consume a good, then either the price has fallen or an external factor has changed.

Only relative prices matter: while the price of a cup of coffee many years ago could have been $0.05, today you might get the same cup for $1.75. These prices are simply money prices (a.k.a. absolute, or nominal, prices); when it comes to a demand decision, a money price alone is useless. If you think about the money price in terms of what other goods $1.75 could buy, or how much of your income is absorbed by $1.75, then you're talking relative prices (a.k.a. real prices). The number of units of any other good Y that must be sacrificed to acquire the first good X, measures the relative price of good X.

For example, if you divide your $10 daily income between apple fritters at today's price of $1 each and chocolate chip bagels at $2 each, these are the money prices of your labor and the snacks. The relative cost of a fritter is one-half of a bagel, and it amounts to one-tenth of your income. Tomorrow, when the price doubles to $2 per fritter, two things happen. The relative price has risen to one bagel, and the relative price of a bagel has fallen from two fritters to one fritter; fritters are now relatively more expensive, and we would expect the consumption of more bagels and fewer fritters. This is known as the substitution effect. Also, relative to your income, the price of a fritter has increased from one-tenth to one-fifth. This lost purchasing power is known as the income effect. (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 quantity demanded resulting from a change in the consumer's purchasing power, or real income.)

A table summarizing the daily consumption of goods at several prices, holding constant all other factors that might influence overall demand, is referred to as a demand schedule. In a demand schedule, the quantity demanded should, according to the law of demand, fall as the price increases. It is often useful to convert a demand schedule into a graphical representation (a demand curve). The law of demand predicts a negative sloping demand curve.