Equilibrium a situation in which the market price has reached the level at which quantity supplied equals

quantity demanded.

Equilibrium price the price that balances quantity supplied and quantity demanded.

Equilibrium quantity the quantity supplied and the quantity demanded at the equilibrium price.

Surplus a situation in which quantity supplied is greater than quantity demanded.

Shortage a situation in which quantity demanded is greater than quantity supplied.

Law of supply and demand the claim that the price of any good adjusts to bring the quantity supplied
and the quantity demanded for that good into balance.

Three Steps for Analyzing Changes in Equilibrium

1. Decide whether the event shifts the supply or demand curve (or perhaps both).

2. Decide in which direction the curve shifts.

3. Use the supply-and demand diagram to see how the shift changes the equilibrium price and quantity.
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Elasticity a measure of the responsiveness of quantity demanded or quantity supplied to one of its
determinants

Price elasticity of demand a measure of how much the quantity demanded of a good responds to a
change in the price of that good, computed as the percentage change in quantity demanded divided by
the percentage change in price.

THE PRICE ELASTICITY OF DEMAND AND ITS DETERMINANTS:

 Availability of Close Substitutes

 Necessities versus Luxuries
 Definition of the Market
  Time Horizon

COMPUTING THE PRICE ELASTICITY OF DEMAND

Price elasticity of demand = Percentage change in quantity demanded/Percentage change in price

Price elasticity of demand = 20 percent/10 percent = 2

THE MIDPOINT METHOD: A BETTER WAY TO CALCULATE PERCENTAGE CHANGES AND ELASTICITIES
Total revenue the amount paid by buyers and received by sellers of a good, computed as the price of the
good times the quantity sold.
• When demand is inelastic (a price elasticity less than 1), price and total revenue move in the same
direction.

• When demand is elastic (a price elasticity greater than 1), price and total revenue move in opposite
directions.

• If demand is unit elastic (a price elasticity exactly equal to 1), total revenue remains constant when the
price changes.
Income elasticity of demand a measure of how much the quantity demanded of a good responds to a
change in consumers’ income, computed as the percentage change in quantity demanded divided by the
percentage change in income.

Higher income raises the quantity demanded. Because quantity demanded and income move in the
same direction, normal goods have positive income elasticities. A few goods, such as bus rides, are
inferior goods: Higher income lowers the quantity demanded. Because quantity demanded and income
move in opposite directions, inferior goods have negative income elasticities.

Cross-price elasticity of demand a measure of how much the quantity demanded of one good responds
to a change in the price of another good, computed as the percentage change in quantity demanded of
the first good divided by the percentage change in the price of the second good.
An increase in hot dog prices induces people to grill hamburgers instead. Because the price of hot dogs
and the quantity of hamburgers demanded move in the same direction, the cross-price elasticity is
positive. Conversely, complements are goods that are typically used together, such as computers and
software. In this case, the cross-price elasticity is negative, indicating that an increase in the price of
computers reduces the quantity of software demanded.

Price elasticity of supply a measure of how much the quantity supplied of a good responds to a change
in the price of that good, computed as the percentage change in quantity supplied divided by the
percentage change in price.

COMPUTING THE PRICE ELASTICITY OF SUPPLY.

THE VARIETY OF SUPPLY CURVES:
Government Policies.

Price ceiling a legal maximum on the price at which a good can be sold.

Price floor a legal minimum on the price at which a good can be sold