Demand & Supply Equilibrium

Demand & Supply Equilibrium

Modigliani

Kezia from Colorado asks me to take a shot at explaining just what the AP exam is looking for when it comes to Equilibrium.

Demand and Supply equilibrium, is with given shifts in demand and supply we can then tell what has happened to the price and quantity of a specific good.

First what we know:

Demand Decreases or Increases - What happens to the price and quantity?

When the demand shifts left (decreases) then the Price & Quantity decreases.

When demand shifts right (increases) then Price & Quantity increases.

Ok so far?

Supply Increases or Decreases   - What happens to price and quantity?

When the supply shifts right (increases) then the Price decreases & Quantity increases.

When supply shifts left (decreases) then Price increases & Quantity decreases.

Demand Increases and then Supply Increases, not once , not twice, but three times.

(Work with me, I'm trying to make a point)

Demand & Supply curve are originally in equilibrium at Point E1

The original Equilibrium point is at (E1)

Price is at PE1 

Quantity is at QE1

Demand Increases to D2

Demand Shifts Right (increases) 

Find the new equilibrium point (E2)

Price has increased to PE2 and Quantity has increased to QE2.

at this point we can say for certain that

Price has increased

Quantity has increased

 But, now Supply Increases (shifts right) to S2

Supply Shifts Right (increases) to S2

Find the new equilibrium point (E3)

Price decreases to PE3

Quantity Increases to QE3

Price originally increased to PE2 

but now decreases to PE3, so price is (Uncertain)

Quantity has definitely increased to QE3

and finally, Supply Increases again to S3

Supply Shifts right (increases) to S3

New equilibrium point is at E4

Price decreases to PE4

Quantity Increases to QE4

Price is Uncertain 

Quantity Increased

From the Demand & Supply Cheat Sheet here

Understand that you can either memorise these demand and supply shifts (not suggested) as they will not change.

So, If Demand increases and supply increases, 

then Price will be uncertain and quantity will increase.

This happens no matter how you draw the curves, close or far apart.

I suggest drawing the graphs as you read the questions, then look for the equilibrium points.

How does the AP exam test these questions.

1995 AP Exam

Answer - E

2008 AP Exam

Answer - D

Government increases tax - supply decreases

People commute longer distances - demand for gas increases

Price Floors & Price Ceilings

Price Floors & Price Ceilings

Floors are High !

Say it again, Floors are High !

One more time, Floors are High !

A price floor is the lowest price that a supplier can charge for its good.

The price floor above is at $5, which mean that the $5 is the minimum price that the supplier can charge for its good. Governments often interfere in the market by passing laws that require producers (suppliers) to charge minimum prices. This price protects the suppliers in that no business can now charge less than the minimum price.

If a business decides to sell its good for less than the $5, the business owner might be fined or sent to jail.

Jacob Meged was a tailor of Polish descent who had a tailor shop at 138 Griffiths Street in Jersey City. He had a wife and four children and he needed money to feed his family.  Other tailors were charging 40 cents, but he wanted to get more business, so he put a sign in his shop window advertising that he would press suits for 35 cents. After all, this was America where you were accustomed to being free to charge what you want.  Beating the competition and being entrepreneurial was the American way, and he would be happy to press suits for 35 cents.  Unfortunately, Jacob didn’t get more business and instead, he was arrested.J. Raymon Tiffany, Special Assistant Attorney General in charge of enforcing NRA codes in New Jersey took responsibility for prosecuting the tailor. When Jacob Meged was read the charges, he told Judge Kinkead that he was only vaguely aware of the existence of a code, but he pled guilty to the charge that he had violated the New Jersey State Recovery Act.  Mr. Tiffany asked the court to impose a sentence stiff enough to warn other code violators that the law had teeth in it.

On Friday, April 20, 1934, Judge Robert V. Kinkead sentenced Jacob Meged to 30 days in the county jail, and he was ordered to pay a $100 fine.   At 40 cents a suit, Meged would have to press 250 suits to cover his fine.  That would be $100 he couldn’t use to feed his family, and in addition to this, he would lose a month’s earnings.

As The New York Times put it, “He believed that the codes were designed to help the ‘little fellow’ and could not believe that by charging 35 cents instead of 40 cents to press a suit would put him behind bars. In court yesterday he stood as if in a trance when sentence was pronounced.  He hoped that it was a joke.”

A price floor below the equilibrium point (market clearing price) is NOT  an effective or binding price floor.

Understand:

If the minimum price (price floor) is set below the equilibrium market clearing point it will have no effect as the market has already cleared.

Jung Sub: I don't get it.

Mr. Waugh: Picture this,, at the $3 price Jung Sub buys all the jars of pinto beans that I'm selling.

I'm happy and Jung Sub is happy. The market has cleared.

Then a government employee walks in the room and says that we can't sell beans for less than $1 per jar. The $1 minimum required price had no effect on the market (IT WASN'T EFFECTIVE), IT MADE NO DIFFERENCE.

PPC Cheat Sheet

PPC Cheat Sheet

2017 AP Macroeconomics FRQ #3

2017 AP Macroeconomics FRQ #3

(A) Draw a CLG of the PPC, with consumer goods on the horizontal axis and capital goods on the vertical axis. Indicate a point on your graph, labeled X, that represents full employment and a possible combination of goods produced.

PPC Cheat Sheet here.

Answer

(B) Assume that there is an increase in the country's national savings. Draw a CLG of the loanable funds market, showing the change in the real interest rate from the increase in savings.

Fiscal Policy Cheat Sheet here.

Understand that if savings is increasing then the supply of loanable funds is increasing.

If the supply of loanable funds is increasing then the RIR, real interest rate is falling.

Answer

(C) On the same graph in part (A), show another point, labeled Z, that represents full employed and a new combination of consumer goods and capital goods consistent with the increase in the nations increased savings.

Higher rate of savings implies a higher rate of capital investment which will lead to more future growth.

Answer

(D)Referring to your answer in part (C), will the long run aggregate supply curve shift right, left or remain the same.

The LRAS will increase in the long-run as savings increase, consumption and investment will increase. Investment will increase in capital goods and therefore future growth can be expected with a shifting rightward of the LRAS curve.

Answer

2017 AP Macroeconomics FRQ #2

2017 AP Macroeconomics FRQ #2

Watch me answer it here

https://youtu.be/tFNOUMUVzcM

(A) Draw a CLG of the money market and show the effect of the reduced holdings of money on the equilibrium nominal interest rate in the short-run.

Money Market = Monetary Policy

Reduced holdings of money = Demand for Money decreases

From the Monetary Policy cheat sheet here

Demand for Money falls, the Nominal Interest Rate (NIR) falls
The opportunity cost of holding cash has fallen.

Answer

(B) Based on the changes in the interest rate in part (A), what will happen to each of the following in the short-run?

(i) Prices of previously issued Bonds. ((Bond Prices will Increase)

MR. Waugh - If interest rates are falling then we must assume that the interest rates of previous bonds must be higher.

Jung Sub - What does that mean, Mr. Waugh?

Mr. Waugh - Well Jung Sub, each bond has an amount of interest that it pays to the owner of the bond every year. It could pay 5% of the face value to the owner every year. Bond holders are rational people. If the banks are only paying 1% to borrow your money a bond holder would be making a profit by having a bond paying 5%.

So, if the nominal interest rate falls to 1%, then the price of a bond paying 5% will increase as it is now a better value than bonds created and sold today with a yield rate of 1%.

Is that clear Jung Sub?

Jung Sub -  Not really Mr. Waugh, but I think we should move on.

Jung Sub's face when I start talking about Bonds.

(ii) The price level and real income.

Cause and effect - If the nominal interest rate falls then consumption increases which drives up AD and therefore the PL and causes the RGDP to increase which implies that real income (Y) increases also.

Answer - PL and Y (incomes) increase

Answer

(C) With a constant money supply, based on your answer in part (B)(ii), will the velocity of money increase, decrease, remain unchanged or will it be indeterminate?

Velocity of money is the rate that money exchanges for goods and services. If incomes are increasing we would expect that the velocity of money would increase.

AD is increasing along with RGDP and (Y) incomes so people are spending money faster than before. Velocity has increased.

Answer

(D) If the FED (central bank) wishes to reverse the changes in the interest rate identified in part (A), what open market operation (OMO) would it use?

If interest rates are falling (part A), then the FED would sell bonds, reducing the money supply and increasing the Nominal Interest Rate.

Answer

2017 AP Macroeconomics FRQ #1

2017 AP Macroeconomics FRQ #1

watch me answer it here

https://youtu.be/RC5FnxOLyRU

(A) Using the numerical values above, draw a CLG of the short-run and long-run Phillips curves. Label the current short run  equilibrium as point B. Plot the numerical values above on the graph.

I find it's most beneficial to draw AD/AS curve with Phillips curves.

Phillips Curve Cheat Sheet here.

Understand that a country with a higher unemployment 7% compared to 5%, and with a low inflation rate of 3% that the appropriate AD?AS curve would be a recessionary curve.

The Phillips curve is fairly simple, helps to know that 

a shift of the AD curve is a movement on the SRPC.

It also helps to know that the NRU or natural rate of unemployment is at full employment (equilibrium)

Answer

(B) Assume the government of X takes no policy action to reduce unemployment. In the long-run, will each of the following shift to the right, left or remain the same?

(i) Short-run aggregate supply curve. Explain.

In the long-run employees will accept lower wages, wages are a resource cost, lower wages will shift the SRAS curve rightward, prices will fall and therefore output will increase back to long-run equilibrium at a lower price level.

(ii) Long-run phillips curve

The long-run phillips curve is unaffected but the short-run phillips curve would shift leftward, inflation would decrease and unemployment would decrease back to the NRU, natural rate of unemployment.

Answer

(C) Identify a fiscal policy action that could be used to reduce the unemployment rate in the short-run.

In the short run the government could use an expansionary fiscal policy (tax lowered or more government spending), 

Fiscal Policy Cheat Sheet here.

Answer

(D) Draw a CLG of the AD/AS graph, showing the effects on equilibrium, PL and RGDP from an expansionary fiscal policy.

As the government spends, consumption increases pushing AD rightward, PL increases and RGDP increases along with (Y) real incomes.

Answer

(E) Based on the change in real GDP identified in part (D), will the supply of County X's currency in the FOREX, increase , decrease, or remain the same? Explain.

Look at the Y, real income above. It is increasing, if incomes are increasing and the PL is increasing then 

PL increases - foreigners buy less of our goods - exports fall

Y, real incomes increase - domestic consumers demand foreign goods - imports increase

AS imports increase, the supply of our currency increases in the FOREX.

Again, if we are importing goods, we must be dumping our currency into the FOREX to buy the foreign currency to pay the foreign producers of the imported goods we want to buy.

Simple, Yes.

Answer

(F) Based on (E) does our currency appreciate, depreciate, no change.

Understand that the valuation of our currency is calculated in relation to the demand/supply of our currency in the FOREX.

So if the supply of our currency increases in the FOREX, we can use a simple supply/demand graph to explain what is going on.

Our currency will depreciate as more and more of it is dumped into the FOREX market buying imported goods.

Answer