Inside This Unit: The Full Breakdown
This unit covers supply, demand, and market equilibrium — the central model of microeconomics. Students learn how prices are determined in competitive markets, how changes in conditions shift supply and demand, and how government interventions affect market outcomes.
Why it matters
Supply and demand is the most-used framework on the entire AP Micro exam. You will draw, shift, and interpret supply and demand diagrams on virtually every free-response question. Mastering this model is non-negotiable.
Key concepts
- Demand shows the quantity buyers are willing and able to purchase at each price, determined by income, tastes, prices of related goods, expectations, and number of buyers.
- Supply shows the quantity sellers are willing and able to offer at each price, determined by input costs, technology, expectations, taxes/subsidies, and number of sellers.
- Equilibrium occurs where supply and demand intersect — the price at which quantity supplied equals quantity demanded.
- Price controls (ceilings and floors) and taxes create surpluses, shortages, or deadweight loss by preventing the market from reaching equilibrium.
Demand and Its Determinants
The law of demand states that quantity demanded falls as price rises, holding other factors constant. This relationship creates a downward-sloping demand curve. Changes in price cause movement along the curve, while changes in other determinants — income, tastes, prices of substitutes and complements, expectations, and number of buyers — shift the entire curve. Elasticity measures how responsive quantity demanded is to price changes: elastic demand means quantity changes proportionally more than price, while inelastic demand means quantity is relatively unresponsive. Understanding elasticity is crucial for predicting the effects of policy changes.
Supply and Market Equilibrium
The law of supply states that quantity supplied rises as price rises, creating an upward-sloping supply curve. Supply determinants include input costs, technology, number of sellers, expectations, and government policies. Equilibrium is the price where quantity demanded equals quantity supplied — there is no tendency for the price to change. When demand or supply shifts, the equilibrium price and quantity adjust. On the AP exam, you must be able to predict the direction of change in both price and quantity when one or both curves shift, and recognize when the effect on one variable is ambiguous.
Government Intervention
Price ceilings set a maximum legal price below the equilibrium, creating shortages (quantity demanded exceeds quantity supplied). Rent control is the classic example. Price floors set a minimum legal price above the equilibrium, creating surpluses (quantity supplied exceeds quantity demanded). The minimum wage is the most-tested example. Taxes and subsidies shift supply or demand, changing the equilibrium and creating deadweight loss — a reduction in total economic surplus. Tax incidence (who bears the burden) depends on the relative elasticities of supply and demand, not on who legally pays the tax. This is a heavily tested concept on the AP exam.
AP exam tip
When a free-response question asks about a tax, always identify: who legally pays, who economically bears the burden (based on elasticity), the new equilibrium price and quantity, and the deadweight loss. Show all of this on your diagram.
Connections to other units
- Unit 0: Supply and demand apply the marginal analysis framework to market interactions.
- Unit 2: Firm behavior in different market structures is analyzed using supply and demand as the competitive baseline.
- Unit 5: Government policies to correct market failures build on the intervention analysis from this unit.
