AP Microeconomics Study Guide

Economics

Study of scarcity and choice

Trade-offs

When one gives up something in order to have something else

Individual Choice

Decisions by individuals about what to do and what not to do

Resource

Anything that can be used to produce something else

Factors of Production

Another phrase for resource: 4 categories are land, labor, capital and entrepeneurship

Land

All resources that come from nature, including plants, water and minerals

Labor

Effort of workesr

Capital

Manufactured goods used to make other goods and services, such as machinery, buildings and tools)

Entrepeneurship

Risk taking, innovation, and the organization of resources for production

Scarcity

When there is not enough of a resource available to satisfy all the various ways a society wants to use it

Marginal Analysis

The study of the costs and benefits of doing a little more of an activity versus a little less

Marginal Benefit

The gain from doing something once more (one extra point for every extra day a student studies)

Marginal Cost

The cost of doing something one more time (going to the beach instead of studying would be giving up that one-point increase)

Opportunity Cost

Value of the next best alternative that you must give up when you make a particular choice

Real Cost

What you must give up to get a certain thing

Microeconomics

The study of how individuals, households, and firms make decisions and how those decisions interact

Household

Person or group of people who share their income

Firm

Any organization that produces goods or services for sale

Macroeconomics

Behavior of how the economy as a whole - focuses on economic aggregates

Positive Economics

The branch of economic analysis that describes the way the economy actually works

Normative Economics

Makes prescriptions about the way the economy should work

Economy

System for coordinating a society’s productive and consumption activities

3 Questions For Each Economy

What goods and services will be produced?

How will those goods and services be produced?

Who will receive the goods and services?

Traditional Economy

Production and consumption decisions are based on the precedent

Amish community

Ease familiarity, and predictably lead to elements of tradition in every economy

Market Economy

Resources are privately owned and decisions of individual producers and consumers largely determine what, how and for whom to produce

No central authority telling people what to produce or who can receive it

Also referred to as capitalist or free enterprise

Command Economy

Resources are publicly owned and a central authority makes production and consumption decisions

Command economies have been tried, but they did not work very well (Soviet Union between 1917-1991 couldn’t meet production targets bc of inadequate supplies)

Mixed Economy

Combines ideas of traditional, command and market economies

Most countries today have a mixed economy

Incentives

Rewards or punishments that motivate particular choices

Market Economy Incentives

Incentives such as the profit motive, encourage suppliers to meet the needs of consumers, such as increasing the supply during a shortage

Command Economy Incentives

Little incentive to meet the economic needs of producers and consumers

Property Rights

Establish ownership and grant individuals the right to trade goods and services with each other

Production Possibilities Curve (PPC)

Model that helps economists think about the trade-offs necessary in every economy (but for only 2 goods)

Model

Simplified representation used to better understand a real-life situation

Other Things Equal Assumption

Phrase that means all other relevant factors remain unchanged

Efficient

If there is no way to make anyone better off without making at least one person worse off 

Productive Efficiency

If it produces on any point on its PPC

Allocative Efficiency

If it produces at the point along its PPC that makes consumers as well off as possible

Economic Growth

An increase in the max amount of goods and services an economy can produce

Technology

The technical means for producing goods and services

Shrinking Economy

Can occur if there are natural disasters or from war

PPC will move inwards

Alexander Selkirk (1704)

Crew member on a ship that abandoned ship and was deserted on an island

Ideas of trade-offs introduced the idea of PPC (one that focuses on 2 goods)

Trade

Process where an individual provides goods/services and receives different goods/services in return

Specialization

The gains from trade come from specialization

Each person specializes in the task that they are good at performing, which allows for the mass production of most of the devices and appliances we use today

Comparative Advantage

When a person’s opportunity cost is the lowest among the people who could produce that good or service

Absolute Advantage

When a person produces more of a good or service within a certain time frame

Terms of Trade

The rate at which one good can be exchanged for another

Specializing & Comparative Advantage Relationship

By specializing in the good they have a comparative advantage in and by trading for the other good, both groups can consume more of each good (gains from trading)

Rational Agents

Consumers, producers, and others who behave rationally and make optimal decisions

Utility

Measure of personal satisfaction

Util

Numerical measure of satisfaction, but the numbers are used to highlight the concept that when making purchases, a higher number is better.

Cost-Benefit Analysis

The process of comparing costs with benefits to inform a decision

Explicit Costs

Paid with dollars

Money spent on one purchase can’t be spent on something else

Implicit Costs

Paid with time and missed opportunities

Time spent on one activity can’t be spent on another activity

Profit

Difference between the total amount of money received in exchange for the goods and services total cost

Total Revenue

The price of the product multiplied by the quantity sold

Accounting Profit

Total Revenue - Explicit Costs

Economic Profit

Total Revenue - Explicit Costs - Implicit Costs

Sunk Cost

Cost that has already been incurred and is nonrecoverable

Should be ignored in a decision about future actions

Utility Function

Shows the relationship between a consumer’s utility and the combination of goods and services

Consumption Bundle

Combination of goods and services

Marginal Utility

Change in total utility generated by consuming one additional unit of a good or service

Marginal Utility Curve

Shows how marginal utility depends on the quantity of a good or service consumed

Principle of Diminishing Marginal Utility

Each successive unit of a good or service consumed adds less to the total utility than does the previous unit

Budget Constraint

Limits the cost of a consumer’s consumption bundle to no more than the consumer’s income

Budget Line

Shows the consumption bundles available to a consumer who spends all of their income

Optimal Consumption Bundle

Consumption bundle that maximizes the consumer’s total utility given their budget constraint

Optimal Consumption Rule

In order to maximize utility, a consumer must equate the marginal utility per dollar spent on each good and service in the consumption bundle

Market

A group of producers and consumers who exchange a good or service for payment

Perfectly Competitive Market

Assumes that there are many buyers and sellers in the market so that no one seller can influence the price of the product

Supply and Demand Model

A model of how a perfectly competitive market works

6 Components of S&D Model

Demand Curve

Set of factors that shift demand curve

Supply Curve

Set of factors that shift supply curve

Market Equilibrium (includes equilibrium price and equilibrium quantity)

The way the market equilibrium changes when the supply or demand curve changes

Demand Schedule

Table that displays the quantity demanded at different prices for a good or service

Quantity Demanded

Actual amount of a good or service consumers are willing and able to buy at some specific price

Demand Curve

Graphical representation of the demand schedule

Shows relationship between quantity and price

Law of Demand

All other things being equal, people demand less of a good or service at higher prices

Change in Demand

Shift of the demand curve, which changes the quantity demanded at any given price

Movement Along Demand Curve

Change in the quantity demanded of a good that is the result of a change in that good’s price

Increase in Demand

Demand Curve shifts to right

Decrease in Demand

Demand Curve shifts to left

Market Demand Curve

The horizontal sum of the individual demand curves of all consumers in that market

5 Factors for Demand Curve Shift

Tastes, Related Goods, Income, Buyers, Expectations

Change in Taste

Fads, changes in beliefs, or changes in culture that shift the demand curve for a good or service

Change in Prices of Related Goods or Services

Changes in prices of a related good or service shift demand differently depending on whether they are substitutes or complements

Substitute Good (Demand)

Two goods are considered substitutes if a rise in the price of one of the goods leads to an increase in the demand for the other good (sweatpants instead of jeans)

Complement Good (Demand)

Two goods are complements if a rise in the price of one of the goods leads to a decrease in the demand for the other good (peanut butter so also jelly)

Change in Income

Changes in income can shift demand for a good differently, depending on whether it is a normal or inferior good

Normal Good

When a rise in income increases the demand for a good

Inferior Good

When a rise in income decreases the demand for a good

Change in Buyers

Changes in the number of buyers or consumers can shift the demand curve

Left for decreased buyers

Right for increased buyers

Change in Expectations

Changes in expectations of how prices will change in the future can shift the demand curve

Expectations of a coming fall in price can cause a decrease in demand today (and vice versa)

Quantity Supplied

The actual amount of a good or service people are willing to sell at a specific price

Supply Schedule

Shows how much of a good or service producers will supply at different prices

Supply Curve

Graphical representation between the quantity supplied and the price

Law of Supply

Other things being equal, the price and quantity supplied of a good are positively related

Change in Supply

Shift of the supply curve, which indicates a change in the quantity supplied at any given price

A decrease in supply means a leftward shift of the supply curve

An increase in supply means a rightward shift of the supply curve

Movement Along Supply Curve

Change in the quantity supplied of a good arising from a change in the good’s price

Changes in Input Prices

Change in the price of an input, a good or service used to produce another good or service

Sugar and cream are inputs for ice cream. If the price of sugar or cream rises, the ice cream supply curve shifts left

Oil is one input for airline fuel. If the price of oil goes down, the supply curve for flights shifts right.

Input

Good or service that is used to produce another good or service

Change in Price of Related Goods Or Services

A change in the price of a related good or service (substitutes or complements in production by the same producer)

Substitute Goods (Supply)

Goods are substitutes if an increase in the price of one causes suppliers to supply less of the other

If the price of heating oil rises, refiners supply less gasoline, shifting the supply curve for gasoline to the left.