AP Microeconomics Exam Review

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197 Terms

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Economics

The study of how people, firms, and societies use their scarce productive resources to best satisfy their unlimited wants

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Factors of Production

Labor, Land, Capital, Entrepreneurial ability

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Physical capital

Manmade equipment like machinery, but also buildings, roads, vehicles, and computers

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Entrepreneurial Ability

The effort and know how to put the other resources (Factors of Production) together in a productive venture

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Scarcity

The difference between unlimited wants and limited economic resources

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Trade-offs

The fact that we are faced with scarce resources implies that individuals, firms, and governments are constantly faced with trade-offs

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Opportunity Cost

The opportunity cost of doing something is what you sacrifice to do it (i.e. if you use a scarce resource to pursue activity X, the opportunity cost of activity X is activity Y, the next best use of that resource)

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Marginal Analysis

Rational individuals and firms weigh the additional benefits against the additional costs (They think at the margin)

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Marginal

"the next one" or "additional" or "incremental"

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Marginal Cost

The additional cost incurred from the consumption of the next unit of a good or service

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Marginal Benefit

The additional benefit received from the consumption of the next unit of a good or service

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Production Possibilities Curve

A model of an individual or a nation that can choose to allocate its scarce resources between the production of two goods or services, it is assumed that those resources are being fully employed and used efficiently

<p>A model of an individual or a nation that can choose to allocate its scarce resources between the production of two goods or services, it is assumed that those resources are being fully employed and used efficiently</p>
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Points outside of the Production Possibilities Curve

Any point outside the frontier is currently unattainable

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The slope of the PPF

The slope of the curve measures the opportunity cost of the good on the x axis

The inverse of the slope measures the opportunity cost of the good on the y axis

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Shape of a realistic PPF

Concave or bowed outward

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Comparative Advantage

The ability to produce goods at a lower opportunity cost that another individual/firm/nation

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Specialization

Individuals/firms/nations produce the goods in which they have a comparative advantage

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Productive efficiency

The economy is producing the maximum output for a given level of technology and resources (all points on the PPF are productively efficient)

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Allocative efficiency

The economy is producing the optimal mix of goods and services (the combination of goods and services that provides the most net benefit to society; the best point on the PPF)

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Substitution effect

The change in quantity demanded resulting from a change in the price of one good relative to the price of other goods

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Income effect

The change in quantity demanded resulting from a change in the consumer purchasing power (real income)

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Determinants of Demand

-Consumer income

-The price of a substitute good

-The price of a complimentary good

-Consumer tastes and preferences for the good

-Consumer expectations about the future price of the good

-The number of buyers in the market for that specific good

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Normal Good

A good for which higher income increases demand

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Inferior Good

A good for which higher income decreases demand

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Substitute Goods

Two goods are substitute goods if the consumer can use either to satisfy the same essential function, therefore experiencing the same degree of happiness (utility)

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Price of Complementary Goods

If any two goods are compliments and the price of one good X falls (rises), the consumer demand for the complement good Y increases (decreases)

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Determinants of Supply

-The cost of an input

-Technology and productivity

-Taxes and subsidies on a good

-Producer expectations about future prices

-The price of other goods that could be produced

-The number of producers in the industry

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Taxes and Subsidies

A per unit tax is treated by firms as an additional cost of production and would therefore decrease the supply cure, or shift it leftward

A per unit subsidy lowers the per unit cost of production and therefore shifts the supply curve rightward

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Market Equilibrium

The market is in this state when the quantity supplied equals the quantity demanded at a given price

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Shortage

this exists at a market price when the quantity demanded exceeds the quantity supplied, can be the result of a price ceiling

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Surplus

this exists at a market price when the quantity supplied exceeds the quantity demanded, this can be the result of a price floor(such as setting a minimum wage)

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Simultaneous Changes in Demand and Supply

When both demand and supply are changing, one of the equilibrium outcomes (price or quantity) is predictable and one is indeterminant

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Consumer Surplus

The difference between your willingness to pay and the price you actually pay

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Producer Surplus

The difference between the price received and the marginal cost of producing the good

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Consumer Surplus on the Graph

The area under the demand curve and above the market price is equal to total consumer surplus

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Producer Surplus on the Graph

The area above the supply curve and below the market price is equal to total producer surplus

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Elasticity

Measures the sensitivity, or responsiveness, of a choice to a change in an external factor

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Price Elasticity of Demand

Measures the sensitivity of consumer quantity demanded for good X when the price of good X changes

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Price Elasticity Formula

Ed= (%change in quantity demanded of good X)/(%change in the price of good X)

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A good is price elastic if...

If Ed > 1

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A good is unit price elastic if...

If Ed = 1

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A good is price inelastic if...

If Ed < 1

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Elasticity on the Demand Curve

Above the midpoint demand is price elastic

At the midpoint demand is unit elastic

Below the midpoint the demand is price inelastic

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Delta Percentage

Delta Percentage = [final cost - initial cost]/initial cost

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Perfectly Inelastic

Any increase in the price results in no decrease in the quantity demanded

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Perfectly Elastic

A decrease in the price causes the quantity demanded to increase without limits

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As the demand curve becomes more vertical

The price elasticity falls and consumers become more price inelastic

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As the demand curve becomes more horizontal

The price elasticity increases and consumers become more price elastic

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Determinants of Elasticity

-Number of Good Substitutes

-Proportion of Income

-Time

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Number of Good Substitutes

If the price of good X increase, and many (few) substitutes exist, the decrease in quantity demanded can be quite elastic (inelastic)

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Proportion of Income

If the price of a good increases, the consumer loses purchasing power. If that good takes up a large (small) portion of the consumers income his responsiveness will be significant (insignificant), or elastic (inelastic)

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Time

it is expected that price elasticity increases (decreases) as more (less) time passes after the initial increase in price

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Total Revenue

TR = Price * Quantity Demanded

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Total Revenue and Elasticity

If demand is inelastic TR increases with a price increase

If demand is elastic TR decreases with a price increases

If demand is unit elastic TR stays the same

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Income Elasticity

A measure of how sensitive consumption of good X is to a change in a consumer's income

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Income Elasticity Formula

Ei = (%change Qd good X) / (%change income)

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Luxury vs. Necessity vs. Inferior goods

If Ei > 1, the good is normal and income elastic (luxury)

If 1 > Ei > 0, the good is normal but income inelastic (a necessity)

If Ei < 0, the good is inferior

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Cross-Price Elasticity of Demand

The sensitivity of consumption of good X to a change in the price of good Y

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Cross-Price Elasticity of Demand Formula

Ex,y = (%change Qd good X) / (%change Price good Y)

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Compliments vs. Substitutes

A cross-price elasticity of demand less than zero identifies a complementary good

A cross-price elasticity of demand greater than zero identifies a substitute good

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Price Elasticity of Supply

Measures the sensitivity of quantity supplied for good X when the price of good X changes

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Price Elasticity of Supply Formula

Es = (%change in quantity supplied of good X) / (%change in the price of good X)

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Price Elasticity of Supply over time

Because suppliers, once the price of a good has changed, usually cannot quickly change the quantity supplied, economists predict that the price elasticity of supply increase as time passes

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Excise Taxes

A per-unit tax on production results in a vertical shift in the supply curve by the amount of the tax

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Incidence of Tax

The proportion of the tax paid by consumers in the form of a higher price for the taxed good is greater if demand for the good is inelastic and supply is elastic

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Dead weight loss

The lost net benefit to society caused by a movement away from the competitive market equilibrium. Policies like excise taxes create lost welfare to society

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Deadweight loss and Elasticity

Deadweight loss increases as the demand or supply curves become more elastic

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Subsidies

Has the opposite effect of an excise tax, as it lowers the marginal cost of production, resulting in a downward vertical shift in the supply curve for good X

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Price Floors

A legal minimum price below which the product cannot be sold. If a floor is installed at some level above the equilibrium, it creates a permanent surplus

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Price Ceilings

A legal maximum price above which the product cannot be sold. If a ceiling is installed at a level below the equilibrium price, it creates a permanent shortage

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Utility

Happiness, benefit, satisfaction, or enjoyment gained from consumption

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Total Utility

The total amount of happiness received from the consumption od a certain amount of a good

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Marginal Utility

The additional utility received (or sometimes lost) from the consumption of the next unit of a good

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Marginal Utility Formula

Mu = (%change Total Utility) / (%change Quantity)

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Utils

A unit of measurement often used to quantify utility

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Utility and Rational Decisions

Even if the monetary price of good X is zero, the rational consumer stops consuming good X at the pint where total utility is maximized

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Law of Diminishing Marginal Utility

States that in a given time period, the marginal utility from consumption of one more of that item falls

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Constrained Utility Maximization

For a one-good case. Constrained by prices and income, a consumer stops consuming a good when the price paid for the next unit is equal to the marginal benefit received

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Utility Maximizing Rule

The consumer maximizes utility when they choose amounts of goods X and Y, with their limited income, so that the marginal utility per dollar spent is equal for both goods

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Utility Maximizing Rule Formula

MUx/Px = MUy/Py or MUx/MUy = Px/Py

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Deriving the Demand Curve from Utility

Utility maximizing behavior of individuals creates individual demand curves

Summing the quantity demanded by individuals at each price creates market demand curves

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Firm

An organization that employs factors of production to produce a good or service that it hopes to profitably sell

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Explicit Costs

direct, purchased, out-of-pocket costs paid to resource suppliers outside the firm (Also called accounting costs)

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Implicit Costs

Indirect, non purchased, or opportunity costs of resources provided by the entrepreneur (Also called economic costs)

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Accounting Profits

The difference between total revenue and total explicit costs

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Economic Profits

The difference between total revenue and total explicit and implicit costs

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Short-run

A period of time too short to change the size of the plant, but many other, more variable resources can be adjusted to meet demand

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Long-run

A period of time long enough to alter the plant size. New firms can enter the industry and existing firms can liquidate and exit

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Characteristics of Firms in the Short-run

Plant size: Fixed

Fixed Cost: Some

Variable Costs: Some

Entry/Exit of Firms: None

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Characteristics of Firms in the Long-run

Plant size: Variable

Fixed Cost: None

Variable Costs: All

Entry/Exit of Firms: Yes

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Production Function

The mechanism for combining production resources, with existing technology, into finished goods and services, Inputs are turned into outputs

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Fixed Inputs

Production inputs cannot be changed in the short run. Usually this is the plant size or capital

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Variable Inputs

Production inputs that the firm can adjust in the short run to meet changes in demand for their output. Often this is labor and/or raw materials

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Total Product (of Labor)

The total quantity, or total output, of a good produced at each quantity of labor employed

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Marginal Product (of Labor)

The change in the total product resulting from a change in the labor input. MP = change in TP / change in Labor. If labor is changing one unit at a time, MP = change in TP

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Average Product (of Labor)

Total product divided by the amount of labor employed. AP = TP / L

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Law of Diminishing Returns

As successive units of a variable resource are added to a fixed resource, beyond some point marginal product falls

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Increasing Marginal Returns

MP is increasing as Labor increases

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Diminishing Marginal Returns

MP decreases as Labor increases

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Negative Marginal Returns

MP becomes negative as Labor increases