AP Microeconomics

Economics

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

Resources

Factors of production, 4 categories: labor, physical capital, land/natural resources, and entrepreneurial ability

Scarcity

The imbalance between limited productive resources and unlimited human wants

Opportunity Cost

The most desirable alternative given up as the result of a decision

Marginal Benefit (MB)

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

Marginal Cost (MC)

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

Marginal Analysis

The rational decision maker chooses an action if MB ≥ MC

Law of Increasing Costs

The more of a good that is produced, the greater the opportunity cost of producing the next unit of that good

Absolute Advantage

Exists if a producer can produce more of a good than all other producers

Comparative Advantage

Exists if a producer can produce a good at lower opportunity cost than all other producers

Specialization

When firms focus their resources on production of goods for which they have comparative advantage

Productive Efficiency

Production of maximum output for a given level of technology and resources. All points on the PPF are productively efficient

Allocative Efficiency

Production of the combination of goods and services that provides the most net benefit to society. The optimal quantity of a good is achieved when the MB = MC of the next unit and only occurs at one point on the PPF

Economic Growth

Occurs when an economy's production possibilities increase. This can be a result of more resources, better resources, or improvements in technology. Better off increasing capital goods instead of consumer goods.

Market Economy (Capitalism)

An economic system based upon the fundamentals of private property, freedom, self-interest, and prices

Law of Demand

Holding all else equal, when the price of a good rises, consumers decrease their quantity demanded for that good

Relative Prices

The number of units of any other good Y that must be sacrificed to acquire good X. Only relative prices matter

Substitution Effect

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

Income Effect

The change in quantity demanded that results from a change in the consumer's purchasing power (or real income)

Determinants of Demand

Consumer income, prices of substitute and complementary goods, consumer tastes and preferences, consumer speculation, and number of buyers in the market all influence demand

Normal Goods

A good for which higher income increases demand

Inferior Goods

A good for which higher income decreases demand

Substitute Goods

Two goods are consumer substitutes if they provide essentially the same utility to consumers

Complementary Goods

Two goods are consumer complements if they provide more utility when consumed together than when consumed separately

Law of Supply

Holding all else equal, when the price of a good rises, suppliers increase their quantity supplied for that good

Determinants of Supply

Costs of inputs, technology and productivity, taxes/subsidies, producer speculation, price of other goods that could be produced, and number of sellers all influence supply

Market Equilibrium

Exists at the point where the quantity supplied equals the quantity demanded

Shortage

Excess demand; a shortage exists at a market price when the quantity demanded exceeds the quantity supplied

Surplus

Excess supply; exists at a market price when the quantity supplied exceeds the quantity demanded.

Total Welfare

The sum of consumer surplus and producer surplus

Consumer surplus

The difference between your willingness to pay and the price you actually pay. It is the area below the demand curve and above the price

Producer surplus

The difference between the price received and the marginal cost of producing the good. It is the area above the supply curve and under the price

Price elasticity

Ed = (%dQd)/(%dP). Ignore negative sign

Price elastic demand

Ed > 1, meaning consumers are price sensitive

Price inelastic demand

Ed < 1

Unit elastic demand

Ed = 1

Perfectly inelastic

Ed = 0, no response to price change

Perfectly elastic

Ed = ∞, infinite change in demand to price change

Determinants of elasticity

Substitutes, cost as percentage of income, and time to adjust to price changes all influence price elasticity

Total Revenue

TR = P * Qd

Total Revenue Test

Total revenue rises with a price increase if demand is price inelastic and falls with a price increase if demand is price elastic

Income Elasticity

Ei = (%dQd good X)/(%d Income)

Cross-Price Elasticity of Demand

Ex,y = (%dQd good X) / (%d Price Y). If Ex,y > 0, goods X and Y are substitutes. If Ex,y < 0, goods X and Y are complementary

Price Elasticity of Supply

Es = (%dQs) / (%dPrice)

Excise Tax

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

Incidence of Tax

The proportion of the tax paid by the consumers and producers. Hint, whichever curve is more inelastic, that party will pay a higher portion of the tax.

Dead Weight Loss

The loss of transactions that should have taken place and do take place due to inefficiencies in the market.

Subsidy

Has opposite effect of an excise tax, as it lowers the marginal cost of production, forcing the supply curve down

Price floor

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

Price Ceiling

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

Law of Diminishing Marginal Utility

The lower of utility from consumption of more and more of that item

Utility Maximizing Rule

MUx / Px = MUy/Py

Accounting Profit

The difference between total revenue and total explicit costs

Economic Profit

The difference between total revenue and total explicit and implicit costs

Explicit costs

Direct, purchased, out-of-pocket costs paid to resource suppliers provided by the entrepreneur

Implicit costs

Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneur

Short run

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

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

Fixed inputs

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

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

Total Product of Labor (TPL)

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

Marginal Product of Labor (MPL)

The change in total product resulting from a change in the labor input. MPL = dTPL/dL, or the slope of total product

Average Product of Labor (APL)

Total product divided by labor employed. APL = TPL/L

Total Fixed Costs (TFC)

Costs that do not vary with changes in short-run output. They must be paid even when output is zero.

Total variable costs (TVC)

Costs that change with the level of output. If output is zero, so are TVCs.

Average Fixed Cost (AFC)

AFC = TFC/Q

Average Variable Cost (AVC)

AVC = TVC/Q

Average Total Cost (ATC)

ATC = TC/Q = AFC + AVC

Economies of Scale

The downward sloping part of the LRAC curve where LRAC falls as plan size increases. This is the result of specialization, lower cost of inputs, or other efficiencies of larger scale.

Constant Returns to Scale

Occurs when LRAC is constant over a variety of plant sizes

Diseconomies of Scale

The upward part of the LRAC curve where LRAC rises as plant size increases. This is usually the result of the increased difficulty of managing larger firms, which results in lost efficiency and rising per unit costs.

Perfect competition

Characterized by many small price-taking firms producing a standardized product in an industry in which there are no barriers to entry or exit

Profit Maximizing Rule

All firms maximize profit by producing where MR = MC

Break-even Point

The output where ATC is minimized and economic profit is zero

Shutdown Point

The output where AVC is minimized. If the price falls below this point, the firm chooses to produce zero units in the short run

Perfectly competitive long-run equilibrium

Occurs when there is no more incentive for firms to enter or exit. P=MR=MC=ATC and profit = 0

Normal Profit

Another way of saying that firms are earning zero economic profits or a fair rate of return on invested resources

Constant cost industry

Entry (or exit) of firms does not shift the cost curves of firms in the industry. MC is perfectly elastic

Monopoly

The least competitive market structure, characterized by a single producer, with no close substitutes, barriers to entry, and price making power

Market power

The ability to set the price above the perfectly competitive level

Natural Monopoly

The case where economies of scale are so extensive that it is less costly for one firm to supply the entire range of demand. This is heavily regulated by the government.

Price discrimination

The practice of selling essentially the same good to different groups of consumers at different prices

Monopolistic competition

A market structure characterized by a many firms producing a differentiated product with easy entry into the market

Oligopoly

A very diverse market structure characterized by a small number of interdependent large firms, producing a standardized or differentiated product in a market with a barrier to entry

Collusive oligopoly

Models where firms agree to mutually improve their situation

Cartel

A group of firms that agree not to compete with each other on the basis of price, production, or other competitive dimensions. Cartel members operate as a monopolist to maximize their joint profits

Marginal Revenue Product (MRP)

Measures the value of what the next unit of a resource (e.g., labor) brings to the firm. MRPL = MR x MPL. In a perfectly competitive product market, MRPL = P x MPL. In a monopoly product market, MR < P so MRPm < MRPc.

Marginal Resource Cost (MRC)

Measures the cost the firm incurs from using an additional unit of input. In a perfectly competitive labor market, MRC = Wage. In a monopsony labor market, the MRC > Wage

Profit Maximizing Resource Employment

The firm hires the profit maximizing amount of a resource at the point where MRP = MRC

Demand for Labor

Labor demand for the firm is MRPL curve.

Derived Demand

Demand for a resource like labor is derived from the demand for the goods produced by the resource

Determinants of Labor Demand

Product demand, productivity, prices of other resources, and complementary resources

Least-Cost Rule

The combination of labor and capital that minimizes total costs for a given production rate. Hire L and K so that MPL / PL = MPK / PK or MPL/MPK = PL/PK

Monopsonist

A firm that has market power in the factor market (a wage-setter)

Private goods

Goods that are both rival and excludable. Only one person can consume the good at a time and consumers who do not pay for the good are excluded from consumption

Public goods

Goods that are both nonrival and nonexcludable. One person's consumption does not prevent another from also consuming that good and if it is provided to some, it is necessarily provided to all, even if they do not pay for that good

Free-Rider Problem

In the case of a public good, some members of the community know that they can consume the public good while others provide for it. This results in a lack of private funding and forces the government to provide it

Spillover benefits

Additional benefits to society not captured by the market demand curve from the production of a good, result in a price that is too high and a market quantity that is too low. Resources are underallocated to the production of this good

Positive externality

Exists when the production of a good creates utility for third parties not directly involved in the consumption of production of the good

Spillover costs

Additional costs to society not captured by the market supply curve from the production of a good, result in a price that is too low and a market quantity that is too high. Resources are overallocated to the production of this good