Microeconomics AP Review

Law of Demand

As price increases, Qd decreases

Law of Supply

As price increases, Qs increases

Shifters of Demand

Substitutes/Compliments, Income, Tastes, Expectations about the Future, and the # of Consumers

Shifters of Supply

Input Prices, Gov Actions (Taxes and Subsdies), the price of similar goods/services, Technology (Productivity), Future Expectations, and # of Producers

Price Floors

Go above equilibrium and creates a surplus

Price Ceilings

Go below equilibrium and creates a shortage

Price Elasticity of Demand

% Change in Qd / % Change in Price

Cross Price Elasticity of Demand

% Change in Qd for X / % Change in Price for Y

Positive = Substitutes

Negative = Compliments

Income Elasticity of Demand

% Change in Qd / % Change in Income

Positive = Normal Good

Negative = Inferior Good

Price Elasticity of Supply

% Change in Qs / % Change in Price

Charactersistics of Inelastic Demand

1: No substitutes

2: Good is a Need

3: Good is a small % of Income

4: Elasticity Coefficent < 1

Characteristics of Elastic Demand

1: Good has Substitutes

2: Good is a Want

3: Good is a large % of Income

4: Elasticity Coefficent >1

Law of Diminishing Marginal Returns

Each successive unit of input yields a lesser output

Total Revenue

Price x Quantity

Accounting Profit

Total Revenue - Explicit Costs

Economic Profit

Total Revenue - Explicit and Implicit Costs

Normal Profit

0 Economic Profit

Fixed Cost

The cost remains constant across all levels of production

Variable Cost

The cost changes with level of production

Total Cost

Fixed Costs + Variable Costs

Marginal Cost

The additional cost from producing one more unit

Economies of Scale

ATC declines as output increases

Diseconomies of Scale

ATC increases as output increases

Optimal Output Rule

Firms will earn the most profit by producing where Marginal Cost = Marginal Revenue

Marginal Revenue

The revenue gained by producing one more unit

Shut Down Rules

Firms will produce so long as MR is greater than AVC

Per Unit Tax/Subsidy

Shifts MC, ATC, and AVC causing a change in Quantity

Lump Sum Tax/Subsidy

Shifts ATC and AFC, causing no change in quantity

Productive Efficiency

Firm Produces at minimum ATC

Allocative Efficiency

Firm produces at MR = MC

Firm Earning a Profit

Price > ATC

Firm Earning a Loss

Price < ATC

Perfect Competition

1: Thousands of Firms

2: Products are Identical

3: Free Entry/Exit

4: Firms are Price Takers

Monopolistic Competition

1: Hundreds of Producers

2: Products are Differentiated

3: Easy Entry/Exit

4: Some Control Over Price

Oligopoly

1: Few Producers

2: Differentiated Product

3: Barriers to Entry/Exit

4: Control Over Price

Monopoly

1: Single Producer

2: Single Product

3: Barriers to Entry/Exit

4: Control Over Price

Why Monopolies are Innefficient

1: Produce too Little

2: Charge too Much

3: Creates Deadweight Loss

Inelastic Range of Demand

Area of Demand where MR > 0

Elastic Range of Demand

Area of Demand where MR < 0

Sunk Cost

A cost already incurred and cannot be reversed

Increasing Returns to Scale

Increasing input results in an increase in output greater than the input

Decreasing Returns to Scale

Increasing input results in an increase in output less than the input

Excess Capacity

The gap between minimum ATC and ATC at the point of profit maximization

Cartel

Group of Producers that agree to restrict output in order to increase price

Price Leadership

If one firm in an Oligopoly raises prices, then others will too

Non Cooperative Behavior

A firm acting in its own self interest even if it hurts other firms

Interdependence

The profit of a firm is influenced by the actions of its competitiors

Socially Optimal Regulation

The government sets the price where D = MC

Fair Returns Regulation

The government sets the price where D = ATC

Quantity Effect

Each additional unit sold increases total revenue

Price Effect

Selling more goods can decrease total revenue because the price of all goods sold must be lowered

Dominant Strategy

A player’s best option is not affected by the actions of other players

Nash Equalibrium

The result that occurs when all parties take the action that maximizes profits

Zero Profit Equalibrium

When a firm earns 0 economic profit at it’s profit maximizing quantity

Derived Demand

The demand for a factor comes from the demand for the product it is used to produced

Marginal Revenue Product

Marginal Product x Marginal Revenue

Marginal Revenue Cost

The cost of producing one more additionall good

Shifters of Labor Demand

1: Demand of the goods the labor is used to produce

2: Change in the Productivity of Labor

3: Change in the cost of substitute and compliment resources

Shifters of Labor Supply

1: Population and its wealth

2: Government Regulation

3: Social Norms

4: Opportunities

Monopsony

A labor market in which there is a single buyer

Cost Minimization Rule

Firms will produce where

Marginal Product of Labor / Wage Rate = Marginal Product of Capital / Rental Rate

Externality

A cost not paid for by the Producer (Negative) or a benefit not given to the producer (Positive)

Marginal Social Cost

The additional harm done to a society due to an action

Marginal Social Benefit

The additional benefit done to a society due to an action

Coase Theorm

Even if there are externalities, the market will reach a solution so long as transaction costs are low

Internalization of Externalities

A firm takes into account the externalities they produce

Pigouvian Tax

A tax designed to correct negative eternalities

Pigouvian Subsidy

A subsidy designed to correct positive externalities

Technology Spillover

New technology from one firm is adopted by others

Network Externality

The value of a good/service is dependent on how many people use it

Types of Market Failures

1: Monopoly

2: Externalities

3: Income Distributions

4: Public Goods

Lorenz Curve

Shows the difference between perfect equality and reality by graphing the percentage of income owned vs the perectage of the population

Gini Coefficient

Measure of the distribution of income across a population

0 = Perfect Equality

1= Perfect Inequality

Public Goods

Goods which are both Non Rivalrous and Non Excludable

Excludable

Only certain people (usually through payment) are able to use

Rivalrous

One person’s consumption inhibits another’s

Free Riders

People who enjoy a good without paying for it

Progressive Tax

Higher income earners pay a larger percentage

Proportional Tax

All individuals pay the same percentage of their income

Maximizing Rule for Public Goods

Goods will be produced at the quantity where MSB = MSC