AP Micro Exam

review for the ap test

scarcity

individuals, businesses and Govs have unlimited wants but limited resources. Economics focuses on this and how it requires individuals, businesses, and Govs to make choices.

factors of production

resources required to produce goods and services: labor, land, capital, and entrepreneurship

capital goods

goods made for indirect consumption. Goods that make consumer goods (oven). If these are prioritized over consumer goods then there is more Economic growth over time.

human capital

skills, knowledge, traits, and experience that makes workers more productive (education) and they need to produce things.

centrally planned economy

a Econ system where the gov owns all resources and decides what goods and services to produce, how to produce them, and who will consume them. not many private businesses in this economic system

market economy

a Econ system where individuals own resources and deiced what goods and services to produce, how to produce them, and who consumes them. There are many private businesses in this economic system.

Production possibilities curve

A graph that illustrates the ideas of scarcity, trade offs and efficiency, shoes different combinations of two goods that can be produced using a country’s resources to the fullest. A point inside the curve is inefficient. A point on the curve is efficient. A point outside the curve is unattainable. The curve can be shifted by a change in resource quantity or quality, a change in technology, or a change in trade (doesn’t change amount produced but changes amount consumed).

opportunity cost

what you or one country gives up when they make a certain choice. It is the value of the next best alternative. A constant type of this a straight line on the PPC and is a result of two products requiring similar resources, resources are easily adaptable between them. A increasing type of this is a curve on the PPC and is a result of two products having different resources needed, resources are not easily adaptable between them. Add explicit and implicit costs to get this.

explicit costs

traditional out of pocket costs associated with choosing one course of action

implicit costs

the monetary or non-monetary opportunity cost of making a choice. (the wage you could’ve made if you had not chosen to attend college or the traveling you can’t do if you go to college).

Utility maximizing rule

marginal utility A/price A = marginal utility B/price B. Maximize the amount of utility you can receive with the money you have. To get total utility add up the times you are going and the utility for each time you are going. Calculate marginal utility from total by subtracting each additional utility. For total consumer surplus, take the total benefit of each unit and subtract the price of the unit from it, do this for all and add up to get it.

physical capital

tools, machines, or manufacturing equipment that is used to produce goods and services.

law of demand

shows an inverse relationship between price and quantity demanded. It is downward sloping as people are less willing to pay for things and buy them when they have a higher price. There are more units to buy when prices are low. Shifted by taste, number of consumers, price of related goods, income, and expectations

law of supply

shows a direct relationship between price and quantity supplied. It is upward sloping as sellers are more willing to sell for a higher price that brings them a higher profit. Shifted by price of resources, number of producers, technology, taxes and subsidies, and expectations.

substitution effect

changes in price motivate consumers to buy relatively cheaper goods, this is a reason that the demand curve is downward sloping

income effect

changes in price affect purchasing power of consumer’s income, this is a reason that the demand curve is downward sloping

law of diminishing marginal utility

as you continue to consume a given product, you will eventually get less additional utility (satisfaction) from each unit you consume. This is a reason that the demand curve is downward sloping

substitutes

goods that are bought when the other is not, they do not go together (ketchup and mayonnaise)

complements

goods that are bought together normally (paper and printer)

inferior good

a good that is generic and is normally bought when incomes are lower

normal good

a good that is brand name and is normally bought when incomes are higher

subsidies

government payments to sellers designed to encourage them to produce more output

price elasticity of demand

Measures how much demand changes and how sensitive it is in response to a change in price

good with inelastic demand

goods that have very little substitutes, usually necessities, elasticity coefficient of less than 1, they are a small portion of income, required now rather than later

Total revenue test

a test used to determine if the price elasticity of demand is inelastic or elastic. It is only good for demand and not supply or the others. If price and total revenue increase and decrease together then it is inelastic. If price increases and total revenue decreases or vice versa it is elastic.

price elasticity of supply

shows how sensitive supply is to a change in price

goods with inelastic supply

goods that are hard to produce, high barriers to entry (few firms), high cost of production or specialized inputs, hard to switch from producing alternative goods, coefficient is less than 1.

goods with elastic demand

goods that have many substitutes, are luxuries, a large portion of income, plenty of time to decide if you want it, coefficient greater than 1.

goods with elastic supply

goods that are easier to produce, low barriers to entry (many firms), low cost of production or generic inputs, easy to switch from producing alternative goods, coefficient greater than 1.

Cross price elasticity of demand

used to determine if two goods are complements ( negative coefficient) or substitutes (positive coefficient).

income elasticity of demand

used to determine if a good is inferior (negative coefficient) or normal (positive coefficient).

Consumer surplus

difference between how much buyers are willing to pay and the price they do actually pay. Usually always the top portion on a graph for supply and demand.

Producer surplus

difference between price and how much seller is willing to sell product for. Usually always bottom portion on a graph for supply and demand.

deadweight loss

When the social optimal quality of goods is not being produced, lost efficiency.

double shift rule

when there is a double shift of supply and demand, either price or quantity will be indeterminate.

price ceiling

legal cap on prices designed to keep prices artificially low. Can only go below equilibrium to be effective and binding, resulting in a shortage

price floor

minimum legal price sellers have to sell a product for. Must go above equilibrium to be binding and effective and result in a surplus.

tax revenue

what the gov earns after putting a tax on sellers for their goods.

law of diminishing marginal returns

the additional output produced from hiring an additional worker or making another product will eventually decrease.

increasing marginal returns

stage 1 in a production function: the MP and TP are rising due to specialization

decreasing marginal returns

stage 2 in a production function: MP falling and TP increasing at decreasing rate. Labor is a fixed resource and each worker adds less and less value.

negative marginal returns

stage 3 in a production function: MP is negative and TP is decreasing. Workers start to get in each others ways.

Fixed costs

costs that dont change are more units are produced or just dont change (rent, salary, pizza oven). An increase in this will shift AFC and ATC but not MC or AVC as it has no effect and it also doesn’t change supply.

variable costs

costs that do change when more units are produced or they just do change (pizza inputs, electricity bills). If this increases then MC, ATC, and AVC will shift but not AFC.

total cost

fixed costs plus variable costs

marginal cost

additional cost of one additional output, when this is below the ATC, it pulls ATC down. When this is above ATC, it pulls ATC up. This is the supply curve after the AVC. This always intersects at ATC and AVC minimums.

perfect competition graph

what graph is this? there should also be a line in the middle saying M=DR

average total cost

total cost/quantity, also AFC + AVC

average variable cost

variable cost/quantity

average fixed cost

fixed cost/quantity

economies of scale

long run average total costs fall as firms can use cost-saving mass production techniques. Getting bigger is getting cheaper. In the long run all resources are variable while in the short run all resources are fixed.

diseconomies to scale

long run average total costs increase as firms get too big and difficult to manage.

constant returns to scale

long run average total costs remain unchanged and the firm’s costs can not fall any lower

accounting profit

total revenue - only explicit costs, at normal profit this is still positive.

economic profit

total revenue - explicit and implicit costs (including opportunity costs). When this is 0 it is called normal profit.

profit maximizing rule

MC = MR, also called the loss minimizing rule. Make sure the marginal cost is equal to the marginal revenue or just the price of the item.

shut down rule

a firm should shut down if price falls below the minimum AVC. It’s better to produce nothing and take fixed costs instead of continuing to produce and lose even more money.

characteristics of perfect competition

This competition has many small firms, low barriers to entry and exist, identical products being made, price takers (have to take the price set by the market), no advertising, and there is no economic profit in the long run (efficient). They sell every unit at same price. Additional revenue of next unit sold is the same as the price.

competitive firm and market in long run equilibrium

what is this? perfect

competitive firm and market making profit

what is this? perfect

competitive firm and market making loss

what is this?

allocative efficiency

in the long run, perfectly competitive firms are producing the amount of product that society wants where the price = marginal costs

productive efficiency

in the long run, perfectly competitive firms are producing at the lowest possible cost where ATC is minimized.

constant cost industry

the market price will stay the same from long run to long run in this type of industry

increasing cost industry

market price will increase from long run to long run in this type of industry.

per unit tax or subsidy

this gov action affects variable costs so that MC, AVC, and ATC will shift → will affect the quantity produced

lump sum tax or subsidy

this gov action affects fixed costs so that AFC, and ATC will shift → will not affect the quantity produced. Lump sum is a one time payment and a per unit is a subsidy for each unit produced.

imperfect competition

To sell another unit, firm must lower price of next unit and the units it could have sold at a higher price. The additional revenue of the next unit is the price minus revenue they lose from lowering the price of all units. It always produces in the elastic range of the demand curve (this is increasing total revenue). Inelastic part of marginal revenue is when total revenue is decreasing. Total revenue is maximized when MR is zero.

* Demand = ATC is where they make no economic profit
* allocatively efficient at Demand = MC

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Barriers to entry are economies of scale (high start up costs), control of scarce resources, and gov or legal barriers.

monopoly

One firm that has a unique product and charges higher prices over it (they have control over price). There are high barriers to entry and are inefficient (DWL). They don’t produce enough (not allocatively efficient), and the produce at higher costs (not productively efficient). They produce where MR = MC. They can price discriminate.

* Govs often regulate these to keep prices low to avoid deadweight loss (they lower it to socially optimal price where P = MC for allocative efficiency or to a fair return price where businesses break even and where P = ATC)

natural monopoly

it is natural for one firm to produce because they can produce at a lower costs → economies of scale make it impractical to have smaller firms (these are like electric companies)

price discrimination

When a firm charges a different price to different consumers (airlines). Demand = MR. Three conditions necessary:


1. firm must not be a price taker
2. firm must be Able to segregate market and identify consumers willing to pay more
3. firms must be Able to make sure consumers cannot resell product to other consumers.

If a monopoly starts doing this then there will be no deadweight loss or consumer surplus (where ATC is decreasing)

monopolistic competition

many small firms that sell differentiated products and have some control over price. They have low barriers to entry and engage in nonprice competition (advertising). They are inefficient (increases DWL). In the long run the price will equal ATC as more firms will enter to also make profit and the demand for each firm will fall until they each make no profit.

oligopoly

few large firms (10 or less) that have control over price and and have huge barriers to entry. They have mutual interdependence on each other (car dealerships) and are inefficient (creates DWL).

Price leadership

type of oligopoly where collusion is illegal and firms cannot set prices so they use a strategy to coordinate prices without outright collusion. 1 firm initiates a price change and others follow

Colluding oligopoly

a type of oligopoly also called a cartel where a group of producers create an agreement to fix prices high. Cartels set price as output at an agreed upon level. They require identical or highly similar demand and costs. They must have a way to punish cheaters and they can act together as a monopoly.

Noncolluding oligopoly

Kinked demand curve model that shows how non collusive firms are interdependent. They are likely to react to competitors pricing by either matching price if another firm cuts their price, causing inelastic demand, or ignore change if one firm raises price and they maintain their lower price, causing inelastic demand. The Marginal Revenue has a vertical gap at the kink and MC can move and Quantity wouldn’t change. Price is sticky there.

Game theory

the study of strategic interactions among rational decision makers and can be analyzed using a chart called a payoff matrix. You can find dominant strategies for the two firms here or the Nash equilibrium (the optimal outcome where neither player can make themselves better off by deviating from the current strategy given the other player’s actions).

Factor Market

market based on businesses demanding the factors of production (land, labor, capital, entrepreneurship) from individuals and households and supplying wage, rent, interest, and profit instead of like in the product market (individuals demanding goods from businesses). There is a steady supply of labor all for the same price.

* There is an inverse relationship between wage and quantity of workers demanded.
* There is a direct relationship between wage and workers supplied by individuals.
* derived demand: the demand for resources is determined by the products they help produce.

shifts demand for labor

* Changes in demand for product
* changes in productivity of resource
* change in price of related resources

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shifts supply of labor

* number of qualified workers (immigration)
* gov regulation/licensing
* cultural expectations

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marginal revenue product

the additional revenue generated by an additional resource/worker

marginal resource cost

the additional cost of an additional resource/worker. Also called marginal factor cost.

the least cost rule

what is this?

Monopsony

A type of imperfect competition in a factor market. There is only one firm hiring workers and the firm is large enough to manipulate market. Workers are relatively immobile and the firm is the wage maker. To hire additional workers they must increase wage.

externalities

They occur when rational decision makers respond to private benefits and costs rather than external benefits and costs.

negative externality

situation that results in external costs on others causing marginal social costs to be higher than marginal private costs. They generate a quantity that is greater than the socially optimal quantity. Can use a per unit tax to mitigate this or gov regulation limiting output

positive externality

situation that results in external benefits and causes marginal social benefit to be higher than marginal private benefit. They generate a quantity that is less than the socially optimal quantity. Can use a per unit subsidy or gov regulation to increase output.

free rider problem

a situation where people use a collective good without paying for it.

public goods

considered a market failure. Profit seeking firms in a free market don’t provide enough of these goods and services since they don’t generate profit from them. If society wants these they have to rely on the government.

nonexclusion

it is impossible to exclude individuals or groups from enjoying benefits of a good or service (public) whether or not they have paid for it

shared consumption

also called nonrivalry; Multiple individuals can use or consume a good or service simultaneously without diminishing availability or quality for others.

antitrust law

laws that are designed to prevent monopolies and make markets more competitive. They cause monopolies to produce at a socially optimal quantity where the firm is making a loss, thus a lump sum subsidy has to be given to keep the firm from closing.

income inequality

inequality in annual earnings among people. Comes from abilities, human capital, inheritance, effects of discrimination, access to financial markets, and mobility.

wealth inequality

how accumulated assets are distributed is unequal

progressive taxes

taxes that take a larger percent of income from high income groups

proportional taxes

taxes that take the same percent of income from all income groups

regressive taxes

taxes that take a larger percent of income from low income groups

Lorenz Curve

What graph is this? Line 1 represents the perfect equality line where all households have the same income and Line 2 represents the Lorenz curve. The x and opposite y axis are the perfect inequality line where 1 house owns all the income.

Gini coefficient

a term that describes the spread of household incomes across all households. It is calculated by doing Area A/ Area A + Area B. It should be a number from 0-1, 0 is perfect equality and 1 is perfect inequality.

market failure

a situation in which the free market system fails to satisfy society’s wants and the government has to step in. Private markets do not efficiently bring out the allocation of resources.