AP Microeconomics Review

Non-Priced Determinants of Demand

Non-Priced Determinants of Demand

Factors like tastes, market size, prices of related goods, changes in income, and expectations that shift the demand curve.

Substitution Effect

An increase in price makes substitutes more attractive, while a decrease makes alternatives less desirable.

Income Effect

Price changes affect purchasing power, influencing the quantity demanded.

Non-Priced Determinants of Supply

Factors like input prices, government tools, number of sellers, technology, and producer expectations that shift the supply curve.

Price Elasticity of Demand

Measures how quantity demanded responds to price changes through tests like necessity, substitutes, and total revenue.

Unit Elastic Demand

Proportional change in quantity demanded with price changes, maximizing total revenue.

Elasticity Coefficient

Measures responsiveness of quantity demanded or supplied to price changes, calculated as percentage change in quantity over price change.

Price Elasticity of Supply

Measures how quantity supplied responds to price changes, with interpretations based on the coefficient.

Consumer and Producer Surplus

Differences between value and price for consumers, and price received and cost for producers, contributing to economic surplus.

Allocative Efficiency

Achieved when marginal cost equals marginal benefit, maximizing economic surplus.

Deadweight Loss

Reduction in economic surplus due to failure to reach equilibrium, calculated by comparing marginal cost and benefit.

Price Floor

Government intervention setting a minimum price, impacting quantity demanded and supplied, leading to surplus and deadweight loss.

Price Ceiling

Government intervention setting a maximum price, affecting quantity demanded and supplied, resulting in shortage and deadweight loss.

Per Unit Excise Tax

Tax imposed on each unit of a good, shifting the supply curve, affecting equilibrium price and quantity, tax revenue, and deadweight loss.

Tax Incidence

Refers to who bears the burden of a tax based on the elasticity of demand or supply.

Production Function

Shows the relationship between the quantity of labor a firm hires and the quantity of output that number of workers produces.

Marginal Product

The additional output produced by one more unit of labor.

Marginal Cost of Labor

The wage paid to workers divided by the marginal product of labor.

Fixed Costs

Costs associated with production that don't change with output.

Variable Costs

Costs that change with the quantity of output.

Total Costs

The sum of fixed costs and variable costs.

Marginal Cost (equation)

The change in total cost divided by the change in quantity of output.

Average Variable Cost

Variable cost divided by the quantity of output.

Average Total Cost

Total cost divided by the quantity of output.

Productive Efficiency

Quantity at the minimum point of the average total cost curve with the lowest average cost of production.

Diseconomies of Scale

Average costs increase due to inefficient bureaucracy as production expands.

Profit Maximization

Firms seek to maximize profit, considering accounting profit and economic profit.

Marginal Revenue

Revenue from selling an additional unit of a good.

Perfect Competition

Market structure with many firms selling identical products, low barriers to entry, and zero economic profit in the long run.

Long Run Equilibrium

Firms earn zero economic profit, and price equals the minimum of the average total cost curve.

Efficiency in Perfect Competition

Firms are allocatively and productively efficient in the long run.

Increasing Cost Industries

More firms in the market shift each individual firm's cost curves up.

Long Run Supply Curve

Horizontal curve where price equals the minimum average total cost in perfect competition.

Factors of Production

land, labor, and physical capital

Law of Diminishing Marginal Returns

increasing, decreasing, negative marginal product phases

Marginal Revenue Product (MRP)

MRP = Marginal Revenue × Marginal Product

Firm's Demand for Labor

quantity of labor a firm hires at a wage rate

Market Demand for Labor

sum of each firm's marginal revenue product

Market Supply of Labor

quantity of labor households supply at a wage rate

Equilibrium Wage and Quantity

point where supply and demand curves intersect

Firms in Perfectly Competitive Factor Markets

many buyers, market sets wage

Marginal Resource Cost (MRC)

cost to hire one more worker

Monopsony

market with one buyer of a resource

Least Cost Combinations of Resources

finding optimal resource combination

5 Characteristics of a Monopoly

1) Single Seller
2) Unique good with no close substitute
3) "Price Maker"
4) High Barriers to Entry
5) Some "Nonprice" Competition

Single Seller (1)

-one firm controls the vast majority of a market
-firm=industry

"Price Maker" (3)

-firm can manipulate price by changing the quantity produced (ie. shifting supply to the left)

High Barriers to Entry (4)

-new firms CANNOT enter market
-no immediate competitors
-firms can make profit in the long-run

Some "Nonprice" Competition (5)

-monopolies still advertise their products in an effort to increase demand

Four Origins of Monopolies (Barriers to Entry)

1) Geography
2) Government
3) Technology or Common Use
4)Mass Production and Low Costs

Main difference between Monopolies and Perfect Competition

MARGINAL REVENUE DOES NOT EQUAL PRICE (MR LESS THAN PRICE)
-monopolies (and all imperfectly competitive firms) have downward sloping demand curve

How does a firm sell more in a monopoly?

A firm must lower its price

Total Revenue Test

If price falls and TR increases, then demand is elastic;
If price falls and TR falls, then demand is inelastic
(A monopoly will only produce in the elastic range)

Where do monopolists produce?

Where MR=MC, but it charges the price consumers are willing to pay identified by the demand curve

Are monopolies efficient?

No, monopolies under-produce and overcharge

What happens to CS and PS for a monopoly?

CS decreases
PS increases
Total Surplus decreases
There is now DWL

Are monopolies productively efficient?

No, they are not producing at the lowest cost (minimum ATC). Instead, they will maximize profit by finding MR=MC

Are monopolies allocatively efficient?

No, price is greater and the monopoly is under producing

Why are monopolies inefficient?

1) Charge a higher price
2) Don't produce enough (Not allocatively efficient)
3) Produce at higher costs (Not productively efficient)
4) Have little incentive to innovate (little external pressure to be efficient)

Natural Monopoly

One firm can produce the socially optimal quantity at the lowest cost due to economies of scale
-It is better to have only one firm because ATC is falling at socially optimal quantity

socially optimal quantity

What society wants, or where supply (MC) meets demand

Why would the government regulate a monopoly?

1) To keep prices low
2) To make monopolies efficient

How does the government regulate monopolies?

Use Price Controls: Price Ceilings

Why don't taxes work for regulating monopolies?

Taxes reduce supply and that is the problem-monopolies are already under-producing to begin with

Socially Optimal Price

P=MC (Allocative Efficiency)

Fair-Return Price (Break-Even)

P=ATC (Normal Profit, no economic profit)

Where should the government place the price ceiling in a monopoly?

Socially Optimal Price
-what society wants-using all resources

What happens if the government sets a price ceiling to get the socially optimal quantity in a natural monopoly?

The firm would make a loss and would require a subsidy

Price Discrimination (definition)

Practice of selling the same product to different buyers at different prices
Ex: Airline Tickets, Movie Theaters, Coupons, GBHS Football Games

Price Discrimination (concept)

-Seeks to charge each consumer what they are willing to pay in an effort to increase profits
-Those with inelastic demand are charges more than those with elastic
-Socially optimal quantity is higher
WHEN PRICE DISCRIMINATION, MR=D

Requirements for Price Discrimination

1) Must have monopoly power
2) Must be able to segregate the market
3) Consumer must NOT be able to resell product

Price for Discriminating Monopoly

range, no set price; monopolies will still accept the price until it hits minimum ATC because there is still a profit

What happens to profit, CS, and DWL in a price discriminating monopoly?

-more profit
-no CS; everyone is paying what they are willing to pay
-DWL is gone

What happens if the government sets a price ceiling to get the socially optimal quantity in a natural monopoly?

The firm would make a loss and would require a subsidy

Monopolistic Qualities

-control over price of own good due to differentiated product
-D greater than MR
-plenty of advertising
-not efficient

Perfect Competition Qualities

-large number of smaller firms
-relatively easy entry and exit
-zero economic profit in long-run since firms can enter

Monopolistic Competition Characteristics

-relatively large number of sellers
-differentiated products
-some control over price
-easy of entry and exit (low barriers)
-a lot of non-price competition (advertising)

Differentiated Products

-goods are NOT identical
-firms seek to capture a piece of the market by making unique goods
-firms use NON-PRICE Competition because these products have substitutes

Non-Price Competition

-brand names and packaging
-product attributes
-service
-location
-advertising

Two Goals to Advertising

1. Increase Demand
2. Make demand more INELASTIC

What does the short-run in monopolistic competition look like?

Monopolistic Competition is made up of price makers, so MR is less than demand and it is the same graph as a monopoly making profit

What happens to monopolistic competition in the long-run?

New firms will enter, driving down the DEMAND for firms already in the market until there is no economic profit; price and quantity falls and TR=TC

Long-run Equilibrium for Monopolistic Competition

Quantity where MR=MC up to Price=ATC

What happens when short-run profits are made in monopolistic competition?

-new firms enter
-more close substitutes and less market share for each existing firm
-demand for each firm falls

What happens when short-run losses are made in monopolistic competition?

-firms exit
-less substitutes and more market shares for remaining firms
-demand for each firm rises

What happens when there is a loss in monopolistic competition?

In the short-run, the graph is the same as a monopoly making a loss; in the long-run, firms will leave, driving up the DEMAND for firms already in the market

Are monopolistically competitive firms efficient?

No; not allocatively efficient because P≠MC and not productively efficient because it isn't producing at minimum ATC

Excess Capacity

-given current resources, the firm CAN produce at the lowest costs (minimum ATC) but they decide not to
-it is the gap between the minimum ATC output and the profit maximizing output, not the amount underproduced

Excess Capacity (reason)

The firm can produce at a lower cost but it holds back production to maximize profit

Advantages of Monopolistic Competition

-large number of firms and product variation meets society's needs
-Non-price Competition (product differentiation and advertising) may result in sustained profits for some firms
Ex: Nike, Apple might continue to make above normal profit because they are well-known

Characteristics of Oligopolies

-few large producers (less than 10)
-identical or differentiated products
-high barriers to entry
-control over price (price maker)
-mutual interdependence (firms use strategic pricing)
Ex: cereal companies, car producers

oligopoly

occurs when only a few large firms start to control an industry
-must use strategic pricing
-have a tendency to collude to gain profit
-collusion=incentive to cheat
-makes informed decisions based on their dominant strategies

collusion

the act of cooperating with rivals in order to "rig" a situation

Barriers to Entry for Oligopolies

1. Economies of Scale
2. High Start-up Costs
3. Ownership of Raw Materials

Game Theory

the study of how people behave in strategic situations

market failure

a situation in which the free-market system fails the satisfy society's wants
- private markets do not efficiently bring about the allocation of resources
- causes the government to step in

four market failure

1. public goods - public parks, bathrooms
2. externalities - third person side effects
3. monopolies
4. unfair distribution of income
- government must step in to allocation resources efficiently

free-riders

individuals that benefit without paying
- keep firms from making profits
- if left to the free market, essential services would not be produced

nonexclusion (public goods)

cannot exclude people from enjoying the benefits (even if they do not pay) ex. national defense

shared consumption (nonrivalry)

one person's consumption of a good does not reduce its usefulness to others ex. city park