AP Micro (Unit 1)

Basic Economic Concepts and Scarcity

• Microeconomics:

  • Studies the decision-making process of individuals.
  • Focuses on how individuals make choices based on their personal context and constraints.

• Individuals (Consumers):

  • Consumers possess unlimited "wants" or "desires".
  • Goal: Want to maximize their own happiness.
  • Aim to satisfy as many "wants" as possible given their limited resources.

• Scarcity:

  • Definition: We have limited resources available relative to unlimited wants.
  • There is a finite amount of most resources in the world.
  • Scarcity dictates that using a scarce resource for one purpose means it cannot be used for something else.

• Trade-off:

  • The act of having to make a choice between competing options.
  • Represents all alternative choices that are given up when a specific decision is made.

• Rival vs. Nonrival Goods:

  • Rival Goods: Resources or goods that get used up or depleted when consumed by an individual.
  • Non-rival Goods: Resources that are not depleted with use, allowing simultaneous consumption by others without reducing availability.

Resource Allocation and Economic Systems

• Economic Resources (Factors of Production):

  • Inputs used to make goods and services (materials):
  1. Land: Includes any natural resources (e.g., water). Payment/Reward: RENT.
  2. Labor: The effort that humans contribute to production (e.g., farmers). Payment/Reward: WAGES.
  3. Capital: Includes machinery, tools, equipment, and buildings (e.g., a delivery truck). Payment/Reward: INTEREST.
  4. Entrepreneurship: Combines land, labor, and capital in new and innovative ways (e.g., CEO, agricultural company founder). Payment/Reward: ECONOMIC PROFIT.

• Crucial Economic Distinctions:

  • MONEY is not a resource: Money itself does not produce goods; money is used to buy economic resources.
  • MONEY is not capital in economics: In economic terminology, capital strictly refers to physical tools, machinery, and buildings used in production, not financial currency.

• Economic Systems:

  • Command Economy:
  • The government owns and decides.
  • The government answers all central production questions.
  • The government controls and owns all resources.
  • The government decides what to produce with those resources, how to produce them, and allocates the final products to consumers.
  • Market Economy:
  • Individuals own resources and make decisions.
  • Individuals in the market control ALL factors of production and make ALL economic decisions.
  • Prices guide individual choices and decisions.
  • Individuals decide what to produce under competitive pressure to produce efficiently.
  • Goods and services are received by the people who are most able and willing to pay for them.
  • Mixed Economy:
  • Some resources are owned by the government, and some are owned by individuals.
  • Individuals and private entities own and control some resources and make most production decisions.
  • The government regulates certain aspects of decision-making and may own or control specific resources for public use.

• Key Characteristics of Market Economies:

  • Private ownership of economic resources.
  • Market price mechanism directs resource allocation.
  • Prices fluctuate based on supply and demand.
  • Consumer demand acts as a driving force behind production decisions.
  • Competition drives price down.
  • Income depends on individual resource ownership and acts as an economic incentive.
  • Unemployment and income inequality are tolerated outcomes within the system.
  • Incentive: Something that encourages or discourages a specific action.

Production Possibilities Curve (PPC)

• Categorization of Output Goods:

  • Capital Goods: Machinery, buildings, tools, equipment. Goods produced to be used by other companies in their future production processes. Producing more capital goods in the present increases total possible production capacity in the long run.
  • Consumer Goods: Food, clothing, headphones, toys, etc. Goods sold directly to consumers to be used as final goods, directly satisfying individual wants.

• Opportunity Cost:

  • Refers to what must be "given up" in order to use a particular resource or produce a specific good.
  • Explicitly defined as the cost or value of the next best alternative given up.
  • Example: Opportunity cost of $1$ machine is $500$ units of soda.

• PPC Curve Geometry and Characteristics:

  • Illustrates the maximum possible combinations of $2$ goods that an economy can produce given fixed resources and technology.
  • Constant Opportunity Cost: The PPC is a straight line. Opportunity cost remains unchanged as production shifts between goods.
  • Increasing Opportunity Cost: The PPC is bowed-out (concave to the origin). Opportunity cost increases as more of one good is produced.

• Points Relative to the PPC:

  • On the PPC Line: Represents efficient and attainable production combinations (resources fully utilized).
  • Inside the PPC: Represents inefficient but attainable production combinations (resources not fully utilized or misallocated).
  • Outside the PPC: Represents unattainable production combinations given current resources and technology.

• Shifts of the Production Possibilities Curve:

  • Outward Shift: Represents economic growth and increased productive capacity.
  • Caused by having more resources or better technology.
  • Inward Shift: Represents decreased productive capacity.
  • Caused by having fewer resources.

• PPC Vocabulary Summary:

  • Efficient: Resources fully used.
  • Inefficient: Resources not fully used.
  • Attainable: Can be produced.
  • Unattainable: Cannot be produced with available resources and technology.

Comparative Advantage and Trade

• Warm-Up Problem Analysis:

  • Problem setup evaluating trade ratios:
  • Option a: None / neither.
  • Option b: Comparative calculations: $\frac{10\,\text{B}}{2\,\text{T}} = 5\,\text{B}$ and $\frac{8\,\text{B}}{1\,\text{T}} = 8\,\text{B}$. Japan has comparative advantage in bikes because it can produce more with less.
  • Option c: $1\,\text{TV}$ for $6\,\text{bikes}$.
  • Rule: Acceptable terms of trade will always be based on the opportunity cost of the producing entities.

• Input vs. Output Model Calculations:

  • Input Model: Focuses on the required resources used to produce a good (e.g., acres of land needed, labor hours needed).
  • Time or resources spent represents the input; what could have been done instead is the opportunity cost.
  • Input Formula Rule: "It goes over" ($\text{Input Opportunity Cost} = \frac{\text{Input}}{\text{Other Input}}$).
  • Output Model: Focuses on the amount produced given a fixed set of resources.
  • Output Formula Rule: "Other goes over" ($\text{Output Opportunity Cost} = \frac{\text{Other Output}}{\text{Output}}$).

• Input Example 1: Luciana vs. Mathias (Tacos and Burgers):

  • Labor hours required:
  • Luciana: $8\,\text{h}$ for $1\,\text{taco}$, $4\,\text{h}$ for $1\,\text{burger}$.
  • Mathias: $12\,\text{h}$ for $1\,\text{taco}$, $3\,\text{h}$ for $1\,\text{burger}$.
  • Opportunity Cost (OPC) of $1\,\text{taco}$:
  • Luciana: $\frac{8\,\text{h}}{4\,\text{h}} = 2\,\text{burgers}$.
  • Mathias: $\frac{12\,\text{h}}{3\,\text{h}} = 4\,\text{burgers}$.
  • Comparative Advantage: Luciana has the comparative advantage in tacos because her opportunity cost is lower ($2 < 4$).
  • Opportunity Cost (OPC) of $1\,\text{burger}$:
  • Luciana: $\frac{4\,\text{h}}{8\,\text{h}} = \frac{1}{2}\,\text{taco}$.
  • Mathias: $\frac{3\,\text{h}}{12\,\text{h}} = \frac{1}{4}\,\text{taco}$.
  • Terms of Trade Example: $1\,\text{taco}$ for $3\,\text{burgers}$.

• Input Example 2: South Africa vs. Ivory Coast (Gold and Silver):

  • Labor hours required:
  • South Africa: $20\,\text{h}$ for Gold, $60\,\text{h}$ for Silver.
  • Ivory Coast: $50\,\text{h}$ for Gold, $100\,\text{h}$ for Silver.
  • Opportunity Cost (OPC) of Gold:
  • South Africa: $\frac{20\,\text{h}}{60\,\text{h}} = \frac{1}{3}\,\text{silver}$.
  • Ivory Coast: $\frac{50\,\text{h}}{100\,\text{h}} = \frac{1}{2}\,\text{silver}$.
  • Opportunity Cost (OPC) of Silver:
  • South Africa: $\frac{60\,\text{h}}{20\,\text{h}} = 3\,\text{gold}$.
  • Ivory Coast: $\frac{100\,\text{h}}{50\,\text{h}} = 2\,\text{gold}$.
  • Comparative Advantage: South Africa has comparative advantage in gold ($\frac{1}{3} < \frac{1}{2}$).
  • Terms of Trade Example: $1\,\text{ton of silver} = 2.5\,\text{gold}$.

Cost-Benefit Analysis

• Types of Costs:

  • Opportunity Cost: The best alternative given up when making a choice.
  • Explicit Costs: Out-of-pocket costs involving direct monetary payment.
  • Implicit Costs: Non-monetary costs or lost opportunities.
  • Example: The explicit cost of attending college includes tuition and fees; giving up your current job and its salary is the implicit cost.

• Quantitative Decision Principles:

  • Economic models use quantitative data and calculations to identify principles.
  • Total cost is calculated by combining explicit costs with opportunity costs (implicit costs).

• Marginal vs. Total Evaluation:

  • Marginal: Refers to "additional". Many decisions are made by comparing marginal benefit to marginal cost.
  • Utility: Measured in units called "utils", representing satisfaction gained (e.g., utils gained by running each additional mile).
  • Total Benefits and Total Costs: Some decisions cannot be broken down into marginal terms and must be evaluated by analyzing total benefits against total costs.
  • Optimal Choice: Total net benefits (the difference between total benefits and total costs) are maximized at the optimal choice.

Marginal Analysis and Consumer Choice

• Fundamental Economic Assumptions:

  • Consumers are rational (they make logical choices that benefit themselves).
  • Consumers actively seek to maximize total utility/satisfaction.

• Marginal Analysis Principles:

  • Rational consumers compare the incremental cost of the next additional unit of a good against its incremental benefit.
  • Incremental Benefit: The additional utility received from consuming the next unit, referred to as marginal utility.
  • Incremental Cost: The additional cost incurred from consuming the next unit, referred to as marginal cost.
  • "Marginal" = Addition of just one more unit.
  • "Utility" = Satisfaction.

• Sunk Costs:

  • Costs that have already been incurred in the past and cannot be recovered.
  • Money already spent should be ignored when making future economic decisions.

• Behavior of Utility:

  • Marginal utility is always decreasing with additional consumption.
  • Total utility will only decrease if the marginal utility becomes negative.

• Law of Diminishing Marginal Utility:

  • The total utility of consuming a good or service increases at a decreasing rate.
  • The marginal utility (additional satisfaction) decreases as consumption of the good increases.

Utility Maximization and Unit Review

• Marginal Utility Per Dollar ($\frac{MU}{P}$):

  • To compare satisfaction across different goods fairly, marginal utility must be weighed against price.
  • Formula: $\frac{MU}{P}$.
  • Decision Rule: If $\frac{MU_A}{P_A} > \frac{MU_B}{P_B}$, the consumer should consume MORE of Good A and LESS of Good B.
  • Optimal Consumption Rule: The optimal combination of two goods occurs when the marginal utility per last dollar spent on both goods is equal:     $\frac{MU_x}{P_x} = \frac{MU_y}{P_y}$

• Coffee Example (Price = $3 per cup):

  • Cups of Coffee = $1$: Total Utility = $10$, $MU = 10$, $\frac{MU}{P} = \frac{10}{3} \approx 3.33$
  • Cups of Coffee = $2$: Total Utility = $18$, $MU = 8$, $\frac{MU}{P} = \frac{8}{3} \approx 2.67$
  • Cups of Coffee = $3$: Total Utility = $24$, $MU = 6$, $\frac{MU}{P} = \frac{6}{3} = 2.00$
  • Cups of Coffee = $4$: Total Utility = $29$, $MU = 5$, $\frac{MU}{P} = \frac{5}{3} \approx 1.67$
  • Cups of Coffee = $5$: Total Utility = $31$, $MU = 2$, $\frac{MU}{P} = \frac{2}{3} \approx 0.67$
  • Cups of Coffee = $6$: Total Utility = $31$, $MU = 0$, $\frac{MU}{P} = \frac{0}{3} = 0.00$

• Vacation Choice Example:

  • Destination Options: Rio Dulce vs. London.
  • Rio Dulce: Marginal Utility = $2000$, Cost = $\$500$.     $\frac{MU}{P} = \frac{2000}{500} = 4\,\text{utils per dollar}$
  • London: Marginal Utility = $5000$, Cost = $\$2000$.     $\frac{MU}{P} = \frac{5000}{2000} = 2.5\,\text{utils per dollar}$
  • Decision: Choose Rio Dulce because it provides a higher marginal utility per dollar ($4 > 2.5$).

• Activity Optimization Example (Bowling vs. Roller Skating):

  • Price of Bowling ($P_b$) = $\$15$ per hour; Price of Skating ($P_s$) = $\$5$ per hour. Total Budget = $\$45$.
  • Hours and Values:
  • Hour 1: $MU_b = 60$, $\frac{MU_b}{P_b} = \frac{60}{15} = 4$ | $MU_s = 25$, $\frac{MU_s}{P_s} = \frac{25}{5} = 5$
  • Hour 2: $MU_b = 30$, $\frac{MU_b}{P_b} = \frac{30}{15} = 2$ | $MU_s = 20$, $\frac{MU_s}{P_s} = \frac{20}{5} = 4$
  • Hour 3: $MU_b = 20$, $\frac{MU_b}{P_b} = \frac{20}{15} = 1.33$ | $MU_s = 10$, $\frac{MU_s}{P_s} = \frac{10}{5} = 2$
  • Hour 4: $MU_b = 10$, $\frac{MU_b}{P_b} = \frac{10}{15} = 0.66$ | $MU_s = 8$, $\frac{MU_s}{P_s} = \frac{8}{5} = 1.6$
  • Hour 5: $MU_b = 5$, $\frac{MU_b}{P_b} = \frac{5}{15} = 0.33$ | $MU_s = 3$, $\frac{MU_s}{P_s} = \frac{3}{5} = 0.6$
  • Optimal Allocation Solution:
  • Purchase $2\,\text{hours of bowling}$ and $3\,\text{hours of skating}$.
  • Budget verification: $2(\$15) + 3(\$5) = \$30 + \$15 = \$45$ (entire budget spent).
  • Equal marginal utility per dollar verification:       $\frac{MU_b}{P_b} = \frac{30}{15} = 2$$\frac{MU_s}{P_s} = \frac{10}{5} = 2$

• Unit 1 Review Problem (Drinks & Snacks):

  • Price of Drinks = $\$2$. Budget = $\$20$.
  • Drinks Schedule:
  • Quantity $1$: Total Utility = $12$
  • Quantity $2$: Total Utility = $21$
  • Quantity $3$: Total Utility = $29$
  • Quantity $4$: Total Utility = $36$
  • Quantity $5$: Total Utility = $42$
  • Quantity $6$: Total Utility = $47$
  • Quantity $7$: Total Utility = $50$
  • Quantity $8$: Total Utility = $52$
  • Part a Calculation:
  • Marginal Utility ($MU$) on 4th drink = $36 - 29 = 7$.
  • Marginal Utility per dollar ($\frac{MU}{P}$) on 4th drink = $\frac{7}{2} = 3.5$
  • Part b Optimal Rule Statement:
  • Both marginal utilities per dollar on both sides are equal to each other ($\frac{MU_x}{P_x} = \frac{MU_y}{P_y}$) and fully exhaust the available budget of $\$20$.