AP Microeconomics Exam Review Flashcards

Unit 1: Basic Economic Concepts

Scarcity and Resources * Definition of Scarcity: Scarcity is the inability of limited resources to satisfy unlimited human wants. An item is considered scarce if there is less of it than is wanted; it will carry a positive price and require giving up something to obtain. * Factors of Production: Goods and services are scarce because the factors used to create them are scarce. These factors include: * Land: Natural resources used in production. * Labor: Human effort and work. * Capital: Manufactured goods used to produce other goods (e.g., machinery, equipment). * Entrepreneurship: The initiative to combine resources to create goods or services.
Economic Systems * Market-Based Economies: These systems emphasize private property rights and utilize prices as a mechanism to distribute scarce resources, goods, and services. * Command Economies: These systems rely on central planners or government bureaucrats to allocate resources and determine which goods and services are produced.
Opportunity Cost and Production Possibilities * Opportunity Cost: The value of the next best alternative given up when making a choice. * Production Possibilities Curve (PPC): A model showing all combinations of two goods that can be produced given fixed resources. * Linear PPC: Indicates constant opportunity costs. This occurs because resources are perfectly adaptable between the production of the two goods. * Bowed-Out PPC: Indicates increasing opportunity costs. As more of one good is produced, the cost in terms of the other good rises because resources are not perfectly adaptable. * Efficiency on the PPC: * Productively Efficient: Any point located directly on the PPC. * Inefficient: Any point inside the curve, indicating idle resources (recalling a recession or high unemployment in a macro economy). * Impossible: Any point outside the curve due to limited resources. * Economic Growth and Contraction: * Growth: Shown by an outward shift of the PPC, caused by an increase in resource quality/quantity or productivity. * Contraction: Shown by an inward shift, resulting from a decrease in resource quality or quantity.
Comparative Advantage and Trade * Absolute Advantage: The ability to produce more of a good or the same amount using fewer resources. * Henry and Jason Example: In an output problem (strawberries and zucchini), Henry has the absolute advantage in both because he can produce more. * Amy and Eric Example: In an input problem (brake jobs and painting cars), Amy has the absolute advantage because she uses lower quantities of inputs. * Comparative Advantage: The ability to produce a good at a lower opportunity cost. * Other-Over Formula (Output Problems): Opportunity cost of Good A = $rac{ ext{Quantity of Good B}}{ ext{Quantity of Good A}}$ . * It-Over Formula (Input Problems): Opportunity cost of Task A = $rac{ ext{Input for Task A}}{ ext{Input for Task B}}$ . * Terms of Trade: Mutually beneficial trade occurs when the terms fall between the opportunity costs of the two parties. For example, if opportunity costs for a painted car are 4 brake jobs (Amy) and 6 brake jobs (Eric), a beneficial trade is 1 car for 5 brake jobs.
Marginal Analysis and Utility * Marginal: Defined as the "change in the total." * Benefit Maximization: Individuals should perform an action as long as the Marginal Benefit ( $MB$ ) is greater than or equal to the Marginal Cost ( $MC$ ) ( $MB ≥ MC$ ). One should stop when MB < MC to avoid lowering total benefit. * Utility Maximizing Combination Formula: To maximize utility across two goods, consumers equate the marginal utility per dollar: * rac{MU_a}{P_a} = rac{MU_b}{P_b} * If one ratio is higher, the consumer should purchase more of that item.

Unit 2: Supply and Demand

The Law of Demand * The Law: Ceteris paribus, consumers buy more at lower prices and fewer at higher prices, resulting in a downward-sloping curve. * Price Change: Causes movement along the curve (change in quantity demanded), not a shift in the curve. * Demand Shifters: Tastes/preferences, Market size (number of consumers), Prices of related goods (Substitutes = direct relationship; Complements = inverse relationship), Income (Normal goods = direct; Inferior goods = inverse), and Future expectations. * Reasons for Downward Slope: * Substitution Effect: As prices rise, consumers switch to substitutes. * Income Effect: Higher prices reduce the purchasing power of income.
The Law of Supply * The Law: There is a direct relationship between price and quantity supplied, resulting in an upward-sloping curve. * Supply Shifters: Input prices (inverse relationship), Government tools (taxes, subsidies, regulations), Number of sellers, Technology, Prices of other produceable goods, and Producer expectations.
Elasticity * Price Elasticity of Demand (PED): Measures the sensitivity of quantity demanded to price changes. * Inelastic: Steep curve, necessities, few substitutes, inexpensive; consumers are insensitive to price changes. * Elastic: Horizontal/flat curve, luxuries, many substitutes, expensive; consumers are sensitive to price changes. * Total Revenue Test: * Elastic: Price and Total Revenue (TR = P × Q) move in opposite directions. * Inelastic: Price and Total Revenue move in the same direction. * Unit Elastic: No change in Total Revenue when price changes. * Graphical Ranges: On a demand curve, the range above the Marginal Revenue ( $MR$ ) curve's positive section is elastic. Where $MR=0$ , it is unit elastic. Where $MR$ is negative, demand is inelastic. * Calculating Coefficients: * ext{Elasticity Coefficient} = rac{ ext{Percentage Change in Quantity}}{ ext{Percentage Change in Price}} * ext{Percentage Change} = rac{ ext{New Value} - ext{Old Value}}{ ext{Old Value}} × 100 * |E| > 1 is elastic; $|E| = 1$ is unit elastic; |E| < 1 is inelastic. * Other Elasticities: * Income Elasticity: rac{ ext{% Change in Quantity}}{ ext{% Change in Income}} . Positive = Normal good; Negative = Inferior good. * Cross-Price Elasticity: rac{ ext{% Change in Quantity of Good A}}{ ext{% Change in Price of Good B}} . Positive = Substitutes; Negative = Complements.
Market Equilibrium and Government Intervention * Equilibrium: The point where Quantity Demanded ( $Q_d$ ) equals Quantity Supplied ( $Q_s$ ). * Surplus: Price is above equilibrium (Q_s > Q_d); prices will fall. * Shortage: Price is below equilibrium (Q_d > Q_s); prices will rise. * Double Shifts: If both curves shift, one axis (Price or Quantity) will be indeterminate unless the magnitude of the shifts is known. * Surplus and Efficiency: * Consumer Surplus: Difference between willingness to pay and actual price. * Producer Surplus: Difference between marginal cost and the actual price received. * Allocative Efficiency: Occurs at equilibrium where total surplus is maximized and there is no Deadweight Loss ( $DWL$ ). * Intervention Consequences: * Binding Price Floor: Set above equilibrium; causes a surplus and $DWL$ . * Binding Price Ceiling: Set below equilibrium; causes a shortage and $DWL$ . * Per-Unit Tax: Shifts supply curve up by the tax amount. Tax revenue = Box between price buyers pay ( $P_b$ ) and price sellers receive ( $P_s$ ). * Tax Incidence: The less elastic party bears more of the tax burden. A perfectly inelastic consumer pays 100% of the tax.
International Trade * World Price: If the world price ( $P_w$ ) is below domestic equilibrium, the country will import the difference between domestic $Q_d$ and domestic $Q_s$ . * Tariffs: A tax on imports that raises the world price, reduces imports, increases producer surplus, generates tax revenue, and creates two triangles of $DWL$ .

Unit 3: Production, Cost, and Perfect Competition

Production Function and Returns * Law of Diminishing Marginal Returns: As more variable resources (labor) are added to fixed resources, the marginal product will eventually decrease. * Returns Phases: Increasing returns (rising marginal product), decreasing returns (falling marginal product), and negative returns (marginal product < 0). * Marginal Cost Relationship: Marginal Cost ( $MC$ ) is the wage divided by marginal product. The $MC$ curve is an upside-down reflection of the marginal product curve.
Cost Curves * Total Costs: Fixed Costs ( $FC$ ) (do not change with output) + Variable Costs ( $VC$ ) (increase with output). * Average Curves: Average Total Cost (ATC = rac{TC}{Q}), Average Variable Cost (AVC = rac{VC}{Q}), and Average Fixed Cost (AFC = rac{FC}{Q}). * Intersection Points: $MC$ always intersects $ATC$ and $AVC$ at their minimum points. * Shifts: Changes in fixed costs shift only $ATC$ . Changes in variable costs shift $ATC$ , $AVC$ , and $MC$ .
Long-Run Costs * Economies of Scale: $LRATC$ is falling; doubling inputs leads to more than double output (increasing returns to scale). * Constant Returns to Scale: $LRATC$ is flat; doubling inputs exactly doubles output. * Diseconomies of Scale: $LRATC$ is rising; doubling inputs leads to less than double output (decreasing returns to scale).
Profit Analysis * Accounting Profit: $ext{Total Revenue} - ext{Explicit Costs}$ . * Economic Profit: $ext{Total Revenue} - ( ext{Explicit Costs} + ext{Implicit Costs})$ . * Normal Profit: Occurs when economic profit is zero ( $TR = ext{Total Opportunity Costs}$ ).
Perfect Competition * Characteristics: Many firms, identical products, no barriers to entry/exit, firms are "Price Takers." * Profit Maximization: All firms produce where $MR = MC$ . * Long-Run Equilibrium: Firms earn zero economic profit (Breakeven). $ATC$ is tangent to the price line ( $P = MR = D = AR$ ). * Market Dynamics: If firms earn economic profit, new firms enter, supply increases, and price falls. If firms earn losses, they exit, supply decreases, and price rises. * Shutdown Rule: A firm will shut down temporarily if Price falls below the minimum $AVC$ (P < AVC).

Unit 4: Imperfect Competition

General Concepts * Price Seekers: Firms must lower price to sell more; therefore, $MR$ falls faster than price ( $MR < D$ ). * Inefficiency: Imperfectly competitive firms are not allocatively efficient ( $P > MC$ ) and create $DWL$ .
Monopoly * Characteristics: One seller, high barriers to entry, unique products. * Economic Profit: Can be maintained in the long run due to entry barriers. * Relative Efficiency: Monopolies charge higher prices and produce lower quantities than perfectly competitive markets. They are neither allocatively nor productively efficient (P > MC; not at min $ATC$ ). * Price Discrimination: Occurs when a firm charges different prices to different consumers for the same good. Perfect price discrimination merges $MR$ with the Demand curve, eliminates consumer surplus, and removes $DWL$ .
Monopolistic Competition * Characteristics: Many sellers, low barriers, differentiated products. * Long-Run Equilibrium: Firms break even ( $ATC$ tangent to $D$ ). Profits lead to entry (shifting firm demand left), while losses lead to exit (shifting firm demand right).
Oligopoly and Game Theory * Oligopoly: Few sellers, high barriers, interdependent behavior. * Payoff Matrix: A tool used to analyze Game Theory. * Sharon Snips and Tuan's Trims Example: * Dominant Strategy: A strategy a player chooses regardless of the opponent's move. (Tuan's Trims: Maintain Price). * Nash Equilibrium: The outcome where neither player has an incentive to deviate. (Lower-right quadrant in the provided matrix). * Collusion: Firms act together like a monopoly to maximize combined profit.

Unit 5: Factor Markets

Demand for Labor * Marginal Revenue Product (MRP): The demand curve for labor. MRP = MR × MP (often Price × Marginal Product in competitive markets). * Derived Demand: Demand for labor is derived from the demand for the product produced.
Market and Firm Relationship * Perfectly Competitive Factor Market: The market sets the wage via Supply and Demand. For the firm, the wage is the Marginal Resource Cost ( $MRC$ ) or Marginal Factor Cost ( $MFC$ ), which is a horizontal line. * Profit Maximizing Hiring: Hire where $MRP = MRC$ .
Monopsony * Definition: A labor market with only one buyer of labor. * Curve Dynamics: The $MRC$ is higher than the Supply curve because hiring an additional worker requires raising the wage for all previous workers. * Outcome: A monopsony hires fewer workers and pays a lower wage than a competitive market, resulting in $DWL$ .
Least-Cost Combination of Resources * Formula: rac{MP_L}{P_L} = rac{MP_k}{P_k} * If the ratio is higher for one resource (e.g., Capital), the firm should hire more of that resource and less of the other.

Unit 6: Market Failures and the Role of Government

Efficiency and Externalities * Social Efficiency: Occurs where Marginal Social Benefit equals Marginal Social Cost ( $MSB = MSC$ ). * Negative Externalities (Spillover Costs): * Production: MSC > MPC. Market overproduces. Correct with a per-unit tax to shift Supply left. * Consumption (e.g., Cigarettes): MPB > MSB. Market overproduces. * Positive Externalities (Spillover Benefits): * Consumption (e.g., Vaccines): MSB > MPB. Market underproduces. Correct with a per-unit subsidy to shift Demand right. * Production (e.g., Safety Training): MPC > MSC. Market underproduces. Correct with a per-unit subsidy to shift Supply right.
Classification of Goods * Rivalry: One person's consumption diminishes the good for others (e.g., a donut). * Excludability: Possible to prevent non-payers from consuming (e.g., a concert arena). * Public Goods: Non-rival and non-excludable (e.g., National Defense). They suffer from the Free Rider Problem, leading to underproduction by the market.
Government Policy and Regulation * Taxes on Firms: * Lump-Sum: Changes $ATC$ only; no change in quantity produced. * Per-Unit: Changes $ATC$ and $MC$ ; changes quantity produced. * Natural Monopolies: Captured when $ATC$ is downward sloping for all relevant output. * Socially Optimal Price: Set where $P = MC$ . Often results in losses for the firm, requiring a lump-sum subsidy. * Fair Return Price: Set where $P = ATC$ . Firm breaks even (zero economic profit). * Anti-Trust Legislation: Designed to encourage competition and limit monopoly power.
Income Distribution and Taxation * Lorenz Curve: Illustrates income distribution. The closer to the 45-degree line of equality, the more equal the distribution. * Gini Coefficient: A numerical measure of inequality. Lower coefficient = more equal. * Tax Types: * Progressive: Higher income earners pay a higher percentage (e.g., U.S. Income Tax). * Regressive: Lower income earners pay a higher percentage of their income (e.g., Sales Tax). * Proportional: Everyone pays the same percentage (Flat Tax).