AP Micro Test
Chapter 1
Economics – the social science concerned with how individuals, institutions, and society make optimal choices under conditions of scarcity
Economic perspective – a viewpoint that envisions individuals and institutions making rational decisions by comparing the marginal benefits and marginal costs associated with their actions
Scarcity – the limits placed on the amounts and types of goods and services available for consumption as the result of there being only limited economic resources from which to produce output; the fundamental economic constraint that creates opportunity costs and that necessitates the use of marginal analysis to make optimal choices
Opportunity cost – the amount of other products that must be forgone or sacrificed to produce a unit of a product
Utility – the want-satisfying power of a good or service; the satisfaction or pleasure a consumer obtains from the consumption of a good or service
Marginal analysis – the comparison of marginal (extra) benefits and marginal costs, usually for decision making
Scientific method – the procedure for the systematic pursuit of knowledge involving the observation of facts and the formulation and testing of hypotheses to obtain theories, principles, and laws
Economic principle – a widely accepted generalization about the economic behavior of individuals or institutions
Other-things-equal assumption (ceteris paribus) – the assumption that factors other than those being considered are held constant
Microeconomics – the part of economics concerned with decision making by individual units such as a household, firm, or industry and individual markets, specific goods and services, and product and resource prices
Macroeconomics – the part of economics concerned with the performance and behavior of the economy as a whole. Focuses on economic growth, the business cycle, interest rates, inflation, and the behavior of major economic aggregates such as the household, business, and government sectors
Aggregate – a collection of specific economic units treated as if they were one unit
Positive economics – the analysis of facts or data to establish scientific generalizations about economic behavior (what is)
Normative economics – the part of economics involving value judgments about what the economy should be like; focused on which economic goals and policies should be implemented; policy economics (what ought to be)
Economizing problem – the choices necessitated because society’s economic wants for goods and services are unlimited but the resources available to satisfy these wants are limited
Budget line – a line that shows the different combinations of two products a consumer can purchase with a specific money income, given the products’ prices
Economic resources – the land, labor, capital, and entrepreneurial ability that are used to produce goods and services. Also known as the factors of production
Land – refers to any and all natural resources that are used to produce goods and services
Labor – any mental or physical exertion on the part of a human being that is used in the production of a good or service.
Capital – man-made physical objects and intangible ideas that do not directly satisfy human wants but which help to produce goods and services that do satisfy human wants; also called capital goods.
Four economic resources – land, labor, capital, entrepreneurial ability
Investment – expenditures that increase the volume of physical capital and intangible ideas that help to produce goods and services
Intangible examples – formulas, processes, algorithms
Consumer goods – products and services that satisfy human wants directly
Capital goods – human-made resources used to produce goods and services; goods that do not directly satisfy human wants; also called capital
Entrepreneurial ability – the human resource that combines the other economic resources of land, labor, and capital to produce new products or make innovations in the production of existing products; provided by entrepreneurs
Entrepreneurs – individuals who provide entrepreneurial ability to firms by setting strategy, advancing innovations, and bearing the financial risk if their firms do poorly
Factors of production – the four economic resources
Production possibilities curve – a curve showing the different combinations of two goods or services that can be produced in a full-employment, full-production economy where the available supplies of resources and technology are fixed
Law of increasing opportunity costs – the principle that as the production of a good increases, the opportunity cost of producing an additional unit rises
Economic growth – the outward shift in the production possibilities curve that results from an increase in resource supplies or quality or an improvement in technology; an increase of real output or real output per capita
Optimal output – MB=MC
MB – marginal benefit
MC – marginal cost
Economic growth is the result of what – increases in supplies of resources, improvements in resource quality, and technological advances
Scientific method consists of – observing real-world behavior and outcomes, forming a hypothesis, testing the hypothesis, modifying hypothesis, continuing to test and modify
Chapter 2
Economic system – a particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem; a method of organizing an economy, of which the mark system and the command system are the two general types
Laissez-faire capitalism – a hypothetical economic system in which the government’s economic role is limited to protecting private property and establishing a legal environment appropriate to the operation of markets in which only mutually agreeable transaction take place between buyers and sellers
Command system – a method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities; socialism; communism
Market system – all the product and resource markets of a market economy and the relationships among them
Market – any institution or mechanism that brings together buyers and sellers of a particular good or service
Private property – the right of private persons and firms to obtain, own, control, employ, dispose of, and bequeath land, capital and other property
Freedom of enterprise – the freedom of firms to obtain economic resources, to use those resources to produce products of the firms’ own choosing, and to sell their products in markets of their choice
Freedom of choice – the freedom of owners of property resources to employ or dispose of them as they see fit, of workers to enter any line of work for which they are qualified, and of consumers to spend their incomes in the manner that they prefer
Self-interest – that which each firm, property owner, worker, and consumer believes is best for itself and seeks to obtain
Competition – the effort and striving between two or more independent rivals to secure the business of one or more third parties by offering the best possible terms
Specialization – the use of the resources of an individual, a firm, a region, or a nation to concentrate production on one or a small number of goods and services
Division of labor – the separation of the work required to produce a product into a number of different tasks that are performed by different workers; specialization of workers
Medium of exchange – any item sellers generally accept and buyers generally use to pay for a good or service; money; a convenient means of exchanging goods and services without engaging in barter
Barter – the direct exchange of one good or service for another good or service
Money – any item that is generally acceptable to sellers in exchange for goods and services
Consumer sovereignty – the determination by consumers of the types and quantities of goods and services that will be produced with the scarce resources of the economy; consumers; direction of production through their dollar votes
Dollar votes – the “votes” that consumers cast for the production of preferred products when they purchase those products rather than the alternatives that were also available
Creative destruction – the hypothesis that the creation of new products and production methods destroys the market power of existing monopolies
Invisible hand – the tendency of competition to cause individuals and firms to unintentionally but quite effectively promote the interests of society even when each individual or firm is only attempting to pursue its own interests
Circular flow diagram – an illustration showing the flow of resources form households to firms and of products from firms to households. Accompanied by reverse flows of money from firms to households and from households to firms
Households – economic entities that provide resources to the economy and use the income received to purchase goods and services that satisfy economic wants
businesses – economic entities that purchase resources and provide goods and services to the economy
sole proprietorship – and unincorporated firm owned and operated by one person
partnership – an unincorporated firm owned and operated by two or more persons
corporation – a legal entity chartered by a state or the federal government that is distinct and separate form the individuals who own it
product market – a market in which products are sold by firms and bought by households
resource market – a market in which households sell and firms buy resources or the services of resources
residual claimant – in a market system, the economic agent who receives whatever profit or loss remains at a firm after all other input providers have been paid. The residual is compensation for providing the economic input of entrepreneurial ability and flows to the firm’s owners
Bury Notes Ch. 1 and 2
Scarcity def
Opportunity cost – anything you give up to do something else
Purposeful behavior
Economics assumes “rational self-interest”
People allocate their time, energy, and money to maximize their satisfaction
NOT the same as selfishness
Utility – the amount of satisfaction from consuming a good or service
Marginal analysis: comparing benefits and costs
Marginal cost of the 1 carat I the additional expense beyond the cost of the ½ carat
Marginal benefit is the perceived lifetime pleasure (utility) of the larger diamond
Scarcity means that the opportunity costs also factor into marginal analysis
Economics uses scientific method to come up with theories, principles, and models
Economics says when the price falls consumers buy more of a product
Firm = business
Economizing problem – choices needed because of society’s unlimited wants but limited resources
Maximum utility is only achieved if a combination of products on the budget line is chosen
Increase in income – budget line shift to right
Capital – factories, storage, transport, tools, machinery
Entrepreneurial ability – the human resource that combines the other economic resources to produce new products or make innovations and also bear the financial risk if their firms do poorly (owners of business)
Assumptions of PPM: full employment, fixed resources, fixed technology, two goods
Marginal cost – the additional from one value to the next when producing another unit of a good or service
Economic systems differ as to who owns the factors of production and method to motivate, coordinate, and direct economic activity
Command system – communism/socialism
Market system has some government economic interventions over somethings and somethings none, can own resources
Government sets rules for economic activity, provides certain goods and services that go un/underproduced and modifies the distribution of income
What will be produced? The goods and services that can be produced at a continuing profit will be produced those that don’t will be discontinued
Profits and losses are the difference between total revenue TR from the total cost TC of producing and selling a good or service
TR>TC expansion of production
TC>TR reduced production and exit of resources
Who will get the output – distributed based on if they want to buy it and if they can buy it
How will the system promote progress? – society desires economic growth and higher standards of living
Chapter 3
Demand – a schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time
Demand schedule – a table of numbers showing the amounts of a good or service buyers are willing and able to purchase at various prices over a specified period of time
Law of demand – the principle that, other things equal, an increase in a product’s price will reduce the quantity of it demanded, and conversely for a decrease in price
Diminishing marginal utility – the principle that as a consumer increases the consumption of a good or service, the marginal utility obtained from each additional unit of the good or service decreases
Income effect – a change in the quantity demanded of a product that results from the change in real income caused by a change in the product’s price
Substitution effect – a change in the quantity demanded of a consumer good that results form a change in its relative expensiveness caused by a change in the good’s own price. The reduction in the quantity demanded of the second of a pair of substitute resources that occurs when the price of the first resource falls and causes firms that employ both resources to switch using more of the first resource and less of the second resource
Demand curve – a curve that illustrates the demand for a product by showing how each possible price (y) is associated with a specific quantity demanded (x)
Determinants of demand – factors other than price that determine the quantities demanded of a good or service. Also referred to as demand shifters because changes in the determinants of demand will cause the demand curve to shift either right or left
Normal good – a good or service whose consumption increases when income increases and falls when income decreases, price remaining constant
Inferior good – a good or service whose consumption declines as income rises, prices held constant
Substitute goods – products or services that can be used in place of each other.
Complementary goods – products and services that are used together
Change in demand – a movement of an entire demand curve or schedule such that the quantity demanded changes at every particular price; caused by a change in one or more of the determinants of demand
Change in quantity demanded – a change in the quantity demanded along a fixed demand curve as a result of a change in the price of the product
Supply – a schedule or curve that shows the various amounts of a product that producers are wiling and able to make available for sale at each of a series of possible prices during a specified period of time
Supply schedule – a table of numbers showing the amounts of a good or service producers are willing and able to make available for sale at each of a series of possible prices during a specified period of time
Law of supply – the principle that an increase of the price of a product will increase the quantity of it supplied, and conversely for a price decrease
Supply curve – a curve that illustrates the supply for a product by showing how each possible price is associated with a specific quantity supplied
Determinants of supply – factors other than price that determine the quantities supplied of a good or service. Also referred to as supply shifters because changes in the determinants of supply will cause the supply curve to shift either right or left
Change in supply – a movement of an entire supply curve or schedule such that the quantity supplied changes at every particular price
Change in quantity supplied – a change in the quantity supplied along a fixed supply curve as a result of a change in the product’s price
Equilibrium price – the price in a competitive market at which the quantity demanded and the quantity supplied are equal, there is neither a shortage nor a surplus, and there is no tendency for price to rise or fall
Equilibrium quantity – the quantity at which the intentions of buyers and sellers in a particular market match at a particular price such that the quantity demanded and the quantity supplied are equal; the profit maximizing output of a firm
Surplus – the amount by which the quantity supplied of a product exceeds the quantity demanded at a specific price
Shortage – the amount by which the quantity demanded of a product exceeds the quantity supplied at a particular price
Productive efficiency – the production of a good in the least costly way; occurs when production takes place at the output at which average total cost is a minimum and marginal product per dollars’ worth of input is the same for all inputs
Allocative efficiency – the apportionment of resources among firms and industries to obtain the production of the products most wanted by society; the output of each product at which its MC and MB are equal
Price ceiling – a legally established maximum price for a good, or service
Price floor – a legally established minimum price for a good or service
Chapter 3 Bury
Why is there an inverse relationship between price and quantity demanded? People buy more of a product at a low price than higher one, as consumers increase the consumption of a good or service the marginal utility decreases
Demand curve – price on y axis, quantity on x axis
Determinants of demand – consumer tastes, number of buyers in market, consumers’ incomes, price of related goods, consumer expectations
Changes in demand happen when one of the determinants occurs
Change in quantity demanded – movement along the existing curve
Chapter 4
Market failure – the inability of a market to bring about the allocation of resources that best satisfies the wants of society; in particular, the overallocation or under allocation of resources to the production of a particular good or service because of externalities, asymmetric information, or because markets fail to provide desired public goods
Total surplus – the sum of consumer surplus and producer surplus; a measure of social welfare; also known as social surplus
Social surplus – the sum of consumer surplus and producer surplus; a measure of social welfare; also known as total surplus
Consumer surplus – the difference between the maximum price a consumer is willing to pay for an additional unit of a product and its market price, the triangular area below the demand curve and above the market price
Producer surplus – the difference between the actual price a producer receives and the minimum acceptable price; the triangular area above the supply curve
Productive efficiency – the production of a god in the least costly way; occurs when production takes place at the output level at which per-unit production costs are minimized
Allocative efficiency – the apportionment of resources among firms and industries to obtain the production of the products most wanted by society; the output of each product at which its marginal cost and marginal benefit are equal, and at which the sum of consumer surplus and producer surplus is maximized
Total surplus – the sum of consumer surplus and producer surplus; a measure of social welfare; also known as social surplus
Efficiency loss – reductions in combined consumer and producer surplus caused by an under allocation or overallocation of resources to the production of a good or service. Also called dead-weight loss
Deadweight loss – reductions in combined consumer and producer surplus caused y an under allocation or overallocation of resources to the production of a good or service. Also called efficiency loss
Externality – a cost or benefit from production or consumption that accrues to someone other than the immediate buyers and sellers of the product being produced or consumed
Negative externality – a cost imposed without compensation on third parties by the production or consumption of sellers or buyers. Example: a manufacturer dumps toxic chemicals into a river, killing fish prized by sports fishers. Also known as an cost or a spillover cost
Positive externality – a benefit obtained without compensation by third parties from the production or consumption of sellers or buyers. Example: a beekeeper benefits when a neighboring farmer plants clover.
Coase theorem – the idea, first stated by economist Ronald Coase, that some externalities can be resolved through private negotiations among the affected parties
Direct controls – government policies that directly constrain activities that generate negative externalities. Examples include maximum emissions limits for factory smokestacks and laws mandating the proper disposal of toxic wastes
Ch. 4 Bury
Externalities affect 3rd parties that may not be involved in the situation. Positive ex. Society benefiting from people paying to go to college
Negative ex. People smoke and others get second-hand smoke
Negative leads to overproduction
Positive leads to an underproduction
Moral hazard problem – people that have insurance will act more recklessly
Chapter 5
Cost benefit analysis – a comparison of the marginal costs of a project or program with the marginal benefits to decide whether or not to employ resources in that project or program and to what extent
Bury chapter 5
Private goods have rivalry and excludability. Ex. Pizza
Public goods have nonrivalry and nonexcludability. Ex. Street lights
Bury Chapter 6
Elasticity of demand – the ratio of the percentage change in quantity demanded of a product or resource to the percentage change in price
Inelastic product – gas
Elastic product – steak
Degree to which demand is price elastic or inelastic
Ed = change in quantity divided by change in price
Sum of quantities/2 sum of two prices/2
Elastic demand – Ed >1
Inelastic demand – Ed <1
Unit elasticity – Ed=1
Perfectly inelastic – Ed=0
Perfectly elastic – Ed = infinity
Determinants of price elasticity of demand – substitutability (if it can be replaced by another company/product), proportion of income (changes in expensive products are elastic, cheap products are usually inelastic), luxuries versus necessities (necessities are inelastic, luxuries are more elastic), time (products become more elastic over time because if it costs more for more time your spending even more money than you would at old cost)
Price elasticity of supply
Immediate market period – length of time over which producers are unable to respond to a change in price with a change in quantity supplied, supply curve will be perfectly inelastic
Short run – a period of time too short to change plant capacity but long enough to use the fixed sized plant more intensively or less intensively
Long run – a period of time long enough for firms to adjust their plant sizes and for new firms to enter or existing firms to leave the industry
Cross elasticity of demand
Exy = %change quantity demanded of product Z
% change price of product Y
Complementary good- cross elasticity is negative
Independent goods – a 0 or near 0 cross elasticity
Normal goods – income elasticity is positive
Inferior goods – negative income elasticity
Income elasticity of demand
Ei = %change quantity demanded
%change of income
Law of Diminishing Marginal Utility
The principle that as a consumer increases the consumption of a good or service, the marginal utility obtained from each additional unit of the good or service decreases
Ex. Getting a car will give a huge amount of utility but any additional utils for a second or third car will be very small in comparison for most people
Three Characteristics of Utility
“Utility” and “Usefulness” are not synonymous. A Picaso painting will provide an art connoisseur lots of utility, but it is functionally useless
Utility is subjective (Not everyone needs a Ford F-150 for instance)
Utility is difficult to quantify (But for the sake of learning we’ll assume it can be measured in utils)
Total Utility and Marginal Utility
Total Utility is the total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a good or service
Marginal Utility is the extra satisfaction a consumer gains from an additional unit of that product
(Notice how Total Utility peaks and starts to decline right as Marginal Utility crosses the X-Axis
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Marginal Utility and Demand
The law of diminishing marginal utility explains why the demand curve for a given product slopes downward. If each additional unit of a good yields smaller and smaller amounts of marginal utility then consumers will only buy additional units of a product if the price falls
Theory of Consumer Behavior
Diminishing marginal utility also explains how consumers allocate their incomes among the many goods and services available for purchase
Consumer Choice and the Budget Constraint
(For simplicity we will make the following assumptions about consumers)
Rational Behavior: consumers try to use their income to derive the greatest amount of utility from it. Consumers want to maximize their total utility.
Preferences: each consumer has clear cut preferences for certain goods and services that are available in the market. Buyers also have a good idea of how much marginal utility they get from each unit of the product they might purchase.
Budget Constraint: at any point in time the consumer has a fixed limited amount of income
Prices: goods are scarce relative to the demand for them, so every good carries a price tag. We also assume that the price of each good is unaffected by the amount purchased by any one particular person. Consumers must compromise, they must choose the most personally satisfying mix of goods and services
Utility Maximizing Rule
The principle that to obtain the greatest total utility, a consumer should allocate income so that the last dollar spent on each good or service yields the same marginal utility (MU). For two goods, X and Y, with prices Px and Py Total Utility (TU) will be maximized when (MUx / Px) = (MUy / Py)
This “balance” is called consumer equilibrium
Take note that the equation above is literally measuring Marginal Utility per Dollar
Just remember. . .
Utility Maximizing Rule: =