AP Microeconomics Exam Review Flashcards

Top Things to Know Going into the AP Exam

1. Produce where Marginal Revenue equals Marginal Cost (MR = MC) Units 3 and 4 (Product Market)

2. Hire resources where Marginal Revenue Product equals Marginal Resource Cost (MRP = MRC) or Marginal Factor Cost (MFC) Unit 5 (Resource Market). Remember: Resource = Factor

3. Socially Optimal Level considering externalities is where Marginal Social Benefit equals Marginal Social Cost (MSB = MSC) Unit 6

4. Know SPITE and GOTPEN

   • Remember: Price (of the thing you are analyzing) does NOT shift the curve

   • If you change Price only, you change the QUANTITY demanded (or supplied)

5. Utility Maximization Rule (Unit 1 – Movies and Go Carts)

   • MUx/Px = MUy/Py

   • Consumer’s budget should be spent to meet the above formula

6. Least Cost Rule (Unit 5 – Workers and Robots)

   • MPL/PL = MPR/PR

   • Given business budget should be spent to hire resources to meet the above formula

7. Normal Profit = Zero economic profit

8. Marginal Cost (MC) = Short-run supply curve

9. Allocative Efficiency (AKA Socially Optimal)

   • P = MC (D=MC for Monopoly)

   • D=S for competitive markets

10. Productive Efficiency

    • P = Min ATC

11. Fair Return

    • P = ATC

    • Zero Economic profit (normal profit)

12. In Perfect Competition (constant cost industry), If you are going from Long-Run to Long-Run, the ONLY thing that changes is Quantity in the Industry.

13. Imperfect Competition (Monopoly, Monopolistic Competition, Oligopoly)

    • MR = 0 is when Total Revenue is maximized

    • To the left is Elastic Range of the demand curve

      • Monopolies will only produce in the elastic range

    • To the right is Inelastic Range

    • Unit elastic where MR = 0

14. Oligopoly: Firms are “Mutually Interdependent”

15. Perfect competition: memorize that the firm is a “Price Taker”

16. Perfectly competitive labor market: the firm/worker is a “Wage Taker”

17. What if they give you a perfectly competitive firm’s average revenue but not Price or MR?

    • Remember for Perfectly competitive firm, Mr. Darp. MR = D = AR = P (Demand = Average Revenue = marginal revenue = price)

18. When graphing a perfectly competitive firm (side by side)

    • Make sure your dots go all the way over from industry to firm

19. Negative Externality

    • How do we know there is an externality?

      • Compare Private to Social (MSB > or < MPB) or (MSC or < MPC)

    • How do we know it’s a market failure?

      • At Q free market compare MSC to MSB (MSC > or < MSB)

    • Production externality always has 2 cost curves

    • Consumption externality always has 2 benefit curves

    • Negative externality always produces too much (Q{\text{free market}} > Q{\text{socially optimal}})

    • Positive externality always produces too little (Q{\text{free market}} < Q{\text{socially optimal}})

    • Solution is per unit tax (decreases output to MSB = MSC Quantity) for negative externalities

      • Be careful, not a lump sum tax!

      • Solution could also be government regulation - e.g., requiring pollution reduction equipment

    • Solution is per unit subsidy (increases output to MSB = MSC Quantity) for positive externalities

    • Deadweight loss always points to the socially optimal point (MSB = MSC)

20. Resource market = factor market

21. Lump Sum Tax or Lump Sum Subsidy – Does NOT affect MC therefore does not affect Quantity (output)!!

    • Does affect ATC.

22. Per Unit Tax or Per Unit Subsidy = Will affect MC and therefore quantity (output).

    • Also affects ATC

23. Absolute/Comparative Advantage

    • You CAN have absolute advantage in both (Input = lower number, Output = higher number)

    • You can ONLY have comparative advantage in 1 thing

      • Output – O:OO (Other goes over)

      • Input – I:OU (Other goes under)

24. Accounting profit vs Economic Profit

    • Accounting Profit: Total Revenue – Explicit Costs

    • Economic Profit: Total Revenue – Explicit Costs – Implicit Costs

    • Remember: If they say: “Suppose the firm is earning zero economic profit, what do we know about accounting profit?”

      • We know it is positive. Why? Because accounting profit only subtracts explicit costs while economic profit subtracts explicit costs AND implicit costs.

25. Definition of Law of Diminishing Marginal Returns – Please know this!!

    • As variable resources (workers) are added to fixed resources (ovens, machinery, tools, factory size, etc.), the additional output produced from each additional worker will eventually fall.

    • Initially, the additional output from each additional worker can increase (increasing marginal returns) due to division of labor and specialization.

    • There is no such thing as Diminishing Marginal Returns in the long run because resources are not fixed in the Long Run

26. Shut Down Rule

    • P < AVC (P < Min AVC)

27. Returns to Scale

    • Constant Returns to Scale = Double inputs, get double the output

    • Increasing Returns to Scale = Double inputs, get MORE than double the output

    • Decreasing Returns to Scale = Double inputs, get LESS than double the output

28. Economies of Scale

    • Economies of Scale – Long Run ATC decreases as you produce more (Quantity increases) because of mass production techniques

    • Constant Returns to Scale – Long Run ATC is as low as it can get (stays flat as you produce more)

    • Diseconomies of Scale – Long Run ATC increases as Quantity output increases because firm gets too big and too difficult to manage

      • Note: If they give you a graph and say “Is the firm experiencing economies of scale?” look to see what is happening with LRATC at the profit maximizing quantity. If the LRATC is falling, then the firm is experiencing economies of scale.

29. Price Elasticity of Demand: % change in Quantity demanded / % change in price

30. Price Elasticity of Supply: % change in Quantity supplied / % change in price

    • When you calculate elasticity of supply you will get a positive number For both elasticity of demand and supply - Be careful: Many students mistakenly put price on top!! For both elasticity of demand and supply

    • Answer > 1 = elastic, answer < 1 = inelastic, answer = 1 is unit elastic

    • When you calculate elasticity of demand, you will get a negative number. Leave the negative number in your answer. However, when you make the statement showing that it is <, =, or > than 1, take the absolute value of the number.

31. Cross Price Elasticity: % change in Quantity of product A / % change in price of product B

    • If the answer is positive = substitutes, if negative = complements

32. Income Elasticity: % change in Quantity / % change in Income

    • If the answer is positive = normal goods

    • If the answer is negative = inferior goods

33. Deadweight Loss – Imaginary arrow points to the socially optimal point

34. Natural monopoly

    • ATC is still falling at socially optimal output

    • If government requires natural monopoly to produce at socially optimal level (govt. sets a price ceiling at Quantity socially optimal), company will have a loss and government will need to subsidize

35. Price Discriminating monopoly

    • Charge every person up to their demand curve (up to what they are willing to pay)

    • Several prices

    • More profit

    • No consumer surplus

    • No deadweight loss

    • Higher quantity = socially optimal quantity

36. Monopolistic Competition

    • Long Run = 0 Economic Profit (normal profit)

    • Excess capacity: Gap between the minimum ATC output and the profit maximizing output

37. Game Theory (Oligopoly)

    • Few firms and the firms are “mutually interdependent”

    • If they say in a game theory FRQ, “What market structure is this and how do we know?” The answer is Oligopoly because there are only 2 firms and the firms are mutually interdependent.

    • Dominant Strategy – best move to make regardless of what your opponent does

    • Nash Equilibrium - The optimal outcome that will occur when both firms make decisions simultaneously and have no incentive to change

      • Remember: The way you find the Nash Equilibrium is take the quadrant(s) that has two tick marks after you have figured out the dominant strategy(ies)

38. Two characteristics of Public Goods

    • 1) Non-Exclusion – Can’t keep others from using it

    • 2) Non-rivalrous (shared consumption) – If I’m using something, doesn’t hurt your use of it

39. Why are Public Goods a “market failure?”

    • Private market will not produce enough private goods due to the “free rider problem.” This is when people benefit without paying (like using a road or national defense without paying).

40. Taxes

    • Progressive Taxes – Takes more from the rich – as you make more $, pay a higher % of income in taxes

      • This is often what is used to reduce income inequality (Federal Income Tax = best example)

    • Regressive Taxes – Hurts the poor – As you make more $, pay a lower % of income in taxes

      • Sales tax, gas tax

    • Proportional Taxes (Flat tax) – As you make more $, pay same % of income in taxes

41. MRP – Marginal Revenue Product

    • If a perfectly competitive resource market and given that you’re making a product sold in a perfectly competitive product market, MRP = MP x P where P is the price of the product sold

      • This covers 95% of the questions you’ll get

    • If they tell you that the product is being sold in a market other than perfect competition the formula is MRP = MP x MR (this should be rare in the questions they give you). Couple of things that there is a small chance they could ask you about:

      • Long run supply curve in constant cost industry is horizontal (this is what we learned)

      • Long run supply curve in increasing cost industry (firms bidding up prices) is upward sloping (they don’t ask this too often)

      • Most of the time MRP = MP x P (price of the product). This is for a perfectly competitive product market. If the product market is not perfectly competitive, then the formula is MRP = MP x MR

      • Sunk costs = costs that already happened and you can’t get it back. Costs in the past should not affect what you do in the future. You should only consider the marginal benefit and marginal cost of the future decision (don’t factor in any old “sunk” costs).

      • Economic rent - portion of a resource’s earnings that exceed the resource’s opportunity cost