AP Microeconomics Study Guide

Unit 1 - Basic Economic Concepts

• Scarcity:

  • Fundamental concept in economics referring to the limited availability of resources compared to unlimited human wants.
  • Applies to all resources, not just financial (e.g. air, water).
  • Economic Problem: Unlimited wants vs. limited resources leads individuals to make choices on resource allocation.

• Microeconomics vs. Macroeconomics:

  • Microeconomics: Focuses on individuals and firms, examining how their choices affect resource allocation and the overall economy.
  • Macroeconomics: Examines the economy as a whole; studies national economic performance, including aggregate variables like money supply and national income.

• Factors of Production:

  • Land: Natural resources (water, oil, minerals).
  • Labor: Human physical effort and skill.
  • Capital:
  • Physical Capital: Tools and equipment used in production.
  • Human Capital: Skills and education of workers.
  • Entrepreneurship: Ability to coordinate production of goods and services.

• Opportunity Costs and Trade-offs:

  • Trade-offs: The alternatives forgone when making decisions.
  • Opportunity Cost: The cost of the next best alternative when making a choice.

• Positive vs. Normative Economics:

  • Positive Economics: Based on factual analysis and testable hypotheses.
  • Normative Economics: Based on subjective opinions and values of researchers.

• Resource Allocation and Economic Systems:

  • Addresses three key questions:
  1. What goods/services to produce?
  2. How to produce these goods/services?
  3. For whom are these goods/services produced?
  • Types of Economic Systems:
  • Centrally-Planned (Command): Government makes all economic decisions.
  • Market Economy: Decisions defined by interactions of consumers and producers; pricing is driven by supply and demand.
  • Mixed Economy: Combination of market and planned economies; allows for private property with government intervention.

• Production Possibilities Curve (PPC):

  • Tools to illustrate trade-offs and opportunity costs.
  • Depicts maximum possible output combinations between two goods produced with fixed resources.
  • Types of Costs:
  • Constant Opportunity Cost: Straight-line PPC.
  • Increasing Opportunity Cost: Curved PPC.

Unit 2 - Supply and Demand

• Demand:

  • Definition: Quantity consumers are willing to purchase at different prices.
  • Law of Demand: As price increases, demand typically decreases, and vice versa.
  • Determinants of Demand:
  • Tastes and preferences, related goods, income, number of buyers, expectations.
  • Substitutes vs. Complements:
  • Substitutes: Goods that replace each other (e.g., tea and coffee).
  • Complements: Goods consumed together (e.g., hamburgers and buns).

• Supply:

  • Definition: The amount of goods producers are willing to sell at different prices.
  • Law of Supply: Price increases lead to increased quantity supplied.
  • Shifters of Supply:
  • Costs of production, technology, taxes, subsidies, number of suppliers.

• Price Elasticity of Demand:

  • Measures the responsiveness of quantity demanded to price changes.
  • Elastic Demand: Sensitive to price changes (>1).
  • Inelastic Demand: Less responsive to price changes (<1).
  • Equation: E_d = rac{ ext{%Change in Quantity Demanded}}{ ext{%Change in Price}}

• Market Equilibrium:

  • Occurs at the price where quantity supplied equals quantity demanded.
  • Consumer Surplus: Difference between what consumers are willing to pay and what they actually pay.
  • Producer Surplus: Difference between the price producers receive and the minimum they would accept.

• Government Intervention:

  • Price floors (minimum prices) lead to surpluses, while price ceilings (maximum prices) lead to shortages.
  • Quotas: Limit quantities that can be produced or sold.

Unit 3 - Production, Cost, and the Perfect Competition Model

• Production Function:

  • Relationship between input quantities used and quantities produced.
  • Key Terms:
  • Fixed Input: Quantity doesn’t change.
  • Variable Input: Quantity can change.
  • Marginal Product: Change in output resulting from a change in input.

• Costs in the Short Run:

  • Fixed Costs: Do not change with output level.
  • Variable Costs: Change with output level.
  • Total Cost: Sum of fixed and variable costs.

• Long-Run Costs:

  • All inputs are variable; firms optimize costs.
  • Economies of Scale: Cost per unit decreases as production increases.
  • Diseconomies of Scale: Cost per unit increases as production increases.

• Profit Maximization:

  • Achieved where marginal revenue (MR) equals marginal cost (MC): $MR = MC$.

Unit 4 - Imperfect Competition

• Monopoly:
  • A market structure with a single producer. No close substitutes exist.
  • Price is set where MR = MC, resulting in allocative inefficiency.
• Monopolistic Competition:
  • Many firms with differentiated products.
  • Firms can make short-term profits; long-term equilibrium results in normal profits.
• Oligopoly:
  • Few firms dominating the market.
  • Firms are interdependent and affected by each other’s actions.

Unit 5 - Factor Markets

• Factor Markets:

  • Market where services of factors of production are bought and sold (e.g., labor).
  • Marginal Revenue Product (MRP): Extra revenue generated by employing one more unit of labor.

• Monopsony:

  • A market with one buyer leading to lower wages than in a competitive market.

Unit 6 - Market Failure and Government Role

• Market Failure: Occurs when resources are not allocated efficiently (MSC does not equal MSB).
• Externalities: Costs or benefits affecting third parties not directly involved in the transaction.
  • Positive Externalities: Benefits to others (e.g., education).
  • Negative Externalities: Costs imposed on others (e.g., pollution).
• Public Goods: Non-rivalrous and non-excludable, leading to underproduction issues (e.g., national defense).
• Government Intervention: Includes taxes, subsidies, and regulations to correct market failures.