AP MICRO ECONOMICS EXAM REVIEW

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AP MICROECONOMICS EXAM REVIEW
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Production Possibility Curve
Be sure you know what each point on this graph
represents.
A
B
R o b o t s
C
W
F
D
E
Shoes
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Land, Labor, Capital and Entrepreneurship
Resource or factor Market
Resource Money Payments
Businesses
Households
Money Payments
Product Market
Goods and Services
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Allocative Efficiency
P
MC
MB
Q
Qop
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Market Equilibrium
P r i c e
Supply
Pe
Demand
Qe
Quantity
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A change in Demand versus a change in the
Quantity Demanded

• Change in Demand
• v Moves the curve
• Income
• Future Expectations
• of Buyers
• Consumer Information
• Taste and Preference
• Substitues and Complements

Change in Quantity Demanded v Moves Along the
SAME curve Caused only by Price change.
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A change in Supply versus a change in the
Quantity Supplied

• Change in Supply
• v Moves the curve
• Costs of Production
• Future Expectations
• of Sellers
• Taxes and Subsidies
• Prices of goods using same resources
• Time period of production

Change in Quantity Supplied v Moves Along the
SAME curve Caused only by Price change.
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Consumer and Producer Surplus
v The value in excess of the purchase price
v The income the firm gets in excess of its
marginal costs
P
S
CS
P1
PS
D
Q
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To t a l U t i l i t y
Marginal Utility
TU
When Total Utility is at its peak, Marginal
Utility is zero.
Marginal Utility reflects the change in total
utility so it is negative when Total Utility
declines.
Unit Consumed
M a r g I n a l U t I l I t y
Marginal Utility diminishes with increased
consumption, is zero where total utility is at a
maximum, and is negative when Total Utility
declines.
MU
Unit Consumed
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Price Floor and Price Ceiling
P
S
Surplus
Pf
P1
Pc
Shortage
D
Q
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E i ? Quantity ? Income
Elasticity
Ed change in Qd change in P

DEMAND
E c ? Quantity of X
? Price of Y
CROSS
INCOME
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Law of Diminishing Returns
Total Product
Total Product, TP
Average Product, AP, and Marginal Product, MP
Average Product
Marginal Product
Quantity of Labor
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MONOPOLY P gt MR The firms DEMAND CURVE is
relatively INELASTIC. MR MC  The firms
maximizes profit. P gt ATC  Long Run ECONOMIC
PROFITS. PRODUCTIVE INEFFICIENCY P gt min
ATC  Firm is not forced to operate with maximum
productive efficiency.  (Least-Cost Method
Production not necessary) ALLOCATIVE
INEFFICIENCY  P gt MC  There is an
UNDERALLOCATION of resources.
PURE COMPETITION P MR The firms DEMAND CURVE
is infinitely ELASTIC MR MC  The firms
maximizes profit. P ATC Long Run (NORMAL
PROFITS) PRODUCTIVE EFFICIENCY P min
ATC  Firm is forced to operate with maximum
productive efficiency. (Least-Cost Method
Production) ALLOCATIVE EFFICIENCY P MC There
is an optimal allocation of resources.
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Pure Competition
P
P
S
MRDARP2
p2
MRDARP
pe
D2
D
qe
q2
Q
Q
The Market
Individual firm
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Firm showing Economic Profit
MC
P
MRMC
Economic Profit
AVC
Q
Q1
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Firm showing Economic Loss
P
ATC
MC
MRMC
Economic Loss
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AVC
Q
Q2
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Firm showing Shutdown position
P
MC
AVC
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At no level of output does the firm cover the
Average Variable Costs.
Q
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Long-run Equilibrium For A Competitive Firm
MC
Price
ATC
MRDARP
Pe
Price MC MR Minimum ATC (normal profit)
Qe
Quantity
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Competitive Firm Supply Curve
MC
P
Q
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Single Price Profit-Maximizing Monopoly
MC
P
ATC
Pe
Economic Profit
ATC
D
Q
MR
Qe
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PRICE DISCRIMINATION
A perfectly discriminating monopolist has
MRD, producing more product and more profit!
MC
P
ATC
Price and Costs
MRD
D
Q
Q1
Q2
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Dilemma of RegulationWhich Price?
P
MR MC
Fair-Return Price
Pm
Socially-Optimum Price
Price and Costs
ATC
Pf
MC
Pr
D
MR
Q
Qm
Qf
Qr
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Deadweight loss under monopoly
P
MC ( S under perfect competition)
Deadweight loss
Deadweight Loss (c)RMC (b)Pm Monopolist
price (a)PMC Purely Competitive price
b
Pm
a
Ppc
Producer surplus
c
AR D
MR
O
Qm
Qpc
Q
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PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
MC
Expect New Competitors
ATC
P1
Price and Costs
AC1
Short-Run Economic Profits
D
MR
Q1
Quantity
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PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
MC
ATC
AC2
P2
Price and Costs
Short-Run Economic Losses
D
MR
Q2
Quantity
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PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
MC
Long-Run Equilibrium
Normal Profit Only
ATC
P3 AC3
Price and Costs
D
MR
Q3
Quantity
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Using Game Theory

• Game theory can be used to describe a game when
• There are rules which govern actions
• There are two or more players
• There are choices of action where strategy
  matters
• The game has one or more outcomes
• The outcome depends on the strategies chosen by
  all players, i.e., there is strategic
  interaction.

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Advertising Game
COMPANY Y COMPANY Y COMPANY Y COMPANY Y
COMPANY X Dont Adv. Advertise
COMPANY X Dont Adv. 10,10 2,15
COMPANY X Advertise 15,2 7,7
?Dominant strategies Strategy 1 dominates
Strategy 2 if every payoff from 2 is dominated by
the respective payoff from 1.
Nash equilibrium a set of strategies, one for
each player, such that no player has an incentive
(in terms of improving his own payoff) to deviate
from his strategy, i.e., each player can do no
better given what the opposing player(s) does.
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MRP MP x P
Marginal Revenue Product equals the Marginal
Product times the Price.
v The MRP curve is the resource demand curve. v
Location of curve depends on the productivity and
the price of the product.
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Optimum Combination Of Resources
Least-Cost Combination of Resources
MP of Capital
MP of Labor
Price of Labor
Price of Capital
MPC
MPL

PC
PL
Profit-Maximizing Combination
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Purely Competitive Labor Market Equilibrium
S
Includes Normal Profit
S MRC
(6)
Wc
Wc
6
Labor Costs
D MRP (? mrps)
d mrp
(1000)
(5)
Individual Firm
Labor Market
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Monopsonistic Labor Market
MRC
S
The competitive solution would result in a
higher wage and greater employment.
Wage Rate (dollars)
Wc
Wm
MRP
Qm
Qc
Quantity of Labor
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Spillover Costs And Benefits
P
SMSC
Spillover costs
SMPC
DMB
Overallocation
Q
Q0
Qe
0
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Spillover Costs And Benefits
P
SMC
Spillover Benefits
DMSB
DMPB
Underallocation
Q
Qe
Q0
0
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Two Goals for Tax Systems

• Tax equity The fairness of a tax system.
• Tax efficiency How a tax system maintains the
  incentives to be productive.

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Two Principles of Tax Equity

• Benefits received principle states that a fair
  tax is one that taxes people in proportion to the
  benefits they receive when government spends
  those tax revenues.
• Ability-to-pay principle states that those who
  can afford to pay more taxes than others should
  be required to do so.

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Three Tax Structures

• Progressive tax collects a higher percentage
  of high incomes than of low incomes.
• Regressive tax collects a higher percentage of
  low incomes than of high incomes.
• Proportional tax collects the same percentage
  of income, no matter what the income.

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Efficiency Loss of a tax
P
St
S
a
P2
Efficiency Loss
b
P1
c
D
O
Q
Q1
Q2
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Cumulative of Income
The Lorenz Curve
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Line of Perfect Equality
Degree of Inequality
100
0
Cumulative of families