AP MICROECONOMICS: AP TEST REVIEW

Unit 1: Intro to Microeconomics: Chapter 1, 2, and 5 1. Define ECONOMICS a. the social science concerned with how individuals, institutions, and society make the best choices under conditions of scarcity 2. Define and identify OPPORTUNITY COSTS a. To obtain one thing, society must forgo the opportunity of getting the next best thing. That sacrifice is the opportunity cost of the society. The basic problem that economics study is that of choice. Since our wants are unlimited and the productive capacity of our economy is limited, we must choose to produce the things we want at the expense of things we want less. b. If you study for two hours, your trade-offs/opportunity costs are making $8.00 an hour at KFC ($16 profit), or $6.00 an hour babysitting ($12 profit), or 2 hours of sleep, ect. 3. Understand the MB=MC RULE P MC a. When producing, your optimal level of output is where your Marginal Benefits (extra benefits of producing one more unit) equals your Marginal Costs (extra costs of producing one more unit). E The point of interception on a graph of your MB Marginal Benefits and Marginal Costs is the Equilibrium Point. Optimal Quantity Q 4. Characteristics and role of incentives in the MARKET SYSTEM a. Aka Capitalism. Private ownership of factors of production and prices (supply and demand) are used to direct economic activity b. Characteristics: c. Private Property capital and land owned privately, also freedom to negotiate binding legal contracts. Private rights encourage investments, innovation, and facilitate change. d. Freedom of Enterprise and Choice Freedom of enterprise allows individuals and firms to produce; freedom of choice allows buyers and sellers to make choices regarding production and consumption. e. Self-Interest Each economic unit attempts to achieve its goal, at the same time delivering something of values to others like goods and services f. Competition among economic units, competition exists. Requires two or more sellers to independently compete in the marketplace, freedom of sellers and buyers to enter and exit the marketplace. Regulatory forces in the market system are taxes, limits, ect. g. Market and Prices Market systems convey decisions made by buyers and sellers of products and resources. Market system itself is the coordinating and organizing mechanism. Allows for communication between buyers and sellers. How? A high number of buying shows the price is too low and a low amount of buying shows the price is too high.

AP MICROECONOMICS: AP TEST REVIEW

h. Technology and Capital Goods Market system encourages the use and rapid development of complex capital goods. This allows for greater efficiency and more output. i. Specialization individuals, firms, regions, or nations produce one or a few good or services rather than the entire range. This allows for greater efficiency. i. Division of Labor human specialization makes use of differences in ability, fosters learning by doing, and saves time ii. Geographic specialization regional and international basis, Florida makes only oranges and Honduras makes only bananas, rather than both FLordia and Honduras make both for themselves. j. Use of Money money is a medium of exchange that facilitates trade; barter exchange/trading goods is problematic because it requires coincidence of wants between buyers and sellers; money must be acceptable to sellers in an exchange; it is sociably defined; global currency differences can lead to trade complications. k. Active, but Limited, Government government has limited role, but addresses market failures in order to increase the effectiveness of the market system. 5. Understanding the concept of COMPARATIVE ADVANTAGE and what it encourages. a. A nation has a comparative advantage when it can produce a product at a lower domestic opportunity costs that can a potential trading partner. b. Specialization and international trade increase the productivity of a nations resources and allow for greater total output than would be possible without trade. In short, they can operate at lower opportunity costs. 6. Be able to calculate COMPARATIVE ADVANTAGE and OPPORTUNITY COST. a. See the two charts below for production possibility for US and Mexico US PRODUCTION POSSIBILITIES A B C D E APPLES 0 5 15 30 90* ORANGES 30* 15 5 2 0 PRODUCTION POSSIBILITIES A B C D E APPLES 0 5 10 15 20 ORANGES 4 3 2 1 0 b. If you look at how much can be produced, US will always out produce Mexico, giving them an ABSOLUTE ADVANTAGE. See arrows for reasoning, but when looking at comparative advantage, you need to look at who gives us the least in opportunity costs. To calculate the opportunity costs forgone by each, take one production possibility set (like C) and calculate how much of the other product that they would give up by producing the other. See the diagram below: MEXICO

AP MICROECONOMICS: AP TEST REVIEW

Must give up 2 Must give up 10 oranges to make 10 apples to make 2 apples (1/5). oranges (5). US Must give up 5 US Must give up 15 oranges to make 15 apples to make 5 apples (1/3). oranges (3). COMPARATIVE Mexico has the COMPARATIVE US has the lower ADVANTAGE lower opportunity ADVANTAGE opportunity cost, costs, so they so they should should make the make the oranges. apples. 7. Shape of PPC and explanation of this shape. What does the PPC illustrate? a. The PPC (Production Possibility Curve) has 4 assumptions: i. full employment of resources ii. resources fixed in terms of quantity/quality iii. fixed technology iv. only two goods being produced (one consumer and one capital pizza and robots) b. Constant Opportunity Costs Increasing Opportunity Costs 9 8 7 6 5 4 3 2 1 APPLES MEXICO ORANGES MEXICO

A Maximum Level of Output

Robots

Inefficient Levels of = Unemployment Production 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Pizzas

9 8 7 6 5 4 3 2 1

Unattainable Levels of Production Growth

1 2 3 4 5 6 7 8 9 10 11 12 13 14

c. The PPC illustrates two main things: i. efficiency each point on the curve represents the max output of the two products ii. underutilization points inside the curve imply that resources are not being used to full potential 8. How do gains from trade affect the PPC? a. If you gain from a trade, your PPC will show growth, like the example on the right, allowing producing more of the good you specialize in.

AP MICROECONOMICS: AP TEST REVIEW

Unit 2: Supply and Demand: Chapter 3, 18, and 19 1. Understand the LAW OF DEMAND and the LAW OF SUPPLY. a. Law of Demand inverse relationship between price and quantity demanded. States that as the price increases, the quantity demanded decreases. Why? People buy less at higher prices and more at lower prices (Black Friday). b. Law of Supply direct/positive relationship between price and quantity supplied. States that as the price increases, the quantity supplied increases. Why? More people are willing to work at $25 an hour that $5 an hour (labor). Demand for Chocolate 2. What are the causes of change in SUPPLY and DEMAND? P a. Income (graph) i. Minimum Wage is increased, so everyone has more money ii. consumer income increases, demand increases iii. consumer income decreases, demand decreases Market Size i. size of market increases, demand increases P ii. size of market decreases, demand decreases Consumer Tastes (graph) i. People begin to cry when the chocolate diet doesnt work. ii. consumer tastes increase, demand increases iii. consumer tastes decrease, demand decreases Consumer Expectations i. consumer expectations increase, demand P increases ii. consumer expectations decreases, demand decreases Substitute Goods good or service that can be used in place of another good or service (graph) i. Chips (substitute for chocolate) are very popular. ii. demand for substitute increases, demand P decreases iii. demand for substitute decreases, demand increases Complementary Goods goods that are used together (graph) i. Marshmallows (complement b/c of smores) are very popular. ii. demand for complementary good increases, demand increases iii. demand for complementary good decreases, demand decreases

b.

c.

d.

e.

f.

AP MICROECONOMICS: AP TEST REVIEW

5 Supply of Wooden Dolls

g. Input Costs (graph) P i. price of wood decreases ii. increase in input costs, supply decreases iii. decrease in input costs, supply increases h. Labor Productivity i. productivity of workers increases, supply increases P ii. productivity of workers decreases, supply decreases i. Government Action (graph) (graph) i. government lowers wood tax ii. excise tax taxes on the production/sale of certain goods iii. new tax or amount of tax increases, supply decreases iv. amount of tax decreases, supply P increases v. government lessens subsidy of wood vi. subsidy government payment for part of production costs vii. amount of subsidy decreases, supply decrease viii. new subsidy or amount of subsidy increase, supply increases j. Technology P i. new wooden dolls machine created ii. new technology, supply increases k. Producers Expectations i. if producers expect a future price increase, they will withhold current supply causing supply to decrease ii. think of pumpkins, why sell in August P when you can make much more money closer to Halloween l. Number of Producers i. a depression causes wood doll shops to close ii. as more producers enter the industry, the supply increases iii. as more producers leave the industry, the supply decreases

AP MICROECONOMICS: AP TEST REVIEW

3. Understand COMPLEMENTARY GOODS. a. The easiest way to understand complementary goods and substitutive goods is by thinking with common sense. b. If I give you a complement (say that you look nice today), you will thank me and feel good. A complementary good works just like this, it helps another good out by working with it. When its demand goes up, the complementary goods demand also goes up, and vice versa. c. If you have a substitute teacher for a day in econ (remember, youre an AP student, so anyway you dont spent learning is a bad day!) you will be sad and depressed, hopelessly lost without our wonderful teacher. Substitute goods feel the same, when one does good, the other must be doing bad. When the demand for one good increase, the demand for the substitute must decrease. 4. Show SHIFTS in the supply and demand curves. a. See number 2 (What are the causes of change in SUPPLY and DEMAND?) 5. What is the shape of a PERFECTLY INELASTIC DEMAND CURVE? a. A perfectly inelastic demand curve is shown to the P right. One thing to note is its vertical line shape. The S understanding that we gain from this is that no matter the price, $5 or $500, people are willing to buy it. No good in the modern world is a perfectly inelastic, but many come close. Think of insulin. A diabetic must have their insulin shot or they may die, therefore, they are willing to pay any amount of D money to keep themselves alive. The only way to affect the price of the good/service is to change the Q supply. low quantity demanded, 6. Understand MARKET EQUILIBRIUM. high quantity supplied a. You market equilibrium is the point where the P supply and demand curve meet. At this point, the S Price to optimal price and quantity are reached. Surplus b. If you operate at a point with a price to high, you high will form a surplus. Equilibrium c. If you operate at a point with a price to low, you Point will form a shortage. Shortage Price to d. Disequilibrium is any point on the graph except the low D equilibrium point. At every disequilibrium point, you will not be operating efficiently. high quantity demanded, Q 7. What will cause a MARKET SURPLUS? low quantity supplied a. A price to high, because you have no demand and too much product (see graph) 8. What will happen to price if there is a SHORTAGE? a. A price to low, because you have too much demand and no product (see graph)

AP MICROECONOMICS: AP TEST REVIEW

9. Know how to calculate PRICE ELASTICITY of demand. Understand the value of the PRICE ELASTICITY COEFFICIENT. a. Price elasticity is measuring the responsiveness to price changes. b. A formula for measuring this is: c. d. Another way to state it would be: e. Once you have figured out your answer, you then use the Price Elastic Coefficient to find if it is relatively elastic or inelastic. The ranges are listed below: g. Elastic: Price Elasticity of Demand > 1 h. Inelastic: Price Elasticity of Demand < 1 i. Unit Elastic: Price Elasticity of Demand = 1 10. Understand the FACTORS affecting ELASTICITY OF SUPPLY. a. If a producer is relatively responsive to changes in price, the supply is more elastic. b. If a producer is relatively unresponsive to change in price, the supply is more inelastic. c. Measuring the elasticity of supply is the same as demand. d. The degree of price elasticity of supply depends on how quickly/easily production resources can be shifted between alternate uses. e. When you think of tickets to a concert, can a supplier P magically supply more space in the short run? No, so the supply is going to be inelastic b/c it doesnt change. 11. Explain ELASTICITY of the demand curve. a. The easiest way to show the difference between the elastic and inelastic shape of demand curve is through a visual. The orange section represents the inelastic demand curve and the green represents the elastic section. The black line is a unit elastic demand curve and the orange and green lines are the perfectly inelastic and perfectly elastic, respectfully. b. For example, the dotted red line is in the green section, which represents elasticity, meaning that the line is relatively elastic. 12. Define UTILITY and the THEORY OF CONSUMER BEHAVIOR. a. Utility is the satisfaction/use that the consumer gets when he/she uses the product. b. The theory of consumer behavior says that people will act with rational behavior. Consumers will try to use his/her income to derive the greatest amount of satisfaction/ maximize total utility. f.

AP MICROECONOMICS: AP TEST REVIEW

13. Be able to calculate MARGINAL UTILITY. a. Marginal Utility is the extra utility/satisfaction that someone gains by consuming on more unit of good/service. Look at the below chart for the utility experienced by someone who is eating candy. Units Total Marginal Consumed Utility Utility 1 5 5 2 8 3 3 10 2 4 11 1 5 11 0 b. By subtracting the total utility between the second and first unit consumed (orange), you can find out how much extra utility that the consumer obtained by eating one more piece of candy. In the next section we will talk about why it is decreasing towards zero. 14. Explain DIMINISHING MARGINAL UTILITY. a. When looking at the chart previous, you can see that the marginal utility is decreasing. This is one of many examples of a strongly observed trend, the diminishing marginal utility. b. The official rule states that as additional units of a good/service are consumed, the marginal utility/extra satisfaction lessens. c. Think of something like a computer. The first computer that you get will give you much satisfaction. Then I give you another, you will gain some extra utility, but not as much b/c you have most of your needs already met. By the time we get to ten computers, you are gaining no utility b/c what do you need ten computers for? 15. Understand the SUBSTITUTION EFFECT and the INCOME EFFECT. a. The substitution effect is the change in the amount that people will buy because they purchase at substitute good instead due to a cheaper price. i. If you go to the grocery store and see that the price of ground beef is $30 a pound and the price for ground turkey is on sale for only $15 a pound, you may decided that it would be better to buy the ground turkey due to the lower price. b. The income effect is the change in the amount that consumers are willing to spend because the buying power of their income that changed, but the actually amount of income has not changed. i. If you go to the same store a week later and the ground beef is now on sale for $20 a pound, you will buy more and feel wealthier, even though you didnt gain any actual money, you just saved more and can spend more than normal because the change in price. 16. Know the FORMULA for UTILITY MAXIMIZATION with a particular income. a. The formula is: b. Rather than just giving the formula, lets do an example. You have ten dollars and you are looking at two different products that you can by. The first is one dollar and the second is two dollars. In the chart below, the Marginal Utilities are listed:

AP MICROECONOMICS: AP TEST REVIEW

PRODUCT A ($1) PRODUCT B ($2) Units Marginal Utility Marginal Utility Marginal Utility Marginal Utility Consumed per Dollar per Dollar 1 10 A. 10 24 B. 12 2 8 C. 8 20 D. 10 3 7 E. 7 18 F. 9 4 5 G. 5 16 H. 8 5 1 I. 1 12 J. 6 The goal of Utility Maximization is to allocate you income so that the last dollar spent on each product yields the maximum marginal utility. When looking at each Marginal Utility per dollar column, I have added in letters to help guide you through the process. c. The most utility that one can obtain is in Box B, so we will pay 2 dollars for this first Product B. d. Now, the next two are Box A and D with 10 utils per dollar. We have now spent a total of 5 dollars and eliminated choices A, B, and D. e. The next highest utility is in Box F, with 9 utils. This brings our total to 7 dollars. f. The next highest utility is in Box C and H, with 8 utils. This adds three more dollars and brings our total to ten dollars, so we have spent all ten of our dollars while gaining the most utility by buying two units of Product A and four units of Product B. g. This is the thought process between the Utility Maximizing Formula. Unit 3: Costs of Production and Market Structure: Chapters 20-23 1. What is the LAW OF DIMINISHING RETURNS? a. As successive units of a variable resource (labor) are added to a fixed resource (land/capital), eventually the additional/marginal product attributed to each additional unit of the variable resource will decline. This assumes that all workers are of equal quality, technology, and production methods. 2. What is the difference between the LONG RUN and the SHORT RUN? a. Short Run has fixed plants the time period is too short to alternate plant capacity, yet long enough to change the plants usage. You can change labor, resources, and materials. Some fixed and some variable costs.

Law of Diminishing Returns

80 70 Total Product Produced 60 50 40 30 20 10 0 0 1 2 3 4 5 6 7 8 9 10 Number of Workers

AP MICROECONOMICS: AP TEST REVIEW

b. Long Run has variable plants the time period is long enough to adjust plant capacity and existing firms to leave or enter the industry. You can make all you resources variable and change them. 3. What do ECONOMIC COSTS include? a. Economic Costs are the opportunity costs to the firm in a money amount. Costs exist for all firms since resources are scarce, productive, and have alternate uses. The Economic Cost is the value or worth a productive resource would have in its best alternate use. 4. Know how all COST CURVES are graphed. Including ATC, AVC, AFC, and MC. a. TC Total Costs i. total costs of production ii. found by adding TVC and TFC curves b. TVC Total Variable Costs i. looks just like the TC, just below it ii. addition of each variable costs c. TFC Total Fixed Costs i. horizontal line ii. always a constant cost d. ATC Average Total Costs i. the total costs of production ii. can be found by adding vertically the AFC and AVC together e. AVC Average Variable Costs i. reflects the law of diminishing returns ii. can be found by dividing Total Variable Costs by Quantity f. AFC Average Fixed Costs i. declines as output increases ii. can be found by dividing Total Fixed Costs by Quantity g. MC Marginal Costs i. the additional cost of one more unit of output ii. can be found by dividing Change in TC by Change in Q 5. Know the relationship between the MC and ATC.

10

Short Run Production Costs

160 140 120 100 80 60 40 20 0 1 2 2 3 4 5 6 7 8 9 10 Quantity TC TVC TFC

Costs ($) costs ($)

Short Run Production Costs

120 100 80 60 40 20 0 1 2 3 4 5 6 7 8 Quantity MC ATC AVC AFC

MC - AVC Relationship
COSTS 40 20 0 1 2 3 4 5 6 Quantity MC AVC

AP MICROECONOMICS: AP TEST REVIEW

6.

11

7.

8.

9.

10.

11.

12.

a. Marginal Costs (MC) intersects both ATC and AVC at their minimum points Understand the difference between ACCOUNTING PROFITS and ECONOMIC PROFITS. a. Your accounting profit is the money that you receive. For example, you sell 10 t-shirts at $10 each; your accounting profit would be $100. b. You economic profit factors out your economic costs (economic profit = accounting profit economic costs). In the above example, you need to take out the money that you could have made by using the fabric for Finding Profit/Loss P something else. 1. MR=MC Rule What is NORMAL PROFIT? MC 2. Drop to AVC a. Normal Profit is the payment made by a firm to 3. Send over to price obtain and retain entrepreneurial ability. If you 4. Shade in Profit ATC did not realize at least this minimum payment MR. D. AR. P. for your effort, you would withdraw/shut down from the line of business and use your abilities Profit AVC elsewhere. So, your normal profit is the minimum cost of doing business. Q Apply the MR=MC RULE to all market structures. a. On all graphs, where MR=MC, you will be operating at your optimal levels. b. See each individual structures section for more detail. Name for a PURE COMPETATOR is what? a. PRICE TAKER the sellers have Market Firm P P no control over price and must S adjust to market prices Shape of industry and firms demand curves in PURE COMPETITION (side-byside graph) D a. The market will have typical Supply and Demand, but the firm must take the equilibrium price D and operate at that price. Examples of PURE COMPETITION. Q Q a. We need a large number of firms producing a standardized product. This is very hard to find in todays economy, but we can come close. The best example would be a farmer. There are many farmers and you really cant MC make your tomatoes that much better than an P opponent. ATC SHUTDOWN CASES AVC a. If you AVC is higher than your P at every output. This means that the variable costs will always be higher than what you would bring in and you will never make any money. See graph. Shutdown MR. D. AR. P.

AP MICROECONOMICS: AP TEST REVIEW

12

P MC 13. What are the characteristics of a MONOPOLY? a. Single Seller ATC b. No close substitute goods/services c. Price Maker controls the entire Same rules for Quantity Supplied and therefore finding Profit controls the Price D d. High Barriers to Entry Inelastic e. Nonprice Competition When MR becomes 14. Relationship between the firm and industrys Negative, Demand curve Q demand curves for a MONOPOLY. becomes inelastic MR a. Because the firm makes up the whole industry, they are the same. The Demand curve is down sloping and always above the MR. Similar to the MR. D.AR.P. Rule in pure competition, The D. AR. P. is still the same. So the Demand, Average Revenue, and Price are all the same 15. What is a NATURAL MONOPOLY and what are its causes? a. An economy with economies of scale so 300 high that a single firm can produce a 250 product with a lower average total cost than any other firm would ever be able 200 to produce. 150 b. One main reason is possession of natural ATC resources. If you control all the oil in 100 North America, not main other firms can 50 be able to be oil producers in the region. 0 c. Economies of Scale have high start up 1 3 5 7 9 11 13 15 costs. See the graph to the right. Quantity 16. How can a monopolist make LONG RUN PROFITS? a. Because it is not operating at an efficient output, the monopoly will raise its prices to cover the losses. Because it has no competition, it can raise its prices as high P as it wants and still get a reasonable amount of service. Elastic Portion 17. What are the ELASTIC regions of the monopolist demand curve? a. The Elastic portion is the part where you Inelastic Portion have a positive MR. The Inelastic portion is the part where you have a negative MR. D

MONOPOLY

Economies of Scale

Costs ($)

Q MR

AP MICROECONOMICS: AP TEST REVIEW

18. Is a monopolist reaching ALLOCATIVE Consumer P EFFICIENCY? Why? Surplus MC a. No b. If you look at the graph to the right, P2 Deadweight you can see the blue shaded region. Loss P1 This is a deadweight loss. A Producer deadweight loss symbolizes a lack of Surplus allocative efficiency. The firm D should be operating at the Price 1, the dotted line, but to make up for Q MR Q2 Q1 losses, it will operate at Price 2. The same is with the quantity. You will have not made as much product as you should have with the given number of resources, so you have been wasteful. This is not the best way to use your resources and is an efficiency loss. 19. What is the relationship between the MR and PRICE when a firms demand curve is downward sloping? a. Remember that the Demand curve is also the Price curve. b. The MR curve will always be underneath the Price curve because the lower price applies not only to the extra units, but it also applies to all prior units of output. 20. What are the characteristics of a MONOPOLISTIC P COMPETITION? MC a. Small Market Shares i. each firm has a relatively small percent of the market b. No Collusion i. groups of producers do not agree on a set price Same set up as a monopoly c. Independent Actions but has more elastic D & MR i. no interdependence Q 21. What is the ELASTICITY of a monopolistic competitors demand curve? a. The set up is the same as a monopoly is, but it has a more elastic Demand and Marginal Revenue cost curve (more horizontal). 22. What is NONPRICE COMPETITION? a. Competition based on distinguishing ones product by product differentiation and then advertising the difference to the consumers. b. Make you product special and say that yours is better because of this specialty. 23. What are the characteristics of an OLIGOPOLY? Why are they hard to analyze? a. A few Large producers i. four firms controlling over 40% of the industry ii. example steel or copper b. Homogenized Products OR i. all the same type of product (steel)

13

ATC D

MR

AP MICROECONOMICS: AP TEST REVIEW

c. Differentiated Product i. many different types of products (cereal, cars) d. They are hard to analyze because they have a high incentive to cheat, but not all cheat, so you have to balance the two different models and try to find the root of the random appearing desire to cheat. Understand INTERDEPENDANCE. a. Relation between its members such that each is mutually dependent on the others. This concept differs from a simple dependence relation, which implies that one member of the relationship can function or survive apart from the other. b. Think of the game theory, both firms will act so they will get the highest profit, but also help out the other in the process. Define and give examples of DIFFERENTIATED Oligopolies and HOMOGENOUS Oligopolies. a. Homogenized Oligopoly i. all the same type of product ii. steel, copper b. Differentiated Oligopoly i. many different types of products P ii. cereal, cars MC What must the FOUR-FIRM CONCENTRATION RATIO be for an Oligopoly to exist? a. If the four firms make up 40% or more of the entire industry, the industry is considered an oligopoly. D What is the relationship between the demand curve and MR curve for a MONOPOLY? a. The Demand curve will always be above the Q MR curve. MR b. Why? c. The MR curve will always be underneath the Price curve because the lower price applies not only to the extra units, but it also applies to all prior units of output. Possibilities of LONG RUN PROFIT in monopolies and pure competition. a.

14

24.

25.

26.

27.

28.

Unit 4: Resource Market: Chapter 25-27 1. Importance of RESCOURCE PRICING. a. Money Income Determination i. resource prices are a major factor in determining the income of households ii. the expenditures that firms make in acquiring economic resources flow as wage, rent, interest, and profit incomes to the households that supply those resources b. Cost Minimization i. to a firm, resource prices are costs

AP MICROECONOMICS: AP TEST REVIEW

ii. to obtain the greatest profit, the firm must produce at the profit-maximizing output with the most efficient combination of resources iii. resource prices play the main role in determining the quantity of land, labor, capital, and entrepreneurial ability hat will be combined in producing each good or service c. Resource Allocation i. just as product prices allocate finished goods and services to consumers, resource prices allocate resources among industries and firms ii. in a dynamic economy, where technology and product demand often changes, the efficient allocation of resources over time calls for the continuous shift of resources from one use to another iii. resource pricing is a major factor in producing those shifts d. Policy Issues i. many polices issues surround the resource market ii. Ex: To what extend should the government redistribute income through taxes and transfers? Should the government do anything to discourage excess pay to corporate executives? Should the government encourage or restrict labor unions? iii. the facts and debates relating to these policy questions are grounded on resource pricing 2. Define and provide examples of DERIVED DEMAND. a. the demand for a resource is an inverse relationship between the price of the resource and the quantity of the resource demanded b. it is derived from the products that the resource help produce c. Ex: The demand for airplanes helps derive the demand for assemblers, airplane wings, etc. The demand for haircuts helps derive the demand for barbers. 3. Define MRC and MRP. a. MRP Marginal Revenue Product i. change in the total revenue resulting from the use of each additional unit of resource (labor) ii. b. MRC Marginal Resource Costs i. the amount that each additional unit of resource adds to the firms total costs ii. 4. Explain what it means if a firm is a WAGE TAKER. a. in a perfect/pure competition labor/resource market, a firm must take whatever the market sets labor at b. See graph

15

LABOR MARKET
P S

INDIVIDUAL FIRM

S=MRC

D = MRP Q

D=MRP Q

AP MICROECONOMICS: AP TEST REVIEW

5. What is the relationship between MRP and the FIRMS RESOURCE P DEMAND CURVE? a. In a purely competitive firm, the Demand curve is the same as the MRP curve. b. when product price is constant, the downward slope of the D=MRP curve is due solely to the decline in the resources marginal product/ law of diminishing returns 6. Understand the Supply and Demand Curves for LABOR HIRED in pure competition for industry and firm. Understand the shaped of each curve. a. The supply and demand curves will have the same look for both the industry and the firm (compared to what we have learned earlier). The industry will be the same as in unit 2, and the firm will remain the same, as seen on the previous page in the side by side graph, as it has in unit 3. The only changes will be the names of the graph, like the D=MRP instead of just the D curve. P S 7. Define ECONOMIC RENT.

16 The red curve shows a pure competition demand curve as the black is an imperfect competition demand curve.

D=MRP Q

a. price paid for the use of land and other natural resources that are completely fixed in total supply b. o the right is the demand and supply curve for land, notice that the supply is fixed because we cant magically make earth bigger to gain more land; the only determinate of price is the demand for it 8. What is the relationship between ECONOMIC RENT and the INCENTIVE FUNCTION? a. the perfectly inelastic supply of land must be contrasted with the relatively elastic supply of capital, such as apartment buildings, machinery, and warehouses; in the long run, capital is not fixed in total supply b. a higher price gives entrepreneurs the incentive to construct and offer larger quantities of property resources; conversely, a decline in price induces suppliers to allow existing facilities to deprecate and not be replaced c. the supply curves of these nonland resources are upward-sloping, meaning that the prices paid to such resources provide an incentive function; a high price provides an incentive to offer more of the resource, whereas a low price prompts resource suppliers to offer less 9. How is EQUILIBRIUM INTEREST RATE determined? a. Just as the equilibrium price and quantity was determined in Interest earlier chapters, equilibrium interest rate is determined by rate (%) where the supply and demand curves meet. b. the loanable funds theory of interest explains the interest rate not in terms of total supply of and demand for money, but, rather, in terms of the supply of and demand for funds available for lending and borrowing

D1 D2 D3 D4 Q

D Q

AP MICROECONOMICS: AP TEST REVIEW

Unit 5: Government and Market Failures: Chapter 28-30 1. What are the characteristics and examples of a PUBLIC GOOD and PRIVATE GOOD? a. Public i. nonrivilary 1. one persons consumption does not prevent the consumption of the good to another 2. roads ii. nonexcludability 1. there is no way that one can prevent someone from benefiting from the good/service 2. national defense b. Private i. rivalry 1. one persons consumption does prevent the consumption of the good to another 2. food ii. excludability 1. people who do not pay for the good/service cannot obtain benefits 2. food 2. How do you determine the OPITMAL QUANTITY of a public good? a. vertical summation of curves i. by survey, etc. government forms an idea of each persons willingness to pay for the good at each quantity and adds up each curve via vertical summation. ii. they then graph the curves and find the equilibrium point and find the quantity b. see number 3 3. Be able to use VERTICAL SUMMATION to calculate the demand for a public good. Quantity Person 1 Person 2 Person 3 Collective Willingness to Pay 1 $4 $5 $9 18 2 3 4 7 14 3 2 3 5 10 4 1 2 3 6 5 0 1 1 2 a. You will be given all the information in the white boxes, but you need to determine the prices in the blue shaded boxes. This is done by adding each persons willingness to pay at a given quantity. (see arrow) 4. Understand how to do a COST-BENEFIT ANALYSIS of Government Action. a. Find if the costs of action are higher than the benefits of the action i. if costs are higher dont do it ii. if benefits are higher do it b. The government wants to find the most beneficial action with the lowest costs, so costbenefit analysis is very common with public goods

17

AP MICROECONOMICS: AP TEST REVIEW

Negative Externality

Tax

CORRECT

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Should be more costs 5. Define and give examples of both a producing POSITIVE EXTERNALITY and a NEGATIVE at red EXTERNALITY. lines, but a. Positive you are i. benefits affect a third party producing over allocation ii. create an under allocation at black Positive Externality Subsidy (Consumer) of resources iii. vaccinations less cost b. Negative more demand i. costs affect a third party ii. create an over allocation of resources under allocation iii. pollution Positive Externality Subsidy (Producer) 6. Understand EXTERNALITIES and relationship with the supply and demand curves. less cost a. costs/benefits accruing to an more demand individual not involved in original economic action b. see the graphs to right under allocation 7. What is the COASE THEOREM? a. if issues rise between two individuals/groups, they should work out a solution amongst themselves 8. Explain the PUBLIC CHOICE THEORY. a. the economic analysis of government decision making, politics, and elections b. when talking about government failures, we want to look at why they happened; to do this, we use a series of techniques and methods, all categorized in the public choice theory, to understand the failure 9. Be able to explain inefficiencies 800 with MAJORITY VOTING. 700 a. Looking at the diagram to the right, you see three 600 different people each 500 voting for a tax. The bar person 1 400 represents the amount of person 2 benefits they receive. If TAX 300 person 3 you look at the NO vote, 200 you have only one person receiving benefits above 100 the $300 tax, so the other 0 two would vote no and Inefficient NO Inefficient Yes the tax would not be passed, but when you look at the total costs ($300 x 3) of $900 and the total benefits

AP MICROECONOMICS: AP TEST REVIEW

($700 + 250 + 200) of $1150, the benefits are larger than the costs, so the logical and correct vote would be YES and pass the tax. This is an example of an inefficient no vote. b. In the next section, the inefficient yes graph, the majority wanted to pass the tax (2/3), so the tax is passed, but when you compare the total costs ($300 x 3) of $900 to the total benefits ($100 + 350 +350) of $800, you see that the tax is costing the people more than what they would be benefiting from it. This is an example of an inefficient yes vote. 10. Define and give examples of a PROGESSIVE TAX, REGRESSIVE TAX, and a PROPORTIONAL TAX. a. Progressive i. tax rate increases as income increases ii. federal individual income tax Spent/Income Tax Rate $200,000 $20,000 10% Increasing 2,000 140 7% 20 1 5% b. Regressive i. tax rate decreases as income increases ii. sales tax Spent/Income Tax Rate $200,000 $10,000 5% Decreasing 2,000 120 6% 20 1.40 7% c. Proportional i. tax rate remains constant as income changes ii. corporate income tax Spent/Income Tax Rate $200,000 $16,000 8% Constant 2,000 160 8% 20 1.60 8% 11. What did the SHERMAN ACT and the CLAYTON ACT do? a. Sherman Antitrust Act or 1890 i. cornerstone of antitrust legislature ii. monopolization was a felony iii. outlawed restrains of trade b. Clayton Antitrust Act of 1914 i. strengthened Sherman Act ii. outlawing techniques that firms may use to develop monopoly power iii. outlawed price discrimination, prohibited tying contracts, and forming of interlocking directorates

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