AP Microeconomics Test Review
12 PM – May 17th, 2012
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
In the beginning …
Economics
 How to allocate scarce resources with unlimited
wants or desires.
Resources
 Labor
 Land/Natural Resources
 Capital
 Entrepreneurship
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Opportunity Costs & Marginal Analysis
Opportunity Costs
 The cost of doing the next best option.
Marginal
 The cost or benefit of “the next one”
 EX If one candy bar costs $2 and two bars cost $3, the
Marginal Costs of 1st bar is $2 and the MC of the 2nd bar
is $1.
 Basis of economic study.
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Production Possibility Frontier
G
o
o
d
A
Measures different
combinations of production
Z is beyond capacity,
borrowing or running
a deficit
Y
W
Z
X & Y are equally
efficient, on the
PPF curve
X
W is inefficient,
Not all resources
In use – a recession
Good B
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AP Microeconomics Test Review
12 PM – May 17th, 2012
Trade Advantages
Example:
Country A
 60 Pizzas
 80 Hot Dogs
Country B
 40 Pizzas
 20 Hot Dogs
RMCE/HWRHS
12 PM – May 17th, 2012
AP Microeconomics Test Review
Absolute Advantage
Who can produce the most?
Pizzas:
 Country A – 60
 Country B – 40
Country A b/c
60 > 40.
Hot Dogs:
 Country A – 80
 Country B – 20
Country A b/c
80 > 20.
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Comparative Advantage
Who gives up the least to produce?
 (items produced/items no longer produced)
Pizzas:
Country B b/c
2.00 > 0.75.
 Country A – (60 Pizzas/80 HD) = 0.75
 Country B – (40 Pizzas/20 HD) = 1.50
Hot Dogs:
 Country A – (80 HD/60 Pizzas) = 1.33
 Country B – (20 HD/40 Pizzas) = 0.50
Country A b/c
1.33 > 0.50
NB There is always comparative advantages for both countries even
when one country has an absolute advantage in both products
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Supply and Demand
Price
S
P
D
Q
Quantity
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AP Microeconomics Test Review
12 PM – May 17th, 2012
Demand
Movement along the curve
 Change in Price
Curve Shift
 Change in Determinants
 Income
 Substitutes
 Complements
 Number Consumers
 Consumer Tastes
 Consumer Expectations
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Supply
Movement along the curve
 Change in price
Curve shift
 Change in Determinants
 Costs of inputs
 Number sellers
 Change in technology
 Taxes
 Producer expectations
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Supply & Demand
Substitutes
Complements
Normal goods
Inferior goods
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AP Microeconomics Test Review
12 PM – May 17th, 2012
Equilibrium
Price
surplus
S
P+1
P
P-1
shortage
Q
D
Quantity
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Price Floors & Ceilings
Price
Price Floor
S
Pf
Deadweight
Loss (DWL)
Price Ceiling
Pc
D
QD
QS
Quantity
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Equilibrium
Consumer Surplus
Price
S
P
Producer Surplus
D
Q
Quantity
Total Welfare is the sum of Consumer & Producer Surpluses
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Elasticity
Measures change in QUANTITY
caused by small changes in PRICE
= %ΔQ / %ΔP
Midpoint Formula =
(Q1-Q2)/((Q1+Q2)/2)
(P1-P2)/((P1+P2)/2)
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Elasticity
Perfectly Elastic
 ED = ∞
Elastic
 1 < ED < ∞
Unit Elastic
 ED = 1
Inelastic
 0 < ED < 1
Perfectly Inelastic
 ED = 0
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Determinants of Elasticity
Substitutes
Income
Time
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AP Microeconomics Test Review
12 PM – May 17th, 2012
Total Revenue (TR) Method
Elastic
 Price & TR move in opposite direction
P 
TR 
P 
TR 
Inelastic
 Price & TR move in the same direction
P 
TR 
P 
TR 
TR = P * Q ….do not compare P & Q !!!
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Types of Elasticity
Income elasticity
 %ΔQ / %Δ Income
 Negative number for Inferior Goods
Cross elasticity
 % Δ Q Good A / % Δ P Good B
 Negative number for Complementary Goods
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Elasticity & Taxes
Government
Revenue
Perfectly
Elastic
Consumption
Taxes paid
By Consumer
Taxes Paid by
Supplier
Least
Most
0%
100 %
Most
Zero
100 %
0%
Elastic
Inelastic
Perfectly
Inelastic
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AP Microeconomics Test Review
12 PM – May 17th, 2012
Changing Elasticities
Price
Inelastic – A large change in price…
… leads to a small change in quantity
13
10
Elastic – A small change in price…
… leads to a large change in quantity
3
2
4 5
11
14
Quantity
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Graphing Tax Revenue
ST
Price
Tax shifts supply
Curve – Price up
& Quantity down
S
PT
Tax Revenue
P
D
QT
Q
Quantity
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Firms, Markets & Costs
Accounting π = TR – Explicit Costs
Economic π = Acct π – Implicit Costs
 Implicit Costs are Opportunity costs
 Long-run has no fixed costs
Sunk Costs
Economies of Scale
TC = TFC + TVC
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Total & Average Cost Graphs
ATC
TC
P
MC
AVC
VC
FC
Q
AFC
Q
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12 PM – May 17th, 2012
AP Microeconomics Test Review
Profits
Π determined by
MC = MR
P
MC
ATC
Π = (P-ATC)*Q
P1
MR
Q1
Q
NB Shut down price for business If Price < Minimum AVC
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Perfect Competition (profits)
Firm
Industry
Price
Price
S
Profits
MC
S2
ATC
P1
D=MR=AR=P
P1
P2
D2
D
Q1Q2
Quantity
q2 q1
Quantity
New firms enter b/c profits, Results in P, Industry Q, Firm q, & π = 0
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12 PM – May 17th, 2012
AP Microeconomics Test Review
Perfect Competition (losses)
Industry
Price
Firm
Price
S2
S
P2
P1
ATC
MC
Losses
D2
D=P=MR=AR
P1
D
Q2 Q1
Quantity
q1q2
Quantity
Firms leave b/c losses, results in P , Industry Q , Firm q , & π = 0
RMCE/HWRHS
12 PM – May 17th, 2012
AP Microeconomics Test Review
Monopoly
Monopoly P set by demand
Curve point above MC=MR
Price
Socially optimal allocation or
allocative efficiency at MC = D
MC
ATC
P
Fair return Price ATC=P
(0 economic profit)
D
Πmax set by MC=MR
Deadweight loss (DWL)
Difference between
Monopoly P & Socially
optimal P
Quantity
Q
MR
RMCE/HWRHS
12 PM – May 17th, 2012
AP Microeconomics Test Review
Monopolistic Competition
MC
P
ATC
P
ATC tangent to D
Equilibrium at
zero economic
profits
MR
Q
Q
Excess Capacity
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12 PM – May 17th, 2012
AP Microeconomics Test Review
Monopolistic Competition
MC
P
ATC
P
P2
ATC < D
Economic profit will
cause firms to enter,
with more firms in
the market, consumers
have more choice &
demand for the
company decrease
MR
Q
D2
D
Q
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12 PM – May 17th, 2012
AP Microeconomics Test Review
Monopolistic Competition
MC
ATC
P
P2
P
ATC > D
Economic losses will
cause firms to exit
which will increase
demand for companies
still in business
MR
Q
D2
D
Q
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Oligopoly
Nash Equilibrium
 Each player know options of
opponent – no need to
change
Confess
10 year
10 year
Don’t Confess
 One choice is always better
Confess
Don’t Confess
20 years
Free
Jill
Barriers to entry
May or may not have
differentiation
4 Firm ratio
Prisoner’s dilemma
Dominant Strategy
Jack
Free
20 years
1 years
1 years
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AP Microeconomics Test Review
12 PM – May 17th, 2012
Oligopoly: Incentive to Collude
Game theory applied
Oligopolists have a strong incentive to
collude and raise their prices.
However, each firm also has an incentive to
cheat by lowering price because the
demand curve facing each firm is more
elastic than the market demand curve.
This conflict makes collusive agreements
difficult to maintain.
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Factor Economics
Demand for inputs
 Labor
 Resources
MRP = Marginal Revenue Product
 MR for factor markets
 = ΔTR / ΔQ
MRC = Marginal Revenue Cost
 MC for factor markets
 = ΔTC / ΔQ
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Factor Economics
If MRP > MRC
 Increase Production
If MRP = MRC
 Max profits
 Stop (ideal) Production
If MRP < MRC
 Decrease production
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Factor Economics
Marginal Productivity / Least Cost
 MPA / PA = MPB / PB
 Firms produce at a level where all costs are
minimized
Derived Demand
 Demand for products creates or affects the
demand for resources such as labor
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Factors & Distribution
Marginal Productivity Theory of
Income Distribution
 Income allocated by how much production is
created
 Theory may lead to
 Income inequality
 Market Imperfections
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Types of Goods
Rivals in Consumption
Yes
No
Yes
Private
Goods
Natural
Monopoly
Common
Resources
Public
Goods
Excludable
No
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AP Microeconomics Test Review
12 PM – May 17th, 2012
Negative Externalities
Supply Failure
Suppliers do not
have to pay the full
value
 Will supply more b/c
costs paid by others
Costs affect supply
Taxes raise price to
public equilibrium
Externality
Cost
Social Cost
P
Private
Cost
P2
P1
Private
Value
Q2
Q1
Q
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AP Microeconomics Test Review
12 PM – May 17th, 2012
Positive Externalities
Demand Failure
Public not willing to pay
full value
External Benefit
Private Cost
P
 Benefits or subsidies needed to
induce suppliers to supply at
lower price levels
P1
Benefits affect demand
Subsidies absorb costs
creating public
equilibrium
Public
Cost
P2
Private
Value
Q1
Q2
Q
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Income Inequality
Lorenz Curve
 Measures ratio between
richest & poorest
quintiles.
Gini Index
 Measures among of
distribution
 Increasing numbers
(ranges from 0.0 to 1.0)
means less equality
RMCE/HWRHS
AP Microeconomics Test Review
12 PM – May 17th, 2012
Miscellaneous
Taxes
 Progressive
 Increasing Marginal Rates
 Proportional
 Regressive
 Decreasing Marginal Rates
Moral Hazard
 Taking higher risks b/c of
insurance or government bailouts
Adverse Selection
 Signaling
 Only those who need product
would buy it (insurance)
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