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AP MICROECONOMICS: AP TEST REVIEW 1

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

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).

The point of interception on a graph of your

Marginal Benefits and Marginal Costs is the

Equilibrium Point.

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.

MC

E

P

MB

Q Optimal Quantity


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 nation’s 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

MEXICO 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:


APPLES ORANGES

MEXICO Must give up 2 oranges to make 10 apples (1/5).

MEXICO Must give up 10 apples to make 2 oranges (5).

US Must give up 5 oranges to make 15 apples (1/3).

US Must give up 15 apples to make 5 oranges (3).

COMPARATIVE ADVANTAGE

Mexico has the lower opportunity costs, so they should make the apples.

COMPARATIVE ADVANTAGE

US has the lower opportunity cost, so they should make the oranges.

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

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.

9

8

7

6

5

4

3

2

1

9

8

7

6

5

4

3

2

1

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

Pizzas

Robots

Unattainable Levels of

Production

Inefficient

Levels of

Production

A Maximum

Level of Output

Growth

= Unemployment


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).

2. What are the causes of change in SUPPLY and DEMAND?

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

b. Market Size

i. size of market increases, demand increases

ii. size of market decreases, demand decreases

c. Consumer Tastes (graph)

i. People begin to cry when the chocolate diet

doesn’t work.

ii. consumer tastes increase, demand increases

iii. consumer tastes decrease, demand decreases

d. Consumer Expectations

i. consumer expectations increase, demand

increases

ii. consumer expectations decreases, demand

decreases

e. 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

decreases

iii. demand for substitute decreases, demand

increases

f. 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

P

P

P

P

Q

Q

Q

Q

Demand for Chocolate


g. Input Costs (graph)

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

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

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

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

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

P

P

P

P

P

Q

Q

Q

Q

Q

Supply of Wooden Dolls


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 good’s demand also goes up, and

vice versa.

c. If you have a substitute teacher for a day in econ (remember, you’re an AP student, so

anyway you don’t 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

right. One thing to note is its vertical line shape. The

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

money to keep themselves alive. The only way to

affect the price of the good/service is to change the

supply.

6. Understand MARKET EQUILIBRIUM.

a. You market equilibrium is the point where the

supply and demand curve meet. At this point, the

optimal price and quantity are reached.

b. If you operate at a point with a price to high, you

will form a surplus.

c. If you operate at a point with a price to low, you

will form a shortage.

d. Disequilibrium is any point on the graph except the

equilibrium point. At every disequilibrium point,

you will not be operating efficiently.

7. What will cause a MARKET SURPLUS?

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)

P

Q

S

D

D

S

P

Q

Equilibrium

Point

Price to

high

Price to

low

low quantity demanded,

high quantity supplied

high quantity demanded,

low quantity supplied

Surplus

Shortage


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.

f. 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

magically supply more space in the short run? No, so

the supply is going to be inelastic b/c it doesn’t

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.

P

Q


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 Consumed

Total Utility

Marginal 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 didn’t 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, let’s 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:


PRODUCT A ($1) PRODUCT B ($2)

Units Consumed

Marginal Utility Marginal Utility per Dollar

Marginal Utility Marginal Utility 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.

0

10

20

30

40

50

60

70

80

0 1 2 3 4 5 6 7 8 9 10

Tota

l Pro

du

ct P

rod

uce

d

Number of Workers

Law of Diminishing Returns


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.

0

20

40

60

80

100

120

140

160

1 2 2 3 4 5 6 7 8 9 10

Co

sts

($)

Quantity

Short Run Production Costs

TC TVC TFC

0

20

40

60

80

100

120

1 2 3 4 5 6 7 8

cost

s ($

)

Quantity

Short Run Production Costs

MC ATC AVC AFC

0

20

40

1 2 3 4 5 6

CO

STS

Quantity

MC - AVC Relationship

MC

AVC


a. Marginal Costs (MC) intersects both ATC and AVC at their minimum points

6. 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

something else.

7. What is NORMAL PROFIT?

a. Normal Profit is the payment made by a firm to

obtain and retain entrepreneurial ability. If you

did not realize at least this minimum payment

for your effort, you would withdraw/shut down

from the line of business and use your abilities

elsewhere. So, your normal profit is the

minimum cost of doing business.

8. 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 structure’s section for more detail.

9. Name for a PURE COMPETATOR is what?

a. PRICE TAKER – the sellers have

no control over price and must

adjust to market prices

10. Shape of industry and firm’s demand

curves in PURE COMPETITION (side-by-

side graph)

a. The market will have typical

Supply and Demand, but the firm

must take the equilibrium price

and operate at that price.

11. Examples of PURE COMPETITION.

a. We need a large number of firms producing a standardized product. This is very hard to

find in today’s economy, but we can come close. The best example would be a farmer.

There are many farmers and you really can’t

make your tomatoes that much better than an

opponent.

12. SHUTDOWN CASES

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.

S

D

D

P

Q Q

D

P Market Firm

P

Q

MC

MR. D. AR. P.

AVC

ATC

Shutdown

MC

ATC

AVC

MR. D. AR. P.

Q

P

Profit

Finding Profit/Loss

1. MR=MC Rule

2. Drop to AVC

3. Send over to price

4. Shade in Profit


13. What are the characteristics of a MONOPOLY?

a. Single Seller

b. No close substitute goods/services

c. Price Maker – controls the entire

Quantity Supplied and therefore

controls the Price

d. High Barriers to Entry

e. Nonprice Competition

14. Relationship between the firm and industry’s

demand curves for a MONOPOLY.

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

high that a single firm can produce a

product with a lower average total cost

than any other firm would ever be able

to produce.

b. One main reason is possession of natural

resources. If you control all the oil in

North America, not main other firms can

be able to be oil producers in the region.

c. Economies of Scale have high start up

costs. See the graph to the right.

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

as it wants and still get a reasonable

amount of service.

17. What are the ELASTIC regions of the monopolist

demand curve?

a. The Elastic portion is the part where you

have a positive MR. The Inelastic portion

is the part where you have a negative

MR.

P

Q

MC

ATC

D

MR

Inelastic

Same rules for

finding Profit

When MR becomes

Negative, Demand curve

becomes inelastic

MONOPOLY

0

50

100

150

200

250

300

1 3 5 7 9 11 13 15

Co

sts

($)

Quantity

Economies of Scale

ATC

P

Q

MR

D

Elastic Portion

Inelastic Portion


18. Is a monopolist reaching ALLOCATIVE

EFFICIENCY? Why?

a. No

b. If you look at the graph to the right,

you can see the blue shaded region.

This is a deadweight loss. A

deadweight loss symbolizes a lack of

allocative efficiency. The firm

should be operating at the Price 1,

the dotted line, but to make up for

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 firm’s 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

COMPETITION?

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

c. Independent Actions

i. no interdependence

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 one’s 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)

P

MC

D

MR Q

Consumer

Surplus

Producer

Surplus

Deadweight

Loss P1

P2

Q2 Q1

MC ATC

D

MR

Q

P

Same set up as a monopoly

but has more elastic D & MR


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.

24. 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.

25. 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

ii. cereal, cars

26. 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.

27. What is the relationship between the demand curve

and MR curve for a MONOPOLY?

a. The Demand curve will always be above the

MR curve.

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.

28. Possibilities of LONG RUN PROFIT in monopolies and pure competition.

a.

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

P MC

D

MR Q


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 firm’s 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 D = MRP

S P

Q Q

P

D=MRP

S=MRC

LABOR MARKET INDIVIDUAL FIRM


5. What is the relationship between MRP and the FIRM’S RESOURCE

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.

7. Define ECONOMIC RENT.

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 can’t 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

earlier chapters, equilibrium interest rate is determined by

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,

P

Q

D=MRP

The red curve shows a

pure competition

demand curve as the

black is an imperfect

competition demand

curve.

P

Q D4

D3

D2

D1

S

rather, in terms of the supply of and demand for funds available

for lending and borrowing

Interest

rate (%)

Q

S

D


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 person’s 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 person’s 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 person’s 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 person’s 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 – don’t do it

ii. if benefits are higher – do it

b. The government wants to find the most beneficial action with the lowest costs, so cost-

benefit analysis is very common with public goods


5. Define and give examples of both a

POSITIVE EXTERNALITY and a NEGATIVE

EXTERNALITY.

a. Positive

i. benefits affect a third party

ii. create an under allocation

of resources

iii. vaccinations

b. Negative

i. costs affect a third party

ii. create an over allocation of

resources

iii. pollution

6. Understand EXTERNALITIES and relationship

with the supply and demand curves.

a. costs/benefits accruing to an

individual not involved in original

economic action

b. see the graphs to right

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

with MAJORITY VOTING.

a. Looking at the diagram to

the right, you see three

different people each

voting for a tax. The bar

represents the amount of

benefits they receive. If

you look at the NO vote,

you have only one person

receiving benefits above

the $300 tax, so the other

two would vote no and

the tax would not be

passed, but when you look at the total costs ($300 x 3) of $900 and the total benefits

Negative Externality

Positive Externality

Positive Externality

Tax

Subsidy (Consumer)

Subsidy (Producer)

Should be

producing

at red

lines, but

you are

producing

at black

more costs

over allocation

CORRECT

under allocation

under allocation

less cost

more demand

less cost

more demand

0

100

200

300

400

500

600

700

800

Inefficient NO Inefficient Yes

person 1

person 2

person 3TAX


($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%

2,000 140 7%

20 1 5%

b. Regressive

i. tax rate decreases as income increases

ii. sales tax


$200,000 $10,000 5%

2,000 120 6%

20 1.40 7%

c. Proportional

i. tax rate remains constant as income changes

ii. corporate income tax


$200,000 $16,000 8%

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

Increasing

Decreasing

Constant

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