Final Exam Review

AP MICROECONOMICS: AP TEST REVIEW1

Unit 1: Intro to Microeconomics: Chapter 1, 2, and 5

1. Define ECONOMICSa. the social science concerned with how individuals, institutions, and society make the

best choices under conditions of scarcity2. 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 RULEa. 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 SYSTEMa. Aka Capitalism. Private ownership of factors of production and prices (supply and

demand) are used to direct economic activityb. 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

QOptimal 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 POSSIBILITIESA B C D E

APPLES 0 5 15 30 90*ORANGES 30* 15 5 2 0

MEXICO PRODUCTION POSSIBILITIESA B C D E

APPLES 0 5 10 15 20ORANGES 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 ORANGESMEXICO 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 resourcesii. resources fixed in terms of quantity/quality

iii. fixed technologyiv. 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?

987654321

987654321

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

RobotsUnattainable Levels of

Production

Inefficient Levels of

Production

A Maximum Level of Output

Growth

= Unemployment


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.

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 increasesiii. consumer income decreases, demand decreases

b. Market Sizei. size of market increases, demand increases

ii. size of market decreases, demand decreasesc. Consumer Tastes (graph)

i. People begin to cry when the chocolate diet doesn’t work.

ii. consumer tastes increase, demand increasesiii. consumer tastes decrease, demand decreases

d. Consumer Expectationsi. consumer expectations increase, demand

increasesii. consumer expectations decreases, demand

decreasese. 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.

P

P

P

PQ

Q

Q

Q

Demand for Chocolate


ii. demand for complementary good increases, demand increasesiii. demand for complementary good decreases, demand decreases

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 Productivityi. productivity of workers increases,

supply increasesii. productivity of workers decreases,

supply decreasesi. Government Action (graph) (graph)

i. government lowers wood taxii. excise tax – taxes on the

production/sale of certain goodsiii. new tax or amount of tax increases,

supply decreasesiv. amount of tax decreases, supply

increasesv. 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. Technologyi. new wooden dolls machine created

ii. new technology, supply increasesk. 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 Producersi. a depression causes wood doll shops

to close

P

P

P

P

P

Q

Q

Q

Q

Supply of Wooden Dolls


ii. as more producers enter the industry, the supply increasesiii. as more producers leave the industry, the supply decreases

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?

Q

P

Q

S

D

D

SP

Q

Equilibrium Point

Price to high

Price to low

low quantity demanded, high quantity supplied

high quantity demanded, low quantity supplied

Surplus

Shortage


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)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. Price Elasticity of Demand=Percent Change∈Quantity Demanded of Product XPercent Change∈Price of Prouct X

d. Another way to state it would be:

e. Price Elasticity of Demand=

Change∈Quantity Demanded of Product XOriginalQuantity Demanded of Product X

Change∈thePrice of Product XOriginal Price of Product X

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 > 1h. Inelastic: Price Elasticity of Demand < 1i. 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.

P

Q


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.

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.

UnitsConsumed

TotalUtility

MarginalUtility

1 5 52 8 33 10 24 11 15 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: MarinalUtility of A

Price of A=MarginalUtility of B

Price of Bb. 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

ConsumedMarginal Utility Marginal Utility

per DollarMarginal Utility Marginal Utility

per Dollar1 10 A. 10 24 B. 122 8 C. 8 20 D. 103 7 E. 7 18 F. 94 5 G. 5 16 H. 85 1 I. 1 12 J. 6The 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.

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 productionii. found by adding TVC and TFC curves

b. TVC – Total Variable Costs

0 1 2 3 4 5 6 7 8 9 100

10

20

30

40

50

60

70

80

Law of Diminishing Returns

Number of Workers

Tota

l Pro

duct

Pro

duce

d

1 2 2 3 4 5 6 7 8 9 100

20406080

100120140160

Short Run Production Costs

TC TVC TFC

Quantity

Cost

s ($)


i. looks just like the TC, just below itii. addition of each variable costs

c. TFC – Total Fixed Costsi. horizontal line

ii. always a constant costd. ATC – Average Total Costs

i. the total costs of productionii. can be found by adding vertically the AFC

and AVC togethere. AVC – Average Variable Costs

i. reflects the law of diminishing returnsii. can be found by dividing Total Variable Costs

by Quantityf. AFC – Average Fixed Costs

i. declines as output increasesii. can be found by dividing Total Fixed Costs by

Quantityg. 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.a. Marginal Costs (MC) intersects both ATC and AVC at

their minimum points6. 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.

1 2 3 4 5 6 7 80

20

40

60

80

100

120

Short Run Production Costs

MC ATC AVC AFC

Quantity

cost

s ($)

1 2 3 4 5 60

20

40

MC - AVC Rela-tionship

MCAVC

Quantity

COST

S

MC

ATC

AVC

MR. D. AR. P.

Q

P

Profit

Finding Profit/Loss

1. MR=MC Rule2. Drop to AVC3. Send over to price4. Shade in Profit


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.

13. What are the characteristics of a MONOPOLY?a. Single Sellerb. No close substitute goods/servicesc. Price Maker – controls the entire

Quantity Supplied and therefore controls the Price

d. High Barriers to Entrye. 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?

S

D

D

P

Q Q

P Market Firm

P

Q

MC

MR. D. AR. P.

AVC

ATC

Shutdown

P

Q

MC

ATC

D

MR

Inelastic

Same rules for finding Profit

When MR becomes Negative, Demand curve becomes inelastic

MONOPOLY


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.

18. Is a monopolist reaching ALLOCATIVE EFFICIENCY? Why?

a. Nob. 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.

1 3 5 7 9 11 13 150

50

100

150

200

250

300

Economies of Scale

ATC

Quantity

Cost

s ($)

P

Q

MR

D

Elastic Portion

Inelastic Portion

PMC

D

MR Q

Consumer Surplus

Producer Surplus

Deadweight LossP1

P2

Q2 Q1


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 Sharesi. each firm has a relatively small

percent of the marketb. No Collusion

i. groups of producers do not agree on a set price

c. Independent Actionsi. 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 producersi. four firms controlling over 40% of the industry

ii. example – steel or copperb. Homogenized Products OR

i. all the same type of product (steel)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

MCATC

D

MR

Q

P

Same set up as a monopoly but has more elastic D & MR


i. many different types of productsii. 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 householdsii. the expenditures that firms make in acquiring economic resources flow as wage,

rent, interest, and profit incomes to the households that supply those resourcesb. Cost Minimization

i. to a firm, resource prices are costsii. to obtain the greatest profit, the firm must produce at the profit-maximizing

output with the most efficient combination of resourcesiii. 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 Allocationi. just as product prices allocate finished goods and services to consumers,

resource prices allocate resources among industries and firmsii. 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 shiftsd. Policy Issues

i. many polices issues surround the resource marketii. Ex: To what extend should the government redistribute income through taxes

and transfers? Should the government do anything to discourage excess pay to

PMC

D

MRQ


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 demandedb. it is derived from the products that the resource help producec. 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 Producti. change in the total revenue resulting from the use of each additional unit of

resource (labor)ii.

MRP= change∈totalrevenueunit change∈resourcequantity

b. MRC – Marginal Resource Costsi. the amount that each additional unit of

resource adds to the firm’s total costsii.

MRC= change∈totalresource costsunit change∈resourcequantity

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 graph5. 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

D = MRP

SP

Q Q

P

D=MRP

S=MRC

LABOR MARKET INDIVIDUAL FIRM

P

Q

D=MRP

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

PS


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 supplyb. 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,

Unit 5: Government and Market Failures: Chapter 28-30

1. What are the characteristics and examples of a PUBLIC GOOD and PRIVATE GOOD?

a. Publici. nonrivilary

1. one person’s consumption does not prevent the consumption of the good to another

2. roadsii. nonexcludability

1. there is no way that one can prevent someone from benefiting from the good/service

2. national defenseb. Private

i. rivalry

QD4D3

D2

D1

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

Interest rate (%)

Q

S

D


1. one person’s consumption does prevent the consumption of the good to another

2. foodii. excludability

1. people who do not pay for the good/service cannot obtain benefits2. 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 quantityb. 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 Pay1 $4 $5 $9 182 3 4 7 143 2 3 5 104 1 2 3 65 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 itii. 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. Positivei. benefits affect a third party

ii. create an under allocation of resources

iii. vaccinationsb. Negative

i. costs affect a third partyii. create an over allocation of

resources

Negative Externality

Positive Externality

Tax

Subsidy (Consumer)

Should be producing at red lines, but you are producing at black

more costs

over allocation

CORRECT

under allocation

less cost more demand


iii. pollution6. Understand EXTERNALITIES and relationship with the supply and demand curves.

a. costs/benefits accruing to an individual not involved in original economic actionb. 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

themselves8. Explain the PUBLIC CHOICE THEORY.

a. the economic analysis of government decision making, politics, and electionsb. 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 ($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 increasesii. federal individual income tax

Spent/Income Tax Rate$200,000 $20,000 10%

2,000 140 7%

Positive Externality Subsidy (Producer)

under allocationless cost more demand

Inefficient NO Inefficient Yes0

100

200

300

400

500

600

700

800

person 1person 2person 3TAX

Increasing


20 1 5%b. Regressive

i. tax rate decreases as income increasesii. sales tax


2,000 120 6%20 1.40 7%

c. Proportionali. tax rate remains constant as income changes

ii. corporate income tax


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 legislatureii. monopolization was a felony

iii. outlawed restrains of tradeb. 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

Decreasing

Constant

Final Exam Review

Documents

ap test review

mrmc rule

understand

income increases

public choice

demand increases

lower price

production