AP MICRO ECONOMICS EXAM REVIEW

Production Possibility Curve A B R o b t s C W F D E Shoes

Households Land, Labor, Capital and Entrepreneurship Resource or factor Market Resource Money Payments Businesses Households Money Payments Product Market Goods and Services

Households Businesses Bs. Taxes Taxes Government Subsidy Transfers Land, Labor, Capital & Entrepreneruial Ability to bs and govt Resource Money Payments paid by bs. and govt Goods and Services for Households and Government Money Payments for goods and services from government and households Households Businesses Bs. Taxes Taxes Government Subsidy Transfers

Allocative Efficiency P MC MB Q Qop

Market Equilibrium P r i c e Supply Pe Demand Qe Quantity

A change in Demand versus a change in the Quantity Demanded √ Moves the curve Income Future Expectations # of Buyers Consumer Information Taste and Preference Substitutes and Complements Change in Quantity Demanded √ Moves Along the SAME curve • Caused only by Price change.

A change in Supply versus a change in the Quantity Supplied √ Moves the curve Costs of Production Future Expectations # of Sellers Taxes and Subsidies Prices of goods using same resources Time period of production Change in Quantity Supplied √ Moves Along the SAME curve • Caused only by Price change.

S D Consumer and Producer Surplus √ The value in excess of the purchase price √ The income the firm gets in excess of its marginal costs P S CS P1 Qe PS D Q

When Total Utility is at its peak, Marginal Utility is zero. TU When Total Utility is at its peak, Marginal Utility is zero. Marginal Utility reflects the change in total utility so it is negative when Total Utility declines. Unit Consumed M a r g I n l U t y Marginal Utility diminishes with increased consumption, is zero where total utility is at a maximum, and is negative when Total Utility declines. MU Unit Consumed

Price Floor and Price Ceiling S Surplus Pf P1 Qe Pc Shortage D Q

E i = %  Quantity % Income Elasticity Ed = % change in Qd % change in P DEMAND E c = %  Quantity of X % Price of Y CROSS E i = %  Quantity % Income INCOME

Law of Diminishing Returns Total Product Total Product, TP Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Marginal Product Quantity of Labor

ECONOMIC INTERPRETATION RELATIONSHIP ECONOMIC INTERPRETATION MR = MC The firm has chosen the output that maximizes profits.   P > ATC Firm is earning Economic Profits P = ATC Firm is earning NORMAL PROFIT (Break-Even Point) (EP = 0) P < ATC; P > AVC Loss Minimization P = AVC SHUTDOWN POINT (firm cannot cover its AVC P < AVC Firm does not produce

PURE COMPETITION MONOPOLY P = MR The firm’s DEMAND CURVE is infinitely ELASTIC MR = MC  The firms maximizes profit. P= ATC Long Run (NORMAL PROFITS) PRODUCTIVE EFFICIENCY P = min ATC  Firm is forced to operate with maximum productive efficiency. (Least-Cost Method Production) ALLOCATIVE EFFICIENCY P = MC There is an optimal allocation of resources. MONOPOLY P > MR The firm’s DEMAND CURVE is relatively INELASTIC. MR = MC  The firms maximizes profit. P > ATC  Long Run ECONOMIC PROFITS. PRODUCTIVE INEFFICIENCY P > min ATC  Firm is not forced to operate with maximum productive efficiency.  (Least-Cost Method Production not necessary) ALLOCATIVE INEFFICIENCY  P > MC  There is an UNDERALLOCATION of resources.

Pure Competition The Market Individual firm P S P MR=D=AR=P2 p2 qe q2 Q Q The Market Individual firm

Firm showing Economic Profit ATC P MC MR=MC MR=D=AR=P $131 Per unit profit Total Revenue Economic Profit $97.78 ATC AVC Q1 Q

Firm showing Economic Loss P ATC MC Per unit loss MR=MC MR=D=AR=P Economic Loss ATC $81 Total Revenue AVC Q2 Q

Firm showing Shutdown position ATC Firm showing Shutdown position P MC AVC MR=D=AR=P $71 At no level of output does the firm cover the Average Variable Costs. Q

Price = MC = MR = Minimum ATC Long-run Equilibrium For A Competitive Firm MC Price ATC MR=D=AR=P Pe Price = MC = MR = Minimum ATC (normal profit) Qe Quantity

Competitive Firm Supply Curve ATC Competitive Firm Supply Curve AVC MC P MR5 Breakeven point— normal profit MR4 MR3 MR2 Shutdown point MR1 Q

Single Price Profit-Maximizing Monopoly MC ATC Pe Economic Profit ATC MR=MC D Q Qe MR

A perfectly discriminating producing more product PRICE DISCRIMINATION A perfectly discriminating monopolist has MR=D, producing more product and more profit! MC P ATC Price and Costs MR=D D Q Q1 Q2

Dilemma of Regulation:Which Price? MR = MC Fair-Return Price Pm Socially-Optimum Price Price and Costs ATC Pf MC Pr D MR Q Qm Qf Qr

Deadweight loss under monopoly MC (= S under perfect competition) Consumer surplus Deadweight loss Deadweight Loss (c)MR=MC (b)Pm Monopolist price (a)P=MC Purely Competitive price b Pm a Ppc Producer surplus c AR = D MR O Qm Qpc Q

MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Expect New Competitors ATC Price and Costs P1 AC1 Short-Run Economic Profits D MR Q1 Quantity

MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC ATC AC2 P2 Price and Costs Short-Run Economic Losses D MR Q2 Quantity

MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Long-Run Equilibrium Normal Profit Only ATC P3 = AC3 Price and Costs D MR Q3 Quantity

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

Advertising Game COMPANY Y COMPANY X Don’t Adv. Advertise 10,10 2,15 15,2 7,7 Dominant strategies: Strategy 1 dominates Strategy 2 if every payoff from 2 is dominated by the respective payoff from 1. Nash equilibrium: a set of strategies, one for each player, such that no player has an incentive (in terms of improving his own payoff) to deviate from his strategy, i.e., each player can do no better given what the opposing player(s) does.

MRP = MP x P Marginal Revenue Product equals the Marginal Product times the Price. √ The MRP curve is the resource demand curve. √ Location of curve depends on the productivity and the price of the product.

Optimum Combination Of Resources Least-Cost Combination of Resources MP of Labor MP of Capital Price of Labor Price of Capital MPL MPC = PL PC Profit-Maximizing Combination MRPL PL MRPC PC 1

Purely Competitive Labor Market Equilibrium S Quantity of Labor Wage Rate (dollars) Includes Normal Profit Non- Labor Costs S = MRC Wc $6 Wc ($6) Labor Costs D = MRP ( mrp’s) d = mrp (1000) (5) Labor Market Individual Firm

Monopsonistic Labor Market MRC S The competitive solution would result in a higher wage and greater employment. Wage Rate (dollars) Wc Wm MRP Qm Qc Quantity of Labor

Spillover Costs And Benefits S=MSC Spillover costs S=MPC D=MB Overallocation Q Q0 Qe

Spillover Costs And Benefits S=MC Spillover Benefits D=MSB D=MPB Underallocation Q Qe Q0

Two Goals for Tax Systems Tax equity: The fairness of a tax system. Tax efficiency: How a tax system maintains the incentives to be productive.

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

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

Efficiency Loss of a tax P St S a P2 Efficiency Loss CONSUMER’S SHARE b P1 PRODUCER’S SHARE c D O Q2 Q1 Q

The Lorenz Curve Cumulative % of Income 100 Line of Perfect Equality Degree of Inequality 100 Cumulative % of families