AP Microeconomics Review #1 Stater April 4, 2019

Fundamentals of economic analysis Key Terms; PPC; Absolute & Comparative Advantage

Central Dilemma Societies have limited resources and unlimited wants, so the study of economics must determine how to best allocate these limited resources.

4 Factors of Production Labor Workers (mental & physical) Land The land itself & natural resources Capital Machines, technology, buildings, etc. Entrepreneurial Ability Someone to put it all together

Key Foundations People are rational and follow their own self- interest People seek to maximize utility (satisfaction/happiness) All choices involve trade-offs (alternatives) Opportunity cost is the value of your next best alternative

Marginal Analysis You should always continue to do something as long as the benefits outweigh the costs Marginal means additional Should I eat the next slice of pizza?? Is it worth it?

Production Possibilities Curve/Frontier Points on the curve represent the combination of products a country/firm/person can produce at a given time with set resources Points inside the curve represent inefficiency/underutilization of resources Points outside the curve are unattainable currently

What is the opportunity cost of moving from point B to point C? A loss of 30 capital goods

Production Possibilities Curve/Frontier The whole curve can shift in (left) or out (right) Shift in: loss of resources Shift out: economic growth (more resources or better tech/education)

Law of Increasing Opportunity Costs As you continue to gain more of one thing, you must give up more and more of the other thing Represented by bowed out (concave out to the origin) shape of the PPC A straight PPC would indicate constant opportunity costs

Two Types of Efficiency Productive efficiency Using all resources in the most efficient/cost-effective way possible Allocative efficiency Producing the optimal combination of goods to meet societal needs

Specialization & Trade People/countries/firms use their resources to specialize in specific tasks They can benefit from trading with each other instead of each trying to make everything

Absolute Advantage vs. Comparative Advantage Being able to produce something more efficiently (at a lower cost) than someone else Comparative: Being able to produce something at a lower opportunity cost than someone else (you give up less than they do to produce the same thing)

Input v. Output Problems Input problem – you’re given varying resources (like time) that go into production Output problem – you’re given varying amounts of the total product/service that comes out of production Short-cut – cross multiply! For input, take the lowest number For output, take the highest

Apples per day (thousands) Oranges per day (thousands) Country A 3 12 Country B 2 4 Output problem – looking for most product, so highest number 3 x 4 = 12 2 x 12 = 24 Second combo is the highest number, so Country B should produce apples (has the comp. adv.) and Country A should produce oranges (has the comp. adv)

Input problem – looking for fewest resources used, so lowest number Minutes to produce 1 bushel of apples Minutes to produce 1 bushel of oranges Country A 10 20 Country B 80 Input problem – looking for fewest resources used, so lowest number 10 x 80 = 800 20 x 20 = 400 Second combo is the lowest number, so Country B should produce apples (has the comp. adv.) and Country A should produce oranges (has the comp. adv)

Market vs. Command Economic Systems Market System Private ownership of property Gov’t role is limited; free enterprise Competition; incentives Command System Gov’t owns most property & the means of production Gov’t makes most economic decisions

Basics of Supply & demand Laws; Determinants; Market Equilibrium; Welfare Analysis

Law of Demand As price increases, quantity demanded decreases, and vice versa. Inverse relationship between price & quantity demanded Downward sloping demand curve

Some reasons behind the law of demand… Substitution effect: if two goods are substitutes and the price of one decreases in relation to the other, people will switch to the cheaper one (demand more of it since it’s cheaper) Income effect: as the price of a good decreases, people can afford more of it relative to their income

Determinants of Demand When one of these changes, demand will increase or decrease TRIBE: T: tastes/preferences of consumers R: related goods’ prices (substitutes & complements I: income of consumers B: number of buyers E: expectations of consumers

Key Distinction A change in quantity demanded is a movement along the demand curve and results only from an increase or decrease in the price of the good. A change in demand means one of the determinants is at play, and the demand curve has shifted left (decrease in demand) or right (increase in demand).

Normal v. Inferior Goods If a good is normal, consumers will demand more of it when their income increases, and less when income decreases New clothes, electronics, restaurant meals If a good is inferior, consumers will demand less of it when their income increases, and more when income decreases Used clothes, Ramen noodles

Substitute v. Complementary Goods If 2 goods are substitutes, one can easily be used in place of the other. If the price of one increases, consumers demand less of that one and more of the other. Nike & Adidas shoes; paperback book & an eBook If 2 goods are complements, they are often used together. If the price of one increases, consumers will demand less of it and therefore also demand less of the complementary good. Movie tickets & popcorn; hotdogs & hotdog buns

Law of Supply As price increases, quantity supplied increases, and as price decreases, Qs decreases. Direct relationship between price & quantity supplied Upward sloping supply curve

Determinants of Supply When one of these changes, supply will increase or decrease ROTTEN: R: resource prices O: other goods’ prices T: taxes or subsidies T: technology E: expectations of producers N: number of sellers

Key Distinction A change in quantity supplied is a movement along the supply curve and results only from an increase or decrease in the price of the good. A change in supply means one of the determinants is at play, and the supply curve has shifted left (decrease in supply) or right (increase in supply).

Typical Market Diagram & Market Equilibrium Supply slopes upward Demand slopes downward Equilibrium is where they intersect P* is equilibrium price Q* is equilibrium quantity Always label the curves, each axis (Price & Quantity), and whatever else you are asked to identify!

Practice shifting the supply & demand curves due to a change in one or more determinants! Always sketch a quick market diagram to see what the effect will be on the equilibrium price & quantity. Just one shift – show it on the diagram (use arrows to show the direction) and analyze how equilibrium price & quantity changed. Double shift – you should draw two market diagrams and show each shift separately The variable that changes in the same direction both times will definitely change in that direction. The variable that changes in a different direction on each diagram is indeterminate. https://www.youtube.com/watch?v=K0AQ9rK8MN4&index=9&list=PL6B2 DBE4C2FC8F845

Government-set price floors & ceilings Price floor – minimum price (only effective if above equilibrium) Results in surplus (Qs > Qd) Price ceiling – maximum price (only effective if below equilibrium) Results in shortage (Qd > Qs)

Welfare Analysis Consumer surplus – the difference between what you are willing to pay for something and what you actually pay (as long as you benefit) Producer surplus – the difference between what a seller is willing to sell a product for and what they actually sell it for (as long as they benefit).

Consumer & Producer Surplus in a Market in Equilibrium The sum of consumer surplus and producer surplus is known as total welfare, or total benefit to society.