A.P. Microeconomics Review Units 1-6

Basic Economic Concepts Unit 1 Basic Economic Concepts

How is Economics used? Positive vs. Normative Economists use the scientific method to make generalizations and abstractions to develop theories. This is called theoretical economics. These theories are then applied to fix problems or meet economic goals. This is called policy economics. Positive vs. Normative Positive Statements- Based on facts. Avoids value judgements (what is). Normative Statements- Includes value judgements (what ought to be).

Would you see the movie three times? Thinking at the Margin # Times Watching Movie Benefit Cost 1st $30 $10 2nd $15 3rd $5 Total $50 Would you see the movie three times? Notice that the total benefit is more than the total cost but you would NOT watch the movie the 3rd time.

5 Key Economic Assumptions Society’s wants are unlimited, but ALL resources are limited (scarcity). Due to scarcity, choices must be made. Every choice has a cost (a trade-off). Everyone’s goal is to make choices that maximize their satisfaction. Everyone acts in their own “self-interest.” Everyone acts rationally by comparing the marginal costs and marginal benefits of every choice Real-life situations can be explained and analyzed through simplified models and graphs.

The Production Possibilities Curve (PPC) Using Economic Models… Step 1: Explain concept in words Step 2: Use numbers as examples Step 3: Generate graphs from numbers Step 4: Make generalizations using graph 6

What is the Production Possibilities Curve? A production possibilities graph (PPG) is a model that shows alternative ways that an economy can use its scarce resources This model graphically demonstrates scarcity, trade-offs, opportunity costs, and efficiency. 4 Key Assumptions Only two goods can be produced Full employment of resources Fixed Resources (Ceteris Paribus) Fixed Technology 7

PRODUCTION POSSIBILITIES How does the PPG graphically demonstrates scarcity, trade-offs, opportunity costs, and efficiency? 14 12 10 8 6 4 2 Impossible/Unattainable (given current resources) A B G C Bikes Efficient D Inefficient/ Unemployment E 0 2 4 6 8 10 Computers 8

Opportunity Cost 1. The opportunity cost of moving from a to b is… Example: 1. The opportunity cost of moving from a to b is… 2 Bikes 2.The opportunity cost of moving from b to d is… 7 Bikes 3.The opportunity cost of moving from d to b is… 4 Computer 4.The opportunity cost of moving from f to c is… 0 Computers 5.What can you say about point G? Unattainable 9

PER UNIT Opportunity Cost How much each marginal unit costs Units Gained Example: 1. The PER UNIT opportunity cost of moving from a to b is… 1 Bike 2.The PER UNIT opportunity cost of moving from b to c is… 1.5 (3/2) Bikes 3.The PER UNIT opportunity cost of moving from c to d is… 2 Bikes 4.The PER UNIT opportunity cost of moving from d to e is… 2.5 (5/2) Bikes NOTICE: Increasing Opportunity Costs 10

3 Shifters of the PPC Fixed Resources (4 Factors) Fixed Technology PRODUCTION POSSIBILITIES 4 Key Assumptions Revisited Only two goods can be produced Full employment of resources Fixed Resources (4 Factors) Fixed Technology What if there is a change? 3 Shifters of the PPC 1. Change in resource quantity or quality 2. Change in Technology 3. Change in Trade 11

What happens if there is an increase in population? PRODUCTION POSSIBILITIES What happens if there is an increase in population? Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Robots Q 1 2 3 4 5 6 7 8 Pizzas 12

What happens if there is an increase in population? PRODUCTION POSSIBILITIES What happens if there is an increase in population? Q A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ C’ Robots D’ E’ Q 1 2 3 4 5 6 7 8 Pizzas 13

Technology improvements in pizza ovens PRODUCTION POSSIBILITIES Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Technology improvements in pizza ovens Robots Q 1 2 3 4 5 6 7 8 Pizzas 14

New robot making technology Question #1 New robot making technology Q A shift only for Robots Robots Q Pizzas 15

Question #2 Decrease in the demand for pizza Q The curve doesn’t shift! A change in demand doesn’t shift the curve Robots Q Pizzas 16

Question #4 BP Oil Spill in the Gulf Q Decrease in resources decrease production possibilities for both Capital Goods (Guns) Q Consumer Goods (Butter) 17

Question #5 Faster computer hardware Q Quality of a resource improves shifting the curve outward Capital Goods (Guns) Q Consumer Goods (Butter) 18

Communism in the Long Run Free Markets in the Long Run Connection to the PPC Communism in the Long Run Free Markets in the Long Run CURRENT CURVE FUTURE CURVE FUTURE CURVE Capital Goods CURRENT CURVE Capital Goods Consumer goods Consumer goods Cuba Puerto Rico 19

Unit 2 Supply and Demand

GRAPHING DEMAND Demand Schedule Price of Cereal $5 10 $4 20 $3 30 $2 Quantity Demanded $5 10 $4 20 $3 30 $2 50 $1 80 Demand o 10 20 30 40 50 60 70 80 Q Quantity of Cereal 21

Where do you get the Market Demand? Billy Jean Other Individuals Market Price Q Demd $5 1 $4 2 $3 3 $2 5 $1 7 Price Q Demd $5 $4 1 $3 2 $2 3 $1 5 Price Q Demd $5 9 $4 17 $3 25 $2 42 $1 68 Price Q Demd $5 10 $4 20 $3 30 $2 50 $1 80 P P P P $3 $3 $3 $3 D D D D Q Q Q Q 3 2 25 30

What Causes a Shift in Demand? 5 Determinates (SHIFTERS) of Demand: Tastes and Preferences Number of Consumers Price of Related Goods Income Future Expectations Changes in PRICE don’t shift the curve. It only causes movement along the curve. 23 23

Prices of Related Goods The demand curve for one good can be affected by a change in the price of ANOTHER related good. Substitutes are goods used in place of one another. If the price of one increases, the demand for the other will increase (or vice versa) Ex: If price of Pepsi falls, demand for coke will… 2. Complements are two goods that are bought and used together. If the price of one increase, the demand for the other will fall. (or vice versa) Ex: If price of skis falls, demand for ski boots will... 24 24

Income The incomes of consumer change the demand, but how depends on the type of good. Normal Goods As income increases, demand increases As income falls, demand falls Ex: Luxury cars, Sea Food, jewelry, homes 2. Inferior Goods As income increases, demand falls As income falls, demand increases Ex: Top Romen, used cars, used cloths, Spam-Inferior Yachts- Normal Off Brand Cereal-Inferior McDonald’s-Inferior Toilet Paper- Probably no connection to income (The point-some products are very reliant on income and others are not) 25 25

Change in Qd vs. Change in Demand There are two ways to increase quantity from 10 to 20 Price of Cereal P A to B is a change in quantity demand (due to a change in price) A to C is a change in demand (shift in the curve) A C $3 $2 B D2 D1 o Q Cereal 10 20 Quantity of Cereal

GRAPHING SUPPLY Supply Schedule Price of Cereal Supply $5 50 $4 40 $3 2 1 Price Quantity Supplied $5 50 $4 40 $3 30 $2 20 $1 10 o 10 20 30 40 50 60 70 80 Q Quantity of Cereal 27

6 Determinants (SHIFTERS) of Supply Prices/Availability of inputs (resources) Number of Sellers Technology Government Action: Taxes & Subsidies 5. Opportunity Cost of Alternative Production 6. Expectations of Future Profit Changes in PRICE don’t shift the curve. It only causes movement along the curve. 28 28

Equilibrium Price = $3 (Qd=Qs) Equilibrium Quantity is 30 Supply and Demand are put together to determine equilibrium price and equilibrium quantity P Supply Schedule Demand Schedule S $5 4 3 2 1 P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 Equilibrium Price = $3 (Qd=Qs) D o 10 20 30 40 50 60 70 80 Q Equilibrium Quantity is 30 29

How much is the surplus at $4? At $4, there is disequilibrium. The quantity demanded is less than quantity supplied. P Supply Schedule Demand Schedule S $5 4 3 2 1 Surplus (Qd<Qs) P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 How much is the surplus at $4? Answer: 20 D o 10 20 30 40 50 60 70 80 Q 30

How much is the shortage at $2? At $2, there is disequilibrium. The quantity demanded is greater than quantity supplied. P Supply Schedule Demand Schedule S $5 4 3 2 1 P Qd $5 10 $4 20 $3 30 $2 50 $1 80 P Qs $5 50 $4 40 $3 30 $2 20 $1 10 How much is the shortage at $2? Answer: 30 Shortage (Qd>Qs) D o 10 20 30 40 50 60 70 80 Q 31

Supply and Demand Analysis Easy as 1, 2, 3 Before the change: Draw supply and demand Label original equilibrium price and quantity The change: Did it affect supply or demand first? Which determinant caused the shift? Draw increase or decrease After change: Label new equilibrium? What happens to Price? (increase or decrease) What happens to Quantity? (increase or decrease) Let’s Practice! 32

Double Shifts Suppose the demand for sports cars fell at the same time as production technology improved. Use S&D Analysis to show what will happen to PRICE and QUANTITY. If TWO curves shift at the same time, EITHER price or quantity will be indeterminate. 33

Voluntary Exchange Terms Consumer Surplus is the difference between what you are willing to pay and what you actually pay. CS = Buyer’s Maximum – Price Producer’s Surplus is the difference between the price the seller received and how much they were willing to sell it for. PS = Price – Seller’s Minimum 34

Consumer and Producer’s Surplus Calculate the area of: Consumer Surplus Producer Surplus Total Surplus P $10 8 6 $5 4 2 1 S CS CS= $25 PS= $20 Total= $45 PS D 2 4 6 8 10 Q 35

Government Involvement #1-Price Controls: Floors and Ceilings #2-Import Quotas #3-Subsidies #4-Excise Taxes 36

#1-PRICE CONTROLS Who likes the idea of having a price ceiling on gas so prices will never go over $1 per gallon? 37

To have an effect, a price ceiling must be below equilibrium Maximum legal price a seller can charge for a product. Goal: Make affordable by keeping price from reaching Eq. To have an effect, a price ceiling must be below equilibrium P Gasoline S $5 4 3 2 1 Does this policy help consumers? Result: BLACK MARKETS Price Ceiling Shortage (Qd>Qs) D o 10 20 30 40 50 60 70 80 Q 38

To have an effect, a price floor must be above equilibrium Minimum legal price a seller can sell a product. Goal: Keep price high by keeping price from falling to Eq. To have an effect, a price floor must be above equilibrium P Corn S $ 4 3 2 1 Surplus (Qd<Qs) Price Floor Does this policy help corn producers? D o 10 20 30 40 50 60 70 80 Q 39

#2 Import Quotas A quota is a limit on number of exports. The government sets the maximum amount that can come in the country. Purpose: To protect domestic producers from a cheaper world price. To prevent domestic unemployment 40

International Trade and Quotas Identify the following: CS with no trade PS with no trade CS if we trade at world price (PW) PS if we trade at world price (PW) Amount we import at world price (PW) If the government sets a quota on imports of Q4 - Q2, what happens to CS and PS? 1.H 2.TLI 3.HIJKLMNRS 4.T 5.Q5-Q1 6. CS gets smaller and PS gets bigger This graphs show the domestic supply and demand for grain. The letters represent area.

#3 Subsidies The government just gives producers money. The goal is for them to make more of the goods that the government thinks are important. Ex: Agriculture (to prevent famine) Pharmaceutical Companies Environmentally Safe Vehicles FAFSA 42

Result of Subsidies to Corn Producers Price of Corn S SSubsidy Price Down Quantity Up Everyone Wins, Right? Pe P1 D o Qe Q1 Q Quantity of Corn 43

Excise Tax = A per unit tax on producers #4 Excise Taxes Excise Tax = A per unit tax on producers For every unit made, the producer must pay $ NOT a Lump Sum (one time only)Tax The goal is for them to make less of the goods that the government deems dangerous or unwanted. Ex: Cigarettes “sin tax” Alcohol “sin tax” Tariffs on imported goods Environmentally Unsafe Products Etc. 44

Government sets a $2 per unit tax on Cigarettes Excise Taxes Supply Schedule Government sets a $2 per unit tax on Cigarettes P P Qs $5 140 $4 120 $3 100 $2 80 $1 60 S $5 4 3 2 1 D o Q 45 40 60 80 100 120 140

Government sets a $2 per unit tax on Cigarettes Excise Taxes Supply Schedule Government sets a $2 per unit tax on Cigarettes P P Qs $5 $7 140 $4 $6 120 $3 $5 100 $2 $4 80 $1 $3 60 S $5 4 3 2 1 D o Q 46 40 60 80 100 120 140

Tax is the vertical distance between supply curves Excise Taxes STax Supply Schedule P P Qs $5 $7 140 $4 $6 120 $3 $5 100 $2 $4 80 $1 $3 60 S $5 4 3 2 1 Tax is the vertical distance between supply curves D o Q 47 40 60 80 100 120 140

Identify the following: Excise Taxes S Identify the following: Price before tax Price consumers pay after tax Price producers get after tax Total tax revenue for the government before tax Total tax revenue for the government after tax P S $5 4 3 2 1 1.$3 2.$4 3.$2 4.$0 5.$160 D o Q 48 40 60 80 100 120 140

Tax Practice CS Before Tax PS Before Tax CS After Tax PS After Tax Tax Revenue for Government Dead Weight Loss due to tax Amount of tax revenue producers pay 1.ABCD 2.HFEG 3.A 4.G 5.BCHF 6.DE 7.HF 49

4 Types of Elasticity Elasticity of Demand Elasticity of Supply Cross-Price Elasticity (Subs vs. Comp) Income Elasticity (Norm or Infer)

1. Elasticity of Demand Elasticity of Demand- Measurement of consumers responsiveness to a change in price. What will happen if price increase? How much will it effect Quantity Demanded Who cares? Used by firms to help determine prices and sales Used by the government to decide how to tax

Inelastic Demand INelastic = Insensitive to a change in price. If price increases, quantity demanded will fall a little If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. 20% 5% A INELASTIC demand curve is steep! (looks like an “I”) Examples: Gasoline Milk Diapers Chewing Gum Medical Care Toilet paper

General Characteristics of INelastic Goods: Inelastic Demand General Characteristics of INelastic Goods: Few Substitutes Necessities Small portion of income Required now, rather than later Elasticity coefficient less than 1 20% 5%

Elastic Demand An ELASTIC demand curve is flat! Elastic = Sensitive to a change in price. If price increases, quantity demanded will fall a lot If price decreases, quantity demanded increases a lot. In other words, the amount people buy is sensitive to price. An ELASTIC demand curve is flat! Examples: Soda Boats Beef Real Estate Pizza Gold

General Characteristics of Elastic Goods: Elastic Demand General Characteristics of Elastic Goods: Many Substitutes Luxuries Large portion of income Plenty of time to decide Elasticity coefficient greater than 1