AP MICRO ECONOMICS EXAM REVIEW

A C F B D E W RobotsRobots Shoes Production Possibility Curve

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 HouseholdsBusinesses Government Bs. Taxes Subsidy Taxes Transfers

P Q MB MC Allocative Efficiency Q op

Market Equilibrium Demand Supply PePe QeQe Quantity PricePrice

A change in Demand versus a change in the Quantity Demanded Change in Demand √ Moves the curve IncomeIncome Future ExpectationsFuture Expectations # of Buyers# of Buyers Consumer InformationConsumer Information Taste and PreferenceTaste and Preference Substitues and ComplementsSubstitues and Complements Change in Quantity Demanded √ Moves Along the SAME curve Caused only by Price change. Caused only by Price change.

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

Consumer and Producer Surplus √ The value in excess of the purchase price √ The income the firm gets in excess of its marginal costs D S P1P1P1P1 QeQeQeQe P Q CS PS

Marginal Utility diminishes with increased consumption, is zero where total utility is at a maximum, and is negative when Total Utility declines. When Total Utility is at its peak, Marginal Utility is zero. MargInalUtIlItyMargInalUtIlIty MU Unit Consumed TotalUtilityTotalUtility TU Marginal Utility reflects the change in total utility so it is negative when Total Utility declines. Marginal Utility

Price Floor and Price Ceiling D S PcPcPcPc Shortage P1P1P1P1 QeQe P Q PfPfPfPf Surplus

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

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

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

The Market Individual firm MR=D=AR=P S P pepepepe qeqeqeqe D Q P Q D2D2D2D2 p2p2p2p2 MR=D=AR=P 2 q2q2q2q2 Pure Competition

MC Firm showing Economic Profit Q1Q1Q1Q1 P Total Revenue ATCATC ATCATC MR=MC Per unit profit Q ATC AVC Economic Profit MR=D=AR=P $131 $97.78

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

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

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

ATC MC Competitive Firm Supply Curve P AVC Q MR 1 MR 2 MR 3 MR 4 MR 5 Shutdown point Breakeven point— normal profit

Single Price Profit-Maximizing Monopoly Q P MR MC D QmQm PePe ATC Economic Profit ATC MR=MC

Q D MC ATC P Q1Q1Q1Q1 Price and Costs PRICE DISCRIMINATION Q2Q2Q2Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! MR=D

Q D MR MC ATC P Price and Costs MR = MC Fair-Return Price Socially-OptimumPrice QmQm QfQf QrQr Dilemma of Regulation:Which Price? PmPm PfPf PrPr

Consumersurplus O P Q P pc Q pc MC (= S under perfect competition ) AR = D a PmPmPmPm QmQmQmQm MR b Deadweight loss under monopoly Producersurplus Deadweightloss Deadweight Loss (c)R=MC (b)P m Monopolist price (a)P=MC Purely Competitive price Deadweight Loss (c)R=MC (b)P m Monopolist price (a)P=MC Purely Competitive price c

D MR P1P1 ATC Price and Costs Q1Q1 Short-Run Economic Profits Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity AC 1 MC

D MR MC P2P2 ATC Price and Costs Q2Q2 Short-RunEconomicLosses PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity AC 2

D MR MC P 3 = AC 3 ATC Price and Costs Q3Q3 PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity Long-Run Equilibrium NormalProfitOnly

Using Game Theory Game theory can be used to describe a game when: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 Y COMPANY X Don’t Adv. Advertise 10,10 10,10 2,15 2,15 Advertise 15,2 15,2 7,7 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 MP of Labor MP of Capital Price of Labor Price of Capital Least-Cost Combination of Resources MP L PLPL MP C PCPC == MRP L PLPL MRP C PCPC 1 Profit-Maximizing Combination

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

Wage Rate (dollars) MRP S WmWm Quantity of Labor MRC WcWc QmQm QcQc The competitive solution would result in a higher wage and greater employment. Monopsonistic Labor Market

P Q Spillover Costs And Benefits D=MB 0 Spillovercosts S=MSC S=MPC Overallocation Q0Q0 QeQe

P Q 0 QeQe Q0Q0 D=MPB D=MSB SpilloverBenefits S=MC Underallocation

Two Goals for Tax Systems 4Tax equity: 4Tax equity: The fairness of a tax system. 4Tax efficiency: 4Tax efficiency: How a tax system maintains the incentives to be productive.

Two Principles of Tax Equity 4 Benefits received principle: 4 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. 4 Ability-to-pay principle: 4 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 $ Progressive tax: collects a higher percentage of high incomes than of low incomes. $ Regressive tax: $ Regressive tax: collects a higher percentage of low incomes than of high incomes. $ Proportional tax: $ Proportional tax: collects the same percentage of income, no matter what the income.

Efficiency Loss of a tax S O P1P1P1P1 Q1Q1Q1Q1 D P Q StStStSt a b c CONSUMER’S SHARE PRODUCER’S SHARE Efficiency Loss Q2Q2Q2Q2 P2P2P2P2

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