1. AP Microeconomics Review #4
Rixie
April 27, 2017

2. Resource Markets Derived Demand; Determinants of Resource Demand;
Perfectly Competitive Labor Market; Monopsony; Least-Cost Hiring Rule

3. Derived Demand
The demand for the factors of production (resources) exists due to the demand for the product

4. Determinants of Resource Demand
Change in demand for the product
Higher demand for lemonade would increase the demand for lemons
Change in efficiency
The more efficient a resource is, the more valuable it is to a business (increase in MRP)
Change in the price of a substitute resource
Firms demand more of the cheaper resource
Change in the price of a complementary resource
If one resource gets cheaper, firms will demand more of the complementary resource as well

5. MRP & MRC
MRP (marginal revenue product) represents the additional income that an additional resource brings to the firm
In perfectly competitive markets:
MRP = Price x Marginal Product (MP)
MRC (marginal resource cost) is the SAME THING as MFC (marginal factor cost), and represents the additional cost of hiring/purchasing one more of a resource
In perfectly competitive resource markets:
MRC = wage

6. Using the MRP = MRC rule The profit-maximization rule for hiring
A firm should hire the quantity where these two curves intersect on a graph.
When given data instead of a graph:
Choose the quantity of the resource where MRP = MRC, or until they are close as can be before MRC > MRP

7. Perfectly Competitive Labor Market
= MRC

8. Perfectly Competitive Labor Market
Firm’s demand curve = MRP (downward sloping)
Firm’s supply curve = MRC = wage (horizontal)
The firm’s wage cannot change unless the market wage changes
Ex: the supply of labor in the industry changes (see next slide)
Ex: the government sets a minimum wage (price floor on the market graph will increase S=MRC=Wage on the firm’s graph)
A shift in the firm’s demand for the resource (MRP) will affect their profit-maximizing quantity of labor

9. Decrease in market supply of labor

10. Market Minimum Wage (price floor)

11. Monopsony Labor Market
Only one firm hiring (the market IS the firm)
Demand curve = MRP (downward sloping)
Still use MRP = MRC rule to find the profit- maximizing quantity of labor
Wage is found on the supply curve (upward sloping)
MRC (or MFC) is upward sloping & above the supply curve
MRC does NOT equal wage!

12. Monopsony Labor Market
Find the profit-maximizing quantity of labor where MRP = MFC. Then, find the wage on the supply curve at that quantity.
To compare to perfect competition (PC) – a PC market would hire where MRP & supply intersect, and pay that wage
Monopsony pays a lower wage & hires fewer workers than PC

13. Least-Cost Hiring Rule
Marginal product per dollar (MP / P)
Allows us to compare the amount of additional product gained from differently priced resources (putting in “like terms”)
To minimize costs, find the combination of quantities that satisfies both conditions:
The ratios of MP / P for each of two resources must be equal.
The firm’s budget must be spent without going over, OR the exact amount of total product must be produced

14. Externalities
Graphing & Interpreting Positive & Negative Externalities

15. Market Failures
When the free market fails at providing the socially optimal amount of something
Spillover costs – cause negative externalities; additional costs to society from the production of a good or service
Ex: the health costs associated with second-hand smoke
Spillover benefits – cause positive externalities; additional benefits to society from the production of a good or service
Ex: the benefits to society from providing affordable education (highly skilled workers, less crime)

16. Negative Externality
P & Q are the free market price and quantity whereas as P1 and Q1 are socially optimal
Problem: The free market produces too much of a good (over-allocation of resources)
Solution: The government can place a per-unit tax on producers to shift the Marginal Private Cost curve to the left, so it becomes equal to Marginal Social Cost curve, eliminating DWL
DWL

17. Positive Externality
P & Q are the free market price and quantity whereas as P1 and Q1 are socially optimal
Problem: The free market produces too little of a good (under-allocation of resources)
Solution: The government can subsidize consumers to shift the Marginal Private Benefit curve to the right, so it becomes equal to Marginal Social Benefit curve, eliminating DWL
DWL

18. The Role of the Government
Public & Private Goods; Income Distribution; Taxation

19. Public Goods Private Goods Must be non-excludable & non-rival
Non-excludable: no one has to pay to use this good/service
Non-rival: multiple people can benefit from/consume the good or service at the same time
Examples: national defense, NASA, fire/police departments
Are either excludable (must be paid for directly by the consumer) or only one person can consume at a time (or both apply)
Examples: a restaurant meal, a symphony ticket, clothing

20. Free-rider problem
Public goods often result in the free-rider problem:
Since people aren’t required to pay for public goods to receive the service, many wouldn’t voluntarily help pay for them
Ex: A neighborhood association provides night-time security and asks residents to chip in. Some residents may refuse to, since they could argue that they don’t want the service (though they’ll still benefit from it). The solution could be a required fee to the neighborhood association to help cover public goods.
The government solution to this problem is usually different types of taxation.

21. Income Distribution
All countries have some degree of income inequality, which is “the extent to which income is distributed in an uneven manner among a population”
(source:
Reasons for inequality:
Natural ability (skill)
Education & training
Discrimination
Preferences of amount & type of work (motivation)
Market power held in the hands of a few (such as monopolies)
Luck and connections

22. Lorenz Curve
The 45 degree line represents perfect income distribution (60% of the population receives 60% of the total income)
The Lorenz curve represents the extent of income inequality – the more curved/farther away from the equality line it is, the more inequality the nation is experiencing (ex: 60% of the population receives only 20% of the total income)

23. Gini Ratio (or Gini Coefficient)
Another method of measuring income distribution
The closer this ratio is to zero, the more equal the distribution
The closer it is to one, the more unequal the distribution
Ex: a Gini ratio of .25 for one country suggests that it has a much more equal distribution of income than a nation with a ratio of .85

24. Types of Taxation
Progressive: People get taxed different rates (percentages) according to their income level
Ex: federal income tax brackets (the more money you make, the higher the bracket is that you’re in, and the higher the rate that you pay)
Regressive: The tax rate (percentage of total income) decreases as income increases
Ex: a given sales tax is the same for everybody, but it will have a greater impact on somebody with a smaller income, because it consumes a higher overall percentage of their total income

25. Types of Taxation
Proportional: the tax rate stays constant regardless of income level (whether you make $30K a year or $150K a year, you get charged, say, 15% of your income)
Many argue that proportional taxation is a type of regressive taxation, and therefore contributes to income inequality; others say it’s just fair