1. AP Microeconomics Review #2
Stater
April 11, 2019

2. Elasticity
Elasticity of Demand; Other Measures of Elasticity; Total Revenue Test; Elasticity of Supply

3. Elasticity of Demand
Measures consumer responsiveness to a price change
Ed = % change in Qd / % change in P
Ed > 1 means relatively elastic demand
Ed = 1 means unit elastic demand
Ed < 1 means relatively inelastic demand

6. Elasticity of Demand – Midpoint Formula
Used to calculate elasticity of demand when given price & quantity data at two separate prices
Ex: when given two points on a demand curve

7. Determinants of Elasticity of Demand
Substitutability
The more subs available, the more elastic the demand
Proportion of income
The larger the portion of income a product consumes, the more elastic the demand
Luxuries v. Necessities
Luxuries are more elastic than necessities
Time
The more time you have to buy something, the more elastic the demand

8. Total Revenue Test TR = Price x Quantity
If price increases and TR decreases, or if price decreases and TR increases, the demand is elastic at that price range.
If price increases and TR increases, or if price decreases and TR decreases, the demand is inelastic at that price range.
Unit elastic – price changes and TR remains constant

10. Cross-price Elasticity of Demand
Exy = % change in Qd of good X / % change in P of good y
Exy > 0 (positive) means the goods are substitutes
Exy < 0 (negative) means the goods are complements

11. Income Elasticity of Demand
Ei = % change in Qd / % change in income
Ei > 0 (positive) means the good is normal
Ei > 1 means the good is normal & a luxury
Ei < 0 (negative) means the good is inferior

12. Elasticity of Supply Es = % change in Qs / % change in price
Es > 1 means relatively elastic supply
Es = 1 means unit elastic supply
Es < 1 means relatively inelastic supply

13. Elasticity of Supply – time periods
Market Period
Immediate time period (shortest)
Perfectly inelastic supply
Short Run
Can only change variable inputs, not plant size
More elastic than market period
Long Run
Can change all inputs
Most elastic

14. Price Controls, Excise Taxes, & Trade Barriers
Graphical Analysis; Effect on Producer & Consumer Surplus; Government Revenue; Effects on Efficiency

15. Excise Tax Per-unit tax on the production of a good
To decrease consumption or collect gov’t revenue
Shifts the supply curve vertically by amount of the tax

16. Excise Tax Results in gov’t revenue = Per-unit Tax Amount X Q
Affects CS & PS
Results in deadweight loss (DWL)
Net benefit lost to society due to a movement away from allocative efficiency

17. Excise Tax Pre-tax: CS = ABCF PS = DEG Post-tax: Per-unit tax = $2
Gov’t revenue = BCD
CS = A
PS = E
DWL = F&G

18. Excise Taxes & Elasticity
The party that is least equipped to respond faces the larger tax burden or incidence.
If supply is more elastic than demand, consumers face the higher burden
If demand is more elastic than supply, producers face the higher burden
If demand is perfectly inelastic, the burden is entirely on consumers in the form of a higher price.
If demand is perfectly elastic, the burden is entirely on producers to cover the tax.

19. Subsidies
Payments made by the government to a firm for producing a product or service deemed needed by society
Ex: Education, Prescription Drug
Shifts supply curve to the right
Higher quantity produced; lower cost to consumers

20. Price Controls (discussed in Review #1)
Know how to analyze effects on CS, PS, & DWL
No gov’t revenue
In this example:
ABC is consumer surplus before the price floor; A is after
DEF is producer surplus before the price floor; BDF is after
C&E become DWL after the price floor

21. Price Controls (discussed in Review #1)
In this example:
ABC is consumer surplus before the price ceiling; ABD is after
DEF is producer surplus before the price ceiling; F is after
C&E become DWL after the price ceiling

22. International Trade Import: Goods we get from abroad
Revenue tariff: excise tax levied on an import NOT produced in the domestic market (ex: bananas)
Protective tariff: excise tax levied on an import that IS produced in the domestic market (ex: steel)
Import quota: a maximum amount of a good that can be imported into the domestic market
Directly affects quantity

23. International Trade Trade barriers result in inefficiency & DWL
Tariffs also result in gov’t revenue (not quotas)
CS & PS are affected
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24. Theory of Consumer Choice
Marginal Analysis; Law of Diminishing Marginal Utility; Utility Maximization

25. Key Terms Utility – happiness/satisfaction
Measured in utils – “happy points”
Total utility – combined satisfaction at a given quantity of product consumed
Marginal utility – additional satisfaction gained from consuming an additional unit
You must add the MU from each previous quantity to get the TU at a given quantity

26. Law of Diminishing Marginal Utility
In a given time period, the additional satisfaction from consuming one more of something falls.
The unconstrained consumer (no price or income restraints), will still rationally stop consuming something when MB = MC, and before MB < MC.

27. Utility-Maximizing Rule
Marginal utility per dollar (MU / P)
Allows us to compare the amount of extra utility gained from differently priced goods (putting in “like terms”)
To maximize utility, find the combination of quantities that satisfies both conditions:
The ratios of MU / P for each of two products must be equal.
All income must be spent without going over.