2. COMMON MISTAKES ON THE AP MICRO EXAM Compiled by: John Ostick Malvern Prep Malvern, PA 19355

3. Consumer and Producer Surplus

6. Dead Weight Loss

7. Dead Weight Loss When the Price is Above P* Q/t P Demand Supply A C 0 Q’ Q* E F P’ P* B Value to the Consumer: 0AEQ’ Consumers Pay Producers: OP’EQ’ The Variable Cost to Producers: OBFQ’ Consumer Surplus: P’AC Producer Surplus: BP’EF DWL FEC

8. Dead Weight Loss When the Price is Below P* Q/t P Demand Supply A P* C 0 Q’ Q* E F P’ B Value to the Consumer: 0AEQ’ Consumers Pay Producers: OP’FQ’ The Variable Cost to Producers: OBFQ’ Consumer Surplus: P’AEF Producer Surplus: BP’F DWL FEC

9. ELASTICITY Tax Incidence & Effects on Revenue and Prices

10. Tax Revenues Efficiency Loss of a Tax Role of Elasticities Qualifications Redistributive Goals Reducing Negative Externalities TAX INCIDENCE AND EFFICIENCY LOSS

11. Perfectly Inelastic Demand D Q/t P S2S2 Q 1 =Q 2 P2P2 S1S1 P1P1

12. Perfectly Elastic Demand Q/t P D S2S2 P 1 =P 2 Q2Q2 S1S1 Q1Q1

13. Inelastic Demand (at moderate prices) P Q/t D S1S1 P1P1 Q1Q1 Q2Q2 S2S2 P2P2

14. Elastic Demand (at moderate prices) Q/t P Q1Q1 D S1S1 P1P1 S2S2 P2P2 Q2Q2

15. DIMINISHING RETURNS  Explanation: As additional units of a variable input (labor) are added to a fixed input (capital), at some point the additional output resulting from the addition of one more unit of variable input declines. This decline is referred to as diminishing marginal return. At this point, total product increases at a decreasing rate.

16.  Rationale: As the variable input increases and the fixed input, by definition, remains the same, there is less fixed input with which the variable input can be combined. Example: As more workers are added but capital remains the same, there is less capital per worker.

17. Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Total Product, TP Quantity of Labor Average Product, AP, and marginal product, MP Quantity of Labor Total Product Marginal Product Average Product Increasing Marginal Returns

18. Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Total Product, TP Quantity of Labor Average Product, AP, and marginal product, MP Quantity of Labor Total Product Marginal Product Average Product Diminishing Marginal Returns

19. Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Total Product, TP Quantity of Labor Average Product, AP, and marginal product, MP Quantity of Labor Total Product Marginal Product Average Product Negative Marginal Returns

20. Two Approaches to Find the PROFIT MAXIMIZING QUANTITY ( PRICE)

21. $1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 900 800 700 600 500 400 300 200 100 0 Total revenue and total cost Total Revenue Total Cost Maximum Economic Profits $299 Break-Even Point (Normal Profit) Break-Even Point (Normal Profit) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 TOTAL REVENUE-TOTAL COST APPROACH

22. $200 150 100 50 0 Cost and Revenue 1 2 3 4 5 6 7 8 9 10 MC MR AVC ATC Economic Profit $131.00 $97.78 MARGINAL REVENUE-MARGINAL COST APPROACH Profit Maximization Position

23. Key Micro Formulas

24. RELATIONSHIPECONOMIC INTERPRETATION MR = MCWhen MR = MC, we know that the firm has chosen the output that maximizes profits. P > ATCFirm is earning ECONOMIC PROFITS P = ATCFirm is earning NORMAL PROFIT (Break-Even Point) (economic profit = 0) P < ATC P > AVC Loss Minimization P = AVCSHUTDOWN POINT (firm will loseTFC if they produce or Shutdown and produce 0. P < AVCFirm does not produce

25. Finding the Perfectly Competitive Firm’s Supply Curve

26. Cost and Revenue, (dollars) MC MR 1 AVC ATC MARGINAL REVENUE-MARGINAL COST APPROACH Quantity Supplied MR 2 MR 3 MR 4 MR 5 P1P1 P2P2 P3P3 P4P4 P5P5 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Marginal Cost & Short-Run Supply Do not Produce – Below AVC

27. Cost and Revenue, (dollars) MC MR 1 MARGINAL REVENUE-MARGINAL COST APPROACH Quantity Supplied MR 2 MR 3 MR 4 MR 5 P1P1 P2P2 P3P3 P4P4 P5P5 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Marginal Cost & Short-Run Supply Yields the Short-Run Supply Curve Supply No Production Below AVC

28. Long Run Equilibrium (Perfectly Competitive Firm)  Productive Efficiency  Allocative Efficiency

29. P MR Q MC ATC Quantity Price Price = MC = Minimum ATC (normal profit) LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM

30. How an Increase in Demand Changes Long- Run Equilibrium for the Firm and Industry

31. Temporary Profits and the Reestablishment Of Long-Run Equilibrium S1S1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN MR D1D1

32. An increase in demand increases profits… MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Economic Profits S1S1

33. New Competitors increase supply and lower Prices decrease economic profits MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Zero Economic Profits S1S1 S2S2

34. How an Decrease in Demand Changes Long- Run Equilibrium for the Firm and Industry

35. Decreases in demand, Losses and the Reestablishment of Long-Run Equilibrium S1S1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D1D1 MR

36. A decrease in demand creates losses… MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Economic Losses S1S1

37. MR D1D1 MC ATC P Q 100 P Q 100,000 Industry Firm (price taker) $60 50 40 $60 50 40 PROFIT MAXIMIZATION IN THE LONG-RUN D2D2 Return to Zero Economic Profits S1S1 S3S3 Competitors with losses decrease supply and prices return to zero economic profits

38. Price and Marginal Revenue for a Monopoly

39. MONOPOLY REVENUES & COSTS Dollars $200 150 200 50 $750 500 250 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q Q

40. MONOPOLY REVENUES & COSTS Dollars $200 150 200 50 $750 500 250 MR Elastic 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 D Q TR Q

41. MONOPOLY REVENUES & COSTS Q Dollars $200 150 200 50 $750 500 250 TR MR D InelasticElastic 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q

42. Failing to remember how to shade the area of ECONOMIC PROFIT THE PROFIT-MAXIMIZING POSITION OF A MONOPOLY

43. Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Remember the MR=MC Rule?

44. And the Shading of Economic Losses LOSS MINIMIZATION OF THE IMPERFECT COMPETITOR

45. Loss Minimization Under Monopoly D MC ATC MR A PmPm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue AVC QmQm V Since P m exceeds AVC, the firm will produce

46. Monopoly vs. Competition

47. PURE COMPETITION MONOPOLY MR = MC The firms maximizes profit. MR = MC The firm maximizes profit. P = ATC The firms just BREAK-EVEN (NORMAL PROFITS) in the Long Run. P > ATC Long Run ECONOMIC PROFITS. P = min ATC Firm is forced to operate with maximum productive efficiency. -------------------------------------- PRODUCTIVE EFFICIENCY (Least-Cost Method Production) P > min ATC Firm is not forced to operate with maximum productive efficiency. PRODUCTIVE INEFFICIENCY (Least-Cost Method Production not necessary) P = MC There is an optimal allocation of resources. ALLOCATIVE EFFICIENCY P > MC There is an UNDERALLOCATION of resources. ALLOCATIVE INEFFICIENCY P = MR The firm’s DEMAND CURVE is infinitely ELASTIC. P > MR The firm’s DEMAND CURVE is less than infinitely ELASTIC.

48. Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC PcPc PmPm QcQc QmQm At MR=MC A monopolist will sell less units at a higher price than in competition An industry in pure competition sells where supply and demand are equal

49. Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC PcPc PmPm QcQc QmQm At MR=MC A monopolist will sell less units at a higher price than in competition Monopoly pricing effectively creates an income transfer from buyers to the seller!

50. Not being able to GRAPH a Natural Monopoly and the Socially- Optimal Output and Fair-Return Output Levels

51. Natural Monopolies Rate Regulation Socially Optimum Price P = MC Fair-Return Price P = ATC Dilemma of Regulation REGULATED MONOPOLY Graphically…

52. REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Monopoly Price MR = MC QmQm PmPm

53. REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Socially-Optimum Price P = MC QrQr PrPr

54. REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Fair-Return Price Normal Profit Only QfQf PfPf

55. REGULATED MONOPOLY Q D MR MC ATC P Price and Costs MR = MC Fair-Return Price Socially-Optimum Price QmQm QfQf QrQr Dilemma of Regulation Which Price? PmPm PfPf PrPr

56. Single PRICE Monopoly vs. Price Discrimination

57. Conditions Monopoly Power Market Segregation No Resale Consequences More Profit More Production PRICE DISCRIMINATION Graphically…

58. Q D MR MC ATC P Q1Q1 Price and Costs Economic profits with a single MR=MC price PRICE DISCRIMINATION

59. Q D MC ATC P Q1Q1 Price and Costs PRICE DISCRIMINATION Q2Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! MR=D

60. Q D MC ATC P Q1Q1 Price and Costs Economic profits with price discrimination PRICE DISCRIMINATION Q2Q2 MR=D

61. Monopolistic Competiton What is it? Monopoly? Competition?

62. D MR P1P1 ATC Price and Costs Q1Q1 Economic Profits Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A1A1 MC

63. D MR P1P1 ATC Price and Costs Q1Q1 Economic Profits Expect New Competitors PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A1A1 New competition drives down the price level – leading to economic losses in the short run MC

64. D MR MC P2P2 ATC Price and Costs Q2Q2 Economic Losses PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A2A2

65. D MR MC P2P2 ATC Price and Costs Q2Q2 Economic Losses PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity A2A2 With economic losses, firms will exit the market – Stability occurs when economic profits are zero

66. D MR MC P 3 = A 3 ATC Price and Costs Q3Q3 PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Quantity Long-Run Equilibrium Normal Profit Only

67. NOW, for the RESOURCE (Factor) MARKETS

68. Remember… Product Market: MR = MC Resource Market: MRP = MFC

69. Units of Resource Total Product (Output) Marginal product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] 0 1 2 3 4 5 6 7 8 Q P 14 12 10 8 6 4 2 Resource price (wage rate) Quantity of resource demanded Pure Competition MRP AS A DEMAND SCHEDULE ] ] ] ] ] ] 0101 0 7 7 $2 2 $ 0 14 $ 14

70. Units of Resource Total Product (Output) Marginal product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] 0 1 2 3 4 5 6 7 8 Q P 14 12 10 8 6 4 2 Resource price (wage rate) Quantity of resource demanded Pure Competition MRP AS A DEMAND SCHEDULE ] ] ] ] ] ] 012012 0 7 13 7676 $2 2 $ 0 14 26 $ 14 12

71. Units of Resource Total Product (Output) Marginal product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] 0 1 2 3 4 5 6 7 8 Q P 14 12 10 8 6 4 2 Resource price (wage rate) Quantity of resource demanded Pure Competition MRP AS A DEMAND SCHEDULE ] ] ] ] ] ] 01230123 0 7 13 18 765765 $2 2 $ 0 14 26 36 $ 14 12 10

72. Units of Resource Total Product (Output) Marginal product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] 0 1 2 3 4 5 6 7 8 Q P 14 12 10 8 6 4 2 Resource price (wage rate) Quantity of resource demanded Pure Competition MRP AS A DEMAND SCHEDULE ] ] ] ] ] ] 0123456701234567 0 7 13 18 22 25 27 28 76543217654321 $2 2 $ 0 14 26 36 44 50 54 56 $ 14 12 10 8 6 4 2 The purely competitive seller’s demand for a resource

73. Units of Resource Total Product (Output) Marginal product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] 0 1 2 3 4 5 6 7 8 Q P 14 12 10 8 6 4 2 Resource price (wage rate) Quantity of resource demanded Pure Competition MRP AS A DEMAND SCHEDULE ] ] ] ] ] ] 0123456701234567 0 7 13 18 22 25 27 28 76543217654321 $2 2 $ 0 14 26 36 44 50 54 56 $ 14 12 10 8 6 4 2 The purely competitive seller’s demand for a resource Now, consider the case of resource demand under Imperfect Competition

74. Units of Resource Total Product (Output) Marginal product (MP) Product Price Total Revenue Marginal Revenue Product (MRP) ] ] ] ] ] ] 0 1 2 3 4 5 6 7 8 Q P 14 12 10 8 6 4 2 Resource price (wage rate) Quantity of resource demanded Imperfect Competition MRP AS A DEMAND SCHEDULE ] ] ] ] ] ] 0123456701234567 0 7 13 18 22 25 27 28 76543217654321 $2.80 2.60 2.40 2.20 2.00 1.85 1.75 1.65 $ 0 18.20 31.20 39.60 44.00 46.25 47.25 46.20 $ 18.20 13.00 8.40 4.40 2.25 1.00 -1.05 The imperfectly Competitive seller’s demand for a resource

75. LABOR MARKETS: Wage Determination

77. PURELY COMPETITIVE LABOR MARKET Purely competitive labor market: Many Firms Numerous Qualified Workers “Wage Taker” Behavior Market Demand for Labor Market Supply of Labor

78. Non- Labor Costs Labor Costs LABOR SUPPLY AND DEMAND PURELY COMPETITIVE MARKET 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 ($10) (5) $10 Includes Normal Profit

79. Wage Rate (dollars) S Quantity of Labor MONOPSONISTIC LABOR MARKET In monopsony MRC lies above the supply curve

80. Wage Rate (dollars) MRP S WmWm Quantity of Labor MRC QmQm MONOPSONISTIC LABOR MARKET MRP = MRC Q m units of labor hired

81. 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

82. EXTERNALITIES Negative Positive

83. COST-BENEFIT ANALYSIS Marginal Cost = Marginal Benefit Rule Spillover Costs Overallocation Spillover Benefits Underallocation Externalities

84. P Q SPILLOVER COSTS AND BENEFITS Illustrating a Negative Externality D 0 Spillover costs StSt S Overallocation Q0Q0 QeQe

85. P Q SPILLOVER COSTS AND BENEFITS Illustrating a Positive Externality 0 QeQe Q0Q0 D DtDt Spillover Benefits StSt Underallocation

86. Taxation Concepts

87. APPORTIONING THE TAX BURDEN Benefits-Received Principle Ability-to-Pay Principle Progressive Tax Regressive Tax Proportional Tax

88. TAX APPLICATIONS: Personal Income Tax Progressive Sales Tax Regressive Corporate Income Tax Proportional - Regressive Payroll Taxes Regressive Property Taxes Regressive Identify whether progressive, regressive, or proportional

89. Price Supports Surpluses Subsidies

90. EFFECT OF PRICE SUPPORTS PePe D S QeQe QcQc QsQs Surplus PsPs Surplus being created by the subsidies Q P Price Support Level

91. International Trade  Comparative Advantage  Case for Free Trade  Export Supply  Import Demand

92. Total output will be greatest when Each good is produced by the nation that has the lowest domestic opportunity cost for that good. U.S has comparative advantage in wheat Brazil has comparative advantage in coffee Principle of Comparative Advantage PRODUCTION POSSIBILITIES

93. Terms of Trade Gains From Trade Improved Options Principle of Comparative Advantage PRODUCTION POSSIBILITIES Trading Possibilities Line Graphically…

94. PRODUCTION POSSIBILITIES A B Coffee (tons) 45 40 35 30 25 20 15 10 5 0 30 25 20 15 10 5 0 5 10 15 20 25 30 5 10 15 20 Wheat (tons) Curve For Each Country United StatesBrazil

95. TRADING POSSIBILITIES LINES Coffee (tons) 45 40 35 30 25 20 15 10 5 0 30 25 20 15 10 5 0 5 10 15 20 25 30 5 10 15 20 A B Trading possibilities line Trading possibilities line Wheat (tons) The Gains from Trade United StatesBrazil

96. TRADING POSSIBILITIES LINES Coffee (tons) 45 40 35 30 25 20 15 10 5 0 30 25 20 15 10 5 0 5 10 15 20 25 30 5 10 15 20 A B Trading possibilities line Trading possibilities line A’ B’ Wheat (tons) The Gains from Trade United StatesBrazil

97. TRADING POSSIBILITIES LINES Coffee (tons) 45 40 35 30 25 20 15 10 5 0 30 25 20 15 10 5 0 5 10 15 20 25 30 5 10 15 20 A B Trading possibilities line Trading possibilities line A’ B’ Wheat (tons) The Gains from Trade United StatesBrazil The Case For Free Trade

98. U.S. EXPORT SUPPLY AND IMPORT DEMAND U.S. Domestic Aluminum Market U.S. Export Supply And Import Demand DdDd SdSd If the world price exceeds the U.S. price by 25 cents... $1.50 1.25 1.00.75.50.25 Price (per pound; U.S. dollars) 1005075125150 Quantity of Aluminum 10050 Price (per pound; U.S. dollars) $1.50 1.25 1.00.75.50.25 Quantity of Aluminum

99. EXPORTS = 50 U.S. EXPORT SUPPLY AND IMPORT DEMAND U.S. Domestic Aluminum Market U.S. Export Supply And Import Demand $1.50 1.25 1.00.75.50.25 10050 DdDd Price (per pound; U.S. dollars) 1005075125150 SURPLUS = 50 $1.50 1.25 1.00.75.50.25 If the world price goes further up... SdSd Quantity of Aluminum

100. EXPORTS = 50 EXPORTS = 100 U.S. EXPORT SUPPLY AND IMPORT DEMAND U.S. Domestic Aluminum Market U.S. Export Supply And Import Demand $1.50 1.25 1.00.75.50.25 10050 DdDd Price (per pound; U.S. dollars) 1005075125150 SURPLUS = 50 SURPLUS = 100 $1.50 1.25 1.00.75.50.25 If world prices fall below $1.00... SdSd U.S. export supply Quantity of Aluminum

101. SHORTAGE = 50 U.S. EXPORT SUPPLY AND IMPORT DEMAND U.S. Domestic Aluminum Market U.S. Export Supply And Import Demand $1.50 1.25 1.00.75.50.25 10050 DdDd Price (per pound; U.S. dollars) 1005075125150 SURPLUS = 50 SURPLUS = 100 $1.50 1.25 1.00.75.50.25 SdSd EXPORTS = 50 EXPORTS = 100 IMPORTS = 50 U.S. export supply Quantity of Aluminum

102. SHORTAGE = 50 SHORTAGE = 100 U.S. EXPORT SUPPLY AND IMPORT DEMAND U.S. Domestic Aluminum Market U.S. Export Supply And Import Demand $1.50 1.25 1.00.75.50.25 10050 DdDd Price (per pound; U.S. dollars) 1005075125150 SURPLUS = 50 SURPLUS = 100 U.S. export supply EXPORTS = 50 EXPORTS = 100 IMPORTS = 50 IMPORTS = 100 U.S. import demand $1.50 1.25 1.00.75.50.25 SdSd Quantity of Aluminum

103. CANADIAN EXPORT SUPPLY AND IMPORT DEMAND Canada’s Domestic Aluminum Market Canada’s Export Supply And Import Demand DdDd SHORTAGE = 50 $1.50 1.25 1.00.75.50.25 10050 Price (per pound; U.S. dollars) 1005075125150 SURPLUS = 100 Canadian export supply Canadian import demand $1.50 1.25 1.00.75.50.25 SdSd SURPLUS = 50 Quantity of Aluminum

104. EQUILIBRIUM WORLD PRICE AND QUANTITY OF EXPORTS & IMPORTS Price (per pound; U.S. dollars) U.S. export supply U.S. import demand Quantity of Aluminum Canadian export supply Canadian import demand 10050 $1.50 1.25 1.00.75.50.25 25.88 Equilibrium