AP Microeconomics
Mr. Wash
Microeconomics Exam Review Guide
UNITS ONE AND TWO
FOUNDATIONS, CONSUMER CHOICE and
ELASTICITY
MARGINAL UTILITY



LAW OF DIMINISHING MARGINAL
UTILITY
IRRATIONAL GOODS
MU of product A/price of A = MU of
product B/price of B = etc.
ELASTICITY



DETERMINANTS OF ELASTICITY
o TIME
o SUBSTITUTES
o NECESSITY
o INCOME
TOTAL REVENUE TEST
o P = TR
 E<1, INELASTIC
o P = TR
 E>1, ELASTIC
"Good Enough Formula":
(Q2 - Q1/Q1)
E=
(P2 - P1/P1)



DEMAND CURVES
o MORE ELASTIC AT HIGH PRICES
o MORE INELASTIC AT LOW
PRICES
o UNIT ELASTIC AT EQUILIBRIUM
UNIT FOUR
COSTS
COSTS
PROFIT MAXIMIZATION FORMULA





EXTERNAL
INTERNAL
o EXPLICIT
 FIXED
 RENT
 INTEREST
 VARIABLE
 WAGES
o IMPLICIT
 NORMAL PROFIT
 (OPPORTUNITY COST)
TOTAL REVENUE = P X Q
TOTAL REVENUE - INTERNAL EXPLICIT
COSTS = ACCOUNTING PROFIT
ACCOUNTING PROFIT - NORMAL PROFIT

if TR > TC
o then MAX PROFIT
o PRODUCE AT MR > MC
if TR < TC
o
o
o
o
but TR > TVC
then MIN LOSSES
PRODUCE AT MR > MC
LOSE LESS THAN TFC,
BUT LONG RUN LOOK TO
= ECONOMIC PROFIT



SHUT DOWN
if TR < TVC
PRODUCTIVE EFFICIENCY
o P = ATC
o EP = 0
o FAIR RETURN
ALLOCATIVE EFFICIENCY
o P = MC
o NATURAL EQUILIBRIUM
o SOCIALLY OPTIMAL
X EFFICIENCY
o MINIMUM POSSIBLE LONG RUN
ATC
o
o
then SHUT DOWN
LOSE TFC
UNIT FOUR
MARKET MODELS
PERFECT
COMPETITION



INFINITE
NUMBER OF
FIRMS
VERY EASY
ENTRY INTO
MARKET
STANDARD
PRODUCT
PRICE TAKER
DEMAND IS
PERFECTLY ELASTIC
AT MARKET PRICE
MONOPOLISTIC
COMPETITION



MANY FIRMS
EASY ENTRY
INTO MARKET
DIFFERENTIAT
ED PRODUCT
OLIGOPOLY



A FEW FIRMS
DIFFICULT
ENTRY INTO
MARKET
DIFFERENTIAT
ED PRODUCT
PRICE MAKER
PRICE MAKER
RISK TAKER
RISK AVOIDER
MONOPOLY



ONE FIRM
IMPOSSIBLE
ENTRY INTO
MARKET
STANDARD
PRODUCT
PRICE MAKER- DEMAND
IS VERY CLOSE TO
PERFECTLY INELASTIC
RISK AVOIDER
RISK TAKER

PRODUCTIVE
EFFICIENCY
o P=
ATC
o ALWA
YS IN
LONG

PRODUCTIVE
EFFICIENCY
o P = ATC
o ALWAY
S IN
LONG
RUN

PRODUCTIVE
EFFICIENCY
o P > ATC
o NEVER
IN
LONG
RUN

PRODUCTIVE
EFFICIENCY
o P > ATC
o NEVER IN
LONG
RUN
o EP > 0
RUN
EP = 0
FAIR
RETUR
N
ALLOCATIVE
EFFICIENCY
o P = MC
o NATUR
AL
EQUILI
BRIUM
o SOCIA
LLY
OPTIM
AL
o ALWA
YS
X EFFICIENCY
o MINIM
UM
POSSIB
LE
LONG
RUN
ATC
o ALWA
YS IN
LONG
RUN
o
o
o
o




EP = 0
FAIR
RETUR
N
ALLOCATIVE
EFFICIENCY
o P > MC
o ARTIFI
CIAL
EQ
o NEVER
X EFFICIENCY
o MINIM
UM
POSSIB
LE
LONG
RUN
ATC
o ALWAY
S
OVERK
APITAL
IZED IN
LONG
RUN



o EP > 0
ALLOCATIVE
EFFICIENCY
o P > MC
o ARTIFI
CIAL
EQ
o NEVER
X EFFICIENCY
o USUAL
LY IN
LONG
RUN
o HIT
AND
RUN
COMPE
TITION
SHORT RUN
COLLUSION
PERFECT COMPETITION
COSTS





EXTERNAL
INTERNAL
o EXPLICIT
 FIXED
 RENT
 INTEREST
 VARIABLE
 WAGES
o IMPLICIT
 NORMAL PROFIT
 (OPPORTUNITY COST)
TOTAL REVENUE = P X Q
TOTAL REVENUE - INTERNAL EXPLICIT
COSTS = ACCOUNTING PROFIT
ACCOUNTING PROFIT - NORMAL PROFIT
= ECONOMIC PROFIT



ALLOCATIVE
EFFICIENCY
o P > MC
o ARTIFICI
AL EQ
o NEVER
X EFFICIENCY
o NEVER
o CONTEST
ABLE
MARKET?
o HIT AND
RUN
COMPETI
TION?
NONPRODUCTIVE
COSTS
o LAWSUIT
S
o LOBBYIN
G
o LYNCHIN
G







PROFIT MAXIMIZATION
FORMULA
TR > TC
o MAX PROFIT
o PRODUCE AT MR > MC
TR < TC
o TR > TVC
 MIN LOSSES
 PRODUCE AT MR >
MC
 LOSE LESS THAN
TFC, BUT LONG RUN
LOOK TO SHUT
DOWN
o TR < TVC
 SHUT DOWN
 LOSE TFC
ALL MARKETS IN LONG RUN
EQUILIBRIUM
o EP = 0
o
PRODUCTIVE EFFICIENCY
o P = ATC
o EP = 0
o FAIR RETURN
ALLOCATIVE EFFICIENCY
o P = MC
o NATURAL EQUILIBRIUM
o SOCIALLY OPTIMAL
X EFFICIENTY
o MINIMUM POSSIBLE LONG RUN
ATC
IMPERFECT MARKETS
MONOPOLISTIC COMPETITION
MONOPOLISTIC COMPETITION



MANY FIRMS
EASY ENTRY INTO MARKET
DIFFERENTIATED PRODUCT
PRICE MAKER
RISK TAKER
CHOOSE NOT TO PRICE DISCRIMINATE,
SO P DOES NOT EQUAL MR
PROFIT MAXIMIZATION FORMULA IN
IMPERFECT COMPETITION:



TR > TC
o MAX PROFIT
o PRODUCE AT MR > MC
BUT Qs < Qd
o SHORTAGE
SO P = Qd
o UNTIL Qd = Qs
o
ARTIFICIAL EQUILIBRIUM
FOR MONOPOLISITIC COMPETITION

LONG RUN
o IF EP > 0
 FIRMS ENTER
 ATC
 P
 EP = 0
o IF EP < 0
 FIRMS LEAVE
 ATC
 P
 EP = 0


LONG RUN PRODUCTIVE EFFICIENCY
X-EFFICIENCY
o OVERCAPITALIZATION FOR
POTENTIAL EXPANSION
NOT ALLOCATIVE EFFICIENT

OLIGOPOLY
OLIGOPOLY




A FEW FIRMS
DIFFICULT ENTRY INTO MARKET
DIFFERENTIATED PRODUCT
INTERDEPENDENT
o NASH BOX
o PRISONER'S DILEMMA
PRICE MAKER
RISK AVOIDER

KINKED DEMAND CURVE
o IF P
 OTHER FIRMS



o
KEEP
PRICE THE SAME
SO DUE TO
SUBSTITUTION
EFFECT, Qd
TR
E>0
IF P



OTHER FIRMS
LOWER PRICES
PRICE WAR
Qd CONSTANT
 TR
 E<0
STABLE MARKET
COLLUSION IF THREATENED FROM
OUTSIDE



X-EFFICIENCY
o OVERCAPITALIZATION FOR
POTENTIAL EXPANSION
NOT PRODUCTIVE EFFICIENCY
NOT ALLOCATIVE EFFICIENT
MONOPOLY
MONOPOLY



ONE FIRM
IMPOSSIBLE ENTRY INTO MARKET
STANDARD PRODUCT
PRICE MAKER
RISK AVOIDER






CONTESTABLE MARKET
o IF NOT X-EFFICIENT, FIRMS WILL
TAKE ADVANTAGE OF WINDOW
OF OPPORTUNITY
o INNOVATION COMES FROM
OUTSIDE
o HIT AND RUN COMPETITION
NON PRODUCTIVE COSTS
o PREDATORY PRICING
o PRICE DISCRIMINATION
o TYING CONTRACTS/BUNDLING
o LOBBYING, LAWSUITS,
LYNCHING
GOVERNMENT REGULATION
o BREAK UP
o NATURAL MONOPOLY
 LONG RUN COSTS ARE
SUCH THAT OPTIMAL
EFFICIENCY IS ACHIEVED
WITH ONLY ONE FIRM
PRODUCING
 ECONOMIES OF SCALE
 PRICE REGULATION
 SOCIALLY
OPTIMAL PRICE
 OVERCAPITALIZA
TION
 FAIR RETURN
PRICE
X-INEFFICIENCY
o OVERCAPITALIZATION

PROTECT AGAINST
POTENTIAL
COMPETITORS
 DEFEND AGAINST
GOVERNMENT PRICE
REGULATION
NOT PRODUCTIVE EFFICIENCY
NOT ALLOCATIVE EFFICIENT
UNIT FIVE
RESOURCE MARKETS
PERFECTLY COMPETITIVE
RESOURCE MARKET
PERFECT COMPETITION
HOUSEHOLDS ARE SELLERS OF RESOURCES



LAND = A
CAPITAL = K
LABOR = L
BUSINESSES ARE BUYERS OF RESOURCES


MRP = MR
MRC (MFC) = MC
LEAST COST FORMULA FOR A
COMBINATION OF RESOURCES:
MRPL
MRPA
MFCK
=
=
MFCL
MFCA
MFCK
=1
PROFIT MAXIMIZATION FORMULA
MRP > MFC
IMPERFECTLY COMPETITIVE
RESOURCE MARKET
IMPERFECT COMPETITION
MONOPSONY
PROFIT MAXIMIZATION FORMULA




TR > TC
o MAX PROFIT
o PRODUCE AT MRP > MFC
BUT Qs > Qd
o SURPLUS
o UNEMPLOYMENT
SO W = Qd
o UNTIL Qd = Qs
ARTIFICIAL EQUILIBRIUM