AP MICROECONOMICS SEMESTER EXAM REVIEW
BASIC ECONOMIC CONCEPTS
Opportunity Costs: next best alternative (given up) when a choice is made
PPC/PPF: production possibilities curve/ production
possibilities frontier:
 Displays opportunity cost
 Shows alternative ways to use resources
 Only two choices
 Point on curve: all resources being utilized
 Point under curve: resources are underutilized
 Point outside curve: unattainable
Comparative Advantage
Demand: relationship between price & the amount that consumers are willing & able to purchase at
various prices
Demand Determinants
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CONSUMER INCOME
o Increase- willing & able to buy at a higher price
o Decrease- willing & able to buy at a lower price
Normal good: More income, consumer buys more. Less income, consumer buys less
Inferior good: More income, consumer buys less. Less income, consumer buys more.
EX: If I was rich I wouldn’t eat McDonalds, I’d eat steak. McDonalds=inferior good
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CONSUMER TASTES & PREFERENCES
o Popular good-increase in demand
o Not popular- decrease in demand
o Advertising influences tastes & preferences
EXPECTATIONS
o Expected changes in future prices
 Increase-buy more
 Decrease-buy less
o Expected changes in income
 Increase-buy more
 Decrease-buy less
NUMBER OF BUYERS
o Group or population
 Increase-demand increase
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 Decrease-demand decreases
PRICE OF RELATED GOOD
o Two goods are substitutes
 One good falls in price- people less willing to buy the other
o Two goods are compliments
 One good falls in price-people more willing to buy the other
Supply: the relationship between price & the amount that producers are willing and able to sell at
various prices in a given period of time
Supply Determinants
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COST OF INPUTS
o Price decreases- producers can produce more goods at each price
o Price increases- producers offer fewer products for sale.
 (supply curve shifts left)
GOVERNMENT REGULATION
o Tight gov. regulation restrict supply.
 Increase costs of inputs.
 Add new features to product
 EX: seat belts to cars
o Relaxed gov. regulation- producers can lower cost of production
TAXES & SUBSIDES
Subsidies- grants. Gov. payments to individuals, businesses or other groups to encourage or protect a
certain type of economic activity (opposite effect of taxes)
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o Lower the cost of production and encourage producers to stay in the market
NUMBER OF PRODUCERS
o A shift in the # of producers can alter the different quantities that all other producers
offer at various prices
PRODUCTIVITY
o Productivity increases-If management motivates workers or if workers are trained to
work efficiently
o Productivity decreases- if workers are unmotivated, untrained, unhappy
 Supply surve shifts left, fewer goods are put into market
TECHNOLOGY
o New technology shifts supply curve right
o If new technology doesn’t work out supply curve sifts left
o Technology almost always increases supply
EXPECTATIONS
o If producers think price will decrease, producers will sell as much as possible
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If producers think price will increase, they’ll withhold supply.
 Supply curve shifts left
Shifts in Supply & Demand
Price Ceilings & Floors
Normal good: More income, consumer buys more. Less income, consumer buys less
Inferior good: More income, consumer buys less. Less income, consumer buys more.
CONSUMER BEHAVIOR & COSTS
Economic Profit
Law of Diminishing Returns: Law of Diminishing Marginal Utility: as a person consumes more of a
product (ceteris peribus) there is a decline in the marginal utility that the person receives. Less & less
satisfaction Law of Diminishing (Marginal) Returns: as successive increments of a variable resource are
added to a fixed resource, the marginal product of the variable resource will eventually decrease
PERFECT COMPETITION
Characteristics
Perfectly competitive market: producers and consumers are price-takers. Consumption & production
decisions DO NOT affect the market price
Perfectly competitive industry: producers are price-takers
FIVE CHARACTERISITICS
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Many firms
o Producers have a small “market share” or percent of sales
Homogenous/standardized products
o Consumers regard products as equivalent
Easy to enter/exit Market
o No obstacles (such as government regulation) prevent producers from entering a
market
o No additional costs are required when shutting down a firm
Firms are price takers
o a producer whose actions cannot effect the market price of a good
MR DARP
Profit-Maximizing Rule: MR = MC (marginal revenue = marginal cost)
Economic Profit: Short Run: Firms are attracted to the Market
Economic Loss: Short Run: Firms leave the Market
Zero Economic Profit: Long Run: Breaking Even
Shut-Down Point: Firm shuts down
MONOPOLY
Characteristics
CHARACTERISTICS
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Single Seller
o Single firm is sole producer
o The firm & industry/market are the same
No Close Substitutes
o Product is very unique competition
o There is only one choice
Price Makers
o Monopolist controls quantity supplied & therefore controls price
Barriers to Entry
o No immediate competitors, barriers keep potential competitors from entering the
industry
o Economic, technological, and legal barriers prevent entry
o Entry is totally blocked in a perfect monopoly
Non-Price Competition
o Monopoly product may be standardized or differentiated
Profit-Maximizing Point: MR=MC
Price Discrimination: practice of charging different people different prices for the same good/service
OLIGOPOLY: An industry with only a small number of producers. Can influence market price
Cartels-agreement by several producers that increases their combined profits by telling each how much
to produce (illegal in the US)
• IF no one cheats, can result in long-run economic profit like a monopoly
• IF one firm cheats, they lower their prices, total industry output increases, total profits in
industry decrease
Game Theory: study of behavior in situations of interdependence
• Tool economists use to analyze strategic behavior (in oligopolies), which is behavior that takes
into account the expected behavior of others and the mutual recognition of interdependence
Nash Equilibrium: (non-cooperative equilibrium) when each player in a game chooses the action that
maximizes his payoff given the actions of the other player, ignoring the effects of his action on the
payoffs received by those other players
• Named after John Nash (Nobel Prize Winner)
• Occurs when each player chooses the best strategy given the strategy of the other player
• All Summed Up
The equilibrium outcome of the game is that both firms will advertise. Even though both would be
better off by not advertising, such an outcome is unstable since each firm would have an incentive to
advertise if its competitor did not (aka cheating). The outcome is known as the “Nash Equilibrium.”
MONOPOLISTIC COMPETITION
Excess Capacity
FACTOR MARKET
Derived Demand
Marginal Revenue Product
Number of Workers to Hire
ROLE OF GOVERNMENT
Lorenz Curve: Illustrates, the inequality of income
distribution
Gini Ratio: The distance of actual distribution of
income from, the line of perfect equality
 Closer to 1, closer to perfect inequality
 Closer to 0, closer to perfect equality
 Calculated: A/(A+B)
Regressive Tax: When the average tax rate
decreases as income increases. EX: sales tax on goods and services.
Progressive Tax: When the average tax rates increase as income increases. EX: In the U.S. the rate of tax paid
increases as your income bracket increases (and vice versa).
Proportional Tax: When there is a constant tax rate regardless of income. EX: flat tax.
Positive Externality: Additional benefit to society EX: gardens. Solution: Subsidy, Voucher
Negative Externality: Additional cost to society. EX: pollution. Solution: Tax