Top 10 pitfalls to avoid on the AP Micro exam
the struggle is real
10. Shifts versus movements along the curve
An increase in demand is not the same as an increase in quantity demanded. Increase in demand is a shift of the whole
curve; increase in quantity demand is a movement along the curve. Same for decreases or supply.
9. Per-unit versus lump-sum taxes
A per-unit tax or subsidy affects a supplier’s marginal decision making because the tax/subsidy shifts the marginal cost
curve. (A per-unit tax shifts it “up” to a higher P for every Q; subsidy shifts it “down.”)
A lump-sum tax or subsidy does not affect marginal decision making. Because lump-sum taxes do not change the
quantity produced, lump-sum taxes do not reduce deadweight loss.
8. Allocative efficiency
Is the same as social optimum. It’s where the price paid by the consumer (P) is equal to the marginal cost of the supplier
(MC). At this point, there is no deadweight loss. Perfectly competitive markets are allocatively efficient.
What’s NOT allocatively efficient? Markets with a price floor or ceiling, markets with taxes that are not to solve a market
failure, markets with externalities, markets with reduced competition (like monopolies, monopolistic competition,
monopsony).
Loss of efficiency = loss of welfare to society = deadweight loss
Look at all of these beautiful graphs that demonstrate efficiency and inefficiency!
For each graph, stop and think:
What is causing the market
inefficiency? Gov’t action? Lack of
competition? Externalities? How
does this inefficiency lead to lost
surplus? Can you redraw these?
7. Productive efficiency
When the supplier is producing at the lowest possible cost, meaning the company is using the least amount of resources
to produce the thing. So the price paid by the consumer, P, is equal to minimum ATC. It means that the producer is
absolutely as efficient as possible with resources, by producing a Q of output that’s in the sweet spot of lowest ATC.
What’s not productively efficient? Every firm graph that is not perfect competition. The most important comparison may
be between perfect competition and monopolistic competition.
Even in long-run equilibrium where the mono comp firm makes zero economic profit, it never becomes productively
efficient. The firm’s good or service is differentiated, so there’s always going to be some person who is willing to buy just
that firm’s version of the good. Because demand is elastic but not perfectly elastic, the firm will always be able to charge
a price higher than its marginal cost. If P>MC, P is not equal to MC nor is P equal to minimum ATC.
EFFICIENCY IS NOT THE SAME AS PROFITABILITY. And speaking of profits…
6. Economic versus Accounting Profit
Profit = Total Revenue – Total Costs. TR = P x Q. TC = Q x ATC or sum of fixed and variable costs.
Economic profit takes into account all opportunity costs. So it’s the accounting profit (which is total revenue minus
explicit costs) less implicit costs. Accounting profit is always higher than economic profit. If economic profit is zero,
accounting profit is positive.
If the AP writers use the phrase “normal profit,” they mean zero economic profit.
5. Understanding relationships among cost curves
Marginal cost intersects ATC and AVC at their minimum points. You must understand this to get the cost curve
relationships. You must draw it correctly as well. Why don’t you go ahead and draw them now? I’ll wait.
MC – nike swoosh. ATC – a smile or macaroni noodle. AVC – a smirk. The difference between ATC and AVC is AFC.
Note: One item that has been popping up on the most recent test or two has been the phrase “increasing cost” versus
“constant cost” industry. When a firm is in a constant cost industry, even if more firms enter, increasing demand for
resources (in factor markets), we assume that the LRATC is not affected. The entry of other firms doesn’t significantly
change costs faced by firms. But if you are told that the firm faces “increasing costs,” that means in the LR, if more firms
enter, the increase in demand for resources will cause resource prices to rise, thereby increasing LRATC. This phrase
doesn’t affect how you draw the initial graph. It might, however, affect a question on long-run situations.
4. Relating inputs and outputs
You may be asked about total product, average
product, or marginal product. Or production function.
Any of these questions just refer to the relationship
between inputs and outputs. Unless told otherwise,
assume diminishing returns to inputs. This graph could
help. However, you will usually be asked to examine a
chart of data with an increase in workers and an
increase in total product that starts to level off (or
positive marginal product that is declining and
eventually could dip below zero).
Marginal product is the inverse of marginal cost. So if
marginal product is falling, marginal cost is rising. Note
that these can’t be on the same graph because there
are different things on the axes.
3. Identifying / understanding economies of scale
Economies of scale is always a long run consideration, but when LRATC is not provided, use ATC as a substitute.
Think of scale as size. The larger the scale of production (the higher the Q), the larger the size of the firm.
At first, it makes sense for the firm to get bigger. The firm can produce at a lower cost per-unit. And average cost per
unit is ATC! So when ATC is falling or decreasing, the firm is benefitting from scaling up production by increasing Q. This
is called economies of scale or increasing returns to scale. (I know. This is a confusing name. I’m sorry for that.) This is
when Apple tries to make iPhones in the deceased Steve Jobs’ garage. Cost per unit will be crazy high.
Then there’s a sweet spot of production, where (LR) ATC is at its minimum. Usually, the curve flattens out somewhat
there. Or sometimes, you might see a monopolist with “constant costs” where MC=ATC and is totally flat. In either case,
you have constant returns to scale. You don’t have economies or diseconomies of scale. This is when Apple has a few
manufacturing plants around the world that are productively efficient (minimum ATC).
What happens if a firm’s Q gets too big? The firm has scaled up production to a point where its per-unit costs start to
increase too much. It is actually not smart for the firm to try to be this big. So economists call this level of production to
be diseconomies of scale or decreasing returns to scale. This is when Apple has an iPhone factory in the back of each
Apple Store. This is also inefficient, and will drive up the costs per unit.
Test yourself: If the firm above is producing at 50 units of output, is it experiencing economies of scale, diseconomies of
scale or constant returns to scale? Then, think about a monopolist. Is the monopolist producing in a region of economies
of scale? Why or why not? (They are.) What about monopolistic competition? (Them too.) You’ll find that most firms
produce in the region of economies of scale if they are profit-maximizing. If the firm is making an error in its profit-
maximizing choice, then it may be in the diseconomies of scale region. Not always, however. Look at the perfect
competition firm above. They are profit-maximizing in the diseconomies of scale region. But is that graph sustainable?
No. Little Miss Perfect Competition firms end up at P=min ATC, at that sweet spot of economies of scale. Economic
theory correctly predicts that most rational firms don’t scale up to a point where they blow potential profit on costs.
2. Correctly labeling all parts of side-by-side graphs and drawing graphs correctly
If you see the phrase “draw a correctly labeled side-by-side graph for the perfectly competitive labor market and Tracy’s
Tulips, which produces tulips in a perfectly competitive tulip market” how many graphs do you need? TWO. You’ll have a
market for labor and the market for labor for Tracy’s firm.
Take each graph step by step. Are the graphs clearly labeled (market and firm)? Are the axes labeled? Did you “give” the
price to the firm from the market? Are the quantities DIFFERENT? (Because they should be - - the labor market is huge
and the firm is tiny.) Did you show the firm’s profit-maximizing rule? For the labor market, it is MRP = MFC. That means
you have to label the firm’s (flat) labor supply curve with S=MFC and the demand with D=MRP. If something shifts, labels
with 1s and 2s. A grader will be more kind to students who do that, because it shows your intended thinking.
Any time you fail to label the graph with MC=MB or the equivalent (MSC=MSB, MRP=MFC, etc.), you are not
demonstrating that you know the profit-maximizing rule in that situation. So they will take a point off at least. (Supply is
always about costs and demand is always about benefits.)
The other tricky part can be to make sure your firm is making a profit or loss when you are asked to show a profit or
loss. Let’s take the example of drawing a monopolist or MC firm making a profit and identifying the area of profit.
Drawing this graph can be tricky because 1) your ATC has to intersect MC at ATC’s min, and 2) your ATC also has to fall
below demand at the quantity where MC=MR. Here’s one approach that might help:
Step 1: Label your axes. Draw your D and MR curves.
Step 2: Draw your MC curve.
Step 3: Identify the firm’s Q&P. Identify the Q where
MC=MR, and label it on the x-axis. Go up to the demand
curve to identify P. Label it on the y-axis.
Step 4: Draw your ATC below the P on the demand
curve but with its minimum point intersecting MC. (If
you wanted to draw a firm making a loss, you would
draw ATC above the firm’s P.) Area of profit or loss = (PATC at your Q) x Q.
1. How elasticity relates to total revenue and/or tax incidence
The side with the more inelastic demand (or supply)
bears the larger brunt of the tax.
Elastic demand (%∆Qd/%∆P) means the quantity effect
dominates. A decrease in price results in MORE
revenue, because there’s such a response of consumers
to buy more of the good. If demand is inelastic, then a
decrease in price doesn’t change quantity as much… so
a decrease in price hurts or reduces revenue.
Although we can talk about the relative elasticity of the
entire demand (or supply) curve, elasticity changes
along the curve. See graph on the top right.
Memorize
elasticity
formulas and you
can reason out
most questions!
You’re going to be great!