AP MICROAP MICRO

ECONOMICS ECONOMICS

EXAM REVIEWEXAM REVIEW

A

C

F

B

D

E

W

Robots

Shoes

Production Possibility CurveProduction Possibility Curve

Land, Labor, Capital & Entrepreneruial Ability to bs and govt

Resource Money Payments paid by bs. and govt

Goods and Services for Households and Government

Money Payments for goods and services from government and households

HouseholdsBusinesses Government

Bs. Taxes

Subsidy

Taxes

Transfers

PP

QQ

MBMB

MCMC

Allocative EfficiencyAllocative Efficiency

Qop

Market EquilibriumMarket EquilibriumMarket EquilibriumMarket Equilibrium

DemandDemand

SupplySupply

Pe

QeQuantity

Price

A change in Demand versus a change in A change in Demand versus a change in the Quantity Demandedthe Quantity Demanded

Change in DemandChange in Demand

√ √ Moves the curveMoves the curve

•IncomeIncome

•Future ExpectationsFuture Expectations

•# of Buyers# of Buyers

•Consumer InformationConsumer Information

•Taste and PreferenceTaste and Preference

•Substitues and ComplementsSubstitues and Complements

Change in Quantity Change in Quantity DemandedDemanded

√ √ Moves Along the Moves Along the SAMESAME curvecurve

• • Caused only by Price Caused only by Price change.change.

A change in Supply versus a change in A change in Supply versus a change in the Quantity Suppliedthe Quantity Supplied

Change in SupplyChange in Supply

√ √ Moves the curveMoves the curve

•Costs of ProductionCosts of Production

•Future ExpectationsFuture Expectations

•# of Sellers# of Sellers

•Taxes and SubsidiesTaxes and Subsidies

•Prices of goods using same resourcesPrices of goods using same resources

•Time period of productionTime period of production

Change in Quantity Change in Quantity SuppliedSupplied

√ √ Moves Along the Moves Along the SAMESAME curvecurve

• • Caused only by Price Caused only by Price change.change.

Consumer and Producer SurplusConsumer and Producer Surplus

√ √ The value in excess of the purchase priceThe value in excess of the purchase price

√ √ The income the firm gets in excess of its marginal costsThe income the firm gets in excess of its marginal costs

DD

SS

PP11

QQee

PP

QQ

CS

PS

Marginal Utility diminishes with increased

consumption, is zero where total utility is at a

maximum, and is negative when Total Utility declines.

When Total Utility is at its peak, When Total Utility is at its peak, Marginal Utility is zero.Marginal Utility is zero.

MargInal

UtIlIty

MUUnit Consumed

Unit Consumed

Total

Uti lity

TUTU

Marginal Utility reflects the Marginal Utility reflects the change in total utility change in total utility so it is so it is negative when Total Utility negative when Total Utility

declines.declines.

Marginal UtilityMarginal Utility

Price Floor and Price CeilingPrice Floor and Price Ceiling

DD

SS

PPcc ShortageShortage

PP11

Qe

PP

QQ

PPffSurplusSurplus

EEd = d = % change in Q % change in Qdd

% change in P % change in P

DEMANDDEMAND

ElasticityElasticity

E E cc = = % % Quantity of X Quantity of X

%% Price of Y Price of Y

CROSSCROSS

INCOMEINCOME E E ii = = % % Quantity Quantity

% % Income Income

Law of Diminishing ReturnsLaw of Diminishing ReturnsT

otal

Pro

du

ct, T

P

Quantity of Labor

Ave

rage

Pro

du

ct, A

P, a

nd

Mar

gin

al P

rod

uct

, MP

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

RELATIONSHIPRELATIONSHIP ECONOMIC INTERPRETATIONECONOMIC INTERPRETATION

MR = MCMR = MC The firm has chosen the output that The firm has chosen the output that maximizes profits.maximizes profits.

     P > ATCP > ATC Firm is earning Economic ProfitsFirm is earning Economic Profits

P = ATCP = ATC Firm is earning NORMAL PROFIT Firm is earning NORMAL PROFIT (Break- (Break-Even Point) (EP = 0)Even Point) (EP = 0)

P < ATC;P < ATC;P > AVCP > AVC

Loss MinimizationLoss Minimization

P = AVCP = AVC SHUTDOWN POINT (firm cannot SHUTDOWN POINT (firm cannot cover its AVCcover its AVC

P < AVCP < AVC Firm does not produceFirm does not produce

PURE COMPETITIONPURE COMPETITIONP = MRP = MR

The firm’s DEMAND CURVE is The firm’s DEMAND CURVE is infinitely ELASTIC infinitely ELASTIC

MR = MC MR = MC The firms maximizes profit.The firms maximizes profit.

P= ATCP= ATCLong Run (NORMAL PROFITS)Long Run (NORMAL PROFITS)PRODUCTIVE EFFICIENCY PRODUCTIVE EFFICIENCY

P = min ATC P = min ATC Firm is forced to operate with Firm is forced to operate with

maximum productive efficiency.maximum productive efficiency.(Least-Cost Method Production)(Least-Cost Method Production)

ALLOCATIVE EFFICIENCYALLOCATIVE EFFICIENCYP = MCP = MC

There is an optimal allocation of There is an optimal allocation of resources.resources.

MONOPOLYMONOPOLYP > MRP > MR

The firm’s DEMAND CURVE is The firm’s DEMAND CURVE is relatively INELASTIC.relatively INELASTIC.

MR = MC MR = MC The firms maximizes profit.The firms maximizes profit.

P P > > ATC ATC Long Run ECONOMIC PROFITS.Long Run ECONOMIC PROFITS. PRODUCTIVE INEFFICIENCYPRODUCTIVE INEFFICIENCY

P > min ATCP > min ATC  Firm is not forced to operate with Firm is not forced to operate with maximum productive efficiency.maximum productive efficiency.

  (Least-Cost Method Production not (Least-Cost Method Production not necessary)necessary)

ALLOCATIVE INEFFICIENCY ALLOCATIVE INEFFICIENCY P > MCP > MC

  There is an There is an UNDERALLOCATION of UNDERALLOCATION of

resources.resources.

The MarketThe Market Individual firmIndividual firm

MR=D=AR=PMR=D=AR=P

SSPP

ppee

qqee

DD

QQ

PP

QQ

DD22

pp22

MR=D=AR=PMR=D=AR=P22

qq22

Pure CompetitionPure Competition

MCMC

Firm showing Economic ProfitFirm showing Economic Profit

QQ11

P

Total Total RevenueRevenue

Total Total RevenueRevenue

ATC

ATC

MR=MCMR=MC

Per unit Per unit profitprofit

Per unit Per unit profitprofit

Q

ATCATC

AVCAVC

Economic ProfitEconomic Profit

MR=D=AR=PMR=D=AR=P$131

$97.78

ATCATCMCMC

Firm showing Economic LossFirm showing Economic Loss

Q2

P

Total Total RevenueRevenue

Total Total RevenueRevenue

ATC

ATC

MR=D=AR=PMR=D=AR=PMR=MCMR=MC

Per unit Per unit lossloss

Per unit Per unit lossloss

Economic LossEconomic LossEconomic LossEconomic Loss

AVCAVC$81

Q

ATCATCMCMC

Firm showing Shutdown positionFirm showing Shutdown position

P

MR=D=AR=PMR=D=AR=P

AVCAVC

At no level of output does At no level of output does the firm cover the the firm cover the

Average Variable Costs.Average Variable Costs.

Q

$71

PPeeMR=D=AR=PMR=D=AR=PMR=D=AR=PMR=D=AR=P

QQee

MCMCATCATC

QuantityQuantity

Pri

ceP

rice

Price = MC = MR = Minimum ATCPrice = MC = MR = Minimum ATC(normal profit)(normal profit)

Price = MC = MR = Minimum ATCPrice = MC = MR = Minimum ATC(normal profit)(normal profit)

Long-run Equilibrium Long-run Equilibrium For A Competitive FirmFor A Competitive FirmLong-run Equilibrium Long-run Equilibrium

For A Competitive FirmFor A Competitive Firm

ATCATC

MCMC

Competitive Firm Supply CurveCompetitive Firm Supply Curve

P

AVCAVC

Q

MRMR11

MRMR22

MRMR33

MRMR44

MRMR55

Shutdown pointShutdown point

Breakeven point— Breakeven point— normal profit normal profit

Single Price Profit-Maximizing Single Price Profit-Maximizing MonopolyMonopoly

Single Price Profit-Maximizing Single Price Profit-Maximizing MonopolyMonopoly

Q

P

MR

MCMC

D

Qm

Pe

ATCATC

Economic Economic ProfitProfit

ATCMR=MCMR=MC

QQDD

MCMC

ATCATC

PP

QQ11

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

PRICE DISCRIMINATIONPRICE DISCRIMINATIONPRICE DISCRIMINATIONPRICE DISCRIMINATION

QQ22

A perfectly discriminatingA perfectly discriminatingmonopolist has MR=D,monopolist has MR=D,producing more productproducing more product

and more profit!and more profit!

MR=DMR=D

Q

DMR

MCMCATC

P

Pri

ce a

nd

Cos

ts

MR = MCMR = MC

Fair-Return PriceFair-Return Price

Socially-OptimumSocially-OptimumPricePrice

Qm Qf Qr

Dilemma of Regulation:Which Price?Dilemma of Regulation:Which Price?

Pm

Pf

Pr

ConsumerConsumersurplussurplus

OO

PP

QQ

PPpcpc

QQpcpc

MCMC(= (= SS under perfect competition under perfect competition))

AR = DAR = D

aa

PPmm

QQmm

MRMR

bb

Deadweight loss under monopolyDeadweight loss under monopolyDeadweight loss under monopolyDeadweight loss under monopoly

ProducerProducersurplussurplus

DeadweightDeadweightlossloss Deadweight LossDeadweight Loss

(c)R=MC(c)R=MC

(b)P(b)Pm m Monopolist Monopolist

priceprice

(a)P=MC Purely (a)P=MC Purely Competitive priceCompetitive price

Deadweight LossDeadweight Loss

(c)R=MC(c)R=MC

(b)P(b)Pm m Monopolist Monopolist

priceprice

(a)P=MC Purely (a)P=MC Purely Competitive priceCompetitive price

cc

DD

MRMR

P1

ATCATC

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

Q1

Short-RunEconomic

Profits

Expect New CompetitorsExpect New Competitors

PRICE AND OUTPUT INPRICE AND OUTPUT INMONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

PRICE AND OUTPUT INPRICE AND OUTPUT INMONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

QuantityQuantity

AC1

MCMC

DD

MRMR

MC

P2

ATCATC

Pri

ce a

nd

Co

sts

Q2

Short-RunShort-RunEconomicEconomic

LossesLosses

PRICE AND OUTPUT INPRICE AND OUTPUT INMONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

PRICE AND OUTPUT INPRICE AND OUTPUT INMONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITION

Quantity

AC2

DD

MRMR

MC

P3 = AC3

ATCATC

Pri

ce a

nd

Co

sts

Q3

PRICE AND OUTPUT INMONOPOLISTIC COMPETITION

PRICE AND OUTPUT INMONOPOLISTIC COMPETITION

Quantity

Long-Run EquilibriumNormalNormalProfitProfitOnlyOnly

Using Game TheoryUsing Game Theory

• Game theory can be used to describe a game Game theory can be used to describe a game when:when:– There are rules which govern There are rules which govern actionsactions;;– There are two or more There are two or more playersplayers;;– There are choices of action where There are choices of action where strategystrategy

matters;matters;– The game has one or more The game has one or more outcomes;outcomes;– The outcome depends on the strategies chosen The outcome depends on the strategies chosen

by all players, i.e., there is by all players, i.e., there is strategic interaction.strategic interaction.

Advertising GameAdvertising Game COMPANY YCOMPANY Y

COMPANY XCOMPANY X

Don’t Adv.Don’t Adv. AdvertiseAdvertise

Don’t Adv.Don’t Adv. 10,1010,10 2,152,15

AdvertiseAdvertise 15,215,2 7,77,7

Dominant strategiesDominant strategies: Strategy 1 dominates Strategy : Strategy 1 dominates Strategy 2 if every payoff from 2 is dominated by the 2 if every payoff from 2 is dominated by the respective payoff from 1.respective payoff from 1.

Nash equilibrium: Nash equilibrium: a set of strategies, one for each a set of strategies, one for each player, such that no player has an incentive (in terms player, such that no player has an incentive (in terms of improving his own payoff) to deviate from his of improving his own payoff) to deviate from his strategy, i.e., each player can do no better given what strategy, i.e., each player can do no better given what the opposing player(s) does.the opposing player(s) does.

MRP = MP x PMRP = MP x PMRP = MP x PMRP = MP x PMarginal Revenue Product equals the Marginal Revenue Product equals the

Marginal Product times the Price.Marginal Product times the Price.

√ √ The MRP curve is the resource The MRP curve is the resource

demand curve.demand curve.

√ √ Location of curve depends on the Location of curve depends on the

productivityproductivity and the and the priceprice of the of the

product. product.

Optimum Combination Of ResourcesOptimum Combination Of ResourcesOptimum Combination Of ResourcesOptimum Combination Of Resources

MP of LaborMP of Labor MP of CapitalMP of Capital

Price of LaborPrice of Labor Price of CapitalPrice of Capital

Least-Cost Combination of ResourcesLeast-Cost Combination of Resources

MPL

PL

MPC

PC

====

MRPL

PL

MRPC

PC

1

Profit-Maximizing CombinationProfit-Maximizing Combination

Non-LaborCosts

LaborCosts

Purely Competitive LaborPurely Competitive LaborMarket EquilibriumMarket Equilibrium

Labor Market

S

D = MRP( mrp’s)

Wc

(1000)

Individual Firm

S = MRC

d = mrp

Wc

Quantity of Labor

Wa

ge

Ra

te (

do

llars

)

Quantity of Labor

($6)

(5)

$6

IncludesNormalProfit

Wa

ge

Ra

te (

do

llars

)W

ag

e R

ate

(d

olla

rs)

MRP

S

Wm

Quantity of LaborQuantity of Labor

MRC

Wc

Qm Qc

The competitiveThe competitivesolution wouldsolution would

result in a higherresult in a higherwage and greaterwage and greater

employment.employment.

Monopsonistic Labor MarketMonopsonistic Labor MarketMonopsonistic Labor MarketMonopsonistic Labor Market

P

Q

Spillover Costs And BenefitsSpillover Costs And BenefitsSpillover Costs And BenefitsSpillover Costs And Benefits

D=MBD=MB

0

SpilloverSpillovercostscosts

S=MSCS=MSC

S=MPCS=MPC

OverallocationOverallocationQ0 Qe

P

Q0 Qe Q0

D=MPBD=MPB

D=MSBD=MSB

SpilloverSpilloverBenefitsBenefits

S=MCS=MC

UnderallocationUnderallocation

Spillover Costs And BenefitsSpillover Costs And BenefitsSpillover Costs And BenefitsSpillover Costs And Benefits

Two Goals for Tax SystemsTwo Goals for Tax SystemsTwo Goals for Tax SystemsTwo Goals for Tax Systems

Tax Tax equityequity:: The fairness of a tax system.

Tax Tax efficiencyefficiency:: How a tax system maintains the incentives to be productive.

Two Principles of Tax EquityTwo Principles of Tax EquityTwo Principles of Tax EquityTwo Principles of Tax Equity

Benefits received principle:Benefits received principle: states that a fair tax is one that taxes people in proportion to the benefits they receive when government spends those tax revenues.

Ability-to-pay principle:Ability-to-pay principle: states that those who can afford to pay more taxes than others should be required to do so.

Three Tax StructuresThree Tax StructuresThree Tax StructuresThree Tax Structures$ Progressive taxProgressive tax: collects a higher

percentage of high incomes than of low incomes.

$ Regressive tax: Regressive tax: collects a higher percentage of low incomes than of high incomes.

$ Proportional tax: Proportional tax: collects the same percentage of income, no matter what the income.

Efficiency Loss of a taxEfficiency Loss of a taxEfficiency Loss of a taxEfficiency Loss of a tax

SS

OO

PP11

QQ11

DD

P P

Q Q

SStt

aa

bb

cc

CONSUMER’S SHARECONSUMER’S SHARECONSUMER’S SHARECONSUMER’S SHARE

PRODUCER’S SHAREPRODUCER’S SHAREPRODUCER’S SHAREPRODUCER’S SHARE

Efficiency Efficiency LossLoss

QQ22

PP22

Cumulative % of familiesCumulative % of families

Cumulative Cumulative % of Income% of Income

00 100100

100100

The Lorenz CurveThe Lorenz Curve

Line of Line of Perfect Perfect EqualityEquality

Degree of Degree of InequalityInequality