🤑AP Microeconomics Study Tools

Key Concepts and Definitions

• Scarcity refers to the limited nature of resources relative to unlimited human wants and needs
• Opportunity cost represents the next best alternative foregone when making a choice
  • Involves a trade-off between competing options
• Marginal analysis examines the additional benefits and costs of incremental changes in behavior
• Positive economics focuses on objective analysis and description of economic phenomena ("what is")
• Normative economics involves subjective value judgments and policy prescriptions ("what ought to be")
• Economic efficiency occurs when society's resources are allocated to maximize total surplus
  • Achieved when marginal benefit equals marginal cost
• Comparative advantage arises when an individual or country can produce a good or service at a lower opportunity cost than others

Economic Models and Graphs

• Production possibilities frontier (PPF) illustrates the maximum combinations of two goods an economy can produce given its resources and technology
  • Points on the frontier represent efficient production, while points inside the frontier indicate inefficiency
• Circular flow model depicts the flow of resources, goods and services, and money payments between households and firms in an economy
• Supply and demand model shows how market prices are determined by the interaction of buyers and sellers
  • Equilibrium occurs at the price where quantity demanded equals quantity supplied
• Graphs are used to visually represent economic relationships and concepts
  • Include supply and demand curves, cost curves, and indifference curves
• Shifts in curves versus movements along curves
  • Shifts are caused by changes in underlying factors (income, preferences, technology)
  • Movements occur due to changes in own price, holding other factors constant
• Positive and negative relationships between variables
  • Positive relationship: variables move in the same direction (demand and income)
  • Negative relationship: variables move in opposite directions (demand and price)

Supply and Demand Analysis

• Law of demand states that, ceteris paribus, quantity demanded falls as price rises
  • Demand curve has a negative slope
• Law of supply states that, ceteris paribus, quantity supplied rises as price increases
  • Supply curve has a positive slope
• Market equilibrium occurs at the intersection of supply and demand curves
  • Equilibrium price clears the market and equilibrium quantity is exchanged
• Determinants of demand include price, income, prices of related goods, tastes and preferences, and expectations
• Determinants of supply include price, input prices, technology, expectations, and number of sellers
• Price elasticity of demand measures the responsiveness of quantity demanded to changes in price
  • Elastic demand $(|E_d| > 1)$, inelastic demand $(|E_d| < 1)$, and unit elastic demand $(|E_d| = 1)$
• Income elasticity of demand measures the responsiveness of demand to changes in income
  • Normal goods have positive income elasticity, while inferior goods have negative income elasticity
• Cross-price elasticity of demand measures the responsiveness of demand for one good to changes in the price of another good
  • Substitutes have positive cross-price elasticity, while complements have negative cross-price elasticity

Market Structures and Firm Behavior

• Perfect competition characterized by many buyers and sellers, homogeneous products, free entry and exit, and perfect information
  • Firms are price takers and face a perfectly elastic demand curve
• Monopoly involves a single seller of a unique product with no close substitutes and high barriers to entry
  • Monopolist is a price maker and faces the market demand curve
• Monopolistic competition combines elements of perfect competition and monopoly
  • Many sellers offering differentiated products with low barriers to entry and exit
• Oligopoly consists of a few interdependent firms that strategically interact with each other
  • Products may be homogeneous (pure oligopoly) or differentiated (differentiated oligopoly)
• Profit maximization occurs where marginal revenue (MR) equals marginal cost (MC)
  • In perfect competition, $MR = P = MC$
  • In imperfect competition, $MR < P$ and $MR = MC < P$
• Price discrimination involves charging different prices to different consumers for the same product
  • Requires market power, ability to segment the market, and prevention of resale

Consumer Theory and Behavior

• Utility measures the satisfaction or benefit derived from consuming a good or service
  • Total utility is the overall satisfaction, while marginal utility is the additional satisfaction from consuming one more unit
• Law of diminishing marginal utility states that marginal utility declines as more of a good is consumed
• Indifference curves represent combinations of two goods that provide the same level of utility to a consumer
  • Downward sloping, convex to the origin, and do not intersect
• Budget constraint shows the combinations of two goods a consumer can afford given their income and the prices of the goods
  • Slope equals the negative of the price ratio $(-P_x/P_y)$
• Consumer equilibrium occurs where the budget constraint is tangent to the highest attainable indifference curve
  • Marginal rate of substitution (MRS) equals the price ratio
• Income and substitution effects explain how consumer behavior changes in response to price changes
  • Substitution effect: consumers substitute toward the relatively cheaper good
  • Income effect: change in purchasing power affects the quantity demanded

Production and Costs

• Production function shows the maximum output that can be produced with a given set of inputs
  • In the short run, at least one input (usually capital) is fixed
• Law of diminishing marginal returns states that as more of a variable input is added to a fixed input, marginal product eventually declines
• Total cost (TC) is the sum of total fixed cost (TFC) and total variable cost (TVC)
  • $TC = TFC + TVC$
• Average cost (AC) is total cost divided by the quantity of output produced
  • $AC = TC/Q$
• Marginal cost (MC) is the change in total cost resulting from producing one more unit of output
  • $MC = ΔTC/ΔQ$
• Short-run cost curves: MC intersects AVC and ATC at their minimum points
• Long-run average cost (LRAC) curve is the envelope of short-run average cost (SRAC) curves
  • Economies of scale: LRAC falls as output increases
  • Diseconomies of scale: LRAC rises as output increases
  • Constant returns to scale: LRAC remains constant as output increases

Factor Markets and Income Distribution

• Factors of production include land, labor, capital, and entrepreneurship
  • Factor prices are determined by supply and demand in factor markets
• Derived demand: demand for a factor of production depends on the demand for the final good it helps produce
• Marginal revenue product (MRP) is the additional revenue generated by employing one more unit of a factor
  • $MRP = MP \times P$, where MP is marginal product and P is the price of the output
• Profit-maximizing condition for factor employment: $MRP = MC$ of the factor
• Wage determination in perfectly competitive labor markets
  • Equilibrium wage equals the marginal revenue product of labor (MRPL)
• Monopsony: a single buyer in a factor market
  • Faces an upward-sloping supply curve and has the ability to set wages
• Economic rent: payment to a factor of production in excess of its opportunity cost
  • Arises due to unique or scarce factors (talent, location)

Market Failures and Government Intervention

• Market failure occurs when the market fails to allocate resources efficiently
  • Causes include externalities, public goods, and information asymmetries
• Externalities are costs or benefits that affect third parties not involved in the market transaction
  • Negative externalities (pollution) lead to overproduction, while positive externalities (education) lead to underproduction
• Public goods are non-rival and non-excludable
  • Free-rider problem leads to underprovision by the market
• Information asymmetries occur when one party has more information than the other
  • Can lead to adverse selection and moral hazard problems
• Government interventions to address market failures
  • Taxes and subsidies to internalize externalities (Pigouvian taxes)
  • Provision of public goods (national defense, infrastructure)
  • Regulations to address information asymmetries (product labeling, licensing)
• Government failure: when government intervention leads to inefficient outcomes
  • Causes include rent-seeking, regulatory capture, and unintended consequences

Real-World Applications

• Minimum wage laws: price floor in the labor market
  • Can lead to unemployment if set above the equilibrium wage
• Rent control: price ceiling in the housing market
  • Can lead to shortages and reduced quality of housing
• Antitrust policy: government intervention to promote competition and prevent monopolies
  • Includes blocking mergers, breaking up firms, and regulating natural monopolies
• International trade: countries specialize based on comparative advantage
  • Trade barriers (tariffs, quotas) reduce the gains from trade and create deadweight loss
• Environmental policy: addressing negative externalities from pollution
  • Carbon taxes, cap-and-trade systems, and regulations (emissions standards)
• Health care markets: characterized by information asymmetries and positive externalities
  • Government interventions include subsidies (Medicare, Medicaid) and regulations (licensing, drug approvals)
• Income inequality and redistribution: government policies to reduce income disparities
  • Progressive taxation, transfer payments (welfare, social security), and public provision of goods and services (education, healthcare)