AP MICRO ECONOMICS EXAM REVIEW Production Possibility Curve

AP MICRO ECONOMICS EXAM REVIEW

Production Possibility Curve A R o b o t s B C F W D E Shoes

Land, Labor, Capital and Entrepreneurship Resource or factor Market Resource Money Payments Businesses Households Money Payments Product Market Goods and Services

Land, Labor, Capital & Entrepreneruial Ability to bs and govt Resource Money Payments paid by bs. and govt Bs. Taxes Businesses Taxes Households Government Subsidy Transfers Money Payments for goods and services from government and households Goods and Services for Households and Government

Allocative Efficiency P MC MB Qop Q

Market Equilibrium P r i c e Supply Pe Demand Qe Quantity

A change in Demand versus a change in the Quantity Demanded Change in Demand √ Moves the curve • Income • Future Expectations • # of Buyers Change in Quantity Demanded √ Moves Along the SAME curve • Caused only by Price change. • Consumer Information • Taste and Preference • Substitutes and Complements

A change in Supply versus a change in the Quantity Supplied Change in Supply Change in Quantity Supplied √ Moves the curve • Costs of Production • Future Expectations • # of Sellers √ Moves Along the SAME curve • Caused only by Price change. • Taxes and Subsidies • Prices of goods using same resources • Time period of production

Consumer and Producer Surplus √ The value in excess of the purchase price √ The income the firm gets in excess of its marginal costs P S CS P 1 PS D Qe Q

T o t a l U t i l i t y TU When Total Utility is at its peak, Marginal Utility is zero. Unit Consumed M a r g I n a l U t I l I t y Marginal Utility Unit Consumed Marginal Utility reflects the change in total utility so it is negative when Total Utility declines. Marginal Utility diminishes with increased consumption, MU is zero where total utility is at a maximum, and is negative when Total Utility declines.

P Pf Price Floor and Price Ceiling Surplus S P 1 Pc Shortage Qe D Q

Elasticity DEMAND Ed CROSS INCOME = % change in Qd % change in P E c = % Quantity of X % Price of Y E i = % Quantity % Income

Average Product, AP, and Marginal Product, MP Total Product, TP Law of Diminishing Returns Total Product Quantity of Labor Average Product Quantity of Labor Marginal Product

RELATIONSHIP ECONOMIC INTERPRETATION MR = MC The firm has chosen the output that maximizes profits. P > ATC Firm is earning Economic Profits P = ATC Firm is earning NORMAL PROFIT (Break-Even Point) (EP = 0) Loss Minimization P < ATC; P > AVC P = AVC SHUTDOWN POINT (firm cannot cover its AVC P < AVC Firm does not produce

PURE COMPETITION MONOPOLY P = MR The firm’s DEMAND CURVE is infinitely ELASTIC MR = MC The firms maximizes profit. P= ATC Long Run (NORMAL PROFITS) PRODUCTIVE EFFICIENCY P = min ATC Firm is forced to operate with maximum productive efficiency. (Least-Cost Method Production) P > MR The firm’s DEMAND CURVE is relatively INELASTIC. MR = MC The firms maximizes profit. P > ATC Long Run ECONOMIC PROFITS. PRODUCTIVE INEFFICIENCY P > min ATC Firm is not forced to operate with maximum productive efficiency. (Least-Cost Method Production not necessary) ALLOCATIVE INEFFICIENCY P > MC There is an UNDERALLOCATION of resources. ALLOCATIVE EFFICIENCY P = MC There is an optimal allocation of resources.

Pure Competition P S P MR=D=AR=P 2 pe MR=D=AR=P D 2 D qe q 2 Q The Market Q Individual firm

Firm showing Economic Profit P MR=MC $131 Economic Profit $97. 78 MC MR=D=AR=P ATC Per unit profit Total Revenue AVC A T C Q 1 Q

P Firm showing Economic Loss MR=MC $81 Per unit loss MC ATC MR=D=AR=P AVC Economic Loss A T C Total Revenue Q 2 Q

Firm showing Shutdown position P MC ATC AVC $71 MR=D=AR=P At no level of output does the firm cover the Average Variable Costs. Q

Long-run Equilibrium For A Competitive Firm Price MC ATC MR=D=AR=P Pe Price = MC = MR = Minimum ATC (normal profit) Qe Quantity

Competitive Firm Supply Curve P Breakeven point— normal profit MC ATC AVC MR 5 MR 4 MR 3 MR 2 Shutdown point MR 1 Q

Single Price Profit-Maximizing Monopoly MC P Pe ATC Economic Profit MR=MC D Qe MR Q

PRICE DISCRIMINATION Price and Costs P A perfectly discriminating monopolist has MR=D, producing more product and more profit! MC ATC MR=D Q 1 Q 2 D Q

Dilemma of Regulation: Which Price? Price and Costs P MR = MC Fair-Return Price Pm Socially-Optimum Price ATC MC Pf Pr D MR Qm Qf Qr Q

P Pm Deadweight loss under monopoly MC (= S under perfect competition) Consumer surplus Deadweight loss b (c)MR=MC a Ppc Producer surplus O Deadweight Loss c (a)P=MC Purely Competitive price AR = D MR Qm (b)Pm Monopolist price Qpc Q

Price and Costs PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION MC Expect New Competitors ATC P 1 AC 1 Short-Run Economic Profits D MR Q 1 Quantity

PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Price and Costs MC ATC AC 2 P 2 Short-Run Economic Losses D MR Q 2 Quantity

Price and Costs PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION Long-Run Equilibrium MC P 3 = AC 3 Normal Profit Only ATC D MR Q 3 Quantity

Using Game Theory • Game theory can be used to describe a game when: – There are rules which govern actions; – There are two or more players; – There are choices of action where strategy matters; – The game has one or more outcomes; – The outcome depends on the strategies chosen by all players, i. e. , there is strategic interaction.

Advertising Game COMPANY Y COMPANY X Don’t Advertise Don’t Adv. 10, 10 15, 2 Advertise 2, 15 7, 7 Dominant strategies: Strategy 1 dominates Strategy 2 if every payoff from 2 is dominated by the respective payoff from 1. Nash equilibrium: a set of strategies, one for each player, such that no player has an incentive (in terms of improving his own payoff) to deviate from his strategy, i. e. , each player can do no better given what the opposing player(s) does.

MRP = MP x P Marginal Revenue Product equals the Marginal Product times the Price. √ The MRP curve is the resource demand curve. √ Location of curve depends on the productivity and the price of the product.

Optimum Combination Of Resources Least-Cost Combination of Resources MP of Labor MP of Capital Price of Labor Price of Capital MPL PL MPC = PC Profit-Maximizing Combination MRPL MRPC PL PC 1

Purely Competitive Labor Market Equilibrium Wage Rate (dollars) S $6 Wc D = MRP ( mrp’s) Wc Non. Labor Costs Includes Normal Profit S = MRC ($6) Labor Costs d = mrp (1000) Quantity of Labor Market (5) Quantity of Labor Individual Firm

Monopsonistic Labor Market Wage Rate (dollars) MRC Wc Wm S The competitive solution would result in a higher wage and greater employment. MRP Qm Qc Quantity of Labor

Spillover Costs And Benefits P S=MSC Spillover costs S=MPC D=MB Overallocation 0 Qe Q

Spillover Costs And Benefits P S=MC Spillover Benefits D=MSB D=MPB Underallocation 0 Qe Q 0 Q

Two Goals for Tax Systems 4 Tax equity: The fairness of a tax system. 4 Tax efficiency: How a tax system maintains the incentives to be productive.

Two Principles of Tax Equity 4 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. 4 Ability-to-pay principle: states that those who can afford to pay more taxes than others should be required to do so.

Three Tax Structures $ Progressive tax: tax collects a higher percentage of high incomes than of low incomes. $ Regressive tax: collects a higher percentage of low incomes than of high incomes. $ Proportional tax: collects the same percentage of income, no matter what the income.