AP MICRO REVIEW

AP Economics

Mr. Crawford

MicroEconomics Exam Review Guide

UNIT ONE
CONSUMER CHOICE and ELASTICITY

MARGINAL UTILITY

LAW OF DIMINISHING MARGINAL UTILITY
IRRATIONAL GOODS
MU of product A/price of A = MU of product B/price of B = etc.

ELASTICITY

DETERMINANTS OF ELASTICITY
- TIME
- SUBSTITUTES
- NECESSITY
- INCOME
TOTAL REVENUE TEST
- P = TR
  - E<1, INELASTIC
- P = TR
  - E>1, ELASTIC
"Good Enough Formula":

E =		(Q2 - Q1/Q1)

		(P2 - P1/P1)

DEMAND CURVES
- MORE ELASTIC AT HIGH PRICES
- MORE INELASTIC AT LOW PRICES
- UNIT ELASTIC AT EQUILIBRIUM

UNIT TWO
COSTS

COSTS

EXTERNAL
INTERNAL
- EXPLICIT
  - FIXED
    - RENT
    - INTEREST
  - VARIABLE
    - WAGES
- IMPLICIT
  - NORMAL PROFIT
  - (OPPORTUNITY COST)
TOTAL REVENUE = P X Q
TOTAL REVENUE - INTERNAL EXPLICIT COSTS = ACCOUNTING PROFIT
ACCOUNTING PROFIT - NORMAL PROFIT = ECONOMIC PROFIT

PRODUCTIVE EFFICIENCY
- P = ATC
- EP = 0
- FAIR RETURN
ALLOCATIVE EFFICIENCY
- P = MC
- NATURAL EQUILIBRIUM
- SOCIALLY OPTIMAL
X EFFICIENCY
- MINIMUM POSSIBLE LONG RUN ATC

PROFIT MAXIMIZATION FORMULA

if TR > TC
- then MAX PROFIT
- PRODUCE AT MR > MC
if TR < TC
- but TR > TVC
- then MIN LOSSES
- PRODUCE AT MR > MC
- LOSE LESS THAN TFC, BUT LONG RUN LOOK TO SHUT DOWN
if TR < TVC
- then SHUT DOWN
- LOSE TFC

UNIT THREE
MARKET MODELS

PERFECT COMPETITION

INFINITE NUMBER OF FIRMS
VERY EASY ENTRY INTO MARKET
STANDARD PRODUCT

MONOPOLISTIC COMPETITION

MANY FIRMS
EASY ENTRY INTO MARKET
DIFFERENTIATED PRODUCT

OLIGOPOLY

A FEW FIRMS
DIFFICULT ENTRY INTO MARKET
DIFFERENTIATED PRODUCT

MONOPOLY

ONE FIRM
IMPOSSIBLE ENTRY INTO MARKET
STANDARD PRODUCT

PRICE TAKER
DEMAND IS PERFECTLY ELASTIC AT MARKET PRICE

RISK TAKER

PRICE MAKER

RISK TAKER

PRICE MAKER

RISK AVOIDER

PRICE MAKER- DEMAND IS VERY CLOSE TO PERFECTLY INELASTIC

RISK AVOIDER

PRODUCTIVE EFFICIENCY
- P = ATC
- ALWAYS IN LONG RUN
- EP = 0
- FAIR RETURN
ALLOCATIVE EFFICIENCY
- P = MC
- NATURAL EQUILIBRIUM
- SOCIALLY OPTIMAL
- ALWAYS
X EFFICIENCY
- MINIMUM POSSIBLE LONG RUN ATC
- ALWAYS IN LONG RUN

PRODUCTIVE EFFICIENCY
- P = ATC
- ALWAYS IN LONG RUN
- EP = 0
- FAIR RETURN
ALLOCATIVE EFFICIENCY
- P > MC
- ARTIFICIAL EQ

NEVER

X EFFICIENCY
- MINIMUM POSSIBLE LONG RUN ATC
- ALWAYS OVERKAPITALIZED IN LONG RUN

PRODUCTIVE EFFICIENCY
- P > ATC
- NEVER IN LONG RUN
- EP > 0
ALLOCATIVE EFFICIENCY
- P > MC
- ARTIFICIAL EQ

NEVER

X EFFICIENCY
- USUALLY IN LONG RUN
- HIT AND RUN COMPETITION
SHORT RUN COLLUSION

PRODUCTIVE EFFICIENCY
- P > ATC
- NEVER IN LONG RUN
- EP > 0
ALLOCATIVE EFFICIENCY
- P > MC
- ARTIFICIAL EQ

NEVER

X EFFICIENCY
- NEVER
- CONTESTABLE MARKET?
- HIT AND RUN COMPETITION?
NON-PRODUCTIVE COSTS
- LAWSUITS
- LOBBYING
- LYNCHING

PERFECT COMPETITION

COSTS

EXTERNAL
INTERNAL
- EXPLICIT
  - FIXED
    - RENT
    - INTEREST
  - VARIABLE
    - WAGES
- IMPLICIT
  - NORMAL PROFIT
  - (OPPORTUNITY COST)
TOTAL REVENUE = P X Q
TOTAL REVENUE - INTERNAL EXPLICIT COSTS = ACCOUNTING PROFIT
ACCOUNTING PROFIT - NORMAL PROFIT = ECONOMIC PROFIT
PROFIT MAXIMIZATION FORMULA
TR > TC
- MAX PROFIT
- PRODUCE AT MR > MC
TR < TC
- TR > TVC
  - MIN LOSSES
  - PRODUCE AT MR > MC
  - LOSE LESS THAN TFC, BUT LONG RUN LOOK TO SHUT DOWN
- TR < TVC
  - SHUT DOWN
  - LOSE TFC
ALL MARKETS IN LONG RUN EQUILIBRIUM
- EP = 0
PRODUCTIVE EFFICIENCY
- P = ATC
- EP = 0
- FAIR RETURN
ALLOCATIVE EFFICIENCY
- P = MC
- NATURAL EQUILIBRIUM
- SOCIALLY OPTIMAL
X EFFICIENTY
- MINIMUM POSSIBLE LONG RUN ATC

IMPERFECT MARKETS

MONOPOLISTIC COMPETITION

MANY FIRMS
EASY ENTRY INTO MARKET
DIFFERENTIATED PRODUCT

PRICE MAKER

RISK TAKER

CHOOSE NOT TO PRICE DISCRIMINATE, SO P DOES NOT EQUAL MR

PROFIT MAXIMIZATION FORMULA IN IMPERFECT COMPETITION:

TR > TC
- MAX PROFIT
- PRODUCE AT MR > MC
BUT Qs < Qd
- SHORTAGE
SO P = Qd
- UNTIL Qd = Qs
- ARTIFICIAL EQUILIBRIUM

FOR MONOPOLISITIC COMPETITION

LONG RUN
- IF EP > 0
  - FIRMS ENTER
  - ATC
  - P
  - EP = 0
- IF EP < 0
  - FIRMS LEAVE
  - ATC
  - P
  - EP = 0

LONG RUN PRODUCTIVE EFFICIENCY
X-EFFICIENCY
- OVERCAPITALIZATION FOR POTENTIAL EXPANSION
NOT ALLOCATIVE EFFICIENT

OLIGOPOLY

A FEW FIRMS
DIFFICULT ENTRY INTO MARKET
DIFFERENTIATED PRODUCT
INTERDEPENDENT
- NASH BOX
- PRISONER'S DILEMMA

PRICE MAKER

RISK AVOIDER

KINKED DEMAND CURVE
- IF P
  - OTHER FIRMS KEEP PRICE THE SAME
  - SO DUE TO SUBSTITUTION EFFECT, Qd

E > 0

IF P
- OTHER FIRMS LOWER PRICES
- PRICE WAR
- Qd CONSTANT

E < 0

STABLE MARKET

COLLUSION IF THREATENED FROM OUTSIDE

X-EFFICIENCY
- OVERCAPITALIZATION FOR POTENTIAL EXPANSION
NOT PRODUCTIVE EFFICIENCY
NOT ALLOCATIVE EFFICIENT

MONOPOLY

ONE FIRM
IMPOSSIBLE ENTRY INTO MARKET
STANDARD PRODUCT

PRICE MAKER

RISK AVOIDER

CONTESTABLE MARKET
- IF NOT X-EFFICIENT, FIRMS WILL TAKE ADVANTAGE OF WINDOW OF OPPORTUNITY
- INNOVATION COMES FROM OUTSIDE
- HIT AND RUN COMPETITION
NON PRODUCTIVE COSTS
- PREDATORY PRICING
- PRICE DISCRIMINATION
- TYING CONTRACTS/BUNDLING
- LOBBYING, LAWSUITS, LYNCHING
GOVERNMENT REGULATION
- BREAK UP
- NATURAL MONOPOLY
  - LONG RUN COSTS ARE SUCH THAT OPTIMAL EFFICIENCY IS ACHIEVED WITH ONLY ONE FIRM PRODUCING
  - ECONOMIES OF SCALE
  - PRICE REGULATION
    - SOCIALLY OPTIMAL PRICE
    - OVERCAPITALIZATION
    - FAIR RETURN PRICE

X-INEFFICIENCY
- OVERCAPITALIZATION
  - PROTECT AGAINST POTENTIAL COMPETITORS
  - DEFEND AGAINST GOVERNMENT PRICE REGULATION
NOT PRODUCTIVE EFFICIENCY
NOT ALLOCATIVE EFFICIENT

UNIT FOUR
RESOURCE MARKETS

PERFECTLY COMPETITIVE
RESOURCE MARKET

PERFECT COMPETITION

HOUSEHOLDS ARE SELLERS OF RESOURCES

LAND = A
CAPITAL = K
LABOR = L

BUSINESSES ARE BUYERS OF RESOURCES

MRP = MR
MRC (MFC) = MC

LEAST COST FORMULA FOR A COMBINATION OF RESOURCES:

MRP_L	=	MRP_A	=	MFC_K	= 1
MFC_L		MFC_A		MFC_K

PROFIT MAXIMIZATION FORMULA

MRP > MFC

IMPERFECTLY COMPETITIVE
RESOURCE MARKET

IMPERFECT COMPETITION

MONOPSONY

PROFIT MAXIMIZATION FORMULA

TR > TC
- MAX PROFIT
- PRODUCE AT MRP > MFC
BUT Qs > Qd
- SURPLUS
- UNEMPLOYMENT
SO W= Qd
- UNTIL Qd = Qs
ARTIFICIAL EQUILIBRIUM