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AP Microeconomics Module 3 Notes
AP Microeconomics
This is a very important module. In fact it represents about 60% of the AP test. Please go over it
carefully and make sure you do understand these concepts. Please WATCH THE TUTORIALS!!!!!
They are really helpful.
Module 3 NOTES
1.
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3.
4.
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6.
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8.
9.
Economic Costs= Explicit costs + Implicit costs
Accounting Profit= Total Revenue-Explicit Costs
Economic Profit= Total Revenue – Economic Costs
Normal Profit= Economic profit = zero
Total Costs=Variable Costs + Fixed Costs TC=FC+VC
Average Costs: costs/#units of output. AC = cost/units of output
Average Total Costs: Total Cost/Total Product
Greatest Efficiency Point: ATC=MC
Short Run Average Total Cost Curve (SRATC): is u-shaped because declining average fixe costs bring
costs down at low production levels.
10. Marginal Cost: Is the extra cost of producing an additional unit. MC=Change TC/Change Q
a. MC : increases as production expands
b. If MC is below AC, then AC is falling.
c. If MC is above AC, then AC is rising.
d. If MC = AV, then AC is constant
e. MC crosses ATC and AVC at their minimum.
11. Total Profit = Total Revenue – Total costs
Perfect Competition Model:
12. Basic assumptions:
a. Many buyers and many sellers
b. Price is established by Supply and Demand
c. Firms and Consumers are PRICE TAKERS.
i. For the Individual firm the Demand curve is perfectly elastic at P*. (Horizontal)
ii. If a Firm charges a price higher than P*, the revenue will be zero
d. Homogeneous product
e. Negligible barriers of entry.
13. Profit Maximization= TR - Costs
a. Firms choose to produce where MR=MC (The revenue from the marginal unit is equal to the
cost of producing the marginal unit.)
b. MR= (Change TR/Change Q)
i. If MR>MC, the firm should increase production.
ii. If MR<MC, production should be reduced.
c. MR=P (since the firm is a price taker)
i. Firm expands production to the point where MC=P
ii. MR=AR=D (demand curve)
14. Firm Decision Making & Short Run Supply
a. If P>ATC, profit exists and the firm will produce Q
b. If P<ATC, the firm will incur in losses
i. The firm will produce at a loss if P>AVC (because it can cover variable costs)
ii. The firm will shut down if P<AVC (because it cannot cover variable costs)
c. SR Supply curve: it is the portion of the MC curve above its intersection with the AVC curve.
15. Long Run
a. Firm can Expand or Contract their fixed factors
b. Freely enter or leave the industry
c. The supply response to an increase in demand is greater in the long run.
d. Economic Profit
i. Are forced to zero economic profit by firms entering the industry
ii. Resources are reallocated from loss-making industries to those making economic
profits.
16. Competition and Efficiency
a. Allocative Efficiency is at Q* where MC=P At this point the cost o the resources used to
produce the marginal unit is equal to the amount of money a consumer is willing to pay for
the marginal unit at Q*. This occurs in both the SR and LR
b. Productive Efficiency: Q* at minimum ATC (production occurs at the lowest average cost per
unit) this occurs in the LR period.
17. Graphing:
a. Individual Firm Graph: It measures dollars per unit of output. Y=$, X=Q, Profit=point where
MR=MC and AP=TP/Q. Average profit is positive if AR>AC and negative if AR<AC. Demand:
horizontal curve
b. Industry Firm: Y=$, X=Q, Demand: down-slopping
c.
Monopolistic Competition Model:
1. Basic Assumption:
a. Large number of buyers and sellers.
b. Imperfect information: price maker
c. Low barriers to entry
d. Differentiated products, such as different brands or levels of service. Costs are higher
due to expenditures to differentiate products
e. Very elastic demand curve
f. Short run behavior like a monopolistic
g. Competition ensures zero economic (normal) profit in the long run
2. Profit SR: production will continue in the SR as long as P>AVC (same as in Monopoly)
a. Produce at loss: ATC>P>AVC
b. Profit: P>ATC
3. Profit LR:
a. The demand curve will shift to the left until P=ATC and economic profits will be zero.
b. P>MC so the consumer is willing to pay more than it costs to produce the good; no
allocative efficiency.
c. Monopolistic competition does not operate at minimum average cost, so productive
efficiency is not achieved.
4. Natural Monopoly
a. It arises because a single firm can supply the market and its long-run average costs
(LRAC) are still falling when the limits of market demand are reached. Examples are
Public Utilities.
5. Unregulated Natural Monopoly: will produce Qu (where MR=LRMC) at Pu, making a profit.
a. There is no incentive for the monopolist to lower price and costs because of lack of
competition.
b. The price will increase to cover and cost increase
c. Real demand curve and true costs are uncertain.
6. Socially Optimal Output (Qo): D=LRMC.
a. Here, allocative efficiency is achieved. Output is produce up to the point where the cost
of an extra unit equals the price consumers are willing to pay for the extra unit.
b. At Q0, Po>LRAC and the monopoly has a loss. This requires a subsidy.
Module 3 AP Micro Terms
Monopoly Pricing
Entry Barrier
Monopsony
Natural Monopoly
Public Utility
Marginal Cost Pricing
Average Variable Cost Pricing
Average Total Cost Pricing
Consumer Surplus
Perfect Competition
Perfect Elastic Demand
Excess Profit
Minimum Losses
Shut Down Point
Entry Barrier
Accounting Profit
Economics Profit
Explicit Cost
Implicit Cost
Long Run
Short Run
Fixed Cost
Variable Costs
Total Costs
Marginal Costs
Average Fixed Costs
Producer Surplus
Efficiency
Deadweight Loss
Monopolistic Competition
Excess Capacity
Product Differentiation
Implicit Contract
Brand Loyalty
Average Variable Costs
Total Revenue
Marginal Revenue
Total Product Curve
Output
Inflection
Diminishing Marginal Returns
Negative Returns
Marginal Product
Average Product
Economies of Scale
Diseconomies of Scale
Fixed Inputs
Variable Inputs
Normal Profit
Economic Profit
Sources: FLVS course 2113; Quick Study Business, Bar Charts, Inc