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AP MICROECONOMICS
REVIEW #1
Rixie
April 6, 2017
FUNDAMENTALS OF
ECONOMIC ANALYSIS
Key Terms; PPC; Absolute & Comparative Advantage
Central Dilemma
■ Societies have limited resources and
unlimited wants, so the study of
economics must determine how to best
allocate these limited resources.
4 Factors of Production
■ Labor
– Workers (mental & physical)
■ Land
– The land itself & natural resources
■ Capital
– Machines, technology, buildings, etc.
■ Entrepreneurial Ability
– Someone to put it all together
Key Foundations
■ People are rational and follow their own selfinterest
■ People seek to maximize utility
(satisfaction/happiness)
■ All choices involve trade-offs (alternatives)
■ Opportunity cost is the value of your next
best alternative
Marginal Analysis
■You should always continue to do
something as long as the benefits
outweigh the costs
■Marginal means additional
■Should I eat the next slice of pizza?? Is it
worth it?
Production Possibilities Curve/Frontier
■ Points on the curve represent the
combination of products a
country/firm/person can produce at a given
time with set resources
■ Points inside the curve represent
inefficiency/underutilization of resources
■ Points outside the curve are unattainable
currently
What is the
opportunity
cost of moving
from point B to
point C?
A loss of 30
capital goods
Production Possibilities Curve/Frontier
■The whole curve can shift in (left) or out
(right)
■Shift in: loss of resources
■Shift out: economic growth (more
resources or better tech/education)
Law of Increasing Opportunity Costs
■As you continue to gain more of one
thing, you must give up more and more
of the other thing
■Represented by bowed out (concave out
to the origin) shape of the PPC
■A straight PPC would indicate constant
opportunity costs
Two Types of Efficiency
■Productive efficiency
– Using all resources in the most
efficient/cost-effective way possible
■Allocative efficiency
– Producing the optimal combination of
goods to meet societal needs
Specialization & Trade
■People/countries/firms use their
resources to specialize in specific tasks
■They can benefit from trading with each
other instead of each trying to make
everything
Absolute Advantage vs. Comparative
Advantage
■ Absolute:
– Being able to produce something more
efficiently (at a lower cost) than someone
else
■ Comparative:
– Being able to produce something at a
lower opportunity cost than someone
else (you give up less than they do to
produce the same thing)
Input v. Output Problems
■ Input problem – you’re given varying
resources (like time) that go into production
■ Output problem – you’re given varying
amounts of the total product/service that
comes out of production
■ Short-cut – cross multiply!
– For input, take the lowest number
– For output, take the highest
Apples per day (thousands)
Oranges per day
(thousands)
Country A
3
12
Country B
2
4
■ Output problem – looking for most product, so highest
number
■ 3 x 4 = 12
■ 2 x 12 = 24
■ Second combo is the highest number, so Country B should
produce apples (has the comp. adv.) and Country A should
produce oranges (has the comp. adv)
Minutes to produce 1
bushel of apples
Minutes to produce 1
bushel of oranges
Country A
10
20
Country B
20
80
■ Input problem – looking for fewest resources used, so
lowest number
■ 10 x 80 = 800
■ 20 x 20 = 400
■ Second combo is the lowest number, so Country B should
produce apples (has the comp. adv.) and Country A should
produce oranges (has the comp. adv)
Market vs. Command
Economic Systems
■ Market System
– Private ownership of property
– Gov’t role is limited; free enterprise
– Competition; incentives
■ Command System
– Gov’t owns most property & the means
of production
– Gov’t makes most economic decisions
BASICS OF SUPPLY &
DEMAND
Laws; Determinants; Market Equilibrium; Welfare
Analysis
Law of Demand
■ As price increases, quantity demanded
decreases, and vice versa.
■ Inverse relationship between price &
quantity demanded
■ Downward sloping demand curve
Some reasons behind the law of
demand…
■ Substitution effect: if two goods are substitutes
and the price of one decreases in relation to
the other, people will switch to the cheaper one
(demand more of it since it’s cheaper)
■ Income effect: as the price of a good
decreases, people can afford more of it relative
to their income
Determinants of Demand
■ When one of these changes, demand will
increase or decrease
■ TRIBE:
– T: tastes/preferences of consumers
– R: related goods’ prices (substitutes &
complements
– I: income of consumers
– B: number of buyers
– E: expectations of consumers
Key Distinction
■ A change in quantity demanded is a
movement along the demand curve and
results only from an increase or decrease in
the price of the good.
■ A change in demand means one of the
determinants is at play, and the demand
curve has shifted left (decrease in demand)
or right (increase in demand).
Normal v. Inferior Goods
■ If a good is normal, consumers will demand
more of it when their income increases, and
less when income decreases
– New clothes, electronics, restaurant
meals
■ If a good is inferior, consumers will demand
less of it when their income increases, and
more when income decreases
– Used clothes, Ramen noodles
Substitute v. Complementary Goods
■ If 2 goods are substitutes, one can easily be used in
place of the other. If the price of one increases,
consumers demand less of that one and more of the
other.
– Nike & Adidas shoes; paperback book & an
eBook
■ If 2 goods are complements, they are often used
together. If the price of one increases, consumers
will demand less of it and therefore also demand
less of the complementary good.
– Movie tickets & popcorn; hotdogs & hotdog buns
Law of Supply
■ As price increases, quantity supplied
increases, and as price decreases, Qs
decreases.
■ Direct relationship between price &
quantity supplied
■ Upward sloping supply curve
Determinants of Supply
■ When one of these changes, supply will
increase or decrease
■ ROTTEN:
– R: resource prices
– O: other goods’ prices
– T: taxes or subsidies
– T: technology
– E: expectations of producers
– N: number of sellers
Key Distinction
■ A change in quantity supplied is a
movement along the supply curve and
results only from an increase or decrease in
the price of the good.
■ A change in supply means one of the
determinants is at play, and the supply
curve has shifted left (decrease in supply)
or right (increase in supply).
Typical Market Diagram & Market
Equilibrium
■ Supply slopes upward
■ Demand slopes downward
■ Equilibrium is where they
intersect
■ P* is equilibrium price
■ Q* is equilibrium quantity
■ Always label the curves, each
axis (Price & Quantity), and
whatever else you are asked to
identify!
Practice shifting the supply & demand
curves due to a change in one or more
determinants!
■ Always sketch a quick market diagram to see what the effect will be on the
equilibrium price & quantity.
■ Just one shift – show it on the diagram (use arrows to show the direction) and
analyze how equilibrium price & quantity changed.
■ Double shift – you should draw two market diagrams and show each shift
separately
– The variable that changes in the same direction both times will definitely
change in that direction.
– The variable that changes in a different direction on each diagram is
indeterminate.
– https://www.youtube.com/watch?v=K0AQ9rK8MN4&index=9&list=PL6B2
DBE4C2FC8F845
Government-set price floors & ceilings
Price floor – minimum price
(only effective if above
equilibrium)
Results in surplus (Qs > Qd)
Price ceiling – maximum price
(only effective if below
equilibrium)
Results in shortage (Qd > Qs)
Welfare Analysis
■ Consumer surplus – the difference between
what you are willing to pay for something
and what you actually pay (as long as you
benefit)
■ Producer surplus – the difference between
what a seller is willing to sell a product for
and what they actually sell it for (as long as
they benefit).
Consumer & Producer Surplus in a
Market in Equilibrium
■ The sum of consumer
surplus and producer
surplus is known as
total welfare, or total
benefit to society.