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AP Microeconomics
Unit III Review
Chapters 5, 6 & 7
What is a demand side market
failures? A supply side market
failure?
When the demand curve fails to
account for the full willingness to
pay for a good; when the supply
curve fails to account for the
whole cost of producing a good
What does consumer surplus
represent? Where does it appear
on an S & D graph?
Difference between what consumer
is willing to pay and actually pays,
represents gains from trade
What does producer surplus
represent? Where does it appear on
an S & D graph?
Difference between what producer
is willing to sell for and actually
sells for, represents gains from
trade
What is achieved when competition
forces producers to use the best
available technologies and
combinations of resources?
productive efficiency
What is achieved when the correct
quantity of a product is produced
relative to other products?
allocative efficiency
What is created when a market
over produces or under produces?
What does this impact most?
deadweight loss (or efficiency loss),
cuts into consumer & producer
surplus
What are the two distinguishing
characteristics of private goods?
Rivalry for consumption &
excludability from consumption
What does it mean that public
goods are “non-rivalry” and “nonexcludable”?
One person’s consumption doesn’t
stop someone else from consuming,
and there’s no effective way to
prevent someone from using the
good once it comes into existence
What is the free-rider problem?
Once someone has created a public
good everyone, including “nonpayers” can benefit
How can a gov’t try to determine
how much of a public good to
supply?
Perform a cost benefit analysis
(using MB & MC to determine
optimum Q) by using collective
willingness to pay instead of
What are positive externalities?
How do they create demand side
market failures?
Spillover benefits of a good, service,
or activity to a 3rd party;
They prevent demand schedule from
reflecting the willingness to pay of
rd
3 parties who receive benefits
What are negative externalities?
How do they create supply side
market failures?
Spillover costs of a good, service, or
activity to a 3rd party;
They prevent supply schedule from
rd
reflecting the costs imposed on 3
parties
What are three key ways
governments intervene in the hopes
of achieving economic efficiency?
Direct controls (regulation), specific
taxes (often excise taxes),
subsidies, and direct provision
(government provides good)
Why would government provide
subsidies to buyers?
To correct for under allocation of an
important good (inoculations,
nutritious food, etc.)
Why would government provide
subsidies to producers?
To encourage production of a
particular good (energy efficient
technology, etc.)
How would direct controls/gov’t
regulations
or specific taxes look on an S & D
graph?
Shift supply to left to adjust for over
allocation
Why would government provide a
public good? What would this look
like on an S&D graph?
Because the good has huge positive
externalities; new demand curve
to right to correct for under
allocation
What is the optimal reduction of an
externality?
When the MC of reducing it is equal
to the MB of reducing it, can be
difficult to determine
How easy is it for the government
to effectively correct market failures
and provide public goods?
Often very difficult, especially as
politics complicates the process
What is the law of diminishing
marginal utility?
Consumer satisfaction declines with
each additional unit consumed
What is utility? What unit is used to
measure it?
The amount of satisfaction a
consumer derives from a good or
service; utils are used to measure
utility
What is used to measure the overall
satisfaction derived from a good?
The satisfaction from consuming
the next unit?
Total utility;
Marginal utility
How does the budget constraint
relate to utility?
Helps determine the utility
maximizing combination
If we say the consumer should
allocate income so that the last
dollar spent on each product yields
the same MU, we are citing the
___.
Utility maximizing rule
What formula best expresses the
goal of the utility maximizing rule?
MU of Product A / Price of A
=
MU of Product B / Price of B
What is the endowment effect?
How does it impact trade?
Describes how people place more
value on things they already
possess, causes people to demand
higher prices for their items in
trade
What does prospect theory deal
with?
The ways people deal with (and
adjust to) goods and bads
Why do companies often shrink
package size instead of increasing
prices?
Because consumers see an
increasing price as a greater loss
(according to Prospect theory)
What are framing affects, and how
do they affect utility?
Consumers respond more positively to
positive statements rather than
negative ones (85% lean vs. 15%
fat), positive framing generates a
sense of more utility
What does an indifference curve
demonstrate?
All of the different combinations of
two goods that maximize utility
What does the slope of the
indifference curve measure?
marginal rates of substitution
(MRS), or rate at which one good
will be substituted for the other
What does the total product curve
demonstrate?
The total amount of output given
changing amounts of one
particular variable input
What does the marginal output
formula calculate?
The change in output from a
change in variable input – helps us
understand the impact of a
change in input, e.g. MPL = ΔQ /
ΔL
What are some examples of fixed
inputs? Variable inputs?
Land, buildings, machinery
Labor, raw materials, advertising
What is the difference between
explicit and implicit costs?
Explicit: what the firm pays (in $$$)
for the resources it needs)
Implicit: Opportunity costs of what the
firm forgoes by using resources to
produce instead of selling for cash
What is the difference between
accounting profit vs. economic
profit?
Accounting profit is strictly explicit
(TR-Explicit Costs)
Economic profit also accounts for
implicit costs (TR-Explicit-Implicit)
In microeconomics, what is the
chief difference between production
in short run vs. long run?
Short run: fixed plant capacity (only
changes in variable inputs)
Long run: variable plant capacity (+
entry/exit)
What are costs that do not change
with variations in output?
fixed costs (insurance, rent, interest
on debt, etc.
What are variable costs? What are
some examples?
Costs that change with variations in
production; labor, utilities, raw
materials, etc.
What is the law of diminishing
marginal returns?
As a variable input is added, the
total resulting product will increase
by diminishing amounts, and
eventually decline (example on
Total Product, TP
The Law of Diminishing Returns
30
TP
20
10
0
Marginal Product, MP
1
LO2
20
2
3
Increasing
Marginal
Returns
4
5
6
7
8
9
Negative
Marginal
Returns
Diminishing
Marginal
Returns
10
AP
1
2
3
4
5
6
7
8 9
MP
7-42
What is total cost (TC)? Average
total cost (ATC)?
The sum of fixed and variable costs at
each level of output TC=TFC+TVC
ATC is the TC divided by a particular
level of output or TC/Q
Short-Run Production Costs
$1100
TC
1000
900
TVC
800
Costs
700
600
Fixed
Cost
500
400
Total
Cost
300
Variable
Cost
200
100
TFC
0
LO3
1
2
3
4
5
6
7
8
9
10
Q
7-44
What are economies of scale?
They explain increasing efficiency (to a
point) of mass production. This
happens through specialization of
labor and mgmt., and the more
efficient use of capital
When do diseconomies of scale
happen?
When it becomes too difficult to
efficiently manage large scale
production
Average Total Costs
MES and Industry Structure
Constant Returns
To Scale
Economies
Of Scale
Diseconomies
Of Scale
Long-run
ATC
q1
q2
Output
LO4
7-47
average variable cost (AVC)
marginal cost (MC)
building long run cost curve