AP Microeconomics: Master Notes UNIT 1: FUNDAMENTALS OF ECONOMIS Key ...

AP Microeconomics: Master Notes

UNIT 1: FUNDAMENTALS OF ECONOMIS Key Terms Economics: The study of how limited resources are

allocated. Microeconomics: Study of how individuals (firms or

households) make choices and are influenced by economic forces. Macroeconomics: Looks at the economy as a whole, focusing on issues such as growth, unemployment, inflation, and business cycles. Scarcity: material wants are unlimited and economic resources are limited or scarce.

Factors of Production o Land: Any productive resource existing in nature, Ex. water, wind, mineral deposits. o Labor: Physical and mental effort of people. Ex. Teacher o Capital: Manufactured goods that can be used in the production process Ex. tools, buildings, machinery Human Capital: Knowledge and skills acquired through training and experience Ex. College or Technical School. o Entrepreneurship: Ability to identify opportunities and organize production, risk taker. Ex. Elon Musk

Economic Reasoning Given limited resources (SCARCITY), there are

opportunity costs for every choice Trade-offs- All the possible options given up when you

make a choice The opportunity cost of an action is the benefit missed by

not choosing the next-best alternative. An action should be chosen only if the expected benefit is greater than the opportunity cost. Implicit Cost: Forgone benefits of any single transactions. Ex. time and effort an owner puts into maintaining a company, rather than expanding it. Explicit Cost: Expenses that are paid with cash or equivalent. Ex. Wages to workers, electricity bill Individuals attempt to maximize utility by allocating and spending their resources according to their preferences. Individual consumption and production options are expanded through the market, where goods and services are exchanged for mutual benefit. Economic Systems All economic systems must answer three basic economic questions o What goods and services to produce? o How to produce those goods and services? o Who consumes those goods and services? Types of Economic Systems o Command Minimize imbalance in wealth via the collective

ownership of property Lacks incentives for extra effort, risk taking, and

innovation Wages determined by the gov. Particularly vulnerable to corruption as the gov. plays

the central role in allocating resources; only one political party

Economic goal emphasized: Price stability, equity, full employment, security

Economic goal deemphasized: Efficiency, freedom, growth of consumer goods/services

o Market Pursuit of individual profit Private individuals control the factors of production Wages determined by negotiations between trade unions and managers Market forces of supply and demand determine the allocation of resources Gov. can regulate business and provide tax-supported social benefits Economic goal emphasized: Efficiency, freedom, price stability, growth Economic goal deemphasized: Equity, security, fullemployment

o Mixed- Both market and command together, reality Production Possibilities Model (Curve) Identify the Points on the PPC

o The A, B, and C represents: Attainable and efficient with these resources

Allocative vs. Productive Efficiency Productive Efficiency: Products are being produced in the least costly way (any point on the curve) Allocative Efficiency: The products being produces are the ones most desired by society. (optimal point depends on the desire of society)

o The X represents: Inefficiency o The Y represents: Not Attainable/Unattainable with these

resources o Movement from A to B is an increase or decrease in

consumer demand.

Production Possibilities Model (Curve)

Reasons for Economic Growth/Contraction o Technology (Quality of Resources) o Land (Quantity of Resources) o Population (Quantity of Resources) o Education (Quality of Resources)

Production Possibilities Model: Economic Growth

Constant Opportunity Cost Graph

Other Shifts: Contraction to just Butter

Trade (Absolute and Comparative Advantage) Absolute advantage describes a situation in which an

individual, business, or country can produce more of a good or service than any other producer with the same quantity of resources. o Just because a country has an absolute advantage, it

doesn't mean that the country necessarily benefits the most from producing that good. Comparative advantage describes a situation in which an individual, business, or country can produce a good or service at a lower opportunity cost than another producer. o Countries will benefit from specialization if one country has a comparative advantage in one good, and the other country has a comparative advantage in the other good.

Example

Increasing Opportunity Cost Why does the graph curve? Resources are not easily

adaptable between products- GUNS VS BUTTER) Explain opportunity cost of curve: The opportunity cost of

the 4th Butter is small (1 Gun), as we go to the 6th, 7th or 8th butter, the opportunity of Guns will go up (2 Guns).

Increasing Opportunity Cost Graph

o Which nation has the absolute advantage in producing corn? Dallas

o Which nation has the absolute advantage in kiwi? Dallas o Which nation has the comparative advantage in corn?

Dallas o Which nation has the comparative advantage in kiwi?

Montezuma o Should Dallas specialize in corn or kiwi? Corn o Should Montezuma specialize in corn or kiwi? Kiwi

Constant Opportunity Cost o Why does the graphs curve remain straight? Resources are easily adapted between products (PIZZA VS CALZONE) o Explain opportunity cost of the curve: As more calzones are made, resources that are easily adapted to produce either good are moved away from pizza and toward calzones. Opportunity cost for each calzone is constant at 2 bicycles.

UNIT 2: SUPPLY, DEMAND AND CONSUMER CHOICE Demand (CONSUMERS, BUYERS, INDIVIDUALS) Law of Demand: if Price goes , the Quantity goes, or if

Price goes , the Quantity goes

Reasons for Law of Demand (DOWNWARD SLOPING CURVE)

o Substitution Effect: At a higher price, consumers are willing to and able to look for substitute (COKE or PEPSI). The substitution effect suggest that at a lower price, consumers have the incentive to substitute the cheaper good for the more expensive service.

o Income Effect: A decline in the price of a good will give more purchasing power to the consumer and he/she can buy more now with the same amount of income.

o Law of Diminishing Marginal Utility: This law states that as we consume additional units of something, the satisfaction (utility) we derive from each additional unit (marginal unit) grows smaller (diminishes)

Changes in Quantity (MOVING ALONG THE CURVE)

o What changes quantity demanded: A change in the price of the good/service

Changes in Demand (SHIFTING THE CURVE) o What shifts the demand curve? o Change in income: Normal goods: an increase in income leads to a rightward shift in the demand curve

Income goes , Demand goes Income goes , Demand goes Inferior goods: an increase in income leads to a

leftward shift since these are usually low-quality items people will avoid when the have more to spend

Income goes , Demand goes

Income goes , Demand goes o Change in taste/preferences o Change in price of complementary goods: the linkage of

products' demand because the work with each other can affect demand for each (Milk and cookies) Price of A Demand for B goes Price of A Demand for B goes o Change in price of substitutes: When the prices of or preference for a substitute changes, demand for both products will change. Price of A Demand for B goes Price of A Demand for B goes o Change in number of buyers o Change in price expectation of buyers Supply (SELLERS, FIRMS, PRODUCERS) The Law of Supply: If price goes , the quantity produced goes or if the price goes , the quantity produced goes

Reasons for Law of Supply (UPWARD SLOPING CURVE)

o Opportunity cost: At a higher prices, profit seeking firms have an incentive to produce more.

o Law of Diminishing Marginal Returns: Since the additional cost of each unit will eventually increase, the firm must increase the price to increase quantity supplied

Changes in Supply (SHIFTING THE CURVE) o What shifts the supply curve? o Price/Availability of inputs (resources) o Number of sellers o Technology o Government Action: taxes and subsidies o Change price expectation o Expectations of future profit

Equilibrium Market Equilibrium: A market is in equilibrium when the

price and quantity are at a level at which supply equals demand. The quantity that consumers demand is exactly equal to the quantity that producers supply. o Equation for Equilibrium: Qd = Qs Market Disequilibrium: Quantity demanded doesn't equal quantity supplied. Creates shortages and surpluses o Shortage: The price is below equilibrium, the amount

demanded will be greater than the amount supplied Equation for Shortage: Qd > Qs o Surplus: The price is above equilibrium, the amount

demanded will be less than the amount supplied Equation for Surplus: Qd < Qs Double Shift in Supply and Demand Double shift rule: If two curves shift at the same time, either price or quantity will be indeterminate. Example below: Demand and supply are increasing, so Price is INDETERMINATE and Quantity has INCREASED

Double Shifts in Supply and Demand Curve

Elasticity Elasticity: Is the responsiveness of consumer to a change in

the price of a product. Equations for elasticity:

Be sure to use absolute values and ignore the --------sign; useful for comparing different products.

Interpreting elasticity o Inelastic Demand Elasticity coefficient less than 1 Few substitutes and necessities Example: Cancer medication o Elastic Demand Elastic coefficient greater than 1 Luxury goods and many substitutes Example: Coke

Inelastic Demand

Elastic Demand

o Elasticity of Supply: Measures seller's responsiveness to changes

Es > 1 Supply is elastic- Producers are responsive to price change

Es < 1 Supply is inelastic- Producers are not responsive to price change

Equation below

Elasticity of Demand Coefficients o Perfect Inelastic= 0 o Relatively Inelastic= Less than 1 o Unit Elastic = 1 o Relatively Elastic= Greater than 1 o Perfectly Elastic = Undefined

Elasticity Varies with Price Range: o More elastic toward to left, less elastic at lower right. o Slope does not measure elasticity--Slope measures absolute changes; elasticity measures relative changes

Elasticity Varies with Price Range

Total Revenue and the Price Elasticity of Demand o Total Revenue: Is the amount paid by buyers and received by sellers of a good. o Equation: TR=P x Q o Total Revenue Test Elastic Demand (EXAMPLE- Coke/Pepsi) Price increase causes TR to decrease Price decrease causes TR to increase Inelastic Demand (EXAMPLE- CANCER DRUGS) Price increase causes TR to increase Price decrease causes TR to decrease Unit Elastic Price changes and TR remains unchanged

Elastic Demand and Total Revenue Graphs

Types of Elasticity

o Cross-Price Elasticity: Measures responsiveness of sales

to changes in price of another good Substitute= Positive sign Complement= Negative sign Independent Goods=zero Equation below

Inelastic Demand and Total Revenue Graphs

o Income Elasticity: Measures responsiveness of buyer to

changes in income Normal Good= positive sign Inferior Goods= negative sign Equation below

Consumer and Producer Surplus at Market Equilibrium Consumer Surplus: Difference between the price a buyer

would have been ready to pay for a good or service (willingness) and the price that he/she actually pays (market price) o Equation for Consumer Surplus: ? Quantity x Price Producer Surplus: Difference between the price that a seller actually receives (market price) and the price at which he/she would have been ready to supply the good or service (willingness) o Equation for Producer Surplus: ? Quantity x Price Total Surplus (SOCIAL WELFARE): The sum of the total consumer surplus and the total producer surplus. o Equation for Total Surplus: ? Quantity x Price CS and PS allows us to access the soundness of economic policies Consumer and Producer Surplus Graph (EFFICENT)

Price Floor/Surplus Graph Price Ceiling/Shortage Graph

Calculate using Consumer and Producer Surplus Graph o Consumer Surplus =$1,250 o Producer surplus=$1,250 o Total Surplus (Social Welfare)=$2,500

Government Effects on Market (DISEQUILIBRIUM AND INEFFICENTCY) Government Price Floors:

o Effective Price Floors, the price is above the equilibrium price

o Example: Minimum wage o Leads to a surplus, because Qs > Qd o Non-effective price floors, the price is below the

equilibrium price

Government Price Ceilings: o Effective price ceilings, the price is below equilibrium price o Example: Rent Control Housing o Provide lower costs for consumers o Leads to a shortage in the market because, Qd > Qs o Can also result in illegal black market activity- selling goods for a higher price

Government Taxes o Indirect Tax: Is one place by the government on the producers of a particular good o Excise Tax: Tax on producers, but the goal is for them to make less of the good (Cigarette, alcohol tax) o For every unit made, the producer must pay o Consumers will pay the tax indirectly through producers o An indirect tax will be shared by both consumers and producers. o Creates disequilibrium and inefficiency in the market, the result is dead weight loss o Dead weight loss: Represents the loss of former consumer and producer surplus in excess of the total revenue of the tax. Transactions that would have taken place in the market if there was not tax. o Tax Incidence: The distribution of the tax burden (WHO ACTUALLY PAYS THE TAX) o Tax Incident (WHO PAYS) If demand is perfectly inelastic: Tax burden paid entirely by consumers If demand is relatively inelastic: Tax burden mostly on consumers If demand is unit elastic: Tax burden shared between consumer and producer If demand is relatively elastic: Tax burden mostly on producers If demand is perfectly elastic: Tax burden paid entirely by producer.

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download