COMMON MISTAKES ON THE AP MICRO EXAM

1
COMMON MISTAKES ON THE AP MICRO EXAM
2
A change in Demand versus a change in the
Quantity Demanded

• Change in Demand
• v Moves the curve
• Income
• Future Expectations
• of Buyers
• Consumer Information
• Taste and Preference
• Substitues and Complements

Change in Quantity Demanded v Moves Along the
SAME curve Caused only by Price change.
3
Consumer and Producer Surplus
v The value in excess of the purchase price
v The income the firm gets in excess of its
marginal costs
P
S
CS
P1
PS
D
Q
4
Price Floor and Price Ceiling
P
S
Surplus
Pf
P1
Pc
Shortage
D
Q
5
E i ? Quantity ? Income
Elasticity
Ed change in Qd change in P

PRICE
E c ? Quantity of X
? Price of Y
CROSS
INCOME
6
Dead Weight Loss When the Price is Below P

• Value to the Consumer
• 0AEQ
• Consumers Pay Producers
• OPFQ
• The Variable Cost to Producers
• OBFQ
• Consumer Surplus
• PAEF
• Producer Surplus
• BPF
• DWL
• FEC

7
TAX INCIDENCE AND EFFICIENCY LOSS

• Tax Revenues
• Efficiency Loss of a Tax
• Role of Elasticities
• Qualifications
• Redistributive Goals
• Reducing Negative Externalities

8
Perfectly Inelastic Demand
9
Perfectly Elastic Demand
10

Inelastic Demand
(at moderate prices)
11
Elastic Demand(at moderate prices)
12
DIMINISHING RETURNS

• Explanation
• As additional units of a variable input
  (labor) are added to a fixed input (capital), at
  some point the additional output resulting from
  the addition of one more unit of variable input
  declines. This decline is referred to as
  diminishing marginal return. At this point,
  total product increases at a decreasing rate.

13

• Rationale
• As the variable input increases and the fixed
  input, by definition, remains the same, there is
  less fixed input with which the variable input
  can be combined.
• Example As more workers are added but
• capital remains the same,
  there is less capital
• per worker.

14
SHORT-RUN PRODUCTION RELATIONSHIPS
Law of Diminishing Returns
Total Product
Total Product, TP
Increasing Marginal Returns
Quantity of Labor
Average Product, AP, and marginal product, MP
Average Product
Marginal Product
Quantity of Labor
15
SHORT-RUN PRODUCTION RELATIONSHIPS
Law of Diminishing Returns
Total Product
Total Product, TP
Diminishing Marginal Returns
Quantity of Labor
Average Product, AP, and marginal product, MP
Average Product
Marginal Product
Quantity of Labor
16
SHORT-RUN PRODUCTION RELATIONSHIPS
Law of Diminishing Returns
Total Product
Total Product, TP
Negative Marginal Returns
Quantity of Labor
Average Product, AP, and marginal product, MP
Average Product
Marginal Product
Quantity of Labor
17
Two Approaches to Find the PROFIT MAXIMIZING
QUANTITY ( PRICE)
18
TOTAL REVENUE-TOTAL COST APPROACH
Break-Even Point (Normal Profit)
1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1
,000 900 800 700 600 500 400
300 200 100 0
Total Revenue
Maximum Economic Profits 299
Total revenue and total cost
Total Cost
Break-Even Point (Normal Profit)
1 2 3 4 5 6 7 8 9 10 11 12
13 14
19
MARGINAL REVENUE-MARGINAL COST APPROACH
Profit Maximization Position
200 150 100 50 0
Economic Profit
MC
MR
131.00
ATC
Cost and Revenue
AVC
97.78
1 2 3 4 5 6 7 8 9 10
20
Key Micro Formulas
21
 
22
Finding the Perfectly Competitive Firms Supply
Curve
23
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost Short-Run Supply
MC
MR5
P5
ATC
MR4
P4
Cost and Revenue, (dollars)
AVC
MR3
P3
MR2
P2
MR1
P1
Do not Produce Below AVC
Q2
Q3
Q4
Q5
Quantity Supplied
24
MARGINAL REVENUE-MARGINAL COST APPROACH
Marginal Cost Short-Run Supply
Yields the Short-Run Supply Curve
Supply
MC
MR5
P5
MR4
P4
Cost and Revenue, (dollars)
MR3
P3
MR2
P2
MR1
P1
No Production Below AVC
Q2
Q3
Q4
Q5
Quantity Supplied
25
Long Run Equilibrium (Perfectly Competitive Firm)

• Productive Efficiency
• Allocative Efficiency

26
LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM
MC
ATC
Price
P
MR
Price MC Minimum ATC (normal profit)
Q
Quantity
27
How an Increase in Demand Changes Long-Run
Equilibrium for the Firm and Industry
28
PROFIT MAXIMIZATION IN THE LONG-RUN
Temporary Profits and the Reestablishment Of
Long-Run Equilibrium
S1
MC
ATC
MR
D1
29
PROFIT MAXIMIZATION IN THE LONG-RUN
An increase in demand increases profits
Economic Profits
S1
MC
ATC
MR
D2
D1
30
PROFIT MAXIMIZATION IN THE LONG-RUN
New Competitors increase supply and lower Prices
decrease economic profits
Zero Economic Profits
S1
S2
MC
ATC
MR
D2
D1
31
How an Decrease in Demand Changes Long-Run
Equilibrium for the Firm and Industry
32
PROFIT MAXIMIZATION IN THE LONG-RUN
Decreases in demand, Losses and the
Reestablishment of Long-Run Equilibrium
S1
MC
ATC
MR
D1
33
PROFIT MAXIMIZATION IN THE LONG-RUN
A decrease in demand creates losses
Economic Losses
S1
MC
ATC
MR
D1
D2
34
PROFIT MAXIMIZATION IN THE LONG-RUN
Competitors with losses decrease supply
and prices return to zero economic profits
S3
Return to Zero Economic Profits
S1
MC
ATC
MR
D1
D2
35
Price and Marginal Revenue for a Monopoly
36
MONOPOLY REVENUES COSTS
200 150 200 50
Dollars
Q
0 1 2 3 4 5 6 7 8 9 10 11 12
13 14 15 16 17 18
750 500 250
Dollars
Q
0 1 2 3 4 5 6 7 8 9 10 11 12
13 14 15 16 17 18
37
MONOPOLY REVENUES COSTS
Elastic
200 150 200 50
Dollars
MR
D
Q
0 1 2 3 4 5 6 7 8 9 10 11 12
13 14 15 16 17 18
750 500 250
Dollars
TR
Q
0 1 2 3 4 5 6 7 8 9 10 11 12
13 14 15 16 17 18
38
MONOPOLY REVENUES COSTS
Inelastic
Elastic
200 150 200 50
Dollars
MR
D
Q
0 1 2 3 4 5 6 7 8 9 10 11 12
13 14 15 16 17 18
750 500 250
Dollars
TR
Q
0 1 2 3 4 5 6 7 8 9 10 11 12
13 14 15 16 17 18
39
Failing to remember how to shade the area of
ECONOMIC PROFITTHE PROFIT-MAXIMIZING POSITION
OF A MONOPOLY
40
OUTPUT AND PRICE DETERMINATION
Profit Maximization Under Monopoly
Remember the MRMC Rule?
Profit Per Unit
MC
122
Profit
ATC
94
D
MR MC
MR
41
And the Shading of Economic LossesLOSS
MINIMIZATION OF THE IMPERFECT COMPETITOR
42
OUTPUT AND PRICE DETERMINATION
Loss Minimization Under Monopoly
Loss Per Unit
MC
ATC
A
Loss
AVC
Pm
V
D
MR MC
MR
Qm
43
Monopolyvs.Competition
44
   
45
INEFFICIENCY OF PURE MONOPOLY
P
S MC
At MRMC A monopolist will sell less units at
a higher price than in competition
Pm
Pc
D
MR
Q
Qc
Qm
46
INEFFICIENCY OF PURE MONOPOLY
P
S MC
At MRMC A monopolist will sell less units at
a higher price than in competition
Monopoly pricing effectively creates an income
transfer from buyers to the seller!
Pm
Pc
D
MR
Q
Qc
Qm
47
Not being able to GRAPH a Natural Monopoly and
the Socially- Optimal OutputandFair-Return
Output Levels
48
REGULATED MONOPOLY
Natural Monopolies
Rate Regulation Socially Optimum Price P
MC Fair-Return Price P ATC Dilemma of Regulation
Graphically
49
REGULATED MONOPOLY
Monopoly Price MR MC
P
Pm
Price and Costs
ATC
MC
D
MR
Q
Qm
50
REGULATED MONOPOLY
P
Socially-Optimum Price P MC
Price and Costs
ATC
MC
Pr
D
MR
Q
Qr
51
REGULATED MONOPOLY
P
Fair-Return Price Normal Profit Only
Price and Costs
ATC
Pf
MC
D
MR
Q
Qf
52
REGULATED MONOPOLY
Dilemma of Regulation Which Price?
P
MR MC
Fair-Return Price
Pm
Socially-Optimum Price
Price and Costs
ATC
Pf
MC
Pr
D
MR
Q
Qm
Qf
Qr
53
Single PRICE Monopolyvs.Price Discrimination
54
PRICE DISCRIMINATION
Conditions
Monopoly Power Market Segregation No Resale
Consequences
More Profit More Production
Graphically
55
PRICE DISCRIMINATION
MC
Economic profits with a single MRMC price
P
ATC
Price and Costs
D
MR
Q
Q1
56
PRICE DISCRIMINATION
A perfectly discriminating monopolist has
MRD, producing more product and more profit!
MC
P
ATC
Price and Costs
MRD
D
Q
Q1
Q2
57
PRICE DISCRIMINATION
MC
Economic profits with price discrimination
P
ATC
Price and Costs
MRD
D
Q
Q1
Q2
58
Monopolistic CompetitionWhat is
it?Monopoly?Competition?
59
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
MC
Expect New Competitors
ATC
P1
A1
Price and Costs
Economic Profits
D
MR
Q1
Quantity
60
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
MC
Expect New Competitors
ATC
New competition drives down the price level
leading to economic losses in the short run
P1
A1
Price and Costs
Economic Profits
D
MR
Q1
Quantity
61
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
MC
ATC
A2
P2
Economic Losses
Price and Costs
D
MR
Q2
Quantity
62
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
MC
ATC
With economic losses, firms will exit the market
Stability occurs when economic profits are zero
A2
P2
Economic Losses
Price and Costs
D
MR
Q2
Quantity
63
PRICE AND OUTPUT IN MONOPOLISTIC COMPETITION
MC
Long-Run Equilibrium
Normal Profit Only
ATC
P3 A3
Price and Costs
D
MR
Q3
Quantity
64
NOW, for theRESOURCE (Factor)MARKETS
65
Remember Product Market MR
MC Resource Market MRP MFC
66
MRP AS A DEMAND SCHEDULE
Pure Competition
Total Product (Output)
Marginal product (MP)
Marginal Revenue Product (MRP)
Units of Resource
Product Price
Total Revenue
0 1
0 7
2 2
0 14


14
7










P
14 12 10 8 6 4 2
Resource price (wage rate)
Q
0 1 2 3 4 5 6 7 8
Quantity of resource demanded
67
MRP AS A DEMAND SCHEDULE
Pure Competition
Total Product (Output)
Marginal product (MP)
Marginal Revenue Product (MRP)
Units of Resource
Product Price
Total Revenue
0 1 2
0 7 13
2 2 2
0 14 26


14 12
7 6










P
14 12 10 8 6 4 2
Resource price (wage rate)
Q
0 1 2 3 4 5 6 7 8
Quantity of resource demanded
68
MRP AS A DEMAND SCHEDULE
Pure Competition
Total Product (Output)
Marginal product (MP)
Marginal Revenue Product (MRP)
Units of Resource
Product Price
Total Revenue
0 1 2 3
0 7 13 18
2 2 2 2
0 14 26 36


14 12 10
7 6 5










P
14 12 10 8 6 4 2
Resource price (wage rate)
Q
0 1 2 3 4 5 6 7 8
Quantity of resource demanded
69
MRP AS A DEMAND SCHEDULE
Pure Competition
Total Product (Output)
Marginal product (MP)
Marginal Revenue Product (MRP)
Units of Resource
Product Price
Total Revenue
0 1 2 3 4 5 6 7
0 7 13 18 22 25 27 28
2 2 2 2 2 2 2 2
0 14 26 36 44 50 54 56


14 12 10 8 6 4 2
7 6 5 4 3 2 1










P
14 12 10 8 6 4 2
The purely competitive sellers demand for a
resource
Resource price (wage rate)
Q
0 1 2 3 4 5 6 7 8
Quantity of resource demanded
70
MRP AS A DEMAND SCHEDULE
Pure Competition
Total Product (Output)
Marginal product (MP)
Marginal Revenue Product (MRP)
Units of Resource
Product Price
Total Revenue
0 1 2 3 4 5 6 7
0 7 13 18 22 25 27 28
2 2 2 2 2 2 2 2
0 14 26 36 44 50 54 56


14 12 10 8 6 4 2
7 6 5 4 3 2 1










P
14 12 10 8 6 4 2
The purely competitive sellers demand for a
resource
Resource price (wage rate)
Q
0 1 2 3 4 5 6 7 8
Quantity of resource demanded
71
MRP AS A DEMAND SCHEDULE
Imperfect Competition
Total Product (Output)
Marginal product (MP)
Marginal Revenue Product (MRP)
Units of Resource
Product Price
Total Revenue
0 1 2 3 4 5 6 7
0 7 13 18 22 25 27 28
2.80 2.60 2.40 2.20 2.00 1.85 1.75
1.65
0 18.20 31.20 39.60 44.00 46.25
47.25 46.20


18.20 13.00 8.40 4.40 2.25
1.00 -1.05
7 6 5 4 3 2 1










P
14 12 10 8 6 4 2
The imperfectly Competitive sellers demand for a
resource
Resource price (wage rate)
Q
0 1 2 3 4 5 6 7 8
Quantity of resource demanded
72
LABOR MARKETSWage Determination
73
(No Transcript)
74
PURELY COMPETITIVE LABOR MARKET
Purely competitive labor market
Many Firms Numerous Qualified Workers Wage
Taker Behavior Market Demand for Labor Market
Supply of Labor
75
LABOR SUPPLY AND DEMAND PURELY COMPETITIVE MARKET
S
Includes Normal Profit
S MRC
Wc
(10)
10
10
10
10
10
10
Wc
Labor Costs
D MRP (? mrps)
d mrp
(1000)
(5)
Individual Firm
Labor Market
76
MONOPSONISTICLABOR MARKET
S
In monopsony MRC lies above the supply curve
Wage Rate (dollars)
Quantity of Labor
77
MONOPSONISTICLABOR MARKET
MRC
S
MRP MRC
Wage Rate (dollars)
Wm
MRP
Qm units of labor hired
Qm
Quantity of Labor
78
MONOPSONISTICLABOR MARKET
MRC
S
The competitive solution would result in a
higher wage and greater employment
Wage Rate (dollars)
Wc
Wm
MRP
Qm
Qc
Quantity of Labor
79
EXTERNALITIES Negative Positive
80
COST-BENEFIT ANALYSIS
Marginal Cost Marginal Benefit Rule
Externalities
Spillover Costs
Overallocation
Spillover Benefits
Underallocation
81
SPILLOVER COSTS AND BENEFITS Illustrating a
Negative Externality
P
St
Spillover costs
S
D
Overallocation
Q
Q0
Qe
0
82
SPILLOVER COSTS AND BENEFITS Illustrating a
Positive Externality
P
St
Spillover Benefits
Dt
D
Underallocation
Q
Qe
Q0
0
83
Taxation Concepts
84
APPORTIONING THE TAX BURDEN
Benefits-Received Principle Ability-to-Pay
Principle

• Progressive Tax
• Regressive Tax
• Proportional Tax

85
TAX APPLICATIONS
Identify whether progressive, regressive, or
proportional

• Personal Income Tax
• Progressive
• Sales Tax
• Regressive
• Corporate Income Tax
• Proportional - Regressive
• Payroll Taxes
• Regressive
• Property Taxes
• Regressive

86
Price Supports SurplusesSubsidies
87
EFFECT OF PRICE SUPPORTS
P
S
Price Support Level
Surplus
Ps
Surplus being created by the subsidies
Pe
D
Q
Qe
88
International Trade

• Comparative Advantage
• Case for Free Trade
• Export Supply
• Import Demand

89
PRODUCTION POSSIBILITIES
Principle of Comparative Advantage
Total output will be greatest when Each good is
produced by the nation that has the lowest
domestic opportunity cost for that good.
U.S has comparative advantage in wheat
Brazil has comparative advantage in coffee
90
PRODUCTION POSSIBILITIES
Principle of Comparative Advantage
Terms of Trade
Gains From Trade Improved Options
Trading Possibilities Line
Graphically
91
PRODUCTION POSSIBILITIES
Curve For Each Country
A
B
92
TRADING POSSIBILITIES LINES
The Gains from Trade
45 40 35 30 25 20 15 10 5 0
Trading possibilities line
30 25 20 15 10 5 0
Coffee (tons)
Coffee (tons)
Trading possibilities line
A
B
5 10 15 20 25 30
5 10 15 20
Wheat (tons)
Wheat (tons)
93
TRADING POSSIBILITIES LINES
The Gains from Trade
45 40 35 30 25 20 15 10 5 0
Trading possibilities line
30 25 20 15 10 5 0
Coffee (tons)
Coffee (tons)
Trading possibilities line
A
A
B
B
5 10 15 20 25 30
5 10 15 20
Wheat (tons)
Wheat (tons)
94
TRADING POSSIBILITIES LINES
The Gains from Trade
45 40 35 30 25 20 15 10 5 0
Trading possibilities line
The Case For Free Trade
30 25 20 15 10 5 0
Coffee (tons)
Coffee (tons)
Trading possibilities line
A
A
B
B
5 10 15 20 25 30
5 10 15 20
Wheat (tons)
Wheat (tons)
95
U.S. EXPORT SUPPLY AND IMPORT DEMAND
U.S. Domestic Aluminum Market
U.S. Export Supply And Import Demand
Sd
If the world price exceeds the U.S. price by 25
cents...
Dd
96
U.S. EXPORT SUPPLY AND IMPORT DEMAND
U.S. Domestic Aluminum Market
U.S. Export Supply And Import Demand
Sd
1.50 1.25 1.00 .75 .50 .25
EXPORTS 50
SURPLUS 50
Price (per pound U.S. dollars)
Price (per pound U.S. dollars)
If the world price goes further up...
Dd
100
50
100
50
75
125
150
Quantity of Aluminum
Quantity of Aluminum
97
U.S. EXPORT SUPPLY AND IMPORT DEMAND
U.S. Domestic Aluminum Market
U.S. Export Supply And Import Demand
Sd
EXPORTS 100
SURPLUS 100
1.50 1.25 1.00 .75 .50 .25
U.S. export supply
EXPORTS 50
SURPLUS 50
Price (per pound U.S. dollars)
Price (per pound U.S. dollars)
If world prices fall below 1.00...
Dd
100
50
100
50
75
125
150
Quantity of Aluminum
Quantity of Aluminum
98
U.S. EXPORT SUPPLY AND IMPORT DEMAND
U.S. Domestic Aluminum Market
U.S. Export Supply And Import Demand
Sd
EXPORTS 100
SURPLUS 100
1.50 1.25 1.00 .75 .50 .25
U.S. export supply
EXPORTS 50
SURPLUS 50
Price (per pound U.S. dollars)
Price (per pound U.S. dollars)
SHORTAGE 50
IMPORTS 50
Dd
100
50
100
50
75
125
150
Quantity of Aluminum
Quantity of Aluminum
99
U.S. EXPORT SUPPLY AND IMPORT DEMAND
U.S. Domestic Aluminum Market
U.S. Export Supply And Import Demand
Sd
EXPORTS 100
SURPLUS 100
1.50 1.25 1.00 .75 .50 .25
U.S. export supply
EXPORTS 50
SURPLUS 50
Price (per pound U.S. dollars)
Price (per pound U.S. dollars)
U.S. import demand
SHORTAGE 50
IMPORTS 50
SHORTAGE 100
IMPORTS 100
Dd
100
50
100
50
75
125
150
Quantity of Aluminum
Quantity of Aluminum
100
CANADIAN EXPORT SUPPLY AND IMPORT DEMAND
Canadas Domestic Aluminum Market
Canadas Export Supply And Import Demand
101
EQUILIBRIUM WORLD PRICE AND QUANTITY OF EXPORTS
IMPORTS