AP Microeconomics Unit III Review

1. AP Microeconomics Unit III Review Chapters 5, 6 & 7

2. 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

3. 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

4. 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

5. What is achieved when competition forces producers to use the best available technologies and combinations of resources? • productive efficiency

6. What is achieved when the correct quantity of a product is produced relative to other products? • allocative efficiency

7. 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

8. What are the two distinguishing characteristics of private goods? • Rivalry for consumption & excludability from consumption

9. What does it mean that public goods are “non-rivalry” and “non-excludable”? • 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

10. What is the free-rider problem? • Once someone has created a public good everyone, including “non-payers” can benefit

11. 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 demand for MB

12. 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 3rd parties who receive benefits

13. 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 reflecting the costs imposed on 3rd parties

14. 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)

15. Why would government provide subsidies to buyers? • To correct for under allocation of an important good (inoculations, nutritious food, etc.)

16. Why would government provide subsidies to producers? • To encourage production of a particular good (energy efficient technology, etc.)

17. How would direct controls/gov’t regulationsor specific taxes look on an S & D graph? • Shift supply to left to adjust for over allocation

18. 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

19. 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

20. 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

21. What is the law of diminishing marginal utility? • Consumer satisfaction declines with each additional unit consumed

22. 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

23. What is used to measure the overall satisfaction derived from a good? The satisfaction from consuming the next unit? • Total utility; • Marginal utility

24. How does the budget constraint relate to utility? • Helps determine the utility maximizing combination

25. 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

26. 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

27. 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

28. What does prospect theory deal with? • The ways people deal with (and adjust to) goods and bads

29. 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)

30. 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

31. What does an indifference curve demonstrate? • All of the different combinations of two goods that maximize utility

32. 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

33. What does the total product curve demonstrate? • The total amount of output given changing amounts of one particular variable input

34. 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

35. What are some examples of fixed inputs? Variable inputs? • Land, buildings, machinery • Labor, raw materials, advertising

36. 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

37. 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)

38. 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)

39. What are costs that do not change with variations in output? • fixed costs (insurance, rent, interest on debt, etc.

40. What are variable costs? What are some examples? • Costs that change with variations in production; labor, utilities, raw materials, etc.

41. 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 next)

42. The Law of Diminishing Returns 30 TP 20 Total Product, TP 10 0 1 2 3 4 5 6 7 8 9 Increasing Marginal Returns Negative Marginal Returns Diminishing Marginal Returns 20 Marginal Product, MP 10 AP 1 2 3 4 5 6 7 8 9 MP 7-42 LO2

43. 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

44. $1100 1000 900 800 700 600 Costs 500 400 300 200 100 0 10 1 2 3 4 5 6 7 8 9 Q Short-Run Production Costs TC TVC Fixed Cost Total Cost Variable Cost TFC 7-44 LO3

45. 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

46. When do diseconomies of scale happen? • When it becomes too difficult to efficiently manage large scale production

47. MES and Industry Structure Diseconomies Of Scale Constant Returns To Scale Economies Of Scale Average Total Costs Long-run ATC q1 q2 Output 7-47 LO4

48. average variable cost (AVC) • marginal cost (MC) • building long run cost curve