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AP MicroeconomicsMr. Wash
Microeconomics Exam Review Guide UNITS ONE AND TWO
FOUNDATIONS, CONSUMER CHOICE and ELASTICITY
MARGINAL UTILITY LAW OF DIMINISHING MARGINAL
UTILITY IRRATIONAL GOODS MU of product A/price of A = MU of
product B/price of B = etc.
ELASTICITY DETERMINANTS OF ELASTICITY
o TIME o SUBSTITUTES o NECESSITY o INCOME
TOTAL REVENUE TEST o P = TR
E<1, INELASTIC o P = TR
E>1, ELASTIC "Good Enough Formula":
E =(Q2 - Q1/Q1)
(P2 - P1/P1) DEMAND CURVES
o MORE ELASTIC AT HIGH PRICES o MORE INELASTIC AT LOW
PRICES o UNIT ELASTIC AT EQUILIBRIUM
UNIT FOURCOSTS
COSTS EXTERNAL INTERNAL
o EXPLICIT FIXED
RENT INTEREST
VARIABLE WAGES
o IMPLICIT NORMAL PROFIT (OPPORTUNITY COST)
TOTAL REVENUE = P X Q TOTAL REVENUE - INTERNAL EXPLICIT
COSTS = ACCOUNTING PROFIT ACCOUNTING PROFIT - NORMAL PROFIT
= ECONOMIC PROFIT
PROFIT MAXIMIZATION FORMULA if TR > TC
o then MAX PROFIT o PRODUCE AT MR > MC
if TR < TCo but TR > TVC o then MIN LOSSES o PRODUCE AT MR > MC o LOSE LESS THAN TFC,
BUT LONG RUN LOOK TO SHUT DOWN
if TR < TVCo then SHUT DOWN
PRODUCTIVE EFFICIENCY
o P = ATC o EP = 0 o FAIR RETURN
ALLOCATIVE EFFICIENCY o P = MC o NATURAL EQUILIBRIUM o SOCIALLY OPTIMAL
X EFFICIENCY o MINIMUM POSSIBLE LONG RUN
ATC
o LOSE TFC
UNIT FOURMARKET MODELS
PERFECT COMPETITION
INFINITE NUMBER OF FIRMS
VERY EASY ENTRY INTO MARKET
STANDARD PRODUCT
MONOPOLISTIC COMPETITION
MANY FIRMS EASY ENTRY
INTO MARKET
DIFFERENTIATED PRODUCT
OLIGOPOLY A FEW FIRMS DIFFICULT
ENTRY INTO MARKET
DIFFERENTIATED PRODUCT
MONOPOLY ONE FIRM IMPOSSIBLE
ENTRY INTO MARKET
STANDARD PRODUCT
PRICE TAKER DEMAND IS
PERFECTLY ELASTIC AT MARKET PRICE
RISK TAKER
PRICE MAKERRISK TAKER
PRICE MAKERRISK AVOIDER
PRICE MAKER- DEMAND IS VERY
CLOSE TO PERFECTLY INELASTIC
RISK AVOIDER PRODUCTIV
E EFFICIENCY
o P = ATC
o ALWAYS IN LONG RUN
o EP = 0
o FAIR RETURN
PRODUCTIVE EFFICIENCY
o P = ATC
o ALWAYS IN LONG RUN
o EP = 0 o FAIR
RETURN
ALLOCATIVE EFFICIENCY
o P >
PRODUCTIVE EFFICIENCY
o P > ATC
o NEVER IN LONG RUN
o EP > 0 ALLOCATIVE
EFFICIENCY o P >
MC o ARTIF
ICIAL EQ
PRODUCTIVE EFFICIENCY
o P > ATC o NEVER
IN LONG RUN
o EP > 0 ALLOCATIVE
EFFICIENCY o P > MC o ARTIFI
CIAL EQ
o NEVER X EFFICIENCY
ALLOCATIVE EFFICIENCY
o P = MC
o NATURAL EQUILIBRIUM
o SOCIALLY OPTIMAL
o ALWAYS
X EFFICIENCY
o MINIMUM POSSIBLE LONG RUN ATC
o ALWAYS IN LONG RUN
MC o ARTIF
ICIAL EQ
o NEVER
X EFFICIENCY
o MINIMUM POSSIBLE LONG RUN ATC
o ALWAYS OVERKAPITALIZED IN LONG RUN
o NEVER
X EFFICIENCY
o USUALLY IN LONG RUN
o HIT AND RUN COMPETITION
SHORT RUN COLLUSION
o NEVER o CONTE
STABLE MARKET?
o HIT AND RUN COMPETITION?
NON-PRODUCTIVE COSTS
o LAWSUITS
o LOBBYING
o LYNCHING
PERFECT COMPETITION
COSTS EXTERNAL INTERNAL
o EXPLICIT FIXED
RENT INTEREST
VARIABLE WAGES
o IMPLICIT NORMAL PROFIT (OPPORTUNITY COST)
TOTAL REVENUE = P X Q TOTAL REVENUE - INTERNAL EXPLICIT
COSTS = ACCOUNTING PROFIT ACCOUNTING PROFIT - NORMAL PROFIT
= ECONOMIC PROFIT
PROFIT MAXIMIZATION FORMULA
TR > TC o MAX PROFIT o PRODUCE AT MR > MC
TR < TC o TR > TVC
MIN LOSSES PRODUCE AT MR >
MC LOSE LESS THAN
TFC, BUT LONG RUN LOOK TO SHUT DOWN
o TR < TVC SHUT DOWN LOSE TFC
ALL MARKETS IN LONG RUN EQUILIBRIUM
o EP = 0 o
PRODUCTIVE EFFICIENCY o P = ATC o EP = 0 o FAIR RETURN
ALLOCATIVE EFFICIENCY o P = MC o NATURAL EQUILIBRIUM o SOCIALLY OPTIMAL
X EFFICIENTY o MINIMUM POSSIBLE LONG RUN
ATC
IMPERFECT MARKETSMONOPOLISTIC COMPETITION
MONOPOLISTIC COMPETITION MANY FIRMS EASY ENTRY INTO MARKET DIFFERENTIATED PRODUCT
PRICE MAKERRISK TAKERCHOOSE NOT TO PRICE DISCRIMINATE, SO P DOES NOT EQUAL MRPROFIT MAXIMIZATION FORMULA IN IMPERFECT COMPETITION:
TR > TC o MAX PROFIT o PRODUCE AT MR > MC
BUT Qs < Qd o SHORTAGE
SO P = Qd o UNTIL Qd = Qs o ARTIFICIAL EQUILIBRIUM
FOR MONOPOLISITIC COMPETITION LONG RUN
o IF EP > 0 FIRMS ENTER ATC P EP = 0
o IF EP < 0 FIRMS LEAVE ATC P EP = 0
LONG RUN PRODUCTIVE EFFICIENCY X-EFFICIENCY
o OVERCAPITALIZATION FOR POTENTIAL EXPANSION
NOT ALLOCATIVE EFFICIENT
OLIGOPOLY
OLIGOPOLY A FEW FIRMS DIFFICULT ENTRY INTO MARKET DIFFERENTIATED PRODUCT INTERDEPENDENT
o NASH BOX o PRISONER'S DILEMMA
PRICE MAKERRISK AVOIDER
KINKED DEMAND CURVE o IF P
OTHER FIRMS KEEP PRICE THE SAME
SO DUE TO SUBSTITUTION EFFECT, Qd
TR E > 0
o IF P OTHER FIRMS
LOWER PRICES PRICE WAR Qd CONSTANT
TR E < 0
STABLE MARKETCOLLUSION IF THREATENED FROM
OUTSIDE X-EFFICIENCY
o OVERCAPITALIZATION FOR POTENTIAL EXPANSION
NOT PRODUCTIVE EFFICIENCY NOT ALLOCATIVE EFFICIENT
MONOPOLY
MONOPOLY ONE FIRM IMPOSSIBLE ENTRY INTO MARKET STANDARD PRODUCT
PRICE MAKERRISK AVOIDER
CONTESTABLE MARKET o IF NOT X-EFFICIENT, FIRMS WILL
TAKE ADVANTAGE OF WINDOW OF OPPORTUNITY
o INNOVATION COMES FROM OUTSIDE
o HIT AND RUN COMPETITION NON PRODUCTIVE COSTS
o PREDATORY PRICING o PRICE DISCRIMINATION o TYING CONTRACTS/BUNDLING o LOBBYING, LAWSUITS,
LYNCHING GOVERNMENT REGULATION
o BREAK UP o NATURAL MONOPOLY
LONG RUN COSTS ARE SUCH THAT OPTIMAL EFFICIENCY IS ACHIEVED WITH ONLY ONE FIRM PRODUCING
ECONOMIES OF SCALE PRICE REGULATION
SOCIALLY OPTIMAL PRICE
OVERCAPITALIZATION
FAIR RETURN PRICE
X-INEFFICIENCY
o OVERCAPITALIZATION PROTECT AGAINST
POTENTIAL COMPETITORS
DEFEND AGAINST GOVERNMENT PRICE REGULATION
NOT PRODUCTIVE EFFICIENCY NOT ALLOCATIVE EFFICIENT
UNIT FIVERESOURCE MARKETS
PERFECTLY COMPETITIVERESOURCE MARKET
PERFECT COMPETITIONHOUSEHOLDS ARE SELLERS OF RESOURCES
LAND = A CAPITAL = K LABOR = L
BUSINESSES ARE BUYERS OF RESOURCES MRP = MR
MRC (MFC) = MC LEAST COST FORMULA FOR A
COMBINATION OF RESOURCES:MRPL = MRPA = MFCK = 1MFCL MFCA MFCK
PROFIT MAXIMIZATION FORMULAMRP > MFC
IMPERFECTLY COMPETITIVERESOURCE MARKET
IMPERFECT COMPETITIONMONOPSONY
PROFIT MAXIMIZATION FORMULA TR > TC
o MAX PROFIT o PRODUCE AT MRP > MFC
BUT Qs > Qd
o SURPLUS o UNEMPLOYMENT
SO W = Qd o UNTIL Qd = Qs
ARTIFICIAL EQUILIBRIUM
