common mistakes on the ap micro exam · consumer and producer surplus √ the value in excess of...

COMMON MISTAKES ON THE AP MICRO EXAM

A change in Demand versus a change in the Quantity Demanded

Change in Demand

√ Moves the curve

•Income

•Future Expectations

•# of Buyers

•Consumer Information

•Taste and Preference

•Substitues and Complements

Change in Quantity Demanded

√ Moves Along the SAMEcurve

• Caused only by Price change.

Consumer and Producer Surplus√ The value in excess of the purchase price

√ The income the firm gets in excess of its marginal costs

D

SP1

Qe

P

Q

CS

PS

Price Floor and Price Ceiling

D

S

Pc Shortage

P1

Qe

P

Q

PfSurplus

Ed = % change in Qd% change in P

PRICE

Elasticity

E c = % Δ Quantity of X%Δ Price of Y

CROSS

INCOME E i = % Δ Quantity%Δ Income

Dead Weight Loss When the Price is Below P*

Q/t

P

Demand

SupplyA

P* C

0 Q’ Q*

E

FP’

B

• Value to the Consumer: • 0AEQ’

• Consumers Pay Producers: • OP’FQ’

• The Variable Cost to Producers: • OBFQ’

• Consumer Surplus: • P’AEF

• Producer Surplus: • BP’F

• DWL• FEC

Tax RevenuesEfficiency Loss of a TaxRole of ElasticitiesQualifications

•Redistributive Goals•Reducing Negative Externalities

TAX INCIDENCE ANDEFFICIENCY LOSS

Perfectly Inelastic Demand

D

Q/t

P

S2

Q1=Q2

P2 S1

P1

Perfectly Elastic Demand

Q/t

P

D

S2

P1=P2

Q2

S1

Q1

Inelastic Demand

(at moderate prices)

P

Q/t

D

S1

P1

Q1Q2

S2

P2

Elastic Demand(at moderate prices)

Q/t

P

Q1

D

S1

P1

S2

P2

Q2

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.

• 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.

Law of Diminishing Returns

SHORT-RUN PRODUCTIONRELATIONSHIPS

Tota

l Pro

duct

, TP

Quantity of Labor

Aver

age

Prod

uct,

AP,

and

mar

gina

l pro

duct

, MP

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

IncreasingMarginalReturns

http://www.mhhe.com/cgi-bin/mcbrue15.pl?url=origin22-1

http://www.mhhe.com/cgi-bin/mcbrue15.pl?url=analogies22-1



Tota

l Pro

duct

, TP

Quantity of Labor

Aver

age

Prod

uct,

AP,

and

mar

gina

l pro

duct

, MP

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

DiminishingMarginalReturns





Tota

l Pro

duct

, TP

Quantity of Labor

Aver

age

Prod

uct,

AP,

and

mar

gina

l pro

duct

, MP

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

NegativeMarginalReturns




Two Approaches to Find the PROFIT MAXIMIZING

QUANTITY ( PRICE)

$1,8001,7001,6001,5001,4001,3001,2001,1001,000

900800700600500400300200100

0

Tota

l rev

enue

and

tota

l cos

tTotal

Revenue

TotalCost

MaximumEconomic

Profits$299

Break-Even Point(Normal Profit)

Break-Even Point(Normal Profit)

1 2 3 4 5 6 7 8 9 10 11 12 13 14

TOTAL REVENUE-TOTAL COST APPROACH

$200

150

100

50

0

Cos

t and

Rev

enue

1 2 3 4 5 6 7 8 9 10

MC

MR

AVCATC

Economic Profit

$131.00

$97.78

MARGINAL REVENUE-MARGINAL COST APPROACH

Profit Maximization Position

http://www.mhhe.com/cgi-bin/mcbrue15.pl?url=graphs23-1

Key Micro Formulas

RELATIONSHIP ECONOMIC INTERPRETATION

MR = MC When MR = MC, we know that the firm has chosen the output that maximizes profits.

P > ATC Firm is earning ECONOMIC PROFITS

P = ATC Firm is earning NORMAL PROFIT (Break-Even Point) (economic profit = 0)

P < ATCP > AVC

Loss Minimization

P = AVC SHUTDOWN POINT (firm will loseTFC if they produce or Shutdown and produce 0.

P < AVC Firm does not produce

Finding the Perfectly Competitive Firm’s

Supply Curve

Cos

t and

Rev

enue

, (do

llars

)MC

MR1

AVC

ATC


Quantity Supplied

MR2

MR3

MR4

MR5

P1

P2

P3

P4

P5

Q2 Q3 Q4 Q5

Marginal Cost & Short-Run Supply

Do notProduce –Below AVC

Cos

t and

Rev

enue

, (do

llars

)MC

MR1


Quantity Supplied

MR2

MR3

MR4

MR5

P1

P2

P3

P4

P5

Q2 Q3 Q4 Q5

Marginal Cost & Short-Run SupplyYields theShort-Run

Supply Curve

Supply

NoProductionBelow AVC

Long Run Equilibrium (Perfectly Competitive

Firm)

• Productive Efficiency• Allocative Efficiency

P MR

Q

MCATC

Quantity

Pric

e

Price = MC = Minimum ATC(normal profit)

LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM

How an Increase in Demand Changes Long-Run Equilibrium for the

Firm and Industry

Temporary Profits and the ReestablishmentOf Long-Run Equilibrium

S1

MCATC

P

Q100

P

Q100,000

IndustryFirm(price taker)

$605040

$605040

PROFIT MAXIMIZATION IN THE LONG-RUN

MR

D1

An increase in demand increases profits…

MR

D1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D2

EconomicProfits

S1

New Competitors increase supply and lowerPrices decrease economic profits

MR

D1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D2

Zero EconomicProfits

S1S2

How an Decrease in Demand Changes Long-Run Equilibrium for the

Firm and Industry

Decreases in demand, Losses and the Reestablishment of Long-Run Equilibrium

S1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D1

MR

A decrease in demand creates losses…

MR

D1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D2

EconomicLosses

S1

MR

D1

MCATC

P

Q100

P

Q100,000


$605040

$605040


D2

Return to ZeroEconomic Profits

S1

S3

Competitors with losses decrease supply andprices return to zero economic profits

Price and Marginal Revenue for a

Monopoly

MONOPOLY REVENUES & COSTS

Dol

lars

Dol

lars

$200

150

200

50

$750

500

250

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Q0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Q


Dol

lars

Dol

lars

$200

150

200

50

$750

500

250

MR

Elastic

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

DQ

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

TR

Q


Q

Dol

lars

Dol

lars

$200

150

200

50

$750

500

250TR

MR D

InelasticElastic

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18Q

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Failing to remember how to shade the area of ECONOMIC PROFIT

THE PROFIT-MAXIMIZING

POSITION OF A MONOPOLY

Profit Maximization Under Monopoly

D

MC

ATC

MR

$94

$122Profit

MR = MC

ProfitPer Unit

OUTPUT AND PRICE DETERMINATION

Q

200

175

150

125

100

75

50

25

0 1 2 3 4 5 6 7 8 9 10

Pric

e, c

osts

, and

reve

nue

Remember the MR=MC Rule?

And the Shading of Economic Losses

LOSS MINIMIZATION OF THE IMPERFECT

COMPETITOR

Loss Minimization Under Monopoly

D

MCATC

MR

APm

Loss

MR = MC

LossPer Unit

OUTPUT AND PRICE DETERMINATION

Q

200

175

150

125

100

75

50

25

0 1 2 3 4 5 6 7 8 9 10

Pric

e, c

osts

, and

reve

nue

AVC

Qm

V

Since Pm exceeds AVC,the firm will produce

Monopoly

vs.

Competition

PURE COMPETITION

MONOPOLY

MR = MC

The firms maximizes profit.

MR = MC

The firm maximizes profit.P = ATC

The firms just BREAK-EVEN (NORMAL PROFITS) in the Long Run.

P > ATC

Long Run ECONOMIC PROFITS.

P = min ATC

Firm is forced to operate with maximum productive efficiency.

--------------------------------------PRODUCTIVE EFFICIENCY

(Least-Cost Method Production)

P > min ATC

Firm is not forced to operate with maximum productive efficiency.

PRODUCTIVE INEFFICIENCY

(Least-Cost Method Production not necessary)

P = MC

There is an optimal allocation of resources.

ALLOCATIVE EFFICIENCY

P > MC

There is an UNDERALLOCATION of resources.

ALLOCATIVE INEFFICIENCY

P = MR

The firm’s DEMAND CURVE is infinitely ELASTIC.

P > MR

The firm’s DEMAND CURVE is less than infinitely ELASTIC.

Q

INEFFICIENCY OF PURE MONOPOLYP

DMR

S = MC

Pc

Pm

QcQm

At MR=MCA monopolistwill sell less

units at ahigher price

than incompetition

An industry in pure competitionsells where supply and

demand are equal

Q

INEFFICIENCY OF PURE MONOPOLYP

DMR

S = MC

Pc

Pm

QcQm

At MR=MCA monopolistwill sell less

units at ahigher price

than incompetition

Monopoly pricing effectivelycreates an income transfer from

buyers to the seller!

Not being able to GRAPH a Natural Monopoly and the Socially- Optimal

Outputand

Fair-Return Output Levels

Natural MonopoliesRate RegulationSocially Optimum Price

P = MCFair-Return Price

P = ATCDilemma of Regulation

REGULATED MONOPOLY

Graphically…

REGULATED MONOPOLY

Q

DMR

MCATC

P

Pric

e an

d C

osts

Monopoly PriceMR = MC

Qm

Pm

REGULATED MONOPOLY

Q

DMR

MCATC

P

Pric

e an

d C

osts

Socially-OptimumPrice

P = MC

Qr

Pr

REGULATED MONOPOLY

Q

DMR

MCATC

P

Pric

e an

d C

osts

Fair-Return PriceNormal Profit Only

Qf

Pf

REGULATED MONOPOLY

Q

DMR

MCATC

P

Pric

e an

d C

osts

MR = MC

Fair-Return Price

Socially-OptimumPrice

Qm Qf Qr

Dilemma of RegulationWhich Price?

Pm

Pf

Pr

Single PRICE Monopoly

vs.

Price Discrimination

ConditionsMonopoly PowerMarket SegregationNo Resale

ConsequencesMore ProfitMore Production

PRICE DISCRIMINATION

Graphically…



QDMR

MC

ATC

P

Q1

Pric

e an

d C

osts

Economic profits witha single MR=MC

price


QD

MC

ATC

P

Q1

Pric

e an

d C

osts


Q2

A perfectly discriminatingmonopolist has MR=D,producing more product

and more profit!

MR=D

QD

MC

ATC

P

Q1

Pric

e an

d C

osts

Economic profits withprice discrimination


Q2

MR=D

Monopolistic Competition

What is it?Monopoly?

Competition?

D

MR

P1

ATCPr

ice

and

Cos

ts

Q1

EconomicProfits

Expect New Competitors

PRICE AND OUTPUT INMONOPOLISTIC COMPETITION

Quantity

A1

MC

D

MR

P1

ATCPr

ice

and

Cos

ts

Q1

EconomicProfits

Expect New Competitors


Quantity

A1

New competition drives down theprice level – leading to economic

losses in the short run

MC

D

MR

MC

P2

ATCPr

ice

and

Cos

ts

Q2

EconomicLosses


Quantity

A2

D

MR

MC

P2

ATCPr

ice

and

Cos

ts

Q2

EconomicLosses


Quantity

A2With economic losses, firms willexit the market – Stability occurswhen economic profits are zero

D

MR

MC

P3= A3

ATCPr

ice

and

Cos

ts

Q3


Quantity

Long-Run EquilibriumNormalProfitOnly

NOW,

for theRESOURCE (Factor)

MARKETS

Remember…

Product Market:MR = MC

Resource Market:MRP = MFC

Units ofResource

TotalProduct(Output)

Marginalproduct

(MP)Product

PriceTotal

Revenue

MarginalRevenue

Product (MRP)

]]]]]]

0 1 2 3 4 5 6 7 8 Q

P 141210

8642R

esou

rce

pric

e(w

age

rate

)

Quantity of resource demanded

Pure CompetitionMRP AS A DEMAND SCHEDULE

]]]]]]

01

07 7 $2

2$ 014

$ 14

Units ofResource


Marginalproduct

(MP)Product

PriceTotal

Revenue

MarginalRevenue

Product (MRP)

]]]]]]

0 1 2 3 4 5 6 7 8 Q

P 141210

8642R

esou

rce

pric

e(w

age

rate

)



]]]]]]

012

07

13

76

$222

$ 01426

$ 1412

Units ofResource


Marginalproduct

(MP)Product

PriceTotal

Revenue

MarginalRevenue

Product (MRP)

]]]]]]

0 1 2 3 4 5 6 7 8 Q

P 141210

8642R

esou

rce

pric

e(w

age

rate

)



]]]]]]

0123

07

1318

765

$2222

$ 0142636

$ 141210

Units ofResource


Marginalproduct

(MP)Product

PriceTotal

Revenue

MarginalRevenue

Product (MRP)

]]]]]]

0 1 2 3 4 5 6 7 8 Q

P 141210

8642R

esou

rce

pric

e(w

age

rate

)



]]]]]]

01234567

07

131822252728

7654321

$22222222

$ 014263644505456

$ 1412108642

The purely competitiveseller’s demand fora resource


Units ofResource


Marginalproduct

(MP)Product

PriceTotal

Revenue

MarginalRevenue

Product (MRP)

]]]]]]

0 1 2 3 4 5 6 7 8 Q

P 141210

8642R

esou

rce

pric

e(w

age

rate

)



]]]]]]

01234567

07

131822252728

7654321

$22222222

$ 014263644505456

$ 1412108642

The purely competitiveseller’s demand fora resource

Now, consider the caseof resource demand under

Imperfect Competition

Units ofResource


Marginalproduct

(MP)Product

PriceTotal

Revenue

MarginalRevenue

Product (MRP)

]]]]]]

0 1 2 3 4 5 6 7 8 Q

P 141210

8642R

esou

rce

pric

e(w

age

rate

)


Imperfect CompetitionMRP AS A DEMAND SCHEDULE

]]]]]]

01234567

07

131822252728

7654321

$2.802.602.402.202.001.851.751.65

$ 018.2031.2039.6044.0046.2547.2546.20

$ 18.2013.008.404.402.251.00-1.05

The imperfectlyCompetitive seller’sdemand for a resource

LABOR MARKETS:

Wage Determination

PURELY COMPETITIVELABOR MARKET

Purely competitive labor market:Many FirmsNumerous Qualified Workers“Wage Taker” BehaviorMarket Demand for LaborMarket Supply of Labor

Non-LaborCosts

LaborCosts

LABOR SUPPLY AND DEMANDPURELY COMPETITIVE MARKET

Labor Market

S

D = MRP(Σ mrp’s)

Wc

(1000)

Individual Firm

S = MRC

d = mrp

Wc

Quantity of Labor

Wag

e R

ate

(dol

lars

)

Quantity of Labor

($10)

(5)

$10$10$10$10$10$10

IncludesNormalProfit

Wag

e R

ate

(dol

lars

)S

Quantity of Labor

MONOPSONISTICLABOR MARKET

In monopsonyMRC lies abovethe supply curve

Wag

e R

ate

(dol

lars

)

MRP

S

Wm

Quantity of Labor

MRC

Qm


MRP = MRC

Qm units oflabor hired

Wag

e R

ate

(dol

lars

)

MRP

S

Wm

Quantity of Labor

MRC

Wc

Qm Qc

The competitivesolution would

result in a higherwage and greater

employment


EXTERNALITIES

Negative

Positive

COST-BENEFIT ANALYSISMarginal Cost = Marginal Benefit Rule

Spillover Costs

Overallocation

Spillover BenefitsUnderallocation

Externalities

P

Q

SPILLOVER COSTS AND BENEFITSIllustrating a Negative Externality

D

0

Spillovercosts

St

S

Overallocation

Q0 Qe

P

Q

SPILLOVER COSTS AND BENEFITSIllustrating a Positive Externality

0 Qe Q0

D

Dt

SpilloverBenefits

St

Underallocation

Taxation Concepts

APPORTIONING THETAX BURDEN

Benefits-Received Principle

Ability-to-Pay Principle

• Progressive Tax• Regressive Tax• Proportional Tax

TAX APPLICATIONS:

• Personal Income TaxProgressive

• Sales TaxRegressive

• Corporate Income TaxProportional - Regressive

• Payroll TaxesRegressive

• Property TaxesRegressive

Identify whether progressive, regressive, or proportional

Price Supports SurplusesSubsidies

EFFECT OF PRICE SUPPORTS

Pe

D

S

QeQc Qs

SurplusPs

Surplus beingcreated by the

subsidies

Q

P

Price SupportLevel

International Trade• Comparative Advantage

• Case for Free Trade

• Export Supply

• Import Demand

Total output will be greatest whenEach good is produced by the nationthat has the lowest domesticopportunity cost for that good.

U.S has comparative advantage in wheat

Brazil has comparative advantage in coffee

Principle of Comparative AdvantagePRODUCTION POSSIBILITIES

Terms of Trade

Gains From TradeImproved Options

Principle of Comparative AdvantagePRODUCTION POSSIBILITIES

Trading Possibilities LineGraphically…

PRODUCTION POSSIBILITIES

A

B

Cof

fee

(tons

)

Cof

fee

(tons

)

45

40

35

30

25

20

15

10

5

0

30

25

20

15

10

5

05 10 15 20 25 30 5 10 15 20

Wheat (tons) Wheat (tons)

Curve For Each CountryUnited States Brazil

TRADING POSSIBILITIES LINES

Cof

fee

(tons

)

Cof

fee

(tons

)

45

40

35

30

25

20

15

10

5

0

30

25

20

15

10

5

05 10 15 20 25 30 5 10 15 20

A

B

Tradingpossibilities line



The Gains from TradeUnited States Brazil


Cof

fee

(tons

)

Cof

fee

(tons

)

45

40

35

30

25

20

15

10

5

0

30

25

20

15

10

5

05 10 15 20 25 30 5 10 15 20

A

B



A’

B’




Cof

fee

(tons

)

Cof

fee

(tons

)

45

40

35

30

25

20

15

10

5

0

30

25

20

15

10

5

05 10 15 20 25 30 5 10 15 20

A

B



A’

B’



The Case ForFree Trade

U.S. EXPORT SUPPLYAND IMPORT DEMAND

U.S. DomesticAluminum Market

U.S. Export SupplyAnd Import Demand

Dd

Sd

If the world priceexceeds the U.S.

price by 25 cents...

$1.50

1.25

1.00

.75

.50

.25Pric

e (p

er p

ound

; U.S

. dol

lars

)

10050 75 125 150Quantity of Aluminum

10050Pr

ice

(per

pou

nd; U

.S. d

olla

rs)

$1.50

1.25

1.00

.75

.50

.25

Quantity of Aluminum

EXPORTS = 50




$1.50

1.25

1.00

.75

.50

.25

10050

DdPric

e (p

er p

ound

; U.S

. dol

lars

)

Pric

e (p

er p

ound

; U.S

. dol

lars

)

10050 75 125 150

SURPLUS = 50

$1.50

1.25

1.00

.75

.50

.25

If the world pricegoes further up...

Sd

Quantity of Aluminum Quantity of Aluminum

EXPORTS = 50

EXPORTS = 100




$1.50

1.25

1.00

.75

.50

.25

10050

DdPric

e (p

er p

ound

; U.S

. dol

lars

)

Pric

e (p

er p

ound

; U.S

. dol

lars

)

10050 75 125 150

SURPLUS = 50

SURPLUS = 100 $1.50

1.25

1.00

.75

.50

.25

If world pricesfall below $1.00...

Sd

U.S.exportsupply


SHORTAGE = 50




$1.50

1.25

1.00

.75

.50

.25

10050

DdPric

e (p

er p

ound

; U.S

. dol

lars

)

Pric

e (p

er p

ound

; U.S

. dol

lars

)

10050 75 125 150

SURPLUS = 50

SURPLUS = 100 $1.50

1.25

1.00

.75

.50

.25

Sd

EXPORTS = 50

EXPORTS = 100

IMPORTS = 50

U.S.exportsupply


SHORTAGE = 50

SHORTAGE = 100




$1.50

1.25

1.00

.75

.50

.25

10050

DdPric

e (p

er p

ound

; U.S

. dol

lars

)

Pric

e (p

er p

ound

; U.S

. dol

lars

)

10050 75 125 150

SURPLUS = 50

SURPLUS = 100

U.S.exportsupply

EXPORTS = 50

EXPORTS = 100

IMPORTS = 50

IMPORTS = 100

U.S.import

demand

$1.50

1.25

1.00

.75

.50

.25

Sd


CANADIAN EXPORT SUPPLYAND IMPORT DEMANDCanada’s DomesticAluminum Market

Canada’s Export SupplyAnd Import Demand

DdSHORTAGE = 50

$1.50

1.25

1.00

.75

.50

.25

10050

Pric

e (p

er p

ound

; U.S

. dol

lars

)

Pric

e (p

er p

ound

; U.S

. dol

lars

)

10050 75 125 150

SURPLUS = 100

Canadianexportsupply

Canadianimport

demand

$1.50

1.25

1.00

.75

.50

.25

Sd

SURPLUS = 50


EQUILIBRIUM WORLD PRICE ANDQUANTITY OF EXPORTS & IMPORTS

Pric

e (p

er p

ound

; U.S

. dol

lars

)

U.S. exportsupply

U.S. importdemand

Quantity of Aluminum

Canadianexportsupply

Canadian importdemand

10050

$1.50

1.25

1.00

.75

.50

.25

25

.88 Equilibrium

common mistakes on the ap micro exam · consumer and producer surplus √ the value in excess of...

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