AP Microeconomics flashcards
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Unit 1: Basic Economic Concepts
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Topic 1.1 · Know the termWhat is scarcity, and why does it force every society to make trade-offs?
Scarcity is the lack of enough resources to meet all of society's wants and needs. Because there is not enough for everything, using resources for one thing means giving up something else.
Review: 1.1 Scarcity
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Topic 1.1 · Which one fitsA town has limited farmland, a fixed number of workers, and a few machines. It also uses a well-known method for rotating crops. Which of these resources is not scarce, and why?
The crop-rotation method. Established knowledge is non-rival: one farm using it leaves just as much for every other farm. Land, labor and capital are scarce because using them one way takes them from another use.
Review: 1.1 Scarcity
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Topic 1.2 · Which one fitsIn Country X, a central planning board decides how many tractors are built and who receives them. In Country Y, buyers and sellers trading at market prices decide. Which economic system does each country have?
X is a command economy, where government planning coordinates resource allocation. Y is a market economy, where prices coordinate it. An economy that combines the two is a mixed economy.
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Topic 1.2 · Know the termWhat three questions does every economic system have to answer when it allocates scarce resources?
What goods and services to produce, how to produce them, and who consumes them. Economic systems differ in the institutions and coordinating mechanism they use to answer those questions.
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Topic 1.3 · Say it in contextAn economy is producing at a point inside its production possibilities curve. What does that point tell you?
Resources are underutilized or used inefficiently, such as unemployed workers or idle factories. The economy could produce more of one good without giving up any of the other.
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Topic 1.3 · Work it outA country with a straight-line PPC can produce 100 cars, or 400 bikes, or any combination on the line between. What is the opportunity cost of one car?
4 bikes. Giving up all 100 cars frees enough resources for 400 bikes, so each car costs 400 / 100 = 4 bikes. A straight-line PPC means that cost stays constant.
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Topic 1.3 · Say it in contextA country's PPC is bowed outward from the origin. What does that shape say about opportunity cost as the country makes more of one good?
Opportunity cost is increasing: each extra unit of one good costs more of the other good than the unit before. A straight-line PPC would mean constant opportunity cost.
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Topic 1.4 · Work it outIn one hour, Ana can make 6 pies or 3 cakes. Ben can make 4 pies or 4 cakes. Who has the comparative advantage in cakes?
Ben. A cake costs him 1 pie, while it costs Ana 2 pies. Ana has the comparative advantage in pies: a pie costs her half a cake and costs Ben a whole cake.
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Topic 1.4 · Spot the mistakeCountry A can produce more wheat and more cloth than Country B using the same resources. "So A has nothing to gain from trading with B." What is wrong?
A has absolute advantage in both goods, but gains from trade come from comparative advantage. If opportunity costs differ, each country specializes in its lower-opportunity-cost good, trades, and consumes beyond its own PPC.
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Topic 1.4 · Work it outMaking a cake costs Ana 2 pies and costs Ben 1 pie. Ben specializes in cakes and trades them to Ana for pies. What range of terms of trade, in pies per cake, benefits both?
More than 1 and fewer than 2 pies per cake. Ben gains if he gets more than the 1 pie a cake costs him, and Ana gains if she pays less than the 2 pies it would cost her. For example, 1.5 pies per cake.
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Topic 1.5 · Work it outJo quits a job paying $30,000 a year to run a food truck, and spends $50,000 a year on supplies and fuel. What is the total economic cost of running the truck for a year?
$80,000. The $50,000 is an explicit cost and the $30,000 salary she gave up is an implicit cost. A rational decision-maker counts both.
Review: 1.5 Cost-Benefit Analysis
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Topic 1.5 · Check the conditionsA city is deciding whether to build a bridge across a river. Half a bridge is useless. Should it compare marginal benefit with marginal cost, or total benefit with total cost?
Total benefit with total cost. The decision cannot be broken into increments, so the city builds the bridge only if total benefit exceeds total cost, giving positive total net benefit.
Review: 1.5 Cost-Benefit Analysis
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Topic 1.6 · Work it outRia spends all her income on pizza and soda. The last slice of pizza gave her 30 utils at $3, and the last soda gave her 10 utils at $2. How should she change her spending to raise total utility?
Buy more pizza and less soda. Pizza gives 30 / 3 = 10 utils per dollar and soda gives 10 / 2 = 5. Moving dollars to pizza raises total utility until marginal utility per dollar is equal for both.
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Topic 1.6 · Spot the mistakeSam paid $40 for a nonrefundable concert ticket and now feels sick. "I paid $40, so I have to go." What is the mistake?
The $40 is a sunk cost: he cannot get it back whatever he does. The optimal choice compares only the marginal benefit of going tonight with its marginal cost, such as feeling worse.
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Topic 1.6 · Know the termWhat is diminishing marginal utility?
Each additional unit of a good consumed adds less satisfaction than the unit before it. The third slice of pizza adds less utility than the first, even though total utility may still rise.
Unit 2: Supply and Demand
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Topic 2.1 · Say it in contextThe price of concert tickets rises from $50 to $70, and nothing else changes. What happens on the demand graph for tickets?
A movement up along the demand curve to a smaller quantity demanded. A change in a good's own price changes quantity demanded; it does not shift the demand curve.
Review: 2.1 Demand
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Topic 2.1 · Which one fitsConsumer incomes rise, and buyers now purchase fewer bus rides at every price. What happened to the demand for bus rides, and what kind of good are they for these buyers?
Demand for bus rides shifted left. Since buyers want fewer at every price after their incomes rose, bus rides are an inferior good for them.
Review: 2.1 Demand
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Topic 2.2 · Which one fitsA new machine cuts the cost of producing solar panels. What happens to the market for solar panels?
Supply shifts right: sellers offer more at every price. Equilibrium price falls and equilibrium quantity rises. Technology is a determinant of supply, so the whole curve moves.
Review: 2.2 Supply
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Topic 2.2 · Spot the mistake"The price of coffee went up, so the supply of coffee increased." What is wrong with that sentence?
A higher own-price raises quantity supplied, a movement along the supply curve. Supply, the whole curve, shifts only when a determinant such as input prices or technology changes.
Review: 2.2 Supply
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Topic 2.3 · Work it outA cafe raises the price of a latte from $4 to $6, and daily sales fall from 110 to 90. Using the midpoint method, what is the price elasticity of demand?
0.5 in absolute value, so demand is inelastic. Quantity changes by 20 / 100 = 20%, price changes by 2 / 5 = 40%, and 20% / 40% = 0.5.
Review: 2.3 Price Elasticity of Demand
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Topic 2.3 · Check the conditionsDemand for a theme park's tickets is price inelastic. If the park raises its ticket price, what happens to its total revenue?
Total revenue rises. With inelastic demand, quantity demanded falls by a smaller percentage than price rises, so price times quantity goes up. With elastic demand, revenue would fall.
Review: 2.3 Price Elasticity of Demand
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Topic 2.3 · Spot the mistake"A downward-sloping straight-line demand curve has the same slope everywhere, so its price elasticity is the same everywhere." What is wrong?
Slope is not elasticity. The same change in price and quantity is a different percentage change at different points, so elasticity varies along a linear demand curve: more elastic at high prices, less elastic at low prices.
Review: 2.3 Price Elasticity of Demand
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Topic 2.3 · Which one fitsWhich has more price-elastic demand: one particular brand of bottled water, or insulin for a person with diabetes?
The brand of bottled water. It has many close substitutes, so buyers switch when its price rises. Insulin has no good substitute, so quantity demanded barely responds to price.
Review: 2.3 Price Elasticity of Demand
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Topic 2.4 · Work it outWhen the price of tomatoes rises 20%, the quantity of tomatoes supplied rises 10%. What is the price elasticity of supply, and is supply elastic or inelastic?
0.5, so supply is inelastic. Price elasticity of supply is 10% / 20% = 0.5, which is less than 1.
Review: 2.4 Price Elasticity of Supply
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Topic 2.4 · Know the termWhat does it mean for supply to be price inelastic?
The percentage change in quantity supplied is smaller than the percentage change in price, so the elasticity of supply is less than 1. Producers cannot easily change how much they make when the price moves.
Review: 2.4 Price Elasticity of Supply
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Topic 2.5 · Work it outIncomes rise 10%, and the quantity demanded of instant noodles falls 5%. What is the income elasticity of demand, and what kind of good are instant noodles?
-0.5, and noodles are an inferior good. A negative income elasticity means buyers want less of the good as their income rises.
Review: 2.5 Other Elasticities
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Topic 2.5 · Spot the mistakeThe cross-price elasticity of demand for Coke with respect to the price of Pepsi is +0.6. "Positive means they are complements." What is wrong?
A positive cross-price elasticity means substitutes: when Pepsi's price rises, people buy more Coke. Complements have a negative cross-price elasticity, and a value near zero means the goods are not related.
Review: 2.5 Other Elasticities
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Topic 2.6 · Work it outA linear demand curve hits the price axis at $20. Equilibrium is a price of $8 and a quantity of 60. What is consumer surplus?
$360. Consumer surplus is the triangle below demand and above price: 1/2 x 60 x ($20 - $8) = 1/2 x 60 x $12 = $360.
Review: 2.6 Market Equilibrium and Consumer and Producer Surplus
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Topic 2.6 · Know the termWhat do consumer surplus and producer surplus measure?
Consumer surplus is the gap between what buyers were willing to pay and the price they paid. Producer surplus is the gap between the price sellers received and the lowest price they would have accepted. Together they are total economic surplus.
Review: 2.6 Market Equilibrium and Consumer and Producer Surplus
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Topic 2.7 · Say it in contextIn a competitive market, the price is above equilibrium and nothing stops it from changing. What is happening, and where does the price go?
There is a surplus: quantity supplied exceeds quantity demanded. Sellers with unsold goods cut the price, raising quantity demanded and lowering quantity supplied until the market clears at equilibrium.
Review: 2.7 Market Disequilibrium and Changes in Equilibrium
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Topic 2.7 · Which one fitsA frost destroys part of the orange crop at the same time a health report makes people want more orange juice. What happens to the equilibrium price and quantity of orange juice?
Price rises; quantity is indeterminate. Supply falls and demand rises, and both push price up. The supply decrease lowers quantity while the demand increase raises it, so without the sizes of the shifts you cannot tell.
Review: 2.7 Market Disequilibrium and Changes in Equilibrium
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Topic 2.8 · Which one fitsA city sets a maximum rent of $900 when the equilibrium rent is $1,200. What does this do to the apartment market?
It is a binding price ceiling, so there is a shortage: quantity demanded exceeds quantity supplied at $900. Fewer apartments are rented than at equilibrium, which creates deadweight loss.
Review: 2.8 The Effects of Government Intervention in Markets
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Topic 2.8 · Spot the mistakeThe equilibrium price of wheat is $7, and the government sets a price floor of $5. "Farmers will now have a surplus of wheat." What is wrong?
A floor set below equilibrium is not binding. The market still clears at $7, so nothing changes. A price floor creates a surplus only when it is above the equilibrium price.
Review: 2.8 The Effects of Government Intervention in Markets
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Topic 2.8 · Work it outWith straight-line supply and demand curves, a $2 per-unit tax in a competitive market cuts the quantity traded from 100 units to 80. What is the deadweight loss?
$20. Deadweight loss is the triangle between the old and new quantities, with height equal to the tax: 1/2 x $2 x 20 = $20.
Review: 2.8 The Effects of Government Intervention in Markets
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Topic 2.8 · Work it outBefore a $3 per-unit tax on sellers, a good sold for $10. After the tax, buyers pay $12. How is the tax split, and which side of the market is less elastic?
Buyers bear $2 per unit and sellers bear $1, since sellers keep $12 - $3 = $9. The less elastic side bears more of a tax, so demand is less elastic than supply here.
Review: 2.8 The Effects of Government Intervention in Markets
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Topic 2.9 · Say it in contextA country opens to free trade, and the world price of steel is below its domestic equilibrium price. What happens to consumer surplus, producer surplus and total surplus in its steel market?
Consumer surplus rises, domestic producer surplus falls, and total surplus rises. The price falls to the world price, and imports fill the gap between domestic quantity demanded and quantity supplied.
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Topic 2.9 · Work it outThe world price of shoes is $40. A $5 per-pair tariff raises the domestic price to $45, and imports fall to 2,000 pairs. How much revenue does the tariff raise?
$10,000. Tariff revenue is the tariff per unit times the units still imported: $5 x 2,000 = $10,000. Consumer surplus and total surplus both fall.
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Topic 2.9 · Which one fitsA government limits sugar imports to less than would come in at the world price. What happens to the domestic price of sugar and to consumer surplus?
The domestic price rises above the world price, because less sugar is available to buyers. Consumer surplus falls, and total economic surplus falls too.
Unit 3: Production, Cost, and the Perfect Competition Model
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Topic 3.1 · Work it outA bakery with one oven adds a third worker, and daily output rises from 50 to 65 loaves. A fourth worker raises it to 75. What is the marginal product of the third and of the fourth worker?
15 loaves for the third (65 - 50) and 10 for the fourth (75 - 65). Marginal product falling as workers share a fixed oven is diminishing marginal returns.
Review: 3.1 The Production Function
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Topic 3.1 · Know the termWhen do diminishing marginal returns occur?
In the short run, when a firm adds more of one input, such as labor, while another input, such as its building or equipment, stays fixed. Each added worker has less of the fixed input to work with, so marginal product eventually falls.
Review: 3.1 The Production Function
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Topic 3.2 · Work it outA firm's total fixed cost is $200. At 50 units of output, its total variable cost is $300. What are average total cost and average fixed cost at 50 units?
ATC = ($200 + $300) / 50 = $10. AFC = $200 / 50 = $4. That leaves AVC at $6, since AFC plus AVC equals ATC.
Review: 3.2 Short-Run Production Costs
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Topic 3.2 · Spot the mistake"If the firm produces nothing this month, its total cost is zero." What is wrong, in the short run?
Total fixed cost is the same at every output level, including zero. A firm producing nothing still pays fixed costs such as rent, so its total cost equals its total fixed cost.
Review: 3.2 Short-Run Production Costs
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Topic 3.2 · Check the conditionsWhy does a firm's marginal cost curve slope upward in the short run?
Because of diminishing marginal returns. Once each added worker produces less extra output, each extra unit of output takes more labor, so it costs more to produce.
Review: 3.2 Short-Run Production Costs
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Topic 3.3 · Say it in contextA firm doubles every one of its inputs, and its output more than doubles. What does that show, and what happens to its long-run average total cost?
Increasing returns to scale. Output grows faster than inputs, so long-run average total cost falls as the firm grows, which is economies of scale.
Review: 3.3 Long-Run Production Costs
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Topic 3.3 · Check the conditionsIn an industry, the minimum efficient scale is very large compared with total market demand. What market structure is likely?
Few firms: an oligopoly, or a natural monopoly if one firm at minimum efficient scale can serve nearly the whole market. Only a few firms can each be big enough to reach the lowest average cost, so many small firms cannot compete on cost.
Review: 3.3 Long-Run Production Costs
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Topic 3.3 · Know the termWhat are economies of scale and diseconomies of scale?
Economies of scale: long-run average total cost falls as the firm grows. Diseconomies of scale: it rises as the firm grows. Between them, constant returns to scale keep it flat.
Review: 3.3 Long-Run Production Costs
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Topic 3.4 · Work it outA shop takes in $120,000 in revenue and pays $80,000 in explicit costs. The owner gave up a $50,000 salary elsewhere to run it. What are its accounting profit and economic profit?
Accounting profit is $40,000 ($120,000 - $80,000). Economic profit is -$10,000, because it also subtracts the $50,000 implicit cost. The owner would do better in the other job.
Review: 3.4 Types of Profit
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Topic 3.4 · Say it in contextA firm's economic profit is zero. Is the owner losing out?
No. Zero economic profit is normal profit: revenue covers every explicit and implicit cost, including the owner's time and what her capital could earn elsewhere. Accounting profit is still positive.
Review: 3.4 Types of Profit
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Topic 3.5 · Check the conditionsAt its current output, a firm's marginal revenue is $12 and its marginal cost is $9. What should it do to maximize profit?
Produce more. Each extra unit adds $3 more to revenue than to cost, so profit keeps rising until marginal revenue equals marginal cost.
Review: 3.5 Profit Maximization
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Topic 3.5 · Spot the mistake"To maximize profit, a firm should produce where its average total cost is lowest." What is wrong?
Profit is maximized where MR = MC. Minimum ATC is the lowest cost per unit, which is usually a different quantity from the one that makes total profit largest.
Review: 3.5 Profit Maximization
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Topic 3.6 · Check the conditionsA perfectly competitive firm faces a price of $6. At its MR = MC output, AVC is $5 and ATC is $8. In the short run, should it produce or shut down?
Produce. Price covers AVC with $1 a unit left over to pay part of fixed cost, so it loses less by operating than by shutting down and losing all of its fixed cost.
Review: 3.6 Firms’ Short-Run Decisions to Produce and Long-Run Decisions to Enter or Exit a Market
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Topic 3.6 · Work it outAt its best output, a firm's total revenue is $400, total variable cost is $500, and total fixed cost is $300. Should it produce or shut down in the short run?
Shut down. Operating loses $400 ($400 - $800). Shutting down loses only the $300 fixed cost. Revenue that does not cover variable cost means the firm loses less by producing nothing.
Review: 3.6 Firms’ Short-Run Decisions to Produce and Long-Run Decisions to Enter or Exit a Market
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Topic 3.7 · Work it outA perfectly competitive firm sells at a market price of $10. At its profit-maximizing output of 40 units, ATC is $8. What is its economic profit, and what happens next?
$80: ($10 - $8) x 40. Positive economic profit attracts new firms, which raises market supply and pushes the price down toward minimum ATC in the long run.
Review: 3.7 Perfect Competition
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Topic 3.7 · Say it in contextWhy is the demand curve facing a single perfectly competitive firm horizontal at the market price?
The firm is a price taker. It can sell all its output at the market price and nothing above it, so for the firm, price equals marginal revenue equals demand.
Review: 3.7 Perfect Competition
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Topic 3.7 · Check the conditionsFor a perfectly competitive firm in long-run equilibrium, how do price, marginal cost and average total cost compare?
P = MC = minimum ATC. Price equal to MC means allocative efficiency, producing at minimum ATC means productive efficiency, and the firm earns zero economic profit.
Review: 3.7 Perfect Competition
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Topic 3.7 · Say it in contextDemand rises in a constant-cost, perfectly competitive industry. Once new firms have finished entering, where is the market price?
Back at its original level, minimum ATC. Entry raises supply until profit is zero again, and in a constant-cost industry input costs do not rise as the industry grows.
Review: 3.7 Perfect Competition
Unit 4: Imperfect Competition
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Topic 4.1 · Work it outA firm with market power sells 10 units at $20 each. To sell an 11th unit it must cut its price to $19. What is the marginal revenue of the 11th unit?
$9. Total revenue goes from $200 to 11 x $19 = $209. Marginal revenue is below the $19 price because the lower price applies to all 11 units, not only the last one.
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Topic 4.1 · Which one fitsA drug company holds a patent on a medicine. A new electric utility would need a $2 billion power plant to start. Which kind of barrier to entry protects each market?
The patent is a legal barrier to entry. The power plant is a high fixed, or start-up, cost. Both keep rivals out and let imperfect competition last.
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Topic 4.1 · Know the termName the imperfectly competitive market structures in product markets and in factor markets.
Product markets: monopoly, oligopoly and monopolistic competition. Factor markets: monopsony. In all of them a firm has some market power, unlike a perfectly competitive firm.
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Topic 4.2 · Check the conditionsHow does a profit-maximizing monopolist choose its quantity and its price?
It produces the quantity where MR = MC, then charges the highest price buyers will pay for that quantity, read from the demand curve. That price is above marginal cost.
Review: 4.2 Monopoly
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Topic 4.2 · Work it outA monopolist maximizes profit by selling 100 units at $30. Its ATC at 100 units is $22. What is its profit, and can it last in the long run?
$800: ($30 - $22) x 100. It can last, because barriers to entry keep new firms from entering and competing it away.
Review: 4.2 Monopoly
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Topic 4.2 · Work it outWith straight-line curves, a monopolist produces 40 units at a price of $50, where its MC is $30. Demand and MC cross at 60 units. What is the deadweight loss?
$200. It is the triangle between demand and MC from 40 to 60 units: 1/2 x (60 - 40) x ($50 - $30) = 1/2 x 20 x $20 = $200.
Review: 4.2 Monopoly
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Topic 4.2 · Know the termOne firm has long-run economies of scale across the entire range of market demand for its product. What kind of market is this?
A natural monopoly. One firm can supply the whole market at a lower average cost than two or more firms could.
Review: 4.2 Monopoly
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Topic 4.3 · Say it in contextA monopolist starts perfectly price discriminating, charging each buyer the most that buyer will pay. What happens to output, consumer surplus and deadweight loss?
Output rises to where price equals MC, the same quantity a competitive market would produce. Consumer surplus falls to zero because the firm captures all of it, and deadweight loss disappears.
Review: 4.3 Price Discrimination
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Topic 4.3 · Check the conditionsA movie theater charges students less than other adults for the same seat. What must be true for this price discrimination to raise its profit?
The theater must have market power, be able to tell the groups apart (a student ID), and stop resale between them. The groups also need different willingness to pay, so separate prices capture more consumer surplus.
Review: 4.3 Price Discrimination
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Topic 4.4 · Say it in contextA monopolistically competitive coffee shop earns economic profit. What happens in the long run?
New shops enter and take some of its customers. Its demand curve shifts left until it is tangent to ATC, so economic profit falls to zero.
Review: 4.4 Monopolistic Competition
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Topic 4.4 · Spot the mistake"A monopolistically competitive firm earns zero economic profit in the long run, so it is efficient, just like a perfect competitor." What is wrong?
Zero profit is not efficiency. Price is above marginal cost, so it is allocatively inefficient, and output is below the quantity that minimizes ATC, which leaves excess capacity.
Review: 4.4 Monopolistic Competition
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Topic 4.5 · Work it outFirms A and B each pick a High or Low price. Payoffs (A, B): both High (10, 10); A High, B Low (2, 14); A Low, B High (14, 2); both Low (5, 5). Does A have a dominant strategy?
Yes, Low. If B picks High, A earns 14 from Low against 10 from High. If B picks Low, A earns 5 from Low against 2 from High. Low is better for A either way.
Review: 4.5 Oligopoly and Game Theory
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Topic 4.5 · Say it in contextTwo firms each choose a High or Low price. Both High pays each $10 million; both Low pays each $5 million. Low is a dominant strategy for each firm. What is the Nash equilibrium, and why is it a problem for them?
Both Low, at $5 million each. Neither can gain by switching alone. Both would be better off at High, but each has an incentive to undercut, as in the Prisoner's Dilemma.
Review: 4.5 Oligopoly and Game Theory
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Topic 4.5 · Work it outIf rival B charges High, Firm A earns $10 from High or $14 from Low. If B charges Low, A earns $2 from High or $5 from Low. How large a penalty on choosing Low makes High dominant for A?
More than $4. High must beat Low in both cases: $14 minus the penalty is below $10 only if the penalty exceeds $4, and $5 minus it is below $2 if it exceeds $3. At exactly $4, A earns $10 either way when B picks High, so High is not strictly better.
Review: 4.5 Oligopoly and Game Theory
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Topic 4.5 · Know the termWhat is a Nash equilibrium?
A set of actions, one per player, where no player can raise their own payoff by changing their action alone, given what the other players are doing.
Review: 4.5 Oligopoly and Game Theory
Unit 5: Factor Markets
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Topic 5.1 · Say it in contextWhy does a firm hire fewer workers when the wage rises, other things constant?
The firm hires as long as a worker adds more to revenue than to cost. A higher wage means fewer workers clear that bar, so the quantity of labor demanded falls.
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Topic 5.1 · Know the termWhat payment does each factor of production earn, and what does a firm weigh when deciding how much of a factor to hire?
Labor earns wages, capital earns interest, and land earns rent. A firm weighs the factor's productivity, the price of the output it helps make, and the factor's own price.
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Topic 5.2 · Which one fitsThe price of the furniture a factory sells rises. What happens to the factory's demand for carpenters?
It shifts right. Each carpenter's output is now worth more in revenue, so marginal revenue product rises and the factory wants more carpenters at every wage.
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Topic 5.2 · Which one fitsMany more nurses graduate from training programs. Which curve shifts in the nursing labor market, and what happens to the wage and the number of nurses employed?
Labor supply shifts right. The equilibrium wage falls and the number of nurses employed rises.
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Topic 5.3 · Work it outA firm sells shirts in a perfectly competitive market at $5 each. Hiring a 4th worker raises output from 30 to 36 shirts an hour. The market wage is $25 an hour. Should it hire the 4th worker?
Yes. The 4th worker's marginal product is 6 shirts, so MRP = 6 x $5 = $30 an hour, more than the $25 wage. Hiring adds $5 an hour to profit.
Review: 5.3 Profit-Maximizing Behavior in Perfectly Competitive Factor Markets
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Topic 5.3 · Check the conditionsIn a perfectly competitive labor market, how many workers does a profit-maximizing firm hire?
Workers up to where the marginal revenue product of labor equals the market wage. The firm is a wage taker, so its marginal resource cost is the wage.
Review: 5.3 Profit-Maximizing Behavior in Perfectly Competitive Factor Markets
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Topic 5.4 · Work it outA monopsony employer pays 4 workers $10 an hour each. To hire a 5th, it must raise the wage to $11 for everyone. What is the marginal resource cost of the 5th worker?
$15. Total labor cost rises from 4 x $10 = $40 to 5 x $11 = $55. MRC exceeds the $11 wage because the four existing workers also get the raise.
Review: 5.4 Monopsonistic Markets
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Topic 5.4 · Say it in contextCompared with a competitive labor market facing the same labor demand and supply, how do the wage and employment compare in a monopsony?
Both are lower. The monopsonist hires where MRP = MRC, and since MRC lies above the labor supply curve, it hires fewer workers and pays the lower wage on the supply curve at that quantity.
Review: 5.4 Monopsonistic Markets
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Topic 5.4 · Know the termWhat is a monopsony?
A market with a single buyer, such as the only large employer in a small town. To hire more workers it must raise the wage, so its marginal resource cost is above the wage.
Review: 5.4 Monopsonistic Markets
Unit 6: Market Failure and the Role of Government
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Topic 6.1 · Check the conditionsWhen does a market's equilibrium quantity equal the socially optimal quantity?
Only when buyers and sellers internalize all social benefits and costs. Then marginal social benefit equals marginal social cost at equilibrium, and total economic surplus is maximized.
Review: 6.1 Socially Efficient and Inefficient Market Outcomes
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Topic 6.1 · Which one fitsWhich of these leads to an inefficient market quantity: a monopoly seller, a factory polluting a river, used-car sellers who know about defects that buyers cannot see?
All three. Market power, a negative externality and asymmetric information each push the equilibrium quantity away from the efficient quantity, which creates deadweight loss.
Review: 6.1 Socially Efficient and Inefficient Market Outcomes
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Topic 6.2 · Say it in contextA factory's smoke harms nearby farms, and the factory pays nothing for that harm. How does the market quantity compare with the socially optimal quantity?
The market produces too much. The factory responds only to its private cost, so marginal social cost is above marginal private cost, and output goes past the point where MSB = MSC.
Review: 6.2 Externalities
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Topic 6.2 · Which one fitsEach unit of a product causes a constant $3 of harm to people outside the market. What per-unit tax brings the market to the socially optimal quantity?
A $3 per-unit tax, equal to the marginal external cost. It raises the private cost of each unit to match marginal social cost, so the market quantity falls to where MSB = MSC.
Review: 6.2 Externalities
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Topic 6.2 · Work it outFor the last flu shot sold, the buyer's marginal benefit is $25, the external benefit to others is $10, and the marginal cost is $30. Should society produce that shot, and will the market?
Society should, but the market will not. Marginal social benefit is $25 + $10 = $35, above the $30 cost, but buyers weigh only their own $25. That is underproduction from a positive externality.
Review: 6.2 Externalities
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Topic 6.2 · Know the termWhat is an externality, and why do externalities arise?
A cost or benefit that falls on people outside a transaction. It arises when property rights are not well defined or transaction costs are high, so the people affected cannot charge or pay for it.
Review: 6.2 Externalities
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Topic 6.3 · Which one fitsClassify each good: fish in the open ocean, a sandwich, national defense.
Ocean fish: rival and non-excludable, an open-access resource that gets overused. The sandwich: rival and excludable, a private good. National defense: non-rival and non-excludable, a public good.
Review: 6.3 Public and Private Goods
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Topic 6.3 · Say it in contextPeople value national defense, yet private firms will not supply enough of it. Why?
The free rider problem. Defense is non-excludable, so people benefit whether or not they pay, and a private firm cannot collect enough revenue. Government ends up as the producer.
Review: 6.3 Public and Private Goods
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Topic 6.3 · Spot the mistake"Public schools are free to attend, so education is a public good." What is wrong?
Education is rival and excludable, so it is a private good. Governments sometimes choose to produce private goods and allow free access; that does not make them public goods.
Review: 6.3 Public and Private Goods
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Topic 6.4 · Check the conditionsA regulator makes a natural monopoly charge a price equal to marginal cost. What problem appears, and how is it solved?
The firm takes a loss. With economies of scale over the whole market, MC is below ATC, so P = MC does not cover average cost. A lump-sum subsidy keeps it producing the allocatively efficient quantity.
Review: 6.4 The Effects of Government Intervention in Different Market Structures
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Topic 6.4 · Spot the mistake"A lump-sum tax on a monopolist will raise its price and cut its output." What is wrong?
A lump-sum tax changes only fixed cost. It leaves MR and MC where they were, so the profit-maximizing quantity and price do not change; only profit falls.
Review: 6.4 The Effects of Government Intervention in Different Market Structures
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Topic 6.4 · Work it outIn a competitive market with straight-line supply and demand curves, the government pays producers a $2 per-unit subsidy, and quantity traded rises from 50 units to 60. What does the subsidy cost the government, and what is the deadweight loss?
It costs $120 ($2 x 60 units). The deadweight loss is 1/2 x $2 x (60 - 50) = $10, because the 10 extra units cost more to make than buyers value them.
Review: 6.4 The Effects of Government Intervention in Different Market Structures
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Topic 6.5 · Say it in contextCountry A has a Gini coefficient of 0.25 and Country B has one of 0.45. What does that comparison tell you?
Income is distributed more unequally in Country B. A higher Gini coefficient means more inequality, and a Lorenz curve that bows further from the line of equality.
Review: 6.5 Inequality
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Topic 6.5 · Which one fitsA tax takes 10% of income from low earners and 3% from high earners. Is it progressive or regressive, and what does it do to inequality?
Regressive, because lower-income people pay a larger share of their income. It widens after-tax income inequality. A progressive tax takes a larger share from higher earners.
Review: 6.5 Inequality
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Topic 6.5 · Know the termWhat does a Lorenz curve show?
How income or wealth is shared across a population. The further the curve bows away from the straight line of perfect equality, the more unequal the distribution.
Review: 6.5 Inequality