AP Microeconomics Exam

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AP Microeconomics

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Unit 1: Basic Economic Concepts 

Unit 2: Supply and Demand

Unit 3: Production, Cost, and the Perfect Competition Model

Unit 4: Imperfect Competition

Unit 5: Factor Markets

Unit 6: Market Failure and Role of Government

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Exam Skills: FRQ/MCQ

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What are the features of a PPC? What is comparative vs. absolute advantage? How do you do marginal analysis? These questions and more will be answered by Shriya about unit 1 of AP Micro!

Unit 1 Review

 is the basic problem in economics in which society does not have enough resources to produce whatever everyone needs and wants.  Basically, it is unlimited wants and needs vs. limited resources.  Scarcity is faced by all societies and economic systems.  Since we are faced with scarcity, we must make choices about how to allocate and use scarce resources.

 is the study of how individuals, firms, and governments deal with scarcity. As a result of facing scarcity, all members of a society have to make choices in an effort to manage our resources in the most efficient way possible.  The choices we make are known as 

 is the study of how individuals, households, and firms make decisions and allocate resources. For example, whether a high school graduate chooses to go to college or directly into the workforce is a microeconomic decision.👨‍💼

 is the branch of economics that studies the behavior and performance of the entire economy instead of just its small parts. The current discussion on unemployment numbers and the national deficit is a macroeconomics topic. 📉

The resources that are scarce in every society are divided into four categories:

each of the alternative choices that you gave up when making a decision.  For example, you walk into the cafeteria for lunch at school and you have the option of pizza, a cheeseburger, or chicken sandwich for lunch.  If you choose to have pizza, then the cheeseburger and chicken sandwich are your trade-offs. 🍕

 this is the value of the next best alternative when making a choice.  Going back to the example of what to have for lunch, if you choose pizza but get to the front of the line and the last slice of pizza was taken by the kid in front of you, you choose a cheeseburger instead.  The cheeseburger is your opportunity cost for choosing pizza because it is the next best alternative if your first choice is unavailable. 🍔

The table below shows two possible combinations of trucks and cars that can be produced given a set amount of resources.  A company or country can move between the two possibilities to best meet their needs.  When they move from combo A to combo B, they give up 6 million trucks, which is their opportunity cost for this decision.  If they were producing at combo B and moved to combo A, their opportunity cost would be 8 million cars.

1.2: Resource Allocation and Economic Systems

In every economy there are three questions that must be answered:

1.3: Production Possibilities Curve (PPC)

Introduction to the Production Possibilities Curve (PPC)

The production possibilities curve is the first graph that we study in microeconomics.  It shows us all of the possible production combinations of goods, given a fixed amount of resources.  We assume three things when we are working with these graphs:

The production possibilities curve can illustrate several economic concepts including:

The opportunity cost of moving from point C to D is 40 tons of oranges. The per unit opportunity cost of moving from point C to point D is 1/2 ton of oranges (40 tons of oranges/80 tons of pears).

If a country produces more capital goods than consumer goods, the country will have greater economic growth in the future. If the country illustrated below produces at point B, they will see more economic growth than if they produce at point D. Since capital goods are tools and machinery, the increased production of them will lead to more production of consumer goods in the future, causing more economic growth.

Constant Opportunity Cost vs. Increasing Opportunity Cost

The production possibilities curve can illustrate two types of opportunity costs.  

 occurs when you produce more and more of one good and you give up more and more of another good.  This occurs when resources are less adaptable when moving from the production of one good to the production of another good.

 occurs when the opportunity cost stays the same as you increase your production of one good.  This indicates that the resources are easily adaptable from the production of one good to the production of another good.

The graph on the left is showing increasing opportunity cost and the graph on the right is showing constant opportunity cost.

Shifters of the Production Possibilities Curve (PPC)

There are several factors that can cause the production possibilities curve to shift.  These factors include:

The production possibilities curve can show how these changes affect it as well as illustrate a change in productive efficiency and inefficiency.

Here are some scenarios that illustrate these shifters:

The graph on the left shows how an improvement in the quality of resources impacts the graph. The graph on the right shows what happens when a country is producing at an inefficient point.

The graph on the left shows a technology change that just impacts one good that a country produces, and the graph on the right shows what happens when the quantity of resources changes (i.e. number of workers decrease).

 are used to illustrate how individual countries or entities interact and trade with each other.  These concepts also focus on how people specialize in what they are good at producing and then trade for goods and services that they are not as efficient at.

There are two types of problems within these concepts: 

 focus on data associated with what each party can produce with a given set of resources and who should specialize in each good. 

 focus on how much of a resource is needed to produce one unit of a particular good or service.

Using the table above, we would determine that Japan has absolute advantage in steel (1200 > 1000) and Canada has absolute advantage in coal (500 > 300).

The per unit opportunity cost for steel in Canada is 1/2 a unit of coal (500/1000)

The per unit opportunity cost for steel in Japan is 1/4 a unit of coal (300/1200)

Since 1/4 is less than 1/2, Japan has comparative advantage in steel

The per unit opportunity cost for coal in Canada is 2 units of steel (1000/500)

The per unit of opportunity cost for coal in Japan is 4 units of steel (1200/300)

Since 2 is less than 4, Canada has comparative advantage in coal.

Japan will export steel to Canada and import coal from Canada

Terms of trade are determined by looking at the two opportunity costs and choosing a number that falls between the opportunity costs in order for it to be beneficial to both countries.

Acceptable terms of trade for this situation would be:

Using the table, we would determine that Brazil has an absolute advantage in the production of cars (2 hours is less than 3 hours).  We would also determine that Brazil has an absolute advantage in the production of trucks (2 hours is less than 6 hours).

The per unit opportunity cost for cars in the United States is 1/2 a truck (3 divided by 6).

The per unit opportunity cost for cars in Brazil is 1 truck (2 divided by 2).

Since 1/2 is less than 1, the United States has a comparative advantage in the production of cars.

The per unit opportunity cost for trucks in the United States is 2 cars (6 divided by 3).

The per unit opportunity cost for trucks in Brazil is 1 car (2 divided by 2).

Since 1 is less than 2, Brazil has comparative advantage in the production of trucks.

The United States will export cars to Brazil and import trucks from Brazil.

Unit 1: Basic Economic Concepts

 is the basic problem in economics in which society does not have enough resources to produce whatever everyone needs and wants.  Basically, it is unlimited wants and needs vs. limited resources.  Scarcity is faced by all societies and economic systems.  Since we are faced with scarcity, we must make choices about how to allocate and use scarce resources.  

 is the branch of economics that studies the behavior and performance of the entire economy instead of just its small parts. The current discussion on the high unemployment rate and the increasing national deficit is a macroeconomics topic. 📉

natural resources and raw materials used to make products.  Ex: water, vegetation, oil, minerals, and animals. 🚜

the effort, skills, and abilities that individuals, or employees, devote to a task for which they get paid. 👷

these types of resources can be divided into two types, physical capital and human capital:

the ability of an individual to coordinate the other categories of resources to invent or produce a good or service. Ex: Bill Gates, Steve Jobs, and Henry Ford. 🚗

this is the value of the next best alternative when making a choice.  Going back to the example of what to have for lunch, if you choose pizza but get to the front of the line and the last slice of pizza was taken by the kid in front of you, you choose a cheeseburger instead.  The cheeseburger is your opportunity cost for choosing pizza because it is the next best alternative if your first choice is unavailable. 🍔

The table below shows two possible combinations of trucks and cars that can be produced given a set amount of resources.  A company or country can move between the two possibilities to best meet their needs.  When they move from Combo A to Combo B, they give up 6 million trucks, which is their opportunity cost for this decision.  If they were producing at Combo B and moved to Combo A, their opportunity cost would be 8 million cars.

Basic Economic Concepts: Scarcity

What goods and services will be produced?


Since scarcity exists, no society has the resources to produce everything that the people want, leading to this question.  An economy has to decide what goods and services are most wanted and needed.  For example, when an economy chooses between building or fixing roads, or buying textbooks for schools.  This can also involve making decisions like whether the government should conserve wilderness areas or open them up for development.



This question deals with how businesses and other producers should go about producing various goods and services. For example, asking whether pipes should be made out of copper or plastic, or whether clothing should be made by machines or made by hand.

For whom will the goods and services be produced


This question is answered after the production of goods and services, as it is decided who should be allowed to consume the goods and services that have been produced.  For example, should it be based on a first-come, first-served basis or based on whether the consumer can afford the goods or services?

Centrally-Planned (Command) Economic System

In this type of economic system, the government makes the basic economic decisions, answers the three basic economic questions, and controls production and wages. Some examples of command economies are North Korea and Cuba. 🇰🇵 🇨🇺

The advantage of this type of economic system is that it is easier to produce goods and make sure everyone is receiving the basic necessities. They are also able to gather resources quickly and on a large scale.

The disadvantage of this type of economic system is that the system is not responsive to consumers' preferences, discourages innovation, and severely limits consumers' choices. This may lead to the development of a black market in command economies.

In this type of economic system, economic decisions are guided by price changes that occur as buyers and sellers interact in the marketplace. The government has a limited role in this system, generally only preventing monopolies. Some examples of market economies are Hong Kong and New Zealand. 🇭🇰🇳🇿

The main advantage of this economic system is that there is a lot of competition, which keeps prices low and offers many options for consumers to choose from. This system is also driven by self-interest, which ensures that the most desired goods and services are produced. Innovation is rewarded.

The disadvantages include a large wealth disparity for individuals living in this economic system and very few public goods.

Mixed economies combine aspects of both free markets and command economies. Private property rights are protected and there is a certain level of economic freedom, but the government can intervene in an effort to meet societal aims and avoid market failures. The United States is a great example of a mixed economic system. 🇺🇸 

An advantages of this type of economic system is that the government can own some public programs like education and transportation, while still keeping the benefits of a market economy, such as encouraging innovation and allowing prices to depend on supply (producers) and demand (consumers). Another advantage is that it rewards the most efficient producers with the highest profit.

This type of economic system can take on the disadvantages of other types of economies depending on which characteristics it emphasizes.  For example, if a certain mixed economy emphasizes the free market aspect, it can leave some members of society without any government support and make businesses hard to regulate.

Resource Allocation and Economic Systems


Introduction to the Production Possibilities Curve (PPC)

The production possibilities curve is the first graph that we study in microeconomics.  It shows us all of the possible production combinations of goods, given a fixed amount of resources.  We assume three things when we are working with these graphs:


The production possibilities curve can illustrate several economic concepts including

The PPC accurately demonstrates how we produce goods and services under the condition of scarcity, which is when there are limited resource, but unlimited wants. The above graph shows how, given a fixed set of resources, we can produce either combination A, B, C, D, or E.

Opportunity Costs/Per Unit Opportunity Cost

This is the value of the next best alternative.  We represent this as what we are losing when we change our production combination. For example, moving from A to B on the graph above has an opportunity cost of 10 units of sugar. Per unit opportunity cost is determined by dividing what you are giving up by what you are gaining. So for the graph above, the per unit opportunity cost when moving from point A to point B is 1/4 unit of sugar (10 sugar/40 wheat).

Opportunity cost can also be determined using a production possibilities table:


Economic growth is shown by a shift to the right of the production possibilities curve.



If a country produces more capital goods than consumer goods, the country will have greater economic growth in the future. Capital goods refers to machinery and tools, while consumer goods include things like phones and clothing. If the country illustrated below produces at point B, they will see more economic growth than if they produce at point D. Since capital goods can be used to produce consumer goods, producing more capital goods will lead to more production of consumer goods in the future, causing economic growth.



Economic contraction is shown by a leftward shift of the production possibilities curve.

The production possibilities curve can illustrate two types of opportunity costs:

 occurs when producing more of one good causes you to give up more and more of another good.  This happens when resources are less adaptable when moving from the production of one good to the production of another good. The graph on the left shows increasing opportunity cost because pizza and robots use very different resources.

 occurs when the opportunity cost stays the same as you increase your production of one good.  This indicates that the resources are easily adaptable from the production of one good to the production of another good. The graph on the right shows constant opportunity cost because pizza and calzones use almost the same exact resources


Change in the quantity or quality of resources


The graph on the left shows how an improvement in the quality of resources (human capital!) causes economic growth. The graph on the right shows what happens when a country is producing at an inefficient point due to high unemployment.



The graph on the left shows a technology change that just impacts one good that a country produces, and the graph on the right shows what happens when the quantity of resources changes (i.e. number of workers decrease).




Production Possibilities Curve (PPC)

the ability to produce more of a good or service with a given amount of resources than someone else.

the ability to produce a good at the lowest opportunity cost.

the rate at which one good can be exchanged for another.

 illustrate how individual countries or entities interact and trade with each other. For example, countries can specialize in what they are good at producing and then trade for goods and services that they are not as efficient at.  

There are two types of problems within these concepts:

problems focus on how much can be produced given a set amount of resources.

problems focus on how much of a resource is needed to produce one unit of a particular good or service.

 you are simply looking for which country can produce a higher amount of the good or service.

 you have to calculate per unit opportunity cost using the formula give up/gain (the amount of good you are giving up divided by the amount of good you are gaining).  Once you have calculated per unit opportunity cost, the country with the lowest one has a comparative advantage.

If the two countries can both make the same amount of the good, then we say neither country has an absolute advantage.

 what they have a comparative advantage in and 

what they don't have a comparative advantage in.

The per unit opportunity cost for 1 unit of steel in Canada is 1/2 unit of coal (500/1000)

The per unit opportunity cost for 1 unit of steel in Japan is 1/4 unit of coal (300/1200) 

Since 1/4 is less than 1/2, Japan has the comparative advantage in steel.

The per unit opportunity cost for 1 unit of coal in Canada is 2 units of steel (1000/500)

The per unit of opportunity cost for 1 unit of coal in Japan is 4 units of steel (1200/300)

Since 2 is less than 4, Canada has the comparative advantage in coal.


Therefore, Japan will export steel to Canada and import coal from Canada.

 you are looking for the country that uses the least amount of resources (i.e. the lower number)

 you have to calculate the per unit opportunity cost using the formula gain/give up.  Once you have calculated the per unit opportunity cost, the country with the lowest one has a comparative advantage.

If the two countries both can make one unit of the good with the same amount of resources, then we say neither country has an absolute advantage.

 what they don't have a comparative advantage in.

Using the table, we would determine that Brazil has an absolute advantage in the production of cars (2 hours < 3 hours). Brazil also has an absolute advantage in the production of trucks (2 hours < 6 hours).

The per unit opportunity cost for 1 car in the United States is 1/2 a truck (3 divided by 6).

The per unit opportunity cost for 1 car in Brazil is 1 truck (2 divided by 2).

The per unit opportunity cost for 1 truck in the United States is 2 cars (6 divided by 3).

The per unit opportunity cost for 1 truck in Brazil is 1 car (2 divided by 2).

Therefore, the United States will export cars to Brazil and import trucks from Brazil.

Comparative Advantage and Trade

In economics, consumers make rational choices by weighing the costs and benefits. In economics, marginal means additional, or the change in the total (you will see this term a lot!)

traditional out of pocket costs associated with choosing one course of action. For example, the explicit cost of going to college is the paying of college tuition. 

monetary or non-monetary opportunity costs of making a choice. For example, the implicit costs of going to college are forgone wages you can't earn when you go to college full-time, or the traveling you can't do because you are in school.

the benefit from consuming an additional unit of a good or service. For the most part, marginal benefit decreases as you consume more and more.

the cost of consuming an additional unit of a good or service. Marginal cost usually increases as you consume more and more.

The general rule in economics is to consume where marginal benefit = marginal cost, also known as the benefit maximizing quantity.

After graduating high school, Billy decided to enroll in a two-year program at the local community college rather than to accept an internship that offered a salary of $15,000 per year. If the annual tuition and fees are $5,000, the annual opportunity cost of attending the community college is:


Opportunity cost includes both explicit and implicit costs.  In this question, the $15,000 in salary for the internship you gave up is the implicit cost, and the $5,000 in tuition and fees is the explicit cost of going to the community college.


All of the following are included in computing the opportunity cost of attending college EXCEPT:

(B) wages the student gave up to attend college

No matter what decision you make, you will always have clothing expenses 

Sylvia works part-time at a local convenience store and earns $12 per hour.  She wants to spend next Saturday afternoon attending a sporting event. The full price of the sporting event is $100, but Sylvia was able to get a discounted price of $75 from her cousin who purchased the ticket and is unable to attend.  If Sylvia took 5 hours off from her job to attend the sporting event, what was her opportunity cost of attending the concert?


Sylvia would have earned $60 from working for 5 hours (implicit cost). She also spent $75 on the ticket (explicit cost). 60 + 75 = 135.


Jane’s marginal benefit per day from drinking Pepsi is given in the table below. The table shows that she values the first Pepsi she drinks at $1.25, the second at $1.20, and so on. If the price of a Pepsi is $1.00, how many should Jane drink?


The optimal number of Pepsis that Jane should drink is 3 because that is where marginal cost ($1.00, the price of a Pepsi) is equal to the marginal benefit of the 3rd Pepsi.



Cost-Benefit Analysis

Marginal analysis allows us to explain how consumers make choices about what goods and services to purchase. As consumers, we want to maximize our satisfaction, which is known as utility maximization. In economics, utility is defined as satisfaction. Marginal utility is essentially the same thing as marginal benefit.

The consumer will spend all of their income.

When choosing which good to buy next, the consumer will always choose the good with the greatest MU/P (Marginal Utility per dollar).

When a consumer stops buying, the MU/P of the last unit of each good should equal each other.

If you are given total utility (TU), you must first calculate marginal utility (MU). To calculate the MU, you subtract the TU going from one unit to another. Sometimes, the problems will give you marginal utility (MU); in this case, you can jump right to the second step!

Once you have marginal utility (MU), calculate marginal utility per dollar (MU/P). This is done by dividing your marginal utility (MU) by the price of the product.

Once you have calculated all these values, the consumer will look to buy the good that has the greatest MU/P first. Then, subtract the cost of that good from your budget.

You continue this process until you have spent all of your budget. 

If the budget given to Sam at the local county fair for food is $18, what would be the combination of hamburgers and soft pretzels that would maximize his utility?

He would first buy ONE soft pretzel because the MU/P of 1 soft pretzel is 8 and the MU/P of one hamburger is 6. He will be left over with $15. 

Next, he will buy a SECOND soft pretzel (MU/P = 6) and a FIRST hamburger (MU/P = 6). He will have $10 at this point.

Then, he will buy a SECOND hamburger (MU/P = 4) and a THIRD soft pretzel (MU/P = 4). He will end up with $5 after this.

Finally, to use the last of his budget, he would buy his THIRD hamburger (MU/P = 3) and the FOURTH soft pretzel (MU/P = 3)

The ideal combination would be 3 hamburgers and 4 soft pretzels.  MU/P of 3 hamburgers = MU/P of 4 soft pretzels (3 = 3), while still staying in budget.

If Heather has a budget of $21 to purchase packs of pencils and composition books for the upcoming school year.  What would be the combination of packs of pencils and composition books she could purchase in order to maximize her utility?

The ideal combination would be 3 pack of pencils and 3 composition books.  MU/P of 3 packs of pencils = MU/P of 3 composition books (4 = 4), while staying in budget.

On the AP Microeconomics exam, they may just give you the MU and price of each good and ask if it is the ideal combination. Here is an example:

The table below shows the per-unit prices and marginal utility for the last unit of popcorn buckets and large sodas that Donna purchased.  Donna spent all of her allocated budget on buckets of popcorn and large sodas at the movies.  To maximize her utility, Donna should have purchased:

(A) more buckets of popcorn and fewer large sodas

(B) fewer buckets of popcorn and more large sodas

Donna should purchase more large sodas and less popcorn buckets because the MU/P of large sodas is greater than the MU/P of buckets of popcorn (MU/P of large sodas is 18/3, which is 6, and the MU/P of buckets of popcorn is 25/5, which is 5). Since 6 > 5, large soda has a greater utility-per-dollar value than popcorn buckets.

The rule of thumb is: if the MU/P for the two goods are not equal, then you buy more of the higher value good and less of the lower value good.

The Law of Diminishing Marginal Utility essentially says that as you consume more and more of a good or service, the additional satisfaction you get from that product decreases more and more. Let's say you were eating cake. For the first slice you eat, you get a lot of utility or satisfaction. For the second slice you eat, you get about the same amount of utility. But as you eat the third, fourth, and fifth slices, you start to gain less satisfaction. By the sixth slice, the marginal utility may actually become negative (which means that your total utility is actually decreasing) because you feel sick from all that sugar.

Unit 1: Basic Economic Concepts

AP Microeconomics

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videos

study guides

browse by units

Free Reviews

Unit 1: Basic Economic Concepts

Unit 2: Supply and Demand

Unit 3: Production, Cost, and the Perfect Competition Model

Unit 4: Imperfect Competition

Unit 5: Factor Markets

Unit 6: Market Failure and Role of Government

Blogs

Exam Skills: FRQ/MCQ

Unit 1: Basic Economic Concepts

AP Microeconomics

all

videos

study guides

browse by units

Free Reviews﻿

Unit 1: Basic Economic Concepts ﻿

Unit 2: Supply and Demand﻿

Unit 3: Production, Cost, and the Perfect Competition Model﻿

Unit 4: Imperfect Competition﻿

Unit 5: Factor Markets﻿

Unit 6: Market Failure and Role of Government﻿

Blogs﻿

Exam Skills: FRQ/MCQ﻿

Free Reviews

Unit 1: Basic Economic Concepts

Unit 2: Supply and Demand

Unit 3: Production, Cost, and the Perfect Competition Model

Unit 4: Imperfect Competition

Unit 5: Factor Markets

Unit 6: Market Failure and Role of Government

Blogs

Exam Skills: FRQ/MCQ