AP Microeconomics: Elasticity, Costs & Market Structures

Opportunity cost

Inside: inefficient (resources unused). On: efficient. Outside: unattainable with current resources and technology.

Absolute advantage: producing more of a good with the same resources. Comparative advantage: producing a good at a lower opportunity cost. Trade should follow comparative advantage.

Keep doing an activity as long as marginal benefit is at least marginal cost; the optimal point is where MB = MC.

E_d = \frac{\%\Delta Q_d}{\%\Delta P} (in absolute value). Greater than 1: elastic. Less than 1: inelastic. Equal to 1: unit elastic.

Total revenue rises. (If demand is elastic, a price rise lowers total revenue.)

Many close substitutes A luxury rather than a necessity A large share of income More time to adjust

Positive: a normal good. Negative: an inferior good (people buy less as income rises).

Positive: the goods are substitutes. Negative: the goods are complements.

Consumer surplus: what buyers were willing to pay minus what they paid (area below demand, above price). Producer surplus: price received minus the minimum sellers would accept (area above supply, below price).

Deadweight loss

Whichever side is more inelastic (less able to change its behavior).

The law of diminishing marginal returns

Fixed costs don't change with output (rent, insurance). Variable costs rise with output (materials, hourly labor). TC = FC + VC.

When MC is below average cost, it pulls the average down; above it, it pulls the average up.

Produce where marginal revenue equals marginal cost (MR = MC).

When price falls below minimum average variable cost (P < AVC): it can't even cover its variable costs.

Accounting profit = revenue − explicit costs. Economic profit = revenue − explicit and implicit (opportunity) costs. Zero economic profit means a normal profit.

Many firms, identical products, free entry and exit, and price takers where P = MR. In the long run, firms earn zero economic profit.

One seller, no close substitutes and high barriers to entry. It is a price maker with MR below price, so it produces less, charges more and creates deadweight loss.

Many firms, differentiated products and easy entry. Firms earn zero economic profit in the long run but have excess capacity. Example: restaurants.

A few large firms that are interdependent (each reacts to the others), with barriers to entry. Analyzed with game theory. Example: airlines.

A dominant strategy is best no matter what the other player does. A Nash equilibrium is where no player can do better by changing strategy alone.

Allocative: producing what society wants most, where P = MC. Productive: producing at the lowest cost, where P = minimum ATC.

Economies of scale

An industry where one firm can supply the whole market at lower cost than several firms because of huge economies of scale, such as water or power utilities.

Price discrimination

The market overproduces because the price ignores the cost to third parties (like pollution). A per-unit (Pigouvian) tax equal to the external cost can correct it.

It is nonrival and nonexcludable (national defense, streetlights). People can benefit without paying, the free-rider problem, so markets underprovide it.

Income inequality. The farther the Lorenz curve bows from the line of equality, the more unequal; the Gini coefficient runs from 0 (perfect equality) to 1.