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AP Microeconomics Study Guide

1
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Scarcity and Opportunity Cost: Scarcity refers to the limited availability of
resources in an economy, meaning it is insufficient to meet our wants and needs
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In other words, the cost of a choice regarding the
benefits foregone
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Scarcity and opportunity cost are central concepts in economics and decisionmaking
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The cost of the shirt is $50, and the price of the concert ticket is $75
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The opportunity
cost of going to the concert is the shirt, as that is the next best alternative you
would have to give up to pursue that choice
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For example, a company may need more help and
decide whether to allocate funds to research and development or marketing
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Governments: Governments also use the concept of opportunity cost to decide
how to allocate resources
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The opportunity cost of building the street is the value of the benefits the
government would have received from making the school and vice versa
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For example, a person may have limited time and
must choose between working overtime and spending time with their family
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2
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Market Structures: Market structures refer to the characteristics of a market, such
as the number of firms, the ease of entry and exit, and the type and extent of
competition
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Monopolistic competition
is a market structure where many firms make differentiated products and some
barriers to entry
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Monopoly is a market
structure where only one firm produces a product without close substitutes
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Example:
Perfect competition: The market for agricultural products such as wheat and corn
is an example of an ideal match
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This results in a high level of
competition and a low level of market power for individual firms
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There are many firms, but each offers a slightly

different product
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There are some barriers to
entry, such as the need for brand recognition and advertising, but new firms can
still enter the market
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Only a few
firms, such as Coca-Cola and Pepsi, significantly impact market outcomes
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Monopoly: The natural gas or electricity market in certain regions may be a
monopoly, with only one firm supplying the product
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There is no close substitute for these products, making it difficult for
new firms to enter the market
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In perfect competition, firms must accept the market
price, while firms have more control over costs in an oligopoly
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Allocation of Resources: Market structures also determine the allocation of
resources in an economy
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Innovation: Market structures can influence the level of innovation in an
economy
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In a
monopoly, there is less incentive to innovate as the firm has already secured its
position in the market
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Demand, Supply, and Market Equilibrium: Understanding how demand and
supply interact to determine market prices and how market equilibrium is
achieved
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Supply refers to the
amount of a good or service that firms can produce and sell at a given price
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Market prices tend to move towards the equilibrium price, and changes
in demand or supply will lead to changes in the market price
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Example:
The apple market is in equilibrium when the quantity of apples demanded by
consumers equals the number of apples supplied by producers
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As a result, the market price will decrease until
the market reaches a new equilibrium
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If a new
technology increases the demand for notebooks, the market price will increase
until the market reaches a new equilibrium
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Changes in demand or supply will
result in changes in the market price, leading to a new market equilibrium
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If the market is balanced, resources are used efficiently,
while resources are misallocated if the market is not in equilibrium
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When the
market is in balance, there is no way for consumers or producers to be made
better off without making someone else worse off
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For example, the
government may impose taxes or regulate the price of a good or service to
promote a more efficient market
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Elasticity: Understanding how demand and supply price elasticity affect market
outcomes
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Price elasticity of demand measures the degree to
which the quantity demanded of a good or service changes in response to a
change in its price
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Understanding price elasticity helps firms and policymakers determine the impact
of price changes on consumer behavior and market outcomes
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It helps us understand how changes in one variable (such
as price) affect another variable (such as quantity demanded or supplied)
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For example, if the cost of a
concert ticket increases by 10%, and the number of tickets sold decreases by 20%,
the price elasticity of demand for concert tickets is -2
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This means that a 1%
increase in price leads to a 2% decrease in the quantity demanded
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For example, if the price of wheat increases
by 10% and the quantity supplied increases by 20%, the price elasticity of supply
for wheat is 2
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This means that a 1% increase in price leads to a 2% increase in
the quantity supplied
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For example,
suppose the price elasticity of demand for a product is inelastic, meaning that
consumers are not very sensitive to price changes
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Revenue Analysis: Understanding the price elasticity of demand for a good or
service can help firms determine the impact of price changes on their revenue
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In
that case, a price increase may increase revenue, while if the price elasticity of
demand is elastic, a price increase may result in a decrease in revenue
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For example, if the price elasticity of demand for a good

is inelastic, a tax on the good may result in higher revenue for the government
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Resource Allocation: Understanding the price elasticity of supply for a good or
service can help policymakers determine the impact of changes in the market on
resource allocation
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In that case, an increase in demand for the good may result in a
significant price increase, while if the price elasticity of supply is elastic, an
increase in demand may result in only a small increase in price
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Consumer Theory: Understanding how consumers make choices based on their
preferences and budget constraints
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Consumers have a limited budget and must choose the combination of goods and
services that provides them with the greatest utility (satisfaction) given their
budget constraints
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Consumer theory uses the concept of utility to measure the satisfaction a
consumer derives from consuming a good or service
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Budget constraint is
another key aspect of consumer theory, as it limits the choices available to
consumers and determines the optimal combination of goods and services they
can afford
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The slope of an indifference curve represents the marginal rate of
substitution, which is the rate at which a consumer is willing to trade one good for

another
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An example of consumer theory in action would be a consumer trying to decide
whether to purchase a new car or take a vacation
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Factors influencing their decision include the price
of the vehicle and leisure, the consumer's preferences and tastes, and any tradeoffs they are willing to make
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It is useful for firms as they attempt to
understand consumer behavior and design products and marketing strategies that
appeal to consumers
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Production and Cost: Understanding how firms make production decisions and
how costs are incurred
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Costs incurred by firms include direct expenses (such as
wages and raw materials) and implicit costs (such as the opportunity cost of using
the owner's time in the production process)
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Production and cost analysis helps firms determine the most efficient and costeffective methods of producing goods and services
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To do this, firms must consider both
explicit and implicit costs
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Implicit costs are the opportunity costs
of using resources in production, such as the value of the owner's time and the
return that could be earned if the resources were invested in alternative uses
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The combination of information that minimizes cost is
referred to as the production function
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An example of production and cost analysis would be a bakery trying to
determine the most efficient way to produce cakes
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The bakery must also consider the opportunity cost of using the
owner's time in production
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In conclusion, understanding the relationship between production and costs is
essential for firms to decide how to allocate their resources and maximize profits
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7
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Market Failure: Markets may fail to allocate resources efficiently in certain
circumstances, such as when there are externalities (effects of a production or

consumption activity on a third party not reflected in market prices) or when
information is asymmetric (when one party has more or better information than
the other)
...
The role of government in correcting market
failures is to intervene in the market through regulation, taxation, or provision of
public goods to achieve a more efficient allocation of resources
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There are several reasons why calls may fail, including externalities,
asymmetric information, and public goods
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For
example, when a factory produces goods, it may emit pollutants that harm
people’s health nearby
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Asymmetric information occurs when one party has more or better information
than the other
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This
information imbalance can lead to market failure as the buyer may not be willing
to pay a fair price for the car, leading to an inefficient allocation of resources
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Examples of public goods
include clean air and national defense
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In these situations, the government can intervene in the market through
regulation, taxation, or provision of public goods to allocate resources efficiently
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In conclusion, market failure occurs when the market fails to allocate resources
efficiently
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8
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Market Power: Market power refers to the ability of a single firm or a small
number of firms to impact market outcomes, such as prices, significantly
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The impact of market power on
market outcomes can result in higher prices, reduced output, and decreased
consumer welfare
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For example, in the airline industry, a few large airlines may have
the significant market power to set prices, limit competition and affect consumer
choices
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Governments may intervene in such markets through antitrust laws and
regulations to prevent firms from exercising excessive market power and
promoting competition
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S
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It's important to note that market power is sometimes good and can sometimes
result from a firm's efficiency and innovation
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9
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International Trade: International trade refers to exchanging goods and services
between countries
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The costs of international trade include job losses in
certain industries and the risk of dependence on foreign countries for certain
goods
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International trade is an important aspect of the global economy, as it allows
countries to specialize in producing goods and services in which they have a
comparative advantage, leading to increased efficiency and consumer welfare
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Through
international trade, Country A can specialize in creating computers and trade
them with Country B for food, leading to a more efficient allocation of resources
and a wider variety of goods available to both countries
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Both countries benefit from access to a wider variety of
goods and services through international trade
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Additionally,
reliance on foreign countries for certain goods can increase the risk of
dependence on these countries
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10
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Macroeconomic Measures: Macroeconomics studies the economy as a whole
rather than the individual parts that make it up
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Inflation measures the rate at which the
general price level of goods and services is increasing
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These measures provide a snapshot of an economy's overall health
and performance and are used to make decisions about economic policy
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GDP is a widely
used measure that reflects the total value of goods and services produced in a
country over a given period
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Unemployment measures the percentage of the labor force currently
without work but seeking employment and is used to track the labor market’s
health
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In that case, this
may indicate a growing economy, while high inflation may indicate an
overheating economy, which could prompt the central bank to increase interest
rates
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In summary, macroeconomic measures provide a comprehensive view of the
overall economy, allowing policymakers to make informed economic policies to
achieve economic growth, price stability, and full employment
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Money and Banking: Understanding the role of money in the economy and
the functions of the banking system
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The role of money in the economy is to facilitate
transactions and reduce the difficulties associated with barter, such as the
problem of double coincidence of wants
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Banks serve as intermediaries between borrowers and lenders,
connecting those with surplus funds to those in need
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12
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Federal Reserve System: The Federal Reserve System, commonly referred to as
the Fed, is the central bank of the United States
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The Fed is
responsible for implementing monetary policy, which manages the supply of
money in the economy to achieve specific goals, such as maintaining low inflation
and promoting economic growth
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13
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Inflation is a sustained increase in the general price of goods and services in an
economy over time
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The effects of inflation include a reduction in the
purchasing power of money and an increase in uncertainty
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In addition, governments can use
fiscal policy, such as reducing government spending or raising taxes, to reduce
demand and control inflation
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Business Cycle: Understanding the phases of the business cycle and the
factors that contribute to economic growth and recession
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The business cycle has four
phases: expansion (economic growth), peak (the end of the expansionary phase),
contraction (recession), and trough (the end of the contractionary phase)
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Understanding the
business cycle is important for businesses to make decisions about production
and investment and for policymakers to make monetary and fiscal policy
decisions
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Macroeconomic Policy: Understanding the role of fiscal and monetary policy
in promoting economic growth and stability
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Fiscal
policy involves using government spending and taxation to influence aggregate
demand and achieve specific macroeconomic goals, such as reducing
unemployment and controlling inflation
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The interplay between fiscal and monetary policy can
significantly impact the economy, and policymakers must carefully consider the
trade-offs between different policy options to achieve their goals

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