Hi everybody, Jacob Reed here from ReviewEcon.com. Today we're going to go over all of the major concepts you need to know for your AP Microeconomics exam. In this video, I'm going to be flying through all of the microeconomics curriculum without a lot of explanations or examples. This video is really designed as a quick review for people who just need it refreshed in their memory but you already have a good sense of AP Microeconomics. If you need a more in-depth review to get you prepared, I would start off with the AP Microeconomics Unit Review Summaries to get you started.
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Now let's get into the content. First up, we've got Unit 1 Basic Concepts. Number one concept is scarcity.
Scarcity is the inability of limited resources to satisfy. are wants. If there's less of an item than is wanted of that item, the item is scarce.
It will have a positive price and you have to give up something to get it. The reason why goods and services are scarce is because factors of production are scarce. Factors of production are land, labor, capital, and entrepreneurship.
We have two different types of economic systems that you need to know on the AP microeconomics exam. The first one is market-based economies. Those emphasize private property rights and they use prices to distribute scarce resources and goods and services. The other type of economy is a command economy.
In command economies, government bureaucrats allocate the resources and the goods and services. That means that the economy is run by central planners. Basic concept in economics is that every choice has a cost.
We call that cost opportunity cost. That is the value of the next best alternative not chosen. It's what you give up.
when you make a choice. Here we have a production possibilities curve. It shows all combinations of two goods that can be produced with fixed resources. This linear production possibilities curve shows constant opportunity costs and that's because the resources that are made to make one good are perfectly adaptable to produce the other good.
If we have a bowed out curve like this, it means that we have increasing opportunity costs. As you produce more and more of one of these goods, the opportunity costs in terms of the other good will consistently increase. and that's because the resources that are used to produce these goods are not perfectly adaptable.
Any point of production on a production possibilities curve means that the economy is productively efficient. Any point of production within the curve is inefficient, and it means some resources are sitting idle and not being used. In a macro economy, it means we have a recession and we have high levels of unemployment.
Points of production outside the curve are impossible because of scarce resources. We can't have an unlimited amount of both. corn and robots in this example. If we have a greater quality or quantity of resources or greater productivity of those resources, we call that economic growth and that is shown as an outward shift of the production possibilities curve.
If on the other hand, we have a decrease in the quality or quantity of resources, we are going to see a shift inward of the production possibilities curve. And now the economy can't produce as many of those two goods. Next, we have absolute advantage.
That's the ability to produce more of something. or the same amount of something using fewer resources. Here with this chart, we have an output problem, and that means more production is better, and Henry has the absolute advantage in the production of both strawberries and zucchini because he can produce more of both. Here we have an input problem for these numbers, and that means lower quantities of inputs mean you have an absolute advantage.
In this case, Amy has the absolute advantage in doing brake jobs and painting cars. Now, comparative advantage is even more important than absolute advantage, and that's the ability to produce something at a lower opportunity cost. If you have an output problem, meaning the numbers in the table are finished products, like we have here, strawberries and zucchini are finished products.
We will use the other over formula. That means the opportunity cost of producing good A will be the numbers we have for the other one, good B divided by good A. In this example here, Henry has the comparative advantage in the production of zucchini, while Jason has the comparative advantage in the production of strawberries, because that's where their lower opportunity costs are found.
If we get an input problem, then the opportunity cost can be calculated with the it over formula. That means the opportunity cost of producing one unit of A will be the numbers we have for that item, A, divided by B. In this example, Amy has the comparative advantage in the production of brake jobs, while Eric has the comparative advantage in the production of painted cars. Now, mutually beneficial terms of trade will fall between the two countries, or in this case, people's opportunity cost.
So, with the opportunity cost we have here... One painted car will be worth between four and six brake jobs if it's going to benefit both Amy and Eric. If it falls outside that range, one person is benefiting while the other is worse off. Next, we've got marginal analysis. Marginal is a term you're going to see over and over again in this class.
Marginal means change in the total. There we've got marginal benefit. It's the change of the total benefit.
And benefit maximizing behavior means you do something until the marginal benefit equals the marginal cost. So as long as the marginal benefit is greater than or equal to the marginal cost, you keep on doing it and keep on acting, but you do not act if the marginal benefit is less than the marginal cost. And that's because that would lower your total benefit.
When it comes to utility maximizing combinations, utility is just another word for benefit for a consumer. Then we are going to have this formula up there. Utility maximizing combinations means that the marginal utility of good A divided by the price of good A will equal the marginal utility of good B divided by the price of good B. If you do that math and find that you have a higher ratio for one item, you want more of that item.
If you have a lower ratio for the other item, you want less of that item. Next up, we're on to Unit 2, that's supply and demand. The law of demand tells us that ceteris paribus, consumers will buy more of a good at low prices and fewer units of a good at high prices.
That law of demand gives us a downward sloping demand curve, and a change in price is going to cause movement along that curve. Price does not change demand, only quantity demanded. Here are our demand shifters.
We've got tastes and preferences, market size, more consumers means more demand. Prices of related goods. Substitutes have a direct relationship for the price of one good and the demand for the other good. Compliments have an inverse relationship.
The price of one good demand for the other good. And then we have changes in income. For normal goods, an increase in income will cause an increase in the demand. And for inferior goods, an increase in income will cause a decrease in the demand for the product.
And the last one is expectations for the future. Any of those changes happen and it's going to shift the actual demand curve. This is a change in demand, not just a change in quantity demanded.
It's something besides price that's changed. Remember, right is an increase and left is a decrease. Reason why demand curves are downward sloping is because the substitution effect.
That tells us that as prices increase, consumers will buy other items instead. Those are the substitutes and the income effect. As prices rise, your income has less purchasing power so you can afford. fewer units. When it comes to the law of supply, we have a direct relationship between price and quantity.
At higher prices, producers will sell more of a good, and at lower prices, producers will sell less. And when you graph out that relationship, it gives us an upward sloping supply curve. And again, price does not change supply.
It's only quantity supply that changes, and a change in price is illustrated as movement along that curve. Those supply shifters we have are input prices. There's an inverse relationship between the price of resources and the supply curve. government tools, that's taxes, subsidies, and regulations. The number of sellers, an increase in the number of sellers will shift that supply curve to the right.
Technology will increase supply and the prices of other goods that these producers can produce. And then of course, producer expectations is our last one. If any of those things change, it's going to shift our supply curve to the right if it's an increase or to the left if it's a decrease.
Price elasticity of demand tells us how much a change in price is going to impact the quantity demanded. If we haven't. inelastic demand curve that means that the products are necessities they have few substitutes or they are inexpensive and we will get a fairly steep sloped demand curve that means that a large change in price has a small change in quantity demanded consumers are insensitive to a price change with inelastic demand curves. An elastic demand curve on the other hand tends to be a luxury, there are many substitutes, or the item is expensive.
There we will have a relatively horizontal demand curve and there a small change in price causes a larger change in quantity demanded. We can also use the total revenue test to determine the price elasticity of demand. Total revenue is price times quantity. If price goes down and total revenue goes up, they're going in opposite directions. That is an elastic demand curve.
price goes down and total revenue goes down now they're going in the same direction that is an inelastic demand curve no change in total revenue with a change in price we call that unit elastic. You can see the total revenue test on a demand curve with a marginal revenue curve below it. As long as marginal revenue is positive, that's the elastic range of the demand curve. Where marginal revenue is zero, the point above is the unit elastic point of that demand curve. And where marginal revenue is negative, that's the inelastic portion of the demand curve above.
You can also calculate elasticity coefficients using the percentage change of quantity divided by the percentage change in price. If you don't know how to calculate percentage change, the preferred method is to use the method of the method. is new minus old divided by old times 100. You'll need to do that twice, once for the percentage change of quantity and again for the percentage change of price. If we have a coefficient that has an absolute value, that means you drop the negative, greater than one, then we call that an elastic or relatively elastic demand curve.
If we have a coefficient that is exactly equal to one, absolute value, then that is unit elastic. And if the absolute value is less than one, meaning it's a decimal, then we have an inelastic demand curve. Another type of elasticity you need to know is income elasticity.
That's about normal goods or inferior goods. We take the percentage change of quantity, quantity is always on top, and divide it by the percentage change of income. If we have a positive coefficient here, that's a normal good, and a negative coefficient shows an inverse relationship between the income and the quantity demanded, and that means we have an inferior good here.
When it comes to cross-price elasticity, we're talking about substitutes and complements. We take the percentage change of quantity, divided by the percentage change in price of the other good. And if we have a positive coefficient, that means these two goods are substitutes.
If we have a negative coefficient, that means they're complements. Now, if we graph supply and demand together where the two curves intersect, that is the price where the quantity demanded equals the quantity supplied. That is equilibrium. It's the price that clears the market. And markets are going to seek that equilibrium.
If price is above equilibrium, we have a Surplus, meaning the quantity supplied, is greater than the quantity demanded, and prices will fall towards equilibrium. If the price is below equilibrium, prices are going to rise because we will have a shortage. That means the quantity demanded is greater than the quantity supplied, causing prices to go up towards that equilibrium.
If we have an increase in the demand within the market, that's going to cause the equilibrium price to go up and the equilibrium quantity to also go up. If we have a decrease in demand, both equilibrium price and quantity will decrease. If we have an increase in supply, then the price will fall and the quantity will increase.
And with a decrease in supply, price is going to increase and quantity is going to decrease if you get a double shift graph it out and see which of the axes conflict if we have a decrease in supply with an increase in the demand that equilibrium quantity is going to be indeterminate because one shift will increase it and the other one will decrease it and it will depend on how big the shifts are as to whether or not the quantity is increasing or decreasing in the end but the price here both shifts are going to increase the price and that means the price is definitely going to increase here's another example with the supply curve increasing and the demand curve also increasing now it's that price axis that's indeterminate because one shift increases it while the other decreases it but both are going to increase the quantity so the quantity is determined as an increase next we've got surplus and dead weight loss consumer surplus is the difference between what consumers are willing to pay and what they actually pay to find the consumer surplus you look at the price that's currently being charged go all the way over till you hit the quantity that we're getting all the way up to that demand curve and that is in this case, a triangle of consumer surplus. The producer surplus, on the other hand, is the difference between the marginal cost of production and what the producers get to charge for their product. There is our triangle of producer surplus here. And if we put them together, that is allocatively efficient.
When we're at equilibrium, we have maximized our total surplus between consumers and producers, and we call that allocatively efficient. There's no deadweight loss, assuming there's no externalities. If we don't reach equilibrium, we could have some deadweight loss.
Here at Q1, we have a red triangle of deadweight loss. That yellow triangle up there is consumer surplus and that green quadrilateral is our producer surplus. But there's deadweight loss, which is an efficiency loss as a result of not reaching equilibrium. Now, if the government gets involved when there are no externalities, there could be some deadweight loss caused. Here we have a binding price floor.
Price floors go up high if they are binding or effective. And then we're going to have some deadweight loss. a larger amount of producer surplus, and in this case, a tiny little bit of consumer surplus.
And we're going to have a surplus as a result because the quantity supplied is greater than the quantity demanded. And we can't let the price drop because of this government intervention. And the quantity sold there is the lower quantity QD.
If the government puts a binding price ceiling, that's going to go below equilibrium if it's effective. And that again is going to give us some deadweight loss because we don't reach the equilibrium quantity. We just have QS that's going to be sold. and we have a shortage here and this dead weight loss. Producer surplus is tiny, consumer surplus is pretty big.
If the government imposes a per unit tax on this item, it's going to shift the supply curve, the vertical distance of that per unit tax. The per unit tax is the difference between PB, that's the price that buyers are going to pay, and PS, that's the price that sellers get after they've paid the tax. That gap there is the amount of the per unit tax. We now have some dead weight loss as a result of not reaching equilibrium.
QT is the quantity we get as a result of this government intervention. And that yellow box there is our tax revenue. Now, that's actually part of our economic surplus. Consumer surplus, producer surplus, and that tax revenue. Now, tax incidence is who takes the burden of the tax.
Less elastic, more of the tax. Here we have a demand curve that is less elastic than the supply curve. So, buyers are going to pay a higher burden of this tax. If the supply curve is the less elastic one, then the buyers are going to take a higher burden of the tax. If we have the extreme of a perfectly elastic supply curve, that means they will pay no tax.
It's simply buyers taking the burden here. And if we have a perfectly inelastic curve, in this case, it's the demand curve that's perfectly inelastic. And that means they pay all of the tax. So that's 100% buyer's loss here. Next, we're going to look at our international trade graph.
We have our domestic demand and our domestic supply with a world price that is below the equilibrium price. domestically. That means consumers can consume as much as they want at that world price. So they actually get Q2 while they produce Q1.
So the difference is going to be imported. We have a small little bit of producer surplus and a massive amount of consumer surplus as a result of this international trade. If we put a tariff on this graph, that's going to raise the world price, the amount of the tariff. It gives us some tariff revenue and we have two little triangles of dead weight loss as a result.
Next up we've got costs and perfect competition. First we have the law of diminishing marginal returns. This is a production function. It shows you the relationship between the quantity of workers and the amount of output a factory will get. If marginal product is increasing, we call that increasing returns.
As marginal product is falling, that's decreasing returns. And then when marginal product is negative, we call that negative returns if we graph it out we see that marginal output is going to increase for a bit and then we will have diminishing marginal returns as that marginal product starts to fall and eventually we will have negative returns when marginal product is negative if we take the wage that these workers are paid and divide it by the marginal product of these workers it gives us the marginal cost of labor and if we graph it out it gives us the marginal cost curve that we see later on in this unit it's just a flipped upside down version of a marginal product curve. So as marginal product is rising, marginal cost is falling and vice versa.
In the short run, we have both fixed costs. Those are the costs that don't change with the quantity produced. And we have variable costs. Those are the ones that increase as more output is produced. Total costs are the fixed costs plus those variable costs added together.
And when you graph out those total cost curves, the horizontal line is that fixed cost curve that doesn't change with the quantity produced. Then the variable cost curve does change with the quantity produced. add those two together and we get that higher curve, that's the total cost curve.
More often, we're going to see these average and marginal cost curves. That marginal cost curve we just saw is the marginal cost of labor. The average variable cost is the total variable cost divided by the quantity produced. And that average total cost curve is the total cost divided by the quantity produced. Both the average total cost and the average variable costs are going to intersect that marginal cost at their minimum points.
Those cost curves can shift with changes in fixed costs. We're going to see only that. ATC move up if it's an increase down if it's a decrease if we have a change in variable costs the ATC the AVC and the MC are all going to shift up with an increase down with a decrease now in the long run all costs are going to be variable we could see a long run average total cost curve and as that average total cost curve is downward sloping we call that economies of scale mathematically as we double inputs we're going to see more than double output and we call that increasing returns to scale In the middle point there, we could see a horizontal portion of the long run average total cost curve. There we call that constant returns to scale. We are doubling our inputs and getting exactly double the output.
And then when our long run average total cost curve starts to upward slope, we call that diseconomies of scale. Mathematically, as we double our inputs, we will get less than double the output. We call that decreasing returns to scale.
Next, we've got types of profit. We've got accounting profit, which is total revenue minus... explicit costs.
Explicit costs are the money directly out of your pocket. Of course, economic profit is more important to us in this class, and that is the total revenue minus those explicit costs. But then we also subtract the implicit costs.
Those are the opportunities of value that are lost as a result of being an entrepreneur. That means the county profit is always going to be greater than. economic profit.
The term normal profit in AP economics means that economic profit is zero. It means that our accounting profit is equal to the implicit cost. For me, if I quit teaching and I go start selling tacos outside of the courthouse, it means that I am earning a teacher's salary if I'm earning zero economic profit.
When it comes to firm decisions, firms are going to always, always, always produce where the marginal revenue equals the marginal cost. That is profit maximizing behavior. If we look at the graph with the marginal cost and the marginal revenue curve, at Q1, our marginal revenue is greater than our marginal cost and they should produce more. At Q3, the marginal cost is greater than the marginal revenue. They should produce less.
Q2 is where marginal revenue equals marginal cost. That is our profit maximizing quantity. Next, let's talk about perfectly competitive markets.
The qualities of perfectly competitive markets is we have lots and lots of firms selling products. These products are identical. There are low or no barriers to entry and as a result of those low barriers to entry there are going to be zero economic profits in the long run.
These firms have no influence on price and they are called price takers as a result because the market is going to set the price for them. Here we call this long run equilibrium. That ATC is tangent to the marginal revenue and demand curve at the profit maximizing quantity.
There is zero economic profit here. Make sure you know how to draw that graph. If we have that average total cost curve a little lower, now we have economic profit. And in the long run, firms are going to seek that economic profit.
So they will enter the market and that will cause that supply curve to shift to the right, driving down that price, which is also going to lower the marginal revenue curve, demand, average revenue and price. So now we have a lower profit maximizing quantity for this firm. And now they're breaking even because now that price is tangent to the minimum of the ATC at the new profit maximizing quantity. If, on the other hand, the firm is earning economic losses because the ATC is a little higher there, then firms are going to exit the market as a result of those economic losses. That's going to shift the supply curve to the left, driving that price upward until it hits the bottom of that average total cost curve.
And now the firm is breaking even. That marginal cost curve is the firm's supply curve above the minimum of the AVC. If the price falls below the minimum of the average variable cost. then the firm will shut down temporarily.
So even if this firm is suffering economic losses, it will lose less than its fixed cost as long as the price is greater than the average variable cost. Next, we're talking about imperfect competition. We've got monopolies, oligopolies, and monopolistic competition. These are the ones that are imperfectly competitive. For most of these firms, as they produce more output, they're going to have to lower the price.
And that means the marginal revenue is going to fall faster than the price will. And so we get a marginal revenue curve below the demand as a result for imperfectly competitive firms. Imperfectly competitive firms are not allocatively efficient because they will price above marginal cost and they have deadweight loss as a result.
Let's talk about monopolies specifically. Monopolies have one seller. They have high barriers to entry.
They have a unique good and they are price seekers. They have some influence on price because they control the market. Here's our monopoly graph. This firm is earning economic profits in the long run because there are barriers to entry.
So no firm can enter the market and compete away their profit. Here we have a monopoly that is breaking even because that ATC is tangent to the demand curve at the profit maximizing quantity. If that ATC moves up a little higher, now we have economic losses for this monopoly. Now, monopolies are not allocatively efficient because they have deadweight loss, but they also are not productively efficient. And that's because that average total cost curve is downward sloping at the profit maximizing quantity.
Compared to a perfectly competitive market, monopolies are going to charge higher prices and produce lower quantities. If this firm perfectly price discriminates, that marginal revenue curve is going to merge back with the demand curve and the firm will still produce where the MR equals MC. And they will actually charge every price along that demand curve until they get to PF there.
That's the price of the last unit produced. Now, monopolistic competition, we have many, many sellers, low barriers to entry. Products are different.
And as a result of that differentiation, each firm has some impact on the price they charge. The graph looks exactly like the monopoly, but here we're going to break even in the long run. No economic losses or profit because the ATC is tangent to the demand curve at the profit maximizing quantity.
Now, if the firm is earning economic profits, firms are going to seek that profit, enter the market. and that is going to shift the demand curve and the marginal revenue curve to the left as this firm has fewer customers and lower market share and as a result this firm is going to break even in the long run if on the other hand the firm is earning economic losses firms are going to exit the market and that's going to mean this firm has a greater market share and that's going to increase the demand dragging with it the marginal revenue curve until the firm breaks even in the long run next we've got oligopolies oligopolies have few sellers high barriers to entry differentiated or homogenous products and they have some impact on the price they charge. Here we don't have a graph that you need to know.
We need to make sure we understand game theory. That's a method of understanding interdependent strategic behavior between entities. In this case, firms.
For oligopolies, we use a payoff matrix to understand the game theory between these two firms. Collusion is the best outcome for both of these firms. In this case, it's that lower quadrant there.
It's the highest combined profit for both firms. They're actually acting like a monopoly here. and doing what's best for both of them combined a dominant strategy is a strategy that one player will take regardless of the actions of the other player in this case here twan's trims has a dominant strategy of maintaining price because that is what they are going to do regardless of what sharon snips does sharon snips on the other hand does not have a dominant strategy because her best move is dependent on what twan's trims does now if you're explaining these on an frq make sure you use numbers to explain it the nash equilibrium is the most likely outcome and here it's that lower right quadrant if either firm changes their decision they will lose profit as a result Next up, we're talking about factor markets.
We've got three key factors of production you need to know. Land, we call the payments for those rent. Labor, the payments for those are wages.
And for capital, the payment is interest. Now, the demand curve for a firm's labor is the marginal revenue product of that firm's labor. The marginal revenue product is the marginal revenue, often the price, times the marginal product. of those workers. Graph it out and that gives us a downward sloping demand curve.
Some the marginal revenue product of all firms within the market and that is their demand for labor. And businesses are the demanders in factor markets. The supply curve for labor comes from households and that's people's willingness to work.
At higher wages they will be more willing to work and at lower wages less willing to work. The demand for labor will shift because of changes in the price of the product, product demand. and the productivity of workers it's a derived demand because the demand for labor often comes from the demand for the product itself but in the end it's really the marginal revenue product of these workers the supply of labor can also shift from the number of workers the availability of those workers the population the age the value of leisure time and countless other things but rightward shifts are an increase and leftward shifts are a decrease you graph out the demand for labor with the supply of labor and that gives us an equilibrium wage and quantity of labor that's higher.
And for the perfectly competitive factor market, the market sets the wage and that wage becomes the supply curve or marginal resource cost for the firm. The firm has their demand curve, that is the marginal revenue product curve, and where the marginal revenue product equals the marginal resource cost, also called marginal factor cost, that is the quantity of workers this firm is going to hire. If there's a change in the demand or supply in the market, that's going to impact the wage, and that change in the wage is going to carry on over to the change in supply. As a result of the wage increasing, it moves that marginal resource cost up or down with the wage. Now, monopsony is another factor market you need to know.
That's where there is one... buyer of labor within the market. They are going to have an upward sloping supply curve and the marginal resource cost is going to be greater than the supply because as they hire more workers, they have to raise the wage on all workers hired.
That means the marginal resource cost or marginal factor cost is greater than the supply and they are still going to hire where the MRC equals the MRP, but they will drop on down below to that supply curve to come up with the wage that's paid. If you compare a monopsony to a perfectly competitive market, they hire less and pay less. That means we have deadweight loss also. When it comes to least cost combinations of labor or capital, we have a formula to determine what's best.
It's the marginal product of labor divided by the price of labor, equaling the marginal product of capital divided by the price of capital. This is just like utility maximizing combinations, but now we're looking at resources. If the ratio is higher for one good, in this case capital, then we're going to want more capital, and in this case less labor because we have a lower ratio for that one. Last unit we've got is market failures. Now, when a market is socially efficient or allocatively efficient, it means that the marginal social benefit is going to equal the marginal social cost at the quantity we get within the market.
Sometimes we might be underproducing and then we are going to have some deadweight loss as a result. We could also overproduce and have deadweight loss as a result. But Q1 in this example is that allocatively efficient or socially optimal quantity and there we would have no deadweight loss.
If we have a market without externalities, equilibrium is allocatively efficient. And a perfectly competitive firm is also going to be allocatively efficient because the price equals marginal cost. But when it comes to a monopoly, they are going to have deadweight loss and they are inefficient as a result of having price greater than marginal cost. Next, we're going to talk about externalities.
Externalities occur when there are costs or benefits that fall on people who don't produce or buy a product. Externalities are a market failure and they lead to the creation of deadweight loss. Externalities can be in production or consumption.
Externalities in production are created by the producers of a product. We can have positive externalities in production like safety training that makes the rest of our community feel a little safer and negative externalities in production like pollution from factories. We can also have externalities in consumption as well.
There the spillover costs or benefits are caused by the consumers of a product. Vaccinations are a positive externality in consumption and a negative externality in consumption is cigarettes. Vaccines offer some protection to people who don't get the vaccine, and the consumption of cigarettes has a negative externality of secondhand smoke. When you have a negative externality in production, the marginal social cost is going to be greater than the marginal private cost, which is the supply curve. The gap between the two is equal to the marginal external cost, and we have a triangle of deadweight loss that points to the allocatively efficient or socially optimal quantity labeled QO.
But without any government intervention, QE, is the market quantity we'll get. The free market will overproduce this product. If we have a negative externality in consumption, then the marginal private benefit will be greater than the marginal social benefit.
Essentially, that negative external cost will be subtracted from the marginal private benefit to give us the marginal social benefit for this product. QE is the market quantity we will get, and QO is the allocatively efficient or socially optimal quantity. And since we are once again overproducing this product with a negative externality, we are going to have that triangle of deadweight loss.
We can correct for negative externalities with a per unit tax. In this case, we have a negative externality in production and we have the government putting the tax on the producers of that product. It will shift the supply curve to the left and bring us closer to the socially optimal quantity of QO. And when we put that tax on producers, it shifts the supply curve to the left, the vertical distance of that tax.
If we make the tax the exact amount of the external cost, then the new supply curve plus the tax will be equal to the marginal social cost. we could also levy the tax on the consumers of this product and that would shift the demand curve to the left instead either way that per unit tax can help us reach that socially optimal quantity if we have a positive externality in consumption instead of a negative one then we are going to add the marginal external benefit to the demand curve giving us a higher marginal social benefit curve qe is the market quantity where supply equals demand but the allocatively efficient or socially optimal quantity is at qo where the marginal social benefit equals the marginal social cost and since we are under producing this product we have that triangle of deadweight loss if we have a positive externality in production on the other hand then we are going to subtract the marginal external benefit from the supply curve giving us a marginal social cost that is lower than the marginal private cost qe is the market quantity we would get for this product but the allocatively efficient quantity is at qo and since we are once again under producing this product we have that triangle of deadweight loss When it comes to correcting for positive externalities, a per-unit subsidy is the preferred method. If the government gives the per-unit subsidy to the consumers of this product, that will shift the demand curve the vertical distance of that subsidy. And if the subsidy is equal to that external benefit, the subsidy will shift that demand curve all the way over to be equal to the marginal social benefit. And when that occurs, the after-subsidy quantity will be equal to QO, and the deadweight loss will be eliminated.
The government could also give the subsidy to the producers of this product. and that would shift the supply curve to the right. Either way, it's going to bring us towards that allocatively efficient quantity. Next, we're going to talk about classifying different types of goods.
All goods can be classified as either rival or non-rival. Rival goods are used up as they are consumed, like a donut. Once I've eaten it, it's gone for the next person.
Whereas non-rival goods are not diminished in quantity or availability as they are consumed, like digital streaming music. You can also classify goods as excludable, meaning that it is possible or practical to prevent people from consuming a good or non-excludable where it is not possible or practical to prevent people from consuming a good a concert in an indoor arena would be an excludable good while a public fireworks display is a non-excludable good the problem with non-excludable goods is they suffer from a free rider problem that means people can enjoy the good without paying for it and that will lead to an underproduction within the market because it just won't be profitable if they don't have to buy it to enjoy it. Now, public goods have two qualities. They are both non-rival and non-excludable. An example of a public good is national defense.
Let's take a look at government controls on firms. If we have a lump sum tax for a firm, it will shift the average total cost curve upward, or if it's a lump sum subsidy, it will ship that average total cost downward. Neither one will change the quantity that the firm produces because the marginal cost doesn't move. So if the government is hoping to change the quantity that's produced, a per unit tax or subsidy is preferable because that will actually move the marginal cost and the average total cost curve upward for a tax or downward for a subsidy.
And that will actually change the profit maximizing quantity because the MR equals MC point moves since the marginal cost moved. Now, natural monopolies are often regulated by the government. A natural monopoly always captures economies of scale because their average total cost curve is downward sloping through all relevant quantities.
Thanks. And if a natural monopoly is unregulated, it is going to produce a lot of deadweight loss because it overprices and underproduces. Now, if the government wants to make this natural monopoly allocatively efficient, it could put a price ceiling at P.O. right there.
That is where the marginal cost equals the price or the demand. That is allocatively efficient. But at the socially optimal quantity of Q.O., this firm is earning economic losses.
If this firm is going to stay in business in the long run, it will have to be given a lump sum subsidy. equal to its economic losses that box right there is the amount if providing a lump sum subsidy is not politically feasible the government may instead impose a fair return price ceiling that is where the average total cost equals the price or the demand at that price ceiling there Still some deadweight loss, but the firm is going to be producing more than the unregulated quantity and the price will also be lower than the unregulated price. As a result, we have a smaller amount of deadweight loss than if this monopoly was unregulated.
The government may pass antitrust legislation to encourage competition, limit monopoly power, and prevent collusion. Here we have the Lorenz curve. It shows income distribution within an economy. The closer we are to that line of equality, the more equal the income distribution is within this economy. The further away that Lorenz curve is from the line of equality, the more unequal the distribution.
The Lorenz curve can create a Gini coefficient for us and the lower the coefficient is, the more equal the income distribution is within that economy. The last thing we're going to look at is taxes. Taxes can be categorized based on the percentage of income.
from those who pay. Regressive taxes have a lower percentage of income for the rich and a higher percentage of income for the poor. Sales taxes are regressive because they make up a larger percentage of poor people's income than rich people's income generally. Progressive taxes, on the other hand, have a higher percentage of income for the wealthy and a lower percentage of income for the poor.
United States income taxes are progressive because marginal tax rates increase as incomes increase. Proportional taxes are the same percentage of income for everybody, both rich and poor. Whoa!
There you have it. That is the bulk of what we can expect to show up on this year's AP microeconomics exam. If you got it all, you are on your way to getting a five on that exam.
If you still need a little more help, head over to reviewecon.com where there's lots of games and activities to help you practice the skills you need to ace that microeconomics exam. That's all for now. I'll see you all next time.