AP Microeconomics

Unit 1

Basic Economic Concepts

8 practice questions · Free response

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Notes

Scarcity and choice

  • Scarcity forces choices. Every choice has an opportunity cost: the value of the next best alternative.
  • Economic systems: command (government decides), market (prices and private choices decide), and mixed (most real economies).
  • Property rights and incentives encourage people to produce and trade.

The production possibilities curve

  • Points on the curve are efficient; inside, inefficient; outside, unattainable.
  • A bowed-out curve shows increasing opportunity cost; a straight line, constant cost.
  • More resources or better technology shift the curve outward.
Good XGood YA (efficient)B (inefficient)C (unattainable)
Points on the curve are efficient; inside is inefficient; outside is unattainable.

Comparative advantage

  • Absolute advantage: more output from the same resources. Comparative advantage: a lower opportunity cost.
  • Specializing by comparative advantage and trading lets both sides consume beyond their own PPCs. Terms of trade must fall between the two parties' opportunity costs for both to gain.

Cost-benefit analysis and marginal thinking

  • Rational decisions compare marginal benefit and marginal cost: keep doing something as long as MB ≥ MC.
  • Total utility and marginal utility: the law of diminishing marginal utility says each additional unit brings less extra satisfaction.
  • Utility-maximizing rule: spend so that $\displaystyle \frac{MU_A}{P_A} = \frac{MU_B}{P_B}$ (the last dollar spent on each good gives the same extra utility).
  • Sunk costs (already paid, can't be recovered) shouldn't affect future decisions.

Practice

The opportunity cost of a decision is:
A straight-line PPC means:
Maria can bake 6 cakes or knit 3 scarves in a day; Sam can bake 4 cakes or knit 4 scarves. Who has a comparative advantage in scarves?
A rational person keeps studying as long as:
The law of diminishing marginal utility says:
Apples cost 1 dollar and oranges cost 2 dollars. The next apple gives 10 utils and the next orange 16 utils. To maximize utility, you should buy:
A movie ticket was already paid for and can't be refunded. When deciding whether to stay at a boring movie, the ticket price is:
In a command economy, most decisions about what to produce are made by:

Free response

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Free-response question

Jamal has 10 dollars to spend on snacks. Chips cost 2 dollars and cookies cost 1 dollar. The marginal utility of the 1st, 2nd and 3rd bag of chips is 20, 16 and 10. The marginal utility of the 1st through 6th cookie is 12, 10, 8, 6, 4 and 2.

(a) Calculate the marginal utility per dollar of the first bag of chips and the first cookie.

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Chips: $\displaystyle \frac{20}{2} = 10$ utils per dollar. Cookie: $\displaystyle \frac{12}{1} = 12$ utils per dollar.

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(b) What combination should Jamal buy to maximize utility? Show your reasoning.

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Buy in order of the highest MU per dollar: cookie 1 (12), cookie 2 (10), chips 1 (10), chips 2 (8), cookie 3 (8), cookie 4 (6). That spends 8 dollars. With 2 dollars left, chips 3 (5 per dollar) beats cookies 5 and 6 (4 and 2 per dollar). Best choice: 3 bags of chips and 4 cookies, costing exactly 10 dollars, for 82 total utils.

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(c) Explain why Jamal doesn't simply buy the snack with the highest total utility.

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He has a limited budget, so he compares extra satisfaction per dollar at the margin rather than total utility.

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