United Grade 12 AP Microeconomics
Chapters: 6
1. Basic Economic Concepts
Scarcity · Resource Allocation and Economic Systems · Production Possibilities Curve · Comparative Advantage and Trade · Cost-Benefit Analysis · Marginal Analysis and Consumer Choice
- Introduction to Microeconomics and the Production Possibility Frontier – Microeconomics studies single units like one buyer or one firm; macroeconomics studies the whole economy. Resources are scarce and have other uses, so every economy must decide what, how and for whom to produce. The production possibility frontier (PPF) shows the best mixes of two goods an economy can make with all its resources used fully. Moving along it has an opportunity cost, which usually rises, so the PPF is concave.
- The Problem of Choice: Scarcity and Opportunity Cost – Our wants are unlimited but resources like money, time, land and workers are limited. This is scarcity, and it forces us to choose. The value of the next best option we give up is the opportunity cost. Economists study how people and societies make these choices. Every society must decide what, how and for whom to produce. Market, planned and mixed economies answer these differently, and a welfare state makes sure basic needs of all are met.
- Consumer's Equilibrium: Utility, Budget Line and Indifference Curves – A consumer is in equilibrium when she gets the most satisfaction from her fixed income at given prices, and has no reason to change her purchases. By utility analysis, with one good she buys until MU (in rupees) = price; with two goods MUx/Px = MUy/Py. By indifference curve analysis, the best bundle is where the budget line just touches the highest indifference curve: MRS = P1/P2, with MRS falling.
2. Supply and Demand
Demand · Supply · Price Elasticity of Demand · Price Elasticity of Supply · Other Elasticities · Market Equilibrium and Consumer and Producer Surplus · Market Disequilibrium and Changes in Equilibrium · The Effects of Government Intervention in Markets · International Trade and Public Policy
- Demand and Price Elasticity of Demand – Demand is the quantity of a good buyers are willing and able to buy at each price in a period. Market demand adds up all buyers' demand at each price. Demand depends on own price, income, prices of related goods, tastes, expectations and number of buyers. A change in own price moves us along the curve; a change in any other factor shifts it. Price elasticity of demand (Ed) = % change in quantity ÷ % change in price; it can also be judged from total expenditure.
- Producer's Equilibrium and Supply – A producer is in equilibrium when profit is the highest and there is no reason to change output. By the MR–MC approach two conditions must hold: MR = MC, and MC must be rising (MC cuts MR from below). Supply is the quantity firms are willing and able to sell at each price. Market supply adds all firms' supply. Supply depends on own price, input prices, technology, taxes, prices of other goods, number of firms and expectations. Own price moves us along the curve; other factors shift it. Es = % change in quantity supplied ÷ % change in price.
- Demand, Supply and Market Equilibrium – The law of demand says buyers want less when the price rises; the law of supply says sellers offer more. The market price settles at equilibrium, where quantity demanded equals quantity supplied, and shifts in demand or supply move it. Some goods break the usual laws (Giffen, Veblen, panic buying). A price ceiling set below equilibrium causes shortages. Markets can also fail, for example with pollution or public goods like street lights, so the government steps in.
- Perfect Competition and Price Determination – In perfect competition, very many firms sell the same product to very many buyers, so each firm is a price taker. The market price is set where market demand equals market supply (Qd = Qs). If demand rises, price and quantity both rise; if supply rises, price falls and quantity rises.
- Price Ceiling and Price Floor – A price ceiling is a legal maximum price set below equilibrium; it causes a shortage (excess demand), queues, rationing and black markets. A price floor is a legal minimum price set above equilibrium; it causes a surplus (excess supply) that the government often buys and stores, as with Minimum Support Price. A ceiling above, or a floor below, equilibrium has no effect.
3. Production, Cost, and the Perfect Competition Model
The Production Function · Short-Run Production Costs · Long-Run Production Costs · Types of Profit · Profit Maximization · Firms' Short-Run Decisions to Produce and Long-Run Decisions to Enter or Exit a Market · Perfect Competition
- Production Function: TP, AP, MP and Returns to a Factor – A production function shows the maximum output a firm can get from given inputs: q = f(L, K). In the short run some inputs are fixed, so output changes only by changing the variable input. TP is total output, MP is the extra output from one more unit of the input, and AP is output per unit. As more labour works on fixed land, MP first rises, then falls, and finally becomes negative: the law of variable proportions (returns to a factor).
- Cost and Revenue: TC, AC, MC and TR, AR, MR – Cost is what a firm spends on inputs. Total cost (TC) = total fixed cost (TFC) + total variable cost (TVC). Dividing by output gives AFC, AVC and AC; marginal cost (MC) is the extra cost of one more unit. AFC keeps falling; AVC, AC and MC are U-shaped, and MC cuts AVC and AC at their minimum. Revenue is money from sales: TR = P × q, AR = TR/q = price, MR = extra TR from one more unit. With a fixed price AR = MR; with a falling price MR lies below AR and TR is highest where MR = 0.
- Market Structures: From Perfect Competition to Monopoly – A market structure describes how many firms sell, how alike their products are, and how easy it is to enter. Perfect competition: many firms, identical goods, free entry, price takers, normal profit in the long run. Monopolistic competition: many firms, differentiated goods, easy entry, some price power. Oligopoly: a few interdependent firms, high barriers, strategic behaviour (game theory, collusion, price leadership). Monopoly: one firm, no close substitutes, high barriers, price maker with possible supernormal profit and price discrimination. Contestable markets show that the threat of entry also limits power.
- Producer's Equilibrium and Supply – A producer is in equilibrium when profit is the highest and there is no reason to change output. By the MR–MC approach two conditions must hold: MR = MC, and MC must be rising (MC cuts MR from below). Supply is the quantity firms are willing and able to sell at each price. Market supply adds all firms' supply. Supply depends on own price, input prices, technology, taxes, prices of other goods, number of firms and expectations. Own price moves us along the curve; other factors shift it. Es = % change in quantity supplied ÷ % change in price.
- Perfect Competition and Price Determination – In perfect competition, very many firms sell the same product to very many buyers, so each firm is a price taker. The market price is set where market demand equals market supply (Qd = Qs). If demand rises, price and quantity both rise; if supply rises, price falls and quantity rises.
4. Imperfect Competition
Introduction to Imperfectly Competitive Markets · Monopoly · Price Discrimination · Monopolistic Competition · Oligopoly and Game Theory
- Market Structures: From Perfect Competition to Monopoly – A market structure describes how many firms sell, how alike their products are, and how easy it is to enter. Perfect competition: many firms, identical goods, free entry, price takers, normal profit in the long run. Monopolistic competition: many firms, differentiated goods, easy entry, some price power. Oligopoly: a few interdependent firms, high barriers, strategic behaviour (game theory, collusion, price leadership). Monopoly: one firm, no close substitutes, high barriers, price maker with possible supernormal profit and price discrimination. Contestable markets show that the threat of entry also limits power.
5. Factor Markets
Introduction to Factor Markets · Changes in Factor Demand and Factor Supply · Profit-Maximizing Behavior in Perfectly Competitive Factor Markets · Monopsonistic Markets
- Factor Markets: How Firms Hire Land, Labour and Capital – Factor markets are where firms buy the inputs they need: land (paid rent), labour (paid wages), capital (paid interest) and enterprise (earning profit). Demand for a factor is derived from demand for the product it makes. A profit-maximising firm hires a factor up to the point where its marginal revenue product (MRP = MP × MR) equals its marginal resource cost (MRC). In a perfectly competitive factor market MRC is the market wage; a monopsony (single buyer) faces MRC above the wage, so it hires fewer workers and pays less.
6. Market Failure and the Role of Government
Socially Efficient and Inefficient Market Outcomes · Externalities · Public and Private Goods · The Effects of Government Intervention in Different Market Structures · Inequality
- Market Failure – A market fails when buying and selling on its own does not give the best result for society. Resources are used in the wrong amounts: too much of some goods (pollution, cigarettes), too little of others (street lights, vaccines, education). Main causes: externalities, public goods, merit and demerit goods, imperfect information, market power and unfair inequality. Governments try to fix it with taxes, subsidies, rules, direct provision and information, but government action can also fail.