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Flashcards · AP® Microeconomics · Unit 1

Unit 1: Basic Economic Concepts flashcards

42 cards on topics 1.1 to 1.6. Pick a topic or study the whole unit.

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1.1 Scarcity

What is scarcity?
The resources available are not enough to satisfy all of society's wants and needs. It is relative (not enough compared with wants) and universal: rich and poor people and countries all face it.
What are the four factors of production?
Land: natural resources as found in nature (farmland, water, minerals). Labour: human effort and skill. Capital: human-made tools, machines and buildings used in production. Entrepreneurship: organising the other factors and taking risk.
Is money capital?
No. Capital means physical tools, machines and buildings used in production. Money buys capital but produces nothing itself.
How does scarcity lead to opportunity cost?
Scarcity forces choice; every choice is a trade-off (more of one thing means less of another); the opportunity cost is the next best alternative given up, not everything given up.
What is the difference between scarcity and a shortage?
Scarcity means there are not enough resources for all wants; it is permanent and everywhere. A shortage is in one market: buyers want more than sellers offer at the current price, and it is temporary.
Why may established knowledge not be scarce?
It is non-rival: any number of people can use a known idea, such as a mathematical rule, at once without using it up. Most factors are rival. Using knowledge still needs scarce time and resources.
Sana has 6 free hours. An essay takes 2 hours and a training session 1 hour. What is the opportunity cost of one essay?
2 training sessions: the 2 hours spent on the essay could have been spent on two 1-hour sessions.

1.2 Resource Allocation and Economic Systems

What three questions must every economy answer?
What to produce, how to produce it, and for whom (who receives the output, not who makes it). Scarcity forces every society to allocate resources by answering them.
What are the two parts of an economic system?
Institutional arrangements (ownership, who decides, laws) and a coordinating mechanism (a central plan, or prices in markets). Describe both, not ownership alone.
How do command, market and mixed economies differ?
Command: mostly state ownership, coordinated by a central plan and output targets. Market: mostly private ownership, coordinated by prices. Mixed: mostly private with some state, coordinated mainly by prices plus government decisions. Real economies are mixed.
How does a market firm decide how to produce?
By the least-cost rule: total cost = (worker-hours × wage) + (machine-hours × rent), and it picks the cheaper method. A high wage pushes firms towards machines; a low wage towards labour.
Method P uses 8 worker-hours and 1 machine-hour; Q uses 2 and 3. Wage $10, machine rent $20 per hour. Which does a market firm choose?
Q. Method P costs 8 × 10 + 1 × 20 = $100; method Q costs 2 × 10 + 3 × 20 = $80.
What are the main strength and limitation of each pure system?
Command: can focus fast on a priority, but planners lack information and incentives are weak, so shortages and surpluses appear. Market: good information and strong incentives, but unequal outcomes and some goods badly provided.
Who decides what is produced in a market economy?
Consumers' spending: it decides which goods earn profits, and firms follow it. A market economy still has some government; no real economy is purely market or purely command.

1.3 Production Possibilities Curve

What does a production possibilities curve (PPC) show?
The maximum combinations of two goods an economy can produce with its resources and technology. It illustrates scarcity (a boundary), trade-offs and opportunity cost.
What do points on, inside and outside the PPC mean?
On the curve: efficient, with full employment of resources. Inside: inefficient, with unemployed or misused resources, but attainable. Outside: unattainable with current resources and technology.
How do you calculate opportunity cost from a PPC?
Opportunity cost of 1 X = amount of Y given up ÷ amount of X gained, using the changes between two points, not the levels. State the unit, e.g. "2 bicycles per tonne of wheat".
What does the shape of a PPC tell you?
Straight line: constant opportunity cost. Bowed outward: increasing opportunity cost, because resources are specialised and not equally suited to both goods (the usual case). Bowed inward: decreasing opportunity cost (rare).
Graph: how do you show economic growth on a PPC, and how does falling unemployment differ?
Axes: quantities of the two goods, with units. More or better resources, or better technology for both goods, shift the whole PPC outward. Falling unemployment does not shift it: the point moves from inside towards the curve. Technology for one good only pivots the curve out along that good's axis.
A straight PPC runs from 30 laptops to 60 tonnes of rice. What is the opportunity cost of 1 tonne of rice?
30 ÷ 60 = 0.5 laptops per tonne. On a straight-line PPC, the cost of 1 X = maximum Y ÷ maximum X.
What does the slope of a PPC measure?
Its size equals the opportunity cost of the good on the horizontal axis. A constant slope means constant opportunity cost.

1.4 Comparative Advantage and Trade

What is the difference between absolute and comparative advantage?
Absolute advantage: a producer can make more of a good with the same resources (or the same amount with fewer). Comparative advantage: it can make the good at a lower opportunity cost. Specialisation follows comparative advantage.
How do you find opportunity cost from output data and from input data?
Output data (units made): cost of 1 X = output of Y ÷ output of X; the larger number has the absolute advantage. Input data (hours per unit): cost of 1 X = hours per X ÷ hours per Y; the smaller number has the absolute advantage.
Can one producer have the comparative advantage in both goods?
No. With two goods and two producers, each has the comparative advantage in a different good, unless their opportunity costs are equal (then no one does). A producer worse at both goods still gains from trade.
What terms of trade benefit both sides?
Terms strictly between the two producers' opportunity costs. If X's cost of a hat is 2 scarves and Y's is 5, X exports hats, and 1 hat for more than 2 but fewer than 5 scarves works for both.
Does trade shift the PPC outward?
No. Specialisation and trade let each side consume outside its own PPC, but the PPC itself does not move.
A potter needs 4 hours per pot and 2 hours per vase. What is the opportunity cost of 1 pot?
4 ÷ 2 = 2 vases. With input data, the hours for the good itself go on top.
Graph: how do you read advantage from two straight-line PPCs on one graph?
The higher intercept on an axis shows the absolute advantage in that good. The flatter line has the lower opportunity cost of the good on the horizontal axis, so that producer has the comparative advantage in it.

1.5 Cost-Benefit Analysis

What is opportunity cost in cost-benefit analysis?
The value of the next-best alternative given up: one option, not all of them added. If Ana values a concert at $40, a match at $55 and a film at $25 and picks the match, its opportunity cost is $40.
What is the difference between explicit and implicit costs?
Explicit costs are money paid to others. Implicit costs are the value of your own resources used, such as wages you give up or rent you could have earned. Total economic cost = explicit + implicit.
How do you choose the optimal option?
Work out net benefit = total benefit − total cost for every option and pick the largest. Not the largest total benefit, and not just any option with a positive net benefit.
A 4-day workshop costs $300; Ari would otherwise earn $80 a day and values the workshop at $650. Should he go?
Yes. Total cost = 300 + 4 × 80 = $620; net benefit = 650 − 620 = $30.
When do you use marginal steps and when do you compare totals?
"How much" decisions (batches, hours): totals or marginal steps give the same answer; add a unit while MB ≥ MC. "All or nothing" decisions (take the job, build the bridge): compare total benefit with total cost.
Why does the accounting view overstate the gain from a choice?
It counts explicit costs only and leaves out implicit costs, especially income given up.
What counts as total benefit for a consumer and for a firm?
For a consumer, utility (often shown in dollars). For a firm, total revenue.

1.6 Marginal Analysis and Consumer Choice

What is the rule for the optimal quantity of an activity?
Do more while the MB of the next unit exceeds its MC, and stop where MB = MC. That is where total net benefit (total benefit − total cost) is largest.
Do sunk costs change the optimal quantity?
No. Sunk costs are already paid and cannot be recovered, so they do not change MB or MC. A non-refundable $25 membership does not change how many classes you should attend.
What is diminishing marginal utility?
Each extra unit consumed adds less satisfaction than the one before. MU = change in TU ÷ change in quantity. Total utility still rises while MU is positive.
What two conditions maximise utility with two goods?
MU_A ÷ P_A = MU_B ÷ P_B, and all income is spent. Both are needed.
The last unit of A gives 40 utils at $5; the last unit of B gives 30 utils at $2. What should the consumer do?
A gives 8 utils per dollar and B gives 15, so buy more B and less A. Compare MU per dollar, not MU, when prices differ.
TU is 10, 18 and 24 utils for 1, 2 and 3 cups. What is the MU of the 3rd cup?
24 − 18 = 6 utils.
How much of a good does a consumer take when its price is zero?
Until MU = 0, where total utility is at its peak. When each unit has a price, the consumer stops before MU reaches zero.

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