1 AP Microeconomics: Test 2 Study Guide Mr. Warkentin 203 Sprague Hall Academic Year Directions: The purpose of this sheet is to quickly capture the topics and skills that you will be responsible for on the upcoming Microeconomics test, as well as to make some suggestions for independent review & practice. Key Concepts Price elasticity of demand is the sensitivity of a good s quantity demanded to changes in its price. This determines (but does not equal) the slope of the demand curve. On a straight line, elasticity is not constant! It is calculated by PEoD = % Q demanded % P Perfectly elastic demand curves are horizontal. Perfectly inelastic demand curves are vertical. Unit elastic demand curves have an elasticity (but not necessarily a slope) of 1. The midpoint method for calculating elasticity of demand uses midpoints to calculate the percentages. The revised formula is: PEod mid = Changes in Total Revenue are impacted by elasticity. If a demand curve is elastic, lowering price increases revenue. If a demand curve is inelastic, lowering price decreases revenue. Cross-price elasticity of demand measures the sensitivity of a good s quantity demanded to changes in price of a related good. It determines whether goods are substitutes (CPE > 0) or complements (CPE < 0). It is calculated by: Q 2 Q 1 Q mid P 2 P 1 P mid CPE = % Q demanded % P related good Income elasticity of demand measures the sensitivity of a good s quantity demanded relative to changes in income levels. It determines whether a good is normal (IE > 0) or inferior (IE < 0). It is calculated by: IE = % Q demanded % I Price elasticity of supply measures the sensitivity of a good s quantity supplied to changes in price. This determines (but does not equal) the slope of the supply curve. It is calculated by: PEoS = % Q supplied % P Consumer surplus is the total value that consumers are getting above and beyond what they pay for. In a supply-demand graph, it is the area of the triangle under the demand curve and above the line representing the price level. Producer surplus is the total value that producers are getting above and beyond what they expect to receive for their goods. In a supply-demand graph, it is the area of the triangle above the supply curve and below the line representing the price level.
2 An excise tax is a per-unit tax levied on a particular good. Cigarettes are a good example of such a tax in practice. Deadweight loss is the loss in consumer/producer/government surplus resulting from the levying of a tax or imposition of a price ceiling, a price floor, or a quota. Utility is a means of measuring the value/happiness that we get from consuming a good. It is measured in the imaginary unit of utils. Marginal utility (MU) is the extra utility a consumer gets from the consumption of one more of a good. When consuming only a single good, a consumer maximizes utility by consuming until MU is 0. The principle of diminishing marginal utility simply states that the more we consume, the lower our marginal utility becomes. Thus, a graph of marginal utility versus quantity consumed is downward sloping. A budget line is a graphical representation of all possible combinations of the consumption of two competing goods, given a person s budget. It functions much like a PPC and always slopes down. Marginal utility per dollar is the value of a good s MU divided by its price. This is a means of comparing utility gains across different goods. When someone is consuming two competing goods on a fixed budget, utility is maximized when the two goods marginal utilities per dollar are equal. In other words, utility is maximized when MU A P A = MU B P B.