Microeconomics Review Workbook

Microeconomics Review Workbook
By
Mike Fladlien
Want more review? Checkout my iPod App, Econexamcram on the iTunes Store. 1
For Hose,
Contents
Production Possibilities 4
Perfect Competition 9
Monopoly 16
Elasticity 24
Production Costs 33
Externalities 40
Basic Macro Concepts 45
AD/AS 56
AS 62
LRS 66
Production Possibilities Name ___________________
Problem PPF1 (3)
For the economy of Alpha, there are 71 units of unskilled labor used to make two goods,
washers and dryers.
Quantity 1 2 3 4 5 6 7 8 9 10
Labor Used 5 12 15 26 36 45 56 71 92 122
a. Draw the production possibilities curve for an economy with 71 labor units and label it
PPC0.
b. What’s the opportunity costs of the eight worker? _________
c. Suppose immigration from Mexico brings in 21 more workers. Draw the new curve to
show the increase in labor and label it PPC1.
d. Suppose technology changes so that productivity increases the 92 labor force to an
equivalent of 122. Draw the new curve and label it PPC2.
Sample Problem 2 – Perfectly substitutable resources.
Suppose that Lucy has baking flour, cake mix, and 2 eggs. With these inputs, she can
either make 10 cupcakes or 10 muffins. These resources are perfect substitutes. Lucy’s
production possibilities curve would be a constant cost, straight line, from 10 muffins to
10 cupcakes. This is shown graphically below.
Lucy has a constant cost of making cupcakes of one

muffin. Suppose Lucy is making 1 cupcake and 4
muffins. If Lucy makes one ore cupcake or 2, then
she can only make 3 muffins. Lucy has a constant
cost of 1 muffin. Likewise, If Lucy decides to make
muffins, she gives up one cupcake. If Lucy decides to
make 5 cupcakes, then she gives up 5 muffins. What
you give up is “opportunity cost”.
Problem PPF2 (0)
Billy Bob can either sheer sheep or shuck corn equally well. In one hour, he can sheer 20
sheep or shuck 20 bushels of corn. Draw Billy Bob’s PPF below.
a. If Billy Bob just sheers sheep, how many sheep can

he sheer? _______
b. If Billy Bob just shucks corn, how many bushels
can be shuck? ________
c. What’s the opportunity cost of shucking one bushel
of corn?_____ Sheering one sheep? _____
Sample Problem 3 – Increasing Opportunity Cost
In Buffoonia, guns can be

transformed into butter. The PPF
schedule and graph shows the
transformation. Buffoonia must
give up more and more guns to get
additional tubs of butter. The cost
of 5 tubs of butter is 2/5 guns. The
costs increase to 3/5, 8/5, and 7/1.
Problem PPF3 (0)
Willy Wonka can transform Wanks into Wongs as shown below. Answer the questions
that follow:
a. What’s the opportunity cost of making the third Wang?
b. Explain why the resources used in making Wonks and

Wangs are not perfectly substitutable.
c. Show how the opportunity cost increases as additional

Wangs are produced.
Sample Problem 4 – Efficiency
Efficiency is shown on the PPF as any point on the boundary. This is so because one
would have to give up some of Good X to get more of Good Y. Think of an iPod that
holds 100 songs. If the owner of the iPod had 50 Rap and 50 Classical songs, the owner
would have to give up one Rap song to make room for one
more Classical song. On the other hand, if the owner only
had 5 songs total, then she could add more of both songs.
Only when something must be given up to get more of
another are the resources efficient. The embedded graph
shows an inefficient point inside the PPF. At 4 MP3 players
and 2 cell phones, the user could have enjoy more of either
good without opportunity cost.
Problem PPF4 (0)
Johan Cabooci can produce oil or watercolor paintings according the PPF below. Answer
the questions that follow.
a. Point F is not obtainable by Johan. What must happen for his

PPF to shift outward? ________________________________
b. If Johan is at Point E, could he paint more watercolors

without giving up any oil paintings? ______________
c. Johan’s girlfriend says that he should only paint oil paintings.

Explain why you might disagree with her. ______________
Problem PPF5 (3)
Mars can make 18 Guns and 6 Roses. Venus can make 6 Guns and 6 Roses. Currently
Mars is making and consuming 9 Guns and 3 Roses. Venus is making and consuming 3
Guns and 3 Roses. Draw their respective PPFs, identify autarky, and find the
comparative advantage of each country. Finally, assume that the two countries trade 2:1.
Draw the new trading possibilities curve.
Solutions:
PPF1
PPF2
20, 20, 1.
PPF3
3 Wonks; each Wang costs more; 1 Wang costs ½ Wonk; 2 cost 1; 3 cost 3; ½ costs 5
PPF4
Increase in land, labor, and capital; Yes; He should not just paint watercolors. He gives
up 5 oil paintings.
PPF5
Perfect Competition Name __________________________
Sample 1
Lee Pullem pulls weeds in the perfectly competitive dandelion removal market. Since
there are millions competing against him, Lee is a price taker. In this example, weed
pullers can sell their services for $2 per yard.
Comp1 (0)
Bill Booge sells Boogers in a perfectly competitive market. Use the Market to compute
total revenue, marginal revenue, and average revenue and graph the demand curve.
Comp2 (0)
Take the data contained in the graph for the market, and perform the following tasks: A.
Determine the market price B. Compute the amount of profit being earned by the firm
C. Compute the total revenue being earned by the firm. D. Determine the total cost
being incurred by the firm. E. The long-run price.
A. __________
B. __________
C. __________
D. __________
E. __________
Comp3 (0) Loss Minimizing
A. _____
B. _____
C. _____
D. _____
E. ______
Comp4 (0) Shut-down case
A. ______
B. ______
C. ______
D. ______
E. ______
Comp5 (2)
Assume that the table below is a true and accurate picture of a perfectly competitive firm
in the Doodle market. The firm sells it output at $2 per Doodle at flea markets, yard
sales, and to spammers. Complete the table.
Q FC VC TC AVC ATC AFC MC TR π
0 4 0
1 4 2
2 4 2.5
3 4 4.75
4 4 10
5 4 17.5
Comp6 (1)
Using the quantities from Comp5, graph TR, FC, VC, and TC. Use a yellow highlighter
to shade the area of profit.
Comp7 (1)
Using the quantities from Comp5, graph ATC, AVC, MC, and MR.
Comp8 (2)
Now, look at your table from Comp5 and your graphs from Comp6 and Comp7.
Explain on the yellow legal pad below why micro economists call this the “loss
minimizing position.” (A few hints might aid you in your discovery. If the firm would
shut down, how much would it lose in fixed costs? How much does the firm lose when it
operates at profit max?) Next, postulate a rule for loss minimization.
Comp9(0)
Complete the table below. All of the data will look like Comp5 except total revenue.
Assume more suppliers enter the market and the price falls to 50¢. Complete the total
revenue and profit columns. Explain whether you think the firm should shut down or
minimize losses? _________________________________________________
Q FC VC TC TR π
0 4 0 4
1 4 2 6
2 4 2.5 6.5
3 4 4.75 8.75
4 4 10 14
5 4 17.5 21.5
Solutions:
Comp1
Comp2 A. $4 B. $6.3 C. $12 D. $5.7 E. $2
Comp3 A. $2 B. -$2.25 C. $3 D. $5.25 E. $3
Comp4 A. $ .50 B. Shut down and lose $4 in fixed costs. C. 0 D. $4 E. $3
Comp5
Q FC VC TC AVC ATC AFC MC TR π

0 4 0 4 0 -4
1 4 2 6 2 6 4 2 2 -4
2 4 2.5 6.5 1.25 3.25 2 .5 4 -2.5
3 4 4.75 8.75 1.58 2.9 1.33 2.5 6 -2.75
4 4 10 14 2.5 3.5 1 5.25 8 -4
5 4 17.5 21.5 3.5 4.3 .8 7.5 10 -11.5
Comp6
Comp7
Comp8
It’s called the loss minimizing position because some fixed costs are covered. By
producing 2.5 units all variable costs are covered and some fixed costs. The rule is P >
AVC to minimize losses.
Comp9
Firm should shut down since P < AVC and the losses keep mounting.
Monopoly Name _____________________
Sample 1: Perfect Competition
Five friends go to an auction and see an Elvis bobble head doll. The auctioneer has
hundreds of the dolls and they all are exactly alike. Alice is willing to pay $5, Betty is
willing to pay $4, Cathy is willing to pay $3, Dolly is willing to pay $2, and Edna is
willing to pay $1 for the dolls. At a marginal cost of $2, how many will be sold, what
will be the total profit, total cost, total revenue, consumer’s surplus, producer’s surplus,
and price of each doll?
Four dolls will be sold at the price of $2

because that’s the resource allocative
efficient price (P = MC). Total revenue will
be $8 and total cost will be $8 for zero profit.
Consumer’s surplus is $8 and producer’s
surplus is $8.
Sample 2: Pure Monopoly
If the same five friends go to an action in which the seller has a monopoly, What will be
the price the dolls sell at, profit, total cost, total revenue, consumer’s and producer’s
surplus?
Two dolls will be sold at $4 dollars. Total

revenue will be $8 and total cost $4 for a $4
profit. Consumer’s surplus will be $2 and
producer’s surplus will be $8.
Sample 3 Price Discriminating Monopoly
A price discriminating monopolist can sell

the same product at different prices. In this
case, Alice pays $5, Betty pays $4, Cathy
Pays $3, and Dolly pays $2. Total revenue
equals $14, total cost equals $8, profit equals
$6, consumer’s surplus equals $0, and
producer’s surplus equals $14.50. When a
monopolist is able to discriminate, profits are
maximized and all surplus is captured by the
producer.
Problem MONO1 (0)
a. This is a single-price monopoly.

What is another name for this type of
monopoly? __________________
b. What price would this monopoly
sell all of her output?________
c. What quantity would the
monopolist sell? ___________
d. How much is total revenue at the
monopoly price?____________
e. How much is total cost at the
monopoly price?____________
f. How much profit does the
monopolist earn?___________
g. What price ranges are
inelastic?______________
h. At what price is the price elasticity
of demand = 1?__________
i. At the monopoly price, how much is
consumer’s surplus?__________
j. Shade the dead weight loss.
k. What price would a perfect competitor charge?___________
l. What price would allow the firm to break even?__________
m. Why does the marginal revenue curve lie below the demand curve? _________
______________________________________________________.
Problem MONO2 (0)
A monopoly might own all of the resources used to make a good or have exclusive
ownership of the resources. A monopoly might have a license, patent, copyright or legal
right to be the sole producer of the good. A monopoly might be large enough that it is the
only business capable of producing and selling the good at an affordable price. Some
monopolies have cozy relationships tacitly act like a monopoly. In each case below,
identify the source of the monopoly power.
a. A liquor store that requires a license. ___________________

b. A railroad that owns all of the tracks for 500 miles around a hub. ______________
c. Larry Litiagator, the only licensed lawyer in a town of 500 people. _____________
d. The U. S. Postal Service. _____________________
e. Terri’s Tropical Fish, the largest outlet for tropical fish in the Midwest. _________
Problem MONO3 (3)
Hornbuckle Carnival Rides has one ride, the Matterhorn. They have the patent on the
ride. The ride which simulates a rollercoaster ride through the Himalayas is popular in
rural towns in Iowa. Complete the table and graph the demand, marginal revenue, and
marginal cost curves. Assume that marginal cost is a constant $9. After you graph the
data, What is the profit maximizing output? a. _________ What is the profit maximizing
price? b. _________ If this were a perfectly competitive firm, what output would be
produced? c. ____________ How much profit would be made by a price discriminating
monopolist? d. _____________
Problem MONO4 (0)
Each of the following brothers are willing to pay the maximum price shown in the table
for an iPod Shuffle.
Buyer Maximum Price

Alex $50
Barry 40
Cisero 30
Donovan 20
Edward 10
Apple’s cost of making the Shuffle includes $50 of fixed costs and a constant marginal
cost of $10. Graph the five brothers’ demand, marginal revenue, and marginal cost
curves. What is the profit maximizing output? a. __________ What is the profit
maximizing price? b. __________ How much profit is made? c. ____________ If Apple
can price discriminate, how many Shuffles will Apple sell? d. ________ How much
profit will be earned by the price discriminating monopolist? e. _______
Problem MONO5 (3)
Punky’s Pies sells ice cream pies in a monopolized market. Data for her market is
contained in the table below: Complete the table and graph the Demand, MR, and MC
curves. Answer questions a, b, c, and d.
P Q TR MR TC MC ATC Profit
20 0 8
18 1 14
16 2 22
14 3 32
12 4 44
10 5 58
8 6 74
6 7 92
4 8 112
2 9 147
a. If Punky only cares about

the maximum revenue she can
earn, how many pies will
maximize her total revenue?
__________
b. How many pies are

produced at the profit-
maximizing output? _____
c. If Punky’s Pies were a

perfectly competitive market,
about how many pies would
she make?______
d. What would be the long-

run price if the market were
perfectly competitive?_____
Problem MONO6(0)
The iMAX is the only theater in the tiny town of Maxwell, a mining town in Rural Iowa.
The demand for popcorn once inside the theater is given in the following demand
schedule:
Price per Drink $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00
Quantity 0 10 20 30 40 50 60 70
Graph the demand, marginal revenue, and marginal cost assuming that marginal cost is a
constant $1.00. What will be the price of a drink at the iMax a. ___________. If the
citizens of Maxwell force the theater to sell at the perfectly competitive price, how many
drinks will be sold? b. _________ How much is total revenue at the profit-maximizing
price? c. ________ How much is total cost at the profit-maximizing price? d.
__________
What is the price elasticity of demand between

$3.00 and $2.00? e. ___________
How much is the dead weight loss when the
iMax sells popcorn at the profit-maximizing
price? f. ____________
How much is consumer’s surplus at the profit-
maximizing price? g. __________
Sample 4 – Natural Monopoly
A natural monopoly is so big that it supplies the

entire market. This market structure is
characterized by high fixed costs that are spread
out over a large range of output. Because of the
high fixed costs, the firm is easily identified by
a broad sweeping ATC curve and low variable
costs. The low variable costs can be seen in the
marginal cost curve which over this range of
output is constant.
Problem MONO7 (0)
In the problem below, answer the questions that follow:
The firm still maximizes profit where MR =

MC. What is the price at the profit
maximizing output? a. __________
If this firm were regulated at the socially
optimal output, that is, resource allocative
output, what would be the price and output?
b. Price ________ Output_______
At the socially optimal output how much
profit is the firm making? c. ________
d. Shade the area dead weight loss.
Should this municipality be subsidized or
taxed? e. _________
Solutions:
MONO1 a. Pure Monopoly b. $7 c. 3 d. $21 e. $12 f. $9 G. Below $5 H.
$5 I. 4.5 J. Shade Triangle; 3,$7 – 3, $4 – 4.5, $5.5 k. $5.5 l. 5 m. The
monopolist has to lower the price to sell the next item.
MONO2 a. License b. Economies of Scale or Exclusive ownership of a resource c.
License d. Legal right e. Possibly all. Answers can vary.
MONO3 a. $14 b. 2.5 c. 5 d. $25 if you include the whole area of consumer’s
surplus; $20 if you assume a stairstep and discrete quantity.
MONO4 a. 3 b. $30 c. 60 in profit d. 5 e. $100
MONO5 a. 5 b. 2.5 c. About 4 d. 10.67
MONO6 a. $4 b. 30 c. 120 d. $30 e. .56 f. 45 g. 4.5

MONO7 a. 6 b. $1, about 5.5 c. -1 d. not shown. E. subsidized.
Elasticity Name __________________
Sample 1:
Dr. D. Kay wants to increase his revenue. He is thinking about raising his prices. He
sees 4 patients per hour no matter what so he has a constant cost of $400 per hour. Dr. D
Kay’s demand for his services is shown. He charges $150.00 per patient.
If Dr. D. Kay is at point A, he is charging $600 per hour and seeing 8 patients in 2 hours.
His total revenue is $1,200.00 for a profit of $400.00.
What happens if Dr. D. Kay raises his price to $700.00 per hour? His total revenue
FALLS and so does his profit. His total revenue
is $700.00 and his total cost is $400.00 for a
profit of $300.00. Dr. Kay should not raise
prices.
What if Dr. D. Kay lowers his price to $500.00

per hour? The good doctor would increase his
revenue to $1,500.00 but his profit would fall to
$200.
Dr. D. Kay should keep his price right where it is

at $600.00.
Dr. Kay could see more patients and perhaps do

more good by working four hours. However, his
profits are maxed by working two hours. Does this explain why doctors aren’t open on
weekends and Fridays?
A good is elastic in the range of demand when total revenue increases when the price
decreases or total revenue falls when the price increases.
Elas1 (0) Total Revenue Test
In the table below, compute the total revenue by multiplying price and quantity for each
price and quantity. Next, circle “E” if the price is elastic, “U” if the price is unit elastic,
and “I” if the price is inelastic.
Sample 2. In AP Microeconomics, three factors influence how elastic the response is

to an increase in price. They are 1) Time 2) Percentage of Budget Spent on the Good 3)
The Number of Substitutes for the Good. For example, the need for air conditioning is
more elastic in winter where the temperatures are below zero than in summer when the
temperatures are above 100 degrees. Salt has few substitutes and is inexpensive. It is
unlikely that consumers will change their demand for salt if salt increases in price. Salt is
inelastic.
Elas2 (0) Three Elements of Elasticity
In the problems below, which factor of elasticity most probably describes the good’s
elasticity.
a. A heart patient’s demand for Aortacin, a medicine that keeps the heart beat rhythmic.
_____________________
b. Plastic surgery for breast implants.
_____________________
c. A caffeine addicts need for caffeine now.
_____________________
d. The need for medical attention for a patient who lops his hand off sawing wood.
____________________
e. The price of a 20¢ can of peas goes up a penny.
____________________
f. The opera La Boheme ticket prices sell for $100 each, but all tickets sell out to a
wealthy clientele.
____________________
g. Cable television increases its service cost by a $1, and hundreds start renting DVDs.
____________________
h. Gas prices are driven up to $4 a gallon, and millions start carpooling to work.
____________________
Elas3 (3)
Billy Soundoff claims that oil companies are a monopoly because he observes profits of
big oil going up when the price of crude oil goes up. He claims that Big Oil can raise
prices and therefore raise profits. Sketch a demand, marginal
revenue, and marginal cost curve and use the concept of
elasticity to show that a monopoly would never operate on the
inelastic portion of the demand curve. Show that a monopoly
only operates on the elastic portion and thus could not raise
price without sacrificing profit.
Sample 3 The Mid Point Formula
Economists rely on observation to explain behavior. To quantify a consumer’s response

to a price change, the College Board uses a mid point formula to determine is demand is
elastic, unit elastic, or inelastic.
If the price of Hungry Harry Porkchops raises fro $6 to $7 and the quantity falls from 20
to 10, the price elasticity of demand, PED equals 4 2/3. The chops are very elastic.
If the price of Ugly Ducklings increases from $2 to $3 and the quantity demanded
changes from 14 to 12, the PED equals .46. Ugly
Ducklings are inelastic.
Elas4 (0)
Use the midpoint formula to calculate the price elasticity of

demand for points, AB, BC, CD, and DE. Calculate the
price elasticity of demand at point A and E.
Sample 4 Cross Elasticity
Goods that are consumed together are complementary goods. Chicken and beef are
substitutes. When the price of peanut butter goes up, people buy less peanut butter and
less jelly. The demand for jelly decreases. A good is a complementary good when the
cross elasticity of demand is negative. A good is a sub when the cross elasticity is
positive. Sally always has cream in her coffee. When the price of coffee increased 10%,
Sally decreased her consumption of cream by 5%. Coffee and cream are complements
for Sally.
Juan is a socialite. For Juan espresso is a substitute latte. When the price of espresso
increases 8%, Juan’s demand for latte increases 10%.
The general formula is given to the left. If the result of the

change in demand for good A divided by the change in the price
for good B is positive, the goods are subs. Otherwise, comp’s.
Elas5 (0)
Complete the table using the Xed formula above.
Good A Good B Xed Sub?

Comp?
Shoes Socks
Qd -8% $P +6%
Pens Pencils
Qd +10% $P +12%
Corn Soybeans
Qd +12% $P +16%
Books Kindle
$P +3% Qd +9%
Review: The total revenue test.
It’s easy to know if a good is elastic. Simple find

total revenue at a price and quantity then raise the
price. Calculate total revenue again. If total
revenue falls, the price is elastic in that range.
Sample 5 Income Elasticity
When your income goes up, do you buy more or

less of a good, say, hotdogs? If you buy more, the
good is a normal good. If you buy less, the good
is an inferior good.
Juan’s boss just gave him a $1 and hour raise. As a result of this wage increase, Juan’s
income goes up. Juan buys more downloads from the iTunes store. For Juan, downloads
are a normal good. If, for example, Juan’s income increased 10% and his downloads
increased 3%, Juan’s income elasticity is +.3 = 3%/10%. Since the result of this ratio is
positive. Downloads are a normal good.
If the good is inferior, than quantity demanded, Qd,

will be negative. A negative income elasticity indicates
that the good is inferior. A positive income elasticity
indicates that the good is normal.
Elas6 (0)
Income Qd Yed Normal?

Inferior?
+Y 3% -10% Head Cheese
+Y 6% +5% Breakfast Bars
-Y 20% +12% Marconi
+Y 50% +64% Diamonds
-Y 35% +40% Ramen Noodles
Sample 6 Elasticity of Supply
Supply can be elastic, inelastic, unit elastic, perfectly inelastic or perfectly elastic. You
might have guessed that the formula is:
Suppose that red roses at Valentine’s Day increasing by

5% and the quantity supplied, QS, increases by 10%.
Roses are elastic in this range.
Elas7 (0)
In the graph below, calculate the price elasticity of supply from point A to B and A to C.
a. Price Elasticity of Supply AB. _______
b. Price Elasticity of Supply AC. _______
Elas8 (1)
Explain why a Snickers Bar has more subs, and therefore more elastic, than candy bars.
Elas9 (0)
Draw a perfectly inelastic supply curve in red and a perfectly elastic supply curve in blue
below.
Elas10 (0)
List at least factors that influence the elasticity of supply.
a.
b.
c.
Solutions
Elas1
Elas2
a. Subs, time b, c, d time e. subs, f. % of budget g and h subs.
Elas3
The monopolist produces where MR=MC which always results in a price on the elastic
portion of the curve.
Elas4
AB 7 BC 1.67 CD 1.67 DE 1/7
Elas5 (Table)
Good A Good B Xed Sub?

Comp?
Shoes Socks -8/6 Comp
Qd -8% $P +6%
Pens Pencils +10/+12 Sub
Qd +10% $P +12%
Corn Soybeans +12/+12 Sub
Qd +12% $P +16%
Books Kindle +3/+9 Sub
$P +3% Qd +9%
Elas6
Income Qd Yed
Normal?
Inferior?
+Y 3% -10% Head Cheese -3.3 Inferior
+Y 6% +5% Breakfast Bars .83 Normal
-Y 20% +12% Macrooni .6 Inferior
+Y 50% +64% Diamonds 1.28 Normal
-Y 35% +40% Ramen Noodles -1.14 Inferior
Elas7
a. Price Elasticity of Supply AB. _.55__
b. Price Elasticity of Supply AC. _1.11_
Elas8
There are more subs for a specific candy bar like Snickers. There are no subs for candy
bars. For example, you could sub a Baby Ruth, Reeses Peanutbutter Cup, or Milky Way
for a Snickers. What would be a reasonable sub for the broad category “Candy Bars”?
Elas9
Elas10
a. Time to change plant or facility

b. Time to get resources
c. Excess capacity
d. Ease of factor substitution
e. Stocks of resources in the production process
Elas10
The three factors influencing the elasticity of supply are: the price of the product from
which the inputs are derived; the amount of time involving in changing supply; and the
price of complementary inputs.
Production Costs Name _________________________
Sample 1 Production Function
The firm’s production function shows how output

is related to labor inputs. As more labor is added
to a fixed resource such as a machine, less is
produced. This is important because labor is
expensive. Costs rise exponentially. For the AP
Exam, it’s important to know that total product
increases at a decreasing rate.
Sample 2 Marginal and Average Products
Marginal Product, MP, is found by

taking the slope of the Total
Product curve. Average Product,
AP, is found by dividing Total
Product by the quantity of labor.
The table shows the calculations.
When MP is above AP, AP is

rising. When MP is below AP, AP
is falling. The MP curve intersects
the AP curve when AP is at the
maximum. Can you give an
intuitive reason why the two curves
must intersect at the maximum AP
curve? Economists like to talk
about the Average Margin Rule to
describe this relationship. If you
equate AP to your GPA, then you
know higher grades in your classes
rise your GPA and lower grades lower your GPA. Because diminishing marginal returns
set in after the second worker, the marginal product pulls the AP curve down.
Costs1 (0)
Use the data contained in the graph for Sample 1 to construct the MP and AP curves.
Draw the MP is red and AP in brown.
Costs2 (0)
Use the data contained in the graph for Sample 2 to construct the Total Product curve.
Sample 3 – Returns to Scale
Using two labor resources results in increasing returns

to scale. After two units of labor are employed,
diminishing marginal returns set in. The fifth worker
adds negative returns.
Costs3 (0)
On the graphs for Costs1 and Costs2, show increasing returns to scale and decreasing
returns to scale.
Sample 4 – Cost Curves
How are the total product curve and marginal product curve related? When marginal
product is at its peak, marginal cost is at the lowest point as the table shows.
Labor TP FC VC TC MC MP
0 0 10 0 10
1 3 10 5 15 1.6 3
2 9 10 10 20 .834 6
3 14 10 15 25 1 5
4 18 10 20 30 1.25 4
5 21 10 25 35 1.6 3
6 23 10 30 40 2.5 2
Sample 5 – AFC, AVC, and ATC
The table data has been plotted on the graph to the left. The rapidly decreasing
slope is due to spreading of fixed costs over a range of output.
Average Variable and Average Total Costs
Costs4 (0)
Complete the table below.
Labor TP MP AP FC VC TC AFC AVC ATC
0 0 8 0
1 6 8 5
2 14 8 10
3 24 8 15
4 32 8 20
5 38 8 25
6 42 8 30
7 44 8 35
Costs5 (0)
Use the data from Costs4 to graph AVC and ATC.
Solutions
Costs1(0)
Although the solution does not resemble the example, MP and AP intersect at the apex. Diminishing
marginal returns are pulling the average product curve down just as the theory predicts.
Costs2 (0)
It’s important to note that the curve increases at a decreasing rate. Of interest to me is how labor combines
with capital to produce output. For some workers the capital might
hinder their output while others can create a monument.
Costs3 (0)
On both graphs, diminishing returns set in immediately.
Costs4 (0)
Labor TP MP AP FC VC TC AFC AVC ATC

0 0 8 0 8
1 6 6 6 8 5 13 1.33 .83 2.17
2 14 8 7 8 10 18 .57 .71 1.28
3 24 10 8 8 15 23 .33 .62 .95
4 32 12 8 8 20 28 .25 .625 .875
5 38 6 7.6 8 25 33 .21 .65 .86
6 42 4 7 8 30 38 .19 .71 .90
7 44 2 6.2 8 35 43 .18 .795 .977
Costs5 (0)
AVC and ATC
2.5
1.5
Costs
AVC
1 ATC
0.5
0
0 2 4 6 8
Quantity
Externalities and Market Failure Name ______________________
Sample 1 – Positive Externalities
Wanda and Willy like to make their house look like a winter wonderland during winter.
They decorate their home with tasteful lights and reefs. Ralph Rider gets tremendous
pleasure from his neighbor’s work but he incurs none of the cost. Economists say that
Wanda and Willy’s displays “spillover” to Ralph. If there are many more neighbors like
Ralph, society would benefit from more winter lights and reefs. Therefore, in the case of
a positive externality, the good is “under produced”.
To induce Wanda and Willy and other

neighbors to put up more lights and reefs, the
government can give energy credits or tax
breaks that effectively lowers the cost. Perhaps
the credits are $2. Since the cost is artificially
lowered the MSC does not shift, but the quantity
increases from 4 to 5. The MSB curve shifts to
the right to restore equilibrium at point 2.
Classic positive externalities include smoke

alarms, flu shots, and education.
Sample 2 – Negative Externality
Michael is a crystal meth addict who has to steal to support his habit. Furthermore, drug
enforcement incarcerates Michael and the state suffers from the burden of rehabilitation
and social medicine. Michael’s addiction has “spill over” costs that are imposed on
family members, law enforcement officials, and social services. From society’s
standpoint, crystal meth is over produced and represents a negative externality.
Economists recommend placing a Pigouvian Tax

on the sale of meth, say $3. This corrective tax
will shift the supply of meth to the left from point
1 to point 2 and increase the price. Now less is
demanded. Since the distribution of meth is
illegal, perhaps the tax comes in the form of a
longer prison sentence or more community
service. The socially optimal output is arrived at
when MSB=MSC.
Classic negative externalities are: pollution,

noise, and flu.
Extern1 (0)
Answer each question “True” or “False”.
____ 1. A negative externality has MSC > MPC.

____ 2. A positive externality is over produced.
____ 3. A Pigouvian Tax corrects a positive externality.
____ 4. When MSB is greater than MPB a negative externality exists.
____ 5. The socially optimal output occurs where MSC = MSB.
Extern2 (0)
Sally Greene has organized a girl group to clean up the city. Many citizens in Sally’s city
wish that she could do more clean up especially along the river. Use the graph below to
show the socially optimal equilibrium if Sally is given an incentive of $3 per hour of
cleanup.
a. Is this a positive or negative externality? ____
b. Should the city subsidize or tax this externality

to achieve the socially optimal output? ________
c. What are some of the spill over externalities

that the city might experience? ______________
Extern3 (0)
Tiny Tim drives a compact car he calls the “bug”. When

he drives up to a dangerous intersection, huge pick up
trucks pull up along side of him and he can’t see on
coming traffic. For Tim, this generates an externality. If
there are hundreds like Tim and they lobby to tax big
trucks, show the new equilibrium on the graph below if
the city levies a tax of $3 per unit.
a. Is the situation described a positive or negative

externality? _________
Sample 3 – Moral Hazard and Adverse Selection
A moral hazard occurs when one party can shift the cost of their actions onto another. A
moral hazard happens after perverse incentives are misaligned. Adverse selection
happens before another event. A classic moral hazard is the seat belt law which
prompted drivers to drive faster. A classic adverse selection case is when someone buys
life insurance after they are diagnosed with a life threatening illness. The difference
between the two is in the time. In both cases the risk and costs have been shifted to
another party who has asymmetrical information.
Extern4 (0)
In each case below, place “MH” if the event describes a moral hazard and “AS” if the
event describes adverse selection.
____ 1. Banks make many sub-prime loans because the FDIC guarantees payment to
bank in the event of default.
____2. Juan puts sells his car when Maheep offers him more than the car is worth even
though the car has a bad ignition.
____3. Because condoms are distributed free at school, Larry engages in more sex than
he would otherwise.
____4. Pete is always broke and keeps spending knowing that his mom will bail him out
with a loan.
____5. Mike does not work to prepare lessons after he earns tenure at Dukes of Hazard
Community College.
____6. ISU’s pet agricultural project on Ethanol is funded even if it is a failure.
____7. Mary does what she wants to do at work because her father is the owner.
____8. Scott, a heavy meth user, applies to work at Barry’s Bar and Grill since they
don’t drug test.
____9. Jim gets a credit card offer in the mail and immediately activates the card even
though he’s deeply in debt.
___10. Every student in Professor Hurt’s class gets at least a B in the class. Kathy is in
Professor Hurt’s class and never studies.
___11. Iowa has a no-fault divorce law. Paris and Astro get married with the idea that
they can easily divorce if they want to.
Sample 4 – Free Rider
A free rider is someone who gets all of the benefits without any of the cost. Free riders
benefit when the good consumed is nonexcludable like national security.
Extern5 (0)
Harry claims that if there were no government no private individual would have the
incentive or the means to provide public education and national defense. Explain in 50
words or less if you agree or disagree with Harry.
Extern6 (0)
On the graph below, sketch the market for gasoline. Assume that exhaust exerts a cost on
third-party individuals who are neither buyers nor sellers of gasoline. Label all curves.
Solutions
Extern1 1. T 2. F 3. F 4. F 5. T
Extern2 Positive, Subsidize, Cleaner and healthier town, equilibrium price is $5 and
quantity is 7
Extern3 $4, negative
Extern4 2, 8 and 9 are adverse selection. The rest are moral hazard.
Extern5 Agree. There would be free riders if someone provided the good itself.
There’s no incentive to produce when all of the benefits accrue to free riders.
Extern6 Anything that looks like Sample 2.
Basic Concepts MACRO Name _______________________
Sample 1 – Unemployment Rate
Let’s begin with the population. That is every man, woman, and child. Now we subtract
those in the military, retired, and those under the age of 16. This is the Civilian Non-
Institutionalized Population. Next, we subtract from CINP those who have given up
looking for work or discouraged workers. We have now derived the Civilian Labor
Force, LF. The labor force is composed of the unemployed plus the employed. The
unemployment rate is found by dividing the number of unemployed by the labor
force. The employment rate is found by dividing the number of employed by the
labor force by the Civilian Non-Institutional Population. Finally, the Labor Force
Participation Rate is found by dividing the Labor Force by the Civilian Non-
Institutional Population.
Basic1 (0)
The data below is from the FRED data base hosted at the St. Louis Federal Reserve Bank.
All data is in thousands, (000). This data can be directly obtained at:
http://research.stlouisfed.org/fred2/categories/12. The series ID is at the top of each
header.
CNP160V CIF160V CE160V UNEMPLOY Year

CINP LF Employment Unemployment
224837 148029 140245 7784 2005
227553 150201 143142 7059 2006
230650 153117 146032 7085 2007
232616 154048 146421 7628 2008
234739 154140 142221 11919 2009
236832 153170 138333 14837 2010
For each year in the table above compute the unemployment rate, employment rate, and
the labor force participation rate.
Unemployment Employment Labor Force Year

Rate Rate Participation Rate
2005
2006
2007
2008
2009
2010
Basic2 (0)
Graph the unemployment rate below using your calculation for Basic1.
A recession often is accompanied by

high unemployment. In what year,
would you opine the recession
began? _______
The natural rate of unemployment is

5%. In what year was the economy
operating at its natural rate of
unemployment? _____
Sample 2 – Inflation Rate
The inflation rate is simply the change in the Consumer Price Index, CPI, from year to
year. For example, if the CPI this year is 112 and the CPI last year was 110, the inflation
rate is 1.8%. A healthy inflation rate is 2%.
Basic3 (0)
The data series is found at http://research.stlouisfed.org/fred2/graph/?id=CPIAUCSL.
Specifically, the series is CPIAUCSL, the Consumer Price Index All Urban Consumers
All Items. Complete the table by calculating the inflation rate.
Year CPI Inflation Rate

2005 191.6
2006 199.2
2007 203.4
2008 212.23
2009 211.96
2010 217.6
Basic4 (0)
Graph the inflation rate you calculated in Basic3. Use the graph below.
a. When the economy was at its natural rate, what was the inflation rate? __________
b. When the unemployment rate was

9.7%, what was the inflation rate?
_________
c. When the unemployment was 4.7%,

what was the inflation rate? ___________
d. In periods of high unemployment, what

do you predict the inflation rate to be,
(high or low)? ___________
Basic5 (0)
Carls Badd loves country and western

music. He swears that there’s a relationship between the number of sad love ballads and
the state of the economy. For the years 2005, 2006, 2007, 2008, 2009, and 2010, Carls
has kept track of the sad songs played on his favorite station, KWBOOHOO in Ames,
Iowa. The table below has his results. Calculate the rate of change in sad songs. Does
Carls Badd theory hold true?
Year Sad Songs Change in Sad Songs

2005 832
2006 800
2007 784
2008 800
2009 840
2010 889
Sample 3 Changing the base
Suppose that the CPI for 5 years for the country of Omega is contained in the table
below.
Year CPI
1 100
2 110
3 120
4 130
5 140
To make year 3 the base year, divide 120/120 and multiply by 100. Next divide, 120 by
120 and multiply by 100, divide 140 by 120 and multiply. To find year index, divide 110
by 120 and multiply by 100. Repeat for year 1. The new index is:
Year CPI
1 83
2 91
3 100
4 108
5 117
Basic6 (0)
Calculate the inflation rate from year 1 to 5 in each table above. Does the selection of the
base year make a difference in the inflation rate? ________
Sample 4 -- Deflator in Action
The table below combines many basic concepts. Real GDP can be calculated by taking
current year output at base year prices or dividing nominal GDP by a price index. The
GDP Deflator is found by dividing nominal GDP by real GDP. Assume that a
cheeseburger is the only good made. See if you can discover how the data interacts with
each other to construct a picture of the economy. Real GDP (AP Way) is found by
dividing nominal GDP by the price index. In year 1, the price index equals 1 ($50/$50),
in year 2, the price index equals 1.2 ($12/$10).
Year Price Quantity NGDP RGDP GDP Deflator RGDP

(AP Way)
1 $10 5 $50 $50 1 $50
2 $12 6 $72 $60 1.2 $60
3 $14 8 $112 $80 1.4 $80
4 $13 7
5 $14 9
Basic7 (0)
Complete the table in Sample 4 for years 4 and 5.
Basic8 (0)
Using the same data as Sample 4, change the base year to year 3. Recalculate the table.

(AP Way)
1 $10 5
2 $12 6
3 $14 8
4 $13 7
5 $14 9
Basic9 (1)
Calculate the real GDP for each year. (NGDP figures are in billions.)
(GDPDEF) (GDPA) Year Real GDP

GDP Deflator NGDP
88 10286 2001
89 10642 2002
91 11142 2003
91 11868 2004
93 12638 2005
95 13398 2006
98 14078 2007
102 14441 2008
105 14256 2009
Sample 5 – Real Interest Rates
The real interest rate is computed by taking the nominal interest rate minus the expected
rate of inflation. If the nominal interest rate is 10% and the expected rate of inflation is
7%, then the real interest rate is 3%.
Basic10 (0)
Complete the table below using Sample 5 as an example.
Real Interest Rate, r Nominal Interest Rate, i Expected Rate of Inflation, πe
8 2
5 10
3 4
3 2
Basic 11 (0)
The table below has had the quantities changed. The intent of this exercise is show how
assumptions made as to the typical quantities consumed by the average consumer,
changes the CPI. Complete the table with the new quantities. How does the GDP
Deflator, nominal GDP, and real GDP change?

(AP Way)
1 $10 8
2 $12 5
3 $14 7
4 $13 9
5 $14 10
Basic 12 (0)
The CPI assumes that the quantities do not change from period to period.
Microeconomics
predicts that a higher
price of a good, say
cheeseburgers, will lead
to a substitution of a
cheaper product such as
soybean burgers. Some
economists assert that
the CPI does not take
into account the
substitution effect and
overstates the CPI. In the space below, explain what those economists mean when they
say the CPI is overstated.
Basic 13 (3)
You are given the following data. Calculate the CPI for Year 1, 2, and 3.
Year 1 Year 2 Year 3

Item $P Q Expenditure $P Expenditure $P Expenditure
A 3 8 3.2 3.1
5 5
B 6 20 6.5 6.7
5
C 5 6 4.5 4.5
Totals
Index
Solutions
Basic1
Unemployment Employment Labor Force Year

Rate Rate Participation Rate
5.25% 62.3% 65% 2005
4.69% 62.9% 66% 2006
4.62% 63.3% 66% 2007
4.95% 63.3% 66% 2008
5.1% 60.5% 65% 2009
9.6% 58.4% 64% 2010
Basic 2
Basic 3
Year CPI Inflation Rate

2005 191.6 ---------------
2006 199.2 3.9%
2007 203.4 2.1%
2008 212.23 4.3%
2009 211.96 0%
2010 217.6 2.8%
Basic 4
Inflation Rate
a. 2009
b. 9.6%
5.00% c. 7.5%
4.00% D. Inverse relationship between
unemployment and inflation.
Inflation Rate
3.00%
2.00% Inflation Rate

Data weakly confirms this.
1.00%
0.00%
2005 2006 2007 2008 2009 2010 2011
-1.00%
Year
Basic 5
Year Sad Songs Change in Sad Songs

2005 832
2006 800 -3.8%
2007 784 -2%
2008 800 2%
2009 840 5%
2010 889 5.8%
Sad songs seem to be related to the state of the economy.
Basic 6
The inflation rate is still 40%. The choice of base doesn’t change the inflation rate but
changes the index.
Basic 7

(AP Way)
1 $10 5 $50 $50 1 $50
2 $12 6 $72 $60 1.2 $60
3 $14 8 $112 $80 1.4 $80
4 $13 7 $91 $70 1.3 $70
5 $14 9 $126 $90 1.4 $90
Basic 8

(AP Way)
1 $10 5 $50 $70 71.4 $70
2 $12 6 $72 $84 85 $84
3 $14 8 $112 $112 100 $112
4 $13 7 $91 $98 92 $98
5 $14 9 $126 $126 100 $126
Basic 9
(GDPDEF) (GDPA) Year Real GDP

GDP Deflator NGDP (billions)
88 10286 2001 11688
89 10642 2002 11957
91 11142 2003 12243
91 11868 2004 13041
93 12638 2005 13589
95 13398 2006 14103
98 14078 2007 14365
102 14441 2008 14157
105 14256 2009 13577
Basic 10
Real Interest Rate, r Nominal Interest Rate, i Expected Rate of Inflation, πe

6 8 2
5 10 5
3 7 4
1 3 2
Basic 11

(AP Way)
1 $10 8 $80 $80 100 $80
2 $12 5 $60 $50 120 $50
3 $14 7 $98 $70 140 $70
4 $13 9 $117 $90 130 $90
5 $14 10 $140 $100 140 $100
Basic 12
Economists mean that the CPI reports that inflation is higher than it actually is. Since
consumers will buyer the cheaper product, inflation doesn’t hurt the consumer as much as
the index suggests.
Basic 13
Year 1 Year 2 Year 3

Item $P Q Expenditure $P Expenditure $P Expenditure
A 3 8 24 3.2 26 3.1 25.2
5 5
B 6 20 120 6.5 130 6.7 135
5
C 5 6 30 4.5 27 4.5 27
Totals 174 183 187.2
Index 100 105 108
Aggregate Demand/Supply Name _____________________________
Sample 1—Real Balances
One reason why aggregate demand slopes downward and to the right is the Real Balances
Effect. When the price level declines, your savings becomes worth more and your
buying power is boosted. For the macro economy, the real balances effect can be
illustrated as shown.
To interpret, suppose that Harriet has $5,000 in cash,

and $10,000 in non monetary assets (car, computer,
and Android). What is the value of her real balances
when the price level is 120? Simply add her assets
together, $15,000, and divide by the price level and
multiply by 100. The value of her assets when the
price level is 120 is $12,500. The value of her real
balances when the price level is 100 is $15,000. As
the price level falls, Harriet’s buying power increases
causing her quantity demanded to increase from Q1 to
Q2. When the price level increases, her buying power decreases and the quantity
demanded falls. Notice that this is a movement along the curve since the only variable
that is changing is the price level.
AD1 (0)
Assume that Harriet has $15,000 in cash and assets. Compute Harriet’s real balances for
each price level in the table below.
Price Level Real Balance

80
90
100
110
AD2(0)
Suppose the price level changes from 123 to 125. What is the inflation rate? _________
Sample 2 – Interest Rate Effect
What is not spent is saved. So when the price level falls, the consumer buys a fixed
market basket and save the rest. The supply of savings increases and interest rates fall.
The lower interest rates induce more business investment and household consumption of
durable goods. The quantity demanded of real GDP increases.
Suppose that when the price level is 120 the interest rate is 8% . This means that for
every $100 dollars a consumer or business borrows, they will pay back $8. If HNI
borrows $10 million to finance capital restructuring, they will pay in interest $800,000.
If the price level drops to 100 and consumers save more, HNI will only pay $600,000 in
interest. This interest rate effect also works in reverse.
AD3 (0)
How much interest would HNI have to repay if they wanted to borrow $10 million and
the interest rate was 4%? _____________
Sample 3 – Foreign Purchases Effect
When the price level is higher in Alpha than the price level in Beta, it’s cheaper for Alpha
consumers to buy from Beta. It’s like buying at Walmart* a pair of shoes for $10 instead
of buying the shoes at Shoe Carnival for $20. So Alpha citizens buy less domestic goods
and the quantity demanded
decreases. In the example,
the price level for Alpha
increases from A to B. Alpha
and Beta consumers find it
cheaper to buy from Beta so
the quantity demanded falls
from Q3 to Q2.
AD4 (0)
Explain how the foreign purchases effect would work if the price level in Alpha
decreased.
Sample 4 – Aggregate Demand Shifts
When the price level changes, the economy moves along the aggregate demand curve for
three reasons. In other words, the quantity of aggregate demand changes as the price
level changes. But the AD curve can shift because
of exogenous variables. Anything that changes
spending shifts the AD curve. So any change in C,
I, G, or Nx shifts the curve. A change in personal
taxes and expectations of future prices will shift the
curve. When people feel wealthier, they spend
more. So if the value of their assets or their income
changes, AD shifts. One example will explain.
Suppose the economy is at point B. If consumers
spend more, business increase their investment, or
the government increases its spending, the AD will
shift to the right to point D. The same shift would
have happened if personal income taxes were reduced, consumers felt that prices were
going to be higher in the future, or stock market assets were increasing. If the USD were
depreciating, the AD would shift from AD to AD1.
AD5 (0)
Event PL (U or D) AD (U or D) Real GDP (U or D)

1. Personal income taxes decrease
2. Consumer confidence spurs increased
spending
3. Housing values skyrockets
4. Businesses become pessimistic about the
future
5. The USD rapidly appreciates because of
higher domestic interest rates
6. Government slashes military spending
7. iPods become the rage around the world.
Domestic exports increase
8. The money supply increases along with
consumption
9. The government pursues contractionary
Fiscal Policy
10. A lower reserve ratio spurs more lending to
business. Investment increases
11. U. S. goods suddenly become attractive to
foreigners
12. Businesses become optimistic about future
sales
13. Foreign income increases
14. Business taxes increases. Businesses
expect lower profits
15. Consumer spending on durables declines
16. USD appreciates relative to foreign
currencies
17. Personal income taxes decline
18. Wealth increases because of higher stock
market values
Solutions
AD1
Price Level Real Balance

80 18750
90 16666.67
100 15000
110 13636.37
AD2
The inflation rate is 1.62%
AD3
The interest is: $400,000
AD4
The USD would appreciate as more US goods would be demanded by foreigners. Net
exports would increase. AD would shift to the right.
Event PL (U or D) AD (U or D) Real GDP (U or D)

1. Personal income taxes decrease Up U Right Up
2. Consumer confidence spurs increased Up U Right Up
spending
3. Housing values skyrockets Up U Right Up
4. Businesses become pessimistic about the
future
5. The USD rapidly appreciates because of Up U Right Up
higher domestic interest rates
6. Government slashes military spending Down D Left Down
7. iPods become the rage around the world. Up U Right Up
Domestic exports increase
8. The money supply increases along with Up U Right Up
consumption
9. The government pursues contractionary Down D Left Down
Fiscal Policy
10. A lower reserve ratio spurs more lending to Up U Right Up
business. Investment increases
11. U. S. goods suddenly become attractive to Up U Right Up
foreigners
12. Businesses become optimistic about future Up U Right Up
sales
13. Foreign income increases Up U Right Up
14. Business taxes increases. Businesses Down D Left Down
expect lower profits
15. Consumer spending on durables declines Down D Left Down
16. USD appreciates relative to foreign Up U Right Up
currencies
17. Personal income taxes decline Up U Right Up
18. Wealth increases because of higher stock Up U Right Up
market values
Aggregate Supply Name ______________________
Sample 1 – Slope of AS Curve
When employees enter into long-term contracts that last for years, changes in the price
level leave the employee sometimes better off and sometimes worse. Suppose Juan signs
a contract to roof houses at $100,000 a year. During the time Juan signs the contract to
the duration, the price level rises fro 150 to 175. Juan’s real earning power declines from
$66,667 to $57,143. Since Juan has signed a contract, his wages are “sticky” as he’s
unable to renegotiate a higher wage in response to a higher price level. However, some
roofers who do not have contracts can raise their prices so that their earnings keep up
with inflation. Sticky wages are a reason why the aggregate supply curve slopes upward.
Likewise, restaurant owners who print expensive menus cannot change their prices in
response to rising prices because of the cost of reprinting menus. Economists refer to
“sticky” prices to describe the restaurant’s response. Yet, some restaurants can change
their prices. Sticky prices are a reason why the aggregate supply curve slopes upward.
Both sticky prices and sticky wages are often used to

describe the slope of the aggregate supply curve. The AS
curve slopes upward and to the right because of sticky wages
and sticky prices.
Sellers routinely believe that they have marked up prices to

keep up with inflation, but economists generally agree that
the producer has underestimated the inflation rate. The
producer produces more as she thinks that she’s keeping up
with inflation. Thus, as the price level increases, some producers make more because
they underestimate the inflation rate. Producer misperceptions are another reason why
the aggregate supply curve slopes upward.
Workers often mistake a raise in their nominal wages with a raise in their real wage rate.
Say that Harry gets a 2% wage increase, but the inflation rate is 5%. Harry’s real wage is
3% lower, but because he misperceives his wage increase as a increase in his real
earnings, Harry works more. Worker misperceptions are another reason the aggregate
supply curve slopes upward.
Sample 2 -- A Horizontal Aggregate Supply Curve
One interpretation of price rigidity is that the AS curve is flat. A flat AS curve infers that
prices are sticky and inflexible downward. I interpret the horizontal AS curve to mean
that there are many idle resources. Since resources
are idle, they come into production at little
opportunity cost so the price of these resources do
not increase. Still, one can interpret the flat AS
curve to mean that in the short run firms simply
meet demand because they are unsure if the demand increase reflects consumer
preferences for their product or a rise in the price levels.
Sample 3 AS Shifts
The AS curve captures the relationship between the price level and real GDP. Changes in
technology, cost of resources, and supply shocks can shift the curve. For example, an
increase in wages paid to labor will shift the AS curve to the
left. If labor becomes more productive, the AS curve will
shift to the right. In AP Macroeconomics, an adverse supply
shock comes from a rise in oil. A positive supply shock
might be the technology of the Internet. In the graph, AS
shifts to the right when resources become cheaper, or a new
technology improves productivity of labor, or there is a
positive supply shock.
AS1 (0)
List the reasons why the AS curve slopes upward and to the right. Explain why each
reason contributes to the slope.
AS2 (0)
On the graph, show a beneficial supply shock.
AS3 (0)
On the graph, show the effects of a decrease in wage rates.
AS4 (0)
On the graph, show an increase in the price level.
AS5 (0)
In the short run, what is the impact on the price level, real GDP, and employment in each
case. Assume an upward sloping AS curve.
Event PL RGDP UnRate

A Wages decrease
B Marginal Product of Labor Increases
C Oil price rise dramatically
D A decline in productivity
E Positive supply shock
F Non labor inputs increase
AS6 (0)
Calculate Juan’s real wage rate at each of the price levels in the table.
Price Level Nominal Wage Real Wage

a 112 $10
b 116 $10
c 125 $10
Solutions
AS1 See Samples
AS2 A new AS curve should be drawn to the right of the original
AS3 A new AS curve should be drawn to the right of the original
AS 4 The students should show a movement along the curve
AS5
Event PL RGDP UnRate

A Wages decrease Down Up Down
B Marginal Product of Labor Increases Down Up Down
C Oil price rise dramatically Up Down Up
D A decline in productivity Up Down Up
E Positive supply shock Down Up Down
F Non labor inputs increase Up Down Up
AS6
Price Level Nominal Wage Real Wage

a 112 $10 $8.93
b 116 $10 $8.62
c 125 $10 $8.00
Long Run Supply Macro Name ___________________________
Sample 1 – Theory
There’s a tendency for a body to come to a rest. When nothing is changing, the body is at
rest or in equilibrium. In
Macroeconomics, when the labor
market is in equilibrium, nothing is
changing, then the economy is in long-
run equilibrium. The graph below
shows the change in the
unemployment rate and the GDP
growth (%) from 1990 to 2010.
(FRED series UNRATE and GDP1
annual data.) Notice that when the
unemployment rate is zero, the
economy is growing at about 3.5%.
At a natural growth rate of 3.5%, real GDP was $12,000 billion in 2005-2006. If the
economy was growing at less than 3.5%, unemployment is increasing. At growth rates
greater than 3.5%, unemployment is decreasing. When the economy is at a growth rate
greater of less than 3.5%, the economy must not be at the natural rate of unemployment.
Sample 2 – The Natural Rate of Employment
A body is in equilibrium when it is at rest. When GDP is changing at 3.5%, then the
labor market should be in equilibrium since labor is used to make GDP. Using the FRED
data base, series UNRATE and GDP1),
graphed this relationship.
This graph shows that when

approximately 6.2% of the labor force is
actively seeking employment, GDP is
growing at the natural rate.
Sample 3 – Long Run Supply
In macroeconomics, long run supply is shown as a vertical line at the natural growth rate
of GDP. This vertical line captures the essence of a body at rest and a reference point. If
short-run equilibrium is anywhere but on this line, the labor market must be adjusting.
Think of the long run like Goldilocks and the three bears. In a recessionary gap, the
porridge is too cold, in an inflationary gap, the porridge is too hot, and in the long run, the
porridge is just right.
LRS1 (0)
In Alpha, AD intersects SRAS at 5 billion in real GDP. In Alpha, the long run supply is
7 billion. Is Alpha’s economy in a recessionary gap, inflationary gap, or in long run
equilibrium (circle one).
LRS2 (0)
In Alpha, the natural rate of unemployment is 5%. Currently, the unemployment rate is
7%. In Alpha GDP growth is less than, greater than, or equal to (Circle one) the natural
GDP growth rate.
LRS3 (0)
In classical economics, wages and prices adjust to bring the economy into long-run
equilibrium. Show this adjustment on the graph below.
LR4 (0)
In classical economics, wages and prices adjust to bring the economy into long-run
equilibrium. Show this adjustment on the graph below.
AS5 (0)
Use Fiscal Policy to move the economy into long run in each case below.
LR6 (0)
In the graph below, show an increase in consumer confidence that increases AD by 1

billion at every level.
a. In terms of real GDP, what is the new SR

equilibrium?
b. Is the unemployment rate above or below the

natural rate?
c. If the economy is left alone and the classical

economists are right, show the new long run
equilibrium on the graph.
LR7 (0)
In the graph below, show how an increase in real balances changes the AD curve if AD
increases by 1 billion at every level.
a. What is the effect on aggregate output? Explain why a change in AD was only
inflationary.
LR8 (0)
When the quantity of factors of production used to create goods increases, so does the
economy’s ability to increase long run supply. The economy’s productive capacity is
captured in the production possibilities curve. Using the graphs below, show how an
increase in technology would move the PPF and LRS.
LR8 (0)
On the graph below, move AD so that the economy is in long run but not experiencing
inflation. Explain what happens when there are further increases in AD.
Solutions
LRS1 recessionary gap LRS2 less than
LRS3
LRS4
LRS5
AD would increase to 82.5. Workers would ask for a

raise as the labor market is below its natural rate. When
wages increase, the SRAS shifts to the left so that 82
billion in real GDP is produced but at a higher price
level or P1. In the long run the only change is an
increase in the price level.
LRS6
LRS7
When any of the factors of production increases, the PPF shifts to the right and so does
the LRS curve.
LRS8
LRS8

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Problem PPF1 (3)

Lucy has a constant cost of making cupcakes of one

Problem PPF2 (0)

a. If Billy Bob just sheers sheep, how many sheep can

Sample Problem 3 – Increasing Opportunity Cost

In Buffoonia, guns can be

a. What’s the opportunity cost of making the third Wang?

b. Explain why the resources used in making Wonks and

c. Show how the opportunity cost increases as additional

Sample Problem 4 – Efficiency

a. Point F is not obtainable by Johan. What must happen for his

b. If Johan is at Point E, could he paint more watercolors

c. Johan’s girlfriend says that he should only paint oil paintings.

Problem PPF5 (3)

Comp3 (0) Loss Minimizing

Q FC VC TC AVC ATC AFC MC TR π

Comp2 A. $4 B. $6.3 C. $12 D. $5.7 E. $2

Comp3 A. $2 B. -$2.25 C. $3 D. $5.25 E. $3

Comp4 A. $ .50 B. Shut down and lose $4 in fixed costs. C. 0 D. $4 E. $3

Q FC VC TC AVC ATC AFC MC TR π

Sample 1: Perfect Competition

Four dolls will be sold at the price of $2

Sample 2: Pure Monopoly

Two dolls will be sold at $4 dollars. Total

A price discriminating monopolist can sell

Problem MONO1 (0)

a. This is a single-price monopoly.

a. A liquor store that requires a license. ___________________

Problem MONO3 (3)

Buyer Maximum Price

a. If Punky only cares about

b. How many pies are

c. If Punky’s Pies were a

d. What would be the long-

What is the price elasticity of demand between

Sample 4 – Natural Monopoly

A natural monopoly is so big that it supplies the

In the problem below, answer the questions that follow:

The firm still maximizes profit where MR =

MONO6 a. $4 b. 30 c. 120 d. $30 e. .56 f. 45 g. 4.5

Elasticity Name __________________

What if Dr. D. Kay lowers his price to $500.00

Dr. D. Kay should keep his price right where it is

Dr. Kay could see more patients and perhaps do

Sample 2. In AP Microeconomics, three factors influence how elastic the response is

Elas2 (0) Three Elements of Elasticity

Sample 3 The Mid Point Formula

Economists rely on observation to explain behavior. To quantify a consumer’s response

Use the midpoint formula to calculate the price elasticity of

Sample 4 Cross Elasticity

The general formula is given to the left. If the result of the

Complete the table using the Xed formula above.

Good A Good B Xed Sub?

It’s easy to know if a good is elastic. Simple find

Sample 5 Income Elasticity

When your income goes up, do you buy more or

If the good is inferior, than quantity demanded, Qd,

Income Qd Yed Normal?

Suppose that red roses at Valentine’s Day increasing by

a. Price Elasticity of Supply AB. _______

b. Price Elasticity of Supply AC. _______

List at least factors that influence the elasticity of supply.

a. Subs, time b, c, d time e. subs, f. % of budget g and h subs.