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Credit Sprint's Guide to Microeconomics Unit 1: Basic Economic Concepts

AP® weight 12–15%CLEP® weight 10–16%

Scarcity means every choice has an opportunity cost. The production possibilities curve shows the tradeoffs, comparative advantage explains why specialization and trade help both sides, and marginal analysis explains how people and firms make decisions one more unit at a time.

What you need to know

  • Opportunity cost is the value of the next-best alternative given up, not the sum of every alternative.
  • A PPC bowed out from the origin shows increasing opportunity cost; a straight-line PPC shows constant opportunity cost.
  • Points inside the PPC are inefficient (unemployed or misallocated resources); points outside are unattainable with current resources and technology.
  • More resources or better technology shift the PPC outward. A technology gain in only one good pivots it outward along that good's axis.
  • Comparative advantage goes to the producer with the lower opportunity cost. Specialization by comparative advantage raises total output.
  • Terms of trade benefit both sides only when they fall between the two producers' opportunity costs.
  • Make decisions at the margin: keep doing something while marginal benefit ≥ marginal cost.
  • Consumers maximize utility by spending so that MU per dollar is equal across goods (MUx/Px = MUy/Py).
  • Diminishing marginal utility: each extra unit of a good adds less satisfaction than the one before.

Formulas

Opportunity cost of X = (units of Y given up) ÷ (units of X gained)
Utility-maximizing rule: MUx ÷ Px = MUy ÷ Py, with all income spent
Total utility rises as long as marginal utility is positive

Exam traps

Watch forAbsolute advantage ≠ comparative advantage. Trade is based on comparative advantage.
Watch forOn an "output" table, opportunity cost is the other good given up; on an "input" table (hours per unit), the math flips.
Watch forSunk costs are irrelevant to marginal decisions. Only future costs and benefits matter.

Key terms

  • Scarcity: Unlimited wants but limited resources. The reason every person, firm and society must make choices.
  • Opportunity cost: The value of the next-best alternative given up when a choice is made.
  • Production possibilities curve (PPC): The maximum combinations of two goods an economy can produce with its resources and technology.
  • Increasing opportunity cost: Each additional unit of a good requires giving up more of the other. Gives a PPC bowed out from the origin.
  • Productive efficiency: Producing at the lowest possible cost: any point on the PPC.
  • Allocative efficiency: Producing the mix of goods society values most, where marginal benefit equals marginal cost.
  • Absolute advantage: Being able to produce more of a good than another producer with the same resources.
  • Comparative advantage: Producing a good at a lower opportunity cost than another producer. The basis for trade.
  • Terms of trade: The rate at which goods are exchanged. Both sides gain if it falls between their opportunity costs.
  • Marginal analysis: Deciding by comparing the extra benefit and extra cost of one more unit.
  • Marginal utility: The additional satisfaction from consuming one more unit of a good.
  • Diminishing marginal utility: Each additional unit consumed adds less satisfaction than the one before.
  • Utility-maximizing rule: Spend all income so that MU per dollar is equal for every good: MUx/Px = MUy/Py.
  • Sunk cost: A cost already paid that can't be recovered. It should not affect future decisions.

Practice questions

Five of the 40 Unit 1 questions in Credit Sprint. Every choice is explained in the app.

1. Which of the following best describes the basic economic problem of scarcity?
  1. Some goods are never available in stores
  2. Poor countries have fewer resources than rich countries
  3. Prices are too high for some consumers
  4. Governments restrict how much people can buy
  5. Wants are unlimited, but the resources to satisfy them are limited
Show answer

Wants are unlimited, but the resources to satisfy them are limited. Scarcity is the gap between unlimited wants and limited resources.

2. Two countries will both gain from trade if the terms of trade
  1. are above both countries' opportunity costs
  2. favor the larger country
  3. fall between their opportunity costs of producing the traded good
  4. equal the opportunity cost of the exporting country
  5. are set by the country with the absolute advantage
Show answer

fall between their opportunity costs of producing the traded good. Each country then gets the good for less than it would cost to make itself.

3. Apples cost $1 and oranges cost $2. Lena's last apple gives her 8 utils and her last orange gives her 12 utils. To maximize utility, she should
  1. buy only oranges, since they give more total utility
  2. keep buying the same amounts
  3. spend less money overall
  4. buy more apples and fewer oranges
  5. buy more oranges and fewer apples
Show answer

buy more apples and fewer oranges. Apples give 8 utils per dollar; oranges give 6.

4. Which of the following is NOT a factor of production?
  1. Labor
  2. Money
  3. Land
  4. Entrepreneurship
  5. Capital
Show answer

Money. Money is a medium of exchange, not a productive resource.

5. Which statement about absolute advantage is correct?
  1. It is impossible for a country to have it in two goods
  2. It determines the pattern of trade
  3. It means producing a good at a lower opportunity cost
  4. A country with an absolute advantage in everything gains nothing from trade
  5. It means producing more of a good with the same resources
Show answer

It means producing more of a good with the same resources. It compares total output, not opportunity cost.