AP Microeconomics practice questions and exam guide

A firm hiring in a competitive labor market hires labor up to where:

1. MP_L is maximum
2. MRP_L equals zero
3. Average product equals wage
4. MRP_L = wage rate (= MFC in competitive markets)

Answer: D — MRP_L = wage rate (= MFC in competitive markets)

B) Labor hiring rule. A) Wrong criterion. C/D) Incorrect.

Cross-price elasticity > 0 between two goods means:

1. They are complements
2. SUBSTITUTES — a rise in one good's price increases demand for the other (e.g., Coke and Pepsi)
3. Independent
4. Inferior goods

Answer: B — SUBSTITUTES — a rise in one good's price increases demand for the other (e.g., Coke and Pepsi)

Cross-price elasticity = % Δ Q_x / % Δ P_y. Positive: substitutes (butter/margarine). Negative: complements (peanut butter/jelly, smartphones/apps). Zero: unrelated. Magnitude indicates strength. Used in antitrust to define markets.

A Pigovian tax is best described as:

1. A general consumption tax
2. A tax on activities that generate negative externalities, set equal to the marginal external cost — internalizes the externality and restores efficiency
3. An income tax
4. Always counterproductive

Answer: B — A tax on activities that generate negative externalities, set equal to the marginal external cost — internalizes the externality and restores efficiency

Pigovian tax (Arthur Pigou): align private cost with social cost. Examples: carbon tax (climate externality), tobacco taxes (health externalities), congestion pricing (traffic externalities). Theoretically efficient; practically challenging to set tax = exact externality size. Cap-and-trade is the quantity-based alternative.

In the SHORT run, a perfectly competitive firm continues operating at a loss as long as:

1. Price exceeds average variable cost — variable costs are covered and some fixed cost is offset
2. Price exceeds average total cost
3. Total revenue exceeds fixed cost
4. Marginal cost is rising

Answer: A — Price exceeds average variable cost — variable costs are covered and some fixed cost is offset

A) Shutdown rule. B) Then there's profit. C/D) Incorrect criteria.

Country A can produce 10 cars or 20 computers per hour; Country B can produce 5 cars or 15 computers per hour. Country A has comparative advantage in:

1. Cars — its opportunity cost is 2 computers per car vs. B's 3 computers per car
2. Computers — A produces more of them
3. Both — A has absolute advantage in both
4. Neither — opportunity costs are identical

Answer: A — Cars — its opportunity cost is 2 computers per car vs. B's 3 computers per car

A) Lower opportunity cost in cars (2 vs 3). B) Confuses absolute with comparative advantage. C) Absolute advantage in both does not imply comparative advantage in both. D) Opportunity costs differ.

Consumer surplus is the area:

1. Above the demand curve and below the price line
2. Below the demand curve and above the price line, up to the quantity transacted
3. Below the supply curve and above price
4. The total revenue rectangle

Answer: B — Below the demand curve and above the price line, up to the quantity transacted

B) Standard geometric definition. A) Reverses regions. C) That's not CS. D) Different concept.

Why are cartels often unstable?

1. Members typically share information openly
2. Each member has an incentive to cheat by lowering price and capturing more sales at the cartel price
3. Antitrust laws are rarely enforced
4. Demand is perfectly inelastic

Answer: B — Each member has an incentive to cheat by lowering price and capturing more sales at the cartel price

B) Cheating incentive. A) Reverses. C) Off topic. D) Incorrect.

Monopsony in the labor market is:

1. Many buyers
2. ONE major buyer of labor; pays a wage below competitive level and employs fewer workers — analogous to monopoly on the sell side
3. Free labor mobility
4. Many sellers

Answer: B — ONE major buyer of labor; pays a wage below competitive level and employs fewer workers — analogous to monopoly on the sell side

Monopsony: company town, sole local hospital, single major employer. Faces upward labor supply curve → MRC > w. Hires fewer at lower wage than competitive market. Minimum wage in monopsony can INCREASE employment (rare exception to standard model).

Diminishing marginal utility implies:

1. Each additional unit consumed yields less additional satisfaction than the previous unit
2. Total utility falls with the first unit
3. Utility grows without bound
4. Marginal utility is constant

Answer: A — Each additional unit consumed yields less additional satisfaction than the previous unit

A) Diminishing-MU pattern. B/C/D) Each contradicts the principle.

The least-cost rule for input combinations is:

1. MP_L = MP_K
2. Use only labor
3. Use whichever input is cheapest in absolute terms
4. MP_L / w = MP_K / r — equate marginal product per dollar across inputs

Answer: D — MP_L / w = MP_K / r — equate marginal product per dollar across inputs

B) Cost minimization rule. A) Ignores prices. C/D) Incorrect.

A perfectly competitive firm in the SHORT RUN should shut down if:

1. Total revenue < total cost
2. Earnings are zero
3. Price < ATC
4. Price < Average Variable Cost (AVC) — at prices below AVC, the firm loses more by operating than by shutting down (still owing fixed costs)

Answer: D — Price < Average Variable Cost (AVC) — at prices below AVC, the firm loses more by operating than by shutting down (still owing fixed costs)

Short-run shutdown decision: produce if P ≥ AVC (cover variable costs and some fixed). Shut down if P < AVC (lose more by operating). Below ATC but above AVC: loss-minimizing decision is to keep producing. Long-run exit decision: exit if P < ATC permanently.

Demand for insulin tends to be:

1. Highly elastic
2. Unit elastic
3. Inelastic — few substitutes and it is a necessity for diabetics
4. Perfectly elastic

Answer: C — Inelastic — few substitutes and it is a necessity for diabetics

B) Necessity + no substitutes → inelastic. A/C/D) Incorrect.

What is marginal revenue product (MRP) of labor?

Additional revenue from hiring one more worker = MP_L × MR (in PC: MP × P). Firm's labor demand.

Why is the MC curve U-shaped?

Initially declining (specialization), then rising (diminishing returns).

Tax incidence with elastic supply?

Consumers bear most (suppliers easily exit).

If demand for good is highly elastic, who pays more of a tax?

Producers (they can't pass much on to consumers without losing too many sales).

How can government correct negative externalities?

Taxes (Pigouvian), regulations, tradable permits, lawsuits/property rights (Coase theorem).

What happens in long-run perfect competition?

Free entry/exit drives economic profit to zero. P = MC = ATC at min ATC.