AP Microeconomics practice questions and exam guide

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

1. Marginal product of labor reaches its highest possible value
2. Marginal revenue product of labor falls all the way to zero
3. Average product of labor happens to equal the wage rate
4. Marginal revenue product of labor equals the wage rate paid

Answer: D — Marginal revenue product of labor equals the wage rate paid

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

Cross-price elasticity > 0 between two goods means:

1. The two goods in question are complements that consumers nearly always end up purchasing together as a bundle
2. The two goods are substitutes, since a price rise in one increases demand for the other
3. The two goods are entirely unrelated to one another in consumer demand
4. The good in question turns out to be an inferior good

Answer: B — The two goods are substitutes, since a price rise in one increases demand for the other

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 broad tax applied evenly to nearly all consumption in the economy
2. A tax on activities that create negative externalities, set equal to the marginal external cost
3. A tax collected on the income that households and individuals earn
4. A type of tax that always ends up hurting the economy it is applied to, without exception

Answer: B — A tax on activities that create negative externalities, set equal to the marginal external cost

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. As long as price exceeds average variable cost
2. Only once price climbs back above average total cost
3. As long as total revenue exceeds fixed cost alone
4. As long as marginal cost keeps rising over output

Answer: A — As long as price exceeds average variable cost

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, since its opportunity cost is 2 computers per car versus B's 3
2. Computers, simply because Country A can produce more of them overall
3. Both, since Country A has an absolute advantage in each good
4. Neither, because the two countries share identical opportunity costs

Answer: A — Cars, since its opportunity cost is 2 computers per car versus B's 3

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. The area above the demand curve and below the price line
2. The area below the demand curve and above the price line, up to the quantity actually transacted
3. The area below the supply curve and above the price
4. The rectangle representing total revenue collected by sellers

Answer: B — The area below the demand curve and above the price line, up to the quantity actually 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 sensitive cost information with each other openly
2. Each member can profit by undercutting the cartel price
3. Antitrust laws against price-fixing are rarely ever enforced
4. Demand for the cartel's product is essentially perfectly inelastic

Answer: B — Each member can profit by undercutting the cartel price

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

Monopsony in the labor market is:

1. There are many independent buyers actively competing with one another to hire workers in this particular labor market
2. One major buyer of labor who pays a wage below the competitive level and hires fewer workers
3. Workers in this labor market can move freely between employers at no cost
4. There are many independent sellers of labor competing in this particular market

Answer: B — One major buyer of labor who pays a wage below the competitive level and hires fewer workers

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 extra unit consumed brings less added satisfaction than the one before it
2. Total satisfaction actually falls the moment the very first unit is consumed
3. Satisfaction from consumption keeps growing without any limit at all
4. The added satisfaction from each extra unit stays exactly the same

Answer: A — Each extra unit consumed brings less added satisfaction than the one before it

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

The least-cost rule for input combinations is:

1. Marginal product of labor simply equals marginal product of capital
2. Use only labor and no capital whatsoever
3. Use whichever single input has the lowest absolute price
4. Marginal product per dollar equal across labor and capital

Answer: D — Marginal product per dollar equal across labor and capital

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 falls below total cost at the firm's current profit-maximizing level of output
2. The firm's earnings for the period happen to equal zero exactly
3. Price falls below average total cost at the firm's profit-maximizing output level, even though it still covers variable cost
4. Price falls below average variable cost, so operating loses more than shutting down despite still owing fixed costs

Answer: D — Price falls below average variable cost, so operating loses more than shutting down despite 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 in response to price changes
2. Unit elastic across the entire relevant range
3. Inelastic, since there are few substitutes and it is a necessity for diabetics
4. Perfectly elastic at the going market price

Answer: C — Inelastic, since there are 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.