Free Principles of Microeconomics CLEP Practice Test

It is the mistaken assumption that what applies in the case of one applies to the case of many.

If you are currently producing 10 units of clothing (point B), and decide to produce at a rate of 20 units of clothing (point C), the food you produce drops from 105 to 95. You are producing an additional 10 units of clothing at the expense of 10 units of food you could have produced. Also note that a combination of 20 units of clothing and 80 units of food is inefficient, because you would be producing less than possible.

When there is a surplus, that means there is more of a product than is in demand. Therefore, the price of the product will drop, and the demand for the product will increase because the price is lower. At the same time, the quantity supplied by the manufacturer will drop to match demand, because it doesn't make sense to produce more than people will buy. Eventually, it will reach an equilibrium point, where the quantity supplied equals the quantity demanded, and the price will stop dropping and be at equilibrium.

Remember, to calculate marginal utility per dollar, divide the marginal utility by the price (MU / P). For the doughnut, MU / P = 30 / $2. For the muffin, MU / P = 20 / $1. The muffin has a marginal utility per dollar of 20, which is higher than the doughnut's MU per dollar of 15, making the muffin the better buy.

If demand is price inelastic, that means quantity demanded changes slowly compared to the price. This is good if you're raising the price, because a fairly large increase in price results in a relatively small decrease in quantity -- which means the revenue grows.

On the other hand, a fairly large decrease in price results in a relatively small increase in quantity -- which means that revenue shrinks.

Basically, with inelastic demand, quantity changes slowly relative to the price, so increased price means increased total revenue.

MRP stands for marginal revenue product, and is the additional revenue from adding one unit of labor -- in other words, how much more money comes in from hiring an additional worker. Obviously, if the additional revenue gained from hiring another worker is less than the wages you have to pay him, then you do not hire another worker. Wage is sometimes referred to as marginal expenditure (ME), so a firm should hire labor until MRP = W, or MRP = ME.

Since Harvey produces 100 glasses of lemonade with average total cost (ATC) of 50 cents per glass we know that his total cost is just ATC x Q or .50 x 100 = $50. We also know that his average variable cost (AVC) is 40 cents per glass so his total variable cost is just AVC x Q or .40 x 100 = $40. Finally we know that total fixed cost is just total cost - total variable cost or $50-$40=$10.

Or, where the MC (Marginal Cost) curve intersects with the AVC curve, since the MC curve always intersects with the AVC curve at its minimum point.

The shutdown point indicates the minimum selling price for the firm to stay in business -- otherwise, staying in operation increases losses. The minimum point on the AVC curve indicates the minimum variable cost for producing each unit of product.

If the price is below this minimum point, that means each unit sold would not cover the variable cost per unit. As seen in the graph below, the shutdown price is P2, selling at P1 would put the company out of business. Remember, this refers to the short-run, in the long-run, the business needs to make a profit, not just equal its variable costs.

In perfect competition, all firms must accept the market price for their product. They are price takers. In monopoly, the firm charges the highest price the consumer will pay.

To determine the price to sell at, a firm looks at the price on the demand curve which corresponds to a given quantity. In perfect competition, the demand curve at a certain price is the same as the MR curve at that price:

In monopoly, the demand curve is separate from and higher than the MR curve:

Normal profit means zero economic profit. At zero economic profit, which means that firms are at the bottom of their ATC curve, there is no entry or exit. When companies are above the minimum point on the ATC curve, new firms enter the market -- they are attracted by the economic profit being made by the current firms. When companies drop below the minimum point on the ATC curve, firms start exiting the market, because they are not making an economic profit.