CLEP Principles of Microeconomics cheat sheet

Scarcity forces choice; every choice has an opportunity cost equal to the value of the best forgone alternative, not the sum of all alternatives.

Production possibilities frontier: points on the curve are efficient, inside are inefficient (unemployment), outside are unattainable; the frontier shifts outward with more resources or better technology.

Law of increasing opportunity cost: a bowed-out PPF arises because resources are not perfectly adaptable between goods; a straight-line PPF means constant opportunity cost.

Comparative advantage drives trade: specialize where opportunity cost is lowest; a country can have absolute advantage in both goods yet still gain from trade.

Circular flow: households supply factors and demand goods; firms demand factors and supply goods; government adds taxes, transfers, and purchases; the foreign sector adds exports and imports.

Positive statements are testable claims about what is; normative statements are value judgments about what ought to be.

Marginal analysis rule: take an action if marginal benefit exceeds marginal cost; the optimal quantity is where MB = MC.

Economic growth shown by an outward PPF shift; a single point's movement along the PPF is not growth but reallocation of output.

Demand curve slopes downward; a change in price moves quantity demanded, while income, tastes, prices of related goods, expectations, or number of buyers shift the whole curve.

Supply curve slopes upward; input costs, technology, taxes/subsidies, expectations, and number of sellers shift supply.

Equilibrium price clears the market; a binding price ceiling set below equilibrium creates shortage, a binding price floor set above equilibrium creates surplus.

Elasticity of demand = % change in quantity / % change in price (midpoint formula); demand is elastic when |E| > 1, unit elastic at 1, inelastic below 1.

Total revenue test: price cut raises revenue if demand is elastic, lowers revenue if inelastic, leaves revenue unchanged at unit elasticity.

Perfect competition: many firms, homogeneous product, free entry; profit maximized where MR = MC = P; long-run economic profit is zero at minimum ATC.

Monopoly: single seller, barriers to entry, downward-sloping demand, MR below price; profit-maximizing output where MR = MC, price read off the demand curve.

Monopolistic competition: many firms, differentiated products, easy entry; short-run profits attract entry, shifting demand left until long-run profit is zero.

Oligopoly: few firms, interdependence; kinked demand, cartels, and game-theoretic outcomes such as the prisoner's dilemma explain price rigidity and collusion incentives.

Derived demand: demand for labor and capital depends on demand for the output those factors produce.

Marginal revenue product of labor (MRPL) = marginal product of labor × marginal revenue; a firm hires until MRPL equals the wage.

In perfect competition, MRP = MP × P; the labor demand curve is the downward-sloping MRPL segment because of diminishing marginal product.

Marginal factor cost (MFC) is the added cost of hiring one more unit; a monopsonist faces MFC above the wage and hires where MRPL = MFC, paying a wage below MRPL.

Factor supply curves: labor supply slopes upward (substitution effect dominates at higher wages); land supply is often fixed, making its price pure rent.

Economic rent is the payment above the minimum needed to keep a factor in its current use; it is the area above the supply curve up to the price.

Human capital investment (education, training) raises productivity and shifts labor demand outward; the decision compares present cost to higher future earnings.

Interest is the price of capital; profit is the residual return to entrepreneurship and can be negative.

Negative externality (e.g., pollution): marginal social cost exceeds marginal private cost, so the market overproduces; corrective tax or tradable permits reduce output toward the social optimum.

Positive externality (e.g., education, vaccines): marginal social benefit exceeds marginal private benefit, so the market underproduces; subsidies or public provision increase output.

Public goods are nonrival and nonexcludable (national defense); private markets undersupply them because of the free-rider problem.

Common resources are rival but nonexcludable (fisheries); overuse leads to the tragedy of the commons, addressed by quotas or property rights.

Externalities create a deadweight loss equal to the area between social and private marginal curves between the private and social quantities.

Government tools include taxes, subsidies, price controls, regulation, antitrust policy, and direct provision; each has efficiency costs to weigh.

Antitrust policy targets monopoly power; regulators may use marginal-cost pricing (efficient but requires subsidy) or average-cost pricing (fair return, less output).

Income redistribution through progressive taxes and transfers reduces inequality but can dampen work incentives; the trade-off is efficiency versus equity.