AP Macroeconomics Page 1 of 5

Unit Review: Basic Economic Concepts

Unit Review Checklist

You probably have study strategies you use before taking exams. Use this checklist to
supplement those strategies and guide you as you study. See if you can answer the
questions or perform the tasks listed below. If you can, check them off and keep moving! If
not, you may want to look into them further before taking the Unit Quiz.

Questions/Tasks Yes!
Can you relate how scarce resources and unlimited wants make decisions
necessary?
Can you define scarcity, self-interest, opportunity cost, and margin?
Can you explain the role of choice in economic theory?
Can you distinguish between positive and normative economics?
Can you interpret a graph called the production possibility frontier and explain
how it's used to demonstrate scarcity, choice, and opportunity cost?
Can you define the law of increasing opportunity costs?
Can you relate the PPF to the concepts of efficiency, opportunity cost, and the
law of increasing opportunity cost?
Can you define and explain the concept of absolute advantage?
Can you define and explain the concept of comparative advantage?
Can you relate the idea of specialization with interdependence and trade?
Can you identify the benefits of specialization?
Can you describe the relationship between economic growth and the PPF?
Can you explain the advantages and disadvantages of free trade?
Can you define and use the concept of demand to model the behavior of
buyers?
Can you define and use the concept of supply to model the behavior of sellers?
Can you analyze and predict market interactions of buyers and sellers using
the model of demand and supply?
Can you explain the measure of price elasticity?
Have you printed and reviewed the Key Terms lists?
Have completed all activities in this unit?
Have you reviewed the Focus Sheets for this unit?
Have you reviewed the important concepts on the following pages of this Unit
Review?

What aspects economics do you better understand now that you've completed this
Unit?

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AP Macroeconomics Page 2 of 5
Unit Review: Basic Economic Concepts

What aspects of economics do you still find difficult and need to look into further
before taking the Unit Quiz?

Costs and Benefits

Important Concepts

• Self-interest and Net Benefits

When people are faced with decisions, they act in their own self-interest by choosing the
alternative that's best for them. This doesn't mean they're selfish. It doesn't mean
there's one answer that's right for everyone. It just means that people will make a cost-
benefit analysis and choose the alternative that gives them the highest benefit after
considering the costs.

• Costs Are Opportunity Costs

An opportunity cost is the cost of a decision. The opportunity cost of a decision includes
the value of the next best alternative not chosen when a decision is made. It's a
marginal cost, because it's the additional cost of a decision.

• Sunk Costs
A sunk cost isn't part of the cost of a decision. It's a cost that has already been paid or
must be paid no matter what decision is made, so it isn't a marginal cost. Although a
sunk cost isn't part of the cost of a decision, it can influence the decision. That's because
sunk costs do give us information.

• Positive and Normative Economics

There are two types of economic analysis: positive and normative. Positive economics
tries to be objective and not include value judgments. A positive economic analysis
presents the benefits and costs of a decision. Normative economics includes value
judgments. A normative economic analysis tells us what decisions should be made.

• The Production Possibilities Frontier

Economists use the PPF to study production. The PPF presents the trade-off of producing
one good against producing another. It shows the efficient production capabilities of a
person, market, or economy.

• PPF and Opportunity Costs

The PPF shows the opportunity cost of producing a good in relation to the production of
another good. To make more of one good or service, we give up production of another
good or service, assuming that the amount of resources available stays the same. PPFs
are usually bowed, showing that the opportunity cost of producing a good or service
increases as more of that good or service is produced.

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AP Macroeconomics Page 3 of 5
Unit Review: Basic Economic Concepts

• PPF and Efficiency

The frontier represents all the different production outputs of two goods or services that
make efficient use of the resources available. Points inside the frontier represent
inefficient use of resources. Points outside are unattainable.

• Shifts of the PPF

The PPF can shift if the number of resources changes. If resources increase, the PPF
shifts outward. If resources decrease, the PPF shifts inward.

Production and Trade

Important Concepts

• Absolute Advantage
If one producer has an absolute advantage in producing a good or service over another
producer, it means the first producer can produce that good or service using fewer
resources than the other producer. People or nations sometimes produce goods or
services that they have an absolute advantage in, but this isn't necessary.

• Comparative Advantage
Comparative advantage compares the opportunity costs that two or more producers face
when they decide to produce a particular good or service. Opportunity cost measures
the trade-off between producing one good instead of another. The producer with the
lower opportunity cost has the comparative advantage for that good or service. This is
an important concept in economics. Make sure you understand comparative advantage
before you finish this Tutorial.

• Trade between Individuals

Individuals benefit when they specialize in the production of a good they have a
comparative advantage in. The terms of trade they'll agree to depend on their
opportunity costs.

• Specialization
People and nations specialize in the production of certain goods or services. They leave
the production of other goods and services to other people or nations. Then they trade
the goods or services in which they specialize for those other goods and services. They
often use money as a medium of exchange.

• PPF for an Economy

We can use the PPF to show how a society's economy benefits from specialization and
trade. Societies specialize in producing goods for which they have a comparative
advantage. We can find these goods by looking at the PPFs of different economies and
comparing their opportunity costs for producing a good or service.

• International Trade: Positive View

Nations benefit when they specialize in producing goods and services in which they have
a comparative advantage. They can then trade their goods and services to other nations
for different goods and services. When they do this, it causes the whole world to use its
resources more efficiently. The theory of comparative advantage comes from the
important early economist David Ricardo.

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AP Macroeconomics Page 4 of 5
Unit Review: Basic Economic Concepts

• International Trade: Normative View

Many economists feel unrestricted international trade has more benefits than costs.
However we must keep the costs in mind. For example, unrestricted trade can damage
or destroy local communities and even whole cultures.

Demand and Supply

Important Concepts

• Demand
Demand shows the relationship between the price and the quantity of a good or service
consumers are willing and able to buy. You'll usually see it represented on a graph as a
demand curve. The demand curve is always downward sloping. This reflects an
important point of economics: the law of demand. The law of demand says that as prices
increase, quantity demanded decreases, and as prices decrease, quantity demanded
increases, ceteris paribus.

• Change in Quantity Demanded

When the price of a good changes, the quantity demanded for that good also changes.
An increase in price causes a decrease in quantity demanded. This is shown as a
movement along the demand curve to a smaller quantity demanded. A decrease in price
causes an increase in quantity demanded, shown as a movement along the demand
curve to a larger quantity.

• Change in Demand
When a change—other than in the price of a good, affects consumer behavior, it causes
a change in demand. This can include things like income, tastes, prices of related goods,
the number of consumers in the market, and future expectations. A change in demand
causes a shift of the entire demand curve. An increase in demand is represented by a
shift to the right; a decrease in demand by a shift to the left.

• Price Elasticity of Demand

Price elasticity of demand compares the size of a price change with the size of the
resulting change in quantity demanded. Economists use this to measure how sensitive
consumers are to a change in price. If consumers are very sensitive, demand is elastic;
if they aren't sensitive, demand is inelastic.

• Supply
Supply shows the relationship between price and the different quantity of a good or
service firms are willing and able to offer for sale. You'll usually see it represented on a
graph as a supply curve. The supply curve is upward sloping. This reflects an important
point of economics, which is sometimes called the law of supply: As prices increase,
quantity supplied increases, and as prices decrease, quantity supplied decreases, ceteris
paribus.

• Change in Quantity Supplied

When the price of a good changes, the quantity supplied for that good changes too. An
increase in price causes an increase in quantity supplied. This is shown as a movement
along the supply curve to a larger quantity. A decrease in price causes a decrease in
quantity supplied, shown as a movement along the supply curve to a smaller quantity.

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AP Macroeconomics Page 5 of 5
Unit Review: Basic Economic Concepts

• Change in Supply
When something changes—other than a change in the price of the good—and affects
firms' supply decisions, it causes a change in supply. This includes anything that
changes the costs of producing the good, like the cost of a production input. A change in
supply causes a shift of the entire supply curve. An increase in supply is represented by
a shift to the right, a decrease in supply by a shift to the left.

• Price Elasticity of Supply

Price elasticity of supply compares the size of a price change to the size of the resulting
change in quantity supplied. If supply is elastic, suppliers respond a lot to a change in
price; if supply is inelastic, suppliers respond very little to a price change.

• Equilibrium
A market left on its own will automatically move to the price where the quantity that
consumers are willing and able to buy is exactly equal to the quantity that firms are
willing and able to offer for sale.

This price is called the equilibrium price; the quantity is called the equilibrium quantity.
Once in equilibrium, there are no market forces acting to cause the price to change.

• Change in Demand
A change in demand causes a market to settle at a new equilibrium price and quantity.
An increase in demand increases both the equilibrium price and equilibrium quantity. A
decrease in demand decreases the equilibrium price and equilibrium quantity.

• Change in Supply
A change in supply also brings about a new equilibrium. An increase in supply causes the
equilibrium price to decrease and equilibrium quantity to increase. A decrease in supply
increases the price and decreases the quantity.

• Change in Demand and Supply

When both demand and supply change, the effect on either the equilibrium price or
equilibrium quantity is indeterminate. If both change in the same way, the effect on
price is indeterminate. If they change in opposite ways, the effect on quantity is
indeterminate.

• Price Ceilings and Price Floors

The government can intervene in a market by legislating a minimum or maximum price.

A price ceiling is a maximum price. When a price ceiling is below the equilibrium price, it
creates a shortage. The quantity demanded exceeds the quantity supplied.

A price floor is a minimum price. When the floor is above the equilibrium price, it creates
a surplus. The quantity supplied exceeds the quantity demanded.

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