Answer Key & Rubric

AP Microeconomics — Full Practice Exam: Answers and Explanations

Detailed Answer Key with Rationales

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MULTIPLE-CHOICE ANSWERS AND EXPLANATIONS

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Basic Economic Concepts (1–10)

1. Answer: A. Scarcity is the fundamental economic problem: human wants are infinite but resources (land, labor, capital, entrepreneurship) are limited. This forces societies to make choices about how to allocate scarce resources.

2. Answer: B. A point inside the PPC indicates that resources are not being fully utilized — there is unemployment or inefficiency. A point on the curve is efficient, and a point outside is unattainable without economic growth.

3. Answer: B. Country A can produce more of both goods (100 > 80 cars, 50 > 40 trucks), so it has an absolute advantage in both. However, opportunity costs are identical for both countries: 1 car = 0.5 trucks for both A and B. Neither has a comparative advantage, and no gains from trade exist.

4. Answer: B. Opportunity cost is the value of the next best alternative that is given up when making a choice. It is NOT necessarily the monetary price; it includes the value of the forgone opportunity.

5. Answer: C. Technological improvement shifts the PPC outward, representing economic growth (the ability to produce more of all goods). Options A and D represent movements along the curve. Options B and E do not shift the PPC.

6. Answer: C. An increase in the price of coffee causes a decrease in quantity demanded (movement along the demand curve), NOT a decrease in demand (which would be a shift). This is a critical distinction.

7. Answer: B. Tea and coffee are substitutes. A decrease in the price of tea makes consumers switch from coffee to tea, decreasing the demand for coffee (shifting the demand curve left).

8. Answer: A. Market equilibrium occurs at the intersection of demand and supply, where quantity demanded equals quantity supplied. There is no tendency for price or quantity to change.

9. Answer: B. A binding price ceiling below equilibrium creates a shortage because quantity demanded exceeds quantity supplied at the artificially low price.

10. Answer: A. A binding price floor above equilibrium creates a surplus because quantity supplied exceeds quantity demanded at the artificially high price.

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Supply and Demand (11–20)

11. Answer: C. Price elasticity of demand of 2.5 > 1, so demand is elastic. Consumers are relatively responsive to price changes.

12. Answer: B. Ed = |%ΔQd / %ΔP| = |2% / 10%| = 0.2. Since 0.2 < 1, demand is inelastic.

13. Answer: B. When demand is inelastic (Ed < 1), price and total revenue move in the same direction. Increasing price increases TR. When demand is elastic, they move in opposite directions.

14. Answer: B. Hot dogs and hot dog buns are complements (used together), so their cross-price elasticity is negative. An increase in the price of hot dogs decreases the demand for buns.

15. Answer: C. Ramen noodles are typically an inferior good — as income rises, people buy less ramen and switch to higher-quality foods. The income elasticity would be negative.

16. Answer: C. Consumer surplus is the area between the demand curve and the market price (the difference between what consumers are willing to pay and what they actually pay).

17. Answer: C. Buyers bear $2 of the $3 tax burden, and sellers bear $1. So buyers bear 2/3 and sellers bear 1/3. The burden falls more heavily on the side of the market that is less elastic (here, buyers are less elastic).

18. Answer: B. DWL is larger when supply and demand are elastic because the tax causes a larger reduction in quantity traded. With elastic curves, a given tax causes a bigger Q reduction → larger DWL triangle.

19. Answer: C. A price floor set at the equilibrium price is non-binding — it has no effect on the market. It must be set above equilibrium to be binding.

20. Answer: D. Price elasticity of demand depends on: availability of substitutes, proportion of income spent, time horizon, and whether the good is defined broadly (inelastic) or narrowly (elastic). The slope of the supply curve does not affect demand elasticity.

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Production, Costs, and Perfect Competition (21–36)

21. Answer: A. The law of diminishing marginal returns states that as more of a variable input is added to a fixed input, the marginal product will eventually decrease. Total output still increases but at a decreasing rate.

22. Answer: D. All three are correct: ATC = TC/Q = (TFC+TVC)/Q = AFC + AVC.

23. Answer: B. MC intersects ATC at its minimum point. When MC < ATC, ATC is falling. When MC > ATC, ATC is rising. They intersect at the turning point.

24. Answer: C. AFC = TFC/Q = 500/100 = $5. AVC = $8. ATC = AFC + AVC = 5 + 8 = $13.

25. Answer: B. The shutdown rule: shut down if P < AVC. At this point, the firm cannot cover its variable costs, so it's better off producing zero and losing only fixed costs.

26. Answer: C. A perfectly competitive firm faces a perfectly elastic (horizontal) demand curve at the market price. The firm is a price taker.

27. Answer: C. TR = 50 × $10 = $500. TC = $550. The firm has a loss of $50. However, we need to check the shutdown rule. FC = unknown but TVC < $500 (since TC = FC + TVC and FC > 0). AVC = TVC/50 < $10. Since P ($10) > AVC (which is less than $10), the firm should continue producing in the short run, covering its variable costs and some fixed costs.

28. Answer: A. In long-run perfect competition: P = MC (allocative efficiency), P = minimum ATC (productive efficiency), and economic profit = zero (free entry and exit).

29. Answer: B. Economies of scale: LRATC decreases as output increases. The firm benefits from increased specialization, bulk purchasing, and other efficiencies of scale.

30. Answer: B. MC = dTC/dQ = 5 + 0.5Q. Set MR = MC: $20 = 5 + 0.5Q → 15 = 0.5Q → Q = 30.

31. Answer: B. The shutdown point is where P = minimum AVC. Below this price, the firm cannot cover variable costs and should shut down.

32. Answer: A. Allocative efficiency: P = MC. This means the last unit produced provides marginal benefit (P) equal to its marginal cost. The socially optimal quantity is produced.

33. Answer: B. Productive efficiency: P = minimum ATC. Goods are produced at the lowest possible per-unit cost. No resources are wasted.

34. Answer: B. New firm entry shifts market supply right, which decreases the market price. This continues until P = minimum ATC and economic profits are zero.

35. Answer: A. Economic profit = Accounting profit − Implicit costs. $30,000 = $50,000 − Implicit costs. Implicit costs = $20,000.

36. Answer: C. Rent on a factory building is a fixed cost — it must be paid regardless of output level. Wages, raw materials, electricity, and shipping are variable costs.

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Imperfect Competition (37–48)

37. Answer: B. A monopolist faces the entire downward-sloping market demand curve (unlike a perfectly competitive firm, which faces a horizontal demand curve at the market price).

38. Answer: B. All profit-maximizing firms produce where MR = MC. For a monopolist, this means producing less than the competitive output and charging a price above MC (found on the demand curve).

39. Answer: B. A government patent grants exclusive production rights for a period, creating a legal barrier to entry and establishing monopoly power.

40. Answer: C. Under perfect price discrimination, the monopolist charges each consumer their maximum willingness to pay. This produces the competitive output level (where P = MC for the last unit), eliminates consumer surplus, and eliminates deadweight loss.

41. Answer: C. Monopolistic competition features many firms selling differentiated products with free entry and exit. Product differentiation (branding, quality, features) is the key distinguishing feature.

42. Answer: B. Long-run monopolistic competition: P > MC (allocative inefficiency), P = ATC but ATC > minimum ATC (excess capacity, not productively efficient), zero economic profit.

43. Answer: B. In an oligopoly, firms are interdependent — each firm's optimal strategy depends on what its rivals do. This is what makes oligopoly strategically complex.

44. Answer: B. In the prisoner's dilemma, the Nash equilibrium (each player's dominant strategy) leads to a worse outcome for both players than if they had cooperated. The individually rational choice leads to a collectively suboptimal result.

45. Answer: B. A natural monopoly exists when LRATC declines continuously over the entire range of market demand, making it most efficient for one firm to serve the entire market.

46. Answer: B. A monopoly produces where MR = MC, but charges P > MC. Some consumers who value the good above MC but below P are not served — this creates deadweight loss. The monopoly underproduces relative to the socially optimal level.

47. Answer: B. In a cartel, each firm has a strong incentive to cheat on the agreement (produce more than their quota) because they can sell at the cartel price and earn more profit. Widespread cheating leads to the cartel's collapse.

48. Answer: B. The kinked demand curve model predicts price rigidity — prices tend to stay the same even when costs change. This is because rivals match price decreases (so lowering price gains little) but not price increases (so raising price loses customers).

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Factor Markets (49–54)

49. Answer: A. The firm hires workers until MRP = MRC (marginal revenue product equals marginal resource cost). In a perfectly competitive labor market, MRC = wage.

50. Answer: B. Derived demand: the demand for labor (and other factors) is derived from the demand for the product that labor produces. If demand for the product increases, demand for labor increases.

51. Answer: C. In a monopsony, the firm faces the upward-sloping market labor supply curve. To hire additional workers, it must raise the wage for ALL workers, so MRC > wage. The firm hires fewer workers and pays a lower wage than in a competitive labor market.

52. Answer: D. MRP = MP × MR = 25 × $4 = $100.

53. Answer: A. The least-cost combination rule: MPL/wage = MPK/rent. This means the marginal product per dollar spent on each input is equal, minimizing total cost for a given output.

54. Answer: B. An increase in the wage causes a decrease in the quantity of labor demanded (movement up along the labor demand curve). It does NOT shift the demand curve itself.

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Market Failure and Government (55–60)

55. Answer: A. A negative production externality means the firm's private cost < social cost. The firm produces too much (where MPC = MPB rather than where MSC = MSB).

56. Answer: B. A Pigouvian tax equal to the marginal external cost internalizes the externality, shifting the supply curve to reflect the full social cost and achieving the socially optimal quantity.

57. Answer: B. National defense is a public good: non-excludable (can't prevent anyone from benefiting) and non-rivalrous (one person's consumption doesn't reduce availability for others).

58. Answer: B. The free rider problem occurs with public goods: individuals can benefit without paying, so no one has an incentive to voluntarily pay, leading to underproduction or no production by private markets.

59. Answer: B. The tragedy of the commons: common resources are non-excludable but rivalrous. Since no one owns the resource, individuals overuse it for personal gain, leading to depletion.

60. Answer: C. The Gini coefficient measures income inequality on a scale from 0 (perfect equality — everyone has the same income) to 1 (maximum inequality — one person has all income).

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FREE-RESPONSE ANSWERS

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FRQ 1 — Gasoline Tax (25 minutes)

(a) Graph requirements:

• Labeled axes: Price (P) vertical, Quantity (Q) horizontal
• Downward-sloping demand curve labeled D
• Upward-sloping supply curve labeled S
• Intersection labeled as equilibrium (Pe, Qe)

  (b) Tax effect on graph:

• Supply shifts left (up) by the amount of the $2 tax
• Label the new supply curve S + tax
• New quantity Qtax is less than Qe
• Pc (price consumers pay) is above Pe
• Pp (price producers receive = Pc − $2) is below Pe
• Tax revenue: shaded rectangle with height = $2 and width = Qtax, labeled "Tax Revenue"
• Deadweight loss: shaded triangle between S and S+tax, from Qtax to Qe, labeled "DWL"

  (c) Consumers bear the larger burden. When demand is relatively inelastic (consumers are not very responsive to price changes), the tax burden falls more heavily on consumers. Producers can pass most of the tax onto consumers because consumers don't reduce their purchases significantly. The inelastic side of the market bears more of the tax burden. Mathematically: consumers bear (Pc − Pe) and producers bear (Pe − Pp), and Pc − Pe > Pe − Pp when demand is less elastic than supply.

  (d) The deadweight loss would be ZERO if demand were perfectly inelastic. With perfectly inelastic demand, the quantity demanded does not change regardless of the price. The tax creates no change in quantity, so there is no deadweight loss triangle. DWL = ½ × tax × ΔQ, and ΔQ = 0 when demand is perfectly inelastic.

  (e) With a $2 per-gallon subsidy:

• Equilibrium quantity increases (supply shifts right/down)
• Equilibrium price falls (for consumers; the effective price received by producers rises by the subsidy amount)
• The subsidy encourages more production and consumption than the socially optimal market equilibrium

FRQ 2 — Monopoly (20 minutes)

(a) Profit-maximizing output and price:

• Demand: P = 80 − 2Q → Total Revenue: TR = 80Q − 2Q² → MR = 80 − 4Q
• TC = 100 + 10Q + Q² → MC = 10 + 2Q
• Set MR = MC: 80 − 4Q = 10 + 2Q → 70 = 6Q → Q = 11.67 (or 35/3)
• P = 80 − 2(35/3) = 80 − 70/3 = 170/3 ≈ $56.67

  (b) Economic profit:

• TR = 80(35/3) − 2(35/3)² = 2800/3 − 2450/9 = 8400/9 − 2450/9 = 5950/9 ≈ $661.11
• TC = 100 + 10(35/3) + (35/3)² = 100 + 350/3 + 1225/9 = 900/9 + 1050/9 + 1225/9 = 3175/9 ≈ $352.78
• Economic Profit = TR − TC = 5950/9 − 3175/9 = 2775/9 ≈ $308.33

  (c) Socially optimal quantity (P = MC):

• 80 − 2Q = 10 + 2Q → 70 = 4Q → Q = 17.5
• P = 80 − 2(17.5) = $45

  (d) Graph requirements:

• Labeled axes: P (vertical), Q (horizontal)
• Downward-sloping demand curve (D): P = 80 − 2Q
• Downward-sloping MR curve below D (steeper): MR = 80 − 4Q
• Upward-sloping MC curve: MC = 10 + 2Q
• U-shaped ATC curve: ATC = 100/Q + 10 + Q
• Mark Qm = 35/3 ≈ 11.67, Pm = $56.67 (where MR = MC, price on D)
• Mark Qae = 17.5, Pae = $45 (where D = MC)

  (e) Deadweight loss:

• Shade the triangle between Qm and Qae, bounded above by D and below by MC
• DWL = ½ × (Pm − Pae) × (Qae − Qm) = ½ × ($56.67 − $45) × (17.5 − 11.67) = ½ × $11.67 × 5.83 ≈ $34.02
• (Or using exact fractions: DWL = ½ × (170/3 − 45) × (35/2 − 35/3) = ½ × (5/6) × (35/6) × ... ≈ $34.03)

  (f) A per-unit tax on the monopolist would INCREASE the deadweight loss. The tax shifts the monopolist's effective MC curve upward, reducing the monopoly's output even further below the socially optimal level. Since the monopoly is already underproducing, reducing output further increases the deadweight loss.

FRQ 3 — Externalities (15 minutes)

(a) This is a NEGATIVE EXTERNAILITY. The coal-burning power plant's production imposes health costs on nearby residents who are not compensated. The firm's private production cost understates the true social cost of production.

(b) Graph requirements:

• Labeled axes: Price (P) vertical, Quantity (Q) horizontal
• Downward-sloping MSB (= MPB) curve (demand)
• Upward-sloping MPC curve (private supply) — below MSC
• Upward-sloping MSC curve — above MPC by the amount of the external cost
• Private market equilibrium: intersection of MPC and MPB, labeled Qm and Pm
• Socially optimal equilibrium: intersection of MSC and MSB, labeled Qs and Ps

  (c) Deadweight loss:

• Shade the triangle between Qs and Qm, bounded above by MSC and below by MPB (or between MSC and MPC, depending on convention — the DWL is the area where MSC > MSB for units between Qs and Qm)

  (d) Per-unit tax effect:

• The tax shifts the supply curve up by the amount of the marginal external cost
• The new supply curve coincides with the MSC curve
• The new equilibrium occurs at the intersection of MSC and MSB → the socially optimal quantity Qs and price Ps
• The tax internalizes the externality, making the firm pay the full social cost of production

  (e) Cap-and-trade system:

• The government sets a total cap on pollution (equal to the socially optimal pollution level)
• It issues tradable permits allowing firms to emit a specific amount of pollution
• Firms that can reduce pollution cheaply will sell permits to firms for whom reduction is expensive
• Through trading, pollution is reduced at the lowest possible cost to society
• The cap ensures total pollution equals the socially optimal level, achieving efficiency
• This is economically equivalent to a Pigouvian tax in outcome, but provides more certainty about total pollution quantity (vs. certainty about price with a tax)