Key Concepts and Study Guide for Microeconomics Exam

Key Concepts in Microeconomics

The Nature of Economics

Microeconomics is the study of how individuals and firms make choices under conditions of scarcity and how these choices affect the allocation of resources.

• Scarcity: The fundamental economic problem of having limited resources to meet unlimited wants.

• Opportunity Cost: The value of the next best alternative forgone when making a decision.

• Economic Models: Simplified representations of reality used to analyze economic behavior and predict outcomes.

• Positive vs. Normative Economics: Positive economics describes 'what is,' while normative economics prescribes 'what ought to be.'

• Example: Choosing to spend time studying economics instead of working a part-time job involves the opportunity cost of lost wages.

Scarcity and Trade-Offs

Scarcity forces individuals and societies to make choices, leading to trade-offs and the need for prioritization.

• Production Possibilities Frontier (PPF): A curve showing the maximum attainable combinations of two products that may be produced with available resources and technology.

• Law of Increasing Opportunity Cost: As production of one good increases, the opportunity cost of producing an additional unit rises.

• Efficient vs. Inefficient Points: Points on the PPF are efficient; points inside are inefficient; points outside are unattainable.

• Example: A country must choose between producing more cars or more computers, illustrating trade-offs.

• Formula: $\text{Opportunity Cost} = \frac{\text{Loss in Good A}}{\text{Gain in Good B}}$

Demand and Supply

Markets are driven by the forces of demand and supply, which determine prices and quantities of goods and services.

• Law of Demand: As price decreases, quantity demanded increases, ceteris paribus.

• Law of Supply: As price increases, quantity supplied increases, ceteris paribus.

• Market Equilibrium: The point where quantity demanded equals quantity supplied.

• Shifts vs. Movements: Changes in price cause movements along curves; changes in other factors (income, tastes, etc.) shift the curves.

• Formula: $Q_d = a - bP$ (Demand), $Q_s = c + dP$ (Supply)

• Example: A rise in consumer income shifts the demand curve for normal goods to the right.

Extensions of Demand and Supply Analysis

Further analysis includes elasticity, consumer and producer surplus, and market interventions.

• Elasticity: Measures responsiveness of quantity demanded or supplied to changes in price or other factors.

• Price Elasticity of Demand: $E_d = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}$

• Consumer Surplus: The difference between what consumers are willing to pay and what they actually pay.

• Producer Surplus: The difference between the price received by sellers and their minimum acceptable price.

• Example: Imposing a price ceiling can create shortages if set below equilibrium price.

Public Goods and Externalities

Some goods and services are not efficiently provided by markets due to non-excludability and non-rivalry, leading to externalities and the need for government intervention.

• Public Goods: Goods that are non-excludable and non-rivalrous (e.g., national defense).

• Private Goods: Goods that are excludable and rivalrous (e.g., food).

• Externalities: Costs or benefits that affect third parties not involved in the transaction.

• Coase Theorem: If property rights are well-defined and transaction costs are low, private bargaining can solve externality problems.

• Tragedy of the Commons: Overuse of common resources due to lack of ownership.

• Example: Pollution from a factory imposes costs on nearby residents (negative externality).

Market Structures

Markets can be classified by the number of firms, product differentiation, and barriers to entry.

• Perfect Competition: Many firms, identical products, no barriers to entry.

• Monopoly: One firm, unique product, high barriers to entry.

• Monopolistic Competition: Many firms, differentiated products, low barriers to entry.

• Oligopoly: Few firms, interdependent decision-making, possible collusion.

• Example: The smartphone market is an oligopoly dominated by a few large firms.

Consumer Choice and Utility

Consumers aim to maximize utility given their budget constraints.

• Utility: Satisfaction or pleasure derived from consuming goods and services.

• Marginal Utility: The additional satisfaction from consuming one more unit.

• Law of Diminishing Marginal Utility: Marginal utility decreases as more units are consumed.

• Budget Constraint: The limit on consumption imposed by income and prices.

• Formula: $\frac{MU_x}{P_x} = \frac{MU_y}{P_y}$ (Utility maximization rule)

• Example: Choosing between buying coffee or tea based on marginal utility per dollar spent.

Income, Poverty, and Welfare

Microeconomics examines the distribution of income, poverty, and the effects of government policies.

• Poverty Line: The minimum income level required to meet basic needs.

• Income Distribution: How income is spread across individuals or households.

• Gini Coefficient: A measure of income inequality (ranges from 0 to 1).

• Welfare Programs: Government initiatives to support low-income individuals.

• Example: Food stamps and unemployment benefits are forms of welfare.

Environmental Economics

Environmental economics studies the impact of economic activity on the environment and policies to address externalities.

• Market Failure: Occurs when markets do not allocate resources efficiently due to externalities or public goods.

• Regulation: Government intervention to correct market failures (e.g., pollution taxes, cap-and-trade).

• Example: Imposing a carbon tax to reduce greenhouse gas emissions.

International Trade and Comparative Advantage

Trade allows countries to specialize and benefit from comparative advantage.

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than others.

• Absolute Advantage: The ability to produce more of a good with the same resources.

• Gains from Trade: Both parties can benefit by specializing and trading.

• Example: If Country A can produce wine more efficiently and Country B can produce cheese more efficiently, both benefit by trading.

• Formula: $\text{Opportunity Cost}_{A} < \text{Opportunity Cost}_{B}$ (Comparative advantage)

Summary Table: Types of Goods

The following table summarizes the main types of goods discussed in microeconomics:

Type of Good	Excludable	Rivalrous	Example
Private Good	Yes	Yes	Bread
Public Good	No	No	National Defense
Common Resource	No	Yes	Fish in the ocean
Club Good	Yes	No	Satellite TV

Additional info:

• Some questions reference specific video clips and articles; students should review these resources for further context.

• Questions cover a broad range of microeconomic topics, suitable for exam preparation.