Microeconomics Comprehensive Exam Study Guide: Efficiency, Equity, Elasticity, Market Structures, and Public Goods

Tradeoffs Between Efficiency and Equity

Understanding Efficiency and Equity

Economics often involves balancing efficiency (maximizing total surplus or output) and equity (fairness in distribution). Policies may improve one at the expense of the other.

• Efficiency: Achieved when resources are allocated to maximize total benefit to society.

• Equity: Achieved when resources are distributed fairly among society's members.

• Tradeoff Example: Taxes or subsidies may improve equity but reduce efficiency by distorting incentives.

Example: Price ceilings, subsidies, or taxes can create deadweight loss (inefficiency) but may improve equity.

Market Demand and Supply: Construction and Interpretation

Market Demand Curve

• Definition: The market demand curve is constructed by horizontally summing individual consumers' demand at each price.

• Graph: Downward sloping, showing inverse relationship between price and quantity demanded.

Market Equilibrium

• Equilibrium: The point where market demand equals market supply; determines the equilibrium price and quantity.

• Consumer Surplus: Area above the price and below the demand curve.

• Producer Surplus: Area below the price and above the supply curve.

Efficiency vs. Equity on the Graph

• Efficiency is maximized at equilibrium (total surplus is maximized).

• Equity concerns may arise if some consumers cannot afford the equilibrium price.

Elasticity: Price Elasticity of Demand

Definition and Formula

• Price Elasticity of Demand: Measures responsiveness of quantity demanded to a change in price.

Formula:

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

• Elastic Demand: Elasticity > 1 (quantity demanded changes more than price).

• Inelastic Demand: Elasticity < 1 (quantity demanded changes less than price).

Determinants of Elasticity

• Availability of substitutes (more substitutes = more elastic demand).

• Proportion of income spent on the good (higher proportion = more elastic).

• Time horizon (demand is more elastic in the long run).

Application: Revenue and Elasticity

• If demand is elastic, a price increase decreases total revenue.

• If demand is inelastic, a price increase increases total revenue.

Price Discrimination

Conditions for Successful Price Discrimination

• Ability to prevent resale between buyers (market segmentation).

• Ability to identify and separate groups with different elasticities of demand.

Relationship to Elasticity

• Charge higher prices to groups with inelastic demand.

• Charge lower prices to groups with elastic demand.

Labour Markets and Minimum Wage

Law of Demand and Minimum Wage

• Traditional view: Increasing minimum wage reduces quantity of labour demanded (law of demand).

• Empirical studies (e.g., Card & Krueger): Some increases in minimum wage do not reduce employment, possibly due to monopsony power or increased productivity.

Business Responses to Higher Wages

• Reduced turnover (lower hiring/training costs).

• Increased worker productivity and morale.

• Lower absenteeism.

Elasticity of Demand for Labour

• Key determinant: Availability of substitutes for labour (e.g., automation).

• With more substitutes, demand for labour is more elastic.

Market Structures and Profit Maximization

Marginal Analysis for Firms

• Marginal Revenue (MR): Change in total revenue from selling one more unit.

• Marginal Cost (MC): Change in total cost from producing one more unit.

• Profit Maximization Rule: Produce the quantity where $MR = MC$.

Economic Profit

• Economic Profit: Total revenue minus total cost (including opportunity costs).

Market Power and Competition

• Firms have market power if they can set prices above marginal cost (e.g., through product differentiation).

• Perfect competition: Many firms, identical products, no market power.

• Monopolistic competition: Many firms, differentiated products, some market power.

Public Goods, Externalities, and the Tragedy of the Commons

Public Goods

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

• Free Rider Problem: People can benefit without paying, leading to under-provision.

Externalities

• Negative Externality: Cost imposed on others (e.g., pollution).

• Positive Externality: Benefit to others (e.g., education, preserved rainforest).

Tragedy of the Commons

• Definition: Overuse of a common resource because no one owns it (e.g., overgrazing, deforestation).

• Solution: Establishing property rights or government intervention.

Application: Amazon Rainforest

• Rainforest is a public good (provides climate regulation, biodiversity).

• Destruction creates negative externalities (loss of carbon sink, biodiversity loss).

• Preservation creates positive externalities (global climate benefits).

• International cooperation may be needed to fund preservation.

Labour Input and Marginal Product

Marginal Product of Labour (MPL)

• Definition: The additional output produced by hiring one more unit of labour.

• Calculation: $\text{MPL} = \frac{\Delta \text{Total Output}}{\Delta \text{Labour}}$

Hiring Rule

• Hire additional workers as long as $\text{MPL} \geq \text{Wage}$ (price of labour).

Demand for Labour Curve

• Downward sloping: As wage increases, quantity of labour demanded decreases.

Summary Table: Key Microeconomic Concepts

Concept	Definition	Key Formula	Example/Application
Efficiency	Maximizing total surplus	-	Market equilibrium
Equity	Fairness in distribution	-	Progressive taxation
Price Elasticity of Demand	Responsiveness of quantity demanded to price	$\frac{\%\ \text{change in Qd}}{\%\ \text{change in P}}$	UP Express fare changes
Marginal Revenue	Change in total revenue from one more unit sold	$MR = \frac{\Delta TR}{\Delta Q}$	Profit maximization
Marginal Cost	Change in total cost from one more unit produced	$MC = \frac{\Delta TC}{\Delta Q}$	Profit maximization
Public Good	Non-excludable, non-rivalrous	-	Amazon rainforest
Externality	Uncompensated impact on others	-	Pollution, education

Additional info: Where the original questions referenced specific graphs or tables, standard microeconomic diagrams and calculations have been described in text. For tables, the main structure and purpose have been preserved, and formulas are provided for calculation steps.