Microeconomics Core Concepts and Applications: Study Guide

Microeconomics Core Concepts

Opportunity Cost

Opportunity cost is a fundamental concept in microeconomics, representing the value of the next best alternative forgone when making a decision.

• Definition: The cost of forgoing the next best alternative when making a choice.

• Calculation: Compare the benefits of the chosen option to the benefits of the alternative not chosen.

• Example: If you spend time studying instead of working, the opportunity cost is the wage you would have earned.

Formula:

$\text{Opportunity Cost} = \text{Value of Next Best Alternative}$

Marginal Analysis

Marginal analysis examines the additional benefits and costs of a decision.

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

• Marginal Benefit (MB): The increase in total benefit from consuming one more unit.

• Application: Decisions are made where MB = MC.

Formula:

$\text{Marginal Cost} = \frac{\Delta \text{Total Cost}}{\Delta \text{Quantity}}$

$\text{Marginal Benefit} = \frac{\Delta \text{Total Benefit}}{\Delta \text{Quantity}}$

Supply and Demand Analysis

Supply and demand are the core mechanisms determining prices and quantities in markets.

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

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

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

• Shifts: Changes in non-price factors shift the curves.

Formula:

$Q_d = f(P)$ (Quantity demanded as a function of price)

$Q_s = f(P)$ (Quantity supplied as a function of price)

Elasticity

Elasticity measures responsiveness of quantity demanded or supplied to changes in price or other factors.

• Price Elasticity of Demand (PED): Measures how much quantity demanded changes with price.

• Income Elasticity of Demand: Measures response to changes in income.

• Cross-Price Elasticity: Measures response to changes in the price of related goods.

• Elastic vs. Inelastic: Elastic demand means consumers are sensitive to price changes; inelastic means they are not.

Formula:

$\text{PED} = \frac{\%\,\text{Change in Quantity Demanded}}{\%\,\text{Change in Price}}$

Consumer and Producer Surplus

Surplus measures the benefit to consumers and producers from market transactions.

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

• Producer Surplus: The difference between the price received and the minimum price at which producers are willing to sell.

Graphical Representation: Surpluses are shown as areas between the demand and supply curves and the market price.

Production Possibilities Curve (PPC)

The PPC illustrates the maximum combinations of two goods that can be produced with available resources.

• Concave PPC: Reflects increasing opportunity costs.

• Straight-Line PPC: Reflects constant opportunity costs.

• Movement Along PPC: Represents trade-offs between goods.

Example: Moving from point A to B on the PPC shows the opportunity cost of producing more of one good.

Comparative and Absolute Advantage

These concepts explain how individuals or countries benefit from specialization and trade.

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

• Comparative Advantage: Ability to produce a good at a lower opportunity cost.

• Application: Specialization according to comparative advantage increases total output.

Table: Comparative vs. Absolute Advantage

Country	Good A Output	Good B Output	Absolute Advantage	Comparative Advantage
Country X	10	5	Good A	Good A
Country Y	6	8	Good B	Good B

Market Equilibrium and Shocks

Market equilibrium occurs where supply equals demand. Shocks can disrupt equilibrium, causing price and quantity changes.

• Equilibrium Price: The price at which quantity supplied equals quantity demanded.

• Shock: An event that shifts supply or demand, such as a natural disaster or policy change.

Types of Goods

Goods are classified based on their relationship to income and other goods.

• Normal Goods: Demand increases as income increases.

• Inferior Goods: Demand decreases as income increases.

• Luxury Goods: Demand increases more than proportionally as income increases.

• Complements: Goods consumed together (e.g., bread and butter).

• Substitutes: Goods that can replace each other (e.g., tea and coffee).

Price Controls: Floors and Ceilings

Price floors and ceilings are government interventions in markets.

• Price Floor: Minimum legal price (e.g., minimum wage).

• Price Ceiling: Maximum legal price (e.g., rent control).

• Effects: Can cause surpluses (floors) or shortages (ceilings).

Deadweight Loss and Tax Incidence

Deadweight loss measures the loss of economic efficiency due to market distortions. Tax incidence refers to how the burden of a tax is shared between buyers and sellers.

• Deadweight Loss: The reduction in total surplus due to inefficiency.

• Tax Incidence: Depends on the relative elasticities of supply and demand.

Graphical Representation: Deadweight loss is shown as the area between supply and demand curves not captured by consumer or producer surplus after a tax.

Economic Efficiency

Efficiency occurs when resources are allocated to maximize total surplus.

• Allocative Efficiency: Producing the mix of goods most desired by society.

• Productive Efficiency: Producing goods at the lowest possible cost.

Summary Table: Key Microeconomic Concepts

Concept	Definition	Formula
Opportunity Cost	Value of next best alternative forgone	$\text{Opportunity Cost} = \text{Value of Next Best Alternative}$
Marginal Cost	Cost of producing one more unit	$\text{MC} = \frac{\Delta \text{TC}}{\Delta Q}$
Price Elasticity of Demand	Responsiveness of quantity demanded to price	$\text{PED} = \frac{\%\,\Delta Q_d}{\%\,\Delta P}$
Consumer Surplus	Difference between willingness to pay and actual price	N/A
Producer Surplus	Difference between price received and minimum acceptable price	N/A
Deadweight Loss	Loss of total surplus due to inefficiency	N/A

Additional info:

• Some topics inferred from checklist and context, such as the graphical representation of concepts and the classification of goods.

• Tables and formulas expanded for clarity and completeness.