Microeconomics Core Concepts and Principles: Structured Study Notes

Scarcity and Economic Decision-Making

Scarcity and Choices

Scarcity is a fundamental concept in economics, referring to the limited nature of resources relative to unlimited human wants. This condition forces individuals and societies to make choices and trade-offs.

• Scarcity: The condition that arises because resources are finite and cannot satisfy all human wants.

• Trade-offs: Choosing one option means giving up another due to limited resources.

• Example: Allocating time between studying and leisure activities.

Three Key Economic Ideas

• People are rational: Individuals use all available information to achieve their goals.

• People respond to incentives: Changes in costs or benefits influence behavior.

• Optimal decisions are made at the margin: Decisions are made by comparing marginal benefits and marginal costs.

Opportunity Cost

Opportunity cost is the value of the next best alternative foregone when making a decision.

• Definition: The cost of forgoing the next best alternative.

• Formula: $\text{Opportunity Cost} = \text{Value of Best Alternative Forgone}$

• Example: Choosing to attend college instead of working full-time; the opportunity cost is the foregone salary.

Types of Economic Systems

Economic Organization

Societies organize their economies in different ways to answer the fundamental questions of what, how, and for whom to produce.

• Centrally Planned Economies: The government makes all decisions about production and allocation.

• Market Economies: Decisions are made by individuals and firms interacting in markets.

• Mixed Economies: Combines elements of both central planning and market mechanisms.

Positive vs. Normative Economics

• Positive Economics: Describes and explains economic phenomena ("what is").

• Normative Economics: Prescribes policies or actions ("what ought to be").

• Example: Positive: "Increasing the minimum wage raises unemployment among teens." Normative: "The government should increase the minimum wage."

Microeconomics vs. Macroeconomics

• Microeconomics: Studies individual markets, firms, and consumers.

• Macroeconomics: Examines the economy as a whole, including inflation, unemployment, and growth.

Production Possibilities Frontier (PPF)

Assumptions and Efficiency

The PPF illustrates the maximum combinations of goods and services that can be produced given available resources and technology.

• Efficient Points: Located on the PPF; all resources are fully utilized.

• Inefficient Points: Inside the PPF; resources are underutilized.

• Unattainable Points: Outside the PPF; not possible with current resources.

Economic Growth and Shifts in the PPF

• Economic growth: Shifts the PPF outward, indicating increased production capacity.

• Factors: Technological advances, increases in resources.

Marginal Opportunity Cost

• Definition: The amount of one good that must be given up to produce more of another good.

• Graphical Representation: The slope of the PPF.

Comparative and Absolute Advantage

Definitions and Calculations

Comparative advantage and absolute advantage are key concepts in trade theory.

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

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

• Formula for Opportunity Cost: $\text{Opportunity Cost of Good A} = \frac{\text{Units of Good B foregone}}{\text{Units of Good A gained}}$

• Example: If Country A can produce 10 cars or 5 trucks, the opportunity cost of 1 car is 0.5 trucks.

Gains from Trade

• Specialization: Countries specialize in goods for which they have comparative advantage.

• Mutual Benefit: Both parties can consume beyond their individual PPFs.

Market Systems and Private Property

Adam Smith and the 'Invisible Hand'

• Invisible Hand: The self-regulating nature of the marketplace.

• Knowledge Problem: Difficulty in centralizing information for efficient allocation.

Private Property Rights

• Definition: The legal right to own and use resources.

• Importance: Encourages investment and efficient resource use.

Demand and Supply

Law of Demand

The law of demand states that, ceteris paribus, as the price of a good increases, the quantity demanded decreases.

• Demand Curve: Downward sloping.

• Substitution and Income Effects: Explain why demand curves slope downward.

Factors Shifting Demand

• Income: Normal vs. inferior goods.

• Prices of related goods: Substitutes and complements.

• Tastes, expectations, number of buyers.

Law of Supply

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

• Supply Curve: Upward sloping.

Market Equilibrium

• Equilibrium Price: Where quantity demanded equals quantity supplied.

• Surplus: Quantity supplied exceeds quantity demanded; price falls.

• Shortage: Quantity demanded exceeds quantity supplied; price rises.

Utility and Consumer Choice

Utility and Marginal Utility

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

• Marginal Utility: Additional satisfaction from consuming one more unit.

• Law of Diminishing Marginal Utility: Marginal utility decreases as consumption increases.

• Calculation: $\text{Marginal Utility} = \frac{\Delta \text{Total Utility}}{\Delta \text{Quantity}}$

Behavioral Economics

• Social Influences: Celebrity endorsements, network externalities, fairness.

• Behavioral Biases: Systematic deviations from rational decision-making.

• Sunk Costs: Costs that cannot be recovered and should not affect current decisions.

Consumer and Producer Surplus

Marginal Benefit and Surplus

• Marginal Benefit: The additional benefit from consuming one more unit.

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

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

Market Efficiency

• Efficiency Condition: $\text{MB} = \text{MC}$ (Marginal Benefit equals Marginal Cost)

• CS and PS Maximized: Consumer and producer surplus are maximized at equilibrium.

Price Controls

• Price Ceilings: Maximum legal price; can cause shortages.

• Price Floors: Minimum legal price; can cause surpluses.

• Graphical Analysis: Show effects on supply and demand curves.

Tax Incidence and Deadweight Loss

• Tax Incidence: The division of a tax burden between buyers and sellers.

• Deadweight Loss: Loss of total surplus due to market distortions (taxes, price controls).

• Formula: $\text{Deadweight Loss} = \frac{1}{2} \times \text{Tax} \times \text{Reduction in Quantity}$

Externalities and Public Goods

Externalities

• Positive Externalities: Benefits to third parties (e.g., education).

• Negative Externalities: Costs to third parties (e.g., pollution).

• Market Failure: Occurs when externalities are not internalized.

Private Solutions and Coase Theorem

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

Public Goods and Common Resources

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

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

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

Type of Good	Rivalrous?	Excludable?	Example
Private Good	Yes	Yes	Food, clothing
Public Good	No	No	National defense
Common Resource	Yes	No	Fish in the ocean
Club Good	No	Yes	Private parks

Government Solutions

• Taxes/Subsidies: Used to internalize externalities.

• Tradable Emissions Permits: Market-based approach to pollution control.

Black Markets

• Definition: Illegal markets that arise when price controls or restrictions are imposed.

Additional info: Some explanations and examples have been expanded for clarity and completeness.