Microeconomics Exam 1 Study Guide: Core Concepts and Applications

Chapter 1: Introduction to Economics

Economics: Definition and Scarcity

Economics is the study of how individuals and societies allocate scarce resources to satisfy unlimited wants. Scarcity forces people to make choices about how to use resources efficiently.

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

• Efficiency: Achieving the maximum output with given resources and technology.

Main Ideas of Economics

• Marginalism: Analysis of the additional or incremental costs or benefits arising from a choice or decision.

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

• Tradeoffs: The idea that in order to gain something, something else must be given up.

• Incentives: Factors that motivate individuals to act or exert effort.

• Rationalism: The assumption that individuals make decisions aimed at maximizing their utility or benefit.

Economic Questions and Methods

• Three Economic Questions: What to produce? How to produce? For whom to produce?

• Scientific Method: The process of developing models, testing hypotheses, and analyzing data to understand economic phenomena.

• Positive vs. Normative Statements: Positive statements describe what is; normative statements prescribe what ought to be.

Economic Systems and Factors of Production

• Economic Systems: The means by which societies organize economic activity (e.g., market, command, mixed economies).

• Factors of Production: The resources used to produce goods and services: land, labor, capital, and entrepreneurship.

Chapter 2: Production Possibilities

Production Possibilities Frontier (PPF)

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

• Graph: The PPF is typically a curve showing tradeoffs between two goods.

• Opportunity Cost and Slope: The slope of the PPF represents the opportunity cost of one good in terms of the other.

• Growth: Outward shifts in the PPF indicate economic growth.

• Shape: A bowed-outward PPF reflects increasing opportunity cost.

Trade and Comparative Advantage

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

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

• Specialization: Focusing on the production of goods for which one has a comparative advantage increases overall efficiency and output.

• Terms of Trade: The rate at which one good is exchanged for another between producers or countries.

Property Rights and Contract Enforcement

• Property Rights: Legal rights to use and dispose of resources or goods.

• Contract Enforcement: The ability to ensure agreements are honored, which is essential for market transactions.

Chapter 3: Demand and Supply

Demand

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

• Quantity Demanded vs. Demand: Quantity demanded refers to a specific amount at a specific price; demand refers to the entire relationship between price and quantity demanded.

• Shifts of Demand vs. Movement Along Demand: A change in price causes movement along the demand curve; changes in other factors (income, tastes, prices of related goods) shift the demand curve.

• Market Demand: The sum of all individual demands for a good or service.

• Demand Shifters: Income, tastes, prices of related goods (substitutes and complements), expectations, and number of buyers.

Supply

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

• Quantity Supplied vs. Supply: Quantity supplied is the amount offered at a specific price; supply is the entire relationship between price and quantity supplied.

• Market Supply: The sum of all individual suppliers' quantities for a good or service.

• Supply Shifters: Input prices, technology, expectations, number of sellers, and prices of related goods.

Equilibrium

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

• Shortages/Surpluses: A shortage occurs when quantity demanded exceeds quantity supplied; a surplus occurs when quantity supplied exceeds quantity demanded.

• Shifts and the Equilibrium: Changes in demand or supply shift the equilibrium price and quantity.

• Simultaneous Shifts: When both demand and supply shift, the effect on equilibrium price and quantity depends on the magnitude and direction of each shift.

Chapter 6: Elasticity

Price Elasticity of Demand

• Definition: Measures the responsiveness of quantity demanded to a change in price.

• Calculation: $\text{Price Elasticity of Demand} = \frac{\%\ \text{Change in Quantity Demanded}}{\%\ \text{Change in Price}}$

• Total Revenue: The relationship between elasticity and total revenue: when demand is elastic, a price increase decreases total revenue; when inelastic, a price increase increases total revenue.

• Along a Linear Demand: Elasticity varies along a straight-line demand curve: more elastic at higher prices, less elastic at lower prices.

• Determinants: Availability of substitutes, necessity vs. luxury, proportion of income spent, time horizon.

• Applications: Pricing strategies, tax incidence, and public policy.

Price Elasticity of Supply

• Definition: Measures the responsiveness of quantity supplied to a change in price.

• Calculation: $\text{Price Elasticity of Supply} = \frac{\%\ \text{Change in Quantity Supplied}}{\%\ \text{Change in Price}}$

• Determinants: Flexibility of production, availability of inputs, time period considered.

Income Elasticity of Demand

• Definition: Measures the responsiveness of quantity demanded to a change in income.

• Calculation: $\text{Income Elasticity of Demand} = \frac{\%\ \text{Change in Quantity Demanded}}{\%\ \text{Change in Income}}$

• Range:

  • Inferior goods: Negative income elasticity.

  • Normal goods: Positive income elasticity.

  • Necessities: Income elasticity between 0 and 1.

  • Luxuries: Income elasticity greater than 1.

Cross-Price Elasticity of Demand

• Definition: Measures the responsiveness of quantity demanded for one good to a change in the price of another good.

• Calculation: $\text{Cross-Price Elasticity of Demand} = \frac{\%\ \text{Change in Quantity Demanded of Good A}}{\%\ \text{Change in Price of Good B}}$

• Range:

  • Substitutes: Positive cross-price elasticity.

  • Complements: Negative cross-price elasticity.

Additional info: Some subtopics and examples were expanded for clarity and completeness based on standard microeconomics curricula.