Microeconomics Exam Study Guide: Core Concepts and Applications

Chapter 1: Foundations of Economics

Economics: Definition and Scarcity

Economics is the study of how individuals and societies allocate limited resources to satisfy unlimited wants. Scarcity refers to the fundamental economic problem of having finite resources to meet infinite desires.

• Scarcity: The condition that arises because resources are limited while human wants are unlimited.

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

• Tradeoffs: The necessity to choose between competing alternatives due to scarcity.

Main Ideas of Economics

• Marginalism: Analysis of the additional or incremental costs and benefits of a decision.

• Incentives: Factors that motivate individuals to act in certain ways.

• Rationalism: The assumption that individuals make decisions logically to maximize their utility.

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

Efficiency and Scientific Method

• Efficiency: Achieving maximum output with given resources.

• Scientific Method: Systematic approach to inquiry involving observation, hypothesis, and testing.

• Positive vs. Normative Statements: Positive statements describe facts; normative statements express opinions or what ought to be.

Economic Systems and Factors of Production

• Economic Systems: The structure of methods and principles a society uses to allocate resources (e.g., market, command, mixed).

• Factors of Production: 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.

• Shape: A bowed-out PPF indicates 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.

• Terms of Trade: The rate at which goods are exchanged between countries or individuals.

Property Rights and Contract Enforcement

• Property Rights: Legal rights to use and transfer resources.

• Contract Enforcement: Mechanisms to ensure agreements are honored.

Chapter 3: 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.

• Graph: Downward-sloping demand curve.

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

• Shift of Demand vs. Movement Along Demand: A shift is caused by non-price factors; movement is caused by price changes.

• Market Demand: The sum of all individual demands in a market.

• Demand Shifters: Income, tastes, prices of related goods, expectations, number of buyers.

Law of Supply

The law of supply states that, ceteris paribus, as the price of a good increases, the quantity supplied increases.

• Graph: Upward-sloping supply curve.

• Market Supply: The sum of all individual supplies in a market.

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

Equilibrium

• Equilibrium: The price and quantity at which demand equals supply.

• Shortages/Surpluses: Shortage occurs when quantity demanded exceeds quantity supplied; 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 depends on the magnitude and direction of each shift.

Chapter 6: Elasticity

Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of quantity demanded to changes in price.

• Calculation: $E_d = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}$

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

• Along a Linear Demand: Elasticity varies along a straight-line demand curve.

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

• Applications: Pricing strategies, tax incidence, revenue forecasting.

Price Elasticity of Supply

• Calculation: $E_s = \frac{\% \text{ change in quantity supplied}}{\% \text{ change in price}}$

• Determinants: Flexibility of producers, availability of inputs, time period.

Income Elasticity of Demand

• Calculation: $E_I = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in income}}$

• Range: Inferior goods (negative elasticity), normal goods (positive elasticity), necessity (elasticity between 0 and 1), luxury (elasticity greater than 1).

Cross-Price Elasticity of Demand

• Calculation: $E_{xy} = \frac{\% \text{ change in quantity demanded of good X}}{\% \text{ change in price of good Y}}$

• Range: Positive for substitutes, negative for complements.

Elasticity Type	Formula	Interpretation
Price Elasticity of Demand	$E_d = \frac{\% \text{ change in Qd}}{\% \text{ change in P}}$	Responsiveness of quantity demanded to price changes
Price Elasticity of Supply	$E_s = \frac{\% \text{ change in Qs}}{\% \text{ change in P}}$	Responsiveness of quantity supplied to price changes
Income Elasticity of Demand	$E_I = \frac{\% \text{ change in Qd}}{\% \text{ change in Income}}$	Responsiveness of quantity demanded to income changes
Cross-Price Elasticity of Demand	$E_{xy} = \frac{\% \text{ change in Qd of X}}{\% \text{ change in P of Y}}$	Responsiveness of demand for one good to price changes of another

Additional info: Some subtopics (such as "Scientific Method" and "Property Rights") were expanded for academic completeness. The table summarizes key elasticity formulas and their interpretations for exam review.