Microeconomics Exam Study Guide: Core Concepts and Applications

Chapter 1: Introduction to Economics, Micro vs Macro, Opportunity Cost, Command vs Market Economy, The Methodology of Economics

Utility, Wants, Resources, and Scarcity

Economics studies how individuals and societies allocate scarce resources to satisfy unlimited wants. Understanding the concepts of utility, resources, and scarcity is fundamental to microeconomics.

• Utility: The satisfaction or benefit derived from consuming goods and services.

• Resources: Inputs used to produce goods and services (land, labor, capital, entrepreneurship).

• Scarcity: The limited nature of resources relative to unlimited wants.

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

• Explicit and Implicit Costs: Explicit costs involve direct monetary payment; implicit costs represent foregone opportunities.

• Example: Choosing to attend college involves explicit costs (tuition) and implicit costs (foregone income).

Market vs Command Economy

Economic systems determine how resources are allocated and goods are produced and distributed.

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

• Command Economy: Central authority makes economic decisions.

• Features of Market Economy: Private property, voluntary exchange, competition, price mechanism.

• Features of Command Economy: Central planning, government ownership, allocation by decree.

• Advantages/Disadvantages: Market economies are efficient but may have inequality; command economies can ensure equity but may lack efficiency.

• Example: The United States is a market economy; North Korea is a command economy.

Microeconomics vs Macroeconomics

Economics is divided into two main branches: microeconomics and macroeconomics.

• Microeconomics: Studies individual markets, firms, and consumer behavior.

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

• Example: Microeconomics analyzes the price of coffee; macroeconomics studies national unemployment rates.

Positive vs Normative Economics

Economic statements can be classified as positive (descriptive) or normative (prescriptive).

• Positive Statements: Objective and fact-based ("Increasing the minimum wage will reduce employment").

• Normative Statements: Subjective and value-based ("The government should increase the minimum wage").

Chapter 3: Supply and Demand

Features of a Perfectly Competitive Market

Perfect competition is a market structure characterized by many buyers and sellers, homogeneous products, and free entry and exit.

• Key Features: Many participants, identical products, no barriers to entry, perfect information.

• Example: Agricultural markets (e.g., wheat).

Demand and the Law of Demand

Demand refers to the quantity of a good consumers are willing and able to buy at various prices.

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

• Marginal Utility: The additional satisfaction from consuming one more unit of a good.

• Demand Curve: Downward sloping due to diminishing marginal utility and substitution effect.

• Equation: $Q_d = f(P)$, where $Q_d$ is quantity demanded and $P$ is price.

Supply and the Law of Supply

Supply is the quantity of a good producers are willing and able to sell at various prices.

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

• Supply Curve: Upward sloping due to increasing marginal cost.

• Equation: $Q_s = f(P)$, where $Q_s$ is quantity supplied and $P$ is price.

Market Equilibrium

Market equilibrium occurs where quantity demanded equals quantity supplied.

• Equilibrium Price: The price at which $Q_d = Q_s$.

• Equilibrium Quantity: The quantity bought and sold at equilibrium price.

• Graphical Representation: Intersection of demand and supply curves.

• Example: If the price is above equilibrium, surplus occurs; if below, shortage occurs.

Shifts in Demand and Supply

Non-price factors can shift demand and supply curves.

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

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

• Example: An increase in consumer income shifts the demand curve for normal goods to the right.

Chapter 4: Market Efficiency, Price Ceilings and Price Floors, Consumer & Producer Surplus, Deadweight Loss

Consumer and Producer Surplus

Surplus measures the benefit to buyers and sellers from market transactions.

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

• Producer Surplus (PS): The difference between the price received and the minimum price producers are willing to accept.

• Equation: $CS = \int_{0}^{Q^*} (D(P) - P^*) dQ$

• Equation: $PS = \int_{0}^{Q^*} (P^* - S(P)) dQ$

• Graphical Representation: CS is the area below the demand curve and above price; PS is the area above the supply curve and below price.

Market Efficiency and Deadweight Loss

Market efficiency is achieved when total surplus (CS + PS) is maximized. Deadweight loss represents lost gains from trade due to market distortions.

• Deadweight Loss (DWL): The reduction in total surplus due to market inefficiency (e.g., price controls).

• Equation: $DWL = \frac{1}{2} \times (Q_{efficient} - Q_{actual}) \times (P_{actual} - P_{efficient})$

• Example: Price floors and ceilings can create DWL by preventing the market from reaching equilibrium.

Price Ceilings and Price Floors

Price controls are government-imposed limits on prices in the market.

• Price Ceiling: Maximum legal price; can cause shortages if set below equilibrium.

• Price Floor: Minimum legal price; can cause surpluses if set above equilibrium.

• Binding vs Non-binding: A price control is binding if it affects the market outcome.

• Example: Rent control (ceiling), minimum wage (floor).

Chapter 7: Elasticity

Elasticity Concepts and Types

Elasticity measures the responsiveness of one variable to changes in another, commonly price and quantity.

• Price Elasticity of Demand (Ed): Responsiveness of quantity demanded to changes in price.

• Equation: $E_d = \frac{\% \Delta Q_d}{\% \Delta P}$

• Types of Elasticity:

  • Demand:

    • Own-price elasticity: Change in quantity demanded due to change in own price.

    • Cross-price elasticity: Change in quantity demanded due to change in price of another good (positive for substitutes, negative for complements).

    • Income elasticity: Change in quantity demanded due to change in income (positive for normal goods, negative for inferior goods).

  • Supply:

    • Price elasticity of supply: Responsiveness of quantity supplied to change in price.

Interpreting Elasticity Values

• Elastic: $|E_d| > 1$ (quantity responds strongly to price changes).

• Inelastic: $|E_d| < 1$ (quantity responds weakly to price changes).

• Unit Elastic: $|E_d| = 1$.

• Relationship to Law of Demand: Elasticity quantifies the slope of the demand curve.

Determinants of Elasticity

• Availability of Substitutes: More substitutes, more elastic demand.

• Definition of Market: Narrowly defined markets, more elastic demand.

• Necessities vs Luxuries: Luxuries, more elastic; necessities, less elastic.

• Time Horizon: Elasticity increases over time.

• Budget Share: Goods that take a larger share of income, more elastic.

Summary Table: Types of Elasticity

Type	Definition	Significance
Price Elasticity of Demand	Responsiveness of Qd to change in price	Measures consumer sensitivity to price
Income Elasticity of Demand	Responsiveness of Qd to change in income	Distinguishes normal vs inferior goods
Cross-Price Elasticity	Responsiveness of Qd to change in price of another good	Identifies substitutes and complements
Price Elasticity of Supply	Responsiveness of Qs to change in price	Measures producer sensitivity to price

Additional info: Some explanations and equations have been expanded for clarity and completeness. Examples and context have been added to ensure the notes are self-contained and suitable for exam preparation.