Microeconomics Final Exam Review: Key Concepts and Structures

Module 7: Market Structures, Taxes, and Efficiency

Stocks and the Efficient Market Hypothesis (EMH)

The Efficient Market Hypothesis (EMH) posits that financial markets are "informationally efficient," meaning that prices of stocks reflect all available information.

• Definition: EMH suggests that it is impossible to consistently achieve higher returns than average market returns on a risk-adjusted basis, given that stock prices already incorporate and reflect all relevant information.

• Implication: Stock prices follow a random walk and cannot be predicted based on past information.

• Example: If a company releases a new product, the stock price will immediately adjust to reflect the expected impact on profits.

Price Ceilings and Floors

Price ceilings and price floors are government-imposed limits on how high or low a price can be charged for a product.

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

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

• Effects: Can lead to shortages (ceiling) or surpluses (floor).

Sales Tax and Excise Tax

Taxes imposed on goods and services affect market outcomes and efficiency.

• Sales Tax: A percentage of the sale price added to the cost of goods/services.

• Excise Tax: A fixed amount per unit sold (e.g., gasoline tax).

• Tax Incidence: Refers to how the burden of a tax is shared between buyers and sellers.

• Deadweight Loss (DWL): The loss of economic efficiency when equilibrium is not achieved due to taxation.

Formula for Deadweight Loss:

$DWL = \frac{1}{2} \times (P_{after} - P_{before}) \times (Q_{before} - Q_{after})$

Module 8: Production, Costs, and Efficiency

Production Function & Technology

The production function describes the relationship between inputs and outputs in the production process.

• Short Run: At least one input is fixed.

• Long Run: All inputs are variable.

Marginal Product (MP) and Law of Diminishing Returns

• Marginal Product (MP): The additional output produced by one more unit of input.

• Law of Diminishing Returns: As more units of a variable input are added to fixed inputs, the additional output from each new unit will eventually decrease.

Formula for Marginal Product:

$MP = \frac{\Delta Q}{\Delta L}$

Types of Returns

• Increasing Returns: Output increases more than proportionally to input.

• Diminishing Returns: Output increases less than proportionally.

• Negative Returns: Output decreases as input increases.

Costs: Explicit, Implicit, Accounting, and Economic

• Explicit Costs: Direct, out-of-pocket payments.

• Implicit Costs: Opportunity costs of using resources.

• Accounting Profit: $\text{Total Revenue} - \text{Explicit Costs}$

• Economic Profit: $\text{Total Revenue} - (\text{Explicit Costs} + \text{Implicit Costs})$

Types of Costs

• Fixed Costs (FC): Do not vary with output.

• Variable Costs (VC): Change with output.

• Total Cost (TC): $TC = FC + VC$

• Average Fixed Cost (AFC): $AFC = \frac{FC}{Q}$

• Average Variable Cost (AVC): $AVC = \frac{VC}{Q}$

• Average Total Cost (ATC): $ATC = \frac{TC}{Q}$

• Marginal Cost (MC): $MC = \frac{\Delta TC}{\Delta Q}$

Economies of Scale & Minimum Efficient Scale (MES)

• Economies of Scale: Cost advantages from increased production.

• Minimum Efficient Scale (MES): The lowest level of output at which long-run average cost is minimized.

Module 9: Perfect Competition and Efficiency

Structure-Conduct-Performance Paradigm

This framework analyzes how market structure affects firm conduct and market performance.

• Structure: Number and size of firms, barriers to entry.

• Conduct: Pricing, advertising, R&D.

• Performance: Efficiency, profitability, consumer welfare.

Productive and Allocative Efficiency

• Productive Efficiency: Producing at lowest possible cost.

• Allocative Efficiency: Resources allocated to maximize consumer and producer surplus.

Perfect Competition (PC)

• Characteristics: Many firms, identical products, no barriers to entry.

• Revenue Structure: $MR = AR = P$

• Short-Run Profit Maximizing Rule: Produce where $MR = MC$

• Shut-Down Rule: Shut down if $P < AVC$

• Long-Run Outcome: Firms earn zero economic profit.

Module 10: Monopoly and Market Power

Monopoly Structure & Barriers to Entry

• Monopoly: Single seller, unique product, high barriers to entry.

• Barriers: Patents, resource ownership, government regulation.

Network Externalities

• Definition: Value of a product increases as more people use it (e.g., social networks).

Module 10 Continued: Monopoly Analysis

Natural Monopolies

• Definition: A market where a single firm can supply at lower cost than multiple firms due to economies of scale.

Revenue Structure of Monopolists

• Marginal Revenue (MR): Less than price due to downward-sloping demand.

Profit-Maximizing Output & Price

• Rule: Monopolist produces where $MR = MC$ and charges price from demand curve.

Price Discrimination

• Definition: Charging different prices to different consumers for the same product.

• Types: First-degree, second-degree, third-degree.

Monopoly Performance and Consequences

• X Inefficiency: Lack of competitive pressure leads to higher costs.

• Regulation and Antitrust Laws: Government policies to limit monopoly power and promote competition.

Module 11: Market Structures Spectrum

Four Market Structures

Structure	Number of Firms	Product Type	Barriers to Entry
Perfect Competition	Many	Identical	None
Monopolistic Competition	Many	Differentiated	Low
Oligopoly	Few	Identical or Differentiated	High
Monopoly	One	Unique	Very High

Monopolistic Competition (MC)

• Product Differentiation: Physical, location, service, and image.

• Demand Curve: Downward sloping, more elastic than monopoly.

• Performance: Some inefficiency, but more variety for consumers.

Oligopoly

• Mutual Interdependence: Firms' decisions affect each other.

• Concentration Ratios: 4-firm ratio, Herfindahl index measure market power.

• Game Theory: Analyzes strategic interactions (e.g., collusion, price wars).

• Collusion: Overt (formal agreements) or covert (secret).

• Obstacles to Collusion: Incentive to cheat, legal restrictions.

• Kinked Demand Curve: Explains price rigidity in oligopoly.

Module 12: Income Distribution and Labor Markets

Lorenz Curve & Gini Coefficient

• Lorenz Curve: Graphical representation of income distribution.

• Gini Coefficient: Numerical measure of inequality (0 = perfect equality, 1 = perfect inequality).

Labor Market Concepts

• Marginal Revenue Product (MRP): Additional revenue from hiring one more unit of labor.

• Formula: $MRP = MP_L \times MR$

• Derived Demand: Demand for labor depends on demand for output.

• Human Capital: Skills, education, and experience that increase productivity.

• Monopsony Power: Single buyer of labor, can set wages below competitive level.

• Economic Rent: Payment to a factor of production above its opportunity cost.

Complications to D & S Model of Wage Determination

• Factors: Minimum wage laws, unions, discrimination, monopsony power.

Additional info: Where concepts were listed without explanation, standard microeconomic definitions and context have been provided to ensure completeness and academic quality.