Microeconomics Final Exam Study Guide: Chapters 1–15

Core Concepts

Scarcity, Opportunity Cost, and Economic Models

Microeconomics begins with the study of how individuals and firms make choices under conditions of scarcity. Scarcity refers to the limited nature of resources, which necessitates trade-offs and the concept of opportunity cost—the value of the next best alternative forgone.

• Scarcity: Limited resources relative to unlimited wants.

• Opportunity Cost: The cost of forgoing the next best alternative when making a decision.

• Economic Model: Simplified representations of reality used to analyze economic situations.

Example: Choosing to spend time studying economics instead of working a part-time job involves the opportunity cost of lost wages.

Principles of Optimization and Marginal Analysis

Optimization involves making the best possible choice given constraints. Marginal analysis examines the impact of small changes in decision variables.

• Optimization: Selecting the best feasible option.

• Marginal Benefit: Additional benefit from one more unit.

• Marginal Cost: Additional cost from one more unit.

Formula: $MB = MC$ at the optimal point.

Comparative Advantage and Trade

Comparative advantage explains how individuals or countries benefit from specializing in the production of goods for which they have the lowest opportunity cost, leading to gains from trade.

• Comparative Advantage: Ability to produce a good at a lower opportunity cost than others.

• Specialization: Focusing on the production of specific goods.

• Gains from Trade: Increased total output and consumption from specialization and exchange.

Basic Demand and Supply

Demand and Supply Fundamentals

Markets are driven by the interaction of demand and supply. Demand reflects consumer willingness to buy at various prices, while supply reflects producer willingness to sell.

• Demand: Quantity of a good consumers are willing to buy at different prices.

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

• Supply: Quantity of a good producers are willing to sell at different prices.

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

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

Formula: $Q_d = Q_s$ at equilibrium.

Example: For linear demand and supply curves, solve for equilibrium price and quantity by setting $Q_d = Q_s$.

Comparative Statics

Comparative statics analyzes the effect of changes in determinants on market outcomes.

• Example: An increase in demand for corn shifts the demand curve right, raising equilibrium price and quantity.

Demand / Consumer Theory

Budget Line and Indifference Curves

Consumer theory examines how individuals allocate their income to maximize utility.

• Budget Line: Shows all combinations of goods a consumer can afford.

• Indifference Curve: Represents combinations of goods yielding equal satisfaction.

• Optimal Purchase Rule: Consumers maximize utility where the budget line is tangent to the highest indifference curve.

Elasticity

Price Elasticity of Demand

Elasticity measures responsiveness of quantity demanded to price changes.

• Point Elasticity Formula: $E_d = \frac{dQ}{dP} \cdot \frac{P}{Q}$

• Average Elasticity Formula: $E_d = \frac{Q_2 - Q_1}{P_2 - P_1} \cdot \frac{P_1 + P_2}{Q_1 + Q_2}$

• Interpretation: Elasticity > 1 is elastic, < 1 is inelastic, = 1 is unit elastic.

Elasticity and Revenue

• Elastic Demand: Price increase reduces total revenue.

• Inelastic Demand: Price increase raises total revenue.

Elasticity Table

Price Elasticity of Demand	Change in Price	Change in Total Revenue
Elastic	↑	↓
Inelastic	↑	↑
Unitary Elastic	↑	No change

Efficiency and Exchange

Consumer and Producer Surplus

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

• Consumer Surplus: Area above price and below demand curve.

• Producer Surplus: Area above supply curve and below price.

• Total Surplus: Sum of consumer and producer surplus.

Deadweight Loss

Deadweight loss is the reduction in total surplus due to market inefficiency, such as price controls or taxes.

• Example: Imposing a price ceiling below equilibrium creates deadweight loss.

Supply In-Depth

Cost Minimization and Cost Curves

Firms seek to minimize costs and maximize profits. Cost curves illustrate relationships between output and costs.

• Total Physical Product (TPP): Total output produced.

• Marginal Physical Product (MPP): Additional output from one more unit of input.

• Principle of Diminishing Marginal Product: As more of an input is used, its marginal product eventually decreases.

• Cost Curves:

  • Total Cost: $TC = FC + VC$

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

  • Average Cost: $AC = \frac{TC}{Q}$

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

Revenue and Profit Maximization

• Total Revenue: $TR = P \times Q$

• Marginal Revenue: $MR = \frac{\Delta TR}{\Delta Q}$

• Profit Maximization: Occurs where $MR = MC$

• Profit: $\pi = TR - TC$

Plotting the Firm and the Industry

Perfect Competition and Economic Profits

In perfect competition, firms earn zero economic profit in the long run as entry and exit drive profits to zero. Short-run profits can exist if price exceeds average cost.

• Zero Economic Profit: $P = minAC$

• Positive Economic Profit: $P > AC$

Trade

Production Possibilities, Comparative and Absolute Advantage

Trade allows countries to consume beyond their production possibilities frontier (PPF) by specializing according to comparative advantage.

• Absolute Advantage: Ability to produce more of a good with the same resources.

• Comparative Advantage: Lower opportunity cost in producing a good.

• Globalization: Integration of markets worldwide.

• Protectionism: Use of tariffs and quotas to restrict trade.

Forms of Industrial Organization

Perfect Competition

Perfect competition features many firms, identical products, and free entry/exit. Firms are price takers and earn zero economic profit in the long run.

• Profit Maximization: $P = MC$

• Long Run: Entry/exit ensures zero economic profit.

Monopoly

Monopoly is a market with a single seller. The monopolist maximizes profit by producing where $MR = MC$ and can earn long-run profits due to barriers to entry.

• Profit Maximization: $MR = MC$

• Barriers to Entry: Legal, technological, or resource-based obstacles.

• Deadweight Loss: Monopoly reduces total surplus compared to perfect competition.

Monopolistic Competition

Monopolistic competition features many firms selling differentiated products. Firms have some market power but face competition.

• Profit Maximization: $MR = MC$

• Long Run: Entry erodes profits; price equals average cost.

Oligopoly

Oligopoly is a market with a few large firms, often producing similar or differentiated products. Strategic interaction is key.

• Game Theory: Used to analyze strategic behavior.

• Duopoly: Two firms dominate the market.

• Collusion: Firms may cooperate to set prices.

Game Theory and Strategic Play

Understanding Games and Nash Equilibrium

Game theory studies strategic interactions among rational players. The Nash equilibrium occurs when no player can improve their outcome by changing strategies unilaterally.

• Players: Decision-makers in the game.

• Strategies: Possible actions for each player.

• Payoffs: Outcomes associated with strategy combinations.

• Nash Equilibrium: Each player's strategy is optimal given the other's strategy.

Prisoner's Dilemma Table

	Confess	Don't Confess
YOU: Confess	3,0	2,10
YOU: Don't Confess	10,2	0,0

Externalities and Public Goods

Externalities

Externalities are costs or benefits that affect third parties outside the market transaction.

• Negative Externality: Imposes costs (e.g., pollution).

• Positive Externality: Provides benefits (e.g., education).

• Solutions: Taxes, subsidies, regulation, Coase theorem.

Public Goods and Common Pool Resources

Public goods are non-excludable and non-rivalrous, leading to free rider problems. Common pool resources are rival but non-excludable, often leading to overuse (tragedy of the commons).

• Public Good: Non-excludable, non-rival (e.g., national defense).

• Common Pool Resource: Non-excludable, rival (e.g., fisheries).

Markets for Factors of Production

Input Markets

Input markets determine the supply and demand for labor, capital, and land. Marginal revenue product of labor (MRPL) is key in labor demand.

• MRPL Formula: $MRPL = MPL \times MR$

• Wage Inequality: Differences in wages due to skills, education, and market conditions.

Trade-offs Involving Time and Risk

Time Preferences and Present Value

Time preferences reflect how individuals value present versus future consumption. Present value calculations discount future payments to their value today.

• Present Value Formula: $PV = \frac{Payment}{(1 + interest\ rate)^t}$

• Risk Preferences: Risk averse, risk seeking, risk neutral.

Example: Choosing between a certain payment and a risky lottery.

Additional info:

• Notes cover all major microeconomics topics from the provided chapter list.

• Tables and diagrams have been recreated in text and HTML format for clarity.