Microeconomics Final Exam Study Guide: Core Concepts, Models, and Applications (Chapters 1-15)

Core Concepts of Microeconomics

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 versus unlimited wants.

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

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

• Correlation and Causation: Distinguishing between relationships and direct cause-effect links.

• Principle of Optimization at the Margin: Decisions are made by comparing marginal benefits and marginal costs.

• Diminishing Marginal Benefit: The additional benefit from consuming one more unit decreases as quantity increases.

• Diminishing Marginal Product of an Input: Adding more of one input, holding others constant, eventually yields lower additional output.

• Price Elasticity of Demand and Supply: Measures responsiveness of quantity demanded or supplied to changes in price.

• Long-run and Short-run: Time frames affecting flexibility of inputs and costs.

• Perfect Competition, Invisible Hand, and Efficiency: In perfectly competitive markets, resources are allocated efficiently through the 'invisible hand' mechanism.

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

• Trade Gains from Innovation, Division of Labor, and Specialization: Specialization increases productivity and trade benefits.

• Factors of Production: Land, labor, capital, and entrepreneurship.

Basic Demand and Supply

Determinants and Equilibrium (Ch. 1-4)

Demand and supply are foundational concepts in microeconomics, determining market prices and quantities.

• Demand: Quantity of a good consumers are willing and able to buy at various prices.

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

• Supply: Quantity of a good producers are willing and able to sell at various prices.

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

• Equilibrium: The price ($P^*$) and quantity ($Q^*$) at which quantity demanded equals quantity supplied.

Equilibrium Equation:

• $Q_D = Q_S$

Comparative Statics: Analysis of how changes in demand or supply affect equilibrium price and quantity.

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

Consumer Theory and Demand in Detail

Budget Line, Indifference Curve, and Optimal Choice (Ch. 5)

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

• Budget Line: Shows all combinations of goods a consumer can afford given income and prices.

• Indifference Curve: Represents combinations of goods providing equal satisfaction to the consumer.

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

• Downward Sloping Demand: As price falls, quantity demanded increases due to substitution and income effects.

Elasticity

Price Elasticity of Demand and Related Concepts (Ch. 5)

Elasticity measures how responsive quantity demanded or supplied is to changes in price or other factors.

• Point Elasticity of Demand: Measures responsiveness at a specific point on the demand curve.

Formula for Point Elasticity:

• $\frac{\Delta Q}{\Delta P} \cdot \frac{P}{Q}$

• Arc Elasticity: Average elasticity between two points on a curve.

Arc Elasticity Formula:

• $\frac{Q_2 - Q_1}{P_2 - P_1} \cdot \frac{P_2 + P_1}{Q_2 + Q_1}$

• Elasticity and Total Revenue: If demand is elastic, a price increase reduces total revenue; if inelastic, total revenue increases.

• Income Elasticity of Demand: Measures responsiveness of demand to changes in consumer income.

• Cross Price Elasticity: Measures responsiveness of demand for one good to changes in the price of another good.

Efficiency and Exchange

Consumer and Producer Surplus, Deadweight Loss (Throughout Course)

Efficiency in markets is measured by the sum of consumer and producer surplus. Price controls and taxes can create deadweight loss, reducing total welfare.

• Consumer Surplus: Area above price and below demand curve; represents benefit to consumers.

• Producer Surplus: Area below price and above supply curve; represents benefit to producers.

• Total Surplus: Sum of consumer and producer surplus; measures total welfare.

• Deadweight Loss: Loss of total surplus due to market inefficiency (e.g., price controls, taxes).

Example: A price ceiling below equilibrium creates deadweight loss by reducing quantity traded.

Price Elasticity of Demand	Elastic	Inelastic	Unitary Elastic
Items	Box 1	Box 2	Box 3
Definition	Box 1	Box 2	Box 3

Additional info: Table entries are placeholders; students should complete with definitions and examples (e.g., elastic: luxury goods, inelastic: necessities).

Supply in Depth

Cost Minimization and Cost Curves (Ch. 6)

Firms seek to minimize costs and maximize profits by analyzing production and cost functions.

• Total Physical Product (TPP): Total output produced by a given amount of input.

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

• Principle of Diminishing Marginal Product: MPP decreases as more input is added, holding others constant.

• Marginal Revenue Product (MRP): Additional revenue from selling output produced by one more unit of input.

• Optimal Input Selection: Input is used up to the point where $MRP = MFC$ (Marginal Factor Cost).

Cost Curves:

• Total Cost (TC): $TC = VC + FC$

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

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

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

• Fixed Cost (FC): Costs that do not vary with output.

Revenue:

• Total Revenue (TR): $TR = P \times Q$

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

Profit Maximization: Firms produce where $MR = MC$.

• If $P > AC$, profit is positive.

• If $P = AC$, profit is zero.

• If $P < AC$, profit is negative.

Plotting the Firm and the Industry

Zero and Positive Economic Profits (Ch. 7 & 10)

Graphical analysis shows how firms and industries reach equilibrium and how profits are determined.

• Zero Economic Profits: Occur when $P = AC$; firms earn normal returns.

• Positive Economic Profits: Occur when $P > AC$; attracts entry in competitive markets.

Example: In perfect competition, entry and exit drive profits to zero in the long run.

International Trade

Production Possibilities, Comparative Advantage, and Trade Policy (Ch. 9)

International trade is driven by comparative advantage and can be affected by tariffs and quotas.

• Production Possibilities Frontier (PPF): Shows maximum output combinations given resources.

• Comparative and Absolute Advantage: Comparative advantage leads to specialization and trade.

• Trade Policy: Tariffs and quotas restrict trade; free trade increases welfare.

• Globalization: Integration of markets worldwide.

Forms of Industrial Organization

Perfect Competition, Monopoly, Monopolistic Competition, Oligopoly (Ch. 7, 12, 14)

Market structures differ in the number of firms, product differentiation, and barriers to entry.

• Perfect Competition: Many firms, identical products, no barriers to entry, price takers.

• Monopoly: Single firm, unique product, high barriers to entry, price maker.

• Monopolistic Competition: Many firms, differentiated products, some barriers to entry.

• Oligopoly: Few firms, interdependent decisions, products may be homogeneous or differentiated.

Profit Maximization: In all market structures, firms maximize profit where $MR = MC$.

Example: In monopoly, price is set above marginal cost, creating deadweight loss.

Game Theory and Strategic Behavior

Nash Equilibrium and Oligopoly (Ch. 13)

Game theory analyzes strategic interactions among firms, especially in oligopoly.

• Game Matrix: Represents payoffs for different strategies.

• Nash Equilibrium: Situation where no player can improve their payoff by changing strategy unilaterally.

• Repeated Games: Strategic behavior may change when games are played repeatedly.

	Advertise	Don't Advertise
Advertise	5,5	7,3
Don't Advertise	3,7	6,6

Additional info: Table shows payoffs for two firms choosing whether to advertise; Nash equilibrium occurs where neither can improve by changing strategy.

Externalities

Negative and Positive Externalities, Solutions (Ch. 9)

Externalities occur when market transactions affect third parties. Solutions include taxes, subsidies, and regulation.

• Negative Externality: Social cost exceeds private cost (e.g., pollution).

• Positive Externality: Social benefit exceeds private benefit (e.g., education).

• Solutions: Taxes, subsidies, mandates, Coase theorem (negotiation).

Types of Goods and Public Resources

Public Goods, Common Pool Resources, and Free Rider Problem (Ch. 9)

Goods are classified by excludability and rivalry. Public goods are non-excludable and non-rival, leading to underprovision.

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

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

• Free Rider Problem: Individuals benefit without paying, leading to underprovision.

• Tragedy of the Commons: Overuse of common resources due to lack of ownership.

Markets for Factors of Production

Input Markets and Wage Determination (Ch. 11)

Firms demand inputs (labor, capital, land) based on marginal productivity. Wages are determined by supply and demand for labor.

• Marginal Revenue Product of Labor (MRPL): Additional revenue from hiring one more worker.

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

Risk and Time Preferences

Present Value and Risk Attitudes (Ch. 15)

Individuals and firms make decisions involving risk and time, using present value calculations and considering risk preferences.

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

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

• Expected Value: Weighted average of possible outcomes.

Example: Choosing between a certain $100 and a lottery ticket with expected value $100 reveals risk preferences.

Additional info: These notes expand on the original study sheet, providing definitions, formulas, and examples for each major topic in a college microeconomics course.