Microeconomics Final Exam Study Guide: Market Structures, Efficiency, and Monopoly

Chapter 4 – Economic Efficiency, Government Price Setting, and Taxes

Basic Concepts

• Consumer, Producer, Social/Total Surplus: Measures of welfare in a market. Consumer surplus is the difference between what consumers are willing to pay and what they actually pay. Producer surplus is the difference between the price producers receive and their cost of production. Social/total surplus is the sum of consumer and producer surplus.

• Demand = Marginal Benefit = Willingness to Pay: The demand curve reflects the maximum price consumers are willing to pay for each unit.

• Supply = Marginal Cost: The supply curve shows the minimum price at which producers are willing to sell each unit.

• Economic Efficiency and Surplus Maximization: Efficiency is achieved when total surplus is maximized, typically at the market equilibrium.

• Price Ceiling and Price Floor Effects: Price ceilings (maximum legal prices) and price floors (minimum legal prices) can create shortages or surpluses and reduce total surplus.

• Tax and Surplus: Taxes create a wedge between what buyers pay and sellers receive, reducing total surplus and creating deadweight loss.

Skills to Master

• Compute consumer and producer surplus from a graph.

• Compute changes in surplus and deadweight loss due to taxes, price controls, or shifts in supply/demand.

• Analyze the effects of a price floor or ceiling on equilibrium and surplus.

• Analyze the effects of a tax on buyers or sellers.

Key Equations

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

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

• Deadweight Loss: Loss in total surplus due to market distortion (e.g., tax, price control).

Example: If a tax is imposed, the deadweight loss is the area between the supply and demand curves from the new lower quantity to the equilibrium quantity.

Chapter 12 – Firms in Perfectly Competitive Markets

Basic Concepts

• Perfect Competition: Many firms, identical products, free entry and exit, price-taking behavior.

• Market Price = Marginal Revenue: Each firm faces a perfectly elastic demand at the market price.

• Profit Maximization Condition: Firms maximize profit where marginal cost equals marginal revenue ($MC = MR$).

• Short Run vs. Long Run: In the short run, firms may earn profits or losses; in the long run, entry and exit drive profits to zero.

• Shutdown Decision: Firms shut down in the short run if price is below average variable cost ($P < AVC$).

• Productive and Allocative Efficiency: In the long run, perfectly competitive markets achieve both productive (lowest ATC) and allocative ($P = MC$) efficiency.

Key Equations

• Total Profit: $\text{Profit} = TR - TC = Q \times (P - ATC)$

• Operating Profit: $\text{Operating Profit} = TR - VC = Q \times (P - AVC)$

• Total Revenue: $TR = P \times Q$

• Total Cost: $TC = ATC \times Q$

• Variable Cost: $VC = AVC \times Q$

• Marginal Cost: $MC = \Delta TC / \Delta Q$

Skills to Master

• Find optimal quantity on a graph.

• Represent profits, revenues, and costs on a graph.

• Compute all the above values.

• Determine whether a firm operates or shuts down in the short run.

• Map long-run market adjustments into individual firm’s graph, and vice versa.

• Represent and compute surplus areas on a graph.

Chapter 13 – Monopolistic Competition

Basic Concepts

• Monopolistic Competition: Many firms, differentiated products, free entry and exit.

• Downward Sloping Demand: Firms face a downward sloping demand curve because they can set their own prices due to product differentiation.

• Marginal Revenue (MR): MR is less than price for a downward sloping demand curve.

• Profit Maximization: Firms maximize profit where $MR = MC$.

• Long Run: Entry and exit drive economic profit to zero, but firms do not produce at minimum ATC (excess capacity).

• Efficiency: Monopolistic competition does not achieve productive or allocative efficiency.

Key Equations

• Marginal Revenue: $MR = \Delta TR / \Delta Q$

• Profit: $\text{Profit} = (P - ATC) \times Q$

Skills to Master

• Find optimal quantity and price on a graph.

• Find the price charged by the firm for the quantity where $MR = MC$.

• Represent profits, revenues, and costs on a graph.

• Compute all the above values.

• Show the deadweight loss resulting from monopolistic competition on a graph.

• Compare the market to perfect competition.

• Represent and compute surplus areas on a graph.

Chapter 14 – Firms in Oligopolistic Markets

Basic Concepts

• Oligopoly: A market with a few large firms, interdependent decision-making, and barriers to entry.

• Game Theory: Used to analyze strategic interactions among firms.

• Collusion and Cartels: Firms may collude to set prices or output, but such agreements are often unstable.

• Punishment Devices: Price matching and price leadership can help sustain collusion.

• Antitrust Laws: Laws and regulations to prevent collusion and promote competition.

Skills to Master

• Solve for the Nash Equilibrium of a simultaneous action game represented by a matrix of payoffs.

• Determine dominant strategies for each player.

• Explain the logic of punishment devices and collusion.

• Show the Nash Equilibrium when there is no dominant strategy.

Chapter 15 – Monopolies

Basic Concepts

• Monopoly: A single firm supplies the entire market for a good or service with no close substitutes and high barriers to entry.

• Sources of Monopoly Power: Patents, copyrights, trademarks, public franchises, control of key resources, and network externalities.

• Profit Maximization: Monopolists maximize profit where $MR = MC$.

• Pricing Behavior: Monopolists set price above marginal cost, leading to deadweight loss and reduced consumer surplus.

• Regulation: Governments may regulate monopolies to reduce inefficiency.

Skills to Master

• Find the output and price charged by a monopoly.

• Show and compute the deadweight loss on the market. Proceed the same way as under monopolistic competition.