Microeconomics First Exam Study Guide: Key Concepts and Applications

Chapter 1: Basics of Graphing

Interpreting Relationships Between Variables

Understanding how two variables, such as X and Y, relate is fundamental in microeconomics. Graphs visually represent these relationships, helping to analyze economic models and data.

• Positive Relationship: As X increases, Y increases (upward-sloping line).

• Negative Relationship: As X increases, Y decreases (downward-sloping line).

• No Relationship: Y remains constant as X changes (horizontal line).

Calculating Slope

The slope measures the rate at which one variable changes in relation to another. For a straight line, the slope is constant; for a curve, the slope can vary along the arc.

• Formula for Slope (Arc):

$\text{Slope} = \frac{\Delta Y}{\Delta X}$

• Application: Slope is used to analyze demand and supply curves, cost functions, and other economic relationships.

Chapter 2: Production Possibilities and Economic Efficiency

Production Possibilities Frontier (PPF)

The PPF illustrates the maximum combinations of two goods or services that an economy can produce given its resources and technology.

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

• Marginal Cost (MC): The additional cost of producing one more unit of a good.

• Marginal Benefit (MB): The additional benefit received from consuming one more unit of a good.

• Productive Efficiency: Producing goods at the lowest possible cost.

• Allocative Efficiency: Producing the mix of goods most desired by society.

Graphing the PPF: The PPF is typically bowed outward, reflecting increasing opportunity costs.

$\text{Opportunity Cost} = \frac{\text{Loss in Good Y}}{\text{Gain in Good X}}$

• Circular Flow Model: Shows how money, goods, and services flow between households and firms in a market economy.

Chapter 3: Demand, Supply, and Market Equilibrium

Demand

Demand refers to the quantity of a good or service that consumers are willing and able to purchase at various prices.

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

• Demand Curve: Downward-sloping, showing inverse relationship between price and quantity demanded.

• Changes in Demand vs. Quantity Demanded:

  • Change in Demand: Shift of the entire demand curve due to factors like income, tastes, or prices of related goods.

  • Change in Quantity Demanded: Movement along the demand curve due to a change in price.

• Equation for Demand Curve:

$Q_d = a - bP$

• Graphing: Plot price on the vertical axis and quantity on the horizontal axis.

Supply

Supply is the quantity of a good or service that 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, showing direct relationship between price and quantity supplied.

• Changes in Supply vs. Quantity Supplied:

  • Change in Supply: Shift of the entire supply curve due to factors like input prices, technology, or number of sellers.

  • Change in Quantity Supplied: Movement along the supply curve due to a change in price.

• Equation for Supply Curve:

$Q_s = c + dP$

• Graphing: Plot price on the vertical axis and quantity on the horizontal axis.

Supply and Demand Interaction

Market equilibrium occurs where the demand and supply curves intersect, determining the equilibrium price and quantity.

• Price as a Regulator: Prices adjust to balance supply and demand, allocating resources efficiently.

• Predicting Changes: Shifts in demand or supply lead to changes in equilibrium price and quantity.

• Graphing Effects: Shifts are shown as movements of the curves; new intersection points indicate new equilibrium.

Chapter 4: Elasticity and Revenue

Price Elasticity of Demand

Price elasticity of demand measures how much quantity demanded responds to a change in price.

• Calculation:

$E_d = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}$

• Interpretation:

  • Elastic Demand: $E_d > 1$ (quantity demanded changes more than price).

  • Inelastic Demand: $E_d < 1$ (quantity demanded changes less than price).

  • Unit Elastic: $E_d = 1$ (quantity demanded changes exactly as price).

• Examples:

  • Elastic: Luxury goods, non-necessities.

  • Inelastic: Necessities, goods with few substitutes.

• Factors Influencing Elasticity: Availability of substitutes, necessity vs. luxury, proportion of income spent, time horizon.

Total Revenue Test

The total revenue test helps determine whether demand is elastic or inelastic.

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

• If price and total revenue move in opposite directions, demand is elastic.

• If price and total revenue move in the same direction, demand is inelastic.

Income Elasticity of Demand

Income elasticity measures how quantity demanded changes as consumer income changes.

• Calculation:

$E_I = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in income}}$

• Interpretation:

  • Normal Goods: $E_I > 0$ (demand increases as income increases).

  • Inferior Goods: $E_I < 0$ (demand decreases as income increases).

Cross Elasticity of Demand

Cross elasticity of demand measures how quantity demanded of one good responds to a change in the price of another good.

• Calculation:

$E_{xy} = \frac{\% \text{ change in quantity demanded of good X}}{\% \text{ change in price of good Y}}$

• Interpretation of Signs:

  • Positive ($E_{xy} > 0$): Goods are substitutes.

  • Negative ($E_{xy} < 0$): Goods are complements.

Additional info:

• For all elasticity calculations, use midpoint (arc) formula for more accurate results:

$E_d = \frac{(Q_2 - Q_1) / [(Q_2 + Q_1)/2]}{(P_2 - P_1) / [(P_2 + P_1)/2]}$

• Graphing skills are essential for visualizing economic concepts and analyzing shifts in curves.