Microeconomics Foundations: Study Notes on Economic Models, Choices, and Market Equilibrium

Lesson 1: Economics Foundations and Models

What is Economics?

Economics is the study of how individuals and societies allocate scarce resources to satisfy unlimited wants. It is not just about money, but about making choices and understanding trade-offs in everyday life.

• Definition: Economics analyzes how people make decisions to achieve their goals given limited resources.

• Scarcity: A situation in which unlimited wants exceed the limited resources available to fulfill those wants.

• Application: Economics helps explain choices in personal finance, business, and government policy.

Choices and Opportunity Cost

Choices are central to economics because resources are scarce. Every choice involves an opportunity cost—the value of the next best alternative forgone.

• Opportunity Cost: The highest-valued alternative that must be given up to engage in an activity.

• Example: Choosing to spend time studying economics means giving up time that could be spent on another activity.

The Economic Problem: What, How, and For Whom?

Societies must answer three fundamental questions:

• What will be produced? Decided by society through individual and collective choices.

• How will it be produced? Determined by firms, technology, and resource allocation.

• Who will receive what is produced? Distribution depends on income, ownership, and market mechanisms.

The Production Possibilities Frontier (PPF)

The PPF illustrates the combinations of two goods that can be produced with available resources and technology, assuming efficiency.

Outcome	Milk (Gallons)	Cheese (Pounds)
A	15	0
B	14	2
C	12	4
D	8	6
E	0	8

Additional info: The PPF demonstrates opportunity cost and efficiency. Points inside the frontier are inefficient; points on the frontier are efficient; points outside are unattainable.

Types of Economies

• Centrally planned economy: Government decides resource allocation.

• Market economy: Decisions are made by households and firms interacting in markets.

• Mixed economy: Combines elements of both market and government decision-making.

Efficiency and Equity

• Productive Efficiency: Production at the lowest possible cost.

• Allocative Efficiency: Production matches consumer preferences ($MU = MC$ for the last unit produced).

• Equity: Fair distribution of economic benefits.

Economic Models

Models are simplified representations of reality used to analyze real-world situations and predict outcomes.

• Models help form hypotheses and test economic theories.

Three Key Economic Ideas

• People are rational: Individuals use available information to achieve goals.

• People respond to incentives: Changes in benefits and costs affect behavior.

• Optimal decisions are made at the margin: Marginal analysis compares additional benefits and costs.

Positive vs. Normative Analysis

• Positive analysis: Objective, fact-based statements about what is.

• Normative analysis: Subjective, value-based statements about what ought to be.

Microeconomics vs. Macroeconomics

• Microeconomics: Focuses on individual decision-making units.

• Macroeconomics: Examines the economy as a whole.

Calculating the Slope of a Line

• Formula: $\text{Slope} = \frac{\text{Change in value on the vertical axis}}{\text{Change in value on the horizontal axis}}$

The Slope of a Nonlinear Curve

• Approximate slope by measuring the slope at a tangent point.

Area of a Triangle

• Formula: $\text{Area of triangle} = \frac{1}{2} \times \text{base} \times \text{height}$

Formula for Percentage Change

• $\text{Percentage Change} = \frac{\text{Value in the second period} - \text{Value in the first period}}{\text{Value in the first period}} \times 100$

Equation of a Line

• $y = mx + b$

Lesson 2: Supply, Demand, and Market Equilibrium

Demand

Demand refers to the decisions people make when buying goods or services. The demand curve shows the relationship between price and quantity demanded.

• Quantity demanded: The amount of a good or service a consumer is willing and able to purchase at a given price.

Markets

• Markets require buyers and sellers.

• Perfectly competitive markets have many buyers and sellers, identical products, and no barriers to entry.

Individual and Market Demand Curves

• Market demand is the sum of individual demand curves.

Shifting the Demand Curve

• Changes in non-price factors shift the entire demand curve.

• Price changes result in movement along the demand curve.

Variables That Shift Market Demand

• Prices of related goods (substitutes and complements)

• Income (normal and inferior goods)

• Tastes

• Population and demographics

• Expected future prices

• Natural disasters and pandemics

Normal vs. Inferior Goods

• Normal goods: Demand increases as income rises.

• Inferior goods: Demand decreases as income rises.

Substitution and Income Effects

• Substitution effect: Change in quantity demanded due to a change in relative price.

• Income effect: Change in quantity demanded due to a change in consumer purchasing power.

Supply

• Quantity supplied: The amount of a good or service a firm is willing and able to sell at a given price.

• Individual supply curves sum to the market supply curve.

Shifting the Supply Curve

• Changes in non-price factors shift the entire supply curve.

• Price changes result in movement along the supply curve.

Variables That Shift Market Supply

• Prices of inputs

• Technological change

• Prices of related goods in production

• Number of firms

• Expected future prices

• Natural disasters and pandemics

Market Equilibrium

• Equilibrium occurs where quantity demanded equals quantity supplied.

• Surplus: Quantity supplied exceeds quantity demanded.

• Shortage: Quantity demanded exceeds quantity supplied.

How Shifts in Demand and Supply Affect Equilibrium

	Supply Curve Unchanged	Supply Curve Shifts to the Right	Supply Curve Shifts to the Left
Demand Curve Unchanged	P unchanged, Q unchanged	P decreases, Q increases	P increases, Q decreases
Demand Curve Shifts to the Right	P increases, Q increases	P may increase, decrease, or unchanged; Q increases	P increases, Q may increase, decrease, or unchanged
Demand Curve Shifts to the Left	P decreases, Q decreases	P may increase, decrease, or unchanged; Q decreases	P decreases, Q may increase, decrease, or unchanged

Finding Market Equilibrium Given Equations

• Set the demand and supply equations equal to each other.

• Solve for equilibrium price ($P$).

• Substitute $P$ into either equation to find equilibrium quantity ($Q$).

• Example: If $Q_d = 100 - 2P$ and $Q_s = 20 + 4P$, set $Q_d = Q_s$ and solve for $P$.