Microeconomics Midterm 1 Review: Demand, Supply, Elasticity, and Market Analysis

Review Questions for Midterm 1

Demand and Supply Analysis

Understanding how markets operate is fundamental in microeconomics. The following questions focus on the behavior of prices and quantities in response to changes in market conditions, as well as the concepts of elasticity and comparative advantage.

• Market Price and Elasticity: The responsiveness of quantity demanded or supplied to changes in price is measured by elasticity. Key terms include:

  • Elastic Demand: Quantity demanded changes significantly with price changes.

  • Inelastic Demand: Quantity demanded changes little with price changes.

  • Perfectly Elastic: Quantity demanded changes infinitely with any price change.

  • Perfectly Inelastic: Quantity demanded does not change with price.

• Market Equilibrium: The market-clearing price is where quantity demanded equals quantity supplied.

• Shifts vs. Movements: A shift in the supply or demand curve indicates a change in a non-price determinant (e.g., technology, preferences), while a movement along the curve is due to a price change.

Elasticity

Elasticity measures how much quantity demanded or supplied responds to changes in price or other factors.

• Price Elasticity of Demand: $\text{Elasticity} = \frac{\%\ \text{change in quantity demanded}}{\%\ \text{change in price}}$

• Interpretation:

  • Elasticity > 1: Elastic

  • Elasticity < 1: Inelastic

  • Elasticity = 1: Unit elastic

  • Elasticity = 0: Perfectly inelastic

  • Elasticity = ∞: Perfectly elastic

• Applications: If the market price increases and demand is inelastic, total revenue increases. If demand is elastic, total revenue decreases.

Comparative Advantage and Specialization

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

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer.

• Absolute Advantage: The ability to produce more of a good with the same resources than another producer.

• Gains from Trade: Both parties can benefit by specializing and trading according to comparative advantage.

• Example: If Alexis paints portraits faster and Bernardine makes jewelry more efficiently, Alexis should paint and Bernardine should make jewelry, then trade.

Market Interventions and Price Controls

Government interventions such as price ceilings and floors can lead to shortages or surpluses.

• Price Ceiling: A legal maximum price. If set below equilibrium, it causes a shortage.

• Price Floor: A legal minimum price. If set above equilibrium, it causes a surplus.

• Example: If the market-clearing price is $10 and a price ceiling is set at $8, a shortage will result.

Economic Problems and Shifts

Markets are affected by various factors, including technology, weather, and policy changes.

• Shifts in Supply: Favorable weather increases supply, shifting the supply curve rightward.

• Shifts in Demand: Changes in consumer preferences or income can shift the demand curve.

• Economic Problems: Scarcity, choice, and opportunity cost are central issues in economics.

Linear Demand Equations

Demand and supply can be represented by linear equations, where price and quantity are related.

• General Form: $P = a - bQ$

• Intercept: The value of $P$ when $Q = 0$.

• Independent Variable: The variable you change (often $Q$ in economics).

• Dependent Variable: The variable that responds (often $P$ in economics).

• Relationship: Can be positive/negative, linear/nonlinear.

Tabular Data: Price and Quantity Effects

The following table summarizes how various events affect price and quantity in the beef steak market:

Event	Price	Quantity
The price of hay increases	Up	Down
The AMA says steaks are good for people	Up	Up
The price of imported wine increases	Can't tell	Can't tell
Cost of trucking beef falls	Down	Up
Beef is endorsed by a famous celebrity	Up	Up

Additional info: Table entries inferred based on standard economic analysis of supply and demand shifts.

Normative vs. Positive Statements

• Positive Statement: Describes what is, can be tested and validated.

• Normative Statement: Describes what ought to be, based on values or opinions.

• Example: "We ought to guarantee everyone a living wage" is normative.