Microeconomics Midterm 1 Study Guide: Chapters 1–6

Ch. 1–6: Core Microeconomic Concepts and Applications

Ch. 1: The Scope and Method of Economics

Economics studies how individuals and societies allocate scarce resources to satisfy unlimited wants. Microeconomics focuses on the behavior of individual consumers, firms, and markets.

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

• Production Possibility Frontier (PPF): A curve showing the maximum attainable combinations of two goods that can be produced with available resources and technology.

• Comparative vs. Absolute Advantage: Comparative advantage refers to the ability to produce a good at a lower opportunity cost than another producer, while absolute advantage is the ability to produce more of a good with the same resources.

• Specialization and Trade: Specialization according to comparative advantage allows for gains from trade, as each party can consume beyond their individual PPF.

Example: If one person can produce apples at a lower opportunity cost than oranges, and another the reverse, both benefit by specializing and trading.

Ch. 2: The Economic Problem: Scarcity and Choice

Scarcity forces individuals and societies to make choices about resource allocation. The PPF illustrates trade-offs and opportunity costs.

• PPF Shape: Usually bowed outward due to increasing opportunity costs.

• Shifts in PPF: Caused by changes in resources or technology.

Example: In a two-person economy, drawing the PPF helps identify who should specialize in which good and the terms of trade.

Ch. 3: Demand, Supply, and Market Equilibrium

Markets allocate resources through the interaction of demand and supply, determining equilibrium price and quantity.

• Law of Demand: As price falls, quantity demanded rises, ceteris paribus.

• Law of Supply: As price rises, quantity supplied rises, ceteris paribus.

• Market Equilibrium: Occurs where quantity demanded equals quantity supplied.

Example: The equilibrium price and quantity for apples can be found where the demand and supply curves intersect.

Ch. 4: Demand and Supply Applications

Applications include calculating consumer and producer surplus, deadweight loss, and the effects of government intervention.

• Consumer Surplus: The difference between what consumers are willing to pay and what they actually pay.

• Producer Surplus: The difference between the price producers receive and the minimum they are willing to accept.

• Deadweight Loss: The loss of total surplus due to market inefficiency, often from taxes or price controls.

• Government Revenue: Calculated as the tax per unit times the quantity sold.

Example: Using the apple market table below, equilibrium occurs at $1.50$ per kg, where demand and supply are both 1200 units.

Price/kg	Demand per week	Supply per week
0.00	1800	0
0.50	1600	400
1.00	1400	800
1.50	1200	1200
2.00	1000	1600
2.50	800	2000
3.50	600	2400
4.00	400	2800
4.50	200	3200
5.00	0	3600

Formulas:

• Consumer Surplus: $CS = \frac{1}{2} \times (Base) \times (Height)$

• Producer Surplus: $PS = \frac{1}{2} \times (Base) \times (Height)$

• Deadweight Loss: $DWL = \frac{1}{2} \times (Quantity_{reduced}) \times (Tax~or~Price~Difference)$

Ch. 5: Elasticity

Elasticity measures the responsiveness of quantity demanded or supplied to changes in price or other factors.

• Price Elasticity of Demand: Measures how much quantity demanded changes with a change in price.

• Formula: $E_d = \frac{\%\,\text{change in quantity demanded}}{\%\,\text{change in price}}$

• Interpretation: If $|E_d| > 1$, demand is elastic; if $|E_d| < 1$, demand is inelastic.

Example: If a 10% price increase leads to a 20% drop in quantity demanded, $E_d = -2$ (elastic demand).

Ch. 6: Household Behavior and Consumer Choice

Consumers maximize utility given their budget constraints. The optimal consumption bundle is where the marginal utility per dollar is equalized across goods.

• Utility: Satisfaction derived from consuming goods and services.

• Marginal Utility (MU): The additional utility from consuming one more unit of a good.

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

• Indifference Curve: Shows combinations of goods that provide the same level of utility.

• Optimal Consumption Rule: $\frac{MU_x}{P_x} = \frac{MU_y}{P_y}$

Example: Given $100, wine at $10/bottle, and quiche at $10 each, the consumer should allocate spending so that the marginal utility per dollar is equal for both goods.

Bottles of Wine	Total Utility	Marginal Utility	Marginal Utility per Dollar
0	0	-	-
1	190	190	19
2	370	180	18
3	490	120	12
4	550	60	6
5	570	20	2

Quiche	Total Utility	Marginal Utility	Marginal Utility per Dollar
0	0	-	-
1	110	110	11
2	190	80	8
3	250	60	6
4	290	40	4
5	310	20	2

To find the optimal bundle: Allocate spending to equalize marginal utility per dollar across goods, without exceeding the $100 budget.

Additional info: Indifference curves are convex to the origin, and the budget line's slope is determined by the price ratio of the two goods. The point of tangency between the highest attainable indifference curve and the budget line is the consumer's equilibrium.