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Microeconomics Midterm 1 Study Guide: Foundations, Markets, Efficiency, and Government Intervention

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CHAPTER 1 - FOUNDATIONS AND MODELS

Basic Concepts in Microeconomics

This section introduces the foundational principles and terminology of microeconomics, which are essential for understanding how individuals and societies allocate scarce resources.

  • Microeconomics: The study of individual decision-making units, such as households and firms, and how they interact in markets.

  • Rationality: The assumption that individuals make decisions aimed at maximizing their utility or benefit.

  • Incentives: Factors that motivate individuals to act in certain ways, often by altering costs or benefits.

  • Optimal Decision at the Margin: Making choices by comparing marginal benefits and marginal costs.

  • Trade-off: The idea that choosing one option means giving up another due to limited resources.

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

  • Centrally Planned vs Market vs Modern Mixed Economies: Comparison of economic systems based on who makes production and allocation decisions.

  • Productive Efficiency: Occurs when goods are produced at the lowest possible cost.

  • Allocative Efficiency: Occurs when resources are allocated to produce the mix of goods most desired by society.

  • Equity: The concept of fairness in the distribution of economic benefits.

  • Positive and Normative Analyses: Positive analysis describes 'what is', while normative analysis prescribes 'what ought to be'.

  • Macroeconomics: The study of the economy as a whole, including inflation, unemployment, and economic growth.

  • Technology: The process by which inputs are transformed into outputs.

  • Capital: Manufactured goods used to produce other goods and services.

How Economists Work

Economists use models and assumptions to analyze economic problems and test hypotheses about behavior and outcomes.

  • Assumptions and Models: Simplified representations of reality used to understand and predict economic phenomena.

  • Testable Hypotheses: Statements that can be empirically verified or refuted.

Production Possibilities Frontier (PPF) and Related Concepts

The PPF illustrates the trade-offs and opportunity costs associated with allocating resources between different goods.

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

  • Absolute Advantage: The ability to produce more of a good or service than competitors using the same amount of resources.

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

  • Four Factors of Production: Land, labor, capital, and entrepreneurship.

  • Property Rights: The legal rights to use and control resources.

Skills in Economic Analysis

Students should be able to apply models and concepts to analyze economic scenarios and make recommendations.

  • Draw and interpret a PPF, determining whether it is linear (constant opportunity cost) or bowed out (increasing opportunity cost).

  • Model economic growth and technological progress as outward shifts of the PPF.

  • Compute opportunity cost using the PPF.

  • Identify specialization based on comparative advantage.

  • Determine mutually beneficial trade quantities.

  • Represent gains from trade.

  • Illustrate the basic circular flow model of the economy.

  • Explain how markets and prices coordinate individual decisions.

  • Discuss the role of property rights in market efficiency.

Example: If Country A can produce 10 cars or 20 computers, and Country B can produce 5 cars or 15 computers, Country A has an absolute advantage in both, but comparative advantage depends on opportunity cost.

CHAPTER 3 - WHERE PRICES COME FROM: THE INTERACTION OF DEMAND AND SUPPLY

Market Structure and Equilibrium

This chapter explores how prices are determined in markets through the interaction of demand and supply.

  • Perfectly Competitive Market: A market with many buyers and sellers, identical products, and no barriers to entry.

  • Demand Curve and Quantity Demanded: Shows the relationship between price and the quantity consumers are willing to buy.

  • Complement vs Substitute Goods: Complements are goods used together; substitutes are goods used in place of each other.

  • Supply Curve and Quantity Supplied: Shows the relationship between price and the quantity producers are willing to sell.

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

  • Market Equilibrium: The point where quantity demanded equals quantity supplied.

  • Competitive Equilibrium: The equilibrium in a perfectly competitive market.

  • Equilibrium Price and Quantity: The price and quantity at which the market clears.

  • Surplus and Shortage: Surplus occurs when quantity supplied exceeds quantity demanded; shortage is the opposite.

Demand Shifters

Factors that cause the demand curve to shift, changing the quantity demanded at every price.

  • Income: Higher income increases demand for normal goods, decreases for inferior goods.

  • Prices of Related Goods: Changes in the price of substitutes or complements affect demand.

  • Tastes: Changes in consumer preferences.

  • Population and Demographics: Larger or changing populations affect market demand.

  • Expected Future Prices: Expectations about future prices can increase or decrease current demand.

  • Natural Disasters and Pandemics: Can disrupt demand patterns.

Supply Shifters

Factors that cause the supply curve to shift, changing the quantity supplied at every price.

  • Prices of Inputs: Higher input prices decrease supply.

  • Technological Change: Improvements increase supply.

  • Prices of Related Goods in Production: If a firm can produce multiple goods, changes in one can affect supply of another.

  • Number of Firms in the Market: More firms increase supply.

  • Expected Future Prices: Expectations can shift supply.

  • Natural Disasters and Pandemics: Can reduce supply.

Analyzing Market Changes

Students should be able to translate economic events into supply or demand shifts, analyze their effects, and distinguish between shifts and movements along curves.

  • Determine equilibrium price and quantity after shifts.

  • Distinguish between a shift (entire curve moves) and a movement along the curve (change in quantity due to price).

Example: If a new technology reduces production costs, the supply curve shifts right, lowering equilibrium price and increasing quantity.

CHAPTER 4 - ECONOMIC EFFICIENCY, GOVERNMENT PRICE SETTING AND TAXES

Consumer and Producer Surplus

This section covers measures of market welfare 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 received and the minimum price at which producers are willing to sell.

  • Willingness to Pay: The maximum price a consumer is willing to pay for a good.

  • Marginal Benefit: The additional benefit from consuming one more unit.

  • Marginal Cost: The additional cost of producing one more unit.

  • Economic Efficiency: Achieved when the sum of consumer and producer surplus is maximized.

  • Price Ceiling: A legal maximum price; can cause shortages.

  • Price Floor: A legal minimum price; can cause surpluses.

Skills in Market Analysis

Students should be able to compute surpluses, analyze deadweight loss, and evaluate the effects of taxes and price controls.

  • Compute consumer and producer surplus from tables or graphs.

  • Calculate deadweight loss and changes in surplus due to market interventions.

  • Analyze the effects of price floors and ceilings on market outcomes.

  • Evaluate the impact of a per-unit tax on equilibrium price and quantity.

  • Compute government tax revenue and excess burden (deadweight loss).

  • Determine tax incidence: how the burden of a tax is shared between consumers and producers.

Key Formulas

  • Consumer Surplus: (area under demand curve above price)

  • Producer Surplus: (area above supply curve below price)

  • Deadweight Loss:

  • Tax Revenue:

Example: If a price ceiling is set below equilibrium, consumer surplus may increase for some, but producer surplus falls and deadweight loss occurs due to inefficient allocation.

Concept

Definition

Example/Application

Opportunity Cost

Value of the next best alternative forgone

Choosing to study economics instead of working a part-time job

Comparative Advantage

Ability to produce at lower opportunity cost

Country A specializes in wheat, Country B in cars

Price Ceiling

Legal maximum price

Rent control in housing markets

Deadweight Loss

Loss of total surplus due to market distortion

Tax reduces quantity traded below efficient level

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