Microeconomics Midterm 2 Study Guide: Demand, Supply, Incentives, Competition, and Monopoly

Chapter 4: Demand, Supply, and Equilibrium

The Money Market

The money market is a fundamental concept in microeconomics, representing the interaction between buyers and sellers of money, which determines the equilibrium interest rate.

• Definition: The money market is where the supply and demand for money meet, influencing interest rates and liquidity.

• Example: Central banks use monetary policy to influence the money market by adjusting the supply of money.

How Do Buyers Behave?

Buyers make decisions based on preferences, budget constraints, and the prices of goods and services.

• Optimization: Buyers aim to maximize utility given their budget.

• Example: A consumer chooses between apples and oranges based on price and personal preference.

Law of Demand, Demand Schedule, and Demand Curve

The law of demand states that, ceteris paribus, as the price of a good increases, the quantity demanded decreases.

• Demand Schedule: A table showing quantities demanded at different prices.

• Demand Curve: A graphical representation of the demand schedule, typically downward sloping.

• Equation: $Q_d = a - bP$

• Example: If the price of coffee rises, fewer cups are purchased.

The Difference Between Qd and D

Qd (Quantity Demanded) refers to the specific amount demanded at a particular price, while D (Demand) refers to the entire relationship between price and quantity demanded.

• Example: A change in price moves along the demand curve (Qd changes), while a change in income shifts the demand curve (D changes).

Individual Demand and Market Demand

Market demand is the sum of all individual demands for a good or service.

• Equation: $Q_{market} = Q_1 + Q_2 + ... + Q_n$

• Example: If three consumers each demand 2, 3, and 5 units, market demand is 10 units.

How to Sell/Buy Items

Transactions occur when buyers and sellers agree on a price, leading to market equilibrium.

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

• Equation: $Q_d = Q_s$

Individual Supply, Supply Schedule, and Supply Curve

The supply schedule shows quantities supplied at different prices, and the supply curve is its graphical representation, typically upward sloping.

• Equation: $Q_s = c + dP$

• Example: As the price of wheat increases, farmers supply more wheat.

The Law of Supply

The law of supply states that, ceteris paribus, as the price of a good increases, the quantity supplied increases.

• Example: Higher prices for smartphones encourage manufacturers to produce more units.

How to Sell/Buy Items

Market transactions are facilitated by the interaction of supply and demand, leading to price determination.

• Example: Auctions and posted prices are common mechanisms for selling and buying items.

Two Types of Market Disequilibrium

Disequilibrium occurs when the market is not at equilibrium, resulting in either excess supply or excess demand.

• Excess Supply (Surplus): Quantity supplied exceeds quantity demanded.

• Excess Demand (Shortage): Quantity demanded exceeds quantity supplied.

Surplus & Market Equilibrium

Market forces push prices toward equilibrium, eliminating surpluses and shortages over time.

• Example: If there is a surplus of cars, prices will fall until equilibrium is reached.

Chapter 5: Consumers and Incentives

Consumer Behavior

Consumers make choices to maximize their satisfaction (utility) given their budget constraints.

• Utility: A measure of satisfaction or happiness from consuming goods and services.

• Budget Constraint: The limit on consumption imposed by income and prices.

Demand Elasticities

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

• Price Elasticity of Demand: $E_d = \frac{\% \text{ change in } Q_d}{\% \text{ change in } P}$

• Cross Price Elasticity of Demand: Measures how the quantity demanded of one good responds to a price change in another good.

• Income Elasticity of Demand: Measures how quantity demanded responds to changes in income.

• Example: If the price of gasoline rises, the quantity demanded may decrease significantly (elastic demand).

Chapter 6: Sellers and Incentives

Seller's Problem

Sellers aim to maximize profit by choosing optimal output and pricing strategies.

• Profit Maximization: Occurs where marginal cost equals marginal revenue.

• Equation: $MR = MC$

Finding the Optimum

Optimal production occurs where the difference between total revenue and total cost is greatest.

• Equation: $\text{Profit} = \text{Total Revenue} - \text{Total Cost}$

Shut Down vs. Staying in Business

Firms decide to shut down if revenue does not cover variable costs in the short run.

• Shut Down Rule: If $P < AVC$, the firm should shut down.

• Example: A restaurant closes temporarily if it cannot cover labor and food costs.

Producer Surplus

Producer surplus is the difference between the price received and the minimum price at which a producer is willing to sell.

• Equation: $\text{Producer Surplus} = \text{Price Received} - \text{Minimum Acceptable Price}$

Competitive Equilibrium in the Long Run

In the long run, firms enter or exit the market until economic profits are zero, leading to efficient allocation of resources.

• Firm Entry: New firms enter when profits are positive.

• Firm Exit: Firms exit when profits are negative.

Chapter 7: Perfect Competition and the Invisible Hand

Allocation of Scarce Resources

Perfect competition leads to efficient allocation of resources, maximizing total surplus.

• Invisible Hand: The self-regulating nature of the marketplace.

• Example: Competitive markets allocate goods to those who value them most.

Price Controls

Government-imposed price ceilings and floors can lead to shortages or surpluses.

• Price Ceiling: Maximum legal price (e.g., rent control).

• Price Floor: Minimum legal price (e.g., minimum wage).

Social Surplus and Deadweight Loss

Social surplus is the sum of consumer and producer surplus. Deadweight loss is the reduction in total surplus due to market inefficiency.

• Equation: $\text{Social Surplus} = \text{Consumer Surplus} + \text{Producer Surplus}$

• Deadweight Loss: Occurs when market is not at equilibrium due to price controls or other distortions.

Chapter 12: Monopoly

Key Characteristics of Monopoly

A monopoly is a market structure with a single seller who controls the entire supply of a good or service.

• Market Power: The ability to set prices above marginal cost.

• Unique Product: No close substitutes.

• Barriers to Entry: Prevent other firms from entering the market.

Barriers to Entry

Barriers to entry protect monopolies from competition.

• Types: Legal (patents, licenses), technological, resource ownership.

• Example: Pharmaceutical companies hold patents that prevent competitors from producing the same drug.