Microeconomics Midterm Exam Study Guide: Key Concepts and Models

Module 1: Foundations of Economics

Economics, Microeconomics, and Macroeconomics

Economics is the study of how individuals and societies allocate scarce resources to satisfy unlimited wants. Microeconomics focuses on the behavior of individual agents, such as households and firms, while macroeconomics examines the economy as a whole.

• Economics: The science of scarcity and choice.

• Microeconomics: Studies individual markets and decision-makers.

• Macroeconomics: Analyzes aggregate outcomes like GDP, inflation, and unemployment.

• Example: Microeconomics analyzes how a rise in the price of coffee affects consumer demand; macroeconomics studies national unemployment rates.

Productive Resources (Factors of Production)

Resources used to produce goods and services are classified as:

• Land: Natural resources

• Labor: Human effort

• Capital: Manufactured goods used in production

• Entrepreneurship: Risk-taking and innovation

Scarcity, Trade-offs, and Opportunity Costs

Scarcity forces choices, leading to trade-offs and opportunity costs.

• Scarcity: Limited resources vs. unlimited wants

• Trade-offs: Choosing one option means giving up another

• Opportunity Cost: The value of the next best alternative forgone

• TANSTAAFL: "There Ain't No Such Thing As A Free Lunch"—all choices have costs

• Example: Choosing to attend college means forgoing income from a full-time job

Rational Behavior, Marginalism, and Economic Decision Rule

Individuals act purposefully to maximize utility, considering marginal benefits and costs.

• Rational Behavior: Making choices that maximize satisfaction

• Marginalism: Decisions made at the margin (additional benefit vs. additional cost)

• Economic Decision Rule: Take action if marginal benefit > marginal cost

• Formula: $MB > MC$

Scientific Method, Economic Principles, and Models

Economists use models and the scientific method to analyze economic phenomena.

• Scientific Method: Systematic observation, hypothesis, testing

• Economic Principles: Generalizations about economic behavior

• Economic Models: Simplified representations of reality

• Simplifying Assumption: Reduces complexity to focus on key relationships

Positive vs. Normative Economics

• Positive Economics: Objective, fact-based statements ("what is")

• Normative Economics: Subjective, value-based statements ("what ought to be")

• Example: "Unemployment is 5%" (positive); "Unemployment should be lower" (normative)

Economic Goals and the Economizing Problem

• Economic Goals: Efficiency, equity, growth, stability

• Economizing Problem: How to allocate limited resources to satisfy wants

Budget Line and Production Possibilities Curve (PPC)

• Budget Line: Shows combinations of goods a consumer can afford

• PPC: Shows maximum output combinations of two goods given resources

• Formula for Budget Line: $P_x X + P_y Y = I$ (where $P_x$, $P_y$ are prices; $X$, $Y$ are quantities; $I$ is income)

• PPC Shape: Bowed outward due to increasing opportunity costs

Module 2: Economic Systems and Market Mechanisms

Types of Economic Systems

• Command System: Central planning by government committees

• Market System: Decentralized decisions by individuals and firms

Three Fundamental Economic Questions

• What to produce?

• How to produce?

• For whom to produce?

Market System Features

• Consumer Sovereignty: "Dollar votes" determine what is produced

• Invisible Hand: Self-interest leads to socially desirable outcomes

• Requirements for Market Efficiency: Well-defined property rights, competition, information

Circular Flow Diagram

• Illustrates the flow of resources, goods, and money between households and firms

Module 3: Trade and Comparative Advantage

Voluntary Exchange and Trade

• Both parties gain from voluntary exchange

Absolute and Comparative Advantage

• Absolute Advantage: Ability to produce more with the same resources

• Comparative Advantage: Ability to produce at a lower opportunity cost

• Principle of Comparative Advantage: Specialize in goods with lowest opportunity cost

• Terms of Trade: Rate at which goods are exchanged

• PPCs Bowed Outward: Reflect increasing opportunity costs

• Example: If Country A can produce 10 cars or 5 trucks, and Country B can produce 6 cars or 6 trucks, each should specialize where they have comparative advantage.

Module 4: Markets, Demand, and Supply

Market and Demand

• Market: Any arrangement for buyers and sellers to exchange goods

• Demand Curve: Shows quantity demanded at each price

• Quantity Demanded: Amount consumers are willing to buy at a specific price

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

• Change in Quantity Demanded: Movement along the demand curve due to price change

• Change in Demand: Shift of the demand curve due to non-price factors

• Factors Shifting Demand: Income, tastes, prices of related goods, expectations, number of buyers

Supply and Supply Curve

• Supply Curve: Shows quantity supplied at each price

• Quantity Supplied: Amount producers are willing to sell at a specific price

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

• Change in Quantity Supplied: Movement along the supply curve due to price change

• Change in Supply: Shift of the supply curve due to non-price factors

• Factors Shifting Supply: Input prices, technology, expectations, number of sellers

Market Equilibrium

• Equilibrium: Where quantity demanded equals quantity supplied

• Equilibrium Price and Quantity: Determined by intersection of supply and demand curves

• Surpluses: Quantity supplied > quantity demanded (price above equilibrium)

• Shortages: Quantity demanded > quantity supplied (price below equilibrium)

• Market Dynamics: Prices adjust to eliminate surpluses and shortages

• Example: If a new technology lowers production costs, supply increases, shifting the supply curve right and lowering equilibrium price.

Module 5: Efficiency, Surplus, and Market Failure

Productive and Allocative Efficiency

• Productive Efficiency: Goods produced at lowest possible cost

• Allocative Efficiency: Resources allocated to produce mix most desired by society

Consumer and Producer Surplus

• Consumer Surplus: Difference between what consumers are willing to pay and what they actually pay

• Producer Surplus: Difference between market price and minimum price producers are willing to accept

Deadweight Loss and Market Failure

• Deadweight Loss: Loss of total surplus due to market inefficiency

• Market Failure: When market outcomes are not efficient

Externalities and Government Intervention

• Externalities: Costs or benefits affecting third parties (positive or negative)

• Government Intervention: Taxes, subsidies, regulation to correct externalities

Public Goods and Free Rider Problem

• Public Goods: Non-excludable and non-rivalrous goods

• Free Rider Problem: Individuals benefit without paying

Information Asymmetries, Adverse Selection, and Moral Hazard

• Information Asymmetry: One party knows more than the other

• Adverse Selection: Hidden information leads to undesirable market outcomes

• Moral Hazard: One party takes risks because they do not bear the full consequences

Module 6: Elasticity

Price Elasticity of Demand ($E_d$)

Measures responsiveness of quantity demanded to price changes.

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

• Inelastic Demand: $|E_d| < 1$ (quantity demanded changes little with price)

• Elastic Demand: $|E_d| > 1$ (quantity demanded changes significantly with price)

• Unit Elastic: $|E_d| = 1$

Elasticity and the Demand Curve

• Linear Demand Curve: Elasticity varies along the curve

• Total Revenue Test: If price and total revenue move in opposite directions, demand is elastic; if they move together, demand is inelastic

• Determinants of Elasticity: Availability of substitutes, necessity vs. luxury, proportion of income spent, time horizon

• Example: Demand for gasoline is typically inelastic in the short run but more elastic in the long run.

Type of Elasticity	Value of $E_d$	Effect on Total Revenue
Elastic	$|E_d| > 1$	Price up, revenue down; price down, revenue up
Inelastic	$|E_d| < 1$	Price up, revenue up; price down, revenue down
Unit Elastic	$|E_d| = 1$	Total revenue unchanged

Additional info: Academic context and examples have been added to expand upon the brief points listed in the original review sheet.