Microeconomics Midterm Study Guide: Principles, Models, and Market Analysis

Chapter 1: The Principles and Practice of Economics

Key Ideas

• Economics is the study of how people make choices to allocate scarce resources.

• Three main principles of economics:

  • Optimization: Individuals and firms strive to choose the best available option to maximize their objectives.

  • Equilibrium: A situation where no individual would benefit by changing their own behavior, given the choices of others.

  • Empiricism: Economists use data and evidence to test theories and determine causality.

Know the Concepts

• Economic Agents and Scarce Resources: Individuals or groups making choices; resources are limited.

• Definition of Economics:

  • Positive vs. Normative Economics: Positive describes what is; normative prescribes what ought to be.

  • Microeconomics vs. Macroeconomics: Micro studies individual agents and markets; macro studies the economy as a whole.

• Optimization:

  • Trade-offs: Choosing one thing often means giving up another.

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

  • Cost-Benefit Analysis: Comparing costs and benefits to make decisions.

• Equilibrium:

  • The Free Rider Problem: When individuals benefit from resources without paying for them.

Chapter 2: Economic Science: Using Data and Models to Understand the World

Key Ideas

• A model is a simplified representation of reality used to analyze economic situations.

• Economists use data to test models and understand how the world works.

• Correlation does not imply causality.

• Experiments help identify cause and effect in economics.

• Research focuses on questions that can be answered with models and data.

Know the Concepts

• The Scientific Method: Involves forming hypotheses and testing them with empirical evidence.

• Causation vs. Correlation:

  • Positive, Negative, and Zero Correlation: Types of relationships between variables.

  • Omitted Variable Bias: When a model leaves out a variable that influences both variables of interest.

• Experimental Economics:

  • Randomized vs. Natural Experiments: Randomized assign subjects randomly; natural use naturally occurring events.

  • Treatment and Control Groups: Used to compare outcomes in experiments.

Know How to

• Plot and interpret graphs.

• Calculate and interpret slopes.

Chapter 3: Optimization: Trying to Do the Best You Can

Key Ideas

• Optimization is when an economic agent chooses the best feasible option.

• Two main approaches:

  • Total Value Analysis:

    1. Translate all costs and benefits into common units.

    2. Calculate the total net benefits of each alternative.

    3. Pick the option with the highest net benefit.

  • Marginal Analysis:

    1. Translate all costs and benefits into common units.

    2. Calculate the marginal consequences of moving between alternatives.

    3. Pick the option where moving to it makes you better off, and away from it makes you worse off.

• Both approaches yield the same optimal choice.

Key Terms

• Optimal Choice or Optimum: The best feasible option.

• Marginal Cost, Marginal Benefit: The additional cost or benefit from one more unit.

• Principle of Optimization: Choose the option with the greatest net benefit.

Chapter 4: Demand, Supply, and Equilibrium

Key Ideas

• In a perfectly competitive market:

  • All sellers sell identical goods or services.

  • No individual buyer or seller can affect the market price.

• The demand curve shows the relationship between price and quantity demanded.

• The supply curve shows the relationship between price and quantity supplied.

• The competitive equilibrium price equates quantity demanded and supplied.

• When prices do not adjust, markets may not clear, leading to shortages or surpluses.

Know the Concepts

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

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

• Types of Goods:

  • Normal vs. Inferior Goods: Normal goods see increased demand as income rises; inferior goods see decreased demand.

  • Complements vs. Substitutes: Complements are used together; substitutes replace each other.

• Demand and Supply Shift Factors: Non-price factors that shift the curves (e.g., income, tastes, technology).

• Competitive Equilibrium: Where demand equals supply.

• Shortage vs. Surplus: Shortage when demand exceeds supply; surplus when supply exceeds demand.

Know How to

• Construct supply and demand curves.

• Find the market equilibrium.

• Analyze effects of shifts and movements along curves.

Chapter 5: Consumers and Incentives

Key Ideas

• The buyer's problem involves tastes, preferences, prices, and budget constraints.

• Optimizing buyers make decisions at the margin.

• The demand curve reflects willingness and ability to pay.

• Consumer surplus is the difference between what a buyer is willing to pay and what they actually pay.

• Elasticity measures responsiveness to changes in price or other variables.

Know the Concepts

• Budget Set/Budget Constraint: All possible combinations of goods a consumer can afford.

• Consumer Surplus: Area between the demand curve and the price line.

• Elasticity:

  • Own Price Elasticity: Responsiveness of quantity demanded to price changes.

  • Cross Price Elasticity: Responsiveness to price changes of related goods.

  • Income Elasticity: Responsiveness to income changes.

  • Elastic vs. Inelastic Demand: Elastic if elasticity > 1; inelastic if < 1.

Know How to

• Construct budget constraints.

• Find equilibrium for the buyer's problem.

• Construct new budget constraints for price or income changes.

• Calculate consumer surplus.

Chapter 6: Sellers and Incentives

Key Ideas

• The seller's problem involves production, costs, and revenues.

• Optimizing sellers make decisions at the margin.

• The supply curve reflects willingness to sell at various prices.

• Producer surplus is the difference between market price and marginal cost.

• Firms enter or exit markets based on profit opportunities.

Know the Concepts

• Production Costs:

  • Variable Costs: Change with output.

  • Fixed Costs: Do not change with output.

  • Total Costs: Sum of variable and fixed costs.

  • Marginal Cost: Cost of producing one more unit.

• Profit Maximization:

  • Profit: $\pi = TR - TC$

  • Total Revenue: $TR = P \times Q$

  • Total Cost: $TC = ATC \times Q$

  • Economic profit occurs when $P > ATC$

  • Economic Profit vs. Accounting Profit: Economic profit includes opportunity costs.

• Equilibrium Condition: Firm maximizes profit where $MR = MC$ in the short run.

• Shutdown Rule: Firm shuts down if price is below average variable cost in the short run.

• Short Run vs. Long Run: In the long run, firms can enter or exit the market.

• Economies of Scale: Cost advantages as output increases; Diseconomies of Scale: Cost disadvantages as output increases.

Know How to

• Construct supply curves.

• Calculate and interpret price elasticity of supply.

• Calculate producer surplus.

Chapter 7: Perfect Competition and the Invisible Hand

Key Ideas

• The invisible hand efficiently allocates goods and services to buyers and sellers.

• It leads to efficient production within and across industries.

• Prices direct the allocation of resources.

• There are trade-offs between efficiency (maximizing the economic pie) and equity (dividing the pie fairly).

Know the Concepts

• Reservation Values: The maximum price a consumer will pay or minimum price a producer will accept.

• Consumer, Producer, and Social Surplus: Measures of welfare in the market.

• Pareto Efficiency vs. Equity: Pareto efficiency means no one can be made better off without making someone else worse off; equity concerns fairness.

• Market Interventions:

  • Price Controls: Price ceiling (maximum price), price floor (minimum price).

  • Quantity Controls: Quotas limiting the amount bought or sold.

Know How to

• Calculate social surplus.

• Find new market equilibrium after interventions or resource reallocations.

• Calculate deadweight loss from market interventions.