Microeconomics Study Guide: Foundations, Demand & Supply, Surplus, and Elasticity

Intro to Economics & Basic Math

Percentage Change

Percentage change is a fundamental concept used to measure how much a value has increased or decreased relative to its original value. It is commonly used in economics to analyze changes in prices, quantities, or economic indicators.

• Formula: $\text{Percentage Change} = \frac{\text{New} - \text{Old}}{\text{Old}} \times 100$

• Example: If GDP increases from 11,150 to 11,720: $\frac{11,720 - 11,150}{11,150} \times 100 = 5.1\%$

Average

The average is used to summarize a set of values by dividing their total by the number of items.

• Formula: $\text{Average} = \frac{\text{Total}}{\text{Number of things}}$

• Example: $(70 + 94 + 69) \div 3 = 77.7$

Slope

Slope measures the rate of change between two variables, often used in economics to analyze graphs.

• Formula: $\text{Slope} = \frac{\Delta Y}{\Delta X}$

Area Formulas

• Rectangle: $\text{Area} = \text{Base} \times \text{Height}$

• Triangle: $\text{Area} = \frac{1}{2} \times \text{Base} \times \text{Height}$

• Application: Total Revenue is often calculated as Price × Quantity.

Opportunity Cost

Opportunity cost is the value of the next-best alternative that is forgone when making a decision.

• Definition: The next-best alternative you give up.

• Key Point: Do not sum all alternatives; only consider the best forgone option.

Scarcity

Scarcity refers to the limited nature of resources, which necessitates choices and leads to opportunity costs.

• Chain: Scarcity → Choices → Opportunity Cost

Equality vs. Efficiency

• Equality: Everyone receives a fair share.

• Efficiency: Maximizing the benefit from available resources.

Microeconomics vs. Macroeconomics

• Microeconomics: Focuses on individuals, businesses, and markets.

• Macroeconomics: Deals with the economy as a whole, including recessions, unemployment, and policy.

Basic Economic Systems

• Market Economy: Decentralized decisions by individuals and businesses.

• Command Economy: Central authority (often government) makes economic decisions.

Recession Chain

Understanding how economic downturns propagate:

• Businesses spend less → Less income → People spend less → Businesses spend even less → Layoffs increase → Unemployment rises

Demand, Supply & Equilibrium

Demand

Demand represents the quantity of a good or service that consumers are willing and able to purchase at various prices.

• Law of Demand: Price increases → Quantity demanded decreases; Price decreases → Quantity demanded increases.

• Movement Along the Curve: Caused by changes in the product's own price.

• Change in Demand: Caused by factors other than the product's own price; shifts the entire curve.

Demand Shifters

• Income

• Prices of related goods

• Tastes/preferences

• Number of consumers

• Expectations

• Season/weather

Normal vs. Inferior Goods

• Normal Good: Income increases → Demand increases

• Inferior Good: Income increases → Demand decreases

Substitutes and Complements

• Substitutes: Goods that can replace each other (e.g., Coke and Pepsi). Substitute's price increases → Demand for the other good increases.

• Complements: Goods used together (e.g., cars and gasoline). Complement's price increases → Demand for the other good decreases.

Supply

Supply is the quantity of a good or service that producers are willing and able to sell at various prices.

• Law of Supply: Price increases → Quantity supplied increases; Price decreases → Quantity supplied decreases.

• Movement Along the Curve: Caused by changes in the product's own price.

• Change in Supply: Caused by factors other than the product's own price; shifts the entire curve.

Supply Shifters

• Input prices

• Technology

• Prices of related goods

• Number of producers

• Expectations

Equilibrium

Equilibrium occurs where the quantity demanded equals the quantity supplied. The intersection of the demand and supply curves determines the equilibrium price and quantity.

• Equilibrium Price: The price at which Qd = Qs.

• Equilibrium Quantity: The quantity traded at equilibrium.

Shortage vs. Surplus

• Shortage: Qd > Qs; occurs when price is below equilibrium.

• Surplus: Qs > Qd; occurs when price is above equilibrium.

Graph Quick Guide

Change	Price	Quantity
Demand ↑	↑	↑
Demand ↓	↓	↓
Supply ↑	↓	↑
Supply ↓	↑	↓

Consumer Surplus & Producer Surplus

Consumer Surplus

Consumer surplus is the difference between what buyers are willing to pay and what they actually pay.

• Formula: $\text{CS} = \text{Willingness to Pay} - \text{Market Price}$

• Example: Willingness to pay = $4; Market price = $1.50; CS = $2.50

• Total Consumer Surplus: Sum the surplus for all buyers who purchase.

Graphing Consumer Surplus

• Area above the market price and below the demand curve.

• Usually forms a triangle: $\text{CS} = \frac{1}{2} \times \text{Base} \times \text{Height}$

Producer Surplus

Producer surplus is the difference between the market price and the minimum price sellers are willing to accept.

• Formula: $\text{PS} = \text{Market Price} - \text{Minimum Acceptable Price}$

• Example: Market price = $21; Minimum acceptable price = $11; PS = $10

• Total Producer Surplus: Sum the surplus for all units produced.

Graphing Producer Surplus

• Area below the market price and above the supply curve.

• Usually forms a triangle.

Effects of Market Price Changes

• Price decreases: Consumer surplus increases, producer surplus decreases.

• Price increases: Consumer surplus decreases, producer surplus increases.

Supply Shift Example

• Production becomes cheaper → Supply shifts right → Equilibrium price falls → Equilibrium quantity rises → Consumer surplus increases.

Elasticity

Price Elasticity of Demand (PED)

Elasticity measures how strongly quantity demanded responds to a price change.

• Formula: $\text{PED} = \frac{\%\Delta Q_d}{\%\Delta P}$

• Midpoint Formula:

  • $\%\Delta Q = \frac{\text{New Q} - \text{Old Q}}{(\text{New Q} + \text{Old Q}) / 2}$

  • $\%\Delta P = \frac{\text{New P} - \text{Old P}}{(\text{New P} + \text{Old P}) / 2}$

• Classification:

  • |PED| > 1: Elastic

  • |PED| < 1: Inelastic

  • |PED| = 1: Unit elastic

• Ignore the negative sign for classification.

• Example: PED = -0.36 → Inelastic (|−0.36| = 0.36)

Interpretation

• PED = -3: A 1% increase in price causes quantity demanded to decrease by 3%.

Factors Affecting Elasticity

• Luxuries: More elastic

• Necessities: Less elastic

• More substitutes: More elastic

• Fewer substitutes: Less elastic

Perfectly Inelastic Demand

• Demand curve is vertical; quantity does not change with price.

Flat vs. Steep Demand Curves

• Flatter curve: More elastic

• Steeper curve: Less elastic

Income Elasticity

Measures how quantity demanded responds to changes in income.

• Formula: $\text{Income Elasticity} = \frac{\%\Delta Q_d}{\%\Delta \text{Income}}$

• Interpretation:

  • Positive: Normal good

  • Negative: Inferior good

  • > 1: Luxury

  • 0 to 1: Necessity

• Example: Income decreases 12%, steak quantity demanded decreases 18%: $\frac{18\%}{12\%} = 1.50$ (Normal luxury)

Elasticity, Revenue & Supply

Price Elasticity of Supply (PES)

Measures how strongly quantity supplied responds to a price change.

• Formula: $\text{PES} = \frac{\%\Delta Q_s}{\%\Delta P}$

• Midpoint Method: Use the average of old and new values for percentage change.

• Classification:

  • PES > 1: Elastic

  • PES < 1: Inelastic

  • PES = 1: Unit elastic

• Example: Price: $70 → $80; Quantity supplied: 30,000 → 50,000 Midpoint price: $75; % change in price:$\frac{80-70}{75} = 13.33\%$Midpoint quantity: 40,000; % change in quantity:$\frac{50,000-30,000}{40,000} = 50\%$PES:$\frac{50\%}{13.33\%} = 3.75$ (Elastic)

Total Revenue & Elasticity

Total revenue is affected by the elasticity of demand.

• Formula: $\text{TR} = \text{Price} \times \text{Quantity}$

• Elastic Demand: Price increases → Revenue decreases; Price decreases → Revenue increases.

• Inelastic Demand: Price increases → Revenue increases; Price decreases → Revenue decreases.

• Unit Elastic: Price changes → Total revenue stays the same.

• Example: PED = -1.62 (Elastic); Price increases → Revenue falls.

Formula Master List

• Total Revenue: $\text{TR} = \text{P} \times \text{Q}$

• Slope: $\frac{\Delta Y}{\Delta X}$

• Percentage Change: $\frac{\text{New} - \text{Old}}{\text{Old}} \times 100$

• Average: $\frac{\text{Total}}{\text{Number}}$

• Rectangle Area: $\text{Base} \times \text{Height}$

• Triangle Area: $\frac{1}{2} \times \text{Base} \times \text{Height}$

• Consumer Surplus: $\text{Willingness to Pay} - \text{Market Price}$

• Producer Surplus: $\text{Market Price} - \text{Minimum Acceptable Price}$

• Price Elasticity of Demand: $\frac{\%\Delta Q_d}{\%\Delta P}$

• Price Elasticity of Supply: $\frac{\%\Delta Q_s}{\%\Delta P}$

• Income Elasticity: $\frac{\%\Delta Q_d}{\%\Delta \text{Income}}$

• Midpoint % Change: $\frac{\text{New} - \text{Old}}{(\text{New} + \text{Old}) / 2}$

Last-Minute Test Cheat Sheet

• Demand: Price ↑ → Qd ↓; Price ↓ → Qd ↑

• Supply: Price ↑ → Qs ↑; Price ↓ → Qs ↓

• Shifts: Demand ↑ = Right; Demand ↓ = Left; Supply ↑ = Right; Supply ↓ = Left

• Equilibrium: Qd = Qs

• Shortage: Qd > Qs

• Surplus: Qs > Qd

• Elasticity: >1 = Elastic; <1 = Inelastic; =1 = Unit elastic

• Revenue: TR = P × Q

• Elastic Demand: Price ↑ → Revenue ↓; Price ↓ → Revenue ↑

• Inelastic Demand: Price ↑ → Revenue ↑; Price ↓ → Revenue ↓

• Consumer Surplus: Above price, below demand

• Producer Surplus: Below price, above supply

• Own Price Change: Move along curve

• Everything Else: Shift curve

Problem-Solving Steps

1. Is this asking for a number? → Find the formula.

2. Is it asking about elasticity? → Calculate percentage changes first.

3. Is there a graph? → Find equilibrium and see which curve moved.

4. Did the product's own price change? → Movement along curve.

5. Did something else change? → Shift the curve.

6. Is price above equilibrium? → Surplus.

7. Is price below equilibrium? → Shortage.

8. Is elasticity greater than 1? → Elastic.

9. Is elasticity less than 1? → Inelastic.

10. Is it asking revenue? → P × Q.