Microeconomics Study Guide: Preliminaries, Supply & Demand, and Consumer Behavior

Chapter 1: Preliminaries

Definition of Economics

Economics is the study of how individuals and societies allocate scarce resources to satisfy unlimited wants. It examines the choices made by agents and the consequences of those choices.

• Scarcity: The fundamental economic problem of having limited resources to meet unlimited desires.

• Resource Allocation: The process of distributing scarce inputs among alternative uses.

Microeconomics vs. Macroeconomics

• Microeconomics: Focuses on the behavior of individual consumers, firms, and markets.

• Macroeconomics: Studies the economy as a whole, including aggregate indicators like GDP, inflation, and unemployment.

• Example: Microeconomics analyzes how a consumer decides what to buy; macroeconomics examines national unemployment rates.

Positive vs. Normative Economics

• Positive Economics: Describes and explains economic phenomena; statements can be tested and validated ("what is").

• Normative Economics: Involves value judgments about what the economy should be like ("what ought to be").

• Example: "An increase in minimum wage will lead to higher unemployment" (positive); "The government should increase the minimum wage" (normative).

Market Definition

• Market: Any arrangement that allows buyers and sellers to exchange goods and services.

• Market Scope: Defined by the product, location, and time period under consideration.

Competitive vs. Noncompetitive Markets

• Competitive Market: Many buyers and sellers, none of whom can influence the market price.

• Noncompetitive Market: Individual buyers or sellers can affect prices (e.g., monopoly, oligopoly).

• Example: Wheat market (competitive); local electricity provider (noncompetitive).

Real vs. Nominal Prices

• Nominal Price: The price of a good in current dollars, not adjusted for inflation.

• Real Price: The price of a good adjusted for changes in the overall price level (inflation).

• Formula: $\text{Real Price} = \frac{\text{Nominal Price}}{\text{CPI}} \times 100$

Functions Review (Slope, Intercept)

• Linear Function: $y = mx + b$, where m is the slope and b is the intercept.

• Slope: Measures the rate of change; $m = \frac{\Delta y}{\Delta x}$

• Intercept: The value of y when x = 0.

Chapter 2: The Basics of Supply and Demand

The Demand Curve

The demand curve shows the relationship between the price of a good and the quantity demanded, holding other factors constant.

• Law of Demand: As price decreases, quantity demanded increases (downward sloping curve).

• Equation: $Q_d = a - bP$

The Supply Curve

The supply curve illustrates the relationship between the price of a good and the quantity supplied.

• Law of Supply: As price increases, quantity supplied increases (upward sloping curve).

• Equation: $Q_s = c + dP$

Equilibrium and the Market Mechanism

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

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

• Equation: Set $Q_d = Q_s$ and solve for P and Q.

Price Controls

• Price Ceiling: Maximum legal price (e.g., rent control); can cause shortages.

• Price Floor: Minimum legal price (e.g., minimum wage); can cause surpluses.

Elasticities of Demand and Supply

Elasticity measures the responsiveness of quantity demanded or supplied to changes in price, income, or the price of related goods.

Price Elasticity of Demand

• Definition: Percentage change in quantity demanded divided by percentage change in price.

• Formula: $E_d = \frac{\%\ \text{change in } Q_d}{\%\ \text{change in } P}$

• Interpretation: If $|E_d| > 1$, demand is elastic; if $|E_d| < 1$, demand is inelastic.

Income Elasticity of Demand

• Definition: Percentage change in quantity demanded divided by percentage change in income.

• Formula: $E_I = \frac{\%\ \text{change in } Q_d}{\%\ \text{change in income}}$

• Normal Good: $E_I > 0$; Inferior Good: $E_I < 0$

Cross Price Elasticity of Demand

• Definition: Percentage change in quantity demanded of one good divided by percentage change in price of another good.

• Formula: $E_{xy} = \frac{\%\ \text{change in } Q_{dx}}{\%\ \text{change in } P_y}$

• Substitutes: $E_{xy} > 0$; Complements: $E_{xy} < 0$

Price Elasticity of Supply

• Definition: Percentage change in quantity supplied divided by percentage change in price.

• Formula: $E_s = \frac{\%\ \text{change in } Q_s}{\%\ \text{change in } P}$

Durable vs. Non-durable Goods

• Durable Goods: Goods that last over time (e.g., cars, appliances); often have more elastic demand.

• Non-durable Goods: Goods consumed quickly (e.g., food, fuel); often have less elastic demand.

Cyclical Industries

• Cyclical Industry: An industry whose sales are strongly affected by the business cycle (e.g., automobiles, construction).

• Non-cyclical Industry: Less affected by economic fluctuations (e.g., utilities, healthcare).

Chapter 3: Consumer Behavior

Consumer Preferences

Consumer preferences describe how individuals rank different bundles of goods according to their satisfaction.

• Assumptions: Preferences are complete, transitive, and more is preferred to less.

• Indifference Curves: Show combinations of goods that provide the same level of utility to the consumer.

• Marginal Rate of Substitution (MRS): The rate at which a consumer is willing to substitute one good for another while maintaining the same utility.

• Equation: $MRS_{xy} = -\frac{\Delta y}{\Delta x}$

• Indifference Curves Map: A set of indifference curves representing different utility levels.

• Perfect Substitutes: Goods that a consumer is willing to substitute at a constant rate (straight-line indifference curves).

• Perfect Complements: Goods that are always consumed together in fixed proportions (L-shaped indifference curves).

• Useless Goods: Goods that do not affect utility.

• Economic Bad: A good that decreases utility (e.g., pollution).

Utility and Utility Functions

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

• Utility Function: Mathematical representation of preferences; e.g., $U(x, y)$.

Budget Constraints

The budget constraint shows all combinations of goods a consumer can afford given their income and prices.

• Budget Line Equation: $P_x x + P_y y = I$

• Effect of Change in Income: Shifts the budget line parallel (right for increase, left for decrease).

• Effect of Change in Prices: Rotates the budget line (pivot around intercept).

• Opportunity Cost: The value of the next best alternative foregone when making a choice.

Consumer Choice

• Consumers maximize utility subject to their budget constraint.

• Optimal choice is where the highest indifference curve is tangent to the budget line.

Marginal Utility and Consumer Choice

• Marginal Utility (MU): The additional satisfaction from consuming one more unit of a good.

• Equation: $MU_x = \frac{\partial U}{\partial x}$

Equal Marginal Principle

• Utility is maximized when the marginal utility per dollar spent is equal for all goods.

• Equation: $\frac{MU_x}{P_x} = \frac{MU_y}{P_y}$

Additional info: Where only brief points were given, standard academic explanations and formulas have been added for completeness and clarity.