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 addresses the fundamental problem of scarcity and the choices that must be made as a result.

Microeconomics vs. Macroeconomics

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

• Macroeconomics examines the economy as a whole, including aggregate measures like GDP, inflation, and unemployment.

• Example: Microeconomics studies how a firm sets prices; macroeconomics studies national unemployment rates.

Positive vs. Normative Economics

• Positive economics deals with objective analysis and facts ("what is").

• Normative economics involves value judgments and opinions ("what ought to be").

• Example: "Raising the minimum wage increases unemployment" (positive); "The government should raise the minimum wage" (normative).

Market Definition

• A market is a group of buyers and sellers of a particular good or service.

• Markets can be local, national, or international in scope.

Competitive vs. Noncompetitive Markets

• Competitive markets have many buyers and sellers, none of whom can influence the market price.

• Noncompetitive markets (e.g., monopoly, oligopoly) have fewer sellers or buyers, allowing for price-setting power.

Real vs. Nominal Prices

• Nominal price is the price of a good in current dollars.

• Real price is the price adjusted for inflation, reflecting purchasing power.

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

Functions Review (Slope, Intercept)

• A linear function can be written as $y = mx + b$, where $m$ is the slope and $b$ is the intercept.

• Slope measures the rate of change; intercept is the value when the independent variable is zero.

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.

• It is typically downward sloping: as price decreases, quantity demanded increases.

• Equation: $Q_d = a - bP$

The Supply Curve

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

• It is typically upward sloping: as price increases, quantity supplied increases.

• Equation: $Q_s = c + dP$

Equilibrium and the Market Mechanism

• Market equilibrium occurs where quantity demanded equals quantity supplied.

• Equilibrium price and quantity are found by solving $Q_d = Q_s$.

• Equation: $a - bP^* = c + dP^*$

Price Controls

• Price ceiling: Maximum legal price (can cause shortages).

• Price floor: Minimum legal price (can cause surpluses).

• Example: Rent control (ceiling), minimum wage (floor).

Elasticities of Demand and Supply

• Elasticity measures responsiveness of quantity demanded or supplied to changes in price, income, or other goods' prices.

Price Elasticity of Demand

• Measures the percentage change in quantity demanded from a 1% change in price.

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

Income Elasticity of Demand

• Measures the responsiveness of quantity demanded to changes in income.

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

Cross Price Elasticity of Demand

• Measures the responsiveness of demand for one good to changes in the price of another good.

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

Price Elasticity of Supply

• Measures the responsiveness of quantity supplied to changes in price.

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

Durable vs. Non-durable Goods

• Durable goods last over time (e.g., cars, appliances); non-durable goods are consumed quickly (e.g., food, fuel).

• Demand for durable goods is often more elastic in the long run.

Cyclical Industries

• Cyclical industries are sensitive to the business cycle, with demand rising in booms and falling in recessions (e.g., automobiles, construction).

Chapter 3: Consumer Behavior

Consumer Preferences

• Consumers have preferences that guide their choices among different bundles of goods.

Assumptions

• Completeness: Consumers can compare and rank all possible bundles.

• Transitivity: Preferences are consistent across choices.

• More is better: Consumers prefer more of a good to less.

Indifference Curves

• An indifference curve shows all combinations of goods that provide the consumer with the same level of satisfaction.

• Indifference curves are typically downward sloping and convex to the origin.

Marginal Rate of Substitution (MRS)

• The MRS is the rate at which a consumer is willing to substitute one good for another while maintaining the same utility.

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

Indifference Curves Map

• A map of indifference curves shows different levels of utility; higher curves represent higher utility.

Perfect Substitutes

• Goods that a consumer is willing to substitute at a constant rate (e.g., Coke and Pepsi for some consumers).

• Indifference curves are straight lines.

Perfect Complements

• Goods that are always consumed together in fixed proportions (e.g., left and right shoes).

• Indifference curves are L-shaped.

Useless Goods

• A good that does not affect the consumer's utility; indifference curves are vertical or horizontal lines.

An Economic Bad

• A good that reduces utility (e.g., pollution); consumers prefer less of it.

Utility and Utility Functions

• Utility is a numerical measure of satisfaction from consuming goods and services.

• A utility function assigns a number to each bundle of goods, representing the consumer's preferences.

• Example: $U(x, y) = x \cdot y$

Budget Constraints

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

Budget Line Equation

• Equation: $P_x x + P_y y = I$

• Where $P_x$ and $P_y$ are prices of goods $x$ and $y$, and $I$ is income.

Effect of Change in Income on the Budget Line

• An increase in income shifts the budget line outward (parallel shift).

• A decrease in income shifts it inward.

Effect of Change in Prices on the Budget Line

• A change in the price of one good rotates the budget line around the intercept of the other good.

Opportunity Cost

• The opportunity cost of a good is the amount of another good that must be given up to obtain one more unit of the first good.

• Formula: $\text{Opportunity Cost of } x = \frac{P_x}{P_y}$

Consumer Choice

• Consumers maximize utility subject to their budget constraint.

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

Marginal Utility and Consumer Choice

• Marginal utility (MU) is the additional satisfaction from consuming one more unit of a good.

• Consumers allocate income so that the marginal utility per dollar is equal across all goods.

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

Equal Marginal Principle

• Utility is maximized when the last dollar spent on each good provides the same marginal utility.