Microeconomics Study Guide: Welfare, Externalities, Comparative Advantage, Utility, and Production

Chapter 4: Welfare

Consumer and Producer Surplus

Consumer and producer surplus are key concepts in microeconomics that measure the benefit to buyers and sellers in a market.

• Consumer Surplus: The difference between what consumers are willing to pay and what they actually pay.

• Producer Surplus: The difference between the price sellers receive and the minimum they are willing to accept.

• Economic Efficiency: Achieved when total surplus (consumer + producer) is maximized.

• Deadweight Loss: The loss of total surplus due to market inefficiency, often caused by price controls or taxes.

Example: If a buyer is willing to pay $10 for a good but pays $7, the consumer surplus is $3.

Price Controls

Price controls are government-imposed limits on the prices that can be charged in the market.

• Price Floors: Minimum allowable price (e.g., minimum wage).

• Price Ceilings: Maximum allowable price (e.g., rent control).

• Effects: Can create shortages (ceilings) or surpluses (floors), and lead to deadweight loss.

Taxes

Taxes affect market outcomes by shifting supply or demand and creating inefficiency.

• Tax Burden: Shared between buyers and sellers depending on elasticity.

• Deadweight Loss: Taxes reduce total surplus and create inefficiency.

• Graphs: Show shifts in supply/demand and changes in surplus.

Formula:

$\text{Deadweight Loss} = \frac{1}{2} \times \text{Tax} \times \text{Reduction in Quantity}$

Chapter 5: Externalities

Types of Externalities

Externalities are costs or benefits that affect third parties not directly involved in a transaction.

• Positive Externality: Benefits others (e.g., education).

• Negative Externality: Imposes costs (e.g., pollution).

• Private Cost/Benefit: Directly incurred by participants.

• Social Cost/Benefit: Includes external effects.

• Socially Optimal Outcome: Where social cost equals social benefit.

Solutions to Externalities

• Pigovian Taxes: Taxes imposed to correct negative externalities.

• Pollution Credits: Tradable permits for pollution rights.

• Command and Control: Direct regulation of behavior.

• Efficient Pollution Cleanup: Achieved when marginal cost of cleanup equals marginal benefit.

Coase Theorem and Private Negotiation

The Coase Theorem states that if property rights are well-defined and transaction costs are low, private parties can negotiate to resolve externalities efficiently.

Public Goods

Public goods are non-excludable and non-rivalrous, leading to the free-rider problem.

• Examples: National defense, public parks.

• Free-Rider Problem: Individuals benefit without paying.

• Inefficiency: Markets may underprovide public goods.

Common Resources

Common resources are rivalrous but non-excludable, often leading to overuse.

• Tragedy of the Commons: Overconsumption of shared resources.

Chapter 9: Comparative Advantage

Comparative Advantage

Comparative advantage is the ability to produce a good at a lower opportunity cost than others.

• Basis for Trade: Specialization increases total output.

Formula:

$\text{Opportunity Cost} = \frac{\text{Units Given Up}}{\text{Units Gained}}$

Tariffs

Tariffs are taxes on imports that affect market outcomes.

• Consumer Surplus: Decreases due to higher prices.

• Producer Surplus: Increases for domestic producers.

• Deadweight Loss: Created by reduced trade.

• Tax Revenue: Collected by government.

Quota/Outsourcing

• Quotas: Limits on quantity of imports.

• Outsourcing: Shifting production to other countries.

Chapter 7: Utility

Utility and Marginal Utility

Utility measures satisfaction from consuming goods and services.

• Total Utility: Overall satisfaction from consumption.

• Marginal Utility: Additional satisfaction from consuming one more unit.

• Law of Diminishing Marginal Utility: Marginal utility decreases as consumption increases.

Formula:

$\text{Marginal Utility} = \frac{\Delta \text{Total Utility}}{\Delta \text{Quantity}}$

Utility Maximization

• Law of Equal Marginal Utilities per Dollar: Consumers allocate spending so that the last dollar spent on each good yields equal marginal utility.

• Income/Substitution Effects: Changes in consumption due to changes in income or relative prices.

• Giffen Good: A good for which demand increases as price increases, due to strong income effect.

Applications

• Celebrity Endorsements: Influence perceived utility.

• Network Externalities: Value increases as more people use the good.

• Fairness: Behavioral factors affect choices.

• Examples: Anti-price gouging laws, concert tickets, tipping, ultimatum game.

Behavioral Economics

• Opportunity Cost: Value of the next best alternative.

• Sunk Cost Fallacy: Failure to ignore costs that cannot be recovered.

• Optimism Bias: Overly optimistic about future behavior.

Chapter 11: Short-Run Production (Partial)

Short-Run Production

Short-run production examines how output changes as variable inputs are added to fixed inputs.

• Marginal Product: Additional output from one more unit of input.

• Average Product: Output per unit of input.

• Law of Diminishing Returns: Marginal product decreases as more input is added.

Formula:

$\text{Marginal Product} = \frac{\Delta \text{Total Output}}{\Delta \text{Input}}$

Short-Run Costs

Short-run costs include fixed, variable, and total costs, as well as average and marginal costs.

• Fixed Costs (FC): Do not vary with output.

• Variable Costs (VC): Change with output.

• Total Costs (TC): $TC = FC + VC$

• Average Fixed Cost (AFC): $AFC = \frac{FC}{Q}$

• Average Variable Cost (AVC): $AVC = \frac{VC}{Q}$

• Average Total Cost (ATC): $ATC = \frac{TC}{Q}$

• Marginal Cost (MC): $MC = \frac{\Delta TC}{\Delta Q}$

• Relationship: MC intersects AVC and ATC at their minimum points.

Cost Type	Formula	Description
Fixed Cost (FC)	—	Does not change with output
Variable Cost (VC)	—	Changes with output
Total Cost (TC)	$TC = FC + VC$	Sum of fixed and variable costs
Average Fixed Cost (AFC)	$AFC = \frac{FC}{Q}$	Fixed cost per unit
Average Variable Cost (AVC)	$AVC = \frac{VC}{Q}$	Variable cost per unit
Average Total Cost (ATC)	$ATC = \frac{TC}{Q}$	Total cost per unit
Marginal Cost (MC)	$MC = \frac{\Delta TC}{\Delta Q}$	Cost of producing one more unit

Additional info: Some topics (e.g., Chapter 11) are only partially listed; further details may be covered in the full chapter.