Microeconomics Study Notes: Core Principles, Markets, and Welfare

Basic Principles of Economics

Scarcity and Choice

Economics studies how individuals and societies allocate scarce resources to satisfy unlimited wants. Scarcity means that resources are limited, so choices must be made about their use.

• Scarcity: The fundamental economic problem of having seemingly unlimited human wants in a world of limited resources.

• Opportunity Cost: The value of the next best alternative forgone when making a decision.

• Trade-offs: Choosing more of one thing means having less of another.

Example: Choosing to spend time studying economics means giving up time that could be spent working or relaxing.

Principles of Decision Making

• People face trade-offs.

• The cost of something is what you give up to get it (opportunity cost).

• Rational people think at the margin.

• People respond to incentives.

Additional info: These principles guide both individual and societal choices in resource allocation.

Reading and Understanding Graphs

Graphical Analysis in Economics

Graphs are essential tools for visualizing economic relationships, such as supply and demand curves, cost structures, and market equilibrium.

• Axes: Typically, price is on the vertical axis and quantity on the horizontal axis.

• Shifts vs. Movements: A shift in a curve indicates a change in a non-price determinant; a movement along a curve is due to a price change.

Introductory Economic Models

Production Possibilities Frontier (PPF)

The PPF shows the maximum combinations of goods and services that can be produced with available resources and technology.

• Efficiency: Points on the PPF are efficient; points inside are inefficient; points outside are unattainable.

• Opportunity Cost: The slope of the PPF represents the opportunity cost of one good in terms of another.

The Market Forces of Supply and Demand

Demand

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

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

• Determinants of Demand: Income, prices of related goods, tastes, expectations, number of buyers.

Supply

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

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

• Determinants of Supply: Input prices, technology, expectations, number of sellers.

Market Equilibrium

Market equilibrium occurs where quantity supplied equals quantity demanded. The equilibrium price is where the supply and demand curves intersect.

• Surplus: Quantity supplied exceeds quantity demanded at a given price.

• Shortage: Quantity demanded exceeds quantity supplied at a given price.

Elasticity

Price Elasticity of Demand

Elasticity measures how much quantity demanded or supplied responds to changes in price or other factors.

• Formula:

$\text{Price Elasticity of Demand} = \frac{\%\ \text{change in quantity demanded}}{\%\ \text{change in price}}$

• Elastic Demand: Elasticity > 1 (quantity demanded changes more than price).

• Inelastic Demand: Elasticity < 1 (quantity demanded changes less than price).

Consumer and Producer Surplus; Price Ceilings and Floors

Consumer and Producer Surplus

Consumer surplus is the difference between what buyers are willing to pay and what they actually pay. Producer surplus is the difference between the price sellers receive and their cost of production.

• Consumer Surplus: Area below the demand curve and above the price.

• Producer Surplus: Area above the supply curve and below the price.

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.

Introduction to Taxes and Subsidies

Taxes

Taxes can be levied on buyers or sellers and affect market outcomes by shifting supply or demand curves.

• Tax Incidence: The division of the tax burden between buyers and sellers depends on the relative elasticities of supply and demand.

Example: If demand is more elastic than supply, sellers bear more of the tax burden.

Externalities

Negative and Positive Externalities

Externalities are costs or benefits of market activities borne by third parties. Negative externalities (e.g., pollution) lead to overproduction, while positive externalities (e.g., education) lead to underproduction.

• Marginal Social Cost (MSC): Includes both private and external costs.

• Marginal Social Benefit (MSB): Includes both private and external benefits.

The Types of Goods

Classification of Goods

Goods are classified based on excludability and rivalry in consumption.

	Excludable	Non-excludable
Rival	Private good	Common resource
Non-rival	Club good	Public good

Example: Fish in the ocean are a common resource; national defense is a public good.

International Trade

Gains from Trade

Trade allows countries to specialize in the production of goods for which they have a comparative advantage, increasing overall economic welfare.

• Comparative Advantage: The ability to produce a good at a lower opportunity cost than another producer.

The Costs of Production

Short-Run and Long-Run Costs

Firms face various costs in production, including fixed and variable costs. Marginal cost is the increase in total cost from producing one more unit.

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

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

Perfect Competition

Characteristics and Outcomes

Perfect competition is a market structure with many buyers and sellers, identical products, and free entry and exit.

• Firms are price takers.

• In the long run, firms earn zero economic profit.

Monopoly

Market Power and Welfare

A monopoly is a market with a single seller that controls the price. Monopolies restrict output and raise prices, leading to deadweight loss.

• Profit Maximization: Monopolists produce where $MR = MC$.

• Deadweight Loss: The loss of total surplus due to monopoly pricing.

Consumer and Producer Surplus; Price Ceilings and Floors

Welfare Analysis

Economic welfare is maximized when the sum of consumer and producer surplus is maximized. Price controls and taxes can reduce total welfare.

Summary Table: Market Structures

Market Structure	Number of Firms	Product Type	Entry Barriers	Price Control
Perfect Competition	Many	Identical	None	No
Monopoly	One	Unique	High	Yes
Oligopoly	Few	Similar or Differentiated	Some	Some
Monopolistic Competition	Many	Differentiated	Low	Some

Additional info:

• These notes cover the main microeconomic principles, including market structures, welfare analysis, and government intervention.

• Graphs and diagrams are essential for understanding these concepts; students should practice drawing and interpreting them.