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 getting 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.

Marginal changes: Small, incremental adjustments to an existing plan of action.

Reading and Understanding Graphs

Graphical Analysis in Economics

Graphs are essential tools for visualizing relationships between variables in economics, such as price and quantity.

• Axes: The horizontal axis (x-axis) typically represents quantity, while the vertical axis (y-axis) represents price.

• Shifts vs. Movements: A movement along a curve is caused by a change in the variable on the axis, while a shift is caused by a change in another factor.

Introductory Economic Models

Production Possibilities Frontier (PPF)

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

• Points on the curve: Efficient production

• Points inside the curve: Inefficient production

• Points outside the curve: Unattainable with current resources

Opportunity cost is illustrated by the slope of the PPF.

The Market Forces of Supply and Demand

Demand

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

• Law of Demand: All else equal, as the price of a good falls, the quantity demanded rises.

• Demand Curve: Downward sloping, showing the inverse relationship between price and quantity demanded.

Supply

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

• Law of Supply: All else equal, as the price of a good rises, the quantity supplied rises.

• Supply Curve: Upward sloping, showing the positive relationship between price and quantity supplied.

Market Equilibrium

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

• Surplus: Quantity supplied exceeds quantity demanded (price above equilibrium).

• Shortage: Quantity demanded exceeds quantity supplied (price below equilibrium).

Elasticity

Price Elasticity of Demand

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

• Price Elasticity of Demand: Percentage change in quantity demanded divided by percentage change in price.

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

• Elastic demand: Elasticity > 1

• Inelastic demand: Elasticity < 1

• Unit elastic: Elasticity = 1

Consumer and Producer Surplus; Price Ceilings and Floors

Consumer and Producer Surplus

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

• Producer Surplus: The difference between the price sellers receive and their cost of production.

Price Controls

• Price Ceiling: A legal maximum on the price at which a good can be sold (e.g., rent control).

• Price Floor: A legal minimum on the price at which a good can be sold (e.g., minimum wage).

Price controls can lead to shortages (ceilings) or surpluses (floors).

Introduction to Taxes and Subsidies

Taxes

Taxes are used by governments to raise revenue and influence market outcomes. The burden of a tax is shared between buyers and sellers depending on the elasticity of supply and demand.

• Tax Incidence: The manner in which the burden of a tax is shared among participants in a market.

Externalities

Definition and Types

Externalities are the uncompensated impact of one person's actions on the well-being of a bystander. They can be negative (e.g., pollution) or positive (e.g., education).

• Negative Externality: Leads to overproduction relative to the social optimum.

• Positive Externality: Leads to underproduction relative to the social optimum.

Government intervention (taxes, subsidies, regulation) can help correct market failures caused by externalities.

The Types of Goods

Classification of Goods

Goods are classified based on excludability and rivalry in consumption.

	Excludable	Non-excludable
Rival	Private goods	Common resources
Non-rival	Club goods	Public goods

Private goods: Both excludable and rival (e.g., food). Public goods: Non-excludable and non-rival (e.g., national defense).

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

Production and Costs

Firms transform inputs into outputs, incurring costs in the process. Understanding costs is essential for profit maximization.

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

• Variable Costs (VC): Costs that vary with output.

• Total Cost (TC): $TC = FC + VC$

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

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

Perfect Competition

Characteristics

• Many buyers and sellers

• Identical products

• Free entry and exit

• Price takers

In perfect competition, firms maximize profit where $P = MC$.

Monopoly

Monopoly Power

A monopoly is a market with a single seller. Monopolists can set prices above marginal cost, 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 measured by the sum of consumer and producer surplus. Price controls and taxes can reduce total welfare.

Additional info:

• Some sections reference diagrams and graphs, which are essential for understanding shifts in supply and demand, elasticity, and welfare analysis.

• Notes include brief references to macroeconomic topics (e.g., GDP), but the main focus is on microeconomic principles.