Principles of Microeconomics: Final Exam Study Guide

Chapter 4: Demand, Supply, and Equilibrium

Law of Demand, Demand Schedule, and Demand Curve

The law of demand states that, all else equal, as the price of a good increases, the quantity demanded decreases, and vice versa. The demand schedule is a table showing the quantity demanded at various prices. The demand curve is a graphical representation of the demand schedule, typically downward sloping.

• Law of Demand: Inverse relationship between price and quantity demanded.

• Demand Schedule: Table listing quantities demanded at different prices.

• Demand Curve: Downward-sloping curve on a price-quantity graph.

• Example: If the price of coffee rises from $2 to $3, the quantity demanded falls from 100 to 80 cups per day.

Market Equilibrium

Market equilibrium occurs where the quantity demanded equals the quantity supplied. At this point, there is no tendency for price to change.

• Equilibrium Price: The price at which Qd = Qs.

• Equilibrium Quantity: The quantity bought and sold at the equilibrium price.

• Formula: $Q_d = Q_s$

• Example: If at $5, buyers want 50 units and sellers offer 50 units, the market is in equilibrium.

The Definition of Markets

A market is any arrangement that allows buyers and sellers to exchange goods and services. Markets can be physical or virtual, local or global.

• Key Features: Buyers, sellers, and a product or service.

• Types: Competitive, monopolistic, oligopolistic, etc.

Law of Supply, Supply Schedule, and Supply Curve

The law of supply states that, all else equal, as the price of a good increases, the quantity supplied increases. The supply schedule is a table showing the quantity supplied at various prices. The supply curve is a graphical representation, typically upward sloping.

• Law of Supply: Direct relationship between price and quantity supplied.

• Supply Schedule: Table listing quantities supplied at different prices.

• Supply Curve: Upward-sloping curve on a price-quantity graph.

Market Disequilibrium: Surplus and Shortage

When the market is not at equilibrium, there can be a surplus (excess supply) or a shortage (excess demand).

• Surplus: Occurs when Qs > Qd (price above equilibrium).

• Shortage: Occurs when Qd > Qs (price below equilibrium).

• Formulas: $\text{Shortage} = Q_d - Q_s$ $\text{Surplus} = Q_s - Q_d$

Outside Factors Affecting Demand and Shifts of Demand Curve

Factors other than price can shift the demand curve, such as income, tastes, prices of related goods, expectations, and number of buyers.

• Increase in Demand: Rightward shift of the demand curve.

• Decrease in Demand: Leftward shift of the demand curve.

• Example: A rise in consumer income increases demand for normal goods.

Chapter 6: Sellers and Incentives

Producer Surplus

Producer surplus is the difference between the market price and the minimum price at which producers are willing to sell. It is the area above the supply curve and below the market price.

• Individual Producer Surplus: Area between price and marginal cost for a firm’s quantity.

• Market Producer Surplus: Area between market price and market supply curve.

Total, Fixed, and Variable Cost

Costs are classified as fixed (do not vary with output) and variable (change with output). Total cost is the sum of fixed and variable costs.

• Formulas: $TC = VC + FC$ $ATC = \frac{TC}{Q}$ or $ATC = AVC + AFC$

• Example: If FC = $100, VC = $200, then TC = $300.

Key Characteristics of Perfectly Competitive Markets

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

• Price Takers: Firms accept the market price.

• Homogeneous Products: No differentiation.

• Free Entry/Exit: No barriers to market entry or exit.

Total and Marginal Revenue

Total revenue (TR) is the total amount received from sales. Marginal revenue (MR) is the additional revenue from selling one more unit.

• Formulas: $TR = P \times Q$ $MR = \frac{\Delta TR}{\Delta Q}$

Profit Maximization and the Optimality Rule (MC = MR)

Firms maximize profit by producing the quantity where marginal cost equals marginal revenue.

• Optimality Rule: $MC = MR$

• Profit: $\pi = TR - TC$ or $\pi = (P - ATC) \times Q$

Chapter 12: Monopoly

The Definition of Monopoly

A monopoly is a market with a single seller and no close substitutes for the product. The monopolist has significant market power.

• Barriers to Entry: Legal, technological, or resource-based obstacles that prevent competition.

• Natural Monopoly: Occurs when economies of scale make a single firm most efficient.

Price Discrimination

Price discrimination occurs when a firm sells the same product at different prices to different consumers.

• Types: First-degree (perfect), second-degree (by quantity), third-degree (by group).

• Formulas: First-degree: $\pi = \text{Total Willingness to Pay} - \text{Total Cost}$ Second-degree: $\pi = (\text{Revenue from Block 1} + \text{Revenue from Block 2} + \ldots) - \text{Total Cost}$ Third-degree: $\pi = (\text{Revenue from Group A} + \text{Revenue from Group B}) - \text{Total Cost}$

• Example: Movie theaters charging different prices for adults and children.

Social Cost and Deadweight Loss from Monopoly

Monopolies can reduce total welfare by producing less than the socially optimal quantity, creating deadweight loss.

• Deadweight Loss: Loss of total surplus due to market inefficiency.

• Consumer and Producer Surplus: Under monopoly, consumer surplus falls and producer surplus may rise, but total surplus is lower than in perfect competition.

Chapter 9: Externalities and Public Goods

Properties of Goods: Rivalry and Excludability

Goods are classified by rivalry (one person's use reduces availability for others) and excludability (people can be prevented from using the good).

Type of Good	Rival?	Excludable?	Example
Private Good	Yes	Yes	Ice cream
Public Good	No	No	National defense
Common Resource	Yes	No	Fish in the ocean
Club Good	No	Yes	Cable TV

Common Goods and the Tragedy of the Commons

Common goods are rival but not excludable, leading to overuse—a phenomenon known as the tragedy of the commons.

• Example: Overfishing in public waters.

• Solutions: Regulation, privatization, or community management.

Externalities: Positive, Negative, and Pecuniary

An externality is a cost or benefit imposed on others not involved in a transaction.

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

• Positive Externality: Provides benefits (e.g., vaccination).

• Pecuniary Externality: Affects others through prices (e.g., increased demand raising prices).

• Remedies: Taxes, subsidies, regulation, or property rights.

• Formulas: $MSC = MC + MEC$ $MSB = MB + MEB$

Chapter 8: Trade

Arguments Against Free Trade

Common arguments include protecting jobs, national security, infant industries, and unfair competition. Economists often challenge these arguments, emphasizing the benefits of trade.

Comparative Advantage and Absolute Advantage

Comparative advantage is the ability to produce a good at a lower opportunity cost than others. Absolute advantage is the ability to produce more of a good with the same resources.

• Opportunity Cost Formula: $OCA = \frac{\text{Quantity of Good B Given Up}}{\text{Quantity of Good A Gained}}$

• Example: If country A gives up 2 units of B to gain 1 unit of A, OCA = 2.

Tariffs and Their Effects on Welfare

A tariff is a tax on imports. It raises domestic prices, reduces imports, and generates government revenue, but creates deadweight loss.

• Tariff Revenue Formula: $\text{Tariff Revenue} = \text{Tariff Rate} \times \text{Quantity of Imports}$

• Deadweight Loss: Area representing lost gains from trade due to the tariff.

Trade Between Countries and Welfare Effects

Trade allows countries to specialize according to comparative advantage, increasing total welfare. However, some groups may lose from trade even as the country as a whole gains.

• Quantity of Imports: $Q_{demand} - Q_{supply}$ (at world/tariff price)

• Quantity of Exports: $Q_{supply} - Q_{demand}$ (at world price)

Geometry for Surplus and Welfare

Economic surplus is often represented as areas on supply and demand graphs.

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

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

• Area of a Triangle: $\text{Area} = \frac{1}{2} \times \text{Base} \times \text{Height}$

• Area of a Rectangle: $\text{Area} = \text{Base} \times \text{Height}$