Principles of Microeconomics: Final Exam Study Guide (ECON 10000-01)

Study Guide - Smart Notes

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Date & Time: March 10th, Tuesday, 10am-12pm (in person)
Allowed Materials: Pen, pencil, eraser, ruler, simple standard function calculator (not scientific)
Format: Multiple-choice, short-answer, and long-answer questions
Coverage: Cumulative, with emphasis on chapters not included in the midterm

Start studying early
Review class notes and note shortcuts/tricks
Redo poll questions, discussion, quizzes, problem sets, past midterms and finals
Work in groups and compare answers
Practice with end-of-chapter problems
Sleep well before the exam

Perfectly competitive markets exhibit distinct behaviors in the short run and long run, especially in response to demand shocks.

Short-Run Equilibrium: Firms may earn profits or losses; number of firms is fixed.
Long-Run Equilibrium: Entry and exit adjust the number of firms; economic profit is zero; market supply curve is horizontal at .
Entry/Exit Dynamics: Positive demand shocks attract entry; negative shocks cause exit.

Surplus measures welfare in markets and is maximized in competitive equilibrium.

Consumer Surplus (CS): Difference between willingness to pay and price paid.
Producer Surplus (PS): Difference between price received and marginal cost; note PS ≠ profit.
Total Surplus (TS): Sum of CS and PS.
Formula:

Competitive Equilibrium: Maximizes total surplus; allocates goods to highest WTP buyers and lowest MC sellers.

Pareto efficiency is a key concept in welfare economics, and the invisible hand describes how self-interested behavior leads to efficient outcomes.

Pareto Efficiency: An allocation where no one can be made better off without making someone else worse off.
Invisible Hand: Competitive markets maximize total surplus and achieve Pareto efficiency.
Breakdowns: Market power, government intervention, externalities, public goods, and asymmetric information can prevent efficiency.

Government policies affect market outcomes, welfare, and efficiency.

Taxes: Per-unit and ad valorem taxes; incidence determined by elasticities.
Effects: Changes in CS, PS, government revenue, total surplus, and deadweight loss.
Subsidies: Benefit recipients, cause overproduction, increase government cost and deadweight loss.
Price Ceilings/Floors: Can be binding or non-binding; cause shortages or surpluses; affect welfare.
Deadweight Loss Formula:

Example: A binding price ceiling below equilibrium causes a shortage and reduces total surplus.

Externalities occur when private costs or benefits differ from social costs or benefits, leading to inefficiency.

Marginal Private Cost (MPC) vs. Marginal Social Cost (MSC): MSC includes external costs.
Marginal Private Benefit (MPB) vs. Marginal Social Benefit (MSB): MSB includes external benefits.
Efficient Quantity: Where MSB = MSC, not necessarily market equilibrium.
Deadweight Loss from Externalities: Area between MSC and MPC (or MSB and MPB) over the inefficient quantity range.
Policy Solutions: Taxes/subsidies, Coase Theorem (property rights, bargaining, transaction costs).

Public goods and common resources are characterized by rivalry and excludability, affecting their provision and use.

Public Goods: Non-rivalrous and non-excludable (e.g., national defense).
Common Resources: Rivalrous but non-excludable (e.g., fisheries).
Vertical Summation: Used to derive social marginal benefit for public goods.
Tragedy of the Commons: Overuse of common resources; policy solutions include taxes, licenses, cap-and-trade.

Monopolies differ from perfect competition in pricing, output, and welfare effects.

Barriers to Entry: Allow monopoly power.
Downward Sloping Demand: Firm faces entire market demand.
Marginal Revenue (MR): For linear demand , .
Profit Maximization: ; find monopoly quantity and price.
Price Discrimination: First-, second-, and third-degree; requires information and prevention of resale.
Social Surplus and Deadweight Loss: Monopoly causes underproduction, higher prices, and deadweight loss.

PPC illustrates opportunity cost, comparative advantage, and gains from trade.

Slope: Represents opportunity cost.
Constant vs. Increasing Opportunity Cost: Linear vs. bowed-out PPC.
Comparative vs. Absolute Advantage: Comparative advantage is based on lower opportunity cost.
Mutually Beneficial Trade: Terms of trade must fall between opportunity costs.
Gains from Trade: Allow consumption outside individual PPC.

World price determines whether a country imports or exports; trade affects welfare.

Imports/Exports: If world price is below domestic equilibrium, country imports; if above, exports.
Winners and Losers: Consumers and producers are affected differently.
Tariffs: Raise domestic price, reduce imports, create government revenue and deadweight loss.
Sources of Deadweight Loss: Overproduction by inefficient producers, underconsumption by consumers.

Game theory analyzes strategic interactions among players.

Game Structure: Players, strategies, payoffs, information; simultaneous vs. sequential games.
Dominant Strategies: Best response regardless of others' actions.
Nash Equilibrium: No player can improve payoff by unilaterally changing strategy.
Mixed Strategies: Randomization can be optimal; compute expected payoffs.
Sequential Games: Use backward induction; identify subgame perfect Nash equilibrium.
Credible vs. Non-Credible Threats: Commitment affects outcomes.
Oligopoly: Apply correct equilibrium concept to predict outcomes.

Concept	Definition	Application
Consumer Surplus	WTP minus price paid	Welfare analysis, policy evaluation
Producer Surplus	Price received minus MC	Welfare analysis, market outcomes
Pareto Efficiency	No improvement possible without harm	Evaluating allocations
Deadweight Loss	Loss of total surplus from inefficiency	Policy analysis (taxes, monopoly, externalities)
Comparative Advantage	Lower opportunity cost	Specialization and trade
Nash Equilibrium	Stable outcome in strategic play	Game theory, oligopoly analysis

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