Principles of Microeconomics: Final Exam Study Guide

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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 different prices, while the demand curve is a graphical representation of this relationship.

Law of Demand: Inverse relationship between price and quantity demanded.
Demand Schedule: Tabular data showing quantities demanded at various 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 a particular price. This price is called the equilibrium price, and the corresponding quantity is the equilibrium quantity.

Equilibrium Price: The price at which demand equals supply.
Equilibrium Quantity: The quantity bought and sold at the equilibrium price.
Example: If at $5 per unit, 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 (like a farmers' market) or virtual (like online marketplaces).

Key Point: Markets facilitate voluntary exchange and determine prices through supply and demand.
Example: The stock market, grocery stores, and online platforms are all types of markets.

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 quantities supplied at different prices, and the supply curve is its graphical representation.

Law of Supply: Direct relationship between price and quantity supplied.
Supply Schedule: Table of quantities supplied at various prices.
Supply Curve: Upward-sloping curve on a price-quantity graph.
Example: As the price of wheat rises, farmers supply more wheat to the market.

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 quantity supplied exceeds quantity demanded at a given price.
Shortage: Occurs when quantity demanded exceeds quantity supplied at a given price.
Example: If the price is set above equilibrium, a surplus results; if below, a shortage occurs.

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.

Rightward Shift: Increase in demand (e.g., higher income for a normal good).
Leftward Shift: Decrease in demand (e.g., decrease in population).
Example: A new health study increases demand for oranges, shifting the demand curve right.

Chapter 6: Sellers and Incentives

Producer Surplus

Producer surplus is the difference between the price sellers receive for a good and the minimum price they are willing to accept.

Formula:
Example: If a seller is willing to accept $5 but sells at $8, producer surplus is $3.

Total, Fixed, and Variable Cost

Firms face different types of costs in production:

Total Cost (TC): The sum of all costs incurred in production.
Fixed Cost (FC): Costs that do not vary with output (e.g., rent).
Variable Cost (VC): Costs that change with the level of output (e.g., raw materials).
Formula:
Example: If FC = $100 and VC = $50, then TC = $150.

Key Characteristics of Perfectly Competitive Markets

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

Many Buyers and Sellers: No single agent can influence the market price.
Homogeneous Products: Goods are identical across sellers.
Free Entry and Exit: Firms can enter or leave the market without barriers.
Price Taker: Firms accept the market price as given.

Total and Marginal Revenue

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

Formulas:
Example: If selling one more unit increases TR from $100 to $110, MR = $10.

Profit Maximization and the Optimality Rule (MC = MR)

Firms maximize profit by producing the quantity where marginal cost (MC) equals marginal revenue (MR).

Optimality Rule:
Example: If MC = $5 and MR = $5 at 100 units, the firm maximizes profit at 100 units.

Short-Run vs. Long-Run Planning

The short run is a period in which at least one input is fixed, while the long run is a period when all inputs can be varied.

Short Run: Some costs are fixed.
Long Run: All costs are variable; firms can enter or exit the market.
Example: A factory lease is fixed in the short run but can be changed in the long run.

Chapter 12: Monopoly

The Definition of Monopoly

A monopoly is a market with a single seller of a unique product with no close substitutes and high barriers to entry.

Key Point: The monopolist is a price maker, not a price taker.
Example: Local water utility companies often operate as monopolies.

Barriers to Entry, Natural Monopolies, Economies of Scale

Barriers to entry prevent new firms from entering the market. Natural monopolies arise when a single firm can supply the entire market at lower cost due to economies of scale.

Barriers: Legal restrictions, control of resources, high startup costs.
Natural Monopoly: Occurs when average costs decline over the relevant range of output.
Example: Electricity distribution is often a natural monopoly.

Benefits of Certain Monopolies

Some monopolies can be beneficial, especially when they result in lower costs or innovation due to economies of scale or patent protection.

Example: Pharmaceutical patents encourage research and development.

Comparison of Different Market Structures

Market structures differ in the number of firms, product differentiation, and market power.

Structure	Firms	Product	Market Power
Perfect Competition	Many	Identical	None
Monopoly	One	Unique	High
Monopolistic Competition	Many	Differentiated	Some
Oligopoly	Few	Identical or Differentiated	Some/High

Price Discrimination: Types, Characteristics, and Examples

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

First-degree: Each consumer pays their maximum willingness to pay.
Second-degree: Price varies by quantity purchased or product version.
Third-degree: Price varies by consumer group (e.g., student discounts).
Example: Airline tickets priced differently for business and leisure travelers.

Social Cost and Deadweight Loss Resulting from Monopoly

Monopolies can lead to deadweight loss, a loss of total surplus due to reduced output and higher prices compared to perfect competition.

Deadweight Loss Formula:
Example: Monopoly restricts output to raise price, causing inefficiency.

Chapter 9: Externalities and Public Goods

Properties of Goods: Rivalry and Excludability

Goods are classified based on rivalry (whether one person's use reduces availability for others) and excludability (whether 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, Tragedy of the Commons, and Solutions

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

Tragedy of the Commons: Overconsumption of a resource due to lack of ownership.
Solutions: Regulation, privatization, or community management.
Example: Overfishing in international waters.

Externalities: Positive, Negative, and Pecuniary

An externality is a cost or benefit that affects third parties not directly involved in a transaction.

Negative Externality: Imposes costs (e.g., pollution).
Positive Externality: Confers benefits (e.g., vaccination).
Pecuniary Externality: Operates through prices (e.g., increased demand raises housing prices).
Remedies: Taxes, subsidies, regulation, or market-based solutions.

Chapter 8: Trade

Arguments Against Free Trade

Common arguments against free trade include protecting domestic jobs, national security, and infant industries.

Protectionism: Use of tariffs, quotas, or subsidies to shield domestic industries.
Example: Imposing tariffs on imported steel to protect local producers.

Comparative Advantage and Absolute Advantage

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

Comparative Advantage: Basis for mutually beneficial trade.
Absolute Advantage: Producing more output with the same input.
Example: If Country A can produce wine at a lower opportunity cost than cheese, it has a comparative advantage in wine.

Tariffs and Their Effects on Welfare

Tariffs are taxes on imports that raise domestic prices, reduce imports, and can create deadweight loss.

Effects: Higher prices for consumers, gains for domestic producers, government revenue, and deadweight loss.
Example: A 10% tariff on imported cars increases their price, reducing quantity demanded.

Trade Between Countries and Welfare Effects

Trade allows countries to specialize according to comparative advantage, increasing overall welfare, but may have distributional effects within countries.

Gains from Trade: Increased total output and consumption possibilities.
Welfare Effects: Some groups may lose (e.g., workers in import-competing industries), but overall gains exceed losses.
Example: Opening trade increases variety and lowers prices for consumers.