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.

• Key Point: The demand curve shows the relationship between price and quantity demanded.

• Example: If the price of coffee rises, fewer cups are purchased per day.

Market Equilibrium

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

• Equilibrium Condition: $Q_d = Q_s$

• Example: If at $P = 5$, buyers want 100 units and sellers offer 100 units, the market is in equilibrium.

Definition of Markets

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

• Key Point: Markets facilitate voluntary exchange and determine prices.

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 quantity supplied at different prices. The supply curve is the graphical representation, typically upward sloping.

• Key Point: The supply curve shows the relationship between price and quantity supplied.

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 $Q_s > Q_d$ (price above equilibrium). Formula: $\text{Surplus} = Q_s - Q_d$

• Shortage: Occurs when $Q_d > Q_s$ (price below equilibrium). Formula: $\text{Shortage} = Q_d - Q_s$

Outside Factors Affecting Demand and Shifts of Demand Curve

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

• Key Point: A shift to the right indicates increased demand; a shift to the left indicates decreased demand.

Chapter 6: Sellers and Incentives

Producer Surplus

Producer surplus is the difference between the price a seller receives and the minimum amount they are willing to accept. It is represented by the area above the supply (or marginal cost) curve and below the market price.

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

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

Total, Fixed, and Variable Cost

Firms face different types of costs:

• Total Cost (TC): The sum of all costs incurred in production. Formula: $TC = VC + FC$

• 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., materials).

Key Characteristics of Perfectly Competitive Markets

• Many buyers and sellers

• Identical products

• Free entry and exit

• Firms are price takers

Total and Marginal Revenue

• Total Revenue (TR): Total income from sales. Formula: $TR = P \times Q$

• Marginal Revenue (MR): Additional revenue from selling one more unit. Formula: $MR = \frac{\Delta TR}{\Delta Q}$

Profit Maximization and the Optimality Rule (MC = MR)

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

• Optimality Rule: $MC = MR$

Chapter 12: Monopoly

Definition of Monopoly

A monopoly is a market structure with a single seller of a unique product with no close substitutes.

• Key Point: Monopolists have market power and can set prices.

Barriers to Entry, Natural Monopolies, Economies of Scale

• Barriers to Entry: Legal, technological, or resource-based obstacles that prevent new firms from entering the market.

• Natural Monopoly: A market where a single firm can supply the entire market at lower cost than multiple firms due to economies of scale.

• Economies of Scale: Average costs decrease as output increases.

Comparison of Market Structures

Characteristic	Perfect Competition	Monopoly
Number of Firms	Many	One
Product Type	Identical	Unique
Market Power	None	High
Entry Barriers	None	High

Price Discrimination

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. Profit: $\pi = \text{Total Willingness to Pay} - \text{Total Cost}$

• Second Degree: Price varies by quantity purchased (block pricing). Profit: $\pi = (\text{Revenue from Block 1} + \text{Revenue from Block 2} + \ldots) - \text{Total Cost}$

• Third Degree: Price varies by consumer group. Profit: $\pi = (\text{Revenue from Group A} + \text{Revenue from Group B}) - \text{Total Cost}$

Social Cost and Deadweight Loss from Monopoly

Monopolies can reduce total welfare by producing less and charging higher prices than competitive markets, creating deadweight loss.

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

Chapter 9: Externalities and Public Goods

Properties of Goods: Rivalry and Excludability

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. Solutions include regulation, privatization, or community management.

Externalities: Positive, Negative, and Pecuniary

• Negative Externality: A cost imposed on others (e.g., pollution).

• Positive Externality: A benefit conferred on others (e.g., vaccination).

• Pecuniary Externality: Occurs when market transactions affect others through prices (e.g., increased demand raises prices for all).

• Remedies: Taxes, subsidies, regulation, or market-based solutions (e.g., tradable permits).

Relevant Formulas

• Marginal Social Cost (MSC): $MSC = MC + MEC$

• Marginal Social Benefit (MSB): $MSB = MB + MEB$

Chapter 8: Trade

Arguments Against Free Trade

Common arguments include protecting domestic jobs, national security, infant industry protection, and retaliation against unfair trade practices.

Comparative Advantage and Absolute Advantage

• Absolute Advantage: The ability to produce more of a good with the same resources.

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

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

Tariffs and Their Effects on Welfare

• Tariff: A tax on imported goods.

• Effects: Raises domestic prices, reduces imports, generates government revenue, and creates deadweight loss.

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

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 (e.g., workers in import-competing industries).

• 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

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

Additional info: These notes synthesize the key concepts and formulas from the exam outline, expanding on definitions, examples, and applications for clarity and exam preparation.