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Microeconomics Final Review

Terms in this set (87)

3 Big Economics Questions
What, How, and Who?
3 Approaches to Answering the 3 Economic Questions
Tradition - Do what we've always done
Command - Gov't planners answer
Market-based - Let prices, property rights, and markets answer the questions (works best)
PPF
Shows the maximum feasible combinations of goods a society can produce, given the current resources and technology
Production Efficient point
A point on the PPF
Allocatively Efficient point
where producers supply the exact amount consumers want
Law of increasing opportunity cost
The O.C. of producing a good increases as more of it is produced.
Law of Demand
Q demanded dec as P inc
Law of Supply
Q supplies inc as P inc
Price of A substitute
Increase in P increases demand
Decrease in P decreases demand
Price of a complement
Increase in P decreases demand
Decrease in P increases demand
Change in cost
An increase shifts supply left
A decrease shifts supply right
Price of production complement
Increase in P increases supply
Decrease in P decreases supply
Price of production substitute
Decrease in P increases supply
Increase in P decreases supply
Expected Future price
Decrease in expected future price increases supply
Surplus
Qs > Qd
Shortage
Qd>Qs
What to do when both curves shift
Draw 2 graphs
Substitutes in Production
Goods produced by same resources. Leather belt and shoes
Complements in Production
goods that are always produced together. Like fuels
Elasticity
A measure of responsiveness to change
Price Elasticity of Demand
Reflects how Qd responds to changes in price
Ed = |%changeQd/%changeP|

At a point: |1/slope| * (P/Qd)
Perfectly elasticity
_______________, Ed = infinity
Perfectly Inelastic
|
| Ed = 0
|
|
Unit Elastic
Ed = 1
Total Revenue Test
Helps determine if a demand is elastic or not depending on how change in price affects total revenue
If demand is elastic,______________________
Raising price will decrease TR
If demand is inelastic, _________________________
Raising price will increase TR
If demand is unit elastic, _______________________
Raising price will not affect TR
Key factors that cause a product to have a high elasticity of demand
Number of Substitutes- More substitutes means high Ed
(There are more subs for luxuries than necessities, and more for narrowly defined products, and more substitutes are found over a longer period of time)

Share of Income- The larger the purchase as a share of income, the greater the Ed
Marginal Benefit
the benefit of one more unit or action
Marginal Cost
The cost associated with one more unit or action
MPB(MB) and MSB
Marginal Private Benefit and Marginal Social Benefit curves are equal to the demand curve if externalities are absent
MPC(MC) and MSC
Marginal Private Cost and Marginal Social Cost curves are equal to the supply curve if externalities are absent
MB and MC intersection
Marginal Private Benefit and Marginal Private Cost intersection determines the equilibrium point
MSB and MSC intersection
Determines the efficient quantity.
Efficient Quantity and Equilibrium quantity
Equal in the absence of externalities
Consumer Surplus
Difference between consumer's willingness to pay and the price her or she actually has to pay.
This is the vertical distance between the demand curve and the price.
Producer Surplus
Difference between the price a producer receives and the minimum price at which he or she would produce and sell it.
This is the vertical distance between the price and the supply curve.
Total Surplus
Equal to CS + PS. This is maximized at the equilibrium point.
If the quantity lies above or below the equilibrium there is a deadweight loss(a loss in surplus)
Price Ceilings
Ex) rent ceiling
Create shortages
Increase search activity
Create black market
Create DWL
Price floor
Ex) min wage
Create surpluses
Min wage results in a surplus of labor called unemployment
Taxes on producer
Shifts supply left
The vertical distance between the two supply curves is the tax amount.
Creates tax revenue for the government
Results in underproduction and DWL
Tax incidence
refers to how the tax burden is divided among consumers and producers

If Ed is more elastic than Es, than producers bear most of tax burden

If Ed is less elastic, consumers bear most of the tax burden
Sale of good made illegal
Shifts supply left
Purchase or possession of good made illegal
Demand shifts left
Net importer
A nation will be one when the domestic price is greater than the world price.
Net exporter
A nation will be one when the domestic price is less than the world price.
Allowing imports effect on surplus
Reduces domestic producer surplus
Increases domestic consumer surplus. (Since they can buy it for less)
Increases total surplus
Allowing exports effect on surplus
Increases domestic producer surplus (since they can sell it for more)
Decreases domestic consumer surplus.
Tariff
Tax on imports
Effectively increases world price
Reduces imports, increases domestic price, increases domestic producer surplus, reduces domestic consumer surplus, generates tax revenue, creates a DWL.
Import Quota
Limit on the number of goods that can be imported.
Effectively shifts the supply curve right for all prices above the world price.
The horizontal distance between the two supply curves is equal to the amount of the quota.

Also:Reduces imports, increases domestic price, increases domestic producer surplus, reduces domestic consumer surplus, generates tax revenue, creates a DWL.
Utility
Measure of happiness or well-being
Cardinal utility
can be measured
Ordinal utility
cannot be directly measured, but can be inferred by asking consumers whether or not they are better off.
Marginal Utility
Change in the total utility due to a small increase in consumption.

MU = deltaUtility/deltaQuantity
Law of diminishing marginal utility
States that marginal utility falls as consumption rises
Consumer equilibrium
The condition in which an individual consumer's budget is spent and the last dollar spent on each good yields the same marginal utility; therefore, utility is maximized.

MUA/PA = MUB/PB = MUC/PC

MU/P is the bang for your buck.
MU/P
Bang for your buck
If MU/P is greater for B than for A, then you will want to consume more of B and less of A to get to consumer equilibrium.
Sole Proprietorship
One owner
Easy to set upo
Taxed once
Unlimited liability
Difficult to raise money
Corporation
Many owners
Difficult to set up
Taxed twice
Limited liability
Easier to raise money
Dividend
A distribution by a corporation to its stockholders on a pro rate (equal) basis
Option
Gives investors the right but not the obligation to buy or sell shares at a certain price.
Call option- gives right to buy at certain price after a period
Put option- gives right to sell at certain price after a period
Short run at least one input is ______
fixed
Capital is fixed and labor is variable
Long run inputs are _____
all variable
Profit maximized at ____
mr = mc
Perfect Competition
Many firms and buyers
Identical products
No barriers to entry or exit
Price takers
D=MR
No DWL

Can ONLY earn a NORMAL profit in long run
Shutdown rules
P > AVC, stay open
P < AVC, shut down
P = AVC, indifferent
Supply curve of an individual firm
the marginal cost curve above the shutdown point(The minimum of the AVC curve)
Monopoly
One firm
Unique good with no close substitutes
Insurmountable barriers to entry
MR<Demand

Sets its own price, but must decrease quantity sold if P increased
This is why MR<Demand

CAN earn PROFIT in the LONG RUN, because of entry barriers

Produces smaller Q at higher P than perfect competition
Restriction in output CREATES DWL
Single-price monopoly
charges same price for all units of the good produced
Price discriminating monopoly
Different prices for same good or service or for different prices for different units of the same good or service

Must prevent arbitrage(Resale of goods)
Ex) airlines charge business travelers more than leisure ones
Two kinds of barriers to entry
Legal barriers(patents, copyrights, public franchises)
Cost barriers(natural monopolies)
Natural Monopoly
Huge fixed costs and small marginal costs, so it can serve the entire market at a lower cost than multiple firms
Ex) power company and public utility company
Two pricing rules for natural monopolies
Marginal cost pricing rule
Average cost pricing rule
Marginal cost pricing rule
P = MC
Must produce quantity demanded
Efficient amount is produced, but economic LOSS
Average cost pricing rule
most popular
P = LRAC
Normal profit
DWL
Qd produced
Efficient amount not produced
Monopolistic Competition
Lots of firms
Differentiated products
No barriers to entry
MR < D
MR = MC to maximize profit
Normal profit in long run only

ATC is tangent to Demand curve in Long run

Higher price and smaller Q than perfect competition
DWL

Not bad for society though, because variety is added
Oligopolistic industry
large barriers to entry
a few firms that are mutually interdependent
Non-cooperative equilibrium
Both firms have a dominant strategy for cheating
Cooperative equilibrium
more likely with more games played
Tit-for-tat strategy
Does this time what its competitor did last time
Anti-trust laws
Sherman Act
Clayton Act

Under these laws, price fixing is ALWAYS ILLEGAL, and the following are illegal if they substantially lessen competition and create monopoly: price discrimination, interlocking boards of directors, exclusive deals, tying contracts, acquiring competitors by buying stock
Vertical merger
A company merges with a supplier or customer
Horizontal merger
A company merges with a competitor
Conglomerate Merger
A company merges with another company in another market
Resale price maintenance(vertical price fixing)
Illegal when unreasonable

Manufacturer tells retailer the min price to sell
Utility for sure vs Utility expected under risk
Expected utility under risk is a straight line under the for sure utility.
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