Microeconomics: Scarcity and Opportunity Cost

• Microeconomics focuses on individual economic agents and their interactions in markets.
• Microeconomics examines how these agents make decisions to allocate scarce resources.

Scarcity, Choice, and Opportunity Cost

• Scarcity is the economic problem of unlimited wants and limited resources.
• Scarcity forces individuals and societies to make choices about resource allocation.
• Opportunity cost is the value of the next best alternative forgone when making a choice, not always monetary.
• Opportunity cost represents the real cost of a decision in terms of what is given up.

Production Possibility Curves (PPC)

• A PPC illustrates the maximum combinations of two goods or services an economy can produce with full and efficient resource employment.
• Points on the PPC indicate efficient production.
• Points inside the PPC represent inefficient production or unemployment of resources.
• Points outside the PPC are unattainable with current resources and technology.
• Concave PPC shape reflects rising opportunity costs: producing more of one good increases the opportunity cost of producing more of the other.

Demand

• Demand refers to the quantity consumers are willing and able to purchase at various prices during a period.
• The law of demand states that quantity demanded decreases as price increases, all else equal.
• A demand curve illustrates the relationship between price and quantity demanded.
• Changes in price cause movements along the demand curve, reflecting changes in quantity demanded.
• Non-price determinants (income, tastes, expectations, prices of related goods) cause shifts in the demand curve.
• Demand curve shifts right with increased demand and left with decreased demand.

Supply

• Supply refers to the quantity producers are willing and able to offer for sale at various prices during a period.
• The law of supply states that quantity supplied increases as price increases, all else equal.
• A supply curve illustrates the relationship between price and quantity supplied.
• Changes in price cause movements along the supply curve, reflecting changes in quantity supplied.
• Non-price determinants (input costs, technology, expectations, number of sellers) cause shifts in the supply curve.
• Supply curve shifts right with increased supply and left with decreased supply.

Market Equilibrium

• Market equilibrium occurs where the quantity demanded equals the quantity supplied.
• The equilibrium price clears the market; there is no surplus or shortage.
• The equilibrium quantity is the quantity traded at the equilibrium price.
• Surpluses occur when the price is above equilibrium, leading to excess supply.
• Shortages occur when the price is below equilibrium, leading to excess demand.
• Market forces push prices toward equilibrium.
• Changes in supply or demand create new equilibrium price and quantity.

Elasticity

• Elasticity measures the responsiveness of one variable to changes in another.
• Price elasticity of demand (PED) measures quantity demanded's responsiveness to price changes.
• PED = (% change in quantity demanded) / (% change in price).
• If PED > 1, demand is elastic, meaning quantity demanded is sensitive to price changes.
• If PED < 1, demand is inelastic, meaning quantity demanded is insensitive to price changes.
• If PED = 1, demand is unit elastic.
• If PED = 0, demand is perfectly inelastic.
• If PED = ∞, demand is perfectly elastic.
• Income elasticity of demand (YED) measures quantity demanded's responsiveness to income changes.
• YED = (% change in quantity demanded) / (% change in income).
• If YED > 0, the good is normal (demand increases with income).
• If YED < 0, the good is inferior (demand decreases with income).
• If YED > 1, the good is income elastic (luxury).
• If 0 < YED < 1, the good is income inelastic (necessity).
• Cross-price elasticity of demand (XED) measures quantity demanded of one good's responsiveness to price changes in another.
• XED = (% change in quantity demanded of good A) / (% change in price of good B).
• If XED > 0, goods are substitutes (Good A demand increases when Good B's price increases).
• If XED < 0, goods are complements (Good A demand decreases when Good B's price increases).
• If XED = 0, goods are unrelated.
• Price elasticity of supply (PES) measures quantity supplied's responsiveness to price changes.
• PES = (% change in quantity supplied) / (% change in price).
• If PES > 1, supply is elastic.
• If PES < 1, supply is inelastic.
• If PES = 1, supply is unit elastic.
• If PES = 0, supply is perfectly inelastic.
• If PES = ∞, supply is perfectly elastic.

Government Intervention

• Price ceilings are maximum prices below equilibrium, leading to shortages.
• Price floors are minimum prices above equilibrium, leading to surpluses.
• Taxes shift the supply curve left, increasing prices and decreasing quantities.
• Subsidies shift the supply curve right, decreasing prices and increasing quantities.
• Quotas restrict the quantity produced or imported.
• These interventions create deadweight loss and economic inefficiency.

Market Failure

• Market failure occurs when markets fail to allocate resources efficiently, leading to misallocation.
• Externalities are costs or benefits that affect uninvolved parties, resulting in over or underproduction.
• Negative externalities (e.g., pollution) impose costs on third parties, leading to overproduction.
• Positive externalities (e.g., education) provide benefits to third parties, leading to underproduction.
• Public goods are non-excludable and non-rivalrous.
• Common access resources are rivalrous and non-excludable, leading to overexploitation.
• Asymmetric information occurs when one party has more information than the other, leading to adverse selection or moral hazard.

Theory of the Firm: Costs of Production

• Explicit costs are direct payments for resources (e.g., wages, rent, materials).
• Implicit costs are opportunity costs of using owned resources (e.g., forgone salary).
• Fixed costs do not vary with output.
• Variable costs vary with output.
• Total cost (TC) = Fixed cost (FC) + Variable cost (VC).
• Average fixed cost (AFC) = FC/Quantity.
• Average variable cost (AVC) = VC/Quantity.
• Average total cost (ATC) = TC/Quantity = AFC + AVC.
• Marginal cost (MC) is the change in total cost from producing one more unit of output.
• MC = Change in TC / Change in Quantity.
• MC intersects AVC and ATC at their minimum points.
• In the short run, at least one factor of production is fixed.
• In the long run, all factors of production are variable.
• Economies of scale occur when long-run average costs decrease as output increases.
• Diseconomies of scale occur when long-run average costs increase as output increases.
• Constant returns to scale occur when long-run average costs remain constant as output increases.

Market Structures

• Perfect competition features many small firms, homogeneous products, free entry/exit, and perfect information.
• Firms are price takers with a perfectly elastic demand curve.
• Profit is maximized where MC = MR = P.
• In the long run, firms earn zero economic profit.
• Monopoly is when single firm dominates the market with a unique product and high entry barriers.
• The firm is a price maker facing a downward-sloping demand curve.
• Profit is maximized where MC = MR.
• Monopolies can earn long-run economic profits.
• Monopolistic competition features many firms, differentiated products, and relatively easy entry/exit.
• Firms have some price control.
• Profit is maximized where MC = MR.
• In the long run, firms earn zero economic profit.
• Oligopoly is when a few large firms dominate the market, products may be homogeneous or differentiated, and there are significant entry barriers.
• Firms are interdependent.
• Strategic behavior (collusion or competition) is common.
• Game theory analyzes oligopoly behavior.

Efficiency

• Allocative efficiency occurs when resources are allocated to produce goods and services that society values most, where P = MC.
• Productive efficiency occurs when goods and services are produced at the lowest possible cost, at the minimum point of the ATC curve.
• Perfect competition achieves both allocative and productive efficiency in the long run.
• Monopoly is generally neither allocatively nor productively efficient.
• Monopolistic competition is allocatively inefficient but may be productively efficient.
• Oligopoly efficiency depends on specific circumstances.