Microeconomics Midterms Exam Reviewer PDF

MICROECONOMICS Midterms Exam Reviewer I. Brief History of Economics Neoclassical Economics (1870s) - Neoclassical economics is an approach to Thomas Robert Maltus (1798) economics in which the...

MICROECONOMICS Midterms Exam Reviewer I. Brief History of Economics Neoclassical Economics (1870s) - Neoclassical economics is an approach to Thomas Robert Maltus (1798) economics in which the production, - British Economist consumption, and valuation of goods and - His main contribution was to highlight the services are observed as driven by the supply relationship between food supply and and demand model. population. His theory states that population - Features theories from Leon Walras and Alfred growth will always tend to outrun the food supply Marshall. and that betterment of humankind is impossible without strict limits on reproduction. Leon Walras - French Mathematical Economist / Georgist - Introduced the analysis of equilibrium in Classical Economics (mid-1700s to 1800s) several markets. - The birth of economic theories. - He formulated the marginal theory of value and - Featured theories from multiple economies pioneered the development of general such as: equilibrium theory. Adam Smith Alfred Marshall - From Scotland - English Economist - coined the “Father of Economics” and is - He was the most influential economist of the considered the most important personality in the period because of his book Principles in history of economics. Economics. - His book, Wealth of the Nations (1776), is - It brought the ideas of supply and demand, known as the bible in economics for a hundred marginal utility, and costs of production into a years. coherent whole. - “It is not from the benevolence of the butcher, - Developed an analysis of equilibrium of a the brewer, or the baker, that we expect our particular market and introduced the concept of dinner, but from their regard to their own “marginalism.” interest.” - Invisible Hand Theory David Ricardo - British Political Economist - Introduced the theory of Comparative Keynesian (1930s) Advantage. - Keynesian economics is a macroeconomic - Principle of Political Economy and Taxation theory of total spending in the economy and its (1817) effects on output, employment, and inflation. - It was developed in an attempt to deal with the John Stuart Mill effects of the Great Depression. - English Political Economist - Developed the basic analysis of political John Maynard Keynes economy. - English Economist - “Political economy” is an old English term that - The General Theory of Employment, Interest applies management to an entire polis (state). and Money (1936) - His theory centers around the idea that Friedrich Engels and Karl Marx governments should play an active role in their - German Philosophers countries' economies, instead of just letting the - Marxist philosophy free market reign. - Their theory follows a belief that at the basis of all history and social conflict is the struggle between classes. - They were greatly influenced by the conditions brought about by the Industrial Revolution upon the working classes. - Das Kapital by Karl Marx is a political movement that challenged Adam Smith’s view. II. Economics, Scarcity, Production III. Circular Flow Model, Opportunity Cost, Market Decisions Economics - From the Greek word Oikonomia which means “household management.” The Circular Flow Model - Is the efficient allocation of the scarce means - Details how resources flow into and out of of production toward the satisfaction of human households, businesses, governments, needs and wants. investors, markets, and foreign entities. - It is the study of scarcity and its implications for the use of resources, production of goods and services, growth of production and welfare over time, and a great variety of other complex issues of vital concern to society. Two concepts of economics: 1. Scarce means of production 2. Make the best of a less-than-ideal situation Scarcity: The Central Problem of Economics - Commodity or service being in short supply, relative to its demand. - Limited availability of economic resources relative to man’s unlimited demand for goods and services. The Concept of Opportunity Cost - In economics, opportunity cost refers to the foregone value of the next best alternative. - It is the value of what is given-up when one makes a choice. Factors of Production 1. Land Basic Decision Problems - All natural resources, God-given and found in nature. 1. Consumption - Fixed resource - Members of a society, with their - Main source of raw materials individual wants, determine what types of goods and services they want to 2. Labor utilize or consume, and the - Any human effort exerted in the corresponding amounts thereof that they production of goods and services. should purchase and utilize. 3. Capital 2. Production - Man made products used in production - Producers determine the market needs of other goods and services. and wants, and demands of consumers, and decide how to allocate their 4. Entrepreneurship resources to meet these demands. - An entrepreneur is a person who organizes, manages, and assumes the 3. Distribution risks of a firm, taking a new idea or a - When and where these products and new product and turning it into a services are distributed is a big factor. successful business. 4. Growth Over Time - How these factors affect future events. Four Basic Economic Questions Demand 1. What to Produce? - The demand of a product is the quantity of a 2. How to Produce? good or service that buyers are willing to buy - Labor-intensive production given its price at a particular time. - Capital-intensive production 3. How much to Produce? Change in Quantity Demanded 4. From whom to Produce? Ceteris Paribus - means “all else being equal.” - Acts as a shorthand indication of the effect of one economic variable on another, provided all other variables remain the same or constant. Forces that Cause the Demand Curve to Change IV. Supply and Demand 1. Tastes or Preferences 2. Changing Income Market 3. Population Change - A market is where buyers and sellers meet. 4. Occasional or Seasonal Product 5. Substitute and Complementary Goods 6. Normal and Inferior Goods Price Control 7. Expectations of future prices - A government regulation establishing a maximum price to be charged for specified goods and services, especially during periods of war or inflation. Supply - It is the quantity of goods or services which a Advantages: Disadvantages: firm is willing to sell at a given price, at a given period in time. Protects consumers May create excess by eliminating price demand or excess Change in Quantity Supplied gouging. supply. Helps producers Often result in losses remain competitive for producers and a and profitable. drop in quality of products and Eliminates services. monopolies. Forces that Cause the Supply Curve to Change Price Floor 1. Optimization in the Factors of - It is the minimum market price set for a certain Production commodity. 2. Technological Change 3. Weather Conditions 4. Number of Sellers 5. Government Policy 6. Future Expectations Price Ceiling - It is the maximum market price set for a certain commodity. V. Elasticity VI. Consumer Behavior Demand Elasticity Utility - Measure of the degree of responsiveness of - Is a want-satisfying power. quantity demanded of a product to a given - The utility of a good or service is the change in one of the independent variables satisfaction or pleasure one gets from which affect demand for that product. consuming it. - The utility of a specific product may vary widely from person to person as utility is subjective. Price Elasticity of Demand Thus, utility is difficult to quantify. - Responsiveness of consumers’ demand to - But for purposes of quantifying consumer change the price of goods sold. behavior, we assume that people’s satisfaction can be measured through imaginary units we call utils (units of utility). Total Utility - It is the amount of satisfaction or pleasure a person derives from consuming some specific quantity (example: 10 units of good/service). Marginal Utility - Is the extra satisfaction a consumer realizes from an additional unit of that product (example: 11th unit of good/service). Alternatively, marginal utility is the change in total utility that results from the consumption of 1 more unit of a product. As more of a product is consumed, total utility increases at a diminishing rate, reaches a maximum, and then declines. Income Elasticity of Demand The Law of Diminishing Marginal Utility - Responsiveness of consumers’ demand in a - Indicates that gains in satisfaction become change in their income. smaller as successive amounts of a specific product are consumed. The Law of Demand - Suggest, all else being equal, as the price of a good falls, the quantity demanded increases, and as the price of a good rises, the quantity demanded decreases. The law of diminishing marginal utility explains why the demand curve for a given product slopes downward. If successive units of goods yield smaller and smaller amounts of marginal utility, then the consumer will buy additional units Cross Elasticity of Demand of a product only if its price falls. - Responsiveness of demand for a certain good, in relation to changes in price of other related Thus, diminishing marginal utility supports the goods. idea that price must decrease for quantity demanded to increase. In other words, consumers behave in ways that make demand curves slope downward. Utility-Maximization / Equimarginal Principle Prices - States that to obtain the greatest total utility, a - Goods are scarce relative to its demand for consumer should allocate money income so that them, so every good carries a price tag. We the last dollar spent on each good or service assume that the price of each good is unaffected yields the same marginal utility. by the amount purchased by any particular person. After all, each person’s purchase is a Consumer Equilibrium tiny part of total demand. Also, because - In marginal utility theory, the combination of consumers have a limited number of dollars, goods purchased maximizes total utility by they cannot buy everything they want. Thus, applying the utility-maximizing rule. consumers must compromise; they must choose the most personally satisfying mix of goods and services. Different individuals will choose The Diamond-Water Paradox different mixes. - Early economists such as Adam Smith were puzzled by the fact that some “essential” goods had much lower prices than some “unimportant” goods. Why would water, essential to life, be priced below diamonds, which have much less usefulness? The paradox is resolved when we acknowledge that water is in great supply relative to demand and thus has a very low price per gallon. Diamonds, in contrast, are rare. Their supply is small relative to demand and, as a result, they have a very high price per carat. Consumer Surplus - The share of the total surplus that is received by a consumer or consumers in the market. - It is defined as the difference between the maximum price a consumer is (or consumers are) willing to pay for a product and the actual price that they do pay. - The maximum price that a person is willing to pay depends on the opportunity cost of that person’s consumption alternatives. Theory of Consumer Behavior Rational Behavior - Consumers are rational. They try to use their income to derive the greatest amount of satisfaction, or utility, from it. Consumers want to get “the most for their money” or, technically, to maximize their total utility. Preferences - Each consumer has clear-cut preferences for certain goods and services that are available in the market. Buyers also have a good idea of how much marginal utility they get from successive units of the products they might purchase. Budget Constraint - At any point in time the consumer has a fixed, limited amount of income. Because each consumer supplies a finite amount of human and property resources to society, he or she earns only limited income. Thus, every consumer faces a budget constraint, even those who earn millions of dollars a year.