Microeconomics Study Guide PDF

Microeconomics Study Guide Chapter 1: Introduction to Economics Scarcity Definition: Limited resources lead to the necessity of choices. Choices and Trade-offs: Scarcity forces individuals and societies to make decisions about how to allocate limited resources, resulting in trade-of...

Microeconomics Study Guide Chapter 1: Introduction to Economics Scarcity Definition: Limited resources lead to the necessity of choices. Choices and Trade-offs: Scarcity forces individuals and societies to make decisions about how to allocate limited resources, resulting in trade-offs (e.g., choosing between spending on healthcare vs. education). Economics Definition: The study of how individuals and societies choose to use limited resources. Three Key Economic Ideas 1. People are Rational: Individuals make decisions based on their self-interest. 2. Respond to Incentives: Changes in costs or benefits influence behavior. 3. Optimal Decisions at the Margin: Decisions are made by comparing additional benefits to additional costs. Opportunity Cost Definition: The value of the next best alternative forgone when making a decision. Example: Choosing to go to college instead of working; the opportunity cost is the income lost during that time. Three Fundamental Questions 1. What goods and services to produce? 2. How to produce the goods and services? 3. Who will receive the goods and services? Economic Organization Definition: How societies organize economic activity. Examples: ○ Centrally Planned Economies: Government makes all economic decisions (e.g., North Korea). ○ Market Economies: Decisions made by individuals and firms (e.g., USA).  ○ Mixed Economies: Combine elements of both (e.g., most European countries). Positive and Normative Economics Positive Economics: Objective analysis of economic behavior (e.g., "Unemployment rates are rising"). Normative Economics: Subjective statements based on opinions (e.g., "The government should lower taxes"). Microeconomics vs. Macroeconomics Microeconomics: Focuses on individual agents and markets. Macroeconomics: Studies the economy as a whole, including inflation and unemployment. Chapter 2: Production Possibilities Frontier (PPF) Production Possibilities Frontier Assumptions: Two goods, full resource utilization, fixed technology. Efficient, Inefficient, Unattainable Points: Points on the curve (efficient), inside the curve (inefficient), outside the curve (unattainable). Marginal Opportunity Costs: ○ Constant: Straight line. ○ Increasing: Bowed-out curve. Factors that Shift the PPF Outward Technological advancements, increase in resources, improvements in education. Trade Creates Value Specialization and trade lead to increased overall production and consumption. Comparative vs. Absolute Advantage Comparative Advantage: Ability to produce at a lower opportunity cost. Absolute Advantage: Ability to produce more of a good with the same resources. Free Market  Definition: An economic system where prices are determined by unrestricted competition between privately owned businesses. Private Property Rights Definition: Legal rights to own, use, and transfer property. Chapter 3: Supply and Demand Demand vs. Quantity Demanded Demand: The relationship between price and quantity demanded. Quantity Demanded: Specific amount at a given price. Law of Demand As price decreases, quantity demanded increases (and vice versa). Substitution and Income Effects Substitution Effect: Consumers replace more expensive goods with cheaper alternatives. Income Effect: Change in consumption due to a change in purchasing power. Factors Shifting Market Demand Income, tastes, expectations, number of buyers, prices of related goods. Change in Demand vs. Change in Quantity Demanded Change in Demand: Shift of the entire demand curve. Change in Quantity Demanded: Movement along the curve due to price change. Supply vs. Quantity Supplied Supply: The relationship between price and quantity supplied. Quantity Supplied: Specific amount at a given price. Law of Supply As price increases, quantity supplied increases (and vice versa). Factors Shifting Market Supply Input prices, technology, number of sellers, expectations. Change in Supply vs. Change in Quantity Supplied Change in Supply: Shift of the entire supply curve. Change in Quantity Supplied: Movement along the curve due to price change. Market Equilibrium Where supply equals demand; determined by the intersection of the supply and demand curves. Surplus vs. Shortage Surplus: Occurs when quantity supplied exceeds quantity demanded; price will decrease. Shortage: Occurs when quantity demanded exceeds quantity supplied; price will increase. Effects of Changes in Demand and Supply Shifts in either curve affect equilibrium price and quantity. Adam Smith and the Invisible Hand Principle The self-regulating nature of the marketplace; individuals pursuing their own interest benefits society as a whole. Chapter 10: Utility and Decision-Making Utility Definition: Satisfaction or pleasure derived from consuming goods and services. Marginal Utility Calculation: Change in total utility from consuming one additional unit. Law of Diminishing Marginal Utility  As consumption increases, the additional satisfaction from each unit decreases. Behavioral Economics Examines psychological factors affecting economic decision-making. Pitfalls in Decision-Making Common biases and errors (e.g., overconfidence, framing effects). Sunk Costs Costs that have already been incurred and cannot be recovered; should not affect current decisions. Chapter 4: Economic Efficiency Marginal Benefit Additional benefit derived from consuming one more unit. Consumer Surplus The difference between what consumers are willing to pay and what they actually pay; represented graphically as the area above the price and below the demand curve. Marginal Cost The cost of producing one more unit. Producer Surplus The difference between the actual price producers receive and the minimum price they would accept; represented graphically as the area below the price and above the supply curve. Economic Efficiency Occurs when MB = MC; maximization of consumer and producer surplus. Deadweight Loss  Loss of economic efficiency when equilibrium is not achieved; illustrated as the area between the supply and demand curves at quantities less than or greater than equilibrium. Price Ceilings Definition: Maximum price set by the government. Examples: Rent controls. Graphical Analysis: Creates shortages when set below equilibrium. Effects of Rent Controls Can lead to shortages and reduced quality of housing. Price Floors Definition: Minimum price set by the government. Examples: Minimum wage. Graphical Analysis: Creates surpluses when set above equilibrium. Tax Incidence Analysis of the distribution of tax burden between buyers and sellers, shown graphically. Deadweight Loss of Taxation The loss in total surplus that results from a tax; illustrated as the area between the supply and demand curves, which decreases total welfare. Black Markets Occur when price controls create shortages, leading to illegal trading. Chapter 5: Externalities and Public Goods Positive and Negative Externalities Definition: Costs or benefits incurred by third parties not involved in a transaction. Graphical Representation: Shifts in supply or demand curves. Market Failure  Occurs when the allocation of resources is not efficient, often due to externalities. Private Solutions to Externalities Coase Theorem: Suggests that private parties can negotiate solutions to externalities without government intervention. Transactions Costs The costs associated with bargaining and enforcing agreements. Public Solutions to Externalities Pigovian Taxes/Subsidies: Taxes on negative externalities or subsidies for positive externalities; shown graphically. Methods of Dealing with Pollution Command and Control: Regulation to limit pollution. Tradable Emissions Allowances: Market-based approach allowing companies to buy/sell pollution rights. Rivalry and Excludability Definitions: ○ Rivalry: One person's consumption reduces availability for others. ○ Excludability: Ability to prevent others from using a good. Four Types of Goods: ○ Private goods (rival, excludable) ○ Public goods (nonrival, nonexcludable) ○ Common resources (rival, nonexcludable) ○ Club goods (nonrival, excludable) Public Goods Definition: Goods that are nonrival and nonexcludable; examples include national defense and public parks. Market Problems: Tend to be underproduced due to free-rider problem. Free-Rider Problem Occurs when individuals benefit from resources without paying, leading to underfunding. Tragedy of the Commons  Definition: Overuse of a shared resource leads to depletion. Examples: Overfishing, deforestation. Causes: Lack of property rights and incentives for conservation.