Microeconomics: Supply, Demand & Competitive Markets

100 question-and-answer flashcards covering key microeconomic concepts: markets, supply & demand, elasticity, surplus, taxes, trade, externalities, market structures, government policy, and welfare analysis.

What mechanism coordinates buyers and sellers in a modern economy?

The interaction of supply and demand within markets.

Define a market in economic terms.

All the buyers and sellers of a particular good or service.

What three conditions characterize a perfectly competitive market?

(1) Highly standardized product, (2) many buyers and sellers, (3) participants well-informed about price.

In a perfectly competitive market, how much influence does one buyer or seller have on price?

None; they are price takers.

State the law of demand.

As the price of a good rises, the quantity demanded falls, and vice versa, ceteris paribus.

What is a demand schedule?

A table showing quantities demanded at various prices.

What does a downward-sloping demand curve represent?

The inverse relationship between price and quantity demanded.

Differentiate between ‘demand’ and ‘quantity demanded’.

Demand is the entire curve; quantity demanded is one point on the curve at a specific price.

List four major factors (besides price) that can shift the demand curve.

Income, prices of related goods, tastes, expectations, and number of buyers.

Define normal goods.

Goods for which demand rises when consumer income rises.

Define inferior goods.

Goods for which demand falls when consumer income rises.

What relationship defines substitutes?

A fall in the price of one good reduces demand for another.

What relationship defines complements?

A fall in the price of one good increases demand for another.

State the law of supply.

As the price of a good rises, the quantity supplied rises, and vice versa, ceteris paribus.

What is a supply schedule?

A table showing quantities supplied at various prices.

Why is the supply curve upward sloping?

Higher prices make supplying additional units profitable, covering increasing marginal costs.

Differentiate between ‘supply’ and ‘quantity supplied’.

Supply is the entire curve; quantity supplied is one point on the curve at a specific price.

Name four factors that shift the supply curve.

Input prices, technology, expectations, and number of sellers.

Define equilibrium in a market.

The price and quantity at which quantity supplied equals quantity demanded.

What is a surplus?

Excess supply occurring when price is above equilibrium.

What is a shortage?

Excess demand occurring when price is below equilibrium.

How do competitive markets self-correct a surplus?

Price falls, encouraging buyers and discouraging sellers until equilibrium is restored.

What is consumer surplus?

The difference between what buyers are willing to pay and what they actually pay.

What is producer surplus?

The difference between the price sellers receive and their marginal cost of production.

Define total surplus.

Consumer surplus plus producer surplus; a measure of overall welfare from trade.

What does Pareto efficiency mean in a market context?

An allocation where no one can be made better off without making someone else worse off.

Explain how a price ceiling can create inefficiency.

It causes shortages, reduces total surplus, and may lead to non-price rationing.

Give an example of a price floor.

Minimum wage laws or agricultural price supports like a wheat price floor.

What is a tax wedge?

The difference between what buyers pay and sellers receive due to a tax.

Who bears the burden of a tax when demand is inelastic relative to supply?

Buyers bear a larger share of the tax burden.

Define deadweight loss.

The reduction in total surplus that results from a market distortion like a tax.

State the formula for the price elasticity of demand.

Elasticity = (% change in quantity demanded) / (% change in price).

When is demand considered elastic?

If elasticity is greater than 1 (quantity responds more than price).

List four determinants of demand elasticity.

Availability of substitutes, necessity vs. luxury, market definition breadth, and time horizon.

Define price elasticity of supply.

Elasticity = (% change in quantity supplied) / (% change in price).

How does ease of market entry affect supply elasticity?

Easier entry and exit make supply more elastic.

What happens to total revenue when price rises and demand is inelastic?

Total revenue increases because quantity falls proportionally less than price rises.

Explain comparative advantage.

Ability to produce a good at a lower opportunity cost than another producer.

What is a production possibility frontier (PPF)?

A curve showing maximum attainable combinations of two goods given resources and technology.

How does trade make both parties better off?

It allows each to consume beyond their own PPF by specializing and exchanging.

What is meant by ‘market failure’?

When unregulated markets produce an inefficient allocation of resources.

Define externality.

A cost or benefit affecting third parties not involved in a transaction.

Differentiate positive and negative externalities.

Positive externalities confer benefits; negative externalities impose costs.

Give an example of a negative externality.

Pollution from a factory affecting nearby residents.

Name a policy tool to correct negative externalities.

Pigovian tax equal to the external cost.

What is the Coase Theorem?

With clear property rights and low transaction costs, parties can negotiate to solve externalities efficiently.

Distinguish between private goods and public goods.

Private goods are rival and excludable; public goods are non-rival and non-excludable.

Why do common resources often suffer overuse?

Because they are rival but non-excludable, leading to the tragedy of the commons.

Define a monopoly.

A market with a single seller and high barriers to entry.

List three sources of monopoly power.

Ownership of a key resource, government franchise/patent, and natural monopoly (economies of scale).

How does a monopolist decide quantity and price?

Produces where marginal revenue equals marginal cost, then charges the highest price the demand curve allows for that quantity.

Why is marginal revenue below price for a monopolist?

Because selling additional units requires lowering price on all units sold.

Explain price discrimination.

Charging different prices to different customers for the same product based on willingness to pay.

What is an oligopoly?

A market dominated by a small number of strategically interdependent firms.

Define cartel.

A group of firms acting together to restrict output and raise prices like a monopoly.

Why are cartels inherently unstable?

Members have incentive to cheat by secretly increasing output for extra profit.

What characterizes monopolistic competition?

Many firms selling differentiated products with free entry and exit.

In the long run, what profits do firms earn in monopolistic competition?

Zero economic profit due to entry of new firms eroding initial gains.

Explain diminishing returns to scale within a firm.

Adding more of a variable input to fixed inputs eventually yields smaller increases in output.

What is marginal cost?

The additional cost of producing one more unit of output.

How does free entry drive economic profits to zero in competitive markets?

Profits attract new firms; increased supply lowers price until profits are eliminated.

Define economic profit versus accounting profit.

Economic profit subtracts explicit AND implicit (opportunity) costs; accounting profit subtracts only explicit costs.

What is crowding out?

When government price floors or deficits reduce private sector activity, such as investment.

Why do rent controls often create shortages?

A price ceiling below equilibrium discourages supply and increases quantity demanded.

How does a binding minimum wage affect the labor market in the model?

Creates a surplus of labor (unemployment) if set above equilibrium wage.

State the formula for total revenue.

Total Revenue = Price × Quantity sold.

What is a marginal buyer?

The buyer indifferent between purchasing and not purchasing at a given price.

How is producer surplus graphically represented?

The area above the supply curve and below the market price up to quantity sold.

What effect does a per-unit tax have on supply and demand curves?

It creates a vertical wedge between them equal to the tax amount.

When supply is perfectly inelastic, who bears the entire tax burden?

Producers, because quantity cannot adjust.

What is an import quota?

A legal limit on the quantity of a good that can be imported.

How do tariffs differ from quotas?

Tariffs raise import prices; quotas restrict quantity and create quota rents.

What is creative destruction?

Process where innovation makes old technologies or firms obsolete, fostering economic growth.

How can patents create both monopoly power and incentives?

They grant temporary monopoly profits, encouraging R&D while eventually diffusing knowledge.

Explain the tragedy of the commons.

Tendency for common resources to be overused because individuals ignore external costs.

Why can public goods lead to free-rider problems?

Non-excludability means people can benefit without paying, so private markets underprovide them.

Define marginal revenue.

The additional revenue from selling one more unit of output.

What is the role of prices as signals in market economies?

They communicate information about scarcity and consumer preferences, guiding resource allocation.

How does technological advancement shift the supply curve?

It lowers production costs, shifting supply rightward and lowering equilibrium price.

What happens to equilibrium price and quantity when both demand and supply increase?

Quantity rises; price change is indeterminate without relative shift magnitudes.

Describe a substitute good using gasoline and electric cars.

If electric car prices fall, demand for gasoline-powered cars decreases, showing they are substitutes.

What is the cross-price elasticity of demand?

Percentage change in quantity demanded of one good divided by percentage change in price of another good.

Why might government subsidize positive externalities?

To encourage greater consumption/production up to the socially optimal level.

Give an example of a complement good pair.

Smartphones and mobile data plans.

What is the income elasticity of demand?

Percentage change in quantity demanded divided by percentage change in income.

How does a luxury good respond to income changes?

Demand rises more than proportionally when income increases (elastic income elasticity >1).

What is the slope of a perfectly inelastic demand curve?

Vertical; quantity demanded does not change with price.

Explain unit elastic demand.

A 1% price change causes a 1% quantity demanded change; total revenue unchanged.

What condition maximizes total surplus in a competitive market?

Price equals marginal cost at equilibrium.

Why do monopolies create deadweight loss?

They restrict output below the competitive level, so some mutually beneficial trades never occur.

What does the Lerner Index measure?

Market power: (Price – Marginal Cost)/Price for a firm.

How do antitrust laws aim to protect competition?

By preventing mergers or practices that substantially lessen competition, e.g., Sherman Act.

What is a natural monopoly?

An industry where one firm can supply the entire market at lower cost than multiple firms due to economies of scale.

Name two common methods regulators use for natural monopolies.

Rate-of-return regulation and price caps.

What is meant by ‘rent seeking’?

Unproductive efforts to gain economic benefits through political or legal channels rather than creating value.

Define pork-barrel politics.

Government spending for localized projects secured primarily to bring money to a representative’s district.

How does a tariff affect domestic producer surplus?

It increases producer surplus by raising domestic prices.

Why is the supply of Van Gogh paintings perfectly inelastic?

Quantity is fixed; no new originals can be produced.

What factor makes the supply of beachfront homes inelastic?

Scarcity of beachfront land (limited resource).

According to the law of supply, what happens when the opportunity cost of supplying rises?

Higher price is required for producers to supply additional units.