Microeconomics: Key Concepts Overview

Economics

Social science concerned with making optimal choices under conditions of scarcity.

Scarcity & Opportunity Cost

Since wants are unlimited but means are limited, one is confronted with making choices and every choice involves a sacrifice, what you give up to get something.

Marginal Benefit & Marginal Cost Analysis

Every time we make a choice, we actually weigh the marginal benefit and cost of choices. We will choose to do something if the marginal benefit is greater than the marginal cost because that is rational and will help maximize utility or satisfaction.

Economic Theories

Economic theories are generalizations based on hypotheses tested and supported with observations.

Macroeconomics

Study economy wide (or national) unemployment, income, inflation, and business cycles patterns.

Microeconomics

Study the behavior of specific economic units that make up the economic system, such as changes in the price of laptops, smartphones, oranges, apples.

Positive Economics

Deals with factual statements, not opinions or value judgments, e.g., Federal Reserve is the central bank of the United States.

Normative Economics

Deals with value judgments, i.e., what something ought to be, e.g., when interest rates decline, stock market should soar.

Economizing Problem

Refers to the need to make choices because economic wants exceed economic means, deciding how to make the best use of limited resources to satisfy unlimited wants.

Budget Line

Shows all possible combinations of two goods that can be purchased, given money income and the prices of the goods.

Shift of Budget Line

An increase in money income will shift the budget line to the right (outwards) while a decrease in money income will shift the consumer's budget line to the left (inwards).

Slope of Budget Line

Slope that is is equal to the ratio of the prices of two goods.

Factors of Production

Land, labor, capital, & entrepreneurial ability.

Land

Refers to natural resources.

Labor

Refers to skills & talents of individuals.

Capital

Refers to machinery, equipment, tools used in the production process.

Entrepreneurial Ability

Refers to someone who takes the initiative to combine land, labor, and capital in order to start up a business.

Money

_____ is not an economic resource because it does not produce anything by itself.

Production Possibilities Curve (PPC)

Illustrates the principle that if all resources of an economy are in use, more of one good can be produced only if less of another good is produced.

Assumptions of Production Possibilities Model

Includes full-employment, fixed-resources, and fixed-technology.

Points Inside the PPC

Indicate that the economy is not making use of all available resources and is therefore inefficient.

Points On the PPC

Show that the economy is operating efficiently since all available resources are fully utilized.

Points Outside the PPC

Are unattainable with the current technology.

Technological Improvement

Causes the PPC to shift outwards to the right, making previously unattainable points attainable.

Recession

Causes the economy to operate inside the PPC without shifting it inwards.

Law of Increasing Opportunity Cost

States that to produce more of a particular good, society must sacrifice larger amounts of another good.

Optimal Point on the PPC

Found by comparing marginal benefits to marginal costs, where MB=MC.

Marginal Benefits (MB)

Should be greater than marginal costs (MC) to increase production.

Marginal Costs (MC)

Should be greater than marginal benefits (MB) to decrease production.

Market

Bring together buyers ("demanders") and sellers ("suppliers"). Everyday consumer markets include the corner gas station, Amazon.com, and the local supermarket.

Characteristic of a competitive market

In competitive markets large number of independently acting buyers and sellers come together to buy and sell standardized products.

Demand

A schedule or curve shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specific period of time.

Law of demand

States that, other things equal, there is an inverse (or negative) relationship between price and quantity demanded.

Inverse relationship between price and quantity demanded

When price increases, quantity demanded decreases and when price decreases, quantity demanded increases.

Diminishing marginal utility

Each buyer of a product will derive less satisfaction from each successive unit of the product consumed.

Income effect

A lower (higher) price increases (decreases) the purchasing power of a buyer's money income, enabling the buyer to purchase more (less) of a product than before.

Substitution effect

Buyers have an incentive to substitute a product whose price has fallen for other products whose price have remained the same.

Market demand

Equal to the horizontal summation of the individual demand schedules at various price levels.

Determinants of demand

Changes in consumer preferences or tastes, changes in the number of buyers, changes in consumer incomes, changes in the prices of related goods, and changes in consumer expectations.

Change in demand

Will be brought by a change in one or more of the determinants of demand.

Change in quantity demanded

A shift of the demand curve to the right indicates an increase in demand whereas a shift of the demand curve to the left indicates a decrease in demand.

Supply

A schedule or curve that shows various amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period of time.

Law of supply

The law of supply states that, other things equal, there is a direct (or positive) relationship between price and quantity supplied.

Reason for direct relationship between price and quantity supplied

To suppliers, price represents revenue, which serves as an incentive to produce and sell a product.

Market supply

Equal to the horizontal summation of the individual supply schedules at various price levels.

Determinants of supply

(1) changes in resource prices, (2) changes in technology, (3) changes in taxes and subsidies, (4) changes in prices of other goods, (5) changes in producer expectations, and (6) changes in the number of sellers.

Change in supply

Will be brought by a change in one or more of the determinants of supply, reflected by a shift of the supply curve either to the right or to the left.

Change in quantity supplied

A change in quantity supplied of a product comes from a change in the price of that product.

Equilibrium price and quantity

Occurs where quantity demanded and quantity supplied are equal.

Equilibrium point

At the equilibrium point, both the buyers and sellers are content with the level of price and output.

Surplus

At any above-equilibrium price, quantity supplied will exceed quantity demanded, resulting in a ______ which will eventually drive prices downwards.

Shortage

A situation where quantity demanded exceeds quantity supplied at a below-equilibrium price, driving prices upwards.

Rationing function of prices

The ability of the forces of supply and demand to establish a price at which selling and buying decisions are consistent.

Allocative efficiency

Concerned with producing the combination of goods and services most desired by society, achieved when marginal cost equals marginal benefit and both consumer and producer surpluses are maximized.

Productive efficiency

Refers to the use of the least-cost method of production using the best technology and the right mix of resources, achieved when per-unit production costs are minimized at that level of output.

Market equilibrium

Achieved when quantity demanded equals quantity supplied, resulting in both allocative and productive efficiency.

Price-ceiling

The maximum legal price producers are allowed to charge, which generates a shortage in the market when set below the equilibrium price.

Price-floor

The minimum legal price producers are allowed to charge, which generates a surplus in the market when set above the equilibrium price.

Government-imposed price-ceiling

A price-ceiling that generates a shortage in the market since it is always less than the equilibrium market price.

Government-imposed price-floor

A price-floor that generates a surplus in the market since it is always more than the market equilibrium price.

Rent controls

An example of a price-ceiling, which are maximum rents established by law to protect low-income families.

Minimum-wage laws

An example of a price-floor, which sets the minimum legal wage that employers must pay their workers.

Equilibrium price

The price at which quantity demanded equals quantity supplied.

Equilibrium quantity

The quantity at which quantity demanded equals quantity supplied.

Complex cases of supply and demand

When both supply and demand change, the equilibrium quantity will shift in the direction of the change, but the price change depends on the relative shifts.

Relative sizes of shifts

The determination of new equilibrium quantity when both supply and demand change, based on the magnitude of the shifts.

Consumer surplus

The difference between what consumers are willing to pay for a good or service versus what they actually pay.

Producer surplus

The difference between what producers are willing to accept for a good or service versus what they actually receive.

Marginal cost

The cost of producing one additional unit of a good or service.

Marginal benefit

The additional benefit received from consuming one more unit of a good or service.

Equilibrium market price

The price at which the quantity of a good demanded by consumers equals the quantity supplied by producers.